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Though a good problem to have, sovereign wealth funds struggle with how to manage the amount of money entrusted to them. Sovereign wealth funds have competing financial, economic, political, and business mandates. From maximizing risk adjusted returns to promoting economic development and diversification to creating national champions or stable earnings for future generations, sovereign wealth funds face a difficult task in managing the competing expectations. This chapter will focus on the investment challenges and objectives of managing such large amounts of money. Though there is little evidence that sovereign wealth funds are using their investment capital to leverage political foreign policy victories, their success as investors is mixed. Rather than confusing their public policy and investment mandates, sovereign wealth may open up additional opportunities for partner firms through their privileged position though firm performance remains mixed. Sovereign wealth funds appear willing to accept different levels of risk through their asset allocation. Whether holding large amounts of cash or short term fixed income securities or a riskier portfolio of equities and alternative investments, countries reveal divergent risk levels in their portfolios. Though a good problem to have, countries are taking a different approach to managing the new found wealth.

The primary concern of politicians and economists stems from the potential for the state to interfere in business matters and either protect or favor a certain business. The interests of government and business are fundamentally different interests. However, if governments favor certain business this creates the possibility that national interests may become corporate interests instead. This chapter explores the fear of politics and sovereign wealth fund becoming closely intertwined, the evidence that they have or not have merged, and the primary concerns such as national security that states might use sovereign wealth funds as instruments of state power. While the evidence that sovereign wealth funds have acted historically as instruments of state power or in collaboration remains thin, the logic behind the fear is not irrational. Drawing upon specific cases where the profit maximizing investment logic and the public policy interests of states have intersected, the politics of sovereign wealth is studied in both the international and domestic context. The sheer size of financial strength make sovereign wealth funds defacto political instruments in both the domestic and international context.

Despite their new found popularity, sovereign wealth funds date back as many as fifty years. Originally intended to counteract the boom and bust cycles of oil and commodity dependent economies, stabilization funds grew out of countries attempts to establish rainy day funds which could tide them over when prices fell and promote economic development. This chapter will provide a brief history of sovereign wealth funds, their evolution from small rainy day funds to major international investors, their increased sophistication, and the spread to an increasing number of countries seeking to manage monetized natural resource wealth.

Sovereign wealth funds are designed to solve specific economic and financial problems. Surplus capital inflows, primarily from commodity dependent states, threaten to cause currency appreciation and increase inflation. This chapter will focus on the economics of sovereign wealth funds and the common policy dilemmas facing these countries. Drawing upon the extensive economics literature focusing on commodity dependent states, this chapter focuses on why do sovereign wealth funds exist, what problems are they designed to solve, and how well do sovereign wealth funds address these problems. Contrary to popular belief, sovereign wealth funds are not political creations, but were created for economic reasons to address specific economic problems and are created in countries with very specific challenges. Countries with large current account surpluses, primarily from natural resource exporting, need to stabilize their inflows and investment patterns to smooth volatile commodity prices. The impact of these structural inflows has not been considered and what economic policies might better suit countries with surpluses has not been fully considered in the sovereign wealth fund debate. This chapter will study, in non-technical language, sovereign wealth funds and the unique set of economic issues faced by their domestic economies.

The two largest European sovereign wealth funds are in Norway and Russia. While each gain their sovereign wealth fund capital from natural resource extraction each country targets different investment objectives with divergent management styles and broader macroeconomic framework. Norway operates its fund as a generational fund for the benefit of future citizens while Russia initially established its fund as a type of rainy day account. What distinguishes Norway and Russia from other funds is the level of transparency in their funds. Norway publishes regulations, ethics, investment decisions, capital levels, and annual returns. Russia specifies by law its investments and publishes monthly updates to paid in capital, investment allocation, and annual returns. Though they both have established and transparent frameworks, the similarities end there. Norway manages a diversified portfolio of equity and fixed income securities with benchmark returns, risk budgets, and clear decision making capital withdrawals to fund government budgets. Conversely, Russia maintains a low risk portfolio of bank deposits and high quality primarily short term sovereign and corporate debt. The Russian preference for running large government budget deficits financed by capital withdrawals from their sovereign wealth fund has fueled wasteful spending and large drops in balances. While an ideal national wealth risk management profile may more closely replicate the Russian investment allocation, their economic and political management reveals the temptations facing commodity rich states.

