Sovereign Wealth Funds Have Buffers Against Oil Shock: Moody’s

As a November 12th report from Moody’s Investors Service highlights, both the number and the AUM of global sovereign wealth funds (SWFs) have grown rapidly over the last decade and change. Moreover, SWFs are becoming a crucial part of the international financial system, and were an important stabilizing force in the financial crisis a few years ago.

Finally, as Elena H. Duggar and the rest of the Moody’s team note: “SWFs facilitate the intergenerational transfer of proceeds from nonrenewable resources, allow for greater portfolio diversification than traditional central bank reserves, and contribute to exchange rate stability by managing excess inflows. SWFs also increasingly fund investments in infrastructure.”

Given that SWFs are now being asked to finance budget deficits and support domestic economies in today’s low oil price environment, it’s even more important that SWF balance sheets be boosted by increased internal revenue generation and greater return on investments, and this process will also likely include a larger percentage of higher return alternative asset classes in their portfolios.

Sovereign Wealth Funds

Sovereign Wealth Funds

Recent trends among sovereign wealth funds

The Moody’s report surveys global SWFs, with a focuson their mandates, funding sources, transparency and investment strategies. Issues such as the SWFs’ role during the global financial crisis of 2007-2009, recent trends in investment allocation, and the ways in which SWFs are impacted by lower commodity prices are also discussed.

Recent sovereign wealth fund facts and trends of note:

Sovereign Wealth Funds

The number of stabilization, savings and reserve investment SWFs in Moody’s-rated countries has grown from 12 at the turn of the century to 26 last year. These SWFs have $4.5 trillion of assets under management (twice the amount of all hedge funds combined) and almost half the $11.6 trillion of global sovereign foreign exchange reserves. SWFs, however, are almost never leveraged.

Keep in mind that sovereign wealth fund assets are highly concentrated. The five largest SWFs (Norway, Saudi Arabia, China, UAE and Kuwait) each have between $500-$900 billion of assets and together represent 76% of total SWF assets. Also of note, the top 10 funds represent 93% of all SWF assets.

Sovereign Wealth Funds

Close to 73% of sovereign wealth funds across the globe have their origins in oil and gas export revenues. The majority of nations with SWFs are resource-rich and focus on exporting commodities, mainly oil and gas. SWFs serve as a fiscal buffer in the event of commodity price shocks and as a vehicle for the accumulation of wealth for future generations in these countries. Another group of nations (most in Asia) have set up SWFs to improve the management of their foreign exchange reserves and to noost returns.

The Middle East-based Gulf Cooperation Council has the greatest concentration of SWFs, then Asia and Europe. Of note, the most recent SWFs have been established in Africa and Latin America.

Sovereign Wealth Funds

SWFs differ greatly in terms of transparency of reporting. A number of large GCC funds provide little information on their investments or performance. Nevertheless, 21 out of the 26 SWFs either publish regular annual reports or disclose information on investment allocation.

As Duggar et al. point out, SWF investment strategies are controlled by their mandates. Stabilization funds (such as Russia, Nigeria and Azerbaijan) serve short- to medium-term objectives and tend toward conservative strategies. Stabilization funds typically have short investment horizons and low risk-return profiles, working to maintain liquidity. On the other hand, savings funds with the long-term goal of saving for future generations (such as Qatar, Singapore and Malaysia) generally try to bring in higher returns over a longer time period. In most cases, savings funds have relatively higher-risk portfolios and tend to hold more equity than fixed income assets.

Sovereign Wealth Funds

SWF investments tend to be well-diversified, with stakes in various equity sectors, and also tend towards a wide geographical dispersion. This stands in contrast to central bank reserves, which in most cases are mainly concentrated in government bonds.

Sovereign wealth funds currently have $1.9 trillion in equity, $0.9 trillion in fixed income and short-term liquid asset, and $0.4 trillion in alternative investments and others, including real estate, private equity and hedge funds. Data is not available on about $1.3 trillion of SWF assets. Of note, the report notes that recent trends in SWF asset allocation indicate growth in higher-risk sectors

The global financial crisis led to gigantic paper losses for many SWFs. The SWFs, however, recovered nearly all of the losses in the next few years by just keeping their long-term positions and riding things out. The Moody’s analysts point out that sovereign wealth funds proved to be a stabilizing force for global financial markets during the crisis.

Sovereign Wealth Funds

Finally, Duggar et al. highlight three recent trends in SWF investment allocations: i) greater allocation to emerging markets; ii) increased allocation to alternative assets, including real estate, infrastructure and private equity; and iii) greater allocation to domestic and regional investments. They argue that these new trends are related to the very low-interest-rate environment and the search for yield, and the growing sophistication of SWF managers and investment strategies.