II. LITERATURE REVIEW
1. W HAT IS SWF?
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II. Literature Review
1. What is SWF?
1.1. Definitions
There are lots of government organizations, international financial institutions, and private researchers publishing research results and reports about SWFs in these years. Those reports have their own definitions of the SWFs. Until now, the definition of SWF is still vague. The definition of SWF may vary with the characteristics they have—the investment policies, the ownership, the accountability, or the investment subjects.
Some investment banks and private research institutes define SWF as a separate pool of government-owned or government-controlled asset that invests in a portfolio with wide range of classes and risks.
However, the most accepted definition of SWF is from IMF (February, 29, 2008): SWFs are government-owned investment funds, set up for a variety of macroeconomic purpose.
They are commonly funded by the transfer of foreign exchange assets that are invested long term, overseas.1
Lots of people would mix up SWFs with other two sovereign investment vehicles, State Owned Enterprises (SOE) and Public Pension Funds. As Table 1 shows, the key differences are (1) the ownership and controller of SWF is government, but SOE and Pension Funds
1 Mark Allen and Jaime Caruana, “Sovereign Wealth Funds—A Work Agenda”, IMF, February 29, 2008, 4-5
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aren’t; and (2) the sources of SWF are from commodity or non-commodity exports, but SOEs are from earnings, and Pension Funds are from contributions.
Table 1. Defining the difference between: SWFs, SOES, and Public Pension Funds2
Source: Sovereign Wealth Fund Institute
To summarize those various definitions, in my opinion, SWF is a large pool of capital with 4 characteristics: (1) owned by sovereign government, (2) funded for the purpose of national interests, (3) mostly sourced by excess reserves and revenues from international trade surplus, and (4) invests in wide range of subjects with different classes and risks with long term investment horizon.
1.2. The Categories of SWFs
There are several categories for the SWF. The most common method to classify SWF is
2 Sovereign Wealth Fund Institutes. http://www.swfinstitute.org/research/investmentvehicles.php
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based on two criteria: one classification is used according to the resource of the funds (Kimmitt, 2008) and the other is used according to the SWFs’ purposes or policies.
Classification by Sources
According to the classification cited by Kimmitt, the SWFs can generally be divided into two categories according to the source of the foreign exchange assets: Commodity SWFs and Non-commodity SWFs.
(1) Commodity SWFs
Commodity SWFs are funded by commodity exports that are either owned or taxed by the government (Kimmitt, 2008). This kind of funds serves different purposes, like fiscal revenue stabilization, balance-of-payments, and intergenerational saving3. Because of the current extended rise in commodity prices, many funds were initially established for the purpose of fiscal stabilization or balance-of-payments sterilization have evolved into intergenerational savings funds.
Typical examples of this type of SWFs are the SWFs funded by oil-exporting countries, like Kuwait, the United Arab Emirates, and Saudi Arabia.
(2) Non-commodity SWFs
Non-commodity SWFs are typically established through transfers of assets from official
3 Here, an intergeneration saving is a saving from selling natural nonrenewable resources by older generation, which used to share with the younger generation in case of running out of nonrenewable resources.
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foreign exchange reserves (Kimmitt, 2008). Non-commodity exporters with large amounts of balance-of-payments surpluses can take advantage of these huge “excess” foreign exchange reserves, transfer them to stand-alone investment funds to be managed, and chase for higher returns.
Typical examples of this type of SWFs are some Asia exporting countries, like China Investment Corporation in China and Khazanah National Berhad in Malaysia.
Classification by Purpose
SWFs can also be classified into several types according to the purpose or the dominant objectives they serve. The followings are five types of SWFs that are commonly accepted in relevant reports4.
(1) Stabilization funds
Stabilization funds are set up by countries with abundant natural resources in order to insulate the budget and economy from volatile commodity prices (e.g., usually oil prices).
For those countries with abundant natural resources, establishing stabilization funds can help to smooth fiscal revenue or sterilize foreign currency inflows. These funds build up assets during the years of ample fiscal revenues to prepare for leaner years.
(2) Savings funds
Savings funds, or intergeneration funds, are established to share wealth across
4 IMF, ”Global Financial Stability Report”, October 2007,p 46
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generations. For countries with rich natural resources, setting savings funds can transfer non-renewable assets into a diversified portfolio of international financial assets. Thus, they can provide wealth for future generations, or take advantage of wealth on other long-term objectives. Therefore, they can reduce the impacts of running out of non-renewable resource in the future.
(3) Reserve investment corporations
Reserve investment corporations are usually established as a separate entity. Its purpose is either to reduce the negative cost-of-carry of holding reserves or to pursue investment policies with higher returns. Usually, the assets in this type of arrangements are still counted as reserves.
(4) Development funds
Development funds are set up for country development. These funds allocate resources for funding priority socioeconomic projects, such as infrastructure.
(5) Pension reserve funds
Pension reserve funds have identified pension or contingent-type liabilities on the government’s balance sheet. Sometimes, the development funds and Pension reserve funds can be considered as subsets of SWFs that are linked to long-term fiscal commitments.
Other purposes may include enhancing the transparency in managing revenues from commodity exports and fiscal policy. In practice, SWFs have multiple purposes or gradually
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changing objectives when situations change. For example, some countries establish SWFs for savings and stabilization purposes, but when the circumstances change, the purpose they emphasis may also change (e.g., change to development funds). This is especially true for countries that export natural resources.