Sovereign wealth fund

A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property or other financial instruments. Sovereign wealth funds have gained world-wide exposure by investing in several Wall Street financial firms including Citigroup, Morgan Stanley, and Merrill Lynch. These firms needed a cash infusion due to losses resulting from the credit crunch.

Some sovereign wealth funds are held solely by central banks, who accumulate the funds in the course of their fiscal 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 which are invested by various entities for the purposes of investment return, and which may not have significant role in fiscal management.

The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, SDRs and 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 which are typically held in domestic and different reserve currencies such as the dollar, euro and yen. Such investment management entities may be set up as official investment companies, state pension funds, or sovereign oil funds, among others.

There have been attempts to distinguish funds held by sovereign entities from foreign exchange reserves held by central banks. The former can be characterized as maximizing long term return, with the latter 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 available to back up this assertion. Some central banks even have begun buying equities, or derivatives of differing ilk (even if fairly safe ones, like Overnight Interest rate swaps).

History

Most of the savings of SWFs originate in accumulated foreign currency reserves. These were formerly held only in gold, as official gold reserves. But under the Bretton Woods system, the United States pegged the dollar to gold, and allowed convertibility of dollars to gold. This effectively made dollars appear as good as gold. The U.S. later abandoned the gold standard, but the dollar has remained relatively stable as a fiat currency, and it is still the most significant reserve currency. In the 1990s and early 2000s, central banks began to hold ever more vast numbers of assets in multiple currencies. Given the sizes (beginning to surpass the total outstanding of domestic bond and stock markets), these amounts have been increasingly often invested in non-traditional banking assets by entities with a specific mission, set by the public authorities.

Sovereign wealth funds as a term has been around at least since 2005. It has become increasingly popular as the spending power of global officialdom rockets upwards.

The traditional investment vehicles for sovereign wealth in the form of foreign currency reserves have been the debt instruments such as government bonds from the industrialized nations. The low returns on these investments, however, have prompted nations with excess foreign reserves to invest in equities to achieve a higher return. The expanded activities of the SWFs over the past several years as well as the increased amounts available to the funds have created concern that the SWFs can destabilize financial markets and the global economy if their investments are motivated by political rather than economic considerations.

On 5 March 2008, a joint sub-committee of the US House Financial Services Committee held a hearing on the subject of ‘Foreign Government Investment in the U.S. Economy and Financial Sector’. The hearing was attended by representatives of the U.S. Department of Treasury, the Securities and Exchange Commission, the Federal Reserve Board, Norway’s Ministry of Finance, Temasek Holdings and the Canada Pension Plan Investment Board.

Early SWFs

Sovereign Wealth Funds have been around for decades but since 2000, the number of Sovereign Wealth Funds have increased dramatically. The first SWF was the Kuwait Investment Authority, a commodity SWF created in 1953 from oil revenues before Kuwait even gained independence from Great Britain. According to many estimates, Kuwait's fund is now worth approximately $250 billion.

Another of the first registered SWF is the Kiribati Revenue Equalisation Reserve Fund. Created in 1956 when the British administration of the Gilbert Islands in Micronesia put a levy on the export of phosphates (bird manure) used in fertilizer, the fund has since then grown to $520m .

Nature and purpose

SWFs are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel it into consumption immediately. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. To reduce the volatility of government revenues, counter the boom-bust cycles' adverse effect on government spending and the national economy or build up savings for future generations, SWFs may be created. One example of such a fund is The Government Pension Fund of Norway.

Other reasons for creating SWFs may be economical, 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 and Temasek Holdings are partially the expression of a desire to bolster Singapore's standing as an international financial centre. The Korea Investment Corporation has since been similarly managed.

Levels

Assets under management of SWFs increased 18% in 2007 to reach $3.3 trillion. Most of this growth stemmed from an increase in official foreign exchange reserves in some Asian countries and rising revenue from oil exports. There was also an additional $6.1 trillion held in other sovereign investment vehicles, such as pension reserve funds, development funds and state-owned corporations and $5.3 trillion in official foreign exchange reserves not held in other sovereign investment vehicles.

ADIA (Abu Dhabi Investment Authority) is named as one of the "Super Seven" funds, all of which have assets over $100 billion. These funds are: The Government Pension Fund of Norway ($350 billion); Government of Singapore Investment Corporation ($330 billion); Kuwait Investment Authority ($250 billion); China Investment Corporation ($200 billion); Singapore's Temasek Holdings ($159.2 billion); and the Stabilisation Fund of the Russian Federation ($158 billion). As a proportion of GDP the five largest funds are Abu Dhabi Investment Authority, Brunei ($30 billion), Kuwait, the Qatar Investment Authority ($60 billion) and Singapore's GIC. Smaller funds, such as those held by Azerbaijan, Trinidad & Tobago, Ecuador and Nigeria account for $0.1 trillion of the world's $2.2 trillion total of SWFs.

