Do Sovereign Wealth Funds Pose a National Security Risk?
The term sovereign wealth fund was first coined by Andrew Rozanov in his article “Who holds the wealth of nations?” Sovereign wealth funds are a state-owned investment fund or entity that are funded primarily by: balance of payments surpluses; official foreign currency operations; proceeds from selling state lands to private entities; rent of state land to private corporations or individuals; taxes on corporations extracting mineral resources from state-owned lands; and fiscal surpluses and receipts resulting from resource exports.
The first recognized sovereign wealth fund is the Kuwait Investment Authority. The fund was established in 1953 with profits from the sale of Kuwaiti oil. The objective of the fund is to preserve wealth and to allow Kuwait to transition from an oil-exporting economy to a newer and more stable source of income for Kuwait and its population.
From 1953 to the present day, there are now 91 sovereign wealth funds in the world, with assets of over $8.2 trillion.
There are informal rules of conduct for sovereign wealth funds under the Santiago Principles. While seeking to promote greater accountability of sovereign wealth funds, the Principles are voluntary and there is no enforcement mechanism. The Linaburg-Maduell Transparency Index which measures public transparency of sovereign wealth funds can be found here.
Historically, sovereign wealth funds have been passive investors in the world economy. That appears to be changing. Sovereign wealth funds are now becoming more proactive in investing in equities, bonds, and real estate worldwide. Sovereign wealth funds are threatening to become behemoth investment trading banks and could crowd out private banks worldwide if the new investment policies of sovereign wealth funds continue to evolve.
The Norwegian Government Pension Fund
The Norwegian Government Pension Fund is in reality two different fund’s. There is the Government Pension Fund Global (GPFG) and the Government Pension Fund Norway (GPFN). The GPFG is that part of the fund that invests in equities worldwide, along with government and corporate bonds and real estate investments, again worldwide. The GPFN invests in Scandinavian countries and in equities that are listed in the Oslo stock exchange. Both of the fund’s are managed by the Norges Bank. The Government Pension Fund Global earned $180 billion in 2019.
Nicolai Tangen, the CEO of the Norwegian Government Pension Fund, has signaled a dramatic change in its philosophy on investing in stocks, bonds, and land worldwide. Tangen is the founder of AKO Capital, a multi-billion-dollar investment company, and one of the largest investment banks in Europe. Tangen, in an interview with the Financial Times, said that “his role is to create a ‘safe area’ where people in the fund can take risks.” Given Tangen’s performance as an investment manager at AKO Capital, it can safely be assumed that the investment policies of the world’s largest sovereign wealth fund will be more aggressive in the investment of its assets in the world market in the near future.
Saudi Arabia’s Public Investment Fund
In the first quarter of 2020, the PIF poured $7.7 billion into blue-chip stocks such as Citigroup, Facebook, and the oil firm Total, but sold these stocks in the second quarter to take advantage of the higher prices of these company’s stocks and bonds. PIF invested $4.7 billion into exchange-traded funds. In July of 2020, the PIF boosted its public markets team by hiring Maziar Alamouti, the former head of Quilter Investors, a wealth management firm. According to a senior Gulf banking manager, executives at PIF are engaging in more equity analyst calls and are using global brokers to execute trades at their direction. In 2020, PIF had a return on investment of 7% and expects to expand the value of the fund to nearly $1.9 trillion by 2030. In order for PIF to achieve this ambitious goal, the fund will have to take risks normally associated with a private investment bank.
Russian Direct Investment Fund
The Russian Direct Investment Fund was established in 2011. The RDIF is currently valued at $10 billion. The RDIF is also a driver of foreign investment into Russia, bringing over $40 billion of investments into Russian businesses.
