Country Investment Funds: How Do They Work?

A country investment fund, or a sovereign wealth fund, is a state-owned investment fund that invests in a variety of assets, including stocks, bonds, real estate, and precious metals. These funds are typically created by governments with budgetary surpluses and are used to benefit a country's economy and its citizens. While most sovereign wealth funds are funded by revenues from commodity exports or foreign exchange reserves, they can also be funded by other sources such as trade surpluses, government-owned natural resource revenues, and government transfer payments. These funds are usually substantial in size and can provide economic stability and growth for a country.

Country funds vs global funds

A country fund is a mutual fund that invests only in the securities of companies in one country. While it can be diversified within sectors, it is concentrated in one country, increasing its exposure to political risk. Country funds are therefore considered to be riskier than global funds.

Global funds, on the other hand, consist of securities from all around the world, including the investor's home country. They are chosen by investors who wish to diversify against country-specific risk without excluding their own country.

Country funds can typically exhibit high returns because of their concentration, but this comes with price volatility and increased risks, particularly in emerging markets. A country fund for Russia, for example, will invest in stocks of Russian companies, Russian government debt, and other Russian-based financial instruments.

Global funds provide a diversified portfolio of global investments that reduces investors' risk exposure. Investing in international securities can increase an investor's potential returns with only a small amount of additional risk.

While a global fund provides diversification, an investor could, in theory, construct a geographically diverse portfolio using individual country funds. This would require a great deal of research and effort and could be accomplished more simply by selecting a global fund. However, country funds can be used to supplement a global portfolio to concentrate a bet on a specific region.

Both country funds and global funds can be used to add geographic diversification to a portfolio. However, country funds present a concentrated risk, as an economic downturn, financial crisis, or geopolitical event in the target country is likely to negatively affect all of that country's stocks.

In summary, country funds and global funds offer different levels of geographic diversification, risk exposure, and potential returns. Country funds provide concentrated exposure to a specific country's market, while global funds offer a more diversified portfolio of international investments.

Country funds and their exposure to risk

Country funds are a type of mutual fund that invests only in the securities of companies in one country. While they can be diversified within sectors, they are highly concentrated in one country, increasing their exposure to risk.

Country risk refers to the uncertainty associated with investing in a particular country and the potential for this uncertainty to lead to losses for investors. This uncertainty can arise from a variety of factors, including political, economic, exchange rate, technological, and sovereign default risk.

Political risk is a significant concern for country funds as they are unable to diversify away this risk. Political instability can create great turmoil in financial markets and reduce the expected return on investment. Additionally, political decisions can result in an unanticipated loss for investors, especially if the political climate becomes unfriendly to outside investors.

Economic risk refers to a country's ability to pay back its debts. A country with weak finances or an unsound economy may struggle to make payments, leading to potential losses for investors.

Exchange rate risk is another factor that country funds are exposed to. Currency fluctuations can significantly impact the value of investments and returns. For example, if a country fund returns 10% in capital gains but experiences a 10% exchange rate loss against the dollar, the net return would be zero.

Country funds are also exposed to the risk of default on locally issued bonds. This risk is heightened in countries with political or economic instability.

Overall, country funds are highly concentrated in a single country, increasing their exposure to various risks. While they can offer high returns, this comes with price volatility and increased risks, especially in emerging markets.

Sovereign wealth funds

A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property, and other financial instruments. SWFs are owned by a state or a political subdivision of a federal state and are used to manage a nation's savings for investment purposes. The funds may be accumulated from various sources, including foreign currency deposits, foreign exchange reserves, gold, special drawing rights (SDRs), and International Monetary Fund (IMF) reserve positions. These funds are typically held in reserve currencies such as the dollar, euro, pound sterling, and yen.

