Thursday, July 24, 2008

Sovereign Wealth Funds eye hedge fund opportunities says State Street report

Following is an extract from State Street’s Sovereign Wealth Funds Report “Assessing the Impact” (Vision Vol. III, Issue 2) which was carried by Hedge Funds Review (HFR). Hedge Funds Review is a market-leading publication for the alternative investment industry.
Sovereign wealth funds (SWFs) will provide strong flows into alternative investments and in particular hedge funds as well as private equity funds, according to latest research by State Street.

State Street said the size and influence of SWFs will continue to grow rapidly as they explore and diversify into more asset classes.

Exposure to hedge funds and other alternatives represents higher volatility than would have been acceptable at earlier stages of the funds’ evolution, according to Andrew Rozanov, head of State Street's Sovereign Advisory and co-author of the report.

“SWFs already have an influence in hedge funds. We think this will continue to increase into hedge funds as SWF asset allocation becomes more diverse,” he told HFR.

“The trend is clear. SWFs can legitimately expect interest from hedge funds due to the size they command and the profile they have. This move will not necessarily be into fund of hedge funds," said John Nugee, head of State Street's official institutions group and co-author of the report.
SWFs currently control nearly $3 trillion in assets. State Street attributes the growth to the reserves of Asian central banks and escalating oil and gas prices. The bank predicts SWF assets will grow to around $20 trillion by 2020.

The report speculates that over time, 10% of SWF assets will be allocated to alternatives with 60% in equities and 30% in bonds. The forecast is based on the asset allocation of a typical pension plan.

Nugee admits diversification has led to questions of where the boundaries of public sector portfolios lie and whether the sector has the skills required to manage increasingly diverse portfolios.

As SWFs continue to diversify into global portfolios, they may sell a portion of their existing US treasury notes and bonds. This will place greater pressure on the US dollar, said State Street. This would mean global equity risk premiums may fall and real bond yields rise.

To give some indication of the economic power the SWFs could wield, State Street estimates that if SWFs allocated 60% of the current $3 trillion in assets to the MSCI All Country World Index, they collectively would own about 5.5% of each company in that index as of end-March 2008.
The same allocation to the FTSE Global All Cap Index would result in about 5.2% ownership of each of the 8,009 companies in that index.

State Street believes SWFs should not be subjected to any greater stipulations on disclosure than other market participants.

Nugee said although there have been calls for greater transparency and some restrictions on what SWFs can do in national markets and the type of companies they can take stakes in, he thinks politicians and others may be overreacting.

He said arguments in favour of transparency have often seemed somewhat simplistic. They have ignored the long history of SWFs operating with a minimum of fuss and controversy.
“Sovereign Wealth Funds are market participants and have the common obligations to obey the rules of the markets and not to abuse them. Demands for greater transparency for SWFs will fail because they are sovereign,” Nugee added.

State Street said there is no such thing as a typical SWF. Each sovereign wealth fund must be viewed on their own merits.

Rozanov pointed out that SWFs differ in their structure, management of assets and the degree of transparency they are prepared to adopt.

Liability profiles of SWFs also constantly changing, leading to important shifts in an individual fund’s risk/return profile and investment constraints. These differences render a one-size-fits-all approach to best practices unworkable.

SWFs, said State Street, could produce sustained interest in emerging market equities and debt and facilitate the development of new asset classes, such as infrastructure, local currency emerging debt and frontier emerging markets.

State Street concludes there is scope for SWFs to influence key corporate decisions and accelerate corporate restructuring in global companies as their resources grow. END