With bond yields at near-record lows, more than $13,000bn of fixed-income securities commanding negative interest rates, and global stock markets looking increasingly volatile or overvalued, sovereign wealth funds (SWFs) are under continuous pressure to make returns that meet their mandates. 

In this low-growth, low-interest rate environment, commodity price declines have also led to reduced inflows to some SWFs and, in some cases, to higher withdrawals as governments seek to stabilise their fiscal positions.


What does a good strategic response look like? What opportunities are SWFs uniquely positioned to pursue? And how should they react to short-term market volatility and be better positioned for structural, long-term macro themes? 

These were the facing the 250 attendees of the International Forum of Sovereign Wealth Funds (IFSWF) annual conference in Auckland, New Zealand. They included 30 members whose funds together account for 80% of the assets under management by SWFs worldwide, or $5500bn of assets.

IFSWF members adhere to the Santiago Principles, a voluntary code promoting stability and economic and financial purposes as the defining features of sovereign capital. The principles provide 24 items of practical guidance on the institutional governance and risk management frameworks necessary for sound long-term investment practice.

Members include the NZ Superannuation Fund, the Australia Future Fund, the State Oil Fund of the Republic of Azerbaijan, the Pula Fund of Botswana, China Investment Corporation, the Korea Investment Corporation, the Kuwait Investment Authority, Morocco’s Ithmar Capital and the Palestine Investment Fund. 

How to diversify an investment portfolio

For SWFs looking for the most efficient way to diversify an asset portfolio, investors should focus on the four forces that drive assets: growth, inflation, discount rate (the future return on cash) and risk premiums, according to Bob Prince, co-chief investment officer at Bridgewater. These factors should be balanced, according to how they affect your portfolio, he said.

He added that Bridgewater looks at the underlying characteristics of asset class as it relates to the economic environment because “every asset has a different form of claim on these cashflows”.

Bridgewater, founded in 1975, manages more than $150bn for around 350 of the largest and most sophisticated global institutional clients including public and corporate pension funds, university endowments, charitable foundations, supranational agencies, sovereign wealth funds and central banks. 

Massimiliano Castelli, head of strategy, global sovereign markets at UBS Asset Management, said that in the future, SWFs could theoretically increase the risk they take but this depends on the maximum loss an institution is willing to take. He noted that data suggests illiquid assets will continue to offer superior returns to liquid assets, and that SWFs without current liquidity needs are uniquely positioned to take advantage of this. 

Mr Castelli also suggested that SWFs establish a tactical/cyclical investment framework. “An ongoing low-return environment or more challenging investment regimes than in the past, such as stagflation, will require much more active investment styles,” he said.

Moreover, a SWF should implement alternative portfolio construction techniques, he said. A move towards “a hedge fund-style investment framework relying on extensive use of derivatives, leverage, sophisticated risk models and, more generally, more sophisticated investment engineering” is one alternative, he suggested. However, this would require a high level of professionalism and depend on whether political sponsors supported such an investment style.

A brighter note

In contrast, John Lipsky (pictured), economist and former managing director of the International Monetary Fund, rejected the argument that the world economy would see low interest rates and low growth for the foreseeable future.

“Despite the alternatives and the pessimism, the outlook, and trend analysis, the consensus forecast isn’t that bad,” he said. “If it can be achieved in a structural sense, it will start to improve the performance and expectations that I think are going to set the stage for a much more favourable outlook ahead.”

Other speakers at the conference agreed that SWFs are well placed to take advantage of the investment opportunities provided by climate change and proposed government actions.

Mats Anderson, former chief executive at one of Sweden’s four pension funds, AP4, said “sustainable investments are drivers for higher returns at a lower risk” and that there was “no conflict between returns and sustainability”.

He explained the fund has three factors that come together to produce sustainability: environment, social and governance (ESG) but added: “It all starts with governance.”  

He also noted that “less than 1% of the total capital of the 15 largest US public pension funds is allocated to ESG-specific strategies”, and that ESG “is treated as a side show rather as an integrated part”.

Climate investments

The fund has a 30- to 40-year investment horizon and, so far, has made the biggest single commitment to low-carbon investing by an institutional investor.

Reyaz Ahmad, chief investment officer and head at IFC Catalyst Fund, estimated that emerging markets would present climate investment opportunities worth $22.6bn between 2016 and 2030. China would lead the way with $14.9bn-worth of opportunities, he said, adding that climate investment opportunities lie in potential smart grid applications.

As a region, east Asia-Pacific presents the most significant investment opportunities, especially in buildings, followed by Latin American and Caribbean, Mr Ahmad said.

The Catalyst Fund manages assets valued at $417.8m and invests in private equity funds focused on providing capital for companies that enable resource efficiency and develop low-carbon products and services, in particular those in emerging markets. As of the second quarter of 2016, the fund had invested in 58 underlying portfolio companies, 13% of which have exposure to water and waste.