Sovereign wealth funds' hunger for alternative assets is growing

Sovereign wealth funds (SWFs) are ploughing an increasing amount of their cash into alternative assets, and Brexit is doing little to deter them from the UK, according to a new report.

PwC has found that SWFs, the largest of which is Norway's £772bn government pension fund, are now allocating 23 per cent of their assets under management to areas such as private equity, real estate, gold and infrastructure.

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As oil prices have fallen and fixed income instruments such as government bonds have produced lower yields, SWFs have been forced to diversify according to PwC. Their allocation to fixed income has dropped from a peak of 40 per cent in 2013 to 30 per cent in 2016.

"We expect alternatives to be prominent in SWF portfolios in the future as they can offer increased diversification, principal protection, a hedge against inflation, and an increase in portfolio performance," said Will Jackson-Moore, PwC’s global head of sovereign investment funds and private equity.

"That being said, finding the right allocation strategy for these asset classes is crucial as including certain alternatives might introduce a new set of risks such as illiquidity, complexity, and cyclicality."

PwC's report noted that despite Brexit, "there has been ongoing sovereign commitment to long-term alternative investments in the UK". Notable forays into the UK by SWFs include investments in Thames Water and Heathrow Airport.

Read more: Sovereign investors snubbing post-Brexit Britain in favour of Germany and the US

Equities, which have also been a SWF stalwart, have seen fairly sustained popularity as allocation remained at 44 per cent last year. But private equity, where sovereign wealth funds will invest in non-listed companies for a longer period, has become one of the hottest alternative classes as SWFs dedicated $45bn to the strategy in 2016.

"The asset class performed well in recent years, with returns of 13.6 per cent over the five-year period," explained PwC's report. But both real estate and infrastructure have the most allocation in terms of number of SWFs.

Though interest rates are likely to rise soon in Europe and the US, PwC predicts that SWFs' allocation to alternatives will continue to grow as their expertise increases and equities prices level out.

"Given that certain experts expect a correction in the market in the short- to medium-term, the relevance of both principal preservation and downside protection could become more pronounced," stated the report.

Read more: Jeremy Grantham, who predicted the last two bubbles, warns the stock market is ready for a "melt-up"

Full story: Sovereign wealth funds' hunger for alternative assets is growing: City A.M.

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