“In the old days you built armies, now you build a sovereign-wealth fund”

Jayne Bok

In the month of January, there has been significantly more willingness by sellers to sell assets at any price. Volume has been extremely high and markets have been strongly linked to oil prices even though, in theory, low energy prices offer valuable cost savings and should be beneficial to many other industries. In order to better understand the link between the pressure on oil prices and the current market sell-off it is crucial to have a detailed look at the funding sources and the asset allocation of sovereign wealth funds.

Sovereign funds’ importance in global financial markets heavily increased in recent years on the back of a large rise in their assets under management. According to the Sovereign Wealth Fund Institute, the world’s sovereign wealth funds together have assets under management of about 7.2 trillion USD, that is twice their size in 2007, and more than what is managed by all the world’s hedge funds and private-equity funds combined, according to J.P. Morgan Asset Management. Furthermore, the growth over the last decade implies that the ratio of assets managed by state funds relative to the size of global equity and bond markets has increased from 5 per cent in 2007 to almost 9 per cent in 2015.

However the main connection between the current market sell-off and the pressure on the oil and gas prices is due to the fact that about 4 trillion USD or 56.6% of the assets under management of sovereign wealth funds are directly funded by income generated from oil and gas businesses. This is because countries such as Norway, Abu Dhabi, Saudi Arabia Kuwait and Qatar have funded their SWFs with the high profits made in the oil and gas industry when the oil and gas prices were high over the last decade.

But now, as the oil price plunged heavily due to over capacities and an expected slowdown in the world economy, budget deficits are pushing the oil-producing countries to liquidate some of their holdings in order to finance the gap in their budgets. This reaction unveils that even though oil exporting countries tried to invest in other industries in order to diversify and to become more independent from the energy sector, they were not really successful in doing so.

Furthermore, the possibility of closing the gap in their budget by increasing taxes or reducing subventions seems to be limited since the political stability in that region may be too fragile.

Lyxor asset management estimated that the assets managed by state-backed investment vehicles in the Gulf region have dropped by around 300 billion USD in recent months. Even Norway was forced to tap into its massive 820 billion USD sovereign wealth fund, the Government Pension Fund Global, for the very first time since inception in 1990.

Due to the fact that the Saudi Arabia´s state budget deficit is currently at a record high, the Saudi Arabian Monetary Agency, which oversees the kingdom’s foreign reserves, withdrew about 70 billion USD from external managers in 2015 to cover the budget deficit and to support its economy. However, taking into account the sell-off in January and the further drop in oil prices to the current level of about 35 USD per barrel, it was estimated by Bank of America that the Saudis´ budget deficit will increase to about 180 billion USD in 2016. Moreover, adding more than 100 billion USD in reserves spent in trying to defend its currency (riyal) peg to the U.S. dollar, the deficit in 2016 is expected to be about four times higher than the year before. Consequently liquidations are expected to further increase during 2016.

Due to the abrupt rise in capital needs, the state funds in need of cash were selling so-called liquid assets, such as high-grade bonds and equities in particular, said Michael Maduell, president of the Sovereign Wealth Fund Institute. Furthermore, a major characteristic of the current market sell-off is the high pressure on financial stocks. Even though financial institutes are expected to suffer under the increasing default rates in the energy sector in the future, it only partially explains the heavily increase of pressure on financial stocks; however having a detailed look on the asset allocation of the sovereign wealth funds of the Gulf States, which liquidated the highest amounts of assets over the last few month, a clear explanation of the pressure on financial stocks can be found.

According to Bloomberg data about one third of the equity holdings by Gulf sovereign wealth funds are financials. When taking into the account that mostly liquid assets such as equities and high grade bonds were sold by SWFs during the last months, it becomes clear why especially financial stocks underperformed during the recent sell-off.


However, since sovereign wealth funds are highly reserved with respect to their disclosure of investment strategies, it is difficult to estimate their holdings in less regulated and less liquid investments. Many have kept funds in low-risk, highly liquid investments in the early 2000s, but as assets grew and global yields tumbled, some invested more in less-liquid assets.

Consequently as soon as the more liquid assets are liquidated by the funds and their governments still require further capital, a liquidation wave of more illiquid and harder tradable assets may start, which with high probability will have an even higher impact on market prices and volatility.

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