Falling oil prices and the collapse of bond yields led sovereign investors to raise their alternatives investments by 50% in 2015, and means they are likely to miss their annual return targets for this year.
Invesco's fourth annual Sovereign Asset Management survey was based upon interviews with executives at sovereign wealth funds, state pension funds and central banks that between them hold some $7 trillion in assets.
The survey reveals that while average annual portfolio returns stood at 6.6% on a five-year view, this fell to 4.1% on a one-year view in 2015. The one-year return figure is a big concern, given that average sovereign investor targets for 2015 stood at 5.9%, or 1.8 percentage points higher.
Sovereign funds look set to miss their return targets this calendar year as well, “because target returns are rarely reviewed”, the study noted.
According to the survey, sovereigns are targeting returns of between 5.3% and 6.7% for 2016, yet the forecast returns for the year are likely to fall into a lower range of 2.4% and 5.9%.
The fall in bond yields in particular has spurred the increase in alternative allocations. The study noted that last year, sovereign investor portfolios on average invested 13.8% of their portfolio assets into real estate, infrastructure or private equity.
That is 50% higher than the 9.2% recorded in 2015, and it marks a much quicker growth in alternative asset allocation. The total in 2013 allocated to alternatives stood at 9.4%.
Real estate was the largest beneficiary, with the total portfolio allocation rising from 4.1% in 2014 to 6.5% last year. However, private equity also rose 50% from 3% to 4.5%. Infrastructure’s growth was slightly lower, increasing from 2.1% of total sovereign assets to 2.8%.
Asset allocation issues
The alternative investment figures might have been higher but for the difficulty of finding good investments.
All-told, 62% of study interviewees said their organisation was underweight in the infrastructure investments they have made relative to their target asset allocation, as of the first quarter of this year. The figure stood at 52% for private equity.
According to the study, “sovereigns have consistently cited ‘sourcing deals’ as the primary challenge for private equity and infrastructure investment”. All told, 59% of sovereigns said deal sourcing was a problem for private equity and 55% said the same for infrastructure.
And Invesco said its research suggested that sovereigns took over two years from allocating assets to private equity to seeing them deployed, while it could take three-and-a-half years or more when it came to infrastructure.
Real estate marked the major exception to this perception. Just 38% of sovereigns said they were underweight in this category. “Sovereigns explained that real estate achieves the diversification benefits and absolute returns they desire with fewer execution challenges than private equity or infrastructure,” the report noted.
Most sovereigns were keen to diversify the real estate investments they made, too. Just over two-thirds (67%) of sovereigns in the survey said they were going to add global real estate into their portfolios, although almost as much (64%) also intend to increase home property investments too. Evidently, it’s a good time to be a property owner holding good assets.
Despite the increased emphasis on alternatives, the study noted that sovereigns appear quite philosophical about this fall in returns.
The investors have on average increased their investment time horizons from 6.4 years in the last survey to 7.6 years. The rise in this period could be a tacit admission among sovereign investors that achieving their investment return objectives could take longer than initially thought.
They remain fairly confident investors, too. Invesco’s Sovereign Confidence Index, which is based on historic performance and aggregate capability (the latter being itself based on investment expertise, people and talent, governance and operations and use of third parties), revealed sovereign investor confidence had risen from 7.6 in 2015 to 7.8 out of a maximum 10.
The sovereigns' internally-managed investing strategies are also seeing some evolution. On average, 48% of the state-linked organisations felt they would increase their traditional actively-managed funds, while just 8% said they would raise passive strategies and 28% felt they would reduce such investments. Additionally, 29% said they would put more into factor-based strategies, which focus on a particular factor in an investment.
Geographically, developed markets remain popular destinations of capital, in large part because of returns. The sovereigns said they enjoyed stock market returns of 7.4% from developed nations between 2013 and 2016 on an annualised basis. Overall emerging market returns were far lower, although India saw a 3.8% rise and China’s stock return growth was 1.2%, despite a very volatile year. Brazil and Russia had big drops.
Another slight beneficiary were frontier markets, which have generally performed better than their larger emerging market brethren. Emerging Asian markets saw average sovereign asset allocations rise from 1.6% in 2014 to 2.3% last year, while investments into Africa rose to 0.9%.
The Invesco study was based upon interviews with chief investment officers or strategy unit executives at 77 leading global sovereign wealth funds, government pension funds and central banks.
This story has been edited to clarify some of the time periods around the quoted statistics.