Sovereign Wealth Fund Returns Collapse As Yield Disappears

Sovereign wealth fund returns are collapsing as yield disappears so managers are looking elsewhere.

Sovereign wealth funds have become somewhat of a status symbol for countries around the world and no fund is larger than that of Norway. Norway’s $960 billion sovereign wealth fund was set up in 1998 and invests the Norwegian state’s proceeds from oil and gas production for future generations. The total annual return targeted by the fund is 4% but according to Reuters, investment returns have consistently missed this target with an average net real return on investment of 3.78% since inception.

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Norway’s sovereign wealth fund has grown so large that it is two-and-a-half times the size of the Norwegian economy. Its size is equivalent to $185,000 for each man, woman, and child in Norway. While the size of the fund offers security for the Norwegian economy, it also presents a problem for the fund’s asset management team. Trying to find assets that can achieve the targeted return of 4% at the right size without taking excessive risk, is a difficult task. Norway’s wealth fund is not the only one facing such an issue.

Sovereign Wealth Fund Returns Collapse As Yield Disappears

The Invesco Global Sovereign Asset Management Study 2017 highlights just how big an issue returns are becoming for sovereign wealth funds. The Invesco study is based on findings with face-to-face interviews with 97 leading sovereign wealth funds, state pension funds and central banks with assets in excess of $12 trillion. The average return target of the sovereign sample for the report is 6.1%, but last year the group only produced a return of 4.1%. Low-interest rates were cited as being by far the biggest hurdle to returns and most important factor when considering asset allocation. Alternative investments have historically provided a way to increase returns in the low return world. However, sovereigns are now reconsidering their allocation towards this asset class thanks to increasing risk of fund withdrawals. Last year, new funding as a percentage of assets under management for the Invesco sovereign sample declined to 5% from the 2015 level of 8% and the percentage of investments canceled increased to 3% from 2015’s 1%.

As shown in the chart below, responding to this trend sovereigns have progressively reduced their exposure to global bonds but maintained exposure to global equities and home market equities in search of better returns. Funds have also branched out into other forms of yield instrument in an attempt to boost returns while minimizing risk and improving liquidity.

According to the 2017 Preqin Sovereign Wealth Fund Review, around 39% of sovereign wealth funds now invest in private debt as they tried to boost returns in an asset class that can take tens of billions of dollars in additional investment without moving the market. According to Prequin, the majority of sovereign wealth funds with more than $10 billion in assets now allocate to private debt, that includes two-thirds of those managing $250 billion or more and all of those managing $100 billion-$249 billion. Mezzanine debt is the most attractive instrument with 70% of sovereign wealth funds surveyed responding that they will target the strategy over the next 12 months. Distressed debt is targeted by 63% of sovereign wealth funds active in the industry, while direct lending is sought by 53%.

As oil nations like Saudi and Qatar face dire economic questions, they can only hope that their sovereign wealth fund returns pick up quickly.