Sovereign wealth funds are slowly putting their $4trn to work in new asset classes, as Emma Cusworth reports
A large number of core infrastructure assets are expected to become available through corporate unbundling and deleveraging, and privatisation in countries still struggling with deficits. Spain has already begun selling airport assets and privatising air traffic control to reduce national debt. The increasing interest in renewable energy, expected to gather force following the Japan disaster, is also supporting growth in climate change investments.
“Infrastructure businesses have demonstrated their resilience,” Lennon said. “Most companies are un-listed and therefore show less correlation with broader markets. Early adopters have been enjoying the benefits of these characteristics and those behind the curve are starting to catch up.”
SWFs have shown a preference for existing infrastructure in non-domestic, developed markets. “These opportunities offer instantaneous yield and have natural inflation-linked characteristics,” Lennon said. “Developed and emerging infrastructure assets perform differently. There is a trade-off between stable yields versus high capital growth.”
Emerging markets
Given the size of SWFs’ investments, emerging markets may also struggle to absorb even a small percentage change in asset allocation. Investors’ comfort and experience also play a significant role.
SWFs are increasingly taking advantage of emerging markets’ long-term growth story with a strategic shift towards emerging equity and debt. “The potential for generating returns in developing markets is relatively attractive,” said JP Morgan Asset Management’s global head of sovereigns, Patrick Thomson.
For some SWFs, however, the financial crisis was a reminder of how important liquidity is, prompting some to cut allocations to illiquid assets. As fiscal deficits prevail, a shortening of SWFs investment horizon could potentially create volatility in some asset classes if large allocations are withdrawn.
Australia’s $71.8bn Future Fund is increasing liquidity under a new strategic plan to decrease the costs associated with illiquid assets in times of crisis. Target allocations to tangible assets, including real estate and infrastructure, have been cut 5% ($3.6bn).
“Generally we are seeing the reverse trend,” Thomson said. “SWFs are typically established with very large fixed income portfolios. Many are therefore very long liquidity. Low yields and the rise of European sovereign default risk have led to a reduction in fixed income towards alternatives. Traditional asset classes are not providing the required returns above inflation. Debate is currently focusing on real assets including real estate and infrastructure, which is one of the most illiquid asset classes suggesting SWFs are increasingly leveraging an even longer-term investment horizon.”
