Sovereign wealth funds (SWFs) are managed separately from official currency reserves. They are pools of money governments invest for profit. Often this money is used to invest in foreign companies. For instance, China's SWF purchased stakes in the US financial firms Morgan Stanley and the Blackstone Group in late 2007. Dubai's SWF bought shares in several Asian companies, including Sony.
SWF assets can include balance-of-payments surpluses, official foreign currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts resulting from commodity exports. They can be structured as a fund, pool or corporation. They do not include foreign currency reserve assets held by monetary authorities for the traditional balance-of-payments or monetary policy purposes, state-owned enterprises (SOEs) in the traditional sense, government-employee pension funds or assets managed for the benefit of individuals.
The assets for the funds can originate through commodity exports (most often oil, but sometimes gas or minerals, which are either taxed or owned by the government) or through transfers of assets from official foreign exchange reserves (called “non-commodity” SWFs). SWFs may originally be created to reduce the volatility of government revenues, to counter the adverse effects of volatility in financial cycles on government spending and the national economy, or to build up savings for future generations.
SWFs usually invest globally, although some also invest indirectly in domestic state-owned enterprises. In addition, they tend to prefer returns over liquidity and thus have a higher risk tolerance than traditional foreign exchange reserves. Some SWFs made bad investments in several Wall Street financial firms just prior to the 2007-2008 financial crisis, including investments in Citigroup, Morgan Stanley and Merrill Lynch. There is some evidence – and much speculation – that SWFs may dial back somewhat on their risk tolerance given recent experience.
The first SWF was the Kuwait Investment Authority, created in 1953 from oil revenues before Kuwait even gained independence from the United Kingdom; that fund is now worth more than $200 billion. Since 2000, the number of sovereign wealth funds has increased dramatically.
Critics of SWFs point out that as this asset pool continues to expand in size and importance, so does its potential impact on various asset markets. In addition, foreign investment by SWFs raises some national security concerns because of speculation that the purpose of the investment might be to secure control of strategically important industries for political rather than financial gain (SWFs currently own significant stakes in some major corporations outside of their home country). Moreover, the lack of transparency for some of the funds – that is, size and source of funds, investment goals, internal checks and balances, disclosure of relationships and holdings in private equity funds – has been another cause for concern by investors and regulators. The International Monetary Fund’s Santiago Principles have tried to address these concerns.
Current estimates of total SWF assets are currently around US$3.9 trillion. Some forecast that the total figure could grow to nearly US$6 trillion or US$10 trillion by 2010 and possibly to US$20 trillion by 2020.
Finance ministries in the past have typically invested currency reserves in US treasury bills and other risk-free bonds issued by wealthy countries. Since SWFs provide countries with a broader range of investment options, some experts say this could facilitate a gradual shift away from investments in US government-backed assets, like treasury bills, and in the dollar.
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