Since their formal introduction on the investment scene in the 2000s, Sovereign Wealth Funds (SWFs) have created both interest and concern among investors. These state-owned investment funds use surplus trade balances and commodity export proceeds from commodity exports to buy global financial assets ranging from cash equivalents and global equities, direct/private equity funds and infrastructure assets.
1. Investments in Global Markets
Sovereign wealth funds invest in global markets for various purposes, including diversifying their portfolios or seeking higher risk-adjusted returns. They may also need to mitigate volatility associated with natural resource rents or overcome absorptive capacity constraints (Cohen 2009; Dixon and Monk 2017).
However, investments in global markets raise issues regarding the legitimacy of state activity within liberal global capital markets. There are fears that investments made on non-commercial grounds may distort financial markets.
Responding to concerns over their connection with state sponsors, sovereign wealth funds have implemented the Santiago Principles (GAPP 19) as an investment guiding framework. They adhere to standard practices employed by institutional investors globally – helping alleviate any worries about how close their fund may be tied to the sponsoring state. Membership in IFSWF further ensures high standards of governance are upheld.
2. Investments in Infrastructure
As state-owned assets became more prominent on global markets, some observers expressed concern that their ownership might skew financial markets in an adverse way. They reasoned that states possess resources and capabilities which private actors simply cannot exploit (Monk 2009; Clark and Dixon 2017).
Faced with concerns over state influence over capital markets, IFSWF members in 2008 agreed on a set of best-practice principles for sovereign wealth funds and investment-receiving countries called the “Santiago Principles.” These regulations stressed the need for funds to invest according to norms typical of institutional investors across global markets; their purpose being ensuring decisions about investing are made solely on commercial rather than political considerations.
Santiago Principles recognize that there is an inextricable link between a sovereign wealth fund and its sponsoring state apparatus that makes it impossible to fully disentangle their financial objectives from political ambitions of their owner-sponsor.
3. Investments in Technology
SWF investment in technology is an indispensable driver of economic growth, creating jobs and increasing productivity while at the same time presenting unique challenges that cannot easily be handled using standard portfolio management models.
Investment in technology raises geopolitical considerations that depend on the political interests of its owner-sponsors and could provide national security advantages through acquired technological expertise.
Sovereign Investment Lab at Universita Commerciale Luigi Bocconi tackles these issues through innovative empirical studies that seek to strike an appropriate balance between financial and strategic goals. For example, research by this lab into one major Asian sovereign investor suggests that it not only seeks robust risk-adjusted returns from its technology investments, but also expects them to deliver demonstrable benefits back home country tech industry – something which necessitates novel partnership structures adapted to each fund’s individual aims.
4. Investments in Real Estate
Sovereign wealth funds (SWFs) occupy an enviable global investment management role but present unique challenges. Notably, they do not fall under the same regulations and rules that apply to traditional money managers; furthermore, their policies and objectives vary significantly; for example commodity-driven SWFs focus on stabilization purposes through natural resource revenue for stabilization purposes as well as savings goals; others focus on economic diversification through development priorities or diversifying away from single resources.
Due to this reason, it is crucial to distinguish the different types of sovereign wealth funds. Commodity-driven SWFs use global bond markets to recycle surplus financial surpluses while non-commodity driven SWFs utilize foreign exchange reserves to maximize long-term return with diversified portfolios.
Both types of SWFs can often come under pressure from their home countries to invest in assets deemed sensitive to national security. Recently, alternative investments have gained increased scrutiny from governments around the world as many debate over whether or not these pose any threat to capital market stability.