Lily in Year 13 looks at the importance of sovereign wealth funds, telling us more about this area of Economics.
Simply, a sovereign wealth fund is a state-owned investment fund meaning countries can invest in shares and assets internationally in the hope that these investments will then increase in value. These profits can then be extracted by a government when shares are sold and ideally then used to benefit the country’s economy and citizens.
The term sovereign wealth fund was initially created in 2005 by the economist Andrew Rozanov who stated that the funds in question “are neither traditional public-pension funds nor reserve assets…but a different type of entity altogether”. A new and exciting form of investment was emerging, now commonly called the sovereign wealth fund.
Sovereign wealth funds are important because of the economic benefits they can bring to a country. The largest fund in the world at the moment is the Government Pension fund of Norway which “owns on average 1.3% of all equities listed worldwide”, which means that Norway owns 1.3% of global stocks and shares, now worth over $1 trillion in assets. This shows the scale of these funds and the influence they can have on the world economy.
One key benefit of sovereign wealth funds is the diversification of countries incomes. This is because sovereign wealth funds almost always invest in foreign assets which is particularly helpful if a country relies on a single commodity for their income as they are more at risk if that particular industry experiences a downturn. This is why many oil reliant countries have sovereign wealth funds as oil markets are often volatile. This factor has become particularly important in 2020 through the corona virus epidemic, one specific example being in the oil industry since “US oil prices went negative for the first time in history” in April 2020, resulting in companies paying people to take oil off their hands because the demand for oil had fallen so rapidly.
This shows the oil industry is particularly vulnerable to large fluctuations in price and if a country relies on oil for their income they could be at risk of an economic downturn (recession). Sovereign wealth funds have been shown to limit this risk as some funds around the Gulf (largely oil reliant countries) are already “channelling some of their billions back to counter the recession triggered by the coronavirus pandemic.”, showing how important these funds have already been for the recovery and survival of oil reliant economies throughout the Covid-19 outbreak.
However, there are debates surrounding the benefits of sovereign wealth funds as there will always be an element of risk in making investments since they can never be one hundred percent safe as assets always have the possibility of decreasing in value. This includes the idea of black swan events – the idea that some events are unpredictable and therefore markets cannot prepare for the shocks they cause. This is one way of stating we can’t predict the future and therefore will never be able to completely rely on an investment bringing positive returns. Which poses the question ‘is it a good idea to be risking millions of public money on the stock market?’
Sovereign wealth funds can be very beneficial but there are always opportunities for investments to turn sour. This means that it is important for a country to analyse the rewards that can be generated before creating a sovereign wealth fund. These countries are still not immune to black swan events which can disrupt the global economy however, if profits from these funds are used well they can actually mitigate these risks and add huge value to their economies, such as through diversification. A well-managed and cleverly invested fund will always benefit the country at hand if it is used wisely. These benefits mean that sovereign wealth funds are likely to become more and more common, making them important as they a likely to become a huge factor of the global economy.
Sources:
Report – Who Holds the Wealth of nations? By Andrew Rozanov – see http://piketty.pse.ens.fr/files/capital21c/xls/RawDataFiles/WealthReportsEtc/SovereignFunds/General/Rozanov2005.pdf
How Sovereign Wealth Funds improve firms’ corporate Governance by Vincent Bermejo – see https://www.forbes.com/sites/esade/2019/11/11/how-sovereign-wealth-funds-improve-firms-corporate-governance/
FT article – US oil prices below zero for the first time in history – see https://www.ft.com/content/a5292644-958d-4065-92e8-ace55d766654
Bloomberg article – Gulf sovereign wealth funds seen shedding $300 billion in market mayhem, by Mathew Martin and Nicolas Parasie – see https://www.bloomberg.com/news/articles/2020-03-26/gulf-sovereign-funds-seen-shedding-300-billion-in-market-mayhem
Nassim Nicholas Taleb ‘The Black Swan’ Penguin see – https://www.amazon.co.uk/Black-Swan-Impact-Highly-Improbable/dp/0141034599