More than half of sovereign investors are overweight equities despite concerns about valuations, inflation and geo-political tensions, according to new research by Invesco.
The sixth annual Invesco ‘Global Sovereign Asset Management Study’ found equities has overtaken fixed income as the biggest asset class across the 126 entities, representing a collective US$17 trillion, included in the survey.
Only 15 per cent of the investors surveyed were underweight equities with allocations overall increasing both by design and rising markets.
“In most cases, sovereigns are content to remain overweight rather than sell down to benchmarks given the bull run and low volatility of equity markets over the last few years,” the Invesco report says.
However, about a third plan to gradually cut strategic asset allocations (SAA) to shares over the medium term.
“Further, most would prefer to achieve this by allowing equity allocations to dilute over time rather than sell, and potentially have to repurchase later (with two sets of trading costs) – a particularly likely scenario for investors in a net inflow position,” the study says.
At the same time about a quarter of respondents – which includes an expanded central bank sector in 2018 – favoured boosting allocations to equities during the next three years.
And sovereign investors were increasingly investing in equities via passive strategies with factor (or smart beta) approaches, in particular, gaining ground.
“Over the last three years, just under half of sovereigns undertook some degree of rotation out of active strategies into passive and factor strategies, to the point where fewer than half of equity portfolios are now actively managed,” the report says.
Nonetheless, the trend towards cap-weighted index funds may have bottomed-out as sovereign wealth investors earmarked both quasi-active factor strategies and high-conviction alpha-hunting managers for attention.
“It may be too early to call a low-water mark for active management and a high-water mark for passive management, but portfolio traffic is now moving in multiple directions,” the Invesco survey says. “Factor strategies appear to be the clearest winners on a forward view; investors increasingly see factor as a third pillar between traditional active and passive investment.”
As well as boosting equity exposure, sovereign investors have significantly increased allocation to ‘private markets’ – including infrastructure, private equity and real estate – from 10 per cent of the total portfolio in 2013 to 20 per cent at the latest count.
“Private market assets are increasingly seen as bringing a broader series of benefits to portfolios compared to other asset classes,” the Invesco study says.
Sovereign wealth investors – with the exception of central banks – were looking to contain external manager costs by shifting to performance fee models with lower base fees, the study found.
“The most common view of equitable fees is that a 25–30% share of alpha achieved should be paid to asset managers as total base and performance fees,” the report says.
Typical sovereign investor expense ratios in the survey ranged between 24-45 basis points. But the report notes expense ratios as low as 3 basis points and some higher than 1 per cent, reflecting the diverse nature of institutions in the study.
In spite of their conservative investment constraints, the survey found central banks were looking to diversify their portfolios into equities and other asset classes.
Almost all central banks were researching cryptocurrencies – chiefly as potential upgrades to payment systems. However, about 12 per cent of traditional sovereign funds were also investigating cryptocurrencies and associated technologies as venture capital opportunities, the report says.
Just three funds had to date invested in, broadly-defined, cryptocurrency-linked firms via illiquid alternative vehicles.
The Invesco survey unearthed a range of views about the viability of cryptocurrencies’ potential role in the global monetary system and as a stand-alone asset class.
Terry Pan, Invesco China chief, says in the report: “Cryptocurrencies as an asset class are unlikely to make an early appearance in sovereign portfolios, but there is considerable interest in the practical applications of cryptocurrencies, especially amongst central banks, and the broader application and investment potential of the underlying technologies.”
The Invesco 2018 study covered 126 entities including 64 sovereign wealth funds and 62 central banks (up from 35 the previous year).