Sovereign wealth funds have certain features in common with some wealth management entities, so findings from a recent State Street report should trigger interest from the sector.
Sovereign wealth funds, which are state-created entities that invest revenues such as oil earnings from countries such as Norway or jurisdictions in the Middle East, are not always actors that private client wealth managers need to take note of. But occasionally there are reports about SWFs that should prompt attention.
A recent report by State Street, the US-headquartered financial group, has eye-catching findings from a 2016 survey of 10 SWFs showing a clear and rising interest in direct private investments and a move away from government bonds. The desire to shift out of government debt is particularly ironic given that the SWFs are, in some cases, run by the same states that issue that debt. (The report is entitled Asset Allocation for the Short and Long Term.)
Recent conferences organised by the publisher of this news service have seen plenty of commentary about how family offices, private banks and other wealth management groups are increasingly drawn to direct investment in companies, either on the equity or debt side. As SWFs are similar to family offices in some respects - such as their presumed long-term investment horizons - the behaviour of SWFs is instructive.
“As a group, these SWFs have substantially expanded their alternative, unlisted, and private investment portfolios. At least 30 per cent of the surveyed group had invested more, and none of the respondents had reduced their exposure,” SSGA said in its report.
One of the authors of the research, Will Kinlaw, senior managing director and global head of State Street’s academic affiliate, State Street Associates, adds to the point: “One of the biggest findings from this research is the growing focus on private markets. Despite the allure of these investments, SWFs are aware of the potential risks, with illiquidity topping the list. However, many have invested considerable time and resource in assessing these markets and have clearly identified attractive opportunities here.”
In its analysis, State Street found that sovereign wealth funds are often choosing to enter private markets because they believe that their long-dated liabilities mean they can benefit from the illiquidity premium that these assets offer. They also think private markets are less efficient and, therefore, present more opportunities for return.
“Even though SWFs have been successful in private markets, many reported ongoing internal debate as to whether the return premium is fair compensation for the risks these types of investments add to the portfolio,” it said.
Another finding was that half of the SWFs interviewed had to make changes to their governance process to be able to decide on private market opportunities.
Private markets are typically - if not always - less liquid, and are less covered by analysts than public ones, so, as State Street notes, many would-be investors need to improve their decision-making processes to gain the tools to enter these markets. What does seem clear is that years of ultra-low or even negative real interest rates, and concerns about valuations of some listed markets such as equities, are making SWFs more interested in the private route. And the same considerations appear to weigh on family offices and wealth managers.
There seems plenty of broad appetite for private investment sectors, such as private equity. More than 1,000 private capital funds secured commitments of $602 billion around the world last year, research firm Preqin has reported, and the firm expects the final figure for the year to be 10 per cent greater as full data comes in. Meanwhile, almost 3,000 funds are in the market, seeking more than $1 trillion from investors. A recent interview by this publication with UBS highlighted the appeal to ultra-high net worth individuals of private capital and direct investing. (See here.)
The report also had comments specifically on Asia. It noted that SWFs indicating an allocation to Asia, including Asia and Japan, are concentrated in three asset classes; some 90 per cent of surveyed SWFs have assets in listed equities, 70 per cent of them have government bond exposure and 60 per cent hold government bonds in this region. Half of the SWFs polled had increased their exposure to emerging markets in the past three to five years and, tellingly, none plan to reduce exposure to these markets in the near future. Japan, the US and the UK represented the three “leading countries” for investments, the State Street report adds.
What is clear, in general, from this report that while the behaviour of sovereign wealth funds doesn't necessarily exactly map that of private client wealth organisations, there is a good deal of cross-over. The trends noted in State Street's analysis of what SWFs deserve attention from the industry.