Middle Eastern sovereign wealth funds remain less transparent and more difficult to disentangle from the local economy than other funds. More dependent on the price of oil than almost any other economies in the world, the Gulf Funds are a microcosm of the criticisms of sovereign wealth funds. Despite strained economic relations and rhetoric over large oil surpluses, Middle Eastern sovereign wealth funds reveal numerous different investment strategies. While the Saudi Arabian Monetary Authority is heavily invested in cash and fixed income securities, the Abu Dhabi Investment Authority holds a higher risk portfolio of debt, equity, and alternative investments. Additionally, Middle Eastern sovereign wealth funds due to their small commodity dependent formation remain intertwined with the government and local economy. More than any other region, it is difficult to tell where a Middle Eastern government ends and the sovereign wealth fund begins. Controlled by the political structure with overlapping managers and in some cases the personal finances of the ruling elite, the Gulf funds provide a fascinating history to the development and pitfalls of sovereign wealth funds.

This chapter examines emerging capital economies from the perspective of creating the new success stories in the developing world. It focuses on the underlying (legal) causes for such successes and the impediments thereto. The perspective of international finance (e.g., foreign direct and foreign portfolio investment), and their relative pitfalls are examined along with a sea change in investment patterns as may be discerned from sovereign wealth funds, and other related issues. Financing private infrastructure projects, the access to private bond and equity markets, and the dangers of global financial contagion are all explored. Finally, the need for the prudential and legal regulation of private equity markets, and related issues, are examined in the context of furthering development objectives.

This chapter provides an introduction to the formation and development of sovereign wealth funds (SWFs) around the world. Its argument is largely about form and function, emphasizing the functions that SWFs provide for nation-states in the context of the global financial system. The purpose here is to classify and explain the rise of SWFs, making links to the relevant literature in the social sciences on institutional innovation and change. It also emphasizes the importance of SWFs as an institutional innovation consistent with and drawing legitimacy from fundamental changes in the global financial system that have prompted governments to seek ways of managing their “place” in a system subject to considerable volatility, risk, and uncertainty.

It is important to understand the evolution into sovereign wealth funds, their behavior, and their political and economic implications of sovereign wealth funds. Despite their diversity in evolution, economic situations, and investment objectives, sovereign wealth funds share some similarities. To form sound policy, it is vital to understand how they operate.

The major Asian sovereign wealth funds are the only funds in the world not based on commodity revenues. China and Singapore created their sovereign wealth funds from accumulated budgetary and trade surpluses. China and Singapore also manage their funds differently taking a more statist view of economic matters targeting specialized industries. Conversely, Chinese and Singaporean investment in both local and foreign firms are focused on controlling stakes in targeted industries. They have taken significant stakes in domestic companies urging them to expand internationally and protecting them from foreign take overs. China has targeted financial services, natural resource, and high technology industries which it views as vital to sustaining and increasing Chinese growth. This investment pattern, more than any other sovereign wealth fund, has caused concern by governments around the world not swayed by the declared benign intentions of the Chinese government. Singapore has taken a statist view to its sovereign wealth fund but designed to build up national flagship giving them preferred access to capital and even venture capital funding for high technology firms. While the intention of Chinese investment worries foreign critics, the inconsistency of declared Singaporean returns is most concerning. The divergence between the stated returns of Temasek, the primary Singaporean indexes, of which they are the primary owner, and other financial metrics such as Singaporean indexes or other sovereign wealth funds is worrying.

Sovereign wealth funds as a vehicle for commodity rich states is an increasing phenomenon. This chapter examines two lesser known funds in unique circumstances and whether sovereign wealth funds as even the problem Focusing on Brazil, and country forming a sovereign wealth fund due to the discovery of large offshore oil deposits, and Azerbaijan a country nearing the end of its oil and gas reserves, we focus on how countries establish their fund framework and what they do after the capital surplus stops. While sovereign wealth funds are the most widely known, other companies enjoy similarly close relationships to government. While sovereign wealth funds have been criticized for political indiscretions and seeking national security secrets, many have been slow to recognize the more predatory national champion companies. Russian and Venezuelan oil and gas companies have taken aggressive movements designed to influence politics in other countries. Chinese state controlled companies have actively sought national security and high technology goods prohibited by US export regulations. Examining specific case studies of government involvement with industry, it is quite possible that the transparency of financial markets prevents greater state over reach than the more subtle and less known government owned firms.

