Sovereign wealth funds are government investment vehicles created to manage a country's financial surpluses, generally from natural resource exports or international reserves. Globally, the total size of SWFs corresponds to approximately US$12 trillion12 trillion, with the largest led by resource-rich countries. Among the funds with the largest assets under management are Norway's Government Pension Fund Global, with approximately US$1.6 1.6 trillion; China Investment Corporation of China, which manages around US$1.2 trillion, with the largest funds led by resource-rich countries. trillion1.2 trillion; and the Abu Dhabi Investment Authority of the United Arab Emirates, with US$0.9 trillion in assets under management. trillion.

According to the International Monetary Fund, sovereign wealth funds can be classified by investment objective, among which the following types can be distinguished: 1) Stabilization fundswhose main objective is to protect the budget and the economy against commodity price volatility and external shocks; 2) Savings funds2) Savings funds, which are intended for future generations, and whose objective is to convert non-renewable assets into a more diversified asset portfolio and to mitigate the effects of Dutch disease ¹ ; 3) Reserve investment companieswhose assets are accounted for as reserve assets and are established to increase the return on these assets; 4) Development fundswhich normally help finance socioeconomic projects or promote industrial policies that could increase the potential growth of a country's production; and 5) Pension reserve fundswhich cover (from sources other than individual pension contributions) contingent pension liabilities not specified on the government's balance sheet (such as future pensions).

Chile's Sovereign Wealth Funds

Chile has two sovereign wealth funds: The Economic and Social Stabilization Fund (FEES) and the Pension Reserve Fund (FRP). Both were created by the Fiscal Responsibility Law (Law 20.128) in 2006, which also determined the regulations for their accumulation (contributions and withdrawals), administration and operation.

The ESSF qualifies as a type of stabilization fund, which is intended to complement The FEES is intended to complement the financing of infrequent and large fiscal deficits, associated with high-cost events and a lower debt capacity of the State. The investments of the FEES are made in financial instruments with high liquidity and low risk of significant losses over a short period of time, such as nominal and inflation-indexed sovereign bonds and U.S. agency MBS. This is because the funds must be available for use in the event of negative shocks.

Since its creation, the FEES has experienced variations in its size due to withdrawals to finance fiscal deficits, especially during the 2008 financial crisis and the COVID-19 pandemic, where US$9.2 billion and US$10 billion were withdrawn, respectively. The largest drawdown on record was in 2021 of approximately $6.2 billion to address the economic challenges resulting from the pandemic.

The PRF, as its name indicates, classifies as a type of pension reserve fund and was created to finance the future pension liabilities of the Chilean pension system, to ensure that the State is able to meet its long-term obligations. It currently complements the financing of the fiscal obligations of the Universal Guaranteed Pension (PGU), the Basic Solidarity Disability Pension, and the Solidarity Disability Pension Contribution. This fund invests in a mix of assets (riskier than the FEES) fixed income and equities, diversified globally to maximize long-term returns. This is due to the more long-term nature of the fund.

The PRF has grown steadily thanks to government contributions and returns on its investments. However, there have been significant withdrawals in recent years to finance pension reforms and social policies. In 2020 and 2021, withdrawals of US$1.5 billion and US$3 billion, respectively, were made to support emergency measures during the pandemic, which were made possible through modifications to the Fiscal Responsibility Law (and its withdrawal regulations). In view of this, two investment sub-portfolios were created: a short-term one, from which the funds were withdrawn between 2020 and 2021 and in which there are now no more resources; and a long-term one, from which the funds were withdrawn between 2020 and 2021 and in which there are now no more resources.. Each one has different investment policies.

The following graph shows the evolution of the market value of both funds.

Chile's sovereign wealth funds have played a relevant role in the country's economic stability, especially in recent years, allowing the government to face economic crises and meet its fiscal and social security obligations. The prudent and strategic management of these assets is due to the institutional framework that our country maintains today in relation to sovereign wealth funds. It is important that the size of the PRFs and ESSFs increase over the next decades in order to be able to use them in situations for which they were designed. With this, Chile would have something to fall back on in the future and be less dependent on the markets for financing.

Vincent Dourthé
Private Debt Team Fynsa AGF

¹ Negative effects that the development of a productive sector (linked to natural resources) has on an economy, causing an inflow of capital flows that appreciate the currency, affecting the competitiveness of other productive sectors.