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This paper develops a framework for partially hedging the market risk of oil reserves through appropriately allocating financial assets for Sovereign Wealth Funds, in particular so-called 'oil revenue' or 'petroleum' funds. Empirically, the hedge potential is substantial even when using relatively coarse partitions of the investment universe, such as Morgan Stanley Capital International (MSCI) country or industry indices. For example, if the market values of oil reserves and financial funds are equal, risk reduction is by as much as 50 per cent (10 per cent if short sales are not allowed) from original levels, translating into a certainty equivalent return of 3.26 per cent pa (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.

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