Recipes for a US sovereign wealth fund

Steven Abrahams | February 21, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The White House plans to propose a new US sovereign wealth fund sometime between now and early May, hoping to join hundreds already investing in equity, debt, real estate and other assets worldwide. The US fund could end up going in directions similar to existing funds, or, in an administration willing to set dramatic precedents, it could go in entirely new directions. One possibility might be to exercise US sovereign power in exchange for assets. Most approaches would likely have limited direct impact on US markets. We should know by sometime in early May.

The mandate for a US sovereign wealth fund

The new push comes from a presidential executive order and a fact sheet issued February 3 directing the Secretary of Treasury and Secretary of Commerce to deliver a sovereign wealth fund plan within 90 days. The order charges the fund with promoting fiscal responsibility, lowering taxes, providing economic security for future generations and promoting US economic and strategic leadership abroad. It also asks for recommendations on funding, investment strategy, structure and governance along with steps needed to set it up, including possible legislation. It is a broad mandate.

Hundreds of funds already in place

A new sovereign wealth fund would join hundreds already in place. Kuwait started the very first in 1953, funded by oil and gas revenues, and Kiribati, a Pacific island country, followed in 1956, funded by phosphate revenues (Exhibit 1). A surge of funds came in the 1970s as oil prices rose and another surge in the late 1990s and early 2000s as the Asian currency crisis led to a global rise in currency reserves. Since the end of the Global Financial Crisis, new funds have launched almost every year.

Exhibit 1: Hundreds of sovereign wealth funds have launched in the last 75 years

Note: Data only shows members of the International Forum of Sovereign Wealth Funds, which does not include all SWFs in operation.
Source: International Forum of Sovereign Wealth Funds, Santander US Capital Markets.

Although the amount of capital invested by these funds is hard to pin down—mainly because the definition of a sovereign wealth fund can vary—the 25 largest today manage more than $12.5 trillion (Exhibit 2). Norway’s is the largest with $1.7 trillion, followed by funds in China, Abu Dhabi and Kuwait. That list includes the Alaska Permanent Fund, set up in 1976 to save and invest revenue from Alaska’s oil for future generations.

Exhibit 2: The 25 largest sovereign wealth funds manage $12.5 trillion

Source: International Forum of Sovereign Wealth Funds, Santander US Capital Markets

These funds pursue different goals with different funding, investment strategy, structure and governance. In practice, funds often pursue multiple goals at the same time, blurring any sharp lines between fund types. But based on their primary goals, funds traditionally fall into fiscal stability, savings, currency reserve funds or development funds. Of course, the US could choose none of the above.

Fiscal stability funds

Fiscal stability funds try to smooth out government spending in countries with large and volatile exposure to oil, gas or other internationally traded natural resources. As the price and revenues from the asset swing up and down, government tax revenues and spending can swing in parallel and magnify domestic boom-and-bust. Boom-and-bust over time can take a balanced economy and make it narrower and more fragile, something often called the Dutch disease after problems in the Netherlands following discovery in the 1960s of natural gas fields in the North Sea. Boom cycles drive up the value of the local currency and make exporting parts of the economy noncompetitive, concentrating employment in the natural resource sector and even creating unemployment in other sectors as the economy grows. During a bust, the entire economy gets wrecked.

A fiscal stability fund can create ballast where the government sets a spending target—often as a percentage of GDP—and adds a cyclical boom-and-bust mechanism on top. Tax revenue that comes in above the target gets invested in the sovereign wealth fund, and any deficits get funded by withdrawals or borrowing against the sovereign wealth fund. Government spending evens out over time.

Importantly, fiscal stability funds do not invest in their own domestic assets. To do that would magnify boom-and-bust and defeat the purpose of the fund. Fiscal stability funds usually invest only in foreign assets, especially in assets with low or even negative correlation to prices in the dominant domestic natural resource. The fund portfolio needs that diversification to be able to make withdrawals or borrow against the fund during economic downturns. The fund also needs at least a healthy share of liquid assets to fund withdrawals.

Savings funds

Governments have also set up sovereign wealth funds as savings vehicles when the country has natural resources that will eventually run out. In these cases, the public has decided to save and invest revenues from the resource for future generations. Government spending usually then runs below the level that natural resource revenues might allow under the assumption that the fund will help support government services long after the resource dries up.

