What’s it: Sovereign wealth funds (SWFs) is a state-owned investment fund. The allocation may be in real assets or in financial assets such as stocks, bonds, and real estate. It is a pooled investment vehicle in global financial markets plus private equity funds and hedge funds.
Countries with large trade surpluses will invest the surplus in sovereign wealth funds, which use and manage the funds for pure investment purposes. It is not a foreign exchange reserve as the central bank manages very conservatively.
The size and influence of sovereign wealth funds have increased since the late 2000s, which has drawn much comment. Since 2005, there have been 40 SWFs on the global market. Their assets under management reached $7.9 trillion in 2019, up from just $879.1 billion in 2001. Most of the world’s largest SWFs belong to oil-producing countries such as Abu Dhabi, Saudi Arabia, Kuwait, Norway, and Russia. Apart from financial markets, they invest in financial institutions and companies from developed countries.
Why are sovereign wealth funds matters
First, the funds invested are significant. They are very significant for influencing global financial markets. They took stakes in global financial institutions such as Morgan Stanley, Citigroup, and Merrill Lynch during the financial crisis. Their influence increased and contributed to asset inflation in the real estate of big cities like London and New York. Also, the fund has the potential to become a pressure group and dominate global financial markets.
Their assets under management increased from $2.79 trillion in 2007 to $7.94 trillion in 2019. The increase was mainly driven by the jump in oil prices during 2007 and 2014.
Second, countries have broad investment options. They don’t just buy securities issued by strong economies like Treasury bills and US dollars. They can also invest in financial institutions, infrastructure, and well-known companies globally.
Such investments make them increasingly strategic economically and politically. Apart from that, of course, they also contribute to increasing revenue for the government.
Third, governance lacks transparency. It then raises suspicions and concerns about investment intentions, whether for purely commercial reasons or political economy reasons. Take, for example, Chinese investments in US companies. It is seen as China’s attempt to gain exposure to advanced technology and the United States economy.
In 2008, international law launched the Santiago Principles, a set of transparent and sound governance structures. These principles also stipulate that investments should act for economic gain and not on behalf of their governments. However, these rules are voluntary for members.
Source of funds
Investment funds managed in sovereign wealth funds come from a variety of sources, including:
- Trade surplus
- Fiscal surplus
- Official foreign currency operation
- Money from privatization
- Government transfer payments
Among these sources, the largest contributor is usually the trade surplus, especially energy. Exporting countries obtain foreign currency, especially the US dollar, from selling oil abroad. They then invest it to generate high returns, rather than as foreign reserves.
Sovereign wealth funds are more long-term oriented. They are expected to be a legacy for future generations in exchange for natural resources that have started to run out.
Sovereign wealth fund types
Citing from the Sovereign Wealth Fund Institute, sovereign wealth funds fall into the following categories:
- Stabilization Funds. The aim of the Stabilization Fund is to reduce the volatility of government revenues, to counter the unfavorable effects of the business cycle on the government budget and the economy.
- Savings Funds. This fund is to build savings for future generations by converting non-renewable natural resources into more sustainable financial assets.
- Pension Reserve Funds. The source of funds usually comes primarily from direct fiscal transfers from the government. It aims to meet the deficits of the social security system in the future.
- Reserve Investment Funds. The source of funds comes from a country’s foreign exchange reserves, intending to reduce negative carry costs when holding foreign exchange reserves.
- Strategic Development Sovereign Wealth Funds (SDSWF). SDSWF’s goal is to support national economic development, such as infrastructure, and support domestic strategic industries.
Purposes of sovereign wealth funds
Sovereign wealth funds are different from the foreign exchange reserves held by the central bank. The first is usually more long-term oriented, and the primary objective is return rather than liquidity. Their investment policy is usually for a period of three to five years. Thus, they are more tolerant of risk than foreign reserves.
Meanwhile, the foreign exchange reserves were not sovereign wealth funds because they had different purposes. The central bank holds them to fulfill obligations and support monetary policy. Thus, liquidity is the primary goal. That way, the central bank can withdraw it momentarily when needed.
The type of investment allocation from each type of category will vary from country to country. Liquidity-worried countries can limit investment only in highly liquid public debt instruments. Meanwhile, those that are more tolerant of risk will allocate their investment to companies with bright prospects such as banks.
In general, the objectives of sovereign wealth funds are:
- Protect and stabilize the budget and economy from excessive volatility due to the appreciation of the domestic currency.
- Diversify the economy from previously relying on non-renewable commodities to higher value-added sectors such as manufacturing and services.
- Generate a greater return than foreign reserves because it is more risk-tolerant.
- Helping the monetary authorities remove unwanted liquidity coming from the trade surplus.
- Increase savings for future generations to be better equipped to face future challenges by converting current non-renewable resource wealth into renewable financial assets.
- Funding social and economic development including infrastructure, physical (such as roads and rail networks) and non-physical (such as education and health).
- As a political economy strategy, primarily through investment in government bonds, institutions, and companies, which play a significant role in the target country’s economy.
