Home / Why sovereign funds are attracted to alternatives

by David Chaplin

Sovereign wealth funds (SWFs) have significantly upped allocations to alternative assets since 2010 during a period when funds under management leapt about US$3 trillion, new research from global consultancy firm PwC reveals.

The PwC study shows the SWF sector lifted exposure to alternative assets from 19 per cent in 2010 to almost a quarter of total investments as at the end of 2016 compared to. Over the six-year stretch total SWF assets under management grew from US$4.4 trillion to US$7.4 trillion, the report says.

Despite a slight dip in market share from 2015 to 2016, SWFs have also increased their influence in the institutional investor space as government-sponsored funds continue to spawn. In 2004 SWFs collectively managed about 4.5 per cent of global institutional investment assets compared to 10 per cent in 2016 (10.2 per cent the previous year).

“With the growing size and diversity of SWFs, we have observed their investments expanding in scope, introducing a variety of new asset classes into their portfolios,” the PwC study says. “A large number of SWFs are increasingly shifting a part of their asset allocation towards alternative investments.”

However, the report warns alternatives also introduce new risks into SWF portfolios “such as illiquidity, complexity, and cyclicality”.

In a statement, PwC global head of sovereign investment funds and private equity, Will Jackson-Moore, said: “SWFs should keep in mind the need for continuous monitoring of their portfolios and their investments and reallocate their capital to reflect economic developments.

“Overall though, the benefits seem to outweigh the costs, as the varied nature of alternatives provides SWFs with the ability to select an asset class specific to their investment needs.”

Nonetheless, the steadily increasing SWF exposure to alternative assets since 2010 came against a backdrop of fluctuating allocations to the mainstay sectors of fixed income and equities. According to the PwC analysis, SWF fixed income portfolio levels jumped from 35 per cent in 2010 to 40 per cent three years later before sinking to just 30 per cent in 2016. During the same time periods SWF equity exposure went from 44 per cent to 37 per cent and back again to 44 per cent by 2016.

“This rise in alternatives can provide portfolio diversification to traditional assets such as equity and bonds, support economic development, and be used as a hedge against crises which is aligned with the long-term investment horizon of SWFs,” the PwC report says.

Of the alternative asset sub-classes, private equity has attracted the most capital from SWFs, PwC says, while the conjoined twins of real estate and infrastructure lured the largest number of funds to invest (63 per cent).

“Investments in private equity are becoming a mainstream option for SWFs, with 61% of them holding the asset class in their portfolios,” the paper says. “In 2016, private equity accounted for 6.1% of SWFs’ assets, compared to 3.7% registered in 2011. This translates to an increase from USD 178bn to USD 451bn in 2016 in terms of [assets under management] an impressive growth rate of 20.5% from 2011 to 2016.”

About 55 per cent of SWFs invested in commodities in 2016 (up from 47 per cent a year earlier) and 33 per cent held hedge funds.

“While all SWFs investing in commodities have exposure to energy, only 44% of them allocate to metals and mining goods,” the PwC study says. “Furthermore, SWFs investing in commodities prefer to devote resources to water and agricultural projects, with 56% and 54% of SWFs investing in these respectively.”

PwC suggests gold would fit well as an alternative diversifier in SWF portfolios, although the report provides no data on current investment levels.

And despite hedge funds ranking as their least popular alternative, SWFs remain influential in the sector. As a group SWFs represent about “12 per cent of capital invested into hedge funds”, the paper says.

“This might increase as SWFs seek further exposure to the asset class in order to diversify their portfolios,” PwC says.

The report says SWFs were also exerting their collective power in the sometimes-problematic hedge fund world including a 2016 deal between the International Forum of Sovereign Wealth Funds (IFSWF) and the Hedge Fund Standards Board (HFSB).

“The agreement is designed to improve the dialogue between hedge funds and SWFs, with the goal to guarantee adequate financial positions from both sides,” the PwC study says. “A mutual exchange of information was set to ensure transparency in both parties’ investment practices.

– Investment News NZ