What is a Sovereign Wealth Fund?

This is a short guide to sovereign wealth funds. For more details, please visit our main website.

There is an official definition of a sovereign wealth fund, written by sovereign wealth funds themselves in 2008 and published in Appendix I of the Santiago Principles. In short, this defines sovereign wealth funds as having three key characteristics:

1. A sovereign wealth fund is owned by the general government, which includes both central government and sub-national governments.
2. Includes investments in foreign financial assets.
3. They invest for financial objectives.

These key elements exclude:

• Public pension funds, which are ultimately owned by the underlying policy holders. 
• Central bank reserve assets, which are not invested for financial objectives, but for safety and liquidity.

These funds fall into two main groups:

Savings Funds

Savings funds are sometimes referred to as intergenerational savings funds because they have decades-long investment horizons. 

Savings funds are often set up by commodity-rich countries to save a portion of their resource wealth for the future. Oil, gas and precious-metal reserves are finite: one day they will run out. There is also a risk that these resources will become stranded assets as climate-change regulation and the rise of green-energy alternatives render hydrocarbon extraction uneconomic.

Some savings funds are designed to finance future liabilities. Pension reserve funds, such as Australia’s Future Fund, the New Zealand Superannuation Fund and Chile’s Pension Reserve Fund, typically invest to build capital that will help defray their sponsoring government’s future pension obligations. Unlike orthodox pension funds, which must continually pay out to their members, pension reserve funds do not have any immediate liabilities. Therefore, they can put their capital to work in long-term investments.

Stabilisation Funds

Stabilisation funds are pools of capital on which governments can draw on to smooth the budget. Often, commodity-rich nations create these funds to manage revenue streams and mitigate the resource curse. The fund will save some of the proceeds from large influxes of revenue and pay out when commodity receipts fall below a specified amount.

By helping to smooth out commodity revenues, stabilisation funds can help governments avoid extreme peaks and troughs in the cycle. These funds are also used to help stabilise the value of the country’s currency during macroeconomic shocks. Stabilisation funds thus tend to hold a large proportion of their assets in liquid investments so that they have access to capital at short notice.

What about sovereign wealth funds that invest domestically?

Over the past decade, governments have sought to use their sovereign wealth to benefit their own economies. These sovereign wealth funds differ from the traditional savings and stabilisation funds in that they are often not derived from fiscal surpluses. As we outline in the annual review, their asset base is more likely to be an aggregation of government stakes in state-owned enterprises – a model popularised by Singapore’s Temasek Holdings – or funded by annual budget distributions.

While these types of institutions are not included in the official definition, in 2014, the IFSWF Board admitted several members that manage only domestic assets, reflecting the changes in the SWF landscape since 2008. Each of these applicants satisfied the Board that they complied with the requirements of a sovereign wealth fund and that their admittance enabled the IFSWF to remain true to its history, founding purpose and obligations.

Such funds have four main functions in their economies:

• Stewarding state-owned enterprises to create national & regional champions
• Enhancing local stock-market liquidity (IPOs, investing in local funds)
• Promoting economic development by investing in strategic sectors
• Attracting long-term foreign direct investment as a promoter or partner

Do some sovereign funds do more than one thing?

Yes. Absolutely. Governments from all over the world have been innovative in how they have used the assets at their disposal to best support their economies. Many funds combine two or more of functions, mixing stabilisation, savings and development.