Sovereign wealth funds more resilient in market storm than expected, says report

Turbulent times

Sovereign wealth funds may have weathered market volatility better than feared, with new research from the International Forum of Sovereign Wealth Funds (IFSWF) and State Street Corporation highlighting that many fund portfolios were already overweight cash and underweight equities in the run-up to the pandemic crisis. 

During March and April, the majority of sovereign wealth funds did not become more risk-averse, and were in fact selling fixed-income assets in order to maintain their allocation toward the higher risk equities class.

Drawing on State Street’s dataset of anonymised and aggregated institutional investor capital flows, and interviews with members of IFSWF’s network of sovereign wealth funds from nearly 40 countries, the new report examines how sovereign wealth funds, and institutional investors more generally, have reacted to the financial market volatility caused by the Covid-19 pandemic.

It found that most sovereign wealth funds, along with other types of institutional investor, began 2020 with underweight positions in risky assets, such as sovereign debt, corporate bond and foreign exchange markets, while cash levels were at the highest levels observed since the global financial crisis.

By the time volatility took hold in March and April, institutional investors did not engage in a panicked selling of equities, as they had done in 2008, but instead took a “more selective approach to risk reduction”. While there was a general flight to safety towards the US relative to emerging markets among all types of institutional investor, most of the surveyed sovereign wealth funds reported they had been selling fixed-income securities to purchase equities and maintain their allocation targets to that asset class. 

Neill Clark, head of State Street Associates EMEA at State Street, says: “We did not observe such widespread risk aversion during this period relative to previous crises and signs suggest there has been a stabilisation in aggregate capital flows observed across asset classes during April.”

Moreover, the report also found that there had been less liquidation of sovereign wealth funds than expected, with only two funds out of the ten surveyed reporting that they had been drawn on by their government to help cope with the greater economic need. Two more also reported that they had been requested to support additional government projects since the beginning of the crisis. 

“Sovereign wealth funds are often referred to as “rainy-day funds”, pools of cash that their government owners can draw upon in times of economic need. It is hard to imagine a rainier day or a greater economic need than the global recession emerging from the Covid-19 pandemic,” explains the report.

“Indeed, rather than tapping their rainy-day funds, several governments from oil-rich nations from the Arabian Gulf to Kazakhstan have recently borrowed from the international bond markets to cover budget shortfalls.”

Furthermore, IFSWF and State Street also pointed out the trend over the past five years towards funds increasing their private equity exposure, which resulted in committed capital to private equity funds reaching an all-time high of USD2.5 trillion in December 2019, according to Bain Capital. 

All the sovereign wealth funds surveyed that allocated to unlisted assets reported that one reason they had increased their cash positions was to satisfy capital calls from general partners, which had continued throughout the turmoil of March and April.

Duncan Bonfield, chief executive of IFSWF, says: “Our research suggests that sovereign wealth funds have not undertaken large-scale liquidations to provide liquidity for governments as widely speculated.

“Instead, they’ve been able to use their cash position to satisfy private-equity managers’ capital calls and invest in the long-term interests of their owners at a time of great uncertainty.”

The full research report, Pandemic, No Panic: Evidence from Institutional Investor Flows, is available on the IFSWF website.