This chapter asks what is the “sovereign” in sovereign wealth funds (SWFs)? More specifically, how can we interpret the SWF phenomenon without succumbing to classical notions surrounding the territorial status of sovereignty and of political economy? The first section discusses sovereignty in theory and in practice, and in relation to SWFs; it also includes a theoretical grounding for the primary contribution of the chapter in the second section. This is a stylized typology of SWFs in relation to the state and its sovereignty. It comprises five ideal-types: postcolonialist, rentier, productivist, territorialist, and moralist. This typology does not seek to replace the more conventional classifications or typologies of SWFs based on their source funding or the explicit a priori objectives of the sponsor. Rather, it is historical shorthand designed to provide an understanding of the long-term significance of SWFs and the factors that might underpin further development of new SWFs in different countries. The different typologies are illustrated with reference to different SWF cases in the following chapters of the book.

This chapter looks to the future and rehearses the argument about form and function, recognizing that today's ideal form of the sovereign wealth fund (SWF) is based on two sets of rules: those related to who is responsible for investment decision-making and those related to the conceptual foundations of investment practice. Thereafter, it suggests that the form of SWFs may not be stable over the long term; the challenge facing SWFs is, in part, about transcending traditional forms of investment management in favor of a genuine commitment to long-term investment in the interest of both the SWF and the sovereign. The chapter argues that transcending the current paradigm may necessitate the transformation of the form of SWFs such that they become strategic investors rather than portfolio investors, knitting together their sponsors' geopolitical interests with investment management.

This chapter presents the first case study, looking past the geopolitical concerns that have plagued sovereign wealth funds (SWFs) and focusing on the competing domestic political interests embedded in sponsoring countries. In other words, the chapter examines the domestic, political claims on SWFs and the principles and practice of governance used to discipline those interests. It shows that there is an ever-present temptation that faces SWF sponsors: the option of spending the assets for current political advantage. Through the case study of Australia's Future Fund (FF), it examines how governance can, in effect, tame political temptation. Indeed, the Australian government specifically addressed the question of political temptation in its design of its SWF. The chapter focuses on the principles used to design the FF and references recent research on the principles of best-practice investment management.

This chapter first looks at the problems associated with managing resource riches, referencing academic literature that coined the phrase “Dutch disease” (resource wealth may be lost by virtue of institutional incapacity and the adverse effects of unmanaged income flows through the domestic economy). It then turns to the issue of institutional innovation, noting that while a couple of Middle Eastern countries were early adopters of the sovereign wealth fund (SWF) institution, the establishment of such funds was driven in large part by Western interests in the region. Only later, when the flow of funds came to dominate Gulf States' macroeconomic planning and development, did the sudden increase of SWF adoption take place. Hence, the SWF is inherently Western. Nonetheless, the Gulf States appear committed to Western economic norms and institutions, if not Western conceptions of liberal democracy.

This introductory chapter provides an overview of sovereign wealth funds (SWFs). It begins with a discussion of how policymakers of all stripes, from democracies to autocracies, have all come to see SWFs as important buffers against global market forces that threaten domestic institutions and policies. It then details the rise of SWFs; the effort to build trust through the voluntary Generally Accepted Principles and Practices, known as the Santiago Principles, developed by the International Working Group of SWFs with the support of the International Monetary Fund; the institutional form and function of SWFs; and the new geography of finance. It argues that SWFs represent the high-water mark of financialization and the next installment of capitalist development following Clark's (2000) pension fund capitalism.

Many countries have set up sovereign wealth funds (SWFs) as vehicles for public saving and wealth management. The majority are in resource-exporting countries; frequently stated objectives are macroeconomic and fiscal stabilization, intertemporal transfer of wealth, and national development. Some resource funds hold assets equivalent to several multiples of GDP, but many funds are relatively small. The evidence shows that the design and operation of an SWF can help or encumber economic management and wealth preservation. Poorly designed stabilization and saving funds without operational flexibility can be costly and interfere with wealth objectives. Many SWFs conduct domestic operations; this creates opportunities but also potentially serious risks to public wealth that must be addressed. Strong SWF governance and transparency are key to achieving sustainable performance and preventing political capture and misuse of public resources. While a number of funds have made progress in these areas, in others much remains to be done.

This chapter examines the investment policies of the Norwegian Government Pension Fund-Global (GPF-G). One of the world's largest investors, this sovereign wealth fund (SWF) has an explicit mission to integrate long-term investment policies with a two-sided ethical commitment. The Norwegian fund's ethical mandate is remarkable when compared to other SWFs. However, this mandate is best understood in terms of procedural rather than substantive justice. The chapter argues that the primary reason for the ethical policies within the GPF-G is to secure domestic legitimacy; its ethical impact is of secondary importance. This argument is sustained by reference to recent work on the nature of state authority and legitimacy in democratic societies, the logic of institutional governance, and the functional integration of decision-making. The chapter concludes with implications for situating the functional performance of the fund in the context of changing global financial markets.