23
Jan
08

Sovereign Wealth Funds

A Sovereign wealth fund (SWF) is a fund owned by a state composed of financial assets such as stocks, bonds, property or other financial instruments .

Sovereign wealth funds are, broadly defined, entities that can manage the national savings for the purposes of investment. The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, SDRs and IMF reserve position held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are assets of the sovereign nations which are typically (but not necessarily) held in domestic and different reserve currencies such as the dollar, euro and yen. The names attributed to the management entities may include central banks, official investment companies, state pension funds, sovereign oil funds and so on.

There have been attempts to distinguish funds held by sovereign entities from foreign exchange reserves held by central banks. The former can be characterized as maximizing long term return , with the latter serving short term currency stabilization and liquidity management. This distinction points in the right direction, but is still unsatisfactory. Many central banks in recent years possess reserves massively in excess of needs for liquidity or foreign exchange management. Moreover it is widely believed most have diversified hugely into assets other than short term, highly liquid monetary ones (almost no data is available however to back up this assertion). Some central banks even have begun buying equities or derivatives of differing ilk (even if fairly safe ones, like Overnight Interest rate swaps).

Nature and Purpose

SWFs are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel it into consumption immediately. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. To reduce the volatility of government revenues, counter the boom-bust cycles’ adverse effect on government spending and the national economy or build up savings for future generations, SWFs may be created. One example of such a fund is The Government Pension Fund of Norway.

Other reasons for creating SWFs may be economical, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf war managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation is partially the expression of a desire to create an international financial center. The Korean Investment Corporation has since been similarly managed.

To download two documents:

  • Why India Should welcome but watch sovereign wealth funds
  • The Rise of Sovereign Wealth Funds

Click here

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