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What is a sovereign wealth fund?
A sovereign wealth fund is a pool of money set aside by a government to benefit its economies and citizens. The money from a sovereign wealth fund comes from the country’s reserves that have grown due to budget surpluses, trade surpluses and revenue gained from exporting natural resources.
The goals of sovereign wealth funds are to protect and add stability to the nation’s budget, earn greater returns on foreign investments, diversify from non-renewable exports, increase savings for future generations, play a role in political strategy and create sustainable long-term capital growth.
Some countries develop sovereign wealth funds to diversify their sources of revenue. For example, countries that rely on oil exports as their primary source of wealth may invest a portion of their reserves in securities or assets to diversify against a dramatic decrease in oil production or oil demand.
Sovereign wealth funds are classified by two categories, commodity and non-commodity. Commodity sovereign wealth funds are funded by exporting commodities. As the price of the commodity rises, the sovereign wealth fund grows at an increased rate. When the price of the commodity falls, this could negatively impact the sovereign wealth fund, and therefore the country it supports.
The investments that grow non-commodity can vary by country. These investments are usually long-term, passive investments. Sovereign wealth funds might invest in traditional investments, such as government bonds, equities and foreign direct investments. Alternative sovereign wealth funds investments are growing and include hedge funds and private equity investments.
According to the International Monetary Fund, sovereign wealth funds harbor a higher degree of risk than traditional portfolios as they hold larger stakes in emerging markets, which are more volatile.
Sovereign wealth fund example
Sovereign wealth funds are relatively new. The first fund was developed by Kuwait in 1953. The Kuwait Investment Authority was created to invest the country’s excess oil revenues. However, since this time, the size and number of sovereign wealth funds has increased substantially. In 2012, there were more than 50 sovereign wealth funds. These funds’ combined value was estimated at over $5 trillion.
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