Shrewd households have a mechanism for saving and investing in good times to help augment future income and mitigate future monetary crises. Sovereign wealth funds (SWFs) do a similar job for nations. SWFs are used to invest surplus cash into assets with the expectation that those assets will give returns in the form of appreciation and income. This surplus of cash comes from commodities (e.g., oil) and non-commodity sources (e.g., current-account surpluses and privatization). Currently, SWFs are geographically concentrated in the Persian Gulf (commodities) and Southeast Asia (current-account surpluses). There are exceptions, such as the Government Pension Fund of Norway, the biggest SWF in the world.
SWFs are increasingly becoming relevant for many reasons. According to The Economist, SWFs are a possible answer to an aging population. Surpluses during population dividend years can fund healthcare spending when the population starts to age. SWFs allow spending on constituents without taxing them, which is politically attractive. Another politically attractive feature is the ability to stabilize government spending. SWFs also allow privatization of money-sucking public sector entities (PSEs) by ensuring that the proceeds from privatization will not be squandered within one election cycle. In a future with universal basic income and AI (artificial intelligence) leaving the workforce redundant, SWFs will only increase in their utility.
SWFs have been in existence since the 1950s, and they grew obscurely into the 2000s. However, in 2008, they came into the limelight after buying shares in failing American banks. Naturally, SWFs came under scrutiny because of their government-owned nature. Since then, an analysis of the nature of the effects on global investment has been due. The SWFs’ opaque nature of investment limits the data on their activities. Therefore, literature has used equal measures of theory and empirical evidence to understand the effects of SWFs on global investment.
Effects of SWFs on global investment
First, SWFs may affect the prices of assets in different countries. In addition, their nationalistic nature creates an agency problem, which may prompt a global investment-protectionist regime. Moreover, it is surmised that SWFs may replace some of the global secondary markets for investments. Furthermore, firm behavior can also be altered because of SWF ownership. Finally, this section will analyze the effects of SWFs on their domestic economies, which is the raisond’êtreof SWFs. Whenever negative effects are found, possible mitigation strategies naturally need to be discussed. Each of these effects deserves individual discussion, starting with the effects of SWFs on prices.
Research has shown that SWFs have no long-term boosting effect on the prices of acquired stocks (there is a short-term increase in the price of the asset). In comparison, private-equity firms have been known to move the price of an acquired stock upwards. This effect shows that SWFs will not have a destabilizing effect on global stock markets. Intuitively, this empirical result is congruent with the long-term investment nature of many SWFs. Furthermore, research has found that SWFs dampen the adverse effect of commodity volatility on economies. This research was conducted for 69 countries and controlled for heterogeneity. Therefore, it can be concluded that SWFs do serve their purpose of stabilizing government expenditure.
SWFs can have three major effects on the behavior of a firm. Due to lack of data, literature has focused on theoretical and intuitive explanations for the behavior of the firm. The firm’s behavior will tend to become long-term in nature. This is because SWFs tend to inject capital with a long-term, passive mindset. This allows management to focus on strategic bets rather than tactical survival via balance-sheet performance. This is also good for the market overall, which has been criticized for focusing on short-term share buybacks rather than long-term investment into products and markets. Focus on the long-term also allows increased tolerance for risks. Furthermore, SWFs may introduce new board members to companies. They may provide new insights, which may lead to increased firm dynamism. This effect is conditional on meritocratic appointments of SWF representatives as board members.
There may be one possible harmful effect of SWFs on the behavior of firms. This pertains to possible situations in which SWFs direct a firm to engage in behavior that goes against the interests of the host country. In the long-term, this may lead to investment protectionism that will limit the potential of the SWF in a best-case scenario and spread to other forms of investment in the worst case. There are two self-policing tactics to limit the negative effects arising from the above-mentioned agency problem. First, to ensure that an SWF abides by the Santiago Principles laid out by the International Forum of Sovereign Wealth Funds (IFSWF). The international nature of the principles stops them from being seen as discriminatory. The second strategy involves limiting the maximum share ownership per firm for a SWF. This tactic will limit influence as well as the risk exposure of a SWF.
Some critics have raised the alarm that SWFs may replace some of the financing from stock markets. This argument rests on the fact that SWFs may have lower public-disclosure requirements as compared to stock markets. However, this argument fails to stand the test of scrutiny on several grounds. First, the assets of the SWFs simply don’t stand up to global requirements. According to Reuters, the combined ownership of all classes of assets for SWFs stood at $7.45 trillion, while BlackRock alone has more than $6 trillion of assets under management (AUM). Second, regulation has two incentives. The first is to protect the investor, while the second is to reduce volatility in the economy. Reducing volatility in the economy will always command major investment channels to be well regulated. Hence, SWFs will complement rather than compete with global investment channels.
The SWF is an essential part of the investment landscape and deserves attention. Overall, SWFs seem to have a stabilizing effect on global investment. At present, their effects cannot be empirically judged because of the opaque nature of the investments. With the implementation of the Santiago Principles, this may change in the future. Furthermore, the Great Depression has shown that protectionism does not work; therefore, any qualms about SWF investment are best dealt with through dialogue and cooperation.