Sovereign wealth fund

A sovereign wealth fund (SWF), or sovereign investment fund is a state-owned investment fund that invests in real and financial assets such as stocks, bonds, real estate, precious metals, or in alternative investments such as private equity funds or hedge funds. Sovereign wealth funds invest globally. Most SWFs are funded by revenues from commodity exports or from foreign exchange reserves held by the central bank.

Some sovereign wealth funds may be held by a central bank, which accumulates the funds in the course of its management of a nation's banking system; this type of fund is usually of major economic and fiscal importance. Other sovereign wealth funds are simply the state savings that are invested by various entities for investment return, and that may not have a significant role in fiscal management.

The accumulated funds may have their origin in, or may represent, foreign currency deposits, gold, special drawing rights (SDRs) and International Monetary Fund (IMF) reserve positions held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are assets of the sovereign nations that are typically held in domestic and different reserve currencies (such as the dollar, euro, pound, and yen). Such investment management entities may be set up as official investment companies, state pension funds, or sovereign funds, among others.

There have been attempts to distinguish funds held by sovereign entities from foreign-exchange reserves held by central banks. Sovereign wealth funds can be characterized as maximizing long-term return, with foreign exchange reserves serving short-term "currency stabilization", and liquidity management. Many central banks in recent years possess reserves massively in excess of needs for liquidity or foreign exchange management. Moreover, it is widely believed most have diversified hugely into assets other than short-term, highly liquid monetary ones, though almost no data is publicly available to back up this assertion.

The term "sovereign wealth fund" was first used in 2005 by Andrew Rozanov in an article entitled, "Who holds the wealth of nations?" in the Central Banking Journal.^[1] The previous edition of the journal described the shift from traditional reserve management to sovereign wealth management; subsequently the term gained widespread use as the spending power of global officialdom has rocketed upward.^{[citation needed]}

China's sovereign wealth funds entered global markets in 2007.^[2]: 4 Since then, their scale and scope have expanded significantly.^[2]: 4

SWFs were the first institutions to use sovereign capital in an effort to contain the financial damage in the early stages of the 2007-2008 global financial crisis.^[2]: 1–2 SWFs are able to react quickly in such circumstances because unlike regulators, SWFs actively participate in the market.^[2]: 2

SWFs grew rapidly between 2008 and 2021, with global assets under management by these funds increasing from approximately $4 trillion to more than $10 trillion.^[2]: 3

SWFs invest in a variety of asset classes such as stocks, bonds, real estate, private equity and hedge funds. Many sovereign funds are directly investing in institutional real estate. According to the Sovereign Wealth Fund Institute's transaction database around US$9.26 billion in direct sovereign wealth fund transactions were recorded in institutional real estate for the last half of 2012.^[3] In the first half of 2014, global sovereign wealth fund direct deals amounted to $50.02 billion according to the SWFI.^[4]

SWFs are typically created when governments have budgetary surpluses and have little or no international debt.^{[dubious – discuss]} It is not always possible or desirable to hold this excess liquidity as money or to channel it into immediate consumption. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. In such countries, the main reason for creating a SWF is because of the properties of resource revenue: high volatility of resource prices, unpredictability of extraction, and exhaustibility of resources.

SWFs are primarily commodity-based and many have been established by oil-rich states.^[2]: 5 SWFs of China are a notable exception to this more typical model.^[2]: 5

Stabilization SWFs are created to reduce the volatility of government revenues, to counter the boom-bust cycles' adverse effect on government spending and the national economy.

Savings SWFs build up savings for future generations. One such fund is the Government Pension Fund of Norway. It is believed that SWFs in resource-rich countries can help avoid resource curse, but the literature on this question is controversial. Governments may be able to spend the money immediately, but risk causing the economy to overheat, e.g., in Hugo Chávez's Venezuela or Shah-era Iran. In such circumstances, saving money to spend during a period of low inflation is often desirable.

