- The Writer holds an MSc in Eurasian Political Economy & Energy from King’s College London and also an MA in European Studies from Sabancı University.
Sovereign wealth funds have been used as massive investment vehicles worth US$7.4 trillion in assets. These government tools have the potential to revolutionize international capital flow and impact the financial services industry around the world. Sovereign wealth funds (SWF) have been used as a channel through which the public sector has gained influence over financial markets. However, in comparison to other widely used investment tools, these massive investment instruments remain little known and in many times treated with suspicion.
The SWF institute defines these funds as “a state-owned investment fund or entity that is commonly established from balance of payment surpluses, official foreign currency operations, the proceeds of privatization, governmental transfer payments, fiscal surpluses, and/or receipts resulting from resource exports.”
Following the initial oil strikes in the Persian Gulf states in the 1950s, with the purpose of managing excessive oil revenues, the first SWF was created in Kuwait in 1953 under the name of the Kuwait Investment Authority. According to the SWF Institute, the Kuwait Investment fund currently holds over $592 billion in assets. In the following oil boom years in the 1970s, oil exporter countries, such as the United Arab Emirates and Saudi Arabia joined the club with the desire to mitigate the negative impact that could potentially arise due to excessive liquidity. The trend escalated in the early 2000s primarily due to increasing oil prices as well as the massive build up of foreign exchange reserves in Asia.
In recent years, states as geographically and economically diverse as South Korea, Venezuela, Iran and Algeria have also established their SWF’s. With the exception of South Korea, these states do not necessarily represent the most advanced economies of the world and have not experienced an overabundance of foreign currency reserves, however, the SWF has become popular, both in size and scope in many states.
Depending on the funding choices pursued, SWF’s are classified as commodity and non-commodity funds. While commodity-based funds mainly emanate from commodity exports, non-commodity funds comprise excess foreign currency reserves. In 2016, the size of commodity-based or oil-gas related SWF’s amounted at about $4.2 trillion while the size of non-commodity SWF’s were approximately valued at $3.1 trillion. While the oil and gas-related SWF’s were equal to 55.5 percent, the remaining 44.5 percent represented non-commodity funds in 2015.
Singapore, China and South Korea are the primary examples of the non-commodity fund users that choose to fund their SWF’s through transfer of assets from foreign exchange reserves. The funds held by natural resource exporting countries, such as Norway and the UAE, are the major countries that benefit from funds from revenues on commodities. However, strategies pursued as an investment preference vary from country to country or are sometimes categorized into what sectors investments are predominantly made such as banking, technology or the energy industry, which varies from hydrocarbons to renewables. While South Korea and Singapore choose to focus on technology as an investment choice, Malaysia primarily targets the energy sector.
When we look at the figures provided by the SWF Institute relating to regional breakdowns, the highest stakes can be seen in the Middle East and Asia, with almost 80 percent, followed by Europe and America with 13 percent and 2.80 percent, respectively. The breakdown of sovereign wealth funds by year of establishment is also telling. Almost 67 percent of SWF’ have been established since 2000, and between 2005 and 2012 more than 32 SWF’s were created. Moreover from 2008 to 2012 alone, the assets of SWF’s grew by 59.1 percent. Since 2005, approximately 40 sovereign wealth funds were created and overall assets of these SWF’s have doubled. Some of the better performing emerging African economies have also hopped on the bandwagon and have raised the presence of sovereign wealth funds globally.
The reasons why SWF’s are established vary from state to state. While some SWFs are established for economic diversification to strengthen national economies to better respond to external shocks during economic hardships, others are created to enable asset liquidity of government pensions and fiscal revenues.
The variety of reasons for the emergence of SWF’s is a divisive issue. Some experts argue that SWF’s will move international economies towards a calmer and more stable path, while others advocate that they can be used as a political bargaining chip. It is difficult to apply a broad formula as to the outcome of SWFs politically, economically or financially as accountability and transparency are inextricably linked to the openness of the country in which the SWF originates. Therefore, SWF’s regulatory structures, attitudes towards transparent and accountable monthly and annual reporting all have to be taken into account before examining the functionality of a particular fund.
Among many SWF’s established up until today, some SWF holder countries such as Norway, Canada and Australia have revealed and published the size of their holdings and the fund managers are held accountable for the fund’s execution. On the other hand, the majority of other well-established SWF’s have not been as clearly open and transparent as some of their counterparts and consequently, SWF’s have attracted major criticism and their effectiveness has been called into question. In this regard the structure of SWFs can be likened to that of hedge funds rather than regulated funds.
Overall in many cases particularly in natural resource rich countries, the excess revenues and reserves invested in SWF’s can be used to help countries diversify their national economy and mitigate the risk of concentrating on a single commodity. In light of challenges to single resource overdependence, SWF’s can help shield economies against volatility, while also optimizing their risk return on national wealth. However, unless the goals of SWF’s are clearly disclosed and an adequate regulatory framework is applied, SWF’s can also be the source of capital market volatility and can increase potential risks for relatively small and emerging economies.
- Opinions expressed in this piece are the author’s own and do not necessarily reflect Anadolu Agency's editorial policy.