Saudi Arabian oil refinery at Yanbu, on the Red Sea coast

McKinsey Global Institute (MGI), a unit of US consulting firm McKinsey, says that four actors—petrodollar investors, Asian central banks, hedge funds, and private equity—are playing an increasingly important role in the world’s financial markets. Although none are new, their rapid growth since 2000 has given them unprecedented clout.

MGI offers new evidence on the size of these new power brokers, their impact on global financial markets, and their growth prospects. Looking at the four players together sheds new light on their collective impact. (Report - free registration required).

Excluding cross-investments between them, oil investors, Asian central banks, hedge funds, and private-equity firms together held $8.4 trillion in assets at the end of 2006. Their assets have tripled since 2000, making them 40 percent of the size of global pension funds. Together, they represent some 5 percent of the world’s $167 trillion of financial assets—a significant share given that five years ago these players were on the fringes of the global financial system.

The power brokers' size and influence will continue to expand. Under current growth trends, MGI finds that their assets will grow to $20 trillion by 2012, reaching more than two-thirds the size of global pension funds. Under a more conservative scenario in which oil prices fell, China’s current-account surplus declined, and growth in hedge funds and private equity slowed, the assets of these four players will still nearly double over the next five years to as much as $15.2 trillion by 2012.

Together these four new players are reshaping global capital markets. They each represent large new pools of liquidity with longer-term investment horizons than traditional investors that allow them to pursue higher returns—and risks. They have markedly diversified the investor base and expanded private markets for capital. They are spurring financial innovation, enabling the more efficient spreading of risk, and spreading liquidity.

MGI says that with these positive developments come new risks. Liquidity from Asian central banks and petrodollar investors may be fueling asset price bubbles in some markets. The state connections of both raises the possibility that political considerations may cloud their investment decisions. Hedge funds may be creating systemic risk through their highly leveraged positions and through banks' large exposure to them. Private-equity firms may be increasing financial market credit risk due to high leverage and their ability to extract looser lending covenants from banks.

The evidence to date gives some reason for optimism that the risks these players pose are manageable. Nevertheless, the concerns being raised by the rise of the new power brokers are real and justify careful monitoring. MGI suggests that the four players would be wise to note public concerns and voluntarily take steps to minimize them.