Cheap money transforming SWF investment strategy

Market changes could push a move to private equity style or deal-based investment

INVESTMENT STRATEGY: SWFs may be forced to drastically alter their investment strategy as the latest US liquidity spree fuels cash inflows by depresses asset returns (Getty Images)

INVESTMENT STRATEGY: SWFs may be forced to drastically alter their investment strategy as the latest US liquidity spree fuels cash inflows by depresses asset returns (Getty Images)

Sovereign funds tasked with managing national wealth may be forced to drastically alter their investment strategy in the coming years as the latest US liquidity spree fuels cash inflows but depresses asset returns.

While their assets are set to hit as much as $10 trillion in the coming decade, a low-returns climate makes orthodox portfolio management more unattractive, pushing these funds further into private equity-style or deal-based investment.

The Federal Reserve's $600bn bond buying plan announced last week and liquidity injected by other leading central banks are a double-edged sword for sovereign wealth funds (SWFs), which currently manage $3 trillion of assets.

Cheap money fuels yield-seeking capital to fast-growing emerging economies, and their measures such as currency intervention to counter inflows boost FX reserves, generating more risk capital to be managed by sovereign wealth funds.

The low interest rate environment underpins demand for commodities or exports from developed economies, boosting windfall revenues, part of which will end up in SWF coffers.

But returns tend to diminish in the low yield environment. A weak dollar and upward pressure on local currencies also erode valuations, squeezing their returns further.

"Sovereign wealth funds had hoped for a transition from the crisis situation to a more benign global economic environment, but considerable risks remain in their business," said Steffen Kern, economist at Deutsche Bank and an expert on SWFs.

"Low interest rates plus [US] quantitative easing impact the monetary and interest rate environment in which SWFs operate. Monetary policies naturally influence the valuation of existing bond portfolios and new investments. This should not be underestimated."

Kern estimates that 40-60 percent of SWF portfolios is still invested in interest-based securities, making them vulnerable to low returns stemming from near-zero interest rates.

The growing pile of cash which sovereign funds manage may make it harder for them to invest flexibly. Kern has upgraded his well-cited projection for total assets under management by SWFs to $10 trillion by 2020, from $7 trillion by 2018.

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Posted by: amitabh khanna

The depressed valuations which make inward flows into some European Markets apart, one has to also take in perspective that potential for value appreciation for SWFs. Although they are long term investors, if the investee countries have poor economic prospects what will these investments do except secure the exit for existing investors in those countries. One has to examine whether SWFs can partner economic regeneration in different countries and become active players in hitherto passive investment strategies.

SWFs should also consider whether they would like to assist in Green Energy initiatives in several countries in the emerging markets where infrastructure shortage is rife.

Posted by: Todd

This is an important question, but I read one article where Dr. Alexander Mirtchev, president of Krull Corp., considers that in the depressed valuations environment of a European economy that appears to have fully embraced austerity, SWFs can broaden their portfolios to include a range of investments worldwide. In the current cash-starved economic environment in Europe and other regions, SWFs appear to become a desired source of financing. They not only buffer their own sovereigns from the boom and bust cycles of the global economy, but may actually become an ?insurer of last resort?. At the very least, SWFs can serve as a ?bridge? that could ease the transition from state intervention to market-oriented strategies. In this manner, sovereign funds are gaining prominence as elements of the fundamental mechanisms that could be deployed to strengthen global economic security

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