Sovereign investors are increasing their allocations to emerging markets and alternatives, according to a new study by Invesco.
The Invesco Global Sovereign Asset Management Study, which is in its second year, is based on surveys with more than 50 sovereign investors including central banks, sovereign wealth funds and government pension funds.
Speaking to Global Investor/ISF, Nick Tolchard, co-chair of Invesco’s Global Sovereign Group and head of Invesco Middle East, said: “Sovereigns’ improved attitude to taking risk over the past 12 months coupled with new money they have received by central governments, has flowed directly into emerging market investment. This has really started to develop as a theme.”
Africa was the standout market in the study, and Latin America also continued to be a popular emerging market, said Tolchard. Both markets had the highest numbers for 2014 allocations.
“That’s clearly not a capitalisation focus. There we are seeing potential correlation between geopolitical relationships, for example where a state entity has a bilateral trade with Latin America. This represents opportunities at a more tactical level than a deal level.”
Such investors are increasingly using strategic asset allocation when investing in emerging markets and alternatives rather than tactical asset allocation, the study found. This method is an investment strategy comprising target allocations for various asset classes, while a tactical strategy is an active one where the percentage of assets held in different categories are rebalanced.
One reason for the increased allocation to emerging markets is improvement in transparency, said Tolchard.
“Doing business in emerging markets is becoming more transparent. There is more financial infrastructure and private equity vehicles that are helping investors to access these markets.”
Despite sovereigns’ increasing focus on emerging markets, Tolchard explained that an underlying preference for developed markets remains, particularly for sovereign investors in the West.
“With western sovereigns we’ve seen more of a focus on risk-based asset allocation, which tends to mean focus on geopolitical risk, shareholder protection, transparency on governance in stocks and organisations. This tends to provide more of a bias towards developed markets perhaps than there would be in future generation funds in Middle East and Asia.”
Sovereigns voted the UK as the most attractive market in the survey and countries with perceived high degree of political stability went higher up the scale.
“The UK is perceived as easy to invest in but also has the financial infrastructure to make that possible, which gives sovereign investors accessibility to the UK relative to other markets such as the US.”
Tolchard said Invesco had noticed a trend where sovereigns are investing in UK infrastructure, whether that be existing assets or increasing interest in forthcoming projects.
As with all markets, the UK’s attractiveness could be bettered or worsened by political events.
“It will be interesting to review UK’s position over the next 12 months and see how it is ranked in next year’s survey.”
Sovereign investors are also increasingly attracted to alternative investments. The study found that 51% of investors rose their exposure to real estate in 2013 while 29% increased new exposure to private equity.
“Stabilisation funds are evolving by moving away from US treasury investing into a more traditional asset allocation model, and there are signs they are moving into alternatives too.”
Tolchard also noted the diversity in risk appetite among sovereign investors.
“Public pension funds have to focus on matching liabilities but they do not have to 100% meet those liabilities as central governments take on some of the responsibility.”
Such investors, known as partial liability sovereigns, have longer time horizons, higher target returns and greater risk-asset exposure than conventional defined benefit and defined contribution sovereign funds.
Sovereigns could look to further increase their allocations to alternatives and emerging markets as 46% of those surveyed estimated an increase in new funding this year compared to 2013. Invesco said this increase was driven by growing country surpluses and strong support from government funds.
The study found that despite the vast difference between sovereign investors, they are increasingly collaborating as their investment strategies become more complex. Some 70% of respondents said they conducted benchmarking against their sovereign funds, a substantial rise from 53% in last year’s survey. Invesco put this increase down to more awareness, collaboration and transparency among sovereigns.
Tolchard said that sovereigns are also exchanging ideas, whereas historically there was little interaction between these investors.
“Sovereign investors are very interested in talking to their peers with experience of investing in alternatives as they allocate to more sophisticated and technical asset classes.”
He also noted: “It’s a challenge to get the right skills and talent to deal with more sophisticated investment strategies, and that will be partly done by hiring people but also through knowledge exchange with asset managers.”