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Sovereign wealth funds flock to infrastructure

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GLOBAL - An increase in sovereign wealth funds' allocations to infrastructure has dwarfed increases to all other asset classes so far this year, according to a report by TheCityUK, a membership body set up last year to promote UK financial services.

This year has seen an increase in SWFs' allocations to all asset classes, except debt instruments, where the percentage of funds investing in the asset fell from 79% to 76%, while those investing in hedge funds fell by 1 percentage point to 36%.

However, investment in infrastructure rose most sharply. While only 47% invested in infrastructure in 2010, this had risen to 61% in 2011. Investment in real estate from all schemes surveyed increased a more modest 5 percentage points to 56%.

Economic senior research manager Marko Maslakovic noted an overall change in how SWFs invest, although he was unable to explain the increase in infrastructure investment.

Furthermore, while the volume of transactions has increased, the size of average transactions has decreased significantly.

"Sovereign wealth funds are more cautious because of recent high-profile losses [in financial services]," Maslakovic said. "They're also diversifying away from financial services - so they're investing more in the energy sector and in raw materials."

This increase in energy investment - which in part accounts for the increase in overall infrastructure portfolios - has been driven by the economic needs of SWFs' sponsors.

The Chinese Investment Corporation, set up to absorb the country's foreign reserves, has invested significantly both in energy and raw materials to support China's industrial economy over the next few years.

"It isn't a political intent but an economic one," said Maslakovic. "There is no political motivation behind it."

However, governments have in some cases clearly viewed SWFs as economic insurance policies. Russia's Reserve Fund lost half its $50bn (€35.2bn) in assets last year after the government raided it to plug the federal budget deficit.

Maslakovic forecast that SWF assets could reach $5.5trn next year, boosted by trade surpluses and commodity exports.

Current political instability in the Middle East is unlikely to change this forecast significantly - though it may have some impact on the direction of investment. SWFs in the troubled region account only for around 3% of global assets.

Despite a marked overall increase in capital available to invest, SWFs' current $4.2trn of reserves have been dwarfed by pension funds' $31.1tn.

Yet there is considerable overlap, with public pension funds accounting for 67% of total sovereign wealth held in special-purpose vehicles.

"A sovereign wealth fund that is also a pension fund would behave as any pension fund would," said Maslakovic.

"Sovereign wealth funds and pension funds are both long-term investors, but sovereign wealth funds will be able to take more risk because they have excess capital. They're more likely to invest in private equity and hedge funds."

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