The Future of Sovereign Wealth Funds
Despite their recent discovery and lengthy history, the story of sovereign wealth funds (SWFs) is just beginning. Sovereign wealth funds became increasingly popular vehicles due to their ability to at least present the illusion of solving a problem, even though their efficacy as noted is minimal. We have focused on the major SWFs and their evolution over time, but it is likely that others may become much larger and that the investment strategy will evolve to better manage the macroeconomic and commodity risks. Countries with large commodity resources are studying SWFs as models for best practices. As the search for commodities continues to expand to ever more remote and challenging locations that have not been explored, it is likely that more countries will face the dilemma of how to prudently manage commodity windfalls. The approaches that countries are taking in managing their futures become ways of balancing the political interest to spend against the economic preference for steady state-income growth.
There is more, however, to the future of SWFs than new countries managing unexpected windfalls. The future of sovereign wealth funds and, more important, the dynamic of a government as investor, will evolve in unexpected ways. The financial crisis in 2008 made clear the risks of the international capital markets. Some countries suffered large drops in their portfolio values or in flagship holdings, causing unwanted publicity, while other countries with different portfolio constructions enjoyed a relatively mild downturn. Since the long-term investor nature of SWFs has allowed them to hold through the crisis and enjoy the rebound and, in some cases, buy when markets dropped, the crisis brought to the forefront concerns about global market volatility and the importance of a well-designed portfolio. For instance, commodity-exporting countries that witnessed the price of oil drop by nearly 50% with similar drops in a highly correlated SWF portfolio were forced to rethink their asset allocation strategy. Conversely, countries like Saudi Arabia and Russia with their primary allocations in high-quality fixed-income instruments suffered smaller losses.
Countries around the world are creating a large number of new SWFs. As with many business or investment fads, the current wave of sovereign wealth fund formations is poorly thought out, with no source of underlying wealth and not