Sovereign investors with trillions of dollars in assets are accelerating allocations to international real estate and private equity at the expense of long-only investments in core equities and bonds, according to a global survey commissioned by Atlanta-based Invesco Ltd.
Even with those investors' continued efforts to build up internal investment capabilities, that shift looks poised to offer significant opportunities for alternatives managers, predicted Nick Tolchard, London-based co-chair of Invesco's global sovereign group and head of Invesco, Middle East.
The survey, conducted in August by consulting firm NMG Group, involved interviews with 37 sovereign investors around the globe — including sovereign wealth funds, state pension funds and central banks — with combined assets of $4.7 trillion, Mr. Tolchard said in an interview.
Investors weren't identified, but Invesco's report on the survey results noted that 11 were based in “the West” — defined as Europe, North America, Australia and New Zealand — with 10 in Asia, nine in “other” emerging markets in Latin America and Africa and eight from the Middle East.
Invesco's first global sovereign survey divided the universe into four categories:
- “Investment” sovereigns, such as Middle East future generation funds, with heavy allocations to international equities, which accounted for 43% of assets of the 37 sovereign investors surveyed;
- “Investment & liability” sovereigns, such as Western pension funds, with income and liability objectives, and broad-based asset allocations, at 12% of the group's assets;
- “Investment & liquidity” sovereigns, such as central banks, with stabilization objectives and a fixed-income bias, accounting for 33%; and
- “Development” sovereigns, focused on strategic investments in private companies in pursuit of broader economic development objectives, at 12% of surveyed assets.
For the 28 sovereigns in the first three “investment” categories, the past year saw a significant pickup across all regions in allocations to alternatives — with investors in Asia, the Middle East, Latin America and Africa moving to narrow the gap with investors in the West, Mr. Tolchard said.
Investments by Western-based sovereign wealth funds in alternative strategies — including real estate, private equity, hedge funds, infrastructure and commodities — accounted on average for 21% of their total portfolios for the year ended Dec. 31, 2012.
Average alternatives allocations came to 12% for Asia-based sovereign investors, 9% for Middle East-based sovereigns and 2% for sovereigns in Latin America and Africa.
The survey results showed international real estate and international private equity leading the way, with a net 69% of respondents increasing allocations to real estate while a net 61% increased allocations to private equity.
Other categories enjoyed strong, if less spectacular, positive responses of 40% for hedge funds, 33% for infrastructure and 11% for commodities.
Those gains apparently came at the expense of allocations to stocks, bonds and cash. Sovereign investors reporting reductions in allocations to cash, international equities and their respective domestic equities exceeded those reporting increased allocations by 8% to 9% for each category. In the low-yield environment of 2012, fixed income was even more unpopular, with a net 38% reporting lower allocations to international bonds and 18% reporting declines in domestic bond investments.
A number of factors are prompting sovereign investors to bring more investment capabilities in-house when making allocations to real estate or private equity — a trend that Asia-based sovereigns have been at the forefront, Mr. Tolchard said.
As sovereign investors boost allocations, the relatively high fees charged by alternatives managers will inevitably prove a hurdle for chief investment officers who “often have a fee budget right across the whole fund,” he said.
Moreover, with the potential scale of rising sovereign investor demand in areas such as private equity poised to challenge the ability of external managers to provide sufficient supply, there'll continue to be pressure on those investors to get more involved in co-investments and direct investments, he said.
The challenge, of course, will be to do that well in practice — a goal that will require bringing skills in-house that are expensive and might ultimately lead a number of big investors to conclude there's ample room to turn to specialist external managers as well, Mr. Tolchard said.
The sovereign sector remains a fragmented one, “with no obvious leader” that all sovereigns view as a template, Mr. Tolchard said. In response to a question of whether there's another sovereign investor that could serve as a benchmark, only two — both based in Asia — were cited as many as three times, while another seven garnered two citations and 12 were cited once, said Mr. Tolchard, who declined to identify them.
Invesco's survey found slightly more than 50% of sovereign investors surveyed adopting some form of benchmarking against sovereign peers.
If the rise in alternatives allocation is potentially a “huge” story, Invesco's report noted that the biggest growth story for the sector could be the rise in the number of development sovereigns, set up to promote economic development in the host country through strategic investments in private companies.
Without naming names, the report noted that the success of development sovereigns in Asia has been widely noted, and “many more countries plan to set up similar funds using surplus capital for private partnerships.”
In Asia, Singapore's S$215 billion (US$172 billion) Temasek Holdings and Malaysia's Khazanah Nasional Berhad are leading examples of development sovereigns.