A senior US official has expressed concern over the recent rapid increase in the number and asset size of sovereign wealth funds (SWFs).

“Despite the clear benefits of open investment policies, there is rising protectionist sentiment globally. Sovereign wealth funds (SWFs) are one focus of rising protectionist sentiment,” said US Deputy Secretary of the Department of Treasury Robert M Kimmitt addressing the US-GCC Investment Forum here.

German Chancellor Angela Merkel and others have expressed concerns about whether sovereign investors such as SWFs might be tempted to invest based on political or strategic goals, rather than true commercial purposes. These concerns are now being discussed more broadly within the European Union and elsewhere, he said.

SWFs are not a new phenomenon. This region has been path breaking, with one of the first funds, the Kuwait Investment Board established in 1953, and several of the largest, such as the Abu Dhabi Investment Authority.

However, the recent rapid increase in the number and asset size of SWFs has raised their profile and generated concerns. Globally the number of funds has doubled since 2000: from 20 in 2000 to almost 40 now, with over 10 established just since 2005. SWFs manage total assets of $1.9-2.9 trillion. Private sector estimates suggest that figure could grow to $10-15 trillion by 2015, he said.

“These developments should not cause alarm, but they do point to a need to take a step back and look at SWFs with calm and precision. As SWFs are an outgrowth of domestic and international economic policies, it makes sense to consider them in terms of their potential impact on financial stability,” Kimmitt said.

He said here, there is much reason to be reassured. SWFs are in principle long term investors that typically do not deviate from their strategic asset allocation in the face of short term volatility. They are not highly leveraged, and it is difficult to see how they could be forced by regulatory capital requirements or sudden investor withdrawals to liquidate positions quickly.

In this context, SWFs may be considered a force for financial stability, supplying liquidity to the markets, bidding up asset prices, and lowering borrowing yields in the countries in which they invest.

It is also important to distinguish SWFs from other sources of sovereign investment. There are similarities, but also important differences. There is no universally accepted definition of a SWF. However, a SWF can be thought of as a government investment vehicle funded by foreign exchange assets, and which manages those assets separately from official reserves. In contrast, international reserves are external assets that are readily available to and controlled by finance ministries and central banks for direct financing of international payment imbalances.

Reserves are by definition invested in highly liquid and marketable securities. Public pension funds are investment vehicles funded with assets set aside to meet the government's future entitlement obligations to its citizens. Public pension funds differ from SWFs in that they are denominated and funded in local currency, usually with relatively low exposure to foreign assets. State owned enterprises (SOEs) can be defined as enterprises where the state has significant control, through full, majority, or significant minority ownership. SOEs may undertake foreign direct investment and occasional portfolio investments, but the majority of state owned enterprises do not invest abroad.
It appears that SWFs have so far been seeking to generate higher investment returns without generating political controversy.

However, it is necessary to remain vigilant, as SWFs do raise a number of issues. First, does the creation of a SWF perpetuate undesirable underlying macroeconomic and financial policies? It is critical that countries do not use SWFs that are non commodity funds as a