How to invest like a sovereign wealth fund

Sovereign wealth funds (SWF) are like a country’s savings account. They’re money a country doesn’t need right now that’s saved for a future rainy day. And although SWFs control trillions of dollars, individual investors can still learn a lot about portfolio management from them.

As of December 2015, there were 79 SWFs around the world, managing US$7.2 trillion, according to the Sovereign Wealth Fund Institute. That’s more than all the world’s hedge funds and private equity funds combined. And it’s more than double the US$3.4 trillion controlled by SWFs at the beginning of 2008.

Out of these 79 SWFs, 45 of them, or 57 percent, are funded by oil money. Four of the five largest SWFs (worth about US$2.5 trillion) belong to smaller countries with huge oil reserves – Norway, Saudi Arabia, Abu Dhabi and Kuwait. When the price of oil was a lot higher than it is now, their SWFs got bigger and bigger. They put aside some of the revenue from the sale of oil to use when the cycle turned, or for when their oil might eventually run out.

Lesson: The basic idea behind a SWF is to save when times are good, so money is there when times are bad. Investors – and everyone, in fact – should do the same. Savings equal wealth, and when those savings are invested properly they will grow over time.

With oil dropping to around US$30 per barrel, many of these SWFs are shrinking. In 2015, the value of all SWFs declined for the first time since 2007. SWFs in countries that rely heavily on oil saw their values drop by US$34 billion in 2015.

Total Sovereign Wealth Fund Assets as of December 2015

Their assets fell for two reasons. First, the poor performance of markets and asset classes around the world – in which SWFs are invested – has hurt their performance. Second, with less oil money, but the same expenses, some countries have started withdrawing from their SWFs to cover the shortfall. And it hasn’t helped that with lower oil prices, inflows into SWFs have fallen.

For example, the Saudi Arabian Monetary Agency Foreign Holdings, the world’s fourth largest SWF (valued at US$628 billion in November 2015), had to withdraw US$70 billion from its fund over the past year – some say the real number is more like US$100 billion – to help cover the government’s budget deficits.

Norway has the world’s largest SWF, thanks to the country’s massive North Sea oil deposits. It was valued at US$900 billion at the end of 2014, but as of this month, it has dropped 11 percent to US$794 billion. In October 2015, Norway said it would have to dip into its SWF for the first time to make up for lower oil revenues.

Lesson: SWFs use their savings when they need them. If it makes more sense to use up cash than to take on debt – say, if the money earned on investments is less than the interest paid on debt – they’ll use it instead of going into debt.

For individual investors, it’s OK to spend money when needed. If you have some money saved, it makes more sense to spend it than to use credit cards or high-interest debt to pay the bills.

Another lesson: SWFs may need some cash right now, but they’re very long-term investors. They plan for generations down the road, not just a few months or a few years. Their long-term plans haven’t changed.

Investors also need a long-term plan that shouldn’t change when the markets fall. Don’t get distracted by all the market noise and make bad short-term decisions.

About 81 percent of SWFs invest in the stock market. The 39 biggest SWFs own about US$2.5 trillion in shares, or about 45 percent of their assets.
SWFs are also big bond market investors. Around 86 percent of SWFs own bonds (as of 2014). And for the same 39 biggest SWFs, bonds account for 29 percent of their portfolios – that’s more than US$1.5 trillion invested in bond markets.

Proportion of Sovereign Wealth Funds Investing in Each Asset Class in 2014

Because of their size, what SWFs do with their investments can affect markets all over the world. In fact, some say the current market turmoil is partly due to SWFs being forced to sell stocks to free up cash they may need to withdraw as they adjust to lower oil prices.

Lesson: SWFs are well diversified. As the chart shows, most SWFs invest in stocks, bonds, infrastructure and real estate. They don’t just own property or hold cash and gold. For example, Norway’s SWF owns shares in around 9,000 companies in 75 countries, and is a major real estate investor around the world.

Individual investors should do the same. Don’t just invest in one type of asset. Diversify to have a mix of stocks, bonds and real estate. There are even some funds you can buy that focus on infrastructure, just like a SWF. And real estate investment trusts (REITs) are an easy way to gain more exposure to the real estate market.

Sovereign wealth funds operate on a scale way beyond what most people can comprehend. But the way they handle their portfolios has good lessons for investors.