An Introduction To The Mysterious World Of Sovereign Wealth Funds - by Richard Wilson

Sovereign wealth funds have attracted a lot of attention in recent years as more countries open funds and invest in big-name companies and assets. Some experts estimate that all sovereign wealth funds combined to hold more than $5 trillion in assets in 2012, a number that is expected to grow relatively quickly. This has given way to a wide concern over the influence these funds have on the global economy. As such, it is important to understand exactly what sovereign wealth funds are and how they first came about.

A sovereign wealth fund is a state-owned pool of money that is invested in various financial assets. The money typically comes from a nation's budgetary surplus. When a nation has excess money, it uses a sovereign wealth fund as a way to funnel it into investments rather than simply keeping it in the central bank or channeling it back into the economy.

The motives for establishing a sovereign wealth fund vary by country. For example, the United Arab Emirates generates a large portion of its revenue from exporting oil and needs a way to protect the surplus reserves from oil-based risk, thus it places a portion of that money in a sovereign wealth fund. Many nations use sovereign wealth funds as a way to accrue profit for the benefit of the nation's economy and its citizens.

Sovereign wealth funds represent a large and growing portion of the global economy. The size and potential impact that these funds could have on international trade has led to considerable opposition, and the criticism has mounted after controversial investments in the United States and Europe. Following the mortgage crisis of 2006-2008, sovereign wealth funds helped rescue struggling Western banks CitiGroup, Merrill Lynch, UBS and Morgan Stanley. This led critics to worry that foreign nations were gaining too much control over domestic financial institutions, and that these nations could use that control for political reasons. This fear could also lead to investment protectionism, potentially damaging the global economy by restricting valuable investment dollars.

In the United States and Europe, many financial and political leaders have stressed the importance of monitoring and possibly regulating sovereign wealth funds. Many political leaders assert that sovereign wealth funds pose a threat to national security and their lack of transparency has fueled this controversy. The United States addressed this concern by passing the Foreign Investment and National Security Act of 2007, which established greater scrutiny when a foreign government or government-owned entity attempts to purchase a U.S. asset.

Western powers have been guarded about allowing sovereign wealth funds to invest and have asked for improved transparency.

The top five largest SWF by assets (data as of February 2008)

1. Abu Dhabi Investment Authority (UAE) - $875 billion
2. Norway Government Pension Fund (Global) - $380 billion
3. Government of Singapore Investment Corporation - $330 billion
4. Saudi Arabia 1 (no official fund name) - $300 billion
5. State Administration of Foreign Exchange (China) - $300 billion

There are genuine geopolitical concerns about what a large sovereign wealth fund could do to a potential adversary nation. Imagine what several hundred billion non-regulated dollars in concentrated wealth could do - under a malicious hand, it could perform a hostile takeover of strategic financial, industrial or infrastructure assets. It could also erode a nation's currency in the foreign exchange markets. In a worst-case scenario, a sovereign wealth fund is a large pool of hidden assets, with no shareholders (or regulations), which could be ruled by a dictator.

Read more: An Introduction To Sovereign Wealth Funds | Benzinga