Other reasons for creating SWFs may be economic, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf War managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation, Temasek Holdings, or Mubadala are partially the expression of a desire to bolster their countries' standing as an international financial centre. The Korea Investment Corporation has since been similarly managed. Sovereign wealth funds invest in all types of companies and assets, including startups like Xiaomi and renewable energy companies like Bloom Energy.^[8]

According to a 2014 study, SWFs are not created for reasons related to reserve accumulation and commodity-export specialization. Rather, the diffusion of SWF can best be understood as a fad whereby certain governments consider it fashionable to create SWFs and are influenced by what their peers are doing.^[9]

As market participants, SWFs influence other institutional investors, who may see investments made alongside SWFs as inherently safer.^[2]: 9 This effect can be seen with increasing frequency, especially with regard to investments made by the Government Pension Fund of Norway, Abu Dhabi Investment Authority, and Temasek Holdings, and China Investment Corporation.^[2]: 9 SLFs help facilitate a state's ability to use its selective equity investments to promote its industrial policies and strategic interests.^[2]: 9

The growth of sovereign wealth funds is attracting close attention because:

• As this asset pool continues to expand in size and importance, so does its potential impact on various asset markets.
• Some countries, like the United States, which passed the Foreign Investment and National Security Act of 2007, worry that foreign investment by SWFs raises national security concerns because the purpose of the investment might be to secure control of strategically important industries for political rather than financial gain.
• Former U.S. Secretary of the Treasury Lawrence Summers has argued that the U.S. could potentially lose control of assets to wealthier foreign funds whose emergence "shake[s] [the] capitalist logic".^[5] These concerns have led the European Union (EU) to reconsider whether to allow its members to use "golden shares" to block certain foreign acquisitions.^[10] This strategy has largely been excluded as a viable option by the EU, for fear it would give rise to a resurgence in international protectionism. In the United States, these concerns are addressed by the Exon–Florio Amendment to the Omnibus Trade and Competitiveness Act of 1988, Pub. L. No. 100-418, § 5021, 102 Stat. 1107, 1426 (codified as amended at 50 U.S.C. app. § 2170 (2000)), as administered by the Committee on Foreign Investment in the United States (CFIUS).^{[further explanation needed]}
• Their inadequate transparency is a concern for investors and regulators: for example, size and source of funds, investment goals, internal checks and balances, disclosure of relationships, and holdings in private equity funds.
• SWFs are not nearly as homogeneous as central banks or public pension funds.
• A lack of transparency and hence an increase in risk to the financial system, perhaps becoming the "new hedge funds".^[11]

The governments of SWFs commit to follow certain rules:

• Accumulation rule (what portion of revenue can be spent/saved)
• Withdraw rule (when the Government can withdraw from the fund)
• Investment (where revenue can be invested in foreign or domestic assets)^[12]

Assets under management of SWFs amounted to $7.94 trillion as of 24 December 2020.^[20]

Countries with SWFs funded by oil and gas exports, totaled $5.4 trillion as of 2020.^[21] Non-commodity SWFs are typically funded by transfer of assets from official foreign exchange reserves, and in some cases from government budget surpluses and privatization revenues. Middle Eastern and Asian countries account for 77% of all SWFs.

Numerous SWFs have gone bust throughout history. The most notable ones have been Algeria's FRR, Brazil's FSB, Ecuador's numerous SWF arrangements, Papua New Guinea's MRSF, and Venezuela's FIEM and FONDEN. The main reason why these funds have been exhausted is due to political instability, while economic determinants generally play a less important role.^[22]

SWFs in unstable countries may provoke risks for recipient states of SWF investments, given that the instability in SWF-sponsor countries makes those investments uncertain and likely to be disinvested to weather political risk in the short-term.^{[citation needed]}

Highly stable countries, such as Denmark, Qatar, China, or Australia are less likely to experience SWF depletion precisely because of their political stability.^{[citation needed]}

• Boutique investment bank
• Fund of funds
• Global financial system
• Government Pension Fund of Norway
• Investment management
• List of exchange-traded funds
• List of hedge funds
• List of investment banks
• List of private equity firms
• List of countries by total wealth
• Urban wealth fund