Strategic Asset Allocation for Sovereign Wealth Funds

Abstract

We propose normative strategic asset allocation models for long horizon sovereign wealth funds (SWFs) subject to background risks. Sustainability constraints or lower expected GDP growth generate larger funds than models with optimal SWF withdrawals. Without strong commitments, SWFs should have lower average stock market exposure as commodity revenues approach depletion, while in well-diversified economies SWFs should smooth business cycle shocks rather than commodity price shocks. The government's taxation capacity and consumption commitments affect asset allocation, and lower real interest rates generate a ``reaching for yield" portfolio behavior. A calibration with consumption commitments and sustainability constraints can explain the observed choices of Norway's Fund.

Keywords: Strategic asset allocation, sovereign wealth funds, sustainability constraint, commodity prices, business cycles.

JEL Classification: E32, G11, G18.