Sovereign Wealth Funds

Sovereign wealth funds (SWFs) are investment funds owned by a government. The International Monetary Fund defines five broad categories of SWF, each with different missions.

Budget stabilization fundsSet up to insulate the budget and economy from commodity price volatility and external shocks.Economic and Social Stabilization Fund of Chile; Timor-Leste Petroleum Fund; Russia’s Oil Stabilization Fund
Development fundsEstablished to allocate resources to priority socio-economic projects, usually infrastructure.Mubadala (UAE); Iran’s National Development Fund; Ireland Strategic Investment Fund
Savings fundsIntended to share wealth across generations by transforming non-renewable assets into diversified financial assets.Abu Dhabi Investment Authority; Kuwait Investment Authority; Qatar Investment Authority; Russia’s National Wealth Fund
Reserve fundsIntended to reduce the negative carry costs of holding reserves or to earn higher return on ample reserves.China Investment Corporation; Korea Investment Corporation; GIC Private Ltd. (Singapore)
Pension reserve fundsSet up to meet identified future outflows with respect to pension-related contingent-type liabilities on governments’ balance sheets.National Social Security Fund (China); New Zealand Superannuation Fund; Future Fund of Australia
Major Types of Sovereign Wealth Funds

The stakeholders in an SWF are as follows:

  • Current and future citizens benefit from the fund’s success either directly through receiving payments or indirectly through lower taxation or increased investment in the domestic economy.
  • Investment offices invest SWF assets either directly in-house or appoint external managers.
  • The board has a fiduciary duty to the ultimate beneficiaries of the fund.
  • Governments are stakeholders in that they may rely on SWF returns to balance budget deficits.

The liabilities of SWFs are linked to their overall mission and generally are less well defined than other types of institutions. The liabilities and investment horizons of the five broad types of SWFs are listed in  SWF Liabilities and Time Horizons.

SWF TypeLiabilities and Investment Horizon
Budget stabilizationUncertain liabilities linked to commodity prices/cyclical industriesShort-term investment horizon because budget support required on a short-term basis
DevelopmentNature of liabilities linked to socioeconomic investments made by the fundSome long-term horizons (e.g., infrastructure), some medium-term horizons (e.g., medical research)
SavingsLiabilities are linked to future generations; therefore, long term
ReserveLiabilities are technically the yield promised on bonds issued by governments/central banks; however, funds will target higher returnsInvestment horizons are very long, typically with no near-term liabilities
Pension reserveLiabilities are linked to future pension payments; therefore, long termFund may have an accumulation stage in which contributions are made and a decumulation phase where benefits are drawn; time horizon will depend on when these stages occur
SWF Liabilities and Time Horizons
  • Budget stabilization funds. These must maintain the highest liquidity level and invest in assets with low risk of significant loss in the short term, in order to meet short-term deficits caused by negative economic- or commodity-related events.
  • Development funds. Because infrastructure and research and innovation investments are long term, funds established to develop such projects generally have low liquidity needs.
  • Savings funds. The main objective is to accumulate wealth for future generations; hence, liquidity needs are lowest. Liquidity needs increase as the nation’s natural resources become depleted and the government withdraws from the fund to meet budgetary needs.
  • Reserve funds. Liquidity needs are lower compared to stabilization funds but higher compared to savings funds. Liquid fixed-income securities are usually held that can be readily sold if there is a dramatic change in the reserves of the central bank.
  • Pension reserve funds. Liquidity needs vary, being lower during the accumulation stage and higher during the decumulation stage.

From a legal and regulatory perspective, SWFs are typically established by laws that give the SWF its mission and structure. This may involve clear rules of asset allocation, particularly in the case of a development fund with a specific socioeconomic mission. In order to avoid political influence, high-quality governance, independence, transparency, and accountability are crucial. The Santiago Principles, a best-practices framework established by the International Forum of SWFs (IFSWF), addresses such concerns alongside other key elements expected of a high-quality SWF, such as ethics, risk management, and regular monitoring for compliance with the principles.

SWFs are generally tax exempt. This may void the SWF’s ability to claim withholding taxes or tax credits that are normally available to taxable investors. Care should be taken when investing internationally to ensure double-taxation treaties exist when subject to withholding taxes abroad. SWFs should take care not to be perceived as using their status to avoid paying taxes in foreign jurisdictions in which they invest.

SWF TypeInvestment Objectives
Budget stabilizationCapital preservationAims to earn returns above inflation with a low probability of lossesShould avoid assets correlated with the source of government revenues
DevelopmentSupport a nation’s economic development and increase long-run economic growthImplicit objective is to earn a real rate of return greater than real domestic GDP growth or productivity growth
SavingsMaintain purchasing power of the assets over time while making ongoing spending on government budgetary needs
ReserveEarn a rate of return in excess of the yield the government/central bank pays on bonds it has issued
Pension reserveEarn returns to meet future unfunded pension and social care payments promised by the government
SWF Investment Objectives

Typical asset allocations differ by type of SWF as follows:

  • Budget stabilization funds. The majority of fixed income and cash is due to the defensive nature of the fund.
  • Development funds. These are driven by the socioeconomic mission of the fund (e.g., investment in local infrastructure projects).
  • Savings funds. A long investment horizon means relatively high allocations toward equities and alternative investments, such as private equity and real assets.
  • Reserve funds. Allocations are similar to those of savings funds, but with lower allocation to alternatives due to the potentially higher liquidity needs.
  • Pension reserve funds. These have high allocations to equities and alternatives due to a long investment horizon and low liquidity needs in the accumulation phase.

As mentioned, savings funds and pension reserve funds typically follow the endowment model. Some may also adopt the Canadian model. Another general theme that drives asset allocation is fewer constraints leading to a broader investment mandate and longer time horizons than most institutional investors allowing for a higher allocation to alternative assets.

Illustrative Asset Allocations for Different Types of Sovereign Wealth Funds

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