SWFs like Norway's Government Pension Fund or Saudi Arabia's Public Investment Fund form part of the broader class of institutional asset allocators. A significant distinguishing characteristic, though, is that an SWF's initial assets typically come from the wealth generated from natural resources, with the investment vehicle of the SWF representing a means of diversifying and providing income for future generations. This mandate means they do not have the acute near-term obligations of, say, a pension plan, and it's this investment horizon that's crucial for understanding the strategic differences of SWFs from other asset allocators.
Overall, the purposes served by SWFs are threefold:
• Provide capital for the future. In this way, SWFs resemble university endowments like Yale's that manage money today for the benefit of students in the future or pension plans like CalPERS that manage money to cover future liabilities.
• Reduce the instability of the government's top line. In this way, SWFs provide their governments with hedging mechanisms against wild swings in the prices on their home country's exports.
• Act as holding companies. SWFs serve as asset managers for their government's biggest long-term bets in areas like infrastructure. In this way, SWFs resemble the GP of a traditional venture capital or private equity fund tasked with portfolio management on the behalf of LPs.
Whatever the remit, every SWF must manage its risk-return profile for the long term, to diversify and to plan for the future. This isn't just about capital preservation but also ensuring there's sufficient money for the tomorrow after tomorrow. And they have several strategies at their disposal.
Similar to other limited partners, SWFs will commit funds to general partnerships in order to generate returns on invested capital. The significant difference is, though, that they often invest from a single lump sum that needs to last in perpetuity—like an endowment but one without the benefit of new donations. For instance, Saudi Arabia's PIF is hardly alone contributing to other pools of capital, such as SoftBank's Vision Fund or Blackstone's Infrastructure Partners.
Given their long investment horizons and deep coffers, some SWFs will also develop the internal resources to invest directly into companies. For instance, Saudi Arabia's PIF holds a direct stake in electric car maker Tesla. The longer investment horizon of a SWF renders the illiquidity of direct investing less of an issue than it can be for other LPs.
Another important incentive for making these moves is they can help SWFs to gain expertise from GPs before embarking on their own. The risk-return profile of an SWF resembles that of an endowment, with its portfolio construction representing longer holding periods for certain asset classes along with an exchange of liquidity to its investments for a risk premium. Above all, these lengthy time horizons do a great deal to explain the investment possibilities of a SWF.
Take Tesla again. Saudi Arabia need not necessarily see a return on its investment now or even the next five years. The fund can literally and figuratively afford to wait for Elon Musk to realize his vision as the rest of the world continues its slow but sustained shift from fossil fuel-based transportation models to a broadly electric footprint—along with all the infrastructure that goes with it.
For Saudi Arabia, its investment in Tesla represents a bet on a set of technologies poised to undermine the very source of the sovereign wealth bound up in the PIF: oil. Although SWFs have historically raised the capital that they allocate from several sources, chief among them is petroleum. To appreciate just how deep this relationship between SWFs and commodities like oil runs, consider Kazakhstan: 2017 population of some 18 million with a GDP of almost $160 billion. Its SWF, the Kazakhstan National Fund, has about $60 billion in AUM. Its mission is, broadly speaking, to provide the country with a hedge against the volatility of the prices for oil, gas and metals.
There are other origins for capital in SWFs, however, including the trade surpluses that underpin the sovereign wealth of Singapore's Temasek Holdings. But the basic purpose remains the same: SWFs provide a bulwark against the pricing volatility of the home country's exports. And that's because SWFs handle the excess capital of a country—or, in the case of the Alaska Permanent Fund, a natural resource-rich US state—and manage it across a range of long-term bets to cover explicit expenditures that governments have entrusted these funds to cover, like state-sponsored pension plans.
SWFs must, therefore, contend with the heightened potential for political corruption. And it's not an unfounded governance consideration. Since these funds are tied to governments and are tasked with managing the wealth of nations, their capacity for acting at possible cross-purposes with sound long-term investment strategies can stem from pressures to achieve short-term political gains like propping up struggling domestic industries.
According to one analysis of this phenomenon, roughly a quarter of SWFs involve politicians, leading almost half the funds from these pools going to deals in the countries where they're headquartered.* Those SWFs with a greater concentration of external managers invest less in the home country of that fund. SWFs with a greater share of political leaders involved have historically chased investment trends more often than those with external managers.
*"The Investment Strategies of Sovereign Wealth Funds," Journal of Economic Perspectives, Shai Bernstein, Josh Lerner and Antoinette Schoar, 2013