Traditionally, sovereign wealth funds (“SWFs”) have made investments directly in US stocks, bonds, private equity funds, or real estate. Today, the activities of SWFs have expanded in a number of ways.
SWFs have begun hedging the foreign currency and interest rate exposures on their investments with financial derivatives. Further, SWFs have also begun to utilize financial derivatives to achieve the fundamental economic exposure that their fund managers may be seeking. SWFs are key investors in many onshore and offshore fund complexes. Fund managers for these fund complexes also have expanded their investment parameters in similar ways to achieve the returns they are seeking.
Why is this significant? Because the US tax treatment of these financial derivatives is not entirely clear for SWFs.