SWFs can be used for different purposes, including:

• Savings or future generation funds
• Public benefit pension reserve funds
• Reserve investment funds
• Strategic Development Sovereign Wealth Funds (SDSWF)
• Industry-specific funds
• Foreign currency reserve assets

The management of SWFs may be carried out by various entities, including state-owned central banks, national monetary authorities, official investment companies, sovereign oil funds, and pension funds. As of June 2024, the top five largest SWFs by assets were:

• Norway Government Pension Fund Global: $1.6 trillion
• China Investment Corporation: $1.35 trillion
• SAFE Investment Company: $1.09 trillion
• Abu Dhabi Investment Authority: $993 billion
• Public Investment Fund of Saudi Arabia: $925 billion

SWFs have existed for over a century, but their number has increased significantly since 2000. The first SWF established for a sovereign state was the Kuwait Investment Authority, created in 1953 from oil revenues. SWFs are particularly common among oil-rich states, but notable exceptions include the SWFs of China.

Sources of sovereign wealth funds

Sovereign wealth funds (SWFs) are primarily funded by a country's budgetary surplus, which is often generated by revenue from natural resources, particularly oil exports. These funds are typically established when governments have budgetary surpluses and little to no international debt.

The sources of sovereign wealth funds can be broken down into two categories: commodity and non-commodity.

Commodity Sovereign Wealth Funds

Commodity sovereign wealth funds are financed by exporting commodities. When the price of a commodity rises, nations that export that commodity will have greater surpluses. Conversely, when there is a fall in the price of a commodity, a deficit is created that could hurt the economy. A sovereign wealth fund acts as a stabilizer to diversify the country's money by investing in other areas.

Commodity sovereign wealth funds are primarily funded by revenues from commodity exports, such as oil, gas, and precious metals. The funds are typically established in countries that depend on raw material exports, as these are susceptible to high volatility in resource prices, the unpredictability of extraction, and the exhaustibility of resources.

Non-Commodity Sovereign Wealth Funds

Non-commodity funds are usually financed by an excess of foreign currency reserves from current account surpluses. They are also funded by transfer of assets from official foreign exchange reserves, and in some cases, from government budget surpluses and privatisation revenues.

Non-commodity funds are more common in countries with high corporate or household saving rates.

Other Sources

Other sources of funding for sovereign wealth funds include:

• Surplus revenue from industries, such as the oil sector
• Unutilized funds from the government budget
• Government transfer payments
• Foreign currency deposits
• Gold
• Special drawing rights (SDRs)
• International Monetary Fund (IMF) reserve positions held by central banks and monetary authorities
• Pension investments
• Industrial and financial holdings

Country-specific sovereign wealth funds

A country investment fund is a mutual fund that invests only in the securities of companies in one country. A more specific type of country investment fund is a sovereign wealth fund (SWF). A sovereign wealth fund is a state-owned investment fund that invests in real and financial assets such as stocks, bonds, real estate, and precious metals.

Sovereign wealth funds are entities that manage the national savings for the purposes of investment. The funds may originate from foreign currency deposits, foreign exchange reserves, gold, special drawing rights (SDRs), and International Monetary Fund (IMF) reserve positions held by central banks and monetary authorities. Other sources include pension investments, oil funds, and other industrial and financial holdings. These funds are typically held in reserve domestic and foreign currencies such as the dollar, euro, pound sterling, and yen.

Sovereign wealth funds are typically created when governments have budgetary surpluses and little to no international debt. They are also created to reduce the volatility of government revenues and to counter the adverse effects of boom-bust cycles on government spending and the national economy. Additionally, savings SWFs are established to build up savings for future generations.

The first sovereign wealth fund was established in 1854 by the U.S. state of Texas to fund public education. The first SWF for a sovereign state was the Kuwait Investment Authority, created in 1953 from oil revenues before Kuwait's independence from the United Kingdom. As of July 2023, Kuwait's Sovereign Wealth Fund is worth $853 billion.

• Government Pension Fund of Norway: The largest sovereign wealth fund in the world, with over $1.1 trillion in assets.
• China Investment Corporation: Manages over $1 trillion in assets.
• Kuwait Investment Authority: Worth over $853 billion as of July 2023.
• Monetary Authority of Singapore.
• Qatar Investment Authority.
• Russian National Wealth Fund.
• National Development Fund of Iran.
• Brunei Investment Agency.

Frequently asked questions