Overseeing a staggering $8 trillion in assets under management (AUM), sovereign wealth funds (SWFs) are major participants in today’s capital markets. These state-owned investment vehicles are meant to bring stability to government finances or provide long-term economic stimulus. Despite sharing a moniker, there are many differences among SWFs—including variation in their sizes, goals and levels of sophistication. Read on to learn more about these influential and important funds.
What are the goals of SWFs?
At a high level, sovereign wealth funds typically have one of three goals: stability, savings or local development. This goal often varies based on the SWF’s source of capital and the needs of the entity controlling it.
What are stabilization funds?
Stabilization funds are designed to reduce the effects of volatile revenues to the government and economy. These funds are set up in countries that are highly dependent on one (sometimes more) specific nonrenewable resource; capital flows into the funds when prices are high, and the government enjoys a surplus. Alternatively, when prices are lower and government finances swing to a deficit, capital flows from the SWF back to the government and economy.
What are savings funds?
Savings funds, which make up the bulk of funds and AUM, are designed to provide an economic boost to the local economy. Natural resource-financed funds are intended to bridge the gap from reliance on a non-renewable resource to the time when the country or region depletes its natural resource base. Savings funds are intended to have a multigenerational time horizon and will be the SWFs of most interest to private market practitioners.
Many of the largest funds fit into this category, including Norway Government Pension Fund Global and Abu Dhabi Investment Authority (ADIA).
What are development funds?
In addition to multigenerational gains, development funds are also tasked with promoting economic growth within the fund’s home country or region. Many of these funds invest in the domestic economy with the goal of catalyzing homegrown markets through infrastructure investing and direct investments in local companies.
What are some differences between SWFs with long-term and short-term goals?
Funds with longer-term horizons are more focused on growth and are better suited for illiquid investments, allowing them to emphasize equity instead of cash. Despite the need to meet current obligations, savings funds already in the payout process are still well suited for higher levels of illiquid assets and investments with equity ownership, similar to pension plans.
What are some other characteristics of SWFs?
How large are SWFs?
Fund sizes for SWFs cover a wide range. They can be as small as North Dakota’s $6 billion Legacy Fund or as large as Norway’s gargantuan $1.1 trillion fund.
What are funding sources for SWFs?
Within savings and development funds, there are two main funding sources: excess natural resource revenues and foreign exchange (FX) reserves (though some capital in these funds comes from issuing bonds as well as excess tax revenue).
How sophisticated are SWFs?
That depends—sophistication varies widely from fund to fund—but it tends to increase along with AUM. Still, even some of the largest funds are limited by the importance these types of funds have to the governments that depend on them. For that reason, many of the largest SWFs may refrain from more sophisticated, risky or direct investments.
What trends are gaining popularity in SWFs?
Despite some elements of risk, we believe most SWFs want to be sophisticated investment managers, eventually handling investments in-house, forging relationships and conducting investments outside the traditional fund structure and expanding private market allocations over time.
For instance, ADIA has doubled its direct PE investments over the past three years according to the fund’s annual filing, clearly illustrating its investment prowess and asserting itself near the head of the pack in terms of sophistication.
Why might SWFs increase their allocations to private markets?
Many large investors that had previously stayed away from private markets are now allocating to them, seeing them as necessary for diversified exposure to global growth. Furthermore, private markets are becoming less illiquid with the proliferation of the secondaries market. This portfolio rebalancing tool allows institutional investors to alter private market allocations in a way that was unavailable even a few years ago.
Want to learn more about sovereign wealth funds? Download our analyst note that covers different fund types and key players in more detail.
