5 Risks Keeping Sovereign Wealth Funds Up at Night

Posted on 05/07/2015

#5. Sustained Low Range of Oil Prices

Sustained low prices of oil are affecting the funding input levels of commodity-based sovereign wealth funds. These current fossil fuel prices are economically squeezing countries like Russia, Saudi Arabia, Venezuela and Iran in harmful ways. Economists, pundits, energy CEOs and policymakers are trying to get a grasp on the long-term price of oil. Lao Tzu, a 6th Century BC Chinese Poet, wrote, “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.”

Commodity-based sovereign funds such as the Abu Dhabi Investment Authority (ADIA) and Kuwait Investment Authority (KIA), may face increased withdrawals to fund deepening fiscal deficits, while cash infusions have shrunk for wealth funds like Norway’s Government Pension Fund Global. Norges Bank Investment Management (NBIM) CEO Yngve Slyngstad revealed to the public that in the first quarter of 2015, Norway’s sovereign wealth fund received the lowest amount of new capital in 16 years.

In 2014, according to the Sovereign Wealth Fund Transaction Database, Gulf sovereign wealth funds directly invested, not including listed real estate and funds, over US$ 10 billion in real estate.

#4.Competition in Alternatives

Increasingly, sovereign wealth funds and pensions are finding fewer opportunities in alternative assets such as private equity and infrastructure. Governments and large utilities are looking to sell off developed infrastructure to cash in on demand, while global buyout funds are being even more bold, taking companies private at rising prices (thanks to inexpensive financing and dry powder). For example, Barcelona-based Abertis Infraestructuras SA is having an initial public offering for its tower operator unit Cellnex Telecom. Real estate appears to be less risky for now, as more public institutional investors rush to buy up core properties. In 2014, according to the Sovereign Wealth Fund Transaction Database, Gulf sovereign wealth funds directly invested, not including listed real estate and funds, over US$ 10 billion in real estate. Some sovereign wealth funds are taking advantage of rising demand for real estate, especially industrial properties. Singapore’s GIC is near exiting its US$ 1 billion real estate portfolio in Australia.

#3. People Are Getting Older in Developed Markets

According to a U.N. report on World Population Aging, “Currently, the total fertility rate is below the replacement level in practically all industrialized countries.” In Europe, Japan and even China, the demographic is getting older. People in these markets will shift toward consuming versus producing. This will have profound effects on economic growth rates, tax policy and sector selections for portfolios.

#2. Repricing of Assets

Deflationary forces have been influencing the actions of central bankers, prompting many banker boards to lower rates. For the larger economies, the United States started easing its monetary policy, followed by Japan, the European Union and recently China. The Bank of Japan hopes its measures to combat deflation work. The central bank is keen on a tighter labor market that will provide mounting pressure on wages – thus fueling domestic consumption. When the Federal Reserve decides to push rates upward, there will most likely be a significant repricing of assets.

During the Federal Reserve’s aggressive push on quantitative easing (QE) measures, the supply of U.S. high-yield grew 50% above normal levels. Issuers were eager to take advantage of cheap money, while investors had to move in to take on more credit risk to boost returns. For example, Australia’s Future Fund is heavily invested in structured credit and private debt, shunning sovereign debt.

#1. Risk of Evaporating Bond Liquidity

Global bond markets are at risk of breaking down, especially if a surprise rise in interest rates occurs. Today, bonds are concentrated in the custody of fewer, but larger fund management companies like BlackRock, PIMCO, and Vanguard. Their combined selling could possibly put bond prices into a downward spiral. This shift in asset class repositioning could hurt institutional investors, as they might not be able to buyback in at a low cost. Investment banks, which have traditionally acted as market makers and have supported liquidity in periods of stress, have been decreasing their activities. Expanded regulation has discouraged these banks to keep significant quantities of bonds on their balance sheet.

Keywords: Norway Government Pension Fund Global, GIC Private Limited.