How Sovereign Wealth Funds Are Changing Direction

A new survey finds sovereign investors are boosting allocations to private assets and emerging markets — and not making big shifts to passive strategies.

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Since Kuwait opened the world’s first sovereign wealth fund in 1953, these state-owned investors have captivated the financial community, swelling in number and size to house over $5 trillion in world assets combined today. As these institutions have grown, so has their risk appetite, a new survey finds.

Over the past three to five years, sovereign wealth funds have made significant shifts toward unlisted investments — private equity, real estate, and infrastructure — and emerging markets, according to a survey of ten funds published in late December by State Street Corp. and the International Forum of Sovereign Wealth Funds, the lead industry group. For the most part, however, traditional investments still account for the majority of sovereign wealth portfolios: The average fund held a diversified portfolio with 53 percent in fixed income, 34 percent in equities, 8 percent in infrastructure and real estate, and 5 percent in hedge funds.

Developed markets accounted for 92.5 percent of the assets, with the top three destinations for investment being the U.S., the U.K., and Japan. Private markets comprised 26.8 percent of the investments. The ten participating institutions varied in their investment objectives and were “broadly distributed across the world.”

Despite the debate raging on Wall Street over the benefits of index investing, the average sovereign fund devoted a little over half of its assets to active management. Moreover, the majority of the respondents indicated that they had not changed those allocations over the past three to five years, nor do they plan to make changes going forward. Only one fund reduced its actively managed portfolio, while none of the funds expected to make cuts in the future.

For traditional asset classes like publicly traded stocks and bonds, the survey suggests sovereign funds are “comfortable” hiring external managers. But they prefer to manage private assets in-house or at least have a more hands-on role.

“This suggests that SWFs view the management of traditional assets as a commodity and the management of private or alternative assets as an area that requires specialized resources and/or competencies,” the report concludes. “Because the additional resources needed for private assets are primarily intended to address issues with transparency and risk management, having the organization play an active role in gathering and sharing objective insights to inform asset management decisions is preferred.”

Sovereign funds may have prioritized building in-house expertise, but it’s not the death knell for financial service providers. When it comes to expanding into new asset classes, these notoriously tight-lipped investors highlighted the importance of building and maintaining outside relationships.

“Whether it is with regard to building internal capacity through cooperation with outside resources, through establishing relationships with consultants/advisors, or through establishing communication channels with external managers, the key competency mentioned revolved around relationship building,” the report states.