Oil-based sovereign funds tipped for asset firesale
Investors the world over are taking big losses amid the coronavirus-driven market rout – but some have it even worse than most.
Sovereign wealth funds built on oil revenues are likely to be tapped to shore up their countries’ balance sheets, as is set to happen with the world's largest such institution in Norway. This follows the sharp drop in crude prices two weeks ago after Saudi Arabia, the largest producer, opted to flood the market with the commodity.
Hence oil funds will need to offload liquid parts of their portfolios at a terrible time to be selling given the global market rout, industry experts told AsianInvestor. And such moves will place an even greater focus on such institutions’ illiquid holdings.
“Oil funds are a very significant subset of the sovereign wealth segment and they have been clattered twice – both by the equity market crash and the oil price drop,” Gary Smith, founder and head of Sovereign Focus, a London-based consultancy, told AsianInvestor. “There is little doubt that these funds are going to be called upon to help domestic budgetary situations."
Brent crude, one of the key benchmark prices, fell 30% from $45 a barrel to $31.02 on March 8 in one of the largest one-day drops in its history. It stood at $29.44 at 6.45 pm UK time on March 23.
“The price [of crude] has fallen a lot further and quicker than many Opec member countries with sovereign funds would have expected,” Smith noted. The main regions for such institutions are the Middle East, North Africa and Central Asia.
“These funds are often called rainy day funds – and this is a pretty rainy day,” he added, noting that the situation was likely to lead to the sale of liquid bonds and equities, and particularly the latter.
“Alternative assets are going to be much harder to liquidate, which puts more pressure on the remaining asset classes in your portfolio,” Smith said. “Which means public equities are going to bear the brunt of any selling that needs to be done.”
That will leave funds with an asset allocation that is “inadvertently” even more focused on private equity and real estate than before after many have built up their illiquid exposure.
The average allocation of the SWF industry today is 28% fixed income, 24% public equities and 48% alternatives, said Diego Lopez, founder and managing director of Global SWF, a New York-based boutique advisory and research firm.
He said he did not have exposure figures for 10 years ago, but said he would be surprised if the average alternatives allocation had been above 20% at that time.
HOLDING OFF
Despite the probable need to respond to government asset demands, SWFs are unlikely to dash to dump assets right away, Lopez argued.
“The need for, and size of, redemptions of liquid assets will go case by case, depending on the country's oil price break-even, overall budget constraints and different options,” he said.
“In general, SWFs will avoid cashing in stocks at the huge discounts they are trading at today and will try to exhaust all other potential options within the portfolio.”
As a result, Lopez said that he did not expect any drastic change to the allocation numbers in the short to medium term, beyond some factor tilting.
“Investment activity may slow down in some of the asset classes, such as riskier assets, and may increase in others, such as discounted stocks or private equity secondaries, but the long-term strategy will remain the same.”
Indeed, some SWFs are likely to have learned from the 2008 global financial crisis, when most did not rebalance their portfolios into listed equities, and thus missed out on the recovery, said Smith. Their response may well be different this time, he suggested.
Others, too, see oil-based SWFs holding off from liquidating assets for as long as they can, although it seems only a matter of time before they will have to do so.
"MOMENT OF RECKONING"
“They should not be responding to crisis moments, and that’s what we’re seeing. We’re not seeing them hitting the panic button,” said Elliot Hentov, London-based head of policy research in the global macro policy research team at State Street Global Advisors.
Moreover, he notes, some oil-sensitive SWFs have repositioned their portfolios since the oil crisis of 2015-2016, when oil prices fell from a peak of $115 per barrel in June 2014 to under $35 in February 2016. They have boosted their allocation to highly liquid shares to be able to respond quickly in a crisis scenario such as the current one, Hentov said.
Nevertheless, with each passing day, the likelihood and the size of liquidations will rise, he added, "but we’re not yet there in just week two or three since the oil price crash".
Still, during the 2015-2016 oil crisis, the liquidations came with a delay of roughly half a year, Hentov said. This time the oil price drop has been quicker and more severe, so the time lag is likely to be considerably shorter, he said, especially given that producing countries' debt and deficit levels are higher in 2020 than in 2015.
“This is a shock scenario, and shock scenarios don’t last forever, so every single sovereign wealth fund will try to delay the moment of reckoning for as long as possible,” he said.
However, he cautioned: “I do have the feeling that with these levels of [market] dislocation over a longer period of time, it is not sustainable to make no changes to allocations.”