Understanding sovereign wealth funds

Exactly what is a sovereign wealth fund (SWF)? What are the main types of SWFs and what do they invest in to meet their objectives?

Sovereign wealth funds are an important but opaque institutional segment, so answering these questions is often difficult and always time consuming. Happily there’s a quality new source covering a sample of 38 SWFs – an Invesco report developed in conjunction with our NMG colleagues in the UK. The report has a wealth of detail, but here are some of the main points.

Sovereign investors are defined as state-owned investors. This broad definition has a number of distinct types:
Stand-alone SWFs – including Australia’s Future Fund.
Public sector pension funds – typically defined benefit funds (which would include Australia’s public sector defined benefit funds).
Central banks – such as the Hong Kong Monetary Authority.
Government ministries – particularly those involved in oil and gas industries.

While every SWF has its distinctive characteristics, we believe they can be broadly segmented by region, size, and objective.

Region and size are relatively straightforward. SWFs can be divided regionally by the West, Asia, Middle East, and emerging markets, with the sample spread roughly evenly between each. Size ranges enormously; from less than $10 billion to over $100 billion. The sample is slightly skewed at both ends – there is a surprisingly large number of mega SWFs.

SWF segmentation by objective is particularly useful, with the main segments being:
Investment SWFs – seeking portfolio diversification. These funds tend to have portfolios with a broad range of strategies across equities, bonds, and alternatives. This segment offers extensive opportunities for asset managers – where investments are outsourced.

Liability SWFs – investing to offset a future liability. This is often related to defined benefit pension commitments, although sometimes only loosely, which means there is a need to generate an income stream at some point in time. This segment is also diversified, but with heavier weightings to bonds and alternatives.

Liquidity SWFs – with objectives relating to national economic stability. Their mandates cover issues such as currency stability, financing public sector budget shortfalls, and provision of fiscal stimulus. Liquidity SWF portfolios are dominated by cash and bonds, with small equity allocations.

Development SWFs – which seek to boost national economic growth. These SWFs are very different and have portfolios of direct strategic investments, with relatively fewer conventional asset management opportunities.

The different segments, and indeed variation within segments, mean a different approach to asset management is often needed. Particularly notable is that overall the use of alternatives is growing – encouraging for asset managers of real estate, infrastructure, total return and private equity. Australian managers, which are known for their strengths in the first two categories, should see opportunities.

Historically SWFs have tended to plough their own furrow, with some limited collaboration between SWFs in the same country. However there is increasing interest in cross-border collaboration, with governments outside the West being seen as pro-SWF investors. While this process is expected to unfold slowly, half already benchmark against other SWFs, opening the way for one-off or longer term partnerships which are most likely to commence with co-investments on specific deals or asset classes.

You can find the report here. Amongst those who will find it useful are institutional asset managers looking to develop relationships with SWFs here and abroad and super funds keen to learn about trends and themes in some of the world’s largest funds.