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Invesco Global Sovereign Asset Management Study
2017
This study is not intended for members of the public or retail investors.
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Cover
Aerial view of Midtown
South, New York
Introduction
We published our first report on the sovereign
asset management industry in 2013 following
interviews with 43 sovereign investors. This year
marks our fifth annual study with evidence-based
findings based predominantly on face-to-face
interviews with 97 leading sovereign wealth funds,
state pension funds and central banks with assets
in excess of US$12 trillion.
Over the past five years we’ve noted a number
of factors influencing sovereigns such as low
interest rates, the falling oil price and reduced
funding. This year however we note geopolitical
shocks in developed markets are shaping decision
making. When coupled with uncertainty over the
end of quantitative easing, the commencement
of quantitative tightening and ongoing volatility
in currencies and commodities it’s clear sovereign
investors are faced with a challenging macroeconomic
and therefore investment environment.
The first theme in this year’s report addresses
the aforementioned factors and notes a continuing
return gap between target and actual returns with
asset deployment challenges limiting the ability for
sovereigns to match strategic asset allocation targets.
We note sovereigns are increasingly looking to evolve
their business models through internalisation or
investment partnerships to reduce management
costs and improve placement efficiency.
Geopolitical risks have led to an increased
concentration on perceived ‘safe haven’ international
markets such as the US, India and Germany as well
as an increasing focus on home market allocations
in an effort to reduce foreign currency exposure.
We focus on real estate in our third theme,
highlighting accelerated growth in the asset class.
We examine the drivers for these allocations as well as
setting out how and where assets are being deployed.
Despite sovereigns being well placed to implement
Environmental, social and governance (ESG)
strategies due to their size and long-term orientation,
the uptake of ESG practices by sovereigns appears
to have varying success. We highlight sovereigns’
polarised perspectives on ESG investing across
various regions.
We conclude with a theme focused on central
banks. This year we have expanded and segmented
our central bank sample to understand differences
in strategy and pace of change with respect to
investment tranches across developed and
emerging markets.
We hope the unique, evidence-based findings
in this year’s report provide a valuable insight into
a fascinating and important group of investors.
Key themes
Shift from investment strategy to business model
The gap between target and actual portfolio returns
along with declines in investment commitments are
reshaping sovereigns’ strategic agendas.
Increasing appeal of perceived ‘safe haven’ markets
Geopolitical uncertainty is leading to a focus on
perceived ‘safe haven’ international markets and
home markets.
Attraction to real estate for matching and
flexible participation
Sovereigns are increasing allocations to high-quality
direct real estate given perceived return, matching
and flexibility attributes.
Environmental, social and governance (ESG)
growth dependent on performance data
Perspectives on ESG are polarised with supporters
moving to further embed and integrate ESG in
investment processes while non-supporters wait
for evidence of investment implications.
Central bank risk appetite driven by financial
market exposure
Central bank investment priorities and risk
appetite vary according to the size of the country’s
reserves and to the level of exposure to financial
market shocks.
Alexander Millar
Head of EMEA Sovereigns & Middle East
and Africa Institutional Sales
alexander.millar@invesco.com
+44 1491 416180
igsams.invesco.com
to view more content
on this year’s themes
01
Sovereign segmentation is crucial to understanding
attitudes and responses to external themes
Economic challenges affect sovereigns differently,
according to their liabilities, risk appetites, funding
dynamics and other factors. We use the framework
in figure 1 to categorise sovereign investors. We will
explore the unique implications of the themes in
this report for each of these segments.
Investment sovereigns
Investment sovereigns do not have any liabilities,
allowing for long time horizons and high exposure to
illiquid asset classes. Due to this investment freedom,
return targets are high – investment sovereigns have
responded to falling returns by targeting greater
illiquid asset exposure (to generate higher returns)
and developing internal management capability
(to capture more of the value chain), however many
funds are reaching limits on these allocations.
Liability sovereigns
Liability sovereigns are split into funds with existing
outflows (current liability sovereigns) and funds with
future liabilities (partial liability sovereigns). While
partial liability sovereigns have similar strategies
to investment sovereigns (due to their long time
horizons), matching outflows is a key concern
for funds with current liabilities. The return gap
is therefore of particular significance to liability
sovereigns and many funds expect their target rates
to eventually increase as they update models to
lower ‘risk free’ rates and increasing life expectancy.
To manage these concerns, many current liability
sovereigns are seeking greater exposure to highyielding
asset classes.
Fig 1. Sovereign profile segmentation
Sovereigns and central banks
Primary objective
Investment only
Investment & liability
Global sovereign profile
Investment sovereigns
(INV)
Liability sovereigns
(LIA)
Sovereign investors
1
Central banks have secondary liquidity objectives as well as primary capital preservation objectives. They are distinct from sovereigns through their role in local market
money supply and their regulatory function.
