Global government-owned institutional investors are shifting into defensive mode amid mounting concerns about an economic slowdown, according to a new Invesco report.
The 2019 ‘Invesco global sovereign asset management study’ found survey respondents – representing over US$20 trillion across almost 140 government wealth funds and central banks – were easing off equities in favour of fixed income and alternative assets.
“A challenging 2018 has led to increased fixed income allocations and a push for more diversification as sovereigns anticipate the end of the current economic cycle,” the Invesco report says.
Sovereign investors are also allocating away from market cap-weighted index strategies towards “more dynamic approaches”, the study says, while rebalancing out of Europe in favour of emerging economies.
Overall, the survey found the government-owned investors had 33 per cent in fixed income assets and 30 per cent in shares as at the end of March this year – an exact mirror-image of the previous year’s result.
During the 12-month period the sovereign investors increased exposure to ‘illiquid alternatives’ to 18 per cent from 17 per cent in the 2018 report. While the year-on-year jump in illiquid alternatives was just 1 per cent, since 2015 investors in the survey have doubled exposure to the asset class.
Liquid alternatives and cash held more-or-less steady over the year with allocations of 3 per cent and 5 per cent, respectively, but ‘direct strategic investments’ (DSI) exposure fell to 11 per cent from 13 per cent in 2018 and a peak of 18 per cent in 2015.
(Somewhat against the multi-year DSI downward trend, last week the NZ Superannuation Fund (NZS) tipped $300 million into a local hotel tourism venture along with construction firm, Russell Group, and private investment business, Lockwood Group.)
Across the alternative investment universe, respondents had allocated 8.7 per cent to real estate, 6.9 per cent to private equity, 2.7 per cent to infrastructure, 2.1 per cent to hedge funds and 1 per cent to commodities. With the exception of infrastructure (which fell 0.5 per cent to reach 2.7 per cent of funds under management in 2019), sovereign funds increased weightings to all alternative asset sub-classes over the year.
More than half (54 per cent) of sovereign investors tipped the end of the economic cycle to hit within one to two years while a more pessimistic 35 per cent gave the global economy only six months, the study says, and 11 per cent saw a downturn in two to three years.
“The view that the end of the economic cycle is close is almost unanimous – some 89% of sovereigns expect the cycle to end within two years,” the Invesco report says. “Late cycle concerns – both volatility and the prospect of negative returns from equities – have pushed sovereigns towards a more defensive position – supported by improved yields in some fixed income markets on the back of an increase in US interest rates.”
Of course, since late 2018 the US Federal Reserve mood has turned more dovish but the Invesco study shows sovereign investors already had mixed feelings about fixed income at the time of the survey over January to March this year. Almost two-thirds of those surveyed said they would maintain current levels of fixed income over the next 12 months as 22 per cent intended to ramp up exposure to the asset class and 14 per cent planned a retreat.
The equities equation was even more divided with 22 per cent expecting to increase holdings in the year ahead and 24 per cent cutting back exposure to shares.
However, sovereign investors were less torn about the benefit of alternative assets over the next 12 months, the Invesco report says.
“The diversification benefits of private market allocations in periods of public markets’ volatility is reinforcing existing strong demand for private market investments – investors plan to increase allocations to infrastructure, real estate and private equity further… ,” the study says. “As well as returns with low correlations to other capital markets, the advantages identified in last year’s report – including inflation protection, long-dated assets, and illiquidity premia – remain very attractive to sovereigns. For liability sovereigns in particular, infrastructure and real estate assets are also often viewed as offering a quasi-match for their liabilities.”
As well as an in-depth look at sovereign investor asset allocation trends, the Invesco study covers themes including: environmental, social and governance (ESG) investing; technology; central bank strategies; and, the “challenges of asset owner scale”.
Terry Pan, Invesco chief greater China, says in the report that scale “has become a real issue for some large funds”.
“Size has distinct benefits in accessing certain opportunities, but even those are often heavily contested, forcing large sovereigns to look at increasingly specialised areas,” Pan says.
The report says large-scale – or US$100 billion plus – sovereign fund faced a number of problems such as building appropriate internal governance and investment capabilities as well as “investment challenges”,
“However, sovereigns in the middle of the size spectrum can find themselves caught in the middle: too large or no longer wishing to use the commingled pools with which small-scale sovereigns must content themselves, but too small to make use of these more sophisticated private market strategies available to large sovereigns,” the study says.
By Invesco’s rankings, the almost $42 billion NZS would fall into the medium-sized sovereign fund category (covering assets under management of between US$25 billion to US$100 billion).