I have always been interested in the business of Sovereign Wealth Funds (SWFs). What drives their establishment? What would be a decent annualised compounded rate of return?
Apologies for the technical, financial terms here, which I will explain later on. Before all of that, how are those sovereign wealth funds classified? And finally, is it better to own a massive SWF or multiple smaller ones? Disclaimer: the above questions will not be answered in the same order.
If you go onto the website of the Sovereign Wealth Fund Institute, you will find that funds have been classified into two different sections. One lists all sovereign wealth funds, and provides you with the sources of income deposited into the SWFs. The second lists all funds, which includes SWFs as well as pensions, endowments (universities’ owned, for instance), and so on.
So there are two rankings based on the content of the two lists. The top three among SWFs being: Norway (Government Pension Fund); the UAE (Abu Dhabi Investment Authority); and China (China Investment Authority). The top three in the all funds section are: the US (Social Security Trust Fund — I find the word trust in the a pension funds’ title quite ironic); Japan (Government Pension Investment Fund); and Norway (Government Pension Fund — yes, the same one topping the Sovereign Wealth Funds’ list).
What drives the creation of a sovereign wealth fund? In three words — preservation of wealth.
And so you will notice that exporters of oil, gas, other commodities and minerals create SWFs to secure a stable future stream of income for these possible scenarios: one, a drop in oil price (I know) or that of other commodities or the commodity in question becomes irrelevant to tomorrow’s international markets.
As for pension-associated funds, those are incepted to deposit contributions of individuals and of the state to pay for future pension expenses. The largest two, Japan’s and the United States’, would face difficulties quite soon when the demographic curve further moves into retirement territory. Side note here: many pensions funds are either bankrupt in technical terms, or are on their way to become bankrupt. Or they are under-funded, which eventually will lead to them being bankrupt if they weren’t reformed.
What would be a decent annualised compounded rate of return? As promised, an annualised return is one that takes overall growth in the fund’s value since its inception, and then divides it over the number of years.
Being compounded indicates that the calculation includes the income generated by the fund and not only what the owning state deposited into it. You can calculate the rate of return by having: the value at inception, the value today, and the year of inception, or of first funds transfer.
What matters here most is how well did a fund or SWF perform in comparison to others. Norway’s SWF, for instance, has a net (after inflation and management fees) annualised rate of return since 1996 (the year Norway’s government started transferring funds into it) of 4 per cent.
On the contrary, Singapore’s Temasek Holdings, which is five times smaller that Norway’s SWF, has achieved an annualised rate of return of 16 per cent since its inception in 1974 — not the net rate of return as in Norway’s SWF’s case. So, which rate of return is more impressive?
“Curse of the big fund”, we call it in finance. The bigger the fund or SWF gets, the harder it is to find growth and return opportunities, even with Norway’s SWF owning 1 per cent of all stocks worldwide.
In 1981, Singapore established another SWF, which is now double the size of its first SWF. With a real (net of inflation) annualised rate of return of 4.9 per cent, its value sets it among the top ten SWFs.
The last thought that I want to leave you with: at what value should a fund, or a SWF, be broken down into smaller funds?
— The writer is a UAE-based economist.