Two new white papers from State Street Corporation and the International Forum of Sovereign Wealth Funds (IFSWF) reveal changes in asset allocation among sovereign wealth funds (SWFs) over the past three to five years.
The studies reveal shifts that include a significant increase in allocations to private markets (private equity, real estate and infrastructure) and emerging markets, as well as a reduction in their exposure to listed and developed-market investments. The research also looked at SWFs’ motivations for entering private markets, the approaches they had to develop to be successful, and lessons learned.
Earlier this year, State Street was appointed by the International Forum of Sovereign Wealth Funds (IFSWF) as one of its two official research partners for its Investment Practice Committee, which has a year-round research program.
The first paper from that partnership, ‘Asset Allocation for the Short and Long Term’, examines how SWFs are keeping up with the post-crisis financial markets, and includes findings from a survey of eight IFSWF members, representing a wide range of SWFs.
“Much like all investors in today’s economic climate, SWFs are balancing traditional financial theory with the complexities presented by today’s real-world circumstances,” says Will Kinlaw, senior managing director and global head of State Street’s academic affiliate, State Street Associates. “They recognise that, in many cases, their long investment horizons represent an advantage, and they are seeking investments that will provide attractive long-term return, risk, and diversification properties. What looks appealing based on monthly returns may look much less so when the horizon is measured over multiple years.”
Key findings of the research include the fact that none of the SWFs interviewed for the research increased their allocation to foreign government bonds and half had reduced their exposure to these securities; Half had increased their exposure to emerging markets, with none reducing their exposure to these geographies, and as a group, these SWFs had substantially expanded their alternative, unlisted, and private investment portfolios. At least 30 per cent of the surveyed group had invested more, and none of the respondents had reduced their exposure.
“One of the biggest findings from this research is the growing focus on private markets,” continues Kinlaw. “Despite the allure of these investments, SWFs are aware of the potential risks, with illiquidity topping the list. However, many have invested considerable time and resource in assessing these markets and have clearly identified attractive opportunities here.”
Ten IFSWF members contributed to the second white paper, ‘Comparison of Members’ Experiences Investing in Public versus Private Markets’, which examines SWFs’ approach to investing in the private markets.
Key findings here included the fact that SWFs often chose to enter private markets as they believed that 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, therefore, present more opportunities for return.
The firm writes that even though SWFs 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.
SWFs 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 SWFs, assigning multi-disciplinary due diligence teams, and proceeding slowly to keep pace with developing in-house capabilities.
Of the SWFs interviewed for the paper, 50 per cent said they had to make changes to their governance process to overcome challenges related to the speed of decision-making regarding private market opportunities.
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,” says Roberto Marsella of CDP Equity (a company of the Cassa Depositi and Prestiti group of Italy), lead of the Investment Practice Committee of 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.”
