New funding for global sovereigns promotes strategic asset allocation to EMs and alts

New funding for global sovereigns promotes strategic asset allocation to EMs and alts

Emerging markets – including Latin America, Africa and China – continue to be the winners of new global sovereign flow, despite a fundamental preference, relative to the total portfolio, for developed markets, a study by Invesco has found. The second annual Invesco Global Sovereign Asset Management Study also shows that sovereign investors continue to favour alternative investments with allocations increasing across all major alternative asset classes, including real estate and private equity, on a net respondent view basis.

Analysis of data within the study highlights that these geographical and asset class shifts can be attributed to the influence of strategic asset allocation over tactical asset allocation in influencing investment strategy and driving investment decisions of global sovereign investors. One influencing factor for this is the expectation of new funding. Almost half (46 per cent) of sovereign investors expect to see an increase in new funding in 2014 beyond the levels seen in 2013, with clear implications on global capital flow.

Alternative investments remain the clear asset class winners in terms of new asset allocation within sovereign investor portfolios, mirroring the trend reported in the 2013 study. On a net respondent view basis, 51 per cent of sovereign investors increased new exposure to real estate in 2013 and 29 per cent to private equity, relative to the total portfolio. In fact, sovereign investors expect to increase new allocations across all major alternative asset classes in 2014 based on net responses – real estate, private equity, infrastructure, hedge funds and commodities - relative to their 2013 asset placements.

Analysis of the findings suggests this continued appetite for alternatives is a structural trend driven by the influence of allocating assets strategically, rather than a short term shift due to tactical allocations to boost short term returns. Firstly, many sovereign investors remain underweight in alternatives relative to their strategic asset allocation targets. These sovereign investors had increased their target allocations for alternatives in the last five years and had yet to reach these targets. Secondly, many sovereign investors (46 per cent) expect funding levels to increase in 2014 relative to 2013.

A large increase in assets encourages more strategic allocation placements since allocating significant assets tactically could lead to breaching internal guidelines. The third reason that increasing appetite for alternatives should be attributed to strategic rather than tactical asset allocation is the fact that alternatives underperformed during this period, with sovereign investors typically citing an average return of seven per cent for alternatives in 2013, compared to a target of eight per cent - which indicates that increasing their overweight in these asset classes is a long-term, strategic decision, rather than a tactical move.

Nick Tolchard, co-chair of Invesco’s global sovereign group and head of Invesco Middle East, says: “Given alternatives underperformed during the period in which their allocations increased, it is clear that a strategic asset allocation strategy is driving sovereign investors to alternatives, rather than tactical allocation. The expected net increase in new funding this year is another key factor that explains this preference for alternatives, driven by increasing country surpluses and strong support from governments for their sovereign funds. However, the main reason is that many sovereign investors, especially those with assets in excess of USD50 billion, are seeing it take time to deploy assets in alternatives and emerging markets and are yet to reach the asset allocation targets set five years ago.”

“We’re regionalizing our infrastructure and building capabilities to support what is becoming, quite frankly, quite a regional yet global FX market,” Sammann said. As the Dodd-Frank mandates are unfolding, and as the Basel III and BCBS/Iosco capital principles are rolled out globally, “there’s some significant impacts to the cost structure around foreign exchange as it relates to product choice– whether you trade bi-laterally, or whether you clear a swap that’s an OTC instrument, or whether you trade directly on exchange,” Sammann said. In addition to futures, CME is offering post-trade services such as clearing and trade reporting. 

“We’re providing clearing services for customers that want to stay in the OTC world, and non-transactional services like trade reporting services,” Sammann said. “We’re in the middle of an unprecedented amount of regulatory change, and it’s moving at different speeds between Europe and the U.S and Asia.”

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