Sovereign Wealth Funds (SWF) has been a tool utilized by countries to manage their resources. Think of it as a state-owned investment wherein the money used is from the surplus reserves of the government. While SWFs have been up for debate since the early 2010s, it is definitely one tool that could benefit the state’s economy and its people.
SWFs are not just hard cash investments. It involves other financial assets such as real estate, stocks, bonds, precious metals, or alternative investments such as hedge funds or private equity funds.
These investment funds have existed for some time already. In fact, the establishment of SWFs started in the 1950s upon the founding of the Kuwait Investment Authority in 1953. So far in 2021, there have been over 90 SWFS worldwide, according to the Sovereign Wealth Fund Institute reports.
Right now, the largest SWF in the world are the following:
- Norway with the Norway Government Pension Fund Global ($1,289,460,000,000)
- China with the China Investment Corporation ($1,045,715,000,000)
- Kuwait with the Kuwait Investment Authority ($692,900,000,000)
- The United Arab Emirates with the Abu Dhabi Investment Authority ($649,175,654,400)
- Hong Kong with Hong Kong Monetary Authority Investment Portfolio ($580,535,000,000)
This data is based on the Sovereign Wealth Fund Institute’s Top 100 Largest SWFs Based on Assets published in 2020.
A Deeper Understanding
Sovereign Wealth Funds are a type of investment fund that has terms, objectives, risks, liquidity concerns, and liabilities. Some SWFs may prefer liquidity over returns and vice versa. Depending on its objectives and assets, SWFs’ risk tolerance may be high or even very conservative.
Now, there are different conventional categories of SWFs. These are:
- Future generation fund or savings funds
- Stabilization funds
- Reserve investment funds
- Public benefit pension reserve funds
- Funds for specific industries
- Strategic Development SWFs
In addition, foreign currency reserve assets are conditional. The government uses these powerful funds for specific purposes or for managing the trading power of a country’s currency internationally.
The Goal of Sovereign Wealth Funds
Most of the time, sovereign wealth funds are confused with foreign exchange reserves. Although they use public money for investments, both have different goals.
Central banks in countries manage their foreign exchange reserves. These reserves are invested conservatively to provide liquid assets in times of crisis. In short, they are invested like an emergency fund in cases of market intervention rather than aiming at long-term returns.
On the other hand, the goal of sovereign wealth funds is to get more returns rather than asset liquidity. So, SWFs can tolerate higher risks than conventional foreign exchange reserves.
SWFs are intended for significant returns, while foreign currency exchange reserves are the country’s financial safety net.
By this time, hopefully, you are getting the gist of what a sovereign wealth fund is. At this point, the pros and cons of SWF will be discussed. This list will give you an overview of whether to invest in it or not.
Pros of a Sovereign Wealth Fund
- SWFs may help in stabilizing the financial market globally.
When there were capital buffers from 2007 to 2008, the capital injections of SWFs reduced the premia of banks for a short period. Because SWFs are a long-term investment, the assets are sitting at a stable position, with the power to help or go against market trends. This event initially proved how SWFs could lessen the volatility of financial markets.
- SWFs add asset diversity for the long run
Sovereign Wealth Funds consist of different government assets that are set to the international investor base. Because of this, they can help lower market volatility, increase market depth, and accord with greater market efficiency.
- SWFs help manage natural resources
In the whole list of current SWFs, countries in the Middle East hold substantial sovereign wealth funds. This region is going at it substantially because Middle East countries are rich in oil resources. In fact, the world’s number one when it comes to this natural resource.
So, investing in an SWF can help them manage their oil wealth for the future generation of not just Middle East countries but of the world’s as well.
Cons of a Sovereign Wealth Fund
- As much as they cause stability, SWFs may also cause volatility.
Because they have large investments just sitting out there in the market, sudden shifts in asset management may contribute to market volatility. For example, suppose alleged transactions that concern relevant markets started circulating. In that case, the affected sectors may herd and add to market volatility. Since SWFs can be very liquid, these investment funds may unintentionally amplify market changes.
- SWFs can lack transparency
Given that SWFs may cause major changes in the market, it would be helpful if the community can anticipate the investors’ risk preferences and asset allocations in an SWF. However, this can be a problem since SWFs sometimes lack transparency regarding their transactions, which may lead to volatility and inaccurate pricing.
- Some SWFs may have political hues
Consequently, because a number of SWFs are not transparent about their corporate governance practices and investments, it is a fear that politics might influence it.
The Bigger Picture
The amount of assets invested in an SWF is indeed a large sum. And the amount of assets invested in an SWF varies from fund to fund. Sovereign Wealth Funds are very powerful that countries may dissolve or create them to meet their citizens’ needs.
If a country has some excess assets from its annual budget (surplus), it could use them for this investment fund. As far as evidence suggests, sovereign wealth funds have played a key role in the international investments development scene. Because these funds hold more than a cumulative of 8 trillion dollars, it may change the current situation of the global economy.
An example of the impact of SWFs was when PIC invested in Uber technologies. It was such a decisive move that Uber has disrupted the worldwide taxi business.
All in all, sovereign wealth fund research suggests that it can indeed stabilize the worldwide financial markets. Moreover, their asset allocations may still bring a relative effect on the economy. If SWFs become more available and transparent of their transactions, maybe this would help the market foresee its actual impact.
If you are interested in Sovereign Wealth Funds and other investments, make sure to get a strategic advisor who could help you with your plans. The world is a big investment opportunity, and you should get all the help that you need. Ask Zeustra today to help you plan your future.