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Sovereign Wealth Funds Looking to Create More Sophisticated Hedge Fund Portfolios - November 2013

by Graeme Terry

  • 04 Nov 2013
  • HF

Data from the recently launched 2014 Preqin Sovereign Wealth Fund Review shows that a number of sovereign wealth funds are looking to create more sophisticated and complex hedge fund portfolios as they become more confident in the asset class. Almost 90% of sovereign wealth funds that invest in hedge funds will consider investing in any hedge fund strategy which means that they can adapt their portfolios in order to react to the best opportunities.

Most commonly sovereign wealth funds invest through a combination of single manager hedge funds and funds of hedge funds, with 57% of sovereign wealth funds constructing their portfolios this way, representing a seven percentage point increase on 2012. The proportion investing solely through funds of hedge funds decreased from 35% to 24% over 2012-13, whilst the proportion investing solely through direct investments increased from 15% to 19%. An increase in sovereign wealth funds investing directly suggests that many funds are becoming more confident in constructing hedge fund portfolios. Alberta Heritage Savings Trust Fund is one sovereign wealth fund that previously invested in both funds of hedge funds and direct investments, but now opts for investment in single-manager funds through both commingled and managed account structures. Managed account structures are more commonly used among sovereign wealth funds than other institutional investors in hedge funds largely due to the strong resources of these funds, which enable them to negotiate terms with fund managers and create customised mandates.

Despite this evidence of sovereign wealth funds becoming more confident in hedge funds, the asset class is still utilised by a smaller proportion of sovereign wealth funds than private equity, real estate and infrastructure. Thirty-one percent of sovereign wealth funds tracked by Preqin currently include a hedge fund allocation. This proportion has decreased from 38% in 2012 which can be partly explained by the number of new sovereign wealth funds being launched in recent years. Newly launched sovereign wealth funds tend to initially target more conservative investments and so do not tend to diversify into asset classes such as hedge funds until later in their development process. However, there is evidence of new sovereign wealth funds entering the hedge fund asset class; Nigerian Sovereign Investment Authority was founded in 2011 with an initial $1bn in seed capital and plans to allocate 8% of its assets to absolute return strategies as well as committing further capital to long/short equity.

Aggregate assets under management of sovereign wealth funds continue to increase, with total assets surpassing $5tn for the first time in 2013. Due to their large resources, sovereign wealth funds are becoming an increasingly prominent investor group and these investors are becoming more sophisticated in their investment approach. This could provide investment opportunities for hedge fund managers in the future, although managers need to convince these investors of their ability to generate consistent strong risk-adjusted returns in order to attract further investment.

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