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Sovereign funds still mulling whether private market returns justify extra risks

Sovereign wealth funds (SWFs) have been boosting their asset allocations to private and emerging markets while cutting their exposure to listed and developed-market investments, but many are still debating whether current returns in private markets really compensate them for the extra risks they pose, according to new research.

Two new white papers from State Street and the International Forum of Sovereign Wealth Funds (IFSWF) show how asset allocation and the approach to private markets has changed at the funds over the last three to five years. 

State Street was appointed earlier this year as one of the IFSWF’s two official research partners for its investment practice committee. 

The first two papers from the partnership, which have just been released, are entitled: “Asset Allocation for the Short and Long Term” and “Comparison of Members’ Experiences Investing in Public versus Private Markets”.

Will Kinlaw, senior managing director and global head of State Street’s unit State Street Associates, said: “One of the biggest findings from this research is the growing focus on private markets.”

Despite the attraction of these investments, he said SWFs were aware of the risks, with illiquidity being the main one.

“However, many have invested considerable time and resource in assessing these markets and have clearly identified attractive opportunities here,” he said.

Eight IFSWF members were interviewed for the survey behind the first paper, with these respondents representing a wide range of SWFs, State Street said.

These SWFs had, as a group, substantially expanded their alternative, unlisted, and private investment portfolios, according to State Street, with at least 30% having invested more over the three to five year period, and none having shrunk their exposure.

But research in the second paper, which took in contributions from ten IFSWF members, revealed that even though SWFs had been successful in private markets, many reported ongoing internal debate about whether the return premium was fair compensation for the risks these types of investments added to portfolios.

Roberto Marsella of CDP Equity — a company within Italy’s Cassa Depositi e Prestiti group — and leader of the Investment Practice Committee of IFSWF, said the investment landscape had evolved greatly in recent years and SWFs had contended with an ever larger range of investment opportunities in both public and private markets.

“In response, many are re-evaluating the methods they employ to construct portfolios and measure and manage portfolio risk,” he said.

“The low interest rate environment creates new challenges and requires reassessment of investment methodologies and professional skills,” said Marsella.

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