The aggregate assets of the world’s sovereign wealth funds rose 11% through 2010 to $3.8 trillion according to a report by Prequin. Whether grand totals like that make much sense, of course, is another matter. The funds are not managed as an aggregated total and each pursues its own strategy. Management risk profiles and investment strategies vary hugely.
However, there appear to be clear signs that having committed a fair number of high profile blunders over the last few years in their search for higher yield, funds have, in general, become better at investing. According to Sam Meakin, managing editor of the 2011 Prequin Sovereign Wealth Fund Review, that 11% increase in AUM through 2010 was largely down to returns on investment.
One of the best performers was the Norwegian Government Pension Fund - Global, which passed the 3 trillion Norwegian kroner mark in 2010 ($537 billion), with an increase in assets under management of $75 billion, according to Prequin. Of course the Norwegian fund, despite its scale, doesn’t get US senators exercised in the way that Middle East petro-dollar based sovereign wealth funds, or China’s SWFs do.
The return on assets was actually substantially better than the 11% indicates, since, as Prequin points out, some SWFs, particularly in the Middle East and Russia, were drawn on heavily by states to support crashing economies through the downturn and their assets shrank accordingly – which of course, means that other SWFs grew that much faster in order to generate that 11% aggregate return. Russia’s sovereign wealth fund, for example, shrank by nearly 60% from 2008 to the start of 2011 and is now down to around $25 billion.
The favourite asset class for SWFs has long been infrastructure, with a significant proportion of that being a local investment in the fund’s domestic infrastructure, but with foreign infrastructure also being sought after. According to Prequin, some 61% of SWFs invested in infrastructure in 2011, up from 47% at the start of 2010. Real estate is another favourite, with more than half the funds looking for “bargains” in real estate. Despite their horrendous performance through the crash, hedge funds remain attractive to SWFs, probably because they represent a more anonymous, lower profile channel for SWF funds.
Having sat on their hands, putting asset allocation on hold for the most part through the worst of the crash, there are now clear signs that SWF managers are back in the hunt for increased yield. Interestingly, private equity (PE), with its potential for above average returns, is of growing interest. SWFs are generally not afraid of committing to medium term investments in relatively illiquid assets provided they feel comfortable that the returns will be there. SWF managers have very significant inflows to place and parking cash in PE funds or larger PE ventures for five years or so is very appealing.
However, the track record of SWF returns out of PE remains fairly dismal. Plus we have to remember that the whole PE game is still in the process of reinventing itself since the primary high-leverage model of a modest equity stake backed by oodles of bank senior debt got bust by the 2008 credit crunch. Still, if you are a SWF manager, with your coffers filling up with cash at a worrying rate, you can’t sit on your hands forever before some government type starts asking why exactly they are employing you… Strategic inaction may be a sensible route when markets get roiled but to most politicians, who after all, as a class are masters at inaction - doing nothing in politics, which can be spun as “steady as she goes”, is often the safest career option - fund managers sitting on cash is the same thing as fund managers not doing their job.
Add to this high and rising inflation in many of the countries with the largest SWFs and it becomes palpably clear that cash is an absolutely certain loss maker on every front. With near zero returns for “low risk” assets like short-dated US Treasuries, cash or cash equivalents remain a real drag on overall fund return performance - unless all other equity classes crash hopelessly, when suddenly a cash holding looks like a brilliant investment decision!
Since we are not in a world where all asset classes other than cash are crashing, but are instead in an investment environment where cash is losing hand over fist while other asset classes are romping away, it follows that the SWF hunt for yield can only intensify in the months ahead.
Further reading on sovereign wealth funds and asset allocation:
- Forget Sovereign Wealth Funds, by Diana Choyleva
- Sovereign wealth funds get back to basics, by Anthony Harrington (blog)
- Sovereign Wealth Funds—Profiles of the Top 10 Players, QFinance Checklist
Tags: asset allocation , cash , fund management , inflation , sovereign wealth funds , SWFs