Sovereign wealth funds: What they are and why accounting firms should get familiar with them

What is a sovereign wealth fund?

First things first, a sovereign wealth fund (SWF) is a government-owned investment fund that pools money generated from a country’s cash reserves. Generally, the money that’s used to fund a SWF comes from an excess of natural resources, such as oil or gas, minerals, lumber, or crops.

SWFs are typically controlled by the country’s government and are used to benefit the economy, businesses, and citizens over the long term. SWFs differ from other government funds because they focus on long-term, generational wealth and economic stability rather than short-term monetary policy.

Sovereign wealth funds: Key characteristics to be familiar with

These investment vehicles have common components to keep an eye out for.

• Funding sources: the money to fund SWFs has to come from somewhere, and this funding generally comes from surplus revenues generated from the sale of some type of resource, such as natural resources (oil, gas, lumber, food, minerals, etc.) or a trade surplus with other nations.

• Investment objectives: the goal of SWFs is to invest in the country’s economic and financial success. As a result, SWFs can use their funds to invest in new industries and sectors, fund business growth, generate new revenue sources, fund materials purchases from other countries, and more.

• Governance: Sovereign wealth funds are managed by government-appointed boards, which often operate independently from the government to avoid political interference. Ideally, SWF boards remain independent, honest, and non-corrupt.

A brief history of sovereign wealth funds

The United States may be new to SWFs, but SWFs are not a new concept. The first sovereign wealth fund, the Kuwait Investment Authority, was created by the Kuwaiti government back in 1953. This fund was followed by Singapore in 1955, Kiribati in 1956, and Belgium in 1962. Larger and more prominent funds include Saudi Arabia in 1971 and Norway in 1990, which is the largest SWF on earth today.

However, while eight new SWFs were created in the 1990s, SWF creation really took off in the early 2000s, with a staggering 29 new funds being created between 2000 and 2009. This growth continued in the following decades, with 22 new SWFs from 2010 and 2019, and another eight from 2020 to today. In fact, the state of Alaska even has a fund of its own.

SWF investing strategies have evolved over the years, with older funds often focused on infrastructure and natural resources. Newer funds invest in these categories as well, but they are also increasingly focusing investing efforts on the technology and data sectors.

Now that we better understand the origins, let’s explore what these investments typically consist of.

How does a sovereign wealth fund work?

An SWF is like an investment account used by an individual — but for an entire country. Excess income from sources like natural resources, trade surpluses, or foreign exchange reserves is used to fund the SWF. The fund then uses this principal balance to make investments in various areas such as infrastructure, natural resources extraction, funding for businesses, international trade advancements, and financial investments.

SWFs are managed by a government-appointed board that makes decisions related to funding, investment strategies, risk management, and performance management. In most cases, the board also manages the allocation of the fund’s assets with the goal of ensuring the country’s financial future while also making sure that the SWF continues to exist for the long run.

What’s the purpose of this type of fund?

In short, the purpose of a sovereign wealth fund is to maximize the chances of financial prosperity for a country’s citizens indefinitely. This is done in several ways.

• Increasing intergenerational wealth via strategic economic investments
• Ensuring economic stability during financial downturns
• Investing in economic and industry development for the future
• Improving fiscal policies and acting as a countrywide emergency fund
• Minimizing the impacts of inflation
• Improving geopolitical power and opportunity

Now that we understand what a SWF is used for, let’s find out some of the reasons why this concept is gaining traction.

Why is the US government putting this into practice?

The United States has been experiencing a long period of significant inflation coupled with rising debt. Increased inflation is caused by the Federal Reserve printing increasingly more US dollars, while rising debt is caused by poor management and allocation of both tax revenues and printed money.

Both of these factors are likely to have influenced the United States’ decision to create its own SWF, with the goal of reducing debt, managing inflation, improving investments into domestic prosperity, and ensuring wealth preservation for future generations.

Sovereign wealth funds are designed to improve prosperity over the long term, from a decade or more to many generations in the future. Historically, US investments have been funded through taxation, money printing, and borrowing, and are typically tied to short-term policy goals or immediate economic needs.

To tie this all together, let’s touch on how accounting professionals can bring this subject up with the business owners they work with.

Approaching this topic with small business clients

A recent OnPay survey found that nearly 50% of accounting professionals have made increasing their client advisory a top priority. In addition, almost one in four small businesses are looking to their accountant for more business planning and strategic advice. Coupled with the possibility of an American SWF coming to pass, it could make business sense for CPAs to consider how this could impact their small business or investor clients.

Here’s how you can broach the topic of SWFs with clients:

• Frame SWFs in the context of business planning: explain how SWFs can influence markets, creating opportunities or risks for specific industries. Also, discuss how SWFs could impact foreign trade, domestic production, stock market growth, and supply chains.
• Anticipate questions from clients: as always, it’s valuable to understand clients’ potential questions and concerns before they even do — and address them right away. Clients might be wondering how an SWF could affect their business, how they can prepare for market shifts, and if there are investment opportunities tied to SWFs.
• Create useful resources: consider creating useful resources to share with clients, such as articles, website blogs, eGuides, videos, or webinars on SWFs and their potential economic impacts. Also, learn about tools on the market designed to track market trends and government investments.
• Connect SWFs to practical business considerations: highlight how understanding SWFs can help clients make informed decisions about growth, risk management, and investment strategies.