Sovereign wealth fund managers fear threat of inflation with economic recovery

Sovereign wealth fund managers are concerned about inflation caused by massive stimulus packages in the West and are investing more in property and commodities to hedge against that risk, Franklin Templeton executives said recently.

"There is quite a lot of interest in real estate and other long-term hedges against inflation," said David Smart, London-based global head of sovereign and supra-national funds at Franklin Templeton.

"When you have this degree of stimulus, if it is not unwound at the right time, the risk on the margins is that inflation will be higher, rather than lower," said Smart, whose team advises or manages around $40 billion from sovereign funds and international organizations.

He said Franklin Templeton is not concerned about hyperinflation, but added the risk is that core inflation might hit 3 percent to 5 percent levels in developed countries, up from the 2 percent levels seen prior to the financial crisis.

Western governments and central banks have spent trillions of dollars to shore up banks and stimulate their economies over the past two years.

While the measures have helped alleviate the worst recession in over 60 years, the surge in money supply has stoked fears that inflation could spike as the global economy recovers.

Smart, a former bond fund manager, said Franklin Templeton's sovereign clients are eager to invest in real estate, in particular UK commercial property, which is offering net rental returns of 7.5 percent to 8 percent.

"From a currency perspective, the fact that sterling has declined quite a lot means in dollar terms you are getting something that would have cost you 50 percent to 60 percent more 18 months ago," Smart said.

Sovereign fund clients are, however, wary about US commercial property due to concerns prices could fall further.

The Federal Reserve reported earlier this month that US banks are at risk of sizeable new loan losses, particularly on commercial property.

"The price adjustments (in the United States) have not been nearly as savage as they have been in the other markets. There are a lot of issues on debt financing which have not really been addressed," Smart said.

Other investments favored by sovereign wealth fund clients include inflation-linked bonds and commodities.

Sovereign funds, which together manage around $3 trillion in assets, have become more active in recent months, pouring billions into energy and commodities after a quiet first half of the year.

State investors led by Chinese and Abu Dhabi funds ploughed 61 percent of their total investments into natural resources and only 15 percent into financials, according to Barclays' estimates.

Smart said sovereign fund clients were concerned about the dollar's weakness and diversifying into other currencies, which partly explained the strength of the euro. Within Asia, the most popular currency was the won, due to the depth of the South Korean bond market.

Sovereign investors will, however, continue to buy US Treasuries, as there were few alternatives, he said.

"I would say the US dollar is still going to be a very substantial part of their portfolio in terms of the asset opportunities that are available in the United States and the liquidity that the bond market offers," he said.

Reuters

(China Daily 11/30/2009 page5)