Because of their size and rapid growth sovereign wealth funds (SWFs) face many of the same problems as other large and long-term institutional investors in a particularly acute form. They must find investment opportunities on a big enough scale to generate sound long-term returns without overwhelming the underlying markets.
But because SWFs hold money in trust on behalf of the nation, they face additional constraints. Managers are under pressure at home to pursue prudent strategies that avoid large losses gambling with the national patrimony, while investments overseas arouse sensitivities in host countries where their investments are located.
MULTIPLE OBJECTIVES AND FUNDING
SWFs are defined by the International Monetary Fund (IMF) as government-owned investment funds set up for macroeconomic purposes, funded by the transfer of foreign exchange and mostly invested in long-term assets overseas (“Sovereign Wealth Funds — A Work Agenda“, 2008).
SWFs are a heterogeneous group, set up for very different reasons, with a wide variety of investment strategies. The IMF identifies five main categories:
* Stabilisation funds set up by commodity-producing countries to smooth fluctuating foreign exchange earnings and government budget revenues caused by large swings in commodity prices or sudden changes in production.
* Savings funds for future generations which convert non-renewable assets (such as oil reserves) into a more diversified portfolio of assets.