Investment opportunities, not drawdowns, are the biggest challenge for sovereign funds

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If a sovereign wealth fund is a coat for a rainy day, then why is hardly anyone putting one on when it’s been pouring down since March?

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One of the curiosities of the Covid-19 pandemic, and the economic carnage it has wrought, is that it has not prompted countries to draw down on the funds they have built to provide resilience at moments exactly like these.

The International Forum of Sovereign Wealth Funds (IFSWF) and State Street recently released research showing that sovereign wealth funds had not undertaken large-scale liquidations to provide liquidity for governments, despite widespread expectation that they would. Only two of 10 funds they spoke to had been drawn down. 

On June 9, as the IFSWF launched its annual review for 2019, its executives confirmed this was still the case. Norway’s sovereign wealth fund is undertaking its biggest ever withdrawal, Oman’s fund has been repurposed, and Ireland’s Strategic Investment Fund has set up a new €2 billion Pandemic Stabilization and Recovery Fund – but otherwise, it’s business as usual.

Lessons learned

Why should this be? Partly, it’s because of the lessons of the global financial crisis. Then, several sovereign wealth funds – which back then were mostly smaller and less sophisticated than today – liquidated funds to deal with the crisis of the day, often by selling equities, the result being that they locked in losses at the bottom.

This time, where there has been a need for funding, sovereigns have instead gone to the debt markets for the absurdly cheap borrowing available. Several oil states with sovereign wealth funds, most obviously in the Gulf but also Kazakhstan, have used international bonds to cover budget shortfalls.

This is a very different situation to the one that the Institute of International Finance expected in March when it said that Gulf sovereign wealth funds could see their assets decline by $296 billion by the end of 2020, $80 billion worth of it in drawdowns.

Instead, the IFSWF’s review spoke of challenges other than liquidity and redemption. The biggest appears to be finding good places to put money to work. It’s not just the miserable absence of yield in high-grade debt. It’s a pretty simple thesis to decide that better returns reside in the more illiquid and inaccessible private debt markets, in private equity and infrastructure. But executing it is a whole other thing.

Stagnation

Data published by IFSWF on June 9 shows that the number of publicly disclosed direct investments made by sovereign wealth funds has stagnated since 2017 – the amount of equity invested has dropped from $54.3 billion in 2017 to $35 billion in 2019. 

Investment size per deal has also dropped: the median value of sovereign wealth fund private equity investment in 2019 was $25 million, less than half the figure in 2016. 

The figures for infrastructure and real estate are at their lowest levels since IFSWF began collating them. Geopolitical strain, slowing global economic growth, less liquid public markets, and the sheer weight of demand for private equity inflating valuations: none of these things are helping.

If there’s a bright side, it’s in evidence that sovereign wealth funds were shrewdly positioned going into the coronavirus pandemic. 

Broadly, they have tended to favour tech, telecom, infrastructure and healthcare – the sectors that have performed best through the pandemic to date. 

The fact that Vir Biotechnology, one of the biotechs best positioned for Covid-19 vaccine research, is backed by sovereign wealth funds from Abu Dhabi, Singapore and Alaska provides some evidence that rainy day funds know what they’re doing when the worst weather sets in.