Nobody expects that it is business as usual for the world’s sovereign wealth funds (SWFs) after the massive losses they’ve sustained from high profile investments in global equities markets prior to September last year, and even higher profile bailouts of financial services giants such as Citigroup.
Many of the better known funds, including the Government of Singapore Investment Corporation (GIC), the China Investment Corporation and the Government Pension Fund of Norway increased their exposure to equities just prior to the financial crisis. These investments might have declined as much as 50 per cent since then, but at least there is the prospect that these investments will regain their lustre and give the SWFs a return. Longevity in terms of return horizons of 30 years plus, after all, is what separates SWFs out from the pack. The SWFs were also high profile losers in bailing out beleagured banks, having piled something like $50bn (D38.5bn) into loss-making enterprises, from which they will be lucky to get back 10c in the dollar.
While these losses have wounded the pride of many associated with SWFs, it has not even come close to putting a dent in their financial power. Everybody knows that they have to put their massive piles of cash (estimated to be over $3,200bn and growing) somewhere in the wake of the crisis.
On the subject of where to put their masses of cash, the question of asset allocation has long dogged SWFs, which are notoriously hard to pin down due to their secrecy and open-ended mandates in terms of return horizon and purpose. But now, in the wake of the turmoil in financial markets and the massive losses sustained by funds, a clearer picture is emerging.
In 2008, research house Preqin found that the vast majority of SWFs (89 per cent of them, in fact) had their funds in equities. This is true for fixed income too (87 per cent). Elsewhere, 73 per cent of SWFs were invested in real estate; just over half in infrastructure; just under half in private equity and 38 per cent in hedge funds.
However, considering the massive volatility and investment losses in financial markets since September last year, understandably there have been changing sentiments at major SWFs as far as asset allocation is concerned. Tim Friedman, Preqin’s head of research, says he expects to see big changes in the make-up of SWF fund allocation when results are next announced in May. He predicts that the asset classes SWFs are moving away from will be those considered alternative, including hedge funds and private equity, whose allocations had been on the increase in the previous three years. Although, he adds that it is difficult for funds to extricate their investments from such assets. “Normally with private portfolios there needs to be a commitment of new funds to maintain their asset allocation, but this is not happening, because many of these funds are already overallocated,” says Mr Friedman.
Building a property allocation
So, if SWFs are backing off from equities, what are they backing into? Bonds, bonds and more bonds, some believe. This would make sense, and it is what market watchers are hearing. Given the obvious advantage of liquidity (ease of entry and exit for vast sums), short-term government (mainly US) bills are an obvious attraction. However, this is the dilemma SWFs are caught in – although they are safe, because of the scarcity of funds in the public sector (with taxation receipts declining), there has been a dramatic rise in their issuance. This in turn results in pressure on yields as we see the overall market flooded. In short, the attractiveness of these instruments has declined markedly.
Furthermore, they are incongruous with the longer-term aims of SWFs of providing for future generations’ social security requirements. In the wake of the crisis, there is definite evidence that these funds are concentrating on their domestic economies in order to protect jobs and create an element of counter-cyclicality to correct the downturn in their economies. This is a logical move and reflects the political nature of SWFs. After all, the money they are investing is a national asset and if the fund cannot be used in the present circumstances to help individuals and businesses, when should it be used?
Consequently much of the recent investment by SWFs has been in infrastructure and property. There is increasing pressure for the large SWFs in the Gulf region to invest in property, according to Steffen Kern, an SWF specialist with Deutsche Bank. “In the Gulf, property prices are a big theme. There are areas in the cities where construction has come to a complete halt because construction was at the core of the recent upturn.”
