This article was written by Freddy Orchard, who is a consultant and author of ‘Safeguarding the Future’. He has been director of Economics at the Monetary Authority of Singapore (1995-1997) and GIC (1989-1999). He currently sits on the investment committees of several Singapore charities.
The term “Sovereign Wealth Fund” (SWF) was coined by financial analyst Andrew Rozanov in his 2005 article “Who Holds the Wealth of Nations?”, to demarcate an emerging breed of state-owned investment funds from other institutional investors. Since then, the term has gained wide usage and SWFs have been acknowledged as a significant investor group.
What is a sovereign wealth fund?
While every SWF has its own unique features, the essence of a SWF is that it is state-owned and mandated to invest the public funds under its charge.
The focus on investing is what differentiates a SWF from a central bank. Central banks hold foreign exchange reserves, essentially to implement exchange rate policy. They also have other functions such as supervising the financial system. A SWF by contrast is primarily an investment management entity enjoined to grow its assets under management (AUM). SWFs invest in a wide range of asset classes such as bonds, listed equity, real estate, private equity and infrastructure. Their asset allocation policy and risk posture will vary with the purpose of the funds they manage.
Depending on their funding source, SWFs can be classified as either commodity or non-commodity based. Commodity-based SWFs include those from oil-producing countries such as the Arab Gulf states, Russia, Brunei and Norway. Non-oil commodity producers include Chile which is funded mainly from copper mining royalties, and Botswana from diamonds and mineral royalties.
In contrast, non-commodity SWFs are funded from reserves accumulated through non- commodity exports, capital inflows, budget surpluses, land sales and public savings, and the privatisation of state-owned enterprises. Most Asian SWFs are in this category, like Singapore, China and South Korea. The share of AUM by non- commodity based SWFs rose from 39% to 48% over the 10 years to 2018.
SWFs vary considerably in size, from Norway’s Government Pension Fund Global (GPFG), which is reported to have the largest AUM at around US$1.1 trillion (end 2019), to SWFs with AUM of less than US$1 billion. SWF wealth is also heavily concentrated, with the top 10 holding about 80% of the combined SWF AUM. Asian and Middle Eastern SWFs each account for 40% of the total AUM of SWFs and European SWFs another 13%.
Several SWFs, like Singapore’s GIC, Norway’s GPFG and Kuwait’s Kuwait Investment Authority (KIA), only invest internationally. Meanwhile, there are SWFs like Malaysia’s Khazanah Nasional and Abu Dhabi’s Mubadala which invest both domestically and internationally.
Different types of sovereign wealth funds
The International Monetary Fund (IMF) categorises SWFs into five types, each with a specific purpose, though many have objectives that straddle several categories: