The composition of fund management vehicles is crucial for the countries to balance strategic investments and investments that provide returns. Sovereign wealth funds have attracted quite some attention as more countries are opening these funds and investing openly in renowned companies and notable assets. There is a dramatic rise in the size and number of Sovereign Wealth Funds. According to the SWFI data, In 2020, more than 91 Sovereign Wealth Funds have accumulated wealth assets that amount to approximately $8.2 trillion. It is important to understand Sovereign Wealth Funds’ history, purpose, types, and growth as they may influence the global economy with their wide reach.
What is a Sovereign Wealth Fund?
A Sovereign Wealth Fund is an investment fund or entity that is owned by the state. When the nation has a budgetary surplus, the money, i.e., Sovereign’s wealth, can be channeled as investments rather than keeping with the Central Bank or pumping it into the economy. In this way, few of the Sovereign Wealth funds invest in the nation’s fiscal surplus. At the same time, some SWFs are established from proceeds of privatization, foreign currency operations, revenues resulting from resource exports such as trading commodities and crude oil. They invest in various asset categories such as equities, government bonds, gold, real estate, foreign direct investments, etc.
What is the purpose and nature of Sovereign Wealth Funds?
Sovereign Wealth Fund, just like other investment funds, has their specific objectives, risk tolerance, terms, liquidity concerns, and liability levels. Depending on the fund’s assets, its tolerance for risk can be very conservative to high-risk tolerance. The funds also have different preferences in terms of long-term returns and liquidity.
The purpose of a Sovereign Wealth Fund is to generate good long-term returns. Usually, a country’s central bank doesn’t focus on long-term returns, rather on managing foreign exchange reserves in the short term while offering easy liquidity in times of a market crisis. Along with diversifying the portfolio and ensuring long-term capital growth, SWFs help stabilize and protect the budget and economy in an excessively volatile export market.
Terms of Investment
The investment in Sovereign Wealth Funds is usually a substantial amount of money. The amounts that each SWF accepts vary from country to country and fund to fund. Some SWFs are more transparent about their investments and corporate governance practices than others. Some may declare their investments periodically, while others may not reveal the same. At times, the SWF invests directly in domestic industries. Various countries can create or dissolve SWFs depending on the needs of their economy and population.
History of Sovereign Wealth Fund
The establishment of the first Sovereign Wealth Fund in 1953 was done as a solution for Kuwait with a budget surplus. The Kuwait Investment Authority was established to invest in excess oil revenues. In 1955, a fund was created by Kiribati to hold its revenue reserves. The actual major SWF was Singapore’s Government Investment Corporation (GIC), established in 1981.
The largest Sovereign Wealth Fund currently in the world is Norway Government Pension Fund Global, which was established in the year 1990 to hold the country’s surplus revenues from the oil trade. It was then known as the Government Petroleum Fund. It changed its name to Norway Government Pension Fund Global in the year 2006 as it now invests in fixed income, equities, and real estate. In 2019, the SWF reported a 19.9% return. The highest allocation of 71% was in equities, which reported a return of 26.0%, while 3% of the fund was in real estate and 27% in fixed income.
Types of Sovereign Wealth Funds
The traditional Classification of Sovereign Wealth Funds includes Stabilization funds, pension reserve funds, reserve investment funds, savings or future generation funds, Strategic development sovereign wealth funds (SDSWF), reserve investment funds, Target Industry-specific funds, including possibly emerging or distressed.
Sovereign Wealth Funds can also be categorized into commodity or non-commodity Sovereign Wealth Funds are based on how the fund is financed.
Commodity Sovereign Wealth Funds are financed by commodity exports. There are greater surpluses in the nation that exports the commodity if there is a rise in the price of the commodity. On the other hand, an economy that thrives on its exports may experience an economic decline in the deficit scenario if there is a fall in the price of the commodity. SWFs diversify the country’s money by investing in various areas, thus stabilizing such economies.
Non-Commodity Sovereign Wealth Funds are financed by the excess of official foreign currency reserves.
Pros and Cons of Sovereign Wealth Funds
The Pros of SWF include stabilizers in times of nationwide recession and increased government spendings. It can help to gain income other than taxes. It promotes diversified management of funds strengthening the economy.
There are certain cons of the SWF, such as the returns of SWF are not guaranteed though predicted. A downturn in SWF can also impact the foreign exchange rates negatively. There is a lack of transparency in certain SWFs, which may lead to mismanagement of funds. Post-2008, there has been an emphasis on transparency to dispel fears of protectionism.
NIIF: India’s Sovereign Wealth Fund
In 2015, India’s first Sovereign Wealth Fund was set up by the government of India- the National Investment and Infrastructure Fund (NIIF). This fund was created to maximize the economic impact in commercially viable projects via infrastructure investment.
NIIF manages funds of over US$4.4 billion, As of Sept 2020. NIIF manages three kinds of funds, namely master fund, fund of funds, and strategic investment fund.
Investors in NIIF
In Oct 2017, Abu Dhabi Investment Authority (ADIA) signed the first agreement of investment worth 1 Billion dollars with NIIF. Contributors in NIIF’s Master Fund include Domestic Institutional Investors (DIIs) such as Kotak Mahindra Life, HDFC Group, Axis Bank, and ICICI bank. An investment of $200 million was announced by Asian Infrastructure Investment Bank (AIIB) in June 2018. As a part of Atma Nirbhar Bharat Abhiyan in November 2020, the union cabinet approved Rs. Six thousand crore investments in NIIF. The most recent investment in NIIF’s Fund was in Feb 2021, by NDB (New Development Bank) that announced an investment of 100 million dollars.
The Sovereign Wealth Funds is a good way for the country to diversify its investment portfolio. The rise of SWF, especially post 2005, has spotlighted its functioning and value addition to a nation’s investments. With India focussing on its Sovereign Wealth Funds and new investments coming in, we might get to see rapid growth in NIIF in the years to unfold.