Although oil, gas and other natural resources have funded both fiscal stability funds and savings funds, savings funds usually have much longer investment horizons. A stability fund might have to come to the rescue of a government struggling with deficits one day, but a savings fund does not. A savings fund consequently may be able to own illiquid assets and tolerate the fluctuation in value that come with that. Or it may be able to buy or fund distressed assets with long recovery timelines. The Alaska Permanent Fund runs this way. And Norway’s sovereign wealth fund, the largest, has also run as a savings vehicle rather than a stability fund.

Currency reserve funds

Currency reserve funds came into play mainly after the 1997 Asia currency crisis, when many countries saw rapid depreciation of their local exchange. Many of those countries then built substantial reserves over the next decade to help manage foreign exchange rates. This cycle typically starts when a country exports more than it imports and consequently sees net strong demand for its domestic currency. The central bank can then print domestic currency and use it to buy up and hold foreign currency, preventing the domestic currency from appreciating against the foreign benchmark. To prevent the inflation that might then occur, the central bank sells bonds denominated in the local currency to absorb the local excess, a process known as sterilization. This still leaves the central bank with foreign currency, and the currency needs to get invested.

Because a reserve fund may need to respond rapidly to shifting exchange rates, it usually needs to hold safe, liquid assets readily converted into cash. That often limits the fund to investing in the short, government debt of major trading counterparties. But some funds have grown so large that reserves far exceed the amount needed to cover even catastrophic swings in exchange rates, and some countries have invested excess reserves in longer and less liquid instruments. In Singapore, for example, the combination of the Monetary Authority of Singapore, GIC Private and Temasek invest reserves over different horizons and, consequently, with different liquidity and return profiles.

Development funds

Some countries sponsor development funds to invest in important social and economic projects. Most of these funds invest in domestic ventures that otherwise would have no other sponsors. Priorities usually get set by public policy. And other than through the costs and benefits of the funded investments, these funds have limited impact on other parts of government.

The possibility of a new purpose

Since US policy in the new administration has taken radically new directions, it is possible that a US sovereign wealth fund could also strike out in a new direction. One area where a US fund might have unique advantage would be in negotiating with other countries for financial stakes or ownership in natural resources including land, minerals, energy or others. Private capital arguably could do the same thing, but the US government could uniquely offer security guarantees or special access to US markets that private capital could not.

The February 3 order mentions some broad purposes for a US fund, but points to nothing specific. If traditional fund goals of fiscal stability, savings, currency policy or development are part of the thinking, they go unmentioned. That leaves the possibility of something entirely new.

Funding a US sovereign wealth fund

The closest the administration comes to specifying the funding of a US fund comes in its fact sheet, which says “President Trump’s economic policies…will result in greater wealth and revenue streams that a sovereign wealth fund can maximize the potential of.” These streams could include tariffs, although those revenues get paid either by US importers or their customers. Or they could include some portion of tax revenues somehow attributable to “greater wealth.” There is no obvious mention of oil and gas or other commodity revenues for funding. Alternatively, the federal government could issue debt in corresponding amounts.

The fact sheet also notes the federal government directly holds $5.7 trillion in assets that presumably could get transferred into a fund, sold or posted as collateral against debt to seed a fund. If reserves of oil and other natural resources count, then the sum is larger.

Governance and public support

Putting substantial amounts of public wealth in a fund immediately attracts intense interest in its goals, operations, investment performance and use of proceeds. That is especially true when investment performance is noticeably good or bad. A group of sovereign wealth funds have drafted guidelines, the Santiago Principles, designed to encourage good governance and public support for sovereign wealth funds. They address a number of issues:

• Clear ownership and responsibility for oversight and management
• Clear rules on funding
• Clear investment goals
• Clear rules for withdrawing proceeds
• Regular communication with the public

Any US fund will have to get these things right.

Public management or private management

Whatever the purpose or funding source, the US, unlike many other states with sovereign wealth funds, has a large and sophisticated private sector that arguably could do a better job of maximizing national wealth for current and future citizens. If the government gets funding from tax revenues, natural resource revenues, existing government assets or new debt, those monies alternatively could flow into private hands—either directly through lower taxes, for instance, or indirectly through vehicles equivalent to a national 401(k) with a menu of investment alternatives. The US traditionally has assumed private interests, properly regulated, will do a better job than government at property balancing return and risk on capital. If the new fund elects not to put monies into private hands, policymakers will have to make the case for some proprietary advantage for government.

