A sovereign wealth fund is a state-owned investment vehicle, and the label covers institutions whose objectives have almost nothing in common. Classify by purpose and the horizon, the liquidity requirement and the risk tolerance fall out of the classification rather than being chosen.
What are the five types of sovereign wealth fund?
Stabilisation funds exist to insulate a budget from a commodity price or a revenue cycle. The horizon is short, the liquidity requirement is severe, and the risk tolerance is low, because the fund's whole purpose is to be spendable in exactly the years when risk assets are falling.
Savings funds convert a depleting resource into a permanent financial asset for future generations. The horizon is multi-generational, the liquidity requirement is limited to the annual transfer, and the risk tolerance is the highest of the five.
Development funds finance domestic economic priorities, so the objective is partly non-financial and the portfolio is frequently concentrated in the home economy, which is exactly where the country's other risks already are.
Reserve investment corporations manage foreign-exchange reserves that remain reserves, seeking higher returns than a central bank's traditional portfolio while staying inside what a reserve manager can defend. The horizon is medium and the constraint set is closer to a central bank's than to an endowment's.
Pension reserve funds pre-fund a state pension obligation whose payouts begin years in the future. The horizon is long but finite and, crucially, deferred, which makes it longer than it looks.
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How does the type turn into an asset allocation?
A stabilisation mandate converts into an allocation in one line of arithmetic. Annual exports times the shortfall per barrel gives the annual draw; the number of years the mandate promises to cover gives the multiple; and that draw as a share of the fund is the sleeve that must be sellable inside the promise period. Worked Example 7 works a case where the answer is 48.44% of the fund, so half of it is a liquidity instrument and the risk tolerance of the other half is whatever remains. A savings fund on identical oil revenue in the same country faces an annual transfer instead of a three-year draw and can hold a majority in growth assets.
Deferral is what makes the pension reserve case interesting. Shifting a payment stream later adds its full length to the Macaulay duration, so an obligation that pays nothing for eighteen years and then pays for forty carries a duration in the low thirties. That is longer than any bond the fund can buy, so a pension reserve fund cannot immunise and holds growth assets by necessity rather than by appetite.
The classification also explains why two sovereign funds in neighbouring countries can hold opposite portfolios and both be right. It is a difference in what the fund is for, not a difference of opinion about markets.