Portfolio choice for a resource-based sovereign wealth fund: An analysis of cash flows

We consider the portfolio choice of a government with a Sovereign Wealth Fund (SWF) when government revenues depend on exhaustible resources, such as oil and gas. The question is whether the SWF portfolio should underweight shares in the resource industry. Some studies have found that these share prices correlate more closely with the overall stock market than the resource price, which would seem to weaken the case for underweighting. However, equity price movements depend not only on changes in expectations of future cash flows, but also on time variation in discount factors. We analyze cash flows directly, rather than trying to disentangle these effects. We have collected cash-flow data for the companies in all of the major industries of the FTSE Global All Cap index, the basis for the strategic index of the Norwegian Government Pension Fund Global. Subsequently, we look at the correlations between each industry's cash flow and the Norwegian government's cash flow from oil and gas. We find a close, statistically significant, and persistent correlation for the oil and gas industry. The correlations for other industries are small and mostly insignificant. We believe that our findings can be used to support proposals for SWFs in countries with significant petroleum revenues to underweight shares in this industry.