Saudi Arabia plans to create a two trillion dollar sovereign wealth fund.

It is good news that Saudi is trying diversify its economy but why do they need a trillion dollar fund?

Large sovereign funds may seem to have a lot of power but due to its size, it has actually constrained investment opportunities. They can’t simply go into markets because they will become the market. For instance, they could easily make a small commodity market price jump by pumping money into it. That is why many hedge funds limit their fund size in order to stay nimble. With such a huge size, the Saudi sovereign fund will have to invest mostly in liquid treasuries and probably large private projects. Even that it would be hard given its a trillion dollars.

So what can the Saudi fund do? Well, it could build schools and actually educate the population and increase productivity. That is long term but sovereign wealth funds are supposed to have very long term investment horizons.

They could also purchase lot of real estate, specially in the developing nations and get steady returns.

A bit more riskier but the fund can invest a lot in R&D by funding a lab with virtually unlimited resources and capitalize on future technology.

Besides these investments, I do not see good markets to park the wealth fund’s money. Alternative investment opportunities are limited and flooding with billions will not be the best idea. The fund cannot just blindly buy company market indexes. They could up to a point but there would be a limit. Hence, it would be interesting to see how the Saudi fund invests.