Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Sovereign funds recover mojo, on track for US$71 trillion by 2030
According to the Global SWF annual report released last week, the state-owned investment universe – a group comprising sovereign wealth funds, public pension funds and central banks – reported US$49.7 trillion under management as at the end of December, equating to about half of the world’s GDP. But despite the improved position, the collective pool of government-controlled funds still fell short of the 2021 peak of US$50.8 trillion.
“Sovereign wealth funds (SWFs) recovered markedly and peaked at US$ 11.2 trillion; public pension funds (PPFs) increased their assets to US$ 23.1 trillion; and central banks (CBs) stayed almost flat at US$ 15.4 trillion,” the report says. “We expect the three groups to reach a combined US$ 50 trillion once again, and pass the 2021 peak at some point in 2024 as they recognize the paper gains most institutions have enjoyed during the past 12 months.”
2023 also saw a number of changes to how SWFs think about investments, with interest in private credit flourishing as with bank flight from the sector kicked off by the GFC accelerated and other institutions stepped in to meet unfulfilled demand from corporate borrowers.
“Sovereign investors are stepping into the breach as banks have exercised caution in the face of hefty losses as default rates climb,” the report says. “They benefit from lower liability constraints that enable them to take on more liquidity risk than banks. Their greater risk appetite is driven by their long-term investment horizon. The asset class was notably resilient amid the pandemic with managers successfully protecting their portfolio values as well as deploying dry powder to add assets.”
But big investors are now running into constraints on “how far and fast” they can allocate to the asset class.
“AustralianSuper, Australia’s largest superannuation fund, reported that private credit comprised 18% of its portfolio, i.e., US$ 27.2 billion, in fixed income, after doubling its investment in the latest financial year,” the report says. “The super fund would like to go further with investment in long-term corporate debt, but CEO Paul Schroder stated that the market needed to develop to allow increased allocations, with greater co-operation between banks, insurers, funds and companies.”
Diego López, Global SWF founder, says in the report: “Save for 2008, the term ‘sovereign wealth fund’ had never been googled so much in a 12-month period. Governments, public bodies, multilateral organizations, asset managers and service providers around the world all have asset owners in their sights.”
Ongoing contributions and market growth should see the state-owned fund pool hit almost US$55 trillion by 2025 and US$71 trillion in 2030, the Global SWF study says, highlighting the outsize influence of the government investment sector on markets.
And the popularity of government-influenced investing is set to grow further, the report says, with five new funds launched in 2023 and another dozen or so in the pipeline. Challenging economic and geopolitical conditions have also seen many state-owned funds reconsider asset allocation decisions – albeit that the sector represents a diverse range of investment mandates and strategic goals.
For example, the report highlights the NZ Superannuation Fund (NZS) as “an advocate for strategic tilting, i.e., short-term active changes relative to the reference portfolio to increase exposure to undervalued asset classes, which has added US$ 2.9 billion since inception”. The Future Fund also scored a mention for its total portfolio approach with “a strong emphasis on diversification”.
“This implies the manipulation of newer levers, including the search for alpha, a focus on liquidity and dynamic asset allocation, pivoting between DM and EM equities, a broader currency basket, more domestic exposure (via infrastructure), and greater weight in gold, commodities, tangibles, and alternative assets. According to the fund, this is a time for investors to challenge existing assumptions and to focus on balancing risk and return.”
With additional reporting by Lachlan Maddock.
