Lately I've been thinking a lot about sovereign wealth funds, and I thought I'd open up a discussion with some thoughts on the issue. In recent years, SWFs have gained a lot of traction (and size) in global markets, to the tune of $5-20 trillion, depending on how you count it. On the face of it, SWFs seem like a great and prudent idea - investing surpluses today to help fund deficits in the future, with the advantage that the extremely long investment horizon of governments allows for better long term returns, massive economies of scale, and the use of illiquid and unconventional investment vehicles. And I think in some cases sovereign wealth funds from petrodollars can be very valuable in sterilizing inflows and minimizing Dutch disease. Furthermore, SWFs might be a good idea even outside of petrostates when countries are facing demographic challenges in the future - pay as you go pension systems get hit hard if you have significant changes in the dependency ratio, and a forward-looking fund can help alleviate these issues.

My concerns, though, have been growing in recent years. In particular, I'm worried that the enormous size of SWFs (and gov't pension funds more generally) are crowding out private capital in many equity markets. Increasingly we're seeing government-controlled pension funds and SWFs exercising influence on corporate decisions - see, for example, the outsized effect of CalPERs' shareholder activism. One could argue that governments may place barriers in place to ensure that these SWFs are professionally managed without political interference. Yet we all know this isn't the case - Norway places lots of restrictions on the investments of their SWFs, and there are plenty of overt and less-obvious political pressures placed on most pension/SWFs throughout the world. Maybe this pressure and these restrictions are not necessarily bad, but I'm uncomfortable with accepting the premise that governments should, through their SWF vehicles, be owning large portions of financial markets.

I also have a bit of a philosophical concern. When companies start hoarding cash or buying back stock, most people rightly conclude that the company is out of ideas on how to use the capital to invest returns, so they are giving it back to the shareholder. I wonder if governments can't be viewed the same way - if they're not using revenues immediately, wouldn't it be better to return them to the private sector, rather than hoarding the money and buying of lots of securities? Private capital is almost certainly more efficient. Some of the concerns SWFs try to address can be dealt with separately - Dutch disease can be mitigated by paying down government debt, in effect increasing the savings rate of the economy since the government is no longer relying on private financing. Moving away from DB pension schemes towards DC and privately managed systems can limit the massive long term liabilities many of these funds address. Changing policies to smooth demographic transitions - e.g. through immigration, higher fertility, raising retirement age, etc. - can limit the dependency ratio problem. In fact, I think long term liabilities can sometimes be shifted to the private sector entirely, even ones traditionally taken on by governments - witness the privatization of most utilities, the growth of public-private partnerships in recent years, etc. We should be moving towards less asset-heavy government, not the reverse.

I have no doubt that states need to own some assets just to keep things running - massive infusions of capital from natural resource exploitation likely can't be entirely mitigated without it, countries still need some sort of pension backstop, etc. Foreign exchange reserves are important to shelter economies from massive capital flows like those we've seen in recent years. Central banks sometimes need to purchase securities as part of monetary policy, as we've seen with QE in recent years. But all of these should be managed in an entirely apolitical manner, and with a focus on limiting the scale of government involvement in asset prices to the bare minimum needed to meet a well-defined policy goal. The expansive sprawl of SWFs and their ilk in recent years suggest that a far more ambitious transition is taking place, where governments will have a much larger role in investment and asset markets. I can't help but think this will be a bad trend. What do you think?


Lastly: stop reading SWF as 'single white female'. I know you were all doing it.