02
Liquidity sovereigns
Liquidity sovereigns manage assets to stimulate
economies that are highly dependent on commodity
prices during a market shock. Due to the unpredictable
and sudden nature of outflows, liquidity sovereigns
have extremely short time horizons and prioritise
portfolio liquidity above investment returns. Despite
low yields of government bonds, liquidity sovereigns
are unable to seek higher returns from alternative
asset classes due to the inherent liquidity risk.
Development sovereigns
The asset and geographic allocation of development
sovereigns is driven by the requirement to encourage
local economic growth (rather than investment
return). Development sovereigns take large (often
controlling) stakes in companies of economic
significance in order to grow their presence in
the local market. While other sovereigns adjust
allocations to maximise their asset growth and yield,
development sovereigns consider their success
in economic metrics such as GDP growth and job
creation, working closely with their investments to
grow long-term strategic assets. This means that
development funds are relatively unreactive to
return shortfalls and asset allocation trends.
Central banks
Central banks are ‘lenders of last resort’ – managers
of a large foreign reserves portfolio to bail out
financial institutions of public importance. Due to
the importance of maintaining reserves to sufficiently
cover such requirements, preservation of capital
is of greatest importance. Central banks also have
high levels of public accountability and disclosure,
encouraging risk aversion through short time horizons
and highly liquid investments. While other sovereigns
invest in home market assets, central bank reserve
managers hold the majority of their assets in foreign
securities, increasing the importance of currency
exposure relative to other sovereigns.
Unlike sovereign investors, central banks have
objectives outside of reserves management, including
local market liquidity management and maintenance
of currency pegs. Since these external factors have
influence over the foreign reserves, in this study we
consider central banks separately from sovereign
investors. However, as many government bonds have
negative yields, certain central banks have looked to
invest in non-traditional asset classes (e.g. equities)
to preserve their capital, closer aligning their foreign
reserves investment strategy to that of sovereign
wealth funds.
Funding challenges
and the low return
environment have
unique implications
for each sovereign
segment.
Investment & liquidity
Investment & development
Capital preservation
Liquidity sovereigns
(LIQ)
Development sovereigns
(DEV)
Central banks 1
(CB)
03
Shift from investment strategy to business model
The gap between target and actual portfolio returns
along with declines in investment commitments are
reshaping sovereigns’ strategic agendas.
1
Worlds highest and longest
glass Bridge as of 2016 in
Zhangjiajie, China
The outlook for macro policy and for the geopolitical
environment remains uncertain
Our fifth annual cycle of interviews took place
between January and March 2017. In speaking with
leading sovereign investors and central banks (with
assets in excess of US$12 trillion) we identified a
number of critical themes that shaped interview
responses. Unsurprisingly, we noted that the outlook
for macro policy and the potential for further
geopolitical shocks dominated discussions.
– Sovereigns see the end of QE (Quantitative
Easing) without a clear indication as to the form or
timeframe for further QT (Quantitative Tightening).
While the US has begun to raise interest rates, the
Federal Reserve is engaged in parallel measures
that may reduce the quantum and pace of further
increases; and there is uncertainty whether and
when other major markets will follow suit
– The bifurcation of the US and other developed
markets (notably the UK, Germany and Japan)
had significant implications for currency rates,
challenging sovereign geographic allocations
– Political change in developed markets (notably
Brexit and the US election) created volatility in
sovereign portfolios, challenging the robustness
of sovereign risk models. As policy changes are
worked through governments (e.g. the terms of
Brexit and US corporate tax reform), there will be
wider implications for long-term geographic and
asset allocation
– Emerging markets face various macro challenges,
with commodity prices recovering slowly (e.g. oil,
natural gas and copper) and an increasingly unstable
political outlook in Brazil and South Africa
Sovereigns face a continuing ‘return gap’
These dynamics suggest a continuation of the
‘lower rates, lower return’ environment over at
least the next 24 months. While the lower return
environment has been a consistent theme in past
years, in 2017 the implications are compounded,
with low interest rates the factor of greatest
importance to both strategic and tactical asset
allocations in figure 2. Risk asset valuations have
inflated over a number of years, while the nearuniform
tilt to alternatives such as infrastructure
has resulted in supply challenges and delays.
In 2016, all sovereign profiles displayed a
return gap (figure 3), driven by the low interest rate
environment, however this shortfall was greatest
among investment sovereigns. Traditionally, liability
sovereigns have hedged fixed income against
inflation (due to the focus on matching outflows
to beneficiaries), while investment sovereigns have
left their inflation exposure open. This has led to
investment sovereigns having the greatest return
gaps, as developed economies return to growth
and inflation rises. While liquidity and development
sovereigns are also suffering from low interest
rates, respondents noted that investment returns
were of secondary importance, relative to liquidity
and development objectives. Furthermore, liquidity
sovereigns noted that their long-duration fixed
income assets had increased in value as rates fell.
