Sovereign fund sell-off seen raising portfolio risks

Forced to offload their most liquid assets of late, oil-based state funds have increased their portfolio risk, according to a report. Meanwhile, more SWFs are in the pipeline.
Sovereign fund sell-off seen raising portfolio risks

Oil-based sovereign wealth funds are making their portfolios more vulnerable to future shocks in their scramble to meet their governments’ short-term cash needs, according to a report by research house Preqin. 

The study also points to growing opportunities for alternative investment managers, as the number of SWFs allocating to alternatives continues to rise and the overall AUM held by state funds globally has swelled despite last year’s volatility.

Many sovereign funds are set up with the aim of meeting long-term needs, such as pensions, notes the 2016 Sovereign Wealth Fund Review, released last week. However, the sharp fall in oil and other commodity prices has led some countries to sell assets or reassign them for other means (see also page 22 in the April issue of AsianInvestor magazine).

“In times of stress such as this, the independence [of SWFs] is being questioned, as states are drawing on sovereign investor assets,” says the report.

And since these funds were not set up to cope with forced disposals, their portfolios are exposed to unnecessary risk due to the fire sale of the most liquid securities such as public equities and government bonds.

“These moves disrupt a fund’s asset allocation and can quickly result in an unintentional overweight to illiquid assets,” says the report. This can be amplified by falls in stock markets which in part may be caused by the selling of large institutions.”

Selling bonds also reduces downside hedging in a portfolio, it adds, raising risk management issues, as liquidity and investment risk are all increased.

Michel Meert, director of PwC’s investment advisory practice in London, who contributed analysis to the report, said: “An aspirational response for states wishing to avoid this scenario in the future would be to create a designated ‘stabilisation fund’ with a clear mandate, expert personnel and appropriate asset allocation, to be able to provide liquidity when called upon, while allowing the longer-term ‘capital maximisation fund’ to truly provide for future generations.”

Saudi Arabia appears to have recognised this, in light of its reported plans to set up a $2 trillion SWF with a view to creating a more diverse and less oil-dependent economy.

SWFs post growth overall
Oil-based funds may have suffered, but last year the overall assets under management of SWFs globally increased by $200 billion (from April 1, 2015 to March 31, 2016), to reach $6.51 trillion in March 2016, says the review. The data is based on direct contact with funds and their advisers and on filings and financial statements.

The growth came from non-commodity backed funds, which added $290 billion in assets, while hydrocarbon funds lost $10 billion and other commodity-based funds saw their AUM more than halve from $130 billion to $50 billion. In all, 45% of sovereign wealth funds saw their assets rise over the 12-month period, while 19% saw their AUM remain much the same as in March 2015.

Although the rate of growth has been noticeably slower than in previous years, SWFs now hold more than double the $3.22 trillion they had in 2009. Collectively, funds based in Asia represent 22% of the number of funds, but 46% of the AUM of funds globally. North America, by contrast, accounts for just 3% of aggregate sovereign wealth fund capital.

Going alternative
A rising proportion of SWFs are now investing in alternative asset classes, although fixed income and public equity investments still comprise the largest proportion of most portfolios.

Real estate remains the most attractive alternative asset class for SWFs, with 61% globally setting a target allocation to property of 10% or more. Singapore’s GIC and Kuwait Investment Authority each has more than $19 billion allocated to property. 

Fifty-five percent of sovereign wealth funds now invest in private equity, up from 47% in 2015, while 62% allocate to both real estate and infrastructure.

More than a third (35%) of sovereign wealth funds were active in private debt as of March 2016, reflecting the growing prevalence of non-bank lenders as credit providers since the 2008 financial crisis.

Seventy percent of SWFs invest in more than one alternative asset class, and around a fifth (22%) have exposure to all six alternative asset classes tracked by Preqin.

Only a third (32%) allocate to hedge funds. However, Preqin suggests that with oil prices remaining low and many funds looking to withdraw capital from their portfolios, liquid strategies may become more important to these entities.

Top 10 Sovereign Wealth Funds by Total Assets under Management
Fund name Country Year established Total assets
($ million)
Government Pension Fund Global Norway 2006 834,620
Abu Dhabi Investment Authority United Arab Emirates 1976 773,000
China Investment Corporation China 2007 746,730
State Administration of Foreign Exchange China 1997 599,510
Kuwait Investment Authority Kuwait 1953 592,000
Hong Kong Monetary Authority Hong Kong 1993 441,033
GIC Singapore 1981 344,000
National Social SecurityFund China 2000 274,595
Qatar Investment Authority Qatar 2005 256,000
Temasek Holdings Singapore 1974 189,797

source: Preqin

Out with the old...
In the last six years, 14 SWFs have been launched, with the Philippines among the countries in line to launch new funds soon, says Preqin. 

In 2015 two funds actually left the market: Indonesia’s sovereign fund, the Government Investment Unit, which transferred its assets to a local infrastructure entity, PT Sarana Multi Infrastruktur; and Mexico’s Oil Income Stabilisation Fund, which consolidated its shrunken assets with another local petroleum-funded entity.

Meanwhile, Preqin is planning to extend its research to other big autonomous investing institutions, particularly pension funds. The purpose is to give an overview of other large investors that might have similar risk-return profiles and long-term aims to SWFs. 

This will cover investors such as Japan’s $1.2 trillion Government Pension Investment Fund and the CPP Investment Board of Canada with $209 billion.

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