Essay: Sovereign Wealth Fund

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The Sovereign Wealth Fund is a state-owned investment fund. The past of Sovereign Wealth Funds dates back to 1950s. They have been becoming more and more popular in recent years. These funds pertaining to governments are large-scaled worldwide. Besides all these, there is a dispute whether it threats countries which is invested by SWFs or not. On the contrary, these funds may have an important role in financial crisis in terms of countries possessing SWFs. In the World, there are many academic studies about SWFs recently.

In the beginning, SWFs were established to utilize revenues of exporting of natural resources, for example, gulf countries. After that, kinds of SWFs were established in varied objectives and funded by different resources e.g. surplus of current account of balance and foreign currency policies like China, Singapore. In the paper, varied SWFs from the World have been demonstrated in tables comparatively in the sense of ranking of them, auditing, governance, investment mandates and aims.

According to the IMF, there five types of SWFs: stabilization funds, savings funds, development funds, pension funds and reserve investment funds. Their explanations and governance models of SWFs are stated with tables in the study. While varied SWFs prefer to invest in domestic, some of them foreign. These kind of investment policies of SWFs show an alteration based on the global financial events like global financial crisis in 2008, European debt crisis in 2009 etc. These funds also helped big banks’does not matter whether banks are from the same country possessing helper SWF’in the World. Some of them with their these kind of investments made loss up to 90%. However, they implemented this policy because of having big investments in that countries having big banks which were going to bankruptcy. Despite making a loss, their other big investments were protected in this way.

Turkey Wealth Fund were established in 2016 and funded in 2017. Because of being a new one in Turkey, it has not started its operations clearly yet. So, in the literature, there is not sufficient academic research. After all headlines, only general informations and objectives about it are given.

SOVEREIGN WEALTH FUNDS (SWFs)

Sovereign Wealth Funds are described as investment funds representing a large pool of savings. These funds are set up by governments of sovereign states for macroeconomic reasons in the global market. According to the International Monetary Fund, SWFs are government-owned investment funds, set up for a variety of macroeconomic purposes.

First Spring and Evolution of SWFs

In the literature, it is accepted that Kuwait Investment Authority established as a first Sovereign Wealth Fund in 1953 in London by sheikh Abdullah Al-Salem Al-Sabah in order to manage surpluses of oil revenues, eventhough it is seen that first spring of Sovereign Wealth Funds took shape with the Permanent School Fund in the USA-Texas in 1854, and establishing of Permanent University Fund in 1876 in the USA followed this. (Table 4) Primarily, SWFs are established by state governments exporting their natural resources to other countries to manage and utilize oil exporting revenues. Then, some SWFs were established as non-commodity. Another milestone in the development of sovereign funds, the Ministry of Economy of Singapore set up the Temasek Holdings fund in 1974. (Ander & Teply, 2014)

The number of SWFs has been growing rapidly. As shown in Figure 1, based upon the data of SWFI, SWF AUM rised before the financial crisis occured between 2008 and 2009. Following this, AUM declined, then, experienced a new first peak in December 2013 and the second peak in March 2015.

Figure 1. SWF assets under management (AUM), September 2007 to June 2016

Source: (Sovereign Wealth Fund Institute, 2017)

According to 2016 Preqin Sovereign Wealth Fund Review, SWFs continue to capture attention as a result of their growing assets under management (AUM) and corresponding influence on global financial markets. Today, the total assets of sovereign wealth funds top $6.51 trillion (Figure 2), more than double the capital these entities represented in 2008, the year Preqin launched its first Sovereign Wealth Fund Review.

Figure 2. Aggregate Sovereign Wealth Fund Assets Under Management ($tn), December 2008 – March 2016

Source: (Preqin, 2016)

Because of that Preqin does not accept some of funds as a SWF, numbers in Figure 2 may appear like contradictive with Figure 1. So, it should be evaluated looking to weight of type of SWFs like Commodity, Non-Commodity, etc.

Characteristics of Sovereign Wealth Funds

Increasing of SWFs in the global market triggered describing and classifying of SWFs differently. SWFs might be classified in terms of sources of finance, investment strategies, governmental policies, etc.

