Total Wealth Management for Oil Revenue Funds

Abstract

We develop a framework for partially hedging the market risk of oil reserves through appropriately allocating financial assets in 'oil revenue' or 'petroleum' funds. Empirically, the hedge potential is substantial even when using relatively coarse partitions of the investment universe, such as MSCI Country or Industry indices. For example, if the market value of oil reserves and financial funds is equal, the variance reduction is as much as 50% (10% if short sales are not allowed) from original levels, translating into a certainty equivalent return of 3.26% p.a. (48 basis points if short sales are not allowed). Moreover, choosing a portfolio along the efficient frontier, which is typically viewed as the key task in asset allocation, is relatively unimportant compared to the hedge decision.