An important point to note is the SWF to Foreign Reserve Exchange Ratio which shows the proportion a government has invested in investments relative to currency reserves. According to the SWF Institute, most oil producing nations in the gulf have a higher SWF to Foreign Exchange Ratio - for example, the Qatar Investment Authority (5.89x) compared to the China Investment Corporation (.12x) - reflecting a more aggressive stance to seek higher returns.

Largest sovereign wealth funds

See also: List of countries by foreign exchange reserves

Country Abbreviation Fund Assets $Billion Inception Origin Approx wealth per citizen  United Arab Emirates (Abu Dhabi Emirate) ADIA Abu Dhabi Investment Authority $875 1976 Oil $1,000,000 Norway GPF Government Pension Fund of Norway $391 1990 Oil $74,500 Singapore GIC Government of Singapore Investment Corporation $330 1981 Non-commodity $100,000 Kuwait KIA Kuwait Investment Authority $264.4 1953 Oil $80,000 China CIC China Investment Corporation $200 2007.09.28 Non-commodity $151 Singapore Temasek HoldingsTemplate:Fn $159.2 1974 Non-commodity $35,400 Australia FFMA Australian Government Future Fund $81.3 2004 Non-commodity $3,900 Qatar QIA Qatar Investment Authority $60 2005 Oil $250,000 United States (Alaska) APFC Alaska Permanent Fund $40.1 1976 Oil $61,000 Libya Libyan Investment Authority $50 2007 Oil $7,200 Russia RNWF Russian National Wealth Fund $32.85 2008 Oil n/a Brunei BIA Brunei Investment Agency $30 1983 Oil $90,100 South Korea KIC Korea Investment Corporation $30 2005 Non-commodity $417 Malaysia KN Khazanah Nasional $18.3 1993 Non-commodity $658 Kazakhstan KNF Kazakhstan National Fund $23.0 2000 Oil $1170 China SAFE State Administration of Foreign Exchange n/a n/a Non-commodity n/a Taiwan NSF National Stabilisation Fund $15 2000 Non-commodity $652 Canada (Alberta) AHF Alberta Heritage Fund $16.6 1976 Oil & Gas $5000 Iran OSF Oil Stabilisation Fund $12.9 1999 Oil $174  United Arab Emirates (Dubai Emirate) Istithmar n/a 2003 Oil n/a Saudi Arabia Saudi Arabia Sovereign Wealth Fund $5.2 2008 Oil n/a

Notes

• Template:Fnb Temasek Holdings does not consider itself a sovereign wealth fund and was excluded from an agreement between Singapore and the United States in 2008 requiring greater disclosure and transparency in transactions involving sovereign wealth funds. Only the Government of Singapore Investment Corporation was involved in the agreement.

Notes

There are several reasons why the growth of sovereign wealth funds is attracting close attention.

• First, as this asset pool continues to expand in size and importance, so does its potential impact on various asset markets.

• Second, and relatedly, some critics worry that foreign investment by sovereign wealth funds 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. These concerns have led the EU to reconsider whether to allow its members to use "golden shares" to block certain foreign acquisitions. Therefore, 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 U.S., 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).

• Third, sovereign wealth funds are not nearly as homogeneous as central banks or public pension funds. However they do have a number of interesting and unique characteristics in common. These make them a distinct and potentially valuable tool for achieving certain public policy and macroeconomic goals.

See also

Central bank

References

Specific references and footnotes:

General references:

• ExcessLiquidity.org: A blog about Sovereign Wealth Funds - News, Commentary, Analysis
• SWF Institute Organization dedicated to Studying Sovereign Wealth Funds
• Who holds the wealth of nations?, from State Street Corp.
• Sovereign wealth funds brim with money from Reuters

External links

• Linaburg-Maduell Transparency Index - Point system on grading sovereign wealth fund transparency
• Sovereign wealth funds and the 2500bn question, Financial Times, 25 May 2007
• Gulf states Sovereign wealth fund reserves swell, Financial Times, 31 May 2007
• The $2.5 trillion wave of cash heading our way, The Daily Telegraph, 16 July 2007
• Singapore's GIC: a tough act to follow, Reuters, 01 August 2007
• Sovereign Wealth Funds: The Need for Greater Transparency and Accountability, Peterson Institute for International Economics, 20 October 2007
• How big could sovereign wealth funds be by 2015, from Morgan Stanley
• The rise of sovereign wealth funds, coverage from 2006 - today. Includes outline of 6 of the top funds' investment strategies. Euromoney.,