Related to the origin of the wealth accumulation, there are two types

of SWFs: (Ander & Teply, 2014)

‘ commodity: foreign currency sources from large volumes of oil export and

from other non-renewable resources (eg. Norway, Russia, Middle East); (Ander & Teply, 2014)

‘ non-commodity: foreign currency reserves from a large surplus of current

account of balance of trade and foreign currency policy (eg. China, Singapore). (Ander & Teply, 2014)

Box 1. A Case of Commodity SWFs ‘ Hotelling Rule

Economic theory offers useful insights into the optimal management of natural resources. One strand of literature focuses on arbitrage arguments and the Hotelling Rule. A country exporting oil or any other exhaustible commodity should be indifferent to whether it keeps the oil under the ground, in which case the return is the expected rise in future oil prices, and getting a market rate of return on its sale (Hotelling Rule for efficient depletion). If the market return of reinvesting the proceeds of extracted oil is depressed, the oil exporter will either consume the proceeds ‘ rather than invest them ‘ or leave the oil under the ground. As capital protectionism, such as restrictions imposed on SWFs from oil-rich countries, will tend to reduce the risk-adjusted return for oil exporters, it may well contribute to higher oil prices as oil supply is withheld.

Source: (Kern, Commodity and Non-Commodity Sovereign Wealth Funds, July 2008)

Based on IMF and GAPP, there are five types of SWFs as follows:

Stabilization funds (Figure 3) are established so as to help the government protect the budget and economy from commodity price volatility and external shocks (e.g., Chile, Iran, and Russia). Their investment scope and liquidity aims have resemblance to central banks reserve managers’, in consideration of their role in countercyclical fiscal policies to smooth boom and bust cycles. They are in tendency to invest largely in highly liquid portfolio of assets by allocating over 80% of their assets to fixed income securities, with government securities including around 70% of total assets. (Al-Hassan, Papaioannou, Skancke, & Chih Sung, November 2013)

Savings funds (Figure 3) are set up to convert exporting revenues of natural resources, minerals. By doing so, they also balance of intergenerational differences in the country (e.g., UAE-Abu Dhabi, Libya, Russia). Their investment mandate emphasizes high risk-return profile, thereby, allocating high portfolio shares to equities and other investments. (Al-Hassan, Papaioannou, Skancke, & Chih Sung, November 2013)

Development funds (Figure 3) are established to finance infrastructural investments, socio-economic projects, and support industrial policies in the country (e.g, UAE-Abu Dhabi, Iran, Malaysia, Mongolia (Table 1)).

Pension funds (Figure 3) are set up to meet identifies outflows hereinafter with respect to pension-related contingent-type liabilities on the government’s balance sheet (e.g., Australia, Ireland, and New Zealand). (Al-Hassan, Papaioannou, Skancke, & Chih Sung, November 2013)

Reserve investment funds (Figure 3) are established in order to manage surpluses of foreign exchange reserves. To get high revenue from their own investments, they invest in risky and high-yield instruments -equities- like stocks, etc. When there is a necessary, these kind of SWFs can be used for supporting foreign Exchange policies of the government possessing SWF (e.g., China, South Korea, Singapore)

Figure 3. Characteristics of SWFs

Source: (International Monetary Fund, April 2012)

Table 1. Selected Sovereign Wealth Funds

Fund Name

Country

Fiscal Stabilization

Savings

Pension Review

Reserve Investment

Australian Future Fund

Australia

State Oil Fund

Azerbaijan

Future Generations Reserve Fund

Bahrain

Economic and Social Stabilization Fund

Chile

China Investment Corporation

China

Oil Stabilization Fund

Ireland

Kazakhstan National Fund*

Kazakhstan

Kuwait Investment Authority

Kuwait

Fiscal Stability Fund*

Mongolia

Government Pension Fund-Global

Norway

National Welfare Fund

Russia

Oil Stabilization Fund

Russia

Abu Dhabi Investment Authority

UAE

Source: (Al-Hassan, Papaioannou, Skancke, & Chih Sung, November 2013)

* SWFs also having development funds

Functions of Sovereign Wealth Funds

Table 2. Functions for Sovereign Wealth Funds

Function

Investment Objectives

Strategic Asset Allocation

Saving

Inter-generational equity, national endowment, meeting particular long-term liabilities or contingent liabilities (pensions)

