Peak Sovereign Wealth Fund?

Via ConvergEx's Nicholas Colas,

Sovereign wealth funds tied to oil producing states have been much in the news of late. With the volatility in energy prices, Norway, Saudi Arabia and Russia have all tapped their SWFs over the course of the year to plug budget shortfalls.  So have we seen “Peak SWF” in terms of assets under management with last year’s $7 trillion balance?  Only if oil prices stay permanently low, an unlikely event barring a global depression.


SWFs are here to stay, and a review of this year’s major conferences dedicated to these investors points to how the global investment landscape will change in coming years.  SWFs want more exposure to non-correlated returns from private equity, infrastructure and hedge funds while using more passive strategies for their “core” financial asset investments. Also, aware that much of their funding comes from carbon-based fuels, some are keenly interested in “Green” investing and other socially-conscious initiatives. The only caveat to the money management industry: SWFs are becoming much more fee conscious.

There was a small piece of good news out of civil war ravaged Libya today: there’s a tanker loading some oil at a terminal in the east of the country.  According to a Wall Street Journal article, it is the first such production in months and provides a glimmer of hope that the country can begin to stabilize the local petroleum-based economy. “Normal” production for Libya is 1.5 million barrels/day. Current output is less than a third of that number.

Given all the terrible news out of the country since the fall of Muammar Ghaddafi in 2011, you might be surprised to know that the country is far from broke.  In fact, the Libyan Investment Authority (LIA) has some $67 billion in assets – the equivalent of $10,000 for every citizen. The only problem is that no one seems to quite agree on the legitimate leadership of the country, and both sides are pressing their claims in British courts. In the meantime, the fund is still a player in global finance with +$8 billion in public equity investments alone. 

Sovereign wealth funds such as the Libyan Investment Authority started in the 1950s – Kuwait had one even before its independence from Great Britain – and they most often associated with energy exporting countries. Their goal is to invest excess cash generated from oil and other fossil fuel sales so that when the country’s natural resources run out there is another base of assets to support the population. There are also SWFs in countries with long histories of exporting finished goods, such as Singapore, Hong Kong and, of course mainland China. 

Now, with oil prices under pressure over the last year it should be no surprise that energy exporting countries would be tapping their SWFs to fill budgetary gaps. Some recent headlines:

Norway, which actually runs the largest sovereign wealth fund in the world, plans to draw approximately $450 million from the fund in 2016 to replace oil revenues diminished by low energy prices.  Since the fund has $820 billion under management, that’s not much of a drawdown. The fixed income portion of the fund generates more than that in interest over the next 12 months, so the fund doesn’t actually have to sell assets to meet the government’s financial needs.


Saudi Arabia, where the central bank also doubles as the country’s SWF, is drawing on its foreign currency reserves to make up for declining oil revenues.  Now, the country still has over $600 billion in reserves, but that is down 10% from last year.


Russia has tapped its SWF for $14.3 billion over the course of 2015 according to press accounts

So was last year some kind of “Peak SWF”, or will the $7 trillion invested in these funds continue to grow?  The short answer is that it depends on energy prices, with 60% of SWF assets domiciled in oil and gas producing countries. So if you believe energy prices will remain low for the next 10 years, then yes…  Sovereign wealth funds might continue to shrink. But if and when (emphasis on the latter) oil prices recover, these funds will certainly resume their growth track.

Regardless of when oil prices turn, SWFs are large enough right now – and for the near future – to play a prominent global role in capital markets.  There are two major conferences for this group of investors just this month – the International Forum of Sovereign Wealth Funds in Milan, and the Institute Fund Summit (hosted by SWFI) in Amsterdam.  If you want to know what’s important to SWFs at the moment, the answers are in the titles of the presentations at these two events:

  • Interest in alternative asset classes, specifically Private Equity, Infrastructure Investments, and Hedge Funds.
  • A focus on European investment, leveraging an improving economic picture for the region.
  • “Decarbonizing Investment Portfolios” by lowering exposures to fossil fuel related companies and also investing in “Clean energy”.
  • Optimal Asset allocation, with an eye on underappreciated asset classes.
  • Responsible Investing benchmarking.
  • Smart beta and factor-based investing.

There are three distinct threads from these topics.  First, at least some SWFs clearly feel they must synchronize their investing approach to the populations they serve.  If environmental responsibility is a national social priority, then that should be reflected in the portfolio (even if the source of the capital was not originally so pristine). Second, SWFs clearly want to move beyond the 60/40 equity-fixed income model and invest in alternative assets. Some of the largest funds (Norway, for example) are already doing this, especially in real estate. Lastly, they want low cost options for “Core” investments in stocks and bonds that still offer some opportunity for outperformance. 

The bottom line to this brief tour of sovereign wealth funds is that, even with the drop in oil prices, the $7 trillion invested in SWFs makes them important participants in global capital markets; what they do, even at the margin, matters.  Having seen the volatility in equity markets – first in 2008 and again this year – they want to diversify.  Moreover, SWFs have the time horizon to look at long time frame projects like real estate and infrastructure; they don’t have to limit their scope to just liquid capital markets like stocks and bonds. The great unknown is how they will reallocate capital if oil prices really do remain muted for longer than expected.  Will they take more risk?  Or less?  And in what form?  Given their collective size, those decisions could alter the global investment environment more permanently than issues like Federal Reserve policy or next quarter’s corporate profits.