Top-10 sovereign wealth funds in the world
The following are the Top-10 sovereign wealth funds in the world:
|1||Norway Government Pension Fund Global||$1,122.1 billion||Norway|
|2||China Investment Corporation||1,045.7||China|
|3||Abu Dhabi Investment Authority||579.6||United Arab Emirates|
|4||Kuwait Investment Authority||533.7||Kuwait|
|5||Hong Kong Monetary Authority Investment Portfolio||528.1||Hong Kong|
|6||GIC Private Limited||453.2||Singapore|
|8||Public Investment Fund||390.0||Saudi Arabia|
|9||National Council for Social Security Fund||325.0||China|
|10||Investment Corporation of Dubai||305.2||United Arab Emirates|
Meanwhile, for the country category, China, the United Arab Emirates, and Norway are the three countries with the largest sovereign wealth funds, amounting to $2.3 trillion, $1.0 trillion, and $1.1 trillion as of October 2020, respectively, based on data from Global SWF. Each has more than one sovereign wealth fund: China (6 SWF), United Arab Emirates (7 SWF), and Norway (3 SWF).
Norway Government Pension Fund Global
Based on data from the Sovereign Wealth Fund Institute, Norway Government Pension Fund Global tops the list with total assets under management at $1.1 trillion. The primary source of investment is surplus oil.
The central bank Norges Bank manages the fund and invests it in about 9,000 companies worldwide. Besides, investments also target the equity, real estate, and fixed income assets markets.
China Investment Corporation
China Investment Corporation (CIC) manages a portion of China’s foreign exchange reserves. CIC operates through its three subsidiaries: CIC International Co., Ltd., CIC Capital Corporation, and Central Huijin Investment Ltd.
Investments are also very diverse, for example, owning shares in London Heathrow Airport and having Deutsche Bank’s head office in London. In 2013, CIC acquired a 12.5% stake in Russian potassium Uralkali, a fertilizer company, for $2 billion. Then, in 2017, CIC bought a 45% stake in the 1211 Avenue of the Americas, New York City office skyscraper.
Abu Dhabi Investment Authority
Abu Dhabi Investment Authority (ADIA) was founded in 1976 and used oil export funds to invest worldwide. Its total assets are estimated at $579.6 billion, citing data from the Sovereign Wealth Fund Institute.
ADIA has shares in the UK airport, London Gatwick, and the Norwegian gas company, Gassed. In 2020, ADIA will invest $507.2 million in Reliance Industries Ltd and Saudi Arabia’s Public Investment Fund.
Kuwait Investment Authority
Kuwait Investment Authority (KIA) is the world’s oldest sovereign wealth fund, with total assets reaching $533.7 billion. KIA was founded in 1953 and invested funds from Kuwait’s surplus oil. Its primary mission is “to achieve a long-term return on investment that will enable future generations of Kuwaitis to face future uncertainties with greater confidence.”
KIA manages the General Reserve Fund (GRF) and the Future Generations Fund (FGF). KIA owns a 24.22% stake in the Kuwaiti Mobile Communications Group, “Zain,” which operates in 8 countries: Kuwait, Saudi Arabia, Lebanon, Bahrain, Iraq, Jordan, Morocco, and Sudan services 48.9 million customers.
Hong Kong Monetary Authority Investment Portfolio
Hong Kong Monetary Authority Investment Portfolio was founded in 1935 and is managed by the Hong Kong monetary authority. The fund has 6 subsidiaries and invests primarily in the bond and equity markets of OECD countries.
Hong Kong Monetary Authority Investment Portfolio set a target allocation of around 71% in bonds and 29% in equities. Most of the investment is in US dollars. With this relatively liquid investment, these funds can be used to maintain the Hong Kong monetary and financial system’s stability and integrity.
GIC Private Limited
GIC Private Limited was founded in 1981 and is one of three reserve management entities in Singapore, together with the Monetary Authority of Singapore (MAS) and Temasek. GIC has assets of up to $453.2 billion and invests in more than 40 countries.
Apart from providing a buffer during the downturn, the fund also aims to maintain the Singapore dollar’s stability and increase government revenue, quoting the GIC website.
Temasek Holdings Private Limited (Temasek) was founded in 1974 and managed assets of $417.4 billion. Temasek invests in around 119 subsidiaries. Temasek has earned and maintained the highest credit ratings, AAA or equivalent, of Moody’s and Standard & Poor’s since 2004.
In 2020, Temasek Holdings added a $3.5 billion investment in BlackRock Inc, increasing its ownership by approximately 3.9%. Furthermore, of the total managed funds, most of them target the markets of China, Singapore, and North America. These three cover nearly 70 of the total portfolio in 2020
Public Investment Fund
Public Investment Fund (PIF) is a sovereign wealth fund owned by Saudi Arabia and was founded in 1971. Its central vision is: “To become the world’s most influential global investment power and investor, enabling the creation of new sectors and opportunities that will shape the future global economy, while driving the economic transformation of Saudi Arabia. “
The fund invests in around 200 portfolios, of which about a fifth are listed on the Saudi Stock Exchange. PIF owns nearly 5% of Tesla’s shares and is a minority shareholder in several well-known global companies such as Boeing, Facebook, and Citigroup.
National Council for Social Security Fund
National Council for Social Security Fund was founded in 2000 and managed the Chinese government’s investment fund. Its primary purpose is to provide reserve funds for China’s social security system. In 2018, part of the investment allocation was domestic (around 92.20%).
Investment Corporation of Dubai
Investment Corporation of Dubai (ICD) was founded in 2006 and managed the United Arab Emirates government’s investment fund. Its investment allocation covers various sectors in the United Arab Emirates, from finance and investment to real estate and entertainment, and is spread across 54 countries.