Sovereign wealth funds are investment accounts made up of surplus funds separate from a nation’s fiscal reserves. They can come from various sources and are invested as a hedge against a nation’s usual source of income. They are of strategic importance, and some nations have enacted laws limiting foreign investment. Some funds are operated by central banks, while others are separate entities.
A sovereign wealth fund is a nation’s investment account, made up of surplus funds, but separate from the reserves the nation maintains for fiscal management purposes. Although the name “sovereign wealth fund” was first used in 2005, the funds themselves have been around since the mid-20th century. The first such fund, the Kuwait Investment Fund, was started in 1953, before that nation had achieved its independence from Great Britain. The determinants of whether a nation has a sovereign wealth fund are whether it has excess cash and the political will to bail it out.
While most sovereign wealth funds are created as a result of a budget surplus, they can come from a variety of sources. Kuwait, for example, started with excess revenue from its state oil drilling company. When a nation faces a glut of cash, it has several options as to its disposal, but these options essentially boil down to spending or saving. Spending can take many forms, such as capital or operating expense, paying down debt, or distribution among taxpayers. Although the spending is politically popular, it can sometimes be fiscally irresponsible. Nations whose economies are heavily dependent on the export of raw materials, for example, are prudent to build up a reserve against market downturns. Others may establish a sovereign wealth fund for a specific purpose, such as the Norwegian Government Pension Fund.
Sovereign wealth funds are invested, sometimes as a hedge against the nation’s usual source of income. For example, the United Arab Emirates (UAE) sovereign wealth fund, started in 1976, was financed with excess revenue from oil operations. Part of his portfolio is dedicated to various investments other than oil, as a hedge against an uncertain future in that market. However, sovereign wealth funds are not immune to questionable investment decisions, with several losing value in the subprime mortgage debacle of the early 21st century.
SWFs are of immense strategic importance for several reasons. A rogue nation with a large sovereign wealth fund could use it to destabilize markets, for example. Any nation could use its sovereign wealth fund to protect or promote its own strategic interests, for example, by accumulating currency or debt of certain nations to compromise its financial integrity or ability to defend itself. Many nations, expressing concern about this power of sovereign wealth funds, have enacted laws limiting foreign investment, or requiring official approval of foreign ownership of domestic companies above a certain percentage.
Although some sovereign wealth funds are held as separate entities, others are operated by their nations’ central banks as part of their overall economic management strategy. Funds held and managed in this manner are generally of significant importance to the nation’s economy, and significant losses to the fund, as occurred during the subprime loan crisis of the early 21st century, can impact the nation’s economy. However, when the fund is operated as a separate entity as a mutual fund, the impact of the fund’s performance on the nation’s economy is diminished.
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