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Asset allocation in a context of falling oil prices: the case of institutions in commodity-exporting countries

 

The essential

  • The recent context of falling oil prices affects sovereign investors in oil-producing countries in two ways: through the value of their financial portfolios and their stream of future revenues.
  • Commodities in general, and oil in particular, are strongly polarized to rising inflation, rising growth and falling stress.
  • An investor willing to hedge its portfolio against falling oil prices will therefore tend to favor assets presenting opposite polarizations, i.e. to falling growth, falling inflation and rising stress.
  • A strategic allocation to hedge against falling oil prices is primarily invested in bonds (55.9% of total assets), with complements in equities (21.7%), currencies (16.4%), volatility (4.4%) and a residual (1.7%) on non-oil commodities.
  • The issue is now whether institutional investors should heed this advice today, given the low level of bond yields and the steep fall already observed in oil prices.
  • When the institution has liabilities in local currencies, holding assets in hard currencies has a positive contribution to its funding ratio.
  • Results need to be adapted to the individualities of each investor, the nature of the oil shock, and must also be integrated with market timing considerations.

Introduction

The recent context of falling oil prices is particularly disturbing for sovereign investors in oil-producing countries, which are undergoing a double punishment, through:

  • the correction of prices in financial markets which took place in recent weeks,
  • the downward revision in their stream of future revenues.

As a result, they are inclined to review their strategic asset allocation with the objective of making it more robust to the potentially negative effects of future episodes of falling oil prices.
A number of academic papers1 do advocate integrating the sovereign’s overall assets and liabilities in defining the allocation of its financial assets. In the current environment, this has two consequences on sovereign investors whose resources are generated by the exploitation of oil and gas:

  • they should diversify their financial portfolio away from these commodities,
  • the risk for these sovereign investors to see their government draw on their assets to finance short-term expenditure represents a liability to be taken into account in defining their asset allocation.

Amundi’s latest Cross Asset Investment Strategy2 addressed the consequences of falling oil prices on macroeconomic developments and financial markets. In this paper we propose:

  • to construct a strategic asset allocation offering diversification against falling oil prices,
  • to check whether our tactical views support a rebalancing towards such asset allocation,
  • to add specific Asset and Liability management considerations, particularly in scenarios of declining oil price leading to domestic currency weakness.
POLA Gianni , Quantitative research at Amundi
TAZE-BERNARD Eric , Chief Allocation Advisor

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Asset allocation in a context of falling oil prices: the case of institutions in commodity-exporting countries
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