An analysis of Sovereign Wealth Funds and international real estate investments

Abstract

In recent times Sovereign Wealth Funds (SWFs) have become an important source of international real estate investments. A number of reports predict the swelling of SWF combined assets from its current figure of $3-4 trillion to $8-12 trillion by 2015. It is also expected that a continuous growth in fiscal surpluses and accumulation of wealth by SWF nations may soon make the combined size of SWFs bigger than other capital market segments such as mutual funds and pension funds. This phenomenal projected growth in SWF assets has created an indispensable need to create and manage a diversified and robust international mixed-asset portfolio. This thesis investigates the relevance of real estate in the SWF portfolio from an execution strategy and portfolio hedging perspective. The real estate strategy section introduces SWFs and their real estate investment behavior and trends. The authors collected execution strategy data by conducting open-ended interviews with real estate leaders of four major SWFs that invest in real estate and nine senior executives representing global real estate investment management and consulting firms. The interview responses are used to understand several topics ranging from the investment objectives and risk spectrum to future trends in SWF real estate investments. The thesis findings reveal the synergies and differences in the views of the two communities and also describe the execution preferences of SWF investors from the purview of their international real estate portfolio. The portfolio-hedging section uses a macro-economic time series model based on long-term asset returns to determine the best hedges for four SWFs (Oil-based, China, Singapore and Korea) in three foreign destinations namely the UK, the US and Japan considering real estate and stocks as the two asset classes. The vector auto-regression (VAR) model presents an extended time series analysis that tests correlations, Granger causality and impulse responses between different home asset and foreign destination pairs. The thesis further illustrates through a simple stylized sub-portfolio analysis the optimal asset allocation between stocks, long-term bonds and real estate for the above combinations. The results show evidence that foreign real estate is an effective hedge against the changes in the home source of wealth for most SWFs. The time series hedging model is fed by long-term asset return data and can be replicated for other SWFs to determine their unique investment strategy. Further, the findings challenge the low allocations given by SWFs to real estate in their global portfolio.