A Note on Portfolio Choice for Sovereign Wealth Funds

Financial Markets and Portfolio Management, Vol. 23, No. 3, pp. 315-327, 2009

Posted: 19 Jun 2010

See all articles by Bernd Scherer

Bernd Scherer

EDHEC Business School - Department of Economics & Finance

Date Written: Juny 1, 2009

Abstract

The current vast account surpluses of commodity-rich nations, combined with record account deficits in developed markets (the United States, Britain) have created a new type of investor. Sovereign wealth funds (SWF) are instrumental in deciding how these surpluses will be invested. We need to better understand the investment problem for an SWF in order to project future investment flows. Extending Gintschel and Scherer (J. Asset Manag. 9(3):215–238, 2008), we apply the portfolio choice problem for a sovereign wealth fund in a Campbell and Viceira (Strategic Asset Allocation, 2002) strategic asset allocation framework. Changing the analysis from a one to a multi-period framework allows us to establish a three-fund separation. We split the optimal portfolio for an SWF into speculative demand as well as hedge demand against oil price shocks and shocks to the short-term risk-free rate. In addition, all terms now depend on the investor’s time horizon. We show that oil-rich countries should hold bonds and that the optimal investment policy for an SWF as a long-term investor is determined by long-run covariance matrices that differ from the correlation inputs that one-period (myopic) investors use.

Keywords: Sovereign wealth fund, Vector autoregression, Oil price shock, Three-fund separation, Portfolio choice

JEL Classification: E32, F34, G11

Suggested Citation

Scherer, Bernd, A Note on Portfolio Choice for Sovereign Wealth Funds (Juny 1, 2009). Financial Markets and Portfolio Management, Vol. 23, No. 3, pp. 315-327, 2009, Available at SSRN: https://ssrn.com/abstract=1626336

Bernd Scherer (Contact Author)

EDHEC Business School - Department of Economics & Finance ( email )

France

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