Sovereign Asset Managers Switch to Passive, Evolve Their Investment Strategies

(February 2, 2011) — Central banks, sovereign wealth funds and other government-owned investment groups are preparing to reassess allocations and risk management, spurred by turbulent financial markets over the past few years.

“Official sector asset managers – central banks, governments and sovereign wealth funds – have not been immune to the difficult market conditions,” John Nugée, senior managing director of SSgA’s Official Institutions Group, said in a statement. “Many have re-examined the performance of their funds, lessons they should draw from the market turmoil and the extra defenses they need in their approach. In many cases the review confirmed that their guiding principles were correct, but a number have decided to make some important changes.”

The findings by SSgA, compiled in a paper titled “Current Issues in Official Sector Asset Management,” show that the financial crisis has spurred some funds to make several significant changes, such as relying more heavily on active investment management strategies compared to passive ones and increasing their focus on the emerging-market debt as yields on traditional asset classes have fallen.

According to the report, one Middle East sovereign wealth fund commented on the significant shift during the past year of assets within sovereign portfolios from active to passive strategies, saying: “In the past we used to assume that assets should be managed actively unless a certain asset class or market clearly did not offer opportunities for active managers or reward active management. Now we tend to see this investment decision the other way round. We conclude that assets should by default be managed passively unless evidence is clear that a given asset class has sufficient imperfections that active management is likely to be consistently rewarded.”

Similarly to SSgA, the International Monetary Fund (IMF)  recently published a report on the investment practices of sovereign wealth funds following the financial crisis. Urging a review of investment objectives, the IMF noted that during the economic downturn, some of these pools of capital changed their asset allocations in ways that may not have been ideal or justified. In a report posted on the firm’s website, the organization said that sovereign wealth funds have a strong capacity to stabilize international capital markets due to their enormous size and long-term investing approach. The report asserted that in response to the global crisis, funds reacted by increasing liquidity, taking on additional risk, or adding new roles to their traditional mandates.

The IMF’s research also explained that the crisis impacted sovereign wealth funds’ asset allocations in varied ways. While the Alaska Permanent Fund and Ireland’s National Pension Reserve Fund increased their share of cash holdings, Norway and the Australian Government Future Fund increased their equity investments. Some funds, such as Singapore’s Temasek Holdings, shifted their investments geographically.