Sovereign funds should take different investment approach — EDHEC

Sovereign wealth funds should split their investments into returns-seeking and hedging portfolios tailored to each fund’s characteristics, according to a new paper by EDHEC.

The paper, funded by Deutsche Bank, suggests SWFs create hedging portfolios tailored to their income from — and payouts to — their state sponsors. The approach “can in fact be seen as the extension to sovereign wealth funds of the liability-driven investing paradigm recently developed in the pension fund industry,” according to the paper, “Asset-Liability Management Decisions for Sovereign Wealth Funds.”

The paper’s lead author, Lionel Martellini, accepts that SWFs have longer time horizons than other investors that they can use to their advantage. However, SWFs’ investment exposures still need to be quantitatively measured and optimized to avoid bias to certain markets, sectors or styles, he argued in the paper.

“While many sovereign funds were built on the idea that they could hold on to investments over long time horizons, some have had to draw back from investments abroad, even if they are marked at a loss at the time, in order to finance investments in their home country,” wrote Mr. Martellini, who is professor of finance at EDHEC Business School and scientific director of EDHEC-Risk Institute.