Why don't sovereign wealth funds (SWF) just invest in the S&P500?
DISCLAIMER: BROUGHT TO YOU BY THE WOKE SALARYMAN FOR THE WOKE SALARYMAN'S AUDIENCES.
It’s been a rough year for many investors. Sovereign Wealth Funds (SWF) – are no exception. You can think of SWFs as a country’s investment portfolio.
Most recently, Singapore’s Temasek posted its worst return since 2016 (-5.07%). Norway’s SWF also posted a US$164 billion loss in 2022. They’re not alone.
Now, here’s a question we often see online whenever sovereign wealth funds (SWF) underperform vs. the S&P500.
Why not just invest in the S&P 500 – the 500 largest companies listed on the US stock exchange?
After all, the returns since inception are around 7% per year. If you can’t beat that, you’re a sub-par investment manager, right?
Well, not exactly.
You see, when investing, you need to take into account risk appetite and risk capacity. This is true, whether you’re a person or a country.
Taking that into account, it’s pretty plain to see why countries don’t invest in the S&P500. Here’s why.
Volatility
During the COVID crash of 2020, the S&P500 fell over 30%. And during the Dot.com bubble of 2001, the S&P500 fell up to 40%, and only recovered a decade later.
This is because the S&P500 is invested in stocks, and stocks do fall. This is a feature, not a bug.
A disciplined individual might be able to wait it out for 10 years for the market to recover, by living like a cockroach.
But countries have high expenses every year.
Healthcare, defence, climate change, public services, welfare etc.
These need to go on despite any economic circumstances.
Imagine telling your citizens that the nation’s reserves have fallen 40%, and telling them that they need to reduce their quality of life for the next 10 years.
Not only is that wildly unpopular, but it’s also hard to explain:
Most people don’t even understand that investing involves volatility. I suspect that even in developed countries, only a minority of the human population is financially literate.
From an asset class perspective, it’d be just bad investing.
Instead, it makes more sense for a SWF to pursue stable returns without too much risk. It’s okay to put some funds in the S&P500, but you might wanna back it up with less volatile instruments: bonds, real estate, etc.
This will, in turn, will sacrifice returns. So yes, that’s why SWFs might have lower returns compared to say, the S&P500, QQQ, and all the other ETFs out there.
Of course, this might mean that during years when the market crashes, SWFs will outperform instead.
Being too dependent on the United States
The United States is still the world’s major superpower. It has an insane ability to attract talent to its shores, defying most developed countries’ ageing population problem.
It also has the world’s most powerful companies.
But, we all can agree that the United States has its own problems and interests. If a country invests its SWFs entirely into the S&P500, they’d have what they call concentration risk.
Because while the S&P500 is diversified across 500 major companies, they’re all listed in just one country.
Yup, 500 egg baskets are in one big US basket. What if the US goes through a period of instability, changes its economic policy, or closes off its stock market to the rest of the world?
Any country – not even the closest US allies in Europe – should think this is a wise decision.
In a changing world where new superpowers are emerging, it makes sense to diversify across countries.
Investing in their own people/projects
Imagine telling your citizens that to improve their lives, you will use hard-earned taxpayers’ money… to invest in another country’s companies.
Doesn’t quite have a punch to it, doesn’t it? Feels even a bit dirty.
You’d expect SWFs to at least invest some of their funds into helping their homegrown talent and companies succeed.
In turn, this can create jobs, or maybe even provide goods and services that help the country.
Other times, countries might have their own unique advantages in a certain industry that they might have more control over.
For example, it might be more profitable for Singapore to invest in say, expanding its seaports and airports than investing in the S&P500. It’s something that Singapore has more control over, too.
Would you invest in the S&P500 if you have a killer business idea that might earn you a lot more?
Same idea.
Does that mean the S&P500 is shit?
Of course, it’s not shit.
Many SWFs are likely to have some S&P500 holdings. But given a country’s many different investing considerations, a pure S&P500 play isn’t wise at all.
The person on the street is more likely to grow wealth by investing regularly in it than by pursuing the latest stock tips.
All that being said, whether you’re a country or an individual you need to do the following:
Understand your risk appetite and capacity
Understand your investment goals
Always prepare for the worst-case scenario
Blindly making investment decisions – even as something tried and tested as the S&P500 – is a fool’s game.
Stay woke, salaryman
You forgot to take into consideration that those companies in S&P 500, while based in US are global companies: Amazon, Tesla, Google, Microsoft, Boeing, Pfizer, just to name a few. These companies are so diversified that they have huge influence in most of the world's economy. This makes S&P500 more diversified than your article leads it to seem. What if the US goes through a period of instability? The companies will still be doing fine as they operate in the rest of the world rather than just in the US market. What if they close off the US stock market to the rest of the world? Even more reason to buy now. Roughly 40% of S&P 500 companies' revenues are earned outside US. You're focusing on where the companies are listed, rather than where the companies operate.