Leading independent investment management firm Invesco released this week its 7th Global Sovereign Asset Management Study, an annual in-depth report on the complex investment behaviour of sovereign wealth funds and central banks, which this year shows disenchantment with Europe among sovereign investors and increased interest in emerging markets, particularly China. According to the study, 88 per cent of investors in the Middle East have exposure to China, versus 73 per cent for all investors globally.
This year’s study was conducted face-to-face amongst 139 individual sovereign investors and central bank reserve managers across the globe representing $20.3 trillion of assets, of which 71 are central banks (62 in 2018), reflecting their growing status as sovereign investors.
China’s attractiveness rating for sovereign investors has improved more than any other major region since 2017. The unique competitive dynamics of China are appealing for sovereigns seeking more diversification, the survey found, with equities continuing to be the asset class most favoured.
Approximately 100 per cent of sovereigns in the Middle East with China exposure held Chinese equities, showing that the government’s measures to open the market to foreign investors are bearing fruit. Middle East respondents have focused on building their expertise in China by investing in partnerships, developing in-house proficiency and setting up dedicated Asian offices.
For sovereigns in the Middle East, investment risk is seen as the biggest challenge to investing in China. Transparency remains a significant obstacle to higher allocations in China for global sovereigns, while for those sovereigns with no existing allocation to China, investment restrictions and currency risk are seen as the main impediments.
Despite the fact that the study was carried out during a period of ongoing rhetoric on a trade war, those surveyed saw China’s pledge to improve safeguarding of intellectual property as grounds for optimism that some resolution of tensions would be reached.
Middle East investors are also increasing allocations to Asia as a region, with 75 per cent having increased allocations in 2018 compared with 47 per cent for all investors surveyed. Indications are that this trend will continue in 2019.
A combination of slowing economic growth and perceptions of rising political risk have led to a decline in the perceived attractiveness of major European economies. Brexit is now influencing asset allocation decisions for 64 per cent of all sovereigns, though this is higher in the region with 78 per cent. Continental Europe is seen as increasingly uncertain with the ascendance of populist movements in major European economies such as Germany and Italy, and is impacting asset allocation decisions for 46 per cent of all respondents.
This has resulted in Europe falling out of favour, with half of sovereign investors in the Middle East decreasing allocations to Europe in 2018 and a similar number planning further decreases in 2019. Only 13 per cent of global sovereigns plan on increasing allocations to Europe this year, compared to a 40 per cent allocation to Asia and 36 per cent to Emerging Markets.
2018 was a challenging year for sovereigns as weak and volatile equity markets led to a decline in overall investment returns. On average, sovereign investors achieved returns of 4 per cent in 2018 compared to 9 per cent in 2017. Despite the decrease in returns, sovereigns performed well given negative returns from global equities, which fell 8.7 per cent in US dollar terms during the year, according to MSCI World Index.
The majority of sovereigns (89 per cent) anticipate the end of the economic cycle within the next two years. This combined with volatility concerns and the prospect of negative returns from equities has led to increased fixed income allocations and more diversification in allocations to infrastructure, real estate and private equity markets.
Fixed income allocations increased to 33 per cent in 2019 from 30 per cent in 2018, becoming sovereigns’ largest asset class. However, in the Middle East, allocations to illiquid alternatives was particularly prominent with 75 per cent increasing allocations to infrastructure, 63 per cent to private equity and 38 per cent to real estate, a marked difference in strategy to the global sample. The region is particularly exposed to global economic cycles due to a reliance on oil revenues and therefore has even greater incentive to invest in such assets for diversification.
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