Governments around the world – most notably in Asia – are planning to set up more investment funds that follow a 'public-private partnership' investment approach, according to research* by Invesco.
The new study – the US fund house's first to focus solely on sovereign institutions, to be released today – also confirms a strong shift by Asian state investors into alternatives.
Although Asian and Middle East sovereigns still allocate less to alternatives than their Western counterparts, the findings suggest they are starting to adopt a more Western approach in terms of their investment models. This is a positive trend for managers specialising in alternatives, notes Desmond Ng, CEO of Greater China at Invesco.
Sovereigns identified various gaps between where they want their capabilities to be and where they in fact are. The most significant disparity, with 37% of respondents citing it, is that of talent.
They feel their biggest challenge is finding, hiring and retaining the right people. In many markets in Asia, for example, sovereigns face remuneration constraints relative to the private sector or a general shortage of skilled individuals for key functions such as risk management and investment strategy, says Ng.
Risk management and asset allocation were viewed as the second and third biggest individual challenges, respectively.
Such issues create opportunities for fund houses, especially through what some are calling 'strategic relationships', says Ng.
That said, sovereign investors in Asia have been growing more and more selective in terms of reducing the number of external mangers or partners they work with, he notes. And they are becoming more demanding of those they do use.
Sovereigns are looking far more often for solutions rather than products, says Ng, and for value-add such as research, performance analytics and even capital commitment. The investment model has evolved, he adds, and this is putting a lot of demand on asset managers in terms of how they engage sovereign funds.
While there are a number of newer, smaller state funds in Asia that are not at such a sophisticated level, the larger more established players often have very specific and advanced requirements.
One area this is happening is in alternatives, where Asian sovereigns increasingly want access to more co-investment opportunities.
The average alternatives allocation by sovereigns in Asia is 12%, the Middle East 9%, the West 21% and other emerging markets 2%. Yet those allocations are growing far faster among non-Western state funds, with Asian and Middle East sovereigns having cited a rise in their alternatives exposure by 54% and 69% respectively in 2012, as against a 26% rise in the West.
The biggest growth in specific alternatives exposure was into international real estate (69%) and international private equity (61%) last year, followed by hedge funds (40%), home real estate (36%) and infrastructure (33%) (see figure below).
But while Asian sovereigns want to boost their alternatives exposure, many of the larger ones are struggling to hit their target allocation, says Ng. That's because for a big state fund, even just a 1% increase is a lot in dollar terms, he notes.
Therefore Asian and Middle Eastern sovereigns will take years to reach their desired exposure, especially given their growing preference – particularly in Asia and the Middle East – for co- or direct investments rather than pooled funds. Respondents have 21% in co-investment private equity structures and are aiming to push that up to 27%.
Offering co-investment opportunities, mainly in private equity and property, has been one of the biggest growth areas for Invesco, says Ng. As of June 30, 12% ($83.6 billion) of its global assets under management were in alternatives.
Meanwhile, as past of the study, Invesco identifies four types of sovereigns: investment sovereigns, whose central purpose is seeking investment returns; development sovereigns, whose objective is typically to support social and infrastructure development in their own countries; liability sovereigns, which have both investment and liability objectives, such as state pensions; and liquidity sovereigns, such as central banks, which typically have stabilisation objectives as regards currencies and economies.
These varying objectives affect the types of investment they make. For example, investment sovereigns invest above all in international equity (that is, 51% of their portfolio), liquidity institutions have 66% in domestic bonds, while development entities have 67% in 'home-market direct strategic' assets.
Meanwhile, in terms of geographic allocations, the most popular countries/regions last year were Africa and China, with 33% and 30% of respondents, respectively, citing rises in exposure to those countries. The biggest falls in exposure were to continental Europe and the UK, presumably chiefly due to the eurozone debt crisis.
The survey also explored sovereign investors' target returns and found that these returns vary between the different categories of sovereign. Development funds have on average a target return of 11.6%, liability sovereigns 7.5%, investment institutions 7.2% and liquidity institutions 4.1%.
There are differences between regions when it came to shortfalls below target returns that institutions are willing to accept (see figure on the left). Interestingly, Asian sovereign funds seem less willing to accept below-target returns than those in other regions.
Two Middle East funds interviewed suggested they would accept a shortfall of 5% and 10%, respectively, one Western state investor cited 7%, while three Asian funds gave figures ranging between -1% and -3%.
*The survey is based on interviews with 37 state investors, including central banks, pension funds and sovereign wealth funds. There were 11 from the West, 10 from Asia, eight from the Middle East and nine from other emerging markets.