Sovereign Wealth Funds-Investment Strategies and Financial Distress

Abstract

Sovereign wealth funds (SWFs) are generally defined as investment funds owned and managed by national governments.¹ SWFs are not a new phenomenon, but, as many emerging markets and commodities-exporting countries have accumulated large stocks of foreign assets, effective wealth management has increasingly become an important public sector responsibility Accordingly, the number of SWFs has been rising and assets under management have increased by more than half in the last decade, thereby exceeding assets managed by hedge funds and accounting for between one-fourth and one-third of all foreign assets held by sovereigns. SWFs have become increasingly important not only within their own countries, but also in the global financial system.

This article discusses the recent developments with regard to sovereign wealth funds (SWFs) and presents a simple model that illustrates their potential impact on global financial stability during periods of market distress. The model incorporates key institutional features of SWFs such as investment strategies, size and disclosure standards that could have a bearing on how shocks are transmitted across financial markets. The model suggests an asymmetric impact of SWFs during financial turmoil and booms, and provides an analytical framework to inform policy discussion with regard to the governance of SWFs.