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Study finds global sovereign investor confidence remains stable

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Invesco has published its fourth annual Invesco Global Sovereign Asset Management Study, a report on the investment behaviour of sovereign wealth funds and central banks. The firm says that this year’s study reveals that despite continued market volatility and the sustained low oil price, global sovereign investor confidence is stable and they continue to pursue long-term investment goals through strategic asset allocation. 

The study found that this year there is a strong preference for the US above other geographical regions and an increased appetite for real estate investment to drive allocations towards alternatives, the firm says.
 
While the challenging macro-economic environment, driven by the sustained low oil price, has impacted on sovereign investment performance, with average annual portfolio returns having fallen, sovereign investors remain better prepared in terms of investment capability and governance.
 
The report finds that net inflows prevail with positive flows into liability and development funds. On average, new funding accounted for 7 per cent of assets, while the average sovereign investor withdrew or cancelled only 3 per cent of assets, as sovereigns cope with funding challenges.  
 
Time horizons for investing are also lengthening as sovereign investors manage these challenges, rising from 6.4 to 7.6 years over the past four years amid continued interest in the diversification benefits and illiquidity premiums offered via alternatives.
 
The study indicates that overall sovereign investor confidence remains stable – and has done since 2013 – with Invesco’s Sovereign Confidence Index highlighting that overall confidence has increased from 7.5 in 2014, to 7.8 in 2016.
 
Tracking confidence based on returns and aggregate capabilities (looking at investment expertise, people and talent, governance and third parties), the index shows that liability & development sovereigns report increased confidence consistently across both categories. While lower returns have impacted investment & liquidity sovereigns, who have seen confidence based on performance drop from 8.4 in 2014 to 7.7 this year, confidence in aggregate capability has gone up from 7.4 to 7.8 over the same period.  
 
Alex Millar, head of EMEA sovereigns, Middle East and Africa institutional sales at Invesco, says: “Many sovereign investors are now comfortable operating in an environment with limited new funding. Some have ceded assets to governments without cancelling long-term investments, while others have not been called upon at all for withdrawals over the last 12 months. Many of these institutions appear confident in their funding outlook and are increasing the importance of their investment objectives relative to their short-term liquidity needs.”
 
While the UK had previously emerged as the preferred developed market for sovereign investment, the US has taken the lead in 2016. Scoring a rating of 6.5 (out of ten) in attractiveness to sovereign investors in 2014, this has risen significantly to 8.2 in 2016 – compared to a slightly lower 7.5 rating in 2016 for the UK3. Sovereign investors also remain bullish on future opportunities in the US, and in US infrastructure in particular. 
 
Sovereign investors expressed the view that the US appears increasingly open to their investments following positive perceptions of sovereign investments into the US financial sector during the global financial crisis. Many also feel it is now easier and more attractive to invest in the US, in large part-linked to more investment friendly policies such as the introduced exemption in 2016 for ‘qualified foreign pension funds’ from the Foreign Investment in Real Property Tax Act on real estate purchases.  
 
New allocations to frontier markets are also on the rise, with allocations to emerging Asia increasing from 1.6 per cent in 2014 to 2.3 per cent in 2015, and in Africa from 0.6 per cent to 0.9 per cent. Manufacturing capability, political stability, and the quality of infrastructure are cited as key factors for this change, and via a range of products including conventional equity and fixed income products, and direct investments into alternatives such as real estate.  
 
Conversely, of the BRIC markets, the study found that Brazil, Russia and China have all lost their attractiveness to sovereign investors amid weaker performance, with only India becoming increasingly attractive. In comparison to the last few years, sovereign investors are now less willing to overlook political and regulatory concerns in these regions in order to hit target allocations. Sovereign investors note a struggle with commodity prices and falling stock markets for large export markets like Brazil and Russia, while the shrinking labour force in China is driving up manufacturing costs and squeezing private sector margins.  
 
Millar says: “Despite being long-term strategic investors, sovereign investors are quick to adjust to perceptions of market attractiveness, responding to latest market data or regulatory change. Market performance and public policy also factor into their longer term strategic asset allocation choices – especially geographically. The ability for governments to attract sovereign investment via policy decisions is a key finding and presents an opportunity for governments globally to attract significant long term capital to support economic growth.”  
 
The study found that sovereign investors have focused on increasing allocations to infrastructure and private equity over the last two years; however attitudes have changed in 2016, and for the first time fewer sovereign investors expect to increase allocations to these asset classes. While allocations to infrastructure and private equity have increased over the last three years, total allocations remain low – at 2.8 per cent on average of total portfolio assets for infrastructure, and 4.5 per cent for private equity.  
 
Conversely, allocations to real estate have risen from 3.0 per cent in 2012 to 6.5 per cent currently (a 29 per cent compound annual growth rate) over a three year period – growing faster than private equity and infrastructure allocations combined. Sovereign investors expect to increase global and local allocations into real estate more than any other asset class in order to meet diversification and absolute return objectives. 
 
 
Sovereign investors attribute this largely to real estate investments carrying fewer execution challenges6 than private equity and infrastructure, where sovereigns have encountered difficulties in deploying their assets. Investors also cite a greater number of credible global asset managers, and a long list of developers and operators, to partner with in real estate investments. As a result, more than 62 per cent of sovereign investors are underweight infrastructure and 52 per cent underweight private equity, relative to their target allocations.
 
Millar says: “While the challenges facing sovereign investors since the start of this period of oil price volatility have clearly not gone unnoticed, and returns have been affected, confidence among global sovereign investors is relatively high. Within Invesco’s sovereign investor profiles*** this confidence is most noticeable amongst Liability and Development sovereigns, while Investment and Liquidity sovereigns have faced greater challenges due to the importance of commodities to their new funding. This year’s study reinforces the view that sovereign investors are better prepared to cope with volatility and funding challenges, and continue seeking strategic asset allocation opportunities, building in-house capabilities, and exploring expert investment partners in order to structure their portfolios towards securing diversified returns for the long-term.” 
 
 

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