Asset allocation in sovereign wealth funds changing, research finds

The past three to five years have seen major changes in asset allocation among sovereign wealth funds including allocations to private and emerging markets, according to latest research.

The papers from State Street and the International Forum of Sovereign Wealth Funds (IFSWF) revealed that none of the sovereign wealth funds interviewed for the research increased their allocation to foreign government bonds. Additionally, half had reduced their exposure to these securities and increased their exposure to emerging markets, with none reducing their exposure to these geographies.

“Much like all investors in today’s economic climate, sovereign wealth funds are balancing traditional financial theory with the complexities presented by today’s real-world circumstances,” said Will Kinlaw, senior managing director and global head of State Street’s academic affiliate, State Street Associates.

In addition, interviewed sovereign wealth funds had substantially expanded their alternative, unlisted, and private investment portfolios. At least 30% of the surveyed group had invested more, and none of the respondents had reduced their exposure.

A second paper entitled “comparison of members’ experiences investing in public versus private markets,” revealed sovereign wealth funds often chose to enter private markets as they believed their long-dated liabilities mean they can benefit from the illiquidity premium that these assets offer. They also thought that private markets are less efficient and present more opportunities for return.

Even though sovereign wealth funds have been successful in private markets, many reported ongoing internal debate as to whether the return premium is fair compensation for the risks these types of investments add to the portfolio.

Sovereign wealth funds also cited a wide range of factors that led to success in private markets, including fostering a culture of long-term investing, attracting and retaining qualified staff, partnering with other sovereign wealth funds and proceeding slowly to keep pace with developing in-house capabilities.

“The investment landscape has evolved significantly in recent years, and SWFs have contended with an ever-expanding array of investment opportunities in both public and private markets,” said Roberto Marsella of CDP Equity and lead of the investment practice committee at IFSWF.

“In response, many are re-evaluating the methods they employ to construct portfolios and measure and manage portfolio risk. The low interest rate environment creates new challenges and requires reassessment of investment methodologies and professional skills.”