Sovereign Wealth Funds Seek to Downplay Public Markets for 2024
Posted on 01/17/2024
by Michael Maduell
Notwithstanding the myriad occurrences of quotations from SWF executives priming the world on low-return forecasts in public markets such as bonds and stocks, sovereign wealth funds are maintaining exposure to these very asset classes. This is mostly because these state-owned actors are so immense (the top 15 in size). The trillions of dollars of capital managed by the top 15 sovereign wealth funds have explanatory power of what these state funds see, analyze, and move money into. Funds like Norway Government Pension Fund Global and Japan Government Pension Investment Fund have been deemed universal asset owners – meaning they buy almost everything listed (the good and the bad, except for the naughty list). These gargantuan public funds even pick up the shady small cap stocks in the U.S., which is why Norway’s SWF is allocating more resources to beef up their corporate activist team in Manhattan. At the World Economic Forum in Davos, on January 16, 2024, Norges Bank Investment Management CEO Nicolai Tangen was quoted, “I think it’s going to be a very slow year. At best, pedestrian, because I think (interest) rates will be slow to get down.”
Wall Street has a different view, or at least a wishful perception, on interest rates. This paves the way as loads of bank research flooded the desks of allocators and experts on CNBC were “instructed” to make the case of many U.S. rate cuts in 2024. Wall Street professionals would love for rates to drop faster and they believe in the government economic figures with a backdrop of an American presidential election, and bet that U.S. inflation is likely to fall definitively over the next 12 months. The case is being made that transitory COVID-19 pandemic-related supply and demand shocks are fading. This is not the case, when one strolls into a grocery store in the United States. I’ve seen fruits, veggies, meat, and dairy products elevated where I reside. This positive news of forecasted multiple rate cuts by Wall Street in 2024, sent U.S. equity markets roaring to a crescendo at the end of 2023. From Tangen’s remarks at WEF, one could postulate he could expect a U.S. rate cut as far out as the fall of 2024. This is in contrast to Bank of America CEO Brian Moynihan who said at Davos in January 2024 that the bank expects to be four interest rate cuts in 2024 and another four in 2025.
Nicolai Tangen’s concerns are high interest rates, persistent inflation, and geopolitical risks. Most of these “spoken” risks flowed from 2022. Tangen added, that inflation would remain persistent and come down “more slowly than I think is generally expected.”
“Wage demand is pretty high across a lot of geographies, which means that inflation is really … sticky,” he said.
Tangen expressed concerns for higher fuel transport costs and higher wages when it comes inflation. In fact, global shipping costs have skyrocketed over the past weeks, which can be partially explained by the recent Iran-backed Houthi attacks on commercial vessels in the Red Sea, Israel’s military retaliation into the Gaza strip from the October civilian attacks, and an emboldened Iran. Approximately 15% of global seaborne trade passes through the Red Sea. The U.S. and U.K. militaries retaliated and fired back into Houthi-controlled lands in Yemen. Countering those attacks, on January 15, 2024, Iran’s Revolutionary Guards dispatched missiles to an alleged Israeli Mossad spy headquarters near the U.S. consulate in Irbil, Iraq.
Let us remember that Norway Government Pension Fund Global’s portfolio and other fixed income heavy players were hit in 2022 and 2023 when their bond portfolios were overly exposed to low-yielding sovereign debt. The value of those holdings was impacted as the Federal Reserve and European Central Bank raised rates to try to contain rampant inflation fueled by the COVID-19 lockdowns. In the past nine months, these asset owners are lining up to buy more sovereign debt from the U.S. at higher interest rates now.
Private Markets
I would expect to see sovereign wealth funds, especially, the ones with ample cash to remain funneling resources to private markets, ex-real estate equity. For example, Tangen is NBIM’s first CEO with a hedge fund background. He has pushed the Norwegian giant to get more involved in private market assets, in which, the massive sovereign fund could eventually allocate to private equity buyout funds and secondaries. Singapore’s GIC Private Limited and gulf sovereign funds like the Abu Dhabi Investment Authority (ADIA) will linger to partake in major co-investments with PE firms on taking companies private, buying more of a private company stake from a liquidating GP, or holding them longer. Pension and SWF, acting as limited partners in vehicles, are also telegraphing to general partners that they will only commit to newer funds if they can get out of the older vintage funds, which is being challenged currently by a divergence in private market corporate valuations. The larger wealth funds have repeated to request in certain situations for more co-investment opportunities, increased informational transparency both in frequency and details, and the usual fee concessions. To get around these new demands, new specialist fund strategies are attracting public funds as broader tactics for diversification and alpha generation. When it comes to venture capital, sovereign funds demand direct access, but are still subject to investments in vaporware or unproven commercial models.
U.S. Equities
U.S. equity markets, contrary to European equities, would likely see renewed inflows from large pools of Westernized public funds. Norway Government Pension Fund Global holds equity positions in more than 9,200 companies globally and owning 1.5% of all listed stocks. Japan’s Government Pension Fund Global and the Japan University Fund, the multiple billion new pool of endowment capital for Japanese universities, has made inroads in allocating mandates to global equity passive managers. Despite, the price-to-earnings (P/E) ratio of the S&P 500 index being now 8x the P/E ratio of international equities, allocators still see growth and safety in U.S. public companies. To compare tenuous time periods, even before the top of the 2008 global financial crisis, the S&P 500 was less than 4x expensive as international equities. A key driver of this is the decades plus dominance of U.S. technology stocks (was FANGS), but has grown to a group of equities now known as the Magnificent 7. The Magnificent 7 has been a playground for hedge funds, and a major holding assortment for passive equity asset owner investors. At the moment, the Magnificent 7 has a market capitalization larger than the gross domestic product of every country in the world other than the United States and China.
Energy Transition
The mobilization of sovereign wealth fund capital into climate finance and energy transition assets, will remain subdued, except when it comes to regional and domestic activities – as these are linked to government policy. Yes, SWFs have increased capital and commitments to funds in this renewable energy area – the majority of the recipients of this capital will be operators in the private markets. Sovereign funds like Temasek Holdings will be on track to drop buckets of money at renewable startups like Aether Fuels, Aira Group, and Monolith LLC. The United Arab Emirates was the host for COP28, but the reality remains mixed as many of these energy transition investments have a far riskier profile compared to technology/AI companies. Sovereign funds like GIC have invested in American utilities, especially when there is an opportunity to “green” the utility.
All in all, as global oil prices hover above the doldrums of 2014, I would expect more SWFs to be opportunistic, aggressive, and contrarian when investing in public markets. Grasping this dimension on market demand for fossil fuels, the 2014-2016 event was one of the largest oil price declines in modern history and had a memorable impact on the SWF investor universe. Asset owners have taken advantage of increasing the duration of their U.S. fixed-income holdings in the fourth quarter of 2024. These buyers scooped up longer-duration Treasuries when 10-year yields marched above 4%. Yes, private credit as an asset class for institutional investors will likely grow in 2024. These SWFs and pension funds continue to expand the shadow lending market as regulators shrug their shoulders. Last, there is an opportunity for fund managers to replace current managers with higher-performing funds. According to SWFI research, sovereign funds and pensions have increased the pace of dropping traditional asset managers in favor of new ones. Interestingly, a number of direct equity investors like the Korea Investment Corporation have been using ETFs in their portfolios.
