No. 1/2022: Capital preservation and current spending with Sovereign Wealth Funds and Endowment Funds:A simulation study

Abstract

We study the dynamic performance of a sovereign wealth fund with the dual purpose of preserving wealth to future generations and provide regular contributions to annual budgets. We do not seek to derive optimal results but use stochastic simulations to study the implications of existing rules. Because our immediate focus is on the Norwegian Government Pension Fund Global, popularly referred to as the oil fund, we study rules established for this fund and calibrate our model from data for this fund’s financial returns as well as the Norwegian fiscal policy for which fund withdrawals make up an integral part. However, our results should be of interest to other sovereign wealth funds as well as endowment funds for universities and other non-profit institutions. Withdrawals are limited to the fund’s expected real returns as a first approximation; however, deviations from this rule are allowed to fund automatic stabilizers as well as discretionary fiscal policy. On top of that, the rule also allows smoothing so as to avoid abrupt changes. We find that this combination of rules implies considerable uncertainty regarding the fund’s future development. It does not preserve the fund’s value for future generations, not even in expectation, and will eventually lead to depletion. Keeping risk (equity share) low and withdrawal rates below the expected rate of return are possible remedies. However, for the depletion risk to be eliminated, stricter bounds must be put on countercyclical fiscal policy than the pattern followed in recent decades.