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Portfolio > Mutual Funds

Sovereign Wealth Funds Face Their Rainy Day

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The 46 countries that have at least one sovereign wealth fund have largely set them up for a rainy day. Now that day has come for most of them: Commodity prices are so depressed that governments need to unseal their piggy banks and with profitable investment opportunities scarce there is little incentive not to. This could end up putting downward pressure on global financial markets.

Of the top 30 sovereign funds (20 shown here), 18 are filled with revenues from oil and gas:

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The largest of the funds, set up in 1990 to safeguard Norway’s oil wealth for future generations, posted its biggest loss in four years last week. It shed $32 billion in the third quarter, all in the stock market, which accounts for 60 percent of its investments. The bursting of the Chinese stock bubble and the general malaise in emerging markets were the principal reasons for the rout. The fund is barely making any profit on its bond holdings as yields on the more reliable debt instruments head toward, or enter, negative territory. Only the fund’s small real estate portfolio yielded a 3 percent profit in the quarter.

At the same time, the inflow of oil money into the fund is drying up, and the Norwegian government is planning to withdraw $440 million from it next year to cover its fiscal deficit — something it had not intended to do until at least the next decade. The original idea was to keep the cash cushion for future generations as Norway’s population ages, but now the current generation needs it.

Norway, of course, is unique in that its fund is so huge — large enough to cover the country’s entire government spending for more than eight years. Its managers say they won’t be forced to divest, even with the losses, the lack of new capital inflow and the government’s financing needs. Other countries’ sovereign funds are not as safe.

In a recent report on Middle Eastern and North African economies, the International Monetary Fund calculated that if oil prices stay at current levels, Saudi Arabia will exhaust its “fiscal buffers” in about five years, and so will Algeria. Bahrain, Libya and Oman have even less time.

Among the Middle Eastern petroleum exporters, the United Arab Emirates, Kuwait and Qatar are the luckiest. They have sufficient cushions to last them more than two decades, as this chart using data from the IMF shows: 

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Even those funds, however, won’t be investing as actively as previously because governments in the Middle East prefer drawing down the funds to reducing budget expenditure. This year, Saudi Arabia has already drawn $80 billion from its international reserves, including the sovereign fund. 

Russia’s cushion is thinner still. At the current rate, its Reserve Fund and National Welfare Fund may be gone by 2018, first deputy finance minister Tatyana Nesterenko said  this month. Like Kazakhstan, Russia is investing part of the money domestically because of a dearth of foreign financing for infrastructure projects. That both undermines the funds’ viability and draws them away from international financial markets.

According to the June, 2015 Preqin Sovereign Wealth Fund Review, the rainy-day funds hold a total of $6.31 trillion in assets, with $927 billion added between 2013 and 2015. These institutions are an important stabilizing factor for markets, providing large, long-term investors relatively untroubled by today’s trends. They are conservative and slow-moving too. The Norwegian sovereign fund made its first investment in U.S. real estate in 2013, and the country’s government is only now considering a mandate for private equity investments. If the commodities blowout continues, however, it will grow more difficult for the national piggy banks to play their current role.

The retreat of the sovereign wealth funds is yet another potential factor of instability in a global economy already suffering from diseases such as slowing growth and diminishing trade. Their asset rebalancing and, possibly, big divestments could shape market trends over the next few years.


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