Sovereign wealth fund (SWF) assets increased by $200bn in the year to March 2016 and now stand at $6.51trn. But the increase has been far from universal and sponsors are adjusting their asset allocations to make their portfolios work harder. 

SWFs reliant on windfall revenues from oil and gas lost $10bn over the year, according to Preqin data. Since oil prices fell sharply and firmly in late 2014 new capital inflows into the big Middle Eastern funds, particularly, have declined and correspondingly forced them to scale back their ambitions. 

SWFs famously scoured global asset markets for trophy assets during the boom years. But now the investment taps have been turned off, says Graham Parry, research director at UK-based Grosvenor Group. “While they still have large accumulated balance sheets, the new funds coming in has gone from a flood to a trickle,” he says. 

According to the Invesco research last year, oil-dependent sovereigns clearly expected to be impacted by the fall in oil prices in terms funding and even withdrawals. 

“That said, they also felt better placed to deal with any potential withdrawals than in the past. This was attributed to better governance and risk management policies put in place after the financial crisis of 2008,” says Alex Millar, Invesco’s head of EMEA sovereigns, Middle East and Africa institutional sales. 

Several cash-strapped governments have urged state funds to sell off assets and return cash. Norway for one has announced plans to withdraw approximately $430m from its state oil fund in 2016. 

Real estate 

SWFs made gross direct real estate acquisitions of $193bn over the ten-year commodity supercycle, according to figures from Grosvenor, so a potential reversal could represent a stark turnaround for real estate markets. 

But the picture isn’t clear-cut. A State Street and Oxford Economics survey released in April found that 88% of government pension funds planned to increase their real estate allocations over the next three years. 

Malaysia’s $178bn pension fund, for example, plans to double its real estate assets in the next few years as it seeks to diversify holdings away from equities and fixed income. “As long-term investors, SWFs have been reporting strong demand for alternative investments as a strategic move to optimise risk-adjusted returns and diversification benefits for a few years now, and this does not appear to be abating,” says Millar. 

Diversification has been validated by the fall in the oil price. “On the whole, the improvement in governance structures and risk management mean that funds are generally mindful of the investment environment that they are in and looking to calibrate their return expectations in line with this,” says Millar. 

“We haven’t seen any signs of funds looking to offset the decline in oil revenues with the taking of more investment risk, but we are seeing growing interest in strategies such as factor investing as a new approach to diversified risk and return.” 

He says last year’s Invesco study revealed that 73% of total SWF real estate investment was allocated to developed markets including 48% to developed Europe. Just over twothirds (68%) of surveyed SWFs also indicated they were looking to increase allocations to commodities. 

Small tilts 

While it is clear that SWFs are seeking to become more nimble it would be a mistake to overstate the phenomenon. “It’s all about small tilts in investment strategy, not massive swings. It’s not like they are out of equities completely and all in alternatives,” says Rod Ringrow, head of sovereign wealth funds sector solutions at State Street. 

State Street’s survey identifies the increasing allocation to higher-yielding assets as the most visible evolution of strategy. 

There are three broad reasons behind this change: zero-interest (or negative) rate policies in the industrialised world; newer funds were mandated to maximise returns; established SWFs developed institutional maturity and are utilising higher yield, less liquid strategies. 

“In response to the low interest rate environment, they continue to seek out opportunities in less liquid assets because they don’t really have a liability profile to match against like pension funds. They are almost perfectly placed provide investment capital to real assets or private equity related investments,” says Ringrow. 

Some SWFs are more focused on infrastructure. In April, Singapore’s SWF CIC announced it would buy almost 20% of US power company ITC for $1.23bn. Others are looking at both increased equity and real estate allocations. 

The State Oil Fund of Azerbaijan, Sofaz, plans to raise its allocation of equity investments from 10% to 15%, up from just 6.5% at end-2014. Its allocation to real estate was also increased, from 5% to 10% in 2015. 

Even if the big Middle Eastern funds have shown less appetite for blockbuster purchases, real estate remains in demand. “There’s a sense that SWFs are still overall underweight in real estate. What’s in its favour is that it has not been the dominant allocation for most SWFs,” says Parry.