While a relative newcomer on the sovereign wealth fund scene, the RDIF has taken the initiative in investing in a vaccine for the COVID-19 virus. Called Sputnik V, the vaccine has been analyzed to be 91.6% effective against the virus. The vaccine can be stored from 2 degrees Celsius to 8 degrees Celsius. With the different variances of the virus, it is becoming increasingly likely that there will be a need to have an annual vaccine to protect against the virus. With this type of efficiency and the low cost and ease of storage of its vaccine, the RDIF is set to earn billions of dollars from the sale of its vaccine.
While the RDIF is not the multi-billion-dollar sovereign wealth fund, its aggressive investment in a vaccine fits into the pattern of the risk-taking investments now being displayed by some larger sovereign wealth funds.
Denmark’s ATP Moves to Riskier Investments
Denmark’s secondary state pension fund, ATP Livslang Pension, recently announced that its fund has decided to decrease its fixed-income investments from 80 to 55% to free up 25% of its fund to invest in private commercial investments that provides a higher return on investment. The fixed asset investments of ATP had a negative return on investment of $277 million. The fund had an overall increase of return on investment of 23.3%, mostly based on the investment of the private sector portfolio. The APT is currently valued at $156.6 billion. Given the funds history of passive investment, this is just another indicator of how sovereign wealth funds are transforming themselves into government-backed investment banks.
Indonesia Investment Authority
In an unusual move, Indonesia has announced the formation of a new sovereign wealth fund to be called the Indonesia Investment Authority (INA) that is not based on the normal criteria of funding for a sovereign wealth fund. While the INA will have seed money from the Indonesian government, some $10 billion, it is actively seeking out investors into the INA. The new fund has financial commitments from the Japan Bank for International Cooperation, and the U.S. International Development Finance Corporation, which would bring the value of the fund to $15 billion. Once the INA is fully established, investors will have the choice of investing in either a “Master Fund” or a “Thematic Fund” which will enable the investor to invest in a particular industry or project.
The fund’s CEO will be Ridha Wirakusumah, a senior banker who was the CEO for Bank Permata. The choice of a private banker again indicates the changing nature of the sovereign wealth fund in today’s financial world.
Possible Economic Consequences of SWFs
The rise, and now evolving nature of sovereign wealth funds, pose a new wrinkle in financial investments in business capital markets worldwide.
One of the effects of the more pro-active investment activities of sovereign wealth funds is the economic concept of “crowding out.” While the term crowding out has typically been used to define government spending driving down private sector spending, the rising commercial investments by sovereign wealth funds globally will eventually crowd out the private investment banks by undercutting their ability to compete in the intermediation of capital worldwide.
With private investment capital unable to compete with a national sovereign wealth fund, various funds have the possibility of evolving into entities competing for power and influence on the world stage, thereby increasing the chances of open warfare among nation-states who wield power through their sovereign wealth fund.
The ability of a sovereign wealth fund to bring large amounts of capital to bear in private investment also brings with it an implicit ability to pressure foreign governments to support the parent company of any sovereign wealth fund in political matters.
While the United States has a protective measure against such pressure in the Committee of Foreign Investment in the United States (CFIUS), which was recently reformed and strengthened by the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA), the question has to be asked do the other modern economies of the world have the same protections in place? While the EU has adopted regulations for some protection against outside investors, EU regulations only suggest that member states review foreign investment in their respective economies.
It is not inconceivable that a sovereign wealth fund, such as the Saudi or the Chinese sovereign wealth fund might be used to pressure governments currently friendly to the United States to oppose a political initiative that would bring about an unfavorable result to the standing of the United States on the world political stage. CFIUS would not be able to affect such a scenario.
With sovereign wealth funds evolving into more predatory investment entities, the danger of financial and political instability increases in world politics, with consequences that cannot be foreseen.
Note: The Norwegian Sovereign Wealth Fund, the Saudi Public Investment Fund and the Russian Direct Investment Fund were all contacted on their future policies of investing in commercial interests worldwide. Each fund declined to respond. The portion of this article dealing with the INA was added at the last moment due to an announcement of its unusual formation.