Infrastructure investing is driving change in sovereign investor behaviour towards greater peer collaboration, but the difficulty of recruiting talent is inhibiting internalisation efforts, finds a global study.
While currency management is expected to increase in importance over time, among certain sovereigns there is a surprising lack of attention on currency hedging even as they diversify international exposures.
In the third annual sovereign asset management study* by Invesco and NMG Consulting, due to be released today, researchers explored the relationship between asset classes and regions.
The study found that while sovereign portfolios had an average of 9% allocated to emerging markets overall, exposure to emerging market infrastructure stood at 17%.
This was seen to reflect a stronger pipeline of infrastructure deals in developing markets, but also to underline how the asset class is viewed as a way to counter volatility of investing in the emerging world. Infrastructure is seen to reduce risks related to politics and regulation.
There was notable correlation, too, between developed markets and real estate: sovereign portfolios had a 56% allocation to developed markets, yet 73% of real-estate exposure was to developed markets.
“What the study showed was a divergence,” said Lindsay Wright, Invesco’s regional head of institutional, alternatives and investment solutions, referring to regional demand-supply dynamics.
“In emerging-market infrastructure sovereigns see a tremendous pipeline with less competition relative to developed markets. But they see better opportunities in supply and pricing in developed market real estate from a regional point of view.”
Respondents said co-investment with other international organisations such as governments, development banks and sovereign investors added credibility to the investment and helped to reduce perceived risk.
But deal size, frequency and cost was a collective challenge, with smaller sovereigns often only able to compete in their home markets.
The main challenge in infrastructure investing was sourcing deals (53%), which was cited to be driving growth in collaboration between sovereigns.
Respondents cited three main benefits to collaboration: the presence of certain peers in a deal effectively guaranteed board approval; a syndicate of sovereigns could improve pricing based on scale and credibility; and a belief that introduction by one sovereign to another may be reciprocated, with sovereigns seen as having an inside track on future domestic projects.
In the past sovereign collaboration was driven by government relationships and regional proximity. But this year sovereigns said investment expertise was the primary driver.
“Traditional relationship models are changing and the investment industry is becoming more integrated and complex,” the researchers surmised.
Generally they observed more discussions among respondents on underlying asset management, in the debate about internal versus external and active versus indexing. This led them to identify a capability gap in internal asset management, notably in talent.
The study found sovereigns were not comfortable increasing internal management across all strategies and asset classes. In certain areas they struggled to deliver alpha, with only the largest sovereigns likely to succeed in alternatives due to challenges of deal availability.
Moreover, respondents highlighted challenges in recruitment, with some saying it was now easier to source a chief investment officer than an underlying portfolio manager.
Nevertheless, the importance placed on internal management remained highest, at 8.9 out of 10, against 8.0 for external active management and 6.1 for external indexing.
Global infrastructure has seen a 10-point rise in external management over the past three years, to 84%. Global private equity has remained consistent (72%), but global real estate (58%) has slipped behind global equity (66%). Global bonds have continued to fall, to 43%.
But the level of understanding on currency management and risks varied. On average, sovereigns rated currency management at 6.6 out of 10 in terms of importance.
However, among sovereigns with hedging and active currency management the figure rose to 7.8, putting it ahead of investment reporting, fund manager selection and operational risk management.
While currency risk is not relevant for certain sovereign investors, still only 21% of respondents hedged exposures, while 36% said they actively managed currency risk and 43% simply said they were exposed.
“The lack of importance attributed to the exposed strategy is consistent with question marks over respondent awareness and understanding,” the researchers said.
Participants were most likely to hedge fixed income, followed by equities and alternatives, even though absolute exposures to equities and alternatives were much higher for investment sovereigns.
Just 7% of small sovereigns adopted active currency management, versus 27% for large sovereigns and 24% for mid-sized.
The researchers said sovereigns would invest more into currency management over the next 12 months as institutions increase global allocations and in anticipation of further currency volatility.
“Currency management will be a theme to watch over the next few years as pension funds particularly globalise what they do,” said Wright.
* A total of 59 sovereigns – pension funds, central banks, state investment funds and sovereign wealth funds – participated in the study. In all, 17 (or 29%) were based in Asia Pacific.