Out with the alpha as beta returns for SWFs

Turbulent financial markets over the past few years have caused many of the world’s leading sovereign funds to reassess their investment strategies and risk management, according to State Street Global Advisors (SSGA).

Some of the funds are making significant changes, including a growing shift from active investment management strategies to passive ones and an increasing focus on the emerging-market debt as yields on traditional asset classes have fallen. 

 Greater focus is being placed on the possibility of accessing different and independent sources of economic value such as land and infrastructure to help diversify sovereign portfolios.

Given the extreme difficulties which many active fund managers endured during the difficult market conditions, some sovereign funds now feel using a more diversified set of market betas is preferable, and they rely less on managers seeking alpha. 

In the past 12 months SSGA has observed a significant shift of assets within sovereign portfolios from active to passive strategies.

One sovereign wealth fund in the Middle East told SSgA: “In the past we used to assume that assets should be managed actively unless a certain asset class or market clearly did not offer opportunities for active managers or reward active management.  Now we tend to see this investment decision the other way round.  We conclude that assets should by default be managed passively unless evidence is clear that a given asset class has sufficient imperfections that active management is likely to be consistently rewarded.”

In its report – Current Issues in Official Sector Asset Management – ,SSGA also notes that sovereign portfolio managers have also placed a growing focus on emerging-market debt, as they look for alternatives to the low yields provided by more traditional asset classes, and some funds also feel that these markets could be long-term safe havens in uncertain times for the major reserve currencies. 

A debate within the sector is growing around diversification, with possible sources including land, infrastructure and even art.  However, a lot of work is still required in order to refine this strategy into a quantifiable theory that can be used to build diverse portfolios.

In addition to this diversification strategy, interest is renewed within the sector in protecting their funds against extreme losses with a possible role for ‘tail’ or ‘disaster’ insurance.  However, this type of cover is very expensive, and the insurance industry providing the scale of cover sovereign funds want may prove difficult, says SSGA, adding that sovereign funds are increasingly realising that insurance against loss is not a viable option.

John Nugée, senior managing director of SSGA’s official institutions group, said: “Official sector asset managers – central banks, governments and sovereign wealth funds – have not been immune to the difficult market conditions.  Many have re-examined the performance of their funds, lessons they should draw from the market turmoil and the extra defenses they need in their approach. 

 In many cases the review confirmed that their guiding principles were correct, but a number have decided to make some important changes.”

©2011 funds europe



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