Sovereign investors are seeking to raise their exposure to emerging markets, alternatives and public equities in the coming years in preparation for an expected US interest rate hike, indicates a survey of official institutions by State Street.

The study, released yesterday, defines official institutions are defined as central banks, sovereign wealth funds and public pension reserve funds.

The need to build more diversified and complex portfolios was cited by 44% of respondents as their main priority over the next two years, followed by an adjustment to higher interest rates (38%) and worries over the volatility of emerging market investments (37%).

An expected interest rate rise by the US Federal Reserve will reduce the value of long-dated fixed income assets, such as government bonds. Many central banks “have expanded their investments away from G3 government bonds in the search for higher yield”, notes the State Street report.

“Respondents show a clear preference for emerging markets when asked where they intended to increase their exposure over the next two years. They also expect public equity and alternatives to become more important portfolio constituents."

“The [theme of] diversification into emerging markets is very much in play," says Henry Quek, State Street's head of official institutions for Asia Pacific. However, the potential rewards will have to be balanced with investment risk, he adds.

A drive to produce higher returns amid volatile markets and a reversal of several years of low interest rates have brought the investment objectives of official institutions more in line with those of private institutions.

“If you invest in similar asset classes or markets, the risks are quite similar,” Quek tells AsianInvestor. Not all official institutions have traditionally had the capabilities to monitor and handle such risks, he adds, and thus need to step up their resources in this area.

Even some central banks have been examining public equity as an investable asset class, notes Quek. But SWFs and public pensions have been comparatively more active in entering the alternatives space, investing into hedge funds, private equity, commercial real estate and infrastructure.

The survey, conducted by FT Remark, involved 62 global official institutions that collectively represent $5.3 trillion in assets.