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After shock of redemptions, sovereign funds rethink strategies
[ LONDON] Having gone from bumper cash inflows to redemptions in just two years, many sovereign wealth funds have been forced to shake up their investment strategies to embrace both super-liquid safe assets with more esoteric illiquid plays to bolster returns.
If the price of retaining easy-to-sell assets to meet sudden government cash calls is near-zero yields in cash deposits or Western government debt, then the $6.5 trillion sovereign fund sector will have to claw back returns by simultaneously moving deeper into riskier, less-liquid territory.
Changes run from radical rethinks about the purpose of such funds such as Saudi Arabia's US$3.5 billion investment in ride service Uber to more nuanced shifts such as Qatar's decision to use more external managers to run its money.
With oil crashing to under US$30 a barrel in early 2016 and still down by more than half since 2014, states such as Saudi Arabia have been forced to raid their coffers to cover day-to-day spending.
And that shift - from managing inflows to managing withdrawals - can present significant portfolio rebalancing and risk management challenges, says Michel Meert, a director at PWC, which advises sovereign wealth funds (SWFs).
For instance, selling stocks and bonds to meet governments'urgent cash needs can lead to unintended overweight positions in other areas, such as more illiquid assets, which cannot be disposed of as quickly. "If you have an external element disrupting portfolios, most of the time it has a negative impact on performance. It incurs costs and you are not necessarily selling at the right time,"Mr Meert said.
Similar unintended overweights can occur in the event of a stock market crash. Recognising this, Norway now allows real estate allocations in its US$868 billion SWF to go as high as 7 per cent, up from its previous 5 per cent ceiling.
This means it won't be forced to sell property if a fall in the value of stocks pushes up real estate's share in the portfolio.
Also, some of the more sophisticated sovereigns now split their portfolios into tranches of short-term, medium-term and long-term assets, said Alex Millar, head of EMEA sovereigns, Middle East and Africa institutional sales at Invesco. "This recognises that at any time they could get a request from the government for some of their funds. So they need to keep a certain percentage of their portfolio liquid and secure for that. Above that threshold, they can park assets for longer."
These changes are taking place alongside a broader shift out of publicly listed stocks and bonds.
Last year, SWFs pulled US$46 billion from external managers, according to eVestment data.
This came amid rollercoaster equity moves and mounting frustration with low or negative interest rates in many Western bond markets.
They are turning instead to unlisted but higher-yielding assets, with some 55 per cent now investing in private equity, up from 47 per cent in 2015, according to research from Preqin.
Start-ups, particularly those that exploit disruptive technologies, are also attracting bigger slabs of SWF capital, including recent investments in GrabTaxi and Chinese internet company Meituan-Dianping.
And private debt vehicles that provide loans for everything from aircraft leasing to infrastructure now attract 35 percent of SWFs, Preqin says. "There is a need for yield," said Declan Canavan, head of alternative strategies at JP Morgan Asset Management.