Sovereign wealth funds to alternative investments: It depends on our mandate (mostly)

In the world of sovereign wealth funds, several giants stand above the rest.  There’s the Abu Dhabi Investment Authority, the China Investment Corporation, and the Government Pension Fund of Norway.  Although some (CIC, for example, along with Singapore’s GIC and Korea’s KIC) owe their existence to trade surpluses, many were the result of natural resources revenues.  Several of the resource-based funds have been around since the first oil boom in the 1970’s.

But there is one Lilliputian sovereign wealth fund that pre-dates the sovereign wealth funds of Norway, Mexico, Alberta and even the storied Abu Dhabi Investment Authority:  the $400 million Kiribati Revenue Equalization Fund (established in 1956).

If the name “Kiribati” rings a bell it may be because that’s the country often held up as an example of a low-lying nation that is about to be claimed by rising sea levels.  It’s also a former British protectorate that once made a good living off its phosphate deposits.  Alas, those deposits eventually ran dry and after some haggling with the British, the country was set free with a pretty healthy trust fund for its 100,000 citizens (roughly the same amount per citizen as Canada’s gigantic Canadian Pension Plan).

The KREF can be described as a national savings plan.  But according to a recent working paper by IMF staffers Peter Kunzel, Yinqiu Lu, Iva Petrova and Jukka Pihlman, there are actually four broad categories of sovereign wealth funds: savings funds (like Kiribati’s), macro-stabilization funds (like Iran’s Oil Stabilization Fund), pension reserve funds (like the New Zealand Superannuation Fund) and “reserve investment funds” (like China’s CIC).  You may be able to find your neighbourhood sovereign wealth fund in the table below from the paper (click to enlarge):

The authors illustrate that the objective and type of sovereign wealth fund dictates its strategic asset allocation (SAA).  Naturally, the SWF’s with shorter term requirements (stabilization funds, for example) are going to allocate more to liquid instruments like cash or more stable instruments like fixed income investments.  They pick a few to make the point.  Below are the December 2007 and December 2009 SAAs for several funds with an economic stabilization mandate: (blue: fixed income, red: cash, grey: equities)

As you can see, the Trinidadians are the only ones with the appetite for any risk – probably because their SWF has both a mandate for economic stabilization and a mandate to “…provide a heritage for future generations…”

Funds that are dedicated to future generations have even more “risky” assets such as equities and, God forbid, “alternative assets”.  Note the SAA for Alberta’s Savings Trust Fund and the Alaska Permanent Fund (the source, we assume, of the $1000 cash hand-outs to every new Alaskan immigrant in 2007’s The Simpson’s Movie) have alternative assets in the mix. (blue: fixed income, grey: equities, green: alternative investments)

Not surprisingly, the fixed income dominated funds posted more stable returns from 2007 to 2009…

…while the more long-term oriented savings funds posted a few ups and downs…

But investment horizon isn’t the only thing driving asset allocations according to Kunzel, Lu, Petrova and Pihlman.  In some cases, they say, funds may have undergone recent “legal and institutional changes” that mean they are simply not able to implement their desired allocations.  In others, the amount of remaining natural resources might have influenced the allocation (the citizens of Kiribati, for example, may not want to gamble that much).  And in many other cases, funds that were initially envisioned for retirees or for future generations have been temporarily re-purposed to stabilize massive fiscal imbalances.

Despite some having been recently tapped to pay the bills, sovereign wealth funds are here to stay – even if the resources aren’t.  Conclude the authors:

“Looking ahead, the scope for SWFs’ stabilizing role in international capital markets will remain substantial. Despite their losses during the crisis and greater domestic focus, SWFs’ relative size and influence in the global market will remain large. Furthermore, SWFs’ longer-term investment strategies relative to most other investors will continue to play an important stabilizing role in the global economy.”

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