A Note on Portfolio Choice For Sovereign Wealth Funds

Sovereign wealth funds (SWFs) are instrumental in deciding how these surpluses will be invested. We need to better understand their investment problem in order to project future investment flows. Extending Gintschel and Scherer (2004, 2008), we apply the portfolio choice problem for a sovereign wealth fund in a Campbell and Viceira (2002) strategic asset allocation framework. Changing the analysis from a one- to a multi-period framework allows us to establish 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 will 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-term covariance matrices that differ from the correlation inputs that one-period (myopic) investors use.