ShiftingWealth: Sovereign Wealth Funds under Corona Stress

Sovereign wealth funds (SWFs) have suffered heavy losses since the outbreak of the coronavirus pandemic; those losses were reinforced by an oil price collapse to lowest level since 2002. Sovereign funds from oil-producing countries mainly in the Middle East and Africa were estimated to dump up to $225 billion in equities, as plummeting oil prices and the coronavirus pandemic hit state finances. For 2020, the sum of SWF equity losses exceeds one trillion US dollars according to a Reuters report of 29^th March.

How large was that loss in relative terms?

This is hard to tell with precision as the SWF industry is shrouded in secrecy. My hunch, though, is that SWF worldwide have seen their total assets plummet by one eighth (12.5%). Aggregate SWF assets had risen to US$ 7.45 trn by Spring 2018, the latest Preqin Sovereign Wealth Fund Review reported. I assume that total assets had continue to rise modestly until the sudden stop early this year.

Assets (US$ bn) Held by Top Ten SWFs, end 2019

Norway Government Pension Fund Global	1.099
China Investment Corporation	941
Abu Dhabi Investment Authority	697
Kuwait investment Authority	592
Hong Kong Monetary Authority	509
GIC Private Ltd Singapore	440
National Council Social Security Fund China	438
SAFE Investment Company China	418
Temasek Holdings Singapore	375
Qatar Investment Authority	328
Total Top Ten	5.837
Source: Statista

The table lists and ranks the top ten SWF by assets, roughly 75% of world assets under management by SWF, combined more than US$ 5.8 trn. Although China´s SWF assets combined were the largest (US$ 1.8 trn) even excluding the Hong Kong Monetary Authority Investment Portfolio, Norways SWF has retained the top position.

The Local Norway reported that Norway´s SWF had lost US$ 125 bn at current exchange rates for the Norway Krona. Its share portfolio, which accounts for about two-thirds of its holdings (equivalent to 1.5 percent of global market capitalisation), reported a 23-percent drop in 2020. Consequently, total assets of Norway´s oil fund have dropped below US$ 1 trn, a level first reached in 2017.

Yngve Slyngstad, the head of Norway´s fund manager Norges Bank Investment Management, announced that the drop in assets would trigger a so-called rebalancing rule, meaning that the SWF will in the long-term buy shares in the global equity markets. The fund’s equity quota, which was on target at 70% at the end of 2019, had fallen to just over 65%. However, does such a high share of equities make sense for the portfolio of an oil-fed SWF? I doubt it. At least, I would advise Norway to wait with equity reinvestment and rather stop extracting oil.

An oil-exporting country optimising production should be indifferent between keeping its oil underground (in which case the return is the expected rise in future oil prices) and receiving a market rate of return on its sale (Hotelling’s Rule for efficient depletion)[1]. The standoff between Russia and Saudi Arabia and the global corona recession have driven the oil price to historically low levels. Over recent years, ICE Brent Crude has cost between 60 and 80 US dollars per barrel. End of March 2020, it stood at around 21-13 US dollars. Eventual mean reversion would imply a rise of 300 percent over the next two, three years. While the Saudis keep on flooding the market, they run down capital, unless the receipts are fully reinvested in financial, physical or human capital (Hartwick’s Rule for intergenerational equity). But they won´t hurt themselves forever, which should mean higher oil prices as their flooding ends.

What can Norway´s SWF expect in terms of future equity returns over the next two, three years? Much depends on the shape of recovery – V, L, W, or U[2]^;[3]. To be sure, hardly the 300 percent rise it can expect for oil. The fund has been mainly invested in big caps such as Apple, Microsoft, Alphabet, Roche, Nestlé and Novartis. But let´s assume the Norway Government Pension Fund Global will simply buy the MSCI World to rebalance its portfolio to the equity quota of 70%. That index has dropped from 2400 and bottomed at 1600 in March, or 33%. To reach old highs, the MSCI World would have to rise by 50%. In case of V-shaped recovery of the world economy at least, the expected rise in oil prices would easily be superior than in global equities. If the world economy does not recover quickly as the coronavirus rambles on, both oil and equity prices will remain depressed at best.

MSCI World v Brent, March 2019 to March 2020

A more permanent point that militates against driving the equity share of oil-fed SWFs to 70% stems from basic insights of modern portfolio theory. It states that portfolio variance can be reduced by selecting securities with low or negative correlations in which to invest, such as stocks and bonds[4]. Indeed, the recent turmoil on both oil and global equity markets drove their correlation to high levels whereas AAA government bonds remained largely unaffected.