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SINGAPORE : Sovereign Wealth Funds (SWFs) have been in the news lately.
But how exactly did they come about and can countries do without them?
Abu Dhabi is the country with the world's largest Sovereign Wealth Fund.
Currently worth more than 500 per cent of its GDP, Abu Dhabi government set up its fund in 1977 to invest the country's surpluses.
Gerard Lyons, Chief Economist, Global Research Group Head, Standard Chartered Bank, said: "The origin of SWFs emanates from the fact that many oil rich countries wanted to have a way to stabilise or protect against fluctuating oil revenues and a few other countries started to also look at the attraction of using their income from commodities more generally to set up funds."
Ho Yew Kee, Vice Dean, Finance and Administration, NUS, said: "Just as any investor, if I have spare money I need to think carefully with what to do with the excess money. Retirement, posterity for those who come after me. For a country we assume a country doesn't die. Then the country has a responsibility to preserve its current wealth such that future generations will have a livelihood."
Professor Robert Merton, Harvard Business School, said: "Most countries do not have investments in every sector. So by using the wealth funds to diversify, as you do here in Singapore, across a number of industries and investment activities outside Singapore, you provide a better risk return benefit to the country. The SWFs, and to an extent, countries, have recognised they have concentrated risks either by industry, commodity, oil or copper, forestry or because of the needs to preserve assets for future generations."
Kuwait lays claim to having one of the earliest Sovereign Wealth Funds.
Set up in 1953, it paved the way for similar funds across the globe over the next half a century.
And as more successful state funds take the limelight with high profile investments, more countries have been looking to hop on the bandwagon.
Japan, for example, is in talks to create its first fund that will put to work its massive stockpile of foreign reserves, the world's second largest after China's.
Mr Lyons said: "Certainly the number of countries increasing or having their own SWF has increased significantly. Nine of the 22 biggest funds were created in the (new) millennium. The number of countries setting up such funds is rising, the amount at their disposal is huge, their targets more controversial."
And such increasingly controversial targets have led to multiple calls for a code of conduct to govern such funds.
While most agree that some standardisation can be useful, they also think that these funds are unlikely to have ulterior motives.
Professor Merton said: "It's of course a possibility if they have a large controlling interest in some companies they can exert influences which are not necessarily that of maximising returns. That's of course a possibility. But I don't think that's inherent and I don't really believe that's the most likely objective for SWFs. There are ways SWFs could choose to mitigate that which are to have investment strategies that are highly diversified and invest in equities and debt and other assets all around the world rather than a few specific assets in a very concentrated way."
Others say there's no reason why a state fund should not work in favour of the state as long as it's done legitimately.
Mr Ho said: "The country can move the SWF (to meet) its security needs. The state funds can take a strategic position not only in generation of returns but protection of critical resources. My gut feel is that this is something that SWFs will think about in the next stage of it."
While it is easy to get carried away with state fund fever, there are countries seen as unlikely to ever have centralised management of state money.
One is the United States.
Mr Ho said: "The concern is always an issue about democracy, rights. In America it'll be a lot more tricky if the Federal government tries to pull together the treasuries of the various states. And the states will have difficulties trying to pull together the treasuries of various counties. The genesis of these counties don't start with a federal system or collective system. It starts with individual parts. To change the system and impose a complete command and control structure or a collective structure is more difficult."
Some say the SWF route is not necessarily the only one to take.
Professor Merton said: "It isn't necessary in today's world to have a SWF to diversify risk using financial markets. So just as an aside, the next generation, whether you have the resources for SWF or not, there are ways to use financial contracts that are well known and available in large sizes to transform the risk of a country to a much more diversified position. I think one of the big innovations for country risk management is for a country to diversify its risk exposure much better with or without having a SWF."
Analysts put current sovereign wealth fund assets in the range of US$1.5 trillion to US$2.5 trillion.
This amount is projected to grow sevenfold to $15 trillion in the next ten years. - CNA/ch
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