Sovereign wealth funds (SWF) represent pools of unregulated capital that are usually established by governments in which to invest their commodity related surplus earnings or trade related excess foreign exchange reserves.

Consequently, SWFs are categorised as either ‘oil/commodity based’ or ‘trade surplus based’. Their total assets have now aggregated $7.45 trillion (as of March 2018) which exceeds the combined global assets of hedge funds and private equity.

Two major factors have led to such exponential growth in SWF assets which initially was driven by the significant accumulation of foreign reserves by central banks during the 1997-98 East Asian financial crises. A virtually unrestrained rise in oil prices which rose from $10 in 1998 to a peak of $148 a decade later further fuelled growth.

Thus, most SWFs have been established in countries that are endowed with natural resources with oil-related funds constituting the most predominant group.

SWFs of the Gulf countries, Russia, ex-Soviet republics, Malaysia, Brunei and Norway comprise this category. A second group of SWFs appeared when Singapore, South Korea, China and other East Asian countries began to accumulate large foreign currency reserves resulting from sustained trade surpluses.

Characteristics common to all SWFs focus on their creation as state owned investment funds rather than an operating company although they are organised independently from the central bank or finance ministry to insulate them from excessive intervention and political influence.

These funds make international and domestic investments in a variety of risky assets whilst targeting commercial rates of return and operate as wealth rather than pension funds since they are not financed by contributions from pensioners and do not incur any liabilities to individual citizens.

The explicit aim of a domestic SWF could be in keeping with the initial mandate of Vietnam’s State Capital Investment Corporation to ‘safeguard and develop state capital efficiently… improve the operational capacity and competitiveness of state-invested enterprises.’

To put things in perspective, the State Bank has recently reported that the total debt of public sector enterprises (PSEs) as of March 2018 totals around Rs 1 trillion which is equivalent to 3.5 per cent of GDP, a figure that this consistently on an upward trajectory.

The creation of an SWF for Pakistan would represent a paradigm shift away from the state acting as an operator of enterprises to an investor deploying its resources more efficiently

Successive governments over almost three decades have failed to solve the conundrum of failing PSEs and the creation of an SWF presents a way out of this morass.

In order to protect fund managers from direct political interference, the entity should be legally and operationally separated from the State Bank, Ministry of Finance and other related government departments for which explicit legislation may need to be enacted.

Consideration could also be given to outsourcing the actual management of the SWF’s portfolio to third party professional managers, selected through a competitive and transparent public procurement process that will be tasked with improving the financial performance of PSEs.

Precedents for such outsourcing are particularly prevalent in various SWFs that have been launched in Africa over the last decade.

To further enhance operational independence, the SWF’s board that will set its investment policy should be weighted in favour of industry professionals and experts rather than government functionaries. Strategic guidelines for the investment policy could be established by the legislature.

Through the creation of a holding company, the SWF’s investment thesis would focus on asset consolidation of PSEs which would not require any monetary capitalisation as the government would transfer its assets in lieu of a cash contribution.

This would enable the SWF’s management to identify assets that may need restructuring, further development or a sale. Also, synergies in the assets’ operations may be best exploited if they are placed within the same entity.

The SWF will aim to enhance the inherent value of its assets through consolidation that creates economies of scale whilst optimising synergies and other efficiencies.

Starting with all federally owned assets, distinct verticals could be created around key sectors such as energy, transport, finance, telecommunications, healthcare and education which would require dedicated management teams focusing on select entities.

Focused oversight resulting in improved corporate governance at PSE level will supplement the above-mentioned advantages and should ultimately improve income and earnings for the SWF’s assets. These cashflows could then be invested in the acquisition or creation of new assets.

Explicit in such asset management would be an interventionist role for the SWF’s managers which would be at variance from the traditionally passive role adopted by such entities in their international investments.

Investor activism would also imply creating greater human resources and capacity at the SWF than would be the case for more passive investment strategies. By linking manager compensation to portfolio performance, the SWF’s management should be incentivised to introduce a sea change in the operating culture of its underlying PSEs.

Whilst there will still be a multitude of issues to be resolved, eschewing political patronage and cronyism in favour of better managed, commercially driven business models will represent significant progress towards reform.

The financial transparency of SWFs is often influenced by the political state of their sponsoring governments.

In Pakistan’s case, the aspiration should be in keeping with democratic societies which typically establish funds through explicit legislation, provide specific operating and investment objectives, ensure independence by maintaining arms-length relationships with state institutions and mandate high standards of professionalism, integrity and information disclosure.

Norway’s Government Pension Fund Global (GPFG), which is the largest SWF with over $1 trillion in assets, represents the gold standard in organisation, independence and disclosure.

The creation of a SWF for Pakistan would represent a paradigm shift away from the state acting as an (often inefficient) operator of enterprises to an investor deploying its resources more efficiently, seeking better governance and expecting commercial returns. The state’s role would then change from patron and patriarch to a fiduciary of public funds.

This turnaround can be achieved if the SWF operates a hybrid business model that combines the potency of state sponsorship and asset accessibility with private sector enterprise and efficiency.

Equally important, the creation of a SWF will be a statement of intent in relation to Pakistan’s economic maturity. It will signify that asset development and value enhancement have become specific economic objectives to benefit future generations and the national economy.

—The writer is a financial sector expert for the World Bank

Published in Dawn, The Business and Finance Weekly, June 25th, 2018