Against this, sovereigns are challenged by fixed
return targets, which are typically set to match
potential liabilities and do not adjust to market
conditions. Despite return challenges, we do not
see a concurrent shift in investment activity
year-on-year (as we go on to explore).
The challenges
of the return gap
are most severe
among investment
sovereigns.
06
Fig 2. Importance of macroeconomic conditions to strategic and tactical asset allocation
• Importance to SAA
• Importance to TAA
8.1
Low interest rates
9.1
7.4
US election
8.5
7.1
Commodity prices
6.6
6.9
Brexit, EU break
7.5
6.5
Stock market volatility
7.5
5.7
Terrorism
5.9
5.6
War in Syria
5.5
5.5
Emerging market
6.9
5.1
Climate change
7.0
5.0
Chinese volatility
6.1
Sample is based on sovereign investors and excludes central banks. SAA=Strategic Asset Allocation. TAA=Tactical Asset Allocation.
Sample=20.
Fig 3. Past year returns and target returns (% AUM)
• Past year returns
• Target returns
4.1 Sovereign sample
57
6.1
2.6
6.3
Investment sovereigns
12
4.9
6.0
Liability sovereigns
27
2.4
3.3
Liquidity sovereigns
7
4.6
7.7
Development sovereigns
11
Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. Data is not weighted by AUM.
07
Fig 4. Expected time (years) to deploy assets
• 2016
• 2017
Infrastructure Private equity Real estate Hedge funds
4
3.5
2.3
2.4
2 2
1.7
1.5
Sample is based on sovereign investors and excludes central banks.
Sample: 2016=21, 2017=35.
08
Deployment challenges are limiting sovereign
ability to match targets
In previous reports, we observed sovereigns' return
gaps, driven by low interest rates and challenging
targets for fixed income allocations. We have also
noted how appetite for alternatives has grown as
sovereigns seek greater returns from private markets.
In last year’s report, we demonstrated that high levels
of competition in infrastructure and private equity
were causing sovereigns to shift deployment of real
assets towards real estate.
Competition for infrastructure and private equity
deals has accelerated in 2016, with deployment
times increasing across alternative asset classes
(figure 4). While the growth in these times is small,
it is significant: sovereigns are increasingly dependent
on their alternative investments to generate yields,
however, growing levels of undeployed capital for
alternative investments are being held in cash and
money market funds, so that sovereigns can respond
quickly when real asset opportunities arise. These
highly liquid investments offer limited returns,
particularly in comparison to sovereign targets for
real asset investments, causing further growth in
the return gap.
Risk of fund withdrawals is slowing further
illiquid asset investment
The ability of sovereigns to respond to the return
gap is being limited by the increasing likelihood of
withdrawals. Over the past three years, governments
have responded to economic volatility by reducing
new funding to sovereigns and, in some cases,
drawing down from sovereign reserves, as seen
in figure 5.
While previously only liability sovereigns
experienced regular drawdown of funds (in the form
of outflows to beneficiaries), an increasing propensity
for government withdrawals is encouraging
investment and liquidity sovereigns to consider the
liquidity of their portfolio. Liquidity sovereigns were
comfortable in their ability to withdraw from their
portfolio at short notice, however, many sovereigns
stated that liquidity management was an entirely
new objective, with certain investment sovereigns
responding by creating tactical allocations to cash
and money market funds. This has led to conflicting
liquidity requirements: sovereigns have to manage
withdrawal risks by shortening time horizons while
simultaneously seeking to access illiquidity premia
to generate greater returns.
Fig 5. Expected new funding and cancelled investments (% AUM)
• New funding
• Cancelled investments
Sovereign sample Investment sovereigns Liability sovereigns Liquidity sovereigns Development sovereigns
2015
37
2016
56
2017
58
2015
9
2016
10
2017
10
2015
17
2016
26
2017
27
2015
14
2016
6
2017
8
2015
7
2016
14
2017
13
15
9
8 8
7 7
6
6 6
5 5
4 4
3 3
-1
-1
0
0
-2 -2
-2
-3 -3
-3
-3
-4 -4
-5 -5
Sample is based on sovereign investors and excludes central banks. Sample sizes shown in grey. Data is not weighted by AUM. Periods shown reflect past year new
funding/cancellations.
09
Fig 6. Change in past year allocations by asset class (% citations)
• Decrease
• Stay the same
• Increase
Global equity
2013
52