Long term investment horizon, diversification with moderate to high risk tolerance, and low liquidity requirement in short-medium run

Precautionary

Stabilize spending in the face of short-term and medium-term volatility in resource income

Liquidity, safety (capital preservation), short to medium term investment horizon

Buffer

Hold committed funds to pace disbursements in line with absorptive capacity constraints

Safety (capital preservation), liquidity, short to medium term investment horizon

Source: (Gelb, Tordo, Halland, Arfaa, & Smith, February 2014)

Sources of Capital for Sovereign Wealth Funds

They are commonly funded by the transfer of foreign exchange assets that are invested long term, overseas. Generally, countries establishing SWFs possess natural resources like petroleum, natural gas, copper, diamond, phospate, etc. (Table 3) Besides, there are also other countries managing non-commodity SWFs getting funded by privatizations, saving funds, foreign exchange reserves, current-account surplus, etc. (Table 3)

Table 3. Resources of Sovereign Wealth Funds

Total value of funds (trillion dollars)

7,379.14

Funds funded by petroleum/natural gas (trillion dollars)

4,224.34

Non-commodity funds (trillion dollars)

3,154.80

Funds funded by petroleum/natural gas (percentage)

57,24

Non-commodity funds (percentage)

42,76

Source: (Sovereign Wealth Fund Institute, 2017)

Different Aims of Sovereign Wealth Funds

Sovereign wealth funds are established for different reasons and objectives. While SWFs funded by commodity exports provide their own countries stability in the economy when the economic troubles have showed themselves, SWFs financed by natural resource exports prefer maximizing returns on the export income and also keeping the national economy more reliance on one income resource. Within this direction, countries having SWFs imply that they have invested these all incomes for next generations of them. For instance, Venezuela’s National Development Fund was established by Hugo Chavez in 2005 in order to benefit and improve the social and economic conditions for Venezuelans, including financing in sectors such as education, healthcare and agriculture. (Preqin, June 2015) Accordingly, so as to reach their own aims, the funds belonging to the nation of any country are managed by qualified investment managers.

In the World, there are roughly 80 wealth funds in more than 40 countries. Norwegian Government Pension Fund-Global is on the top of the Sovereign Wealth Fund Ranking List (Table 4) with $ 922 billion as a commodity SWF financed by petroleum. Abu Dhabi Investment Authority in the United Arab Emirates, which is also financed by oil like Norway, is ranked at the second of the list with $ 828 billion. Besides that, China Investment Corporation, a non-commodity SWF ranked at the third, is managing 813 billion dollars.

Table 4. Sovereign Wealth Fund Ranking List

Country

SWF Name

Assets USD-Billion

Inception

Source (Origin)

Added

Added

Linaburg- Maduell Transparency Index (LMTI)

Democracy Index*

Freedom Ratings**

Norway

Government Pension Fund-Global

922.11

1990

Oil

10

9,93

1,0

UAE-Abu Dhabi

Abu Dhabi Investment Authority

828

1976

Oil

6

2,75

6,0

China

China Investment Corporation

813.8

2007

Non-Commodity

8

3,14

6,5

Kuwait

Kuwait Investment Authority

592

1953

Oil

6

3,85

5,0

Singapore

Government of Singapore Investment Corporation

350

1981

Non-Commodity

6

6,38

4,0

Qatar

Qatar Investment Authority

335

2005

Oil & Gas

5

3,18

5,5

China

National Social Security Fund

295

2000

Non-Commodity

5

3,14

6,5

Australia

Australian Future Fund

99.4

2006

Non-Commodity

10

9,01

1,0

Russia

National Welfare Fund

72.2

2008

Oil

5

3,24

6,5

Libya

Libyan Investment Authority

66

2006

Oil

1

2,25

6,5

Iran

National Development Fund of Iran

62

2011

Oil & Gas

5

2,34

6,0

US-Texas

Texas Permanent School Fund

37.7

1854

Oil & Others

10

7,98

1,0

Malaysia

Khazanah Nasional

34.9

1993

Non-Commodity

9

6,54

4,0

Canada

Alberta’s Heritage Fund

13.4

1976

Oil

9

9,15

1,0

Russia

Russian Direct Investment Fund

13

2011

Non-Commodity

n/a

3,24

6,5

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