Strategic Asset Allocation and Portfolio Construction for Sovereign Wealth Managers

Abstract

Increasing numbers of nations are facing a new challenge in managing significant accumulations of national wealth. The amount of external reserves accumulated by many countries exceeds that which even conservative central bank managers deem necessary to effect desired monetary and foreign exchange policies. According to an IMF survey in April 2008, sovereign wealth funds are projected to grow from $2–3 trillion in assets today to over $6 trillion in 2013. There is an increasing consensus that the appropriate investment policy for such excess assets, which are commonly regarded as having the luxury of a longer-term investment focus, is one that is less conservative than the traditional strategies for central bank reserves. The emphasis has shifted from a singular focus on safety and liquidity toward the achievement of higher levels of return, albeit by accepting higher levels of short-term risk. In fact, leading sovereign fund managers and central banks have already made commitments to an expanded range of asset classes. The expansion of investment latitude includes maturity extensions along the sovereign yield curves that form the core of traditional central bank liquidity portfolios, as well as investments in fixed income sectors such as corporate bonds and mortgage-backed securities, and even asset classes such as public and private equities, real estate, and hedge funds. Most recently, in light of the credit turmoil impacting financial institutions, a number of sovereign wealth funds have made direct investments in troubled institutions and have purchased commercial real estate overseas.

This chapter is derived from previous works by the authors, published in Sovereign Wealth Management, in 2007 by Central Banking Publications Ltd.