Likely limited impact on US markets

For US markets, it is hard to see how a US sovereign wealth fund would have a direct impact. Fiscal stability funds usually invest in offshore assets. Savings funds often invest in illiquid assets, which could include US assets, but that role currently is played by insurance companies and private debt and equity. The US does not hold significant foreign currency reserves, and a large development fund could look a lot like industrial policy, which the US typically has not embraced.

The deadline for the plan is May 3. Stay tuned.

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The view in rates

The drumbeat of approaching tariffs has helped flatten the yield curve, push up inflation expectations and lower expected growth and real rates since the first threats against Canada, China and Mexico started on January 31. Although higher tariffs on China and on steel and aluminum are in place, the administration is now examining reciprocal tariffs on all nations as soon as April 1. That should keep the tariff trade in place.

The market still broadly prices in two cuts in 2025, but the significant jump in consumer inflation expectations in January should give the Fed pause. Consumer expectations for price increases in the next five to 10 years hit 3.5% in January, the highest since April 1995. The Fed likes to keep inflation expectations anchored around 2%, and, although only one report, the latest numbers may ring alarms.

Beyond 2025, the market continues to fade the dot path, with the market pricing funds 29 bp above the dots at the end of 2026 and 82 bp above the dots at the end of 2027.  The futures market that far out is admittedly less liquid, but still a signal of skepticism about the Fed’s ability to eventually cut. The market clearly does not believe inflation is dead. Breakeven 2-year inflation rose 42 bp in January and is up 23 bp in February.

With longer rates, the appetite of foreign official portfolios and rising real rates seem to be playing leading roles. Foreign official holdings of Treasury debt in custody at the New York Fed fell through mid-January, in rough parallel with rising rates, and have since rebounded, in rough parallel with falling rates. Real 10-year rates similarly rose into mid-January and have since dropped back, again in line with the changes in nominal rates.

With discussions of tariffs, changes in immigration policy and an active battle underway in Congress over federal spending, the range of potential paths next year for the Fed has expanded. Rate volatility still does not look fully priced into options markets, especially for longer tenors.

Other key market levels:

• Fed RRP balances closed at $69 billion as of Friday, up $10 billion in the last week. With RRP at 4.25%, Treasury repo at 4.38% and MBS repo at 4.42%, cash has much better alternatives than RRP. Balances should trending down.
• Setting on 3-month term SOFR closed Friday at 332 bp, up 2 bp on the week.
• Further out the curve, the 2-year note traded Friday at 4.20%, down 9 bp in the last week. The 10-year note traded at 4.43%, down 6 bp in the last week.
• The Treasury yield curve traded Friday with 2s10s at 23 bp, flatter by 11 bp in the last week. The 5s30s traded Friday at 41 bp, flatter by 5 bp over the same period
• Breakeven 10-year inflation traded Friday at 242 bp, down 1 bp in the last 1week. The 10-year real rate finished the week at 201 bp, down 6 bp in the last week.

The view in spreads

Anecdotally, the demand for credit has been fierce. But that may be changing with concerns about tariffs, government job cuts and growth. Spreads in many corners of the corporate and structured credit markets stand near, at or below the tightest levels in a decade or more. Credit spreads have marginally widened in the lst few sessions

The Bloomberg US investment grade corporate bond index OAS traded on Friday at 80 bp, wider by 2 bp in the last week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 130 bp, tighter by 4 bp in the last week. Par 30-year MBS TOAS closed Friday at 31 bp, tighter by 4 bp in the last week.

The view in credit

Fundamentals for consumer and most corporate credit continue to look stable. Most investment grade corporate and most consumer balance sheets have fixed-rate funding so falling rates have limited immediate effect. Consumer debt service coverage is roughly at 2019 levels. The rate of serious delinquency in residential mortgages and of loans in foreclosure have barely changed over the last year. The balance sheets of smaller companies show signs of rising leverage and lower operating margins. Leveraged loans also are showing signs of stress, with the combination of payment defaults and liability management exercises, or LMEs, often pursued instead of bankruptcy, back to 2020 post-Covid peaks. If the Fed only eases slowly this year, fewer leveraged companies will be able to outrun interest rates, and signs of stress should increase. LMEs are very opaque transactions, so a material increase could make important parts of the leveraged loan market hard to evaluate.