What is a Sovereign Wealth Fund – Your Ultimate Guide to SWFs

what is a sovereign wealth fund

When it comes to making investments, individuals, business and countries use various tools or approaches to this important aspect of creating wealth. Today, you might be wondering, what is a sovereign wealth fund?

Well, it is the same question I have in mind. I therefore went to find out through research and talking to industry leaders about what a sovereign wealth fund is and what it does or used for.

In this article, I share with you the information that I gathered about sovereign wealth funds.

What is a Sovereign Wealth Fund (SWF)?

In definition, a sovereign wealth fund is a pool or stash of cash, normally owned or set aside by a government for investment purposes. It is a way in which a country invests in markets. This pool of cash comes from the country’s budget surplus reserves and in most cases from revenues generated from sale of oil and gas resources. Sovereign wealth fund investments help a country to diversify investments to benefit citizens and future generations, and they are hold in excess of $8 trillion in investments.

Sovereign wealth funds have attracted significant attention as more countries open funds and invest in big-name companies and assets—some more transparently than others.

This has given way to widespread concern over the influence these funds have on the global economy. As such, it is important to understand exactly what sovereign wealth funds are and how they first came about.

What is a sovereign wealth fund – what does it mean

As mentioned above, a sovereign wealth funds are state-owned. It is an investment fund that a country uses and comprises of money generated by the government.

Having a sovereign wealth fund (SWF) means that a country has some form of surplus reserves. It means that the country is generating more revenues than it is consuming. This is a good thing.

In that regard, a sovereign fund is a vehicle through which the country invests the excess budget surplus to benefit it’s citizens. This can therefore be argued to be a sign of prudent financial and fiduciary responsibility.

Sovereign wealth funds bring a great deal of economic benefits to a country and the people, both current and future generations.

Types of Sovereign Funds

Like any other type of investment fund, sovereign wealth funds have their own objectives, terms, risk tolerances, liability matches and liquidity objectives.

Based on the assets and objectives of a sovereign funds, the risk management plan can range from very conservative to very high risk tolerance.

7 Types of Sovereign Wealth Funds

There are about seven types of sovereign wealth funds and they include;

  1. Stabilization Sovereign Wealth Funds
  2. Saving or Future Generation Funds
  3. Public Benefit Pension Reserve Funds.
  4. Reserve Investment Funds
  5. Strategic Development Sovereign Wealth Funds
  6. Targeted Sovereign Wealth Funds
  7. Foreign Currency Reserve Assets

The above are the types of sovereign wealth fund that you will find across in one form or the other.

What is a sovereign wealth fund used for

The emergence and rise of sovereign wealth funds has been hailed as important to the development of international investing.

You might ask; what is a sovereign wealth fund used for? This is a good question and there several uses of a SWF. They include;

  1. Helps to stabilize an economy through diversification.
  2. Development of a country’s infrastructure.
  3. To generate wealth for the future generations

These are some of the primary functions of a sovereign wealth fund.

Examples Sovereign Wealth Funds

It is important for you to realize that sovereign wealth funds are relatively new. The first sovereign wealth fund was established in 1953 by Kuwait.

Kuwait Investment Authority was created to invest the country’s excess oil revenues.

From 1953 to date, the size and the number of sovereign wealth funds has increased in a substantial way. Right now, there are over 88 sovereign wealth funds in the world, holding over $8 trillion in investments or assets.

5 Largest Sovereign Wealth Funds by Assets

The top five largest sovereign wealth funds by assets as of December 2020 included:

  1. Norway Government Pension Fund Global – $1,073,590,000,000
  2. China Investment Corporation – $940,604,000,000
  3. Abu Dhabi Investment Authority – $579,621,120,000
  4. Kuwait Investment Authority – $533,650,000,000
  5. Hong Kong Monetary Authority Investment – $528,054,000,000

The above are some of the largest SWFs and tell you the influence or financial power they have on global economy.

To fully understand how big a sovereign wealth fund can grow, I have compiled a list of some of the largest sovereign wealth funds in the world. These are funds you should know and understand how they operate or invest their pool of cash.

How SWFs Make Investments

The goals of sovereign wealth funds are to protect and add stability to the nation’s budget, earn greater returns on foreign investments, diversify from non-renewable exports, increase savings for future generations, play a role in political strategy and create sustainable long-term capital growth.

Some countries develop sovereign wealth funds to diversify their sources of revenue.

For example, countries that rely on oil exports as their primary source of wealth may invest a portion of their reserves in securities or assets to diversify against a dramatic decrease in oil production or oil demand.

Categories of Sovereign Wealth Funds

Sovereign wealth funds are classified by two categories;

  1. Commodity wealth funds
  2. Non-commodity Wealth Funds

Let us look at these two categories now.

  1. Commodity SWFs

Commodity sovereign wealth funds are funded by exporting commodities. As the price of the commodity rises, the sovereign wealth fund grows at an increased rate. When the price of the commodity falls, this could negatively impact the sovereign wealth fund, and therefore the country it supports.

  1. Non-Commodity SWFs

The investments that grow non-commodity can vary by country. These investments are usually long-term, passive investments. Sovereign wealth funds might invest in traditional investments, such as government bonds, equities and foreign direct investments.

Alternative sovereign funds investments are growing and include hedge funds and private equity investments.

According to the International Monetary Fund, sovereign wealth funds harbor a higher degree of risk than traditional portfolios as they hold larger stakes in emerging markets, which are more volatile.

Conclusion

In conclusion, you should also know that the amount of money in sovereign wealth funds is usually substantial.

The acceptable investments included in each SWF vary from fund to fund and country to country.

Countries can create or dissolve SWFs to match the needs of their population. Funds with liquidity concerns may limit investments to only very liquid public debt instruments.

In some cases, sovereign wealth funds will invest directly in domestic industries. Liquidity, debt, and allocation balances can be some of the key factors in investment terms.