Asset owner caution helps soothe Covid-19 pain

Institutional investors' defensiveness early in 2020 helped cushion them from the worst of the market impact of the coronavirus, and many have since sold fixed income securities to maintain overall equity positions, finds research released on Thursday (May 14) by the International Forum of Sovereign Wealth Funds (IFWSF) and State Street. 

Meanwhile eight out of 10 interviewed sovereign wealth funds (SWFs) haven't faced any calls on their capital, but one expert believes they could face other pressures as the pandemic rolls on. 

The IFSWF and State Street survey was based upon a mixture of anonymised quantitative data on the capital flows and portfolio positions of long-term institutional investors, combined with qualitative data from interviews with 10 SWFs.

The report pointed to the fact that asset owners had been increasingly cautious heading into 2020, and that mindset served them well when the impact of the coronavirus spread. 

“During downturns State Street observed selective risk taking and opportunistic portfolio rebalancing, but no wholesale change in strategic asset allocation,” it stated. 

Investors' cash and short-term fixed income allocations had hit a historial high of 30% after the global financial crisis of 2008, dropped to 10% to 15% a few years later, only to start rising once more after 2018, Neill Clark, head of Europe, the Middle East and Africa at State Street Associates, said on a media call on the launch of the new survey.

This reflected that asset owners had underweighted risk assets on concerns that valuations were getting too high and were unsupported by fundamentals, he added.

"[Those allocations] continued to rise recently to stand at a level that was close to 25%," Clark noted.

To reach this defensive position, the investors in particular cut sovereign debt, corporate bond and foreign exchange exposure, and held the highest levels of cash observed since the 2008 crisis, the report added.

That left many institutional investors relatively well positioned to limit the pain of the market downturn as the coronavirus began making itself felt in February and March. 

INSTITUTIONAL INVESTOR HOLDINGS ACROSS RISK ASSETS AND CASH

As markets plummeted in those months, State Street said the investors generally didn't embark on widespread equity selling, unlike in 2008. They took a more selective approach to risk reduction, and even bought more equities to maintain their overall position as prices dropped.

"We found signs of risk aversion were less persistent and broad-based then in previous crises and there were more signs of strategic discipline and maintaining overall global equity exposure, which meant on a global level equity levels have remained robust in 2020," said Clark. 

And with funds having conducted their rebalancing, some are selectively looking to buy into risky assets once more, and particularly equities. 

“As sovereign wealth funds and other institutions appear to have completed their rebalancing exercises, heavy fixed income redemptions look to be subsiding and institutional investors have displayed some appetite for risk with inflows into emerging-market fixed income, emerging market foreign exchange and carry,” the report said.

SWF EXPERIENCE

According to the report, the 10 interviewed SWFs broadly supported these findings. It also noted that only two of the 10 SWFs had experienced calls on their capital by their backing governments, despite the difficult conditions.

SOVEREIGN WEALTH FUNDS' ASSET ALLOCATION CHANGES, 20022018

 

This, it contended, was notable, particularly given that many SWFs are based in oil-exporting countries and the price of crude has plunged this year. 

This is despite expectations by several experts that some form of asset liquidation or portfolio shift will be inevitable to cope with the anticipated huge economic downturn.

In response to a question from AsianInvestor about the likelihood of SWFs facing capital calls later in the year as the financial impact of the coronavirus continues to be felt, a spokeswoman for the IFSWF said it did not appear too likely at the moment. 

"For those funds with a stabilisation role, they have made a large allocation to liquid assets, and are positioned and prepared for additional withdrawals, but haven't been asked to contribute further yet," she noted.

In addition, the spokeswoman said that oil-producing countries had generally been able to raise large sums of cheap debt, which has often been an easier funding option than liquidating sovereign fund assets.

Norges Bank Investment Management, which manages the world's largest SWF, is an exception. In March it said it would raise daily sales of foreign exchange from Nkr500 million ($44 million) to Nkr1.6 billion ($142 million), as Norway sought greater measures to respond to the impact of the coronavirus.  

BROADER EFFECTS

NBIM may not be the only government fund to do so. It's worth noting that IFSWF has 38 full or associate members, so 10 interviews constitute a distinct minority. In addition, the likelihood that the economic conditions remain difficult over many more months means that it is a little early to be certain that SWFs will avoid having calls on their capital this year. 

"The level of withdrawals this year will be highly dependent on the country’s overall financial strength and the spending rule and hierarchy of the funds," a sovereign wealth fund expert from another organisation told AsianInvestor. 

That said, the expert noted that many oil-based SWFs were in countries where central bank reserves had expanded in recent years, offering a buffer. Meanwhile, sovereign funds in Asia are generally less vulnerable, given that their funds are not sourced from commodities.

"At the end of the day, it comes down to the performance versus liquidity debate," he said.

Joe Marsh contributed to this article.