A year of solid returns for global equities hasn't derailed a broad-based push by sovereign wealth funds into alternative strategies, according to Atlanta-based Invesco Ltd.'s second annual report on the industry.
Among major categories, Invesco's survey of 52 sovereign wealth funds with combined portfolio assets of $5.7 trillion showed global infrastructure joining real estate as a segment enjoying particularly high levels of demand.
For the latest survey, home-market private equity topped the list of alternative segments poised to pick up assets this year, with a net 64% of respondents reporting plans to boost allocations in 2014, followed by global real estate, with a net 60%, and home market real estate, with a net 54%.
But infrastructure enjoyed the steadiest pickup in interest, with a net 53% of respondents reporting plans to boost allocations in 2014, up from 47% in 2013 and 22% in 2012.
And while the continued weight of institutional money flowing into real estate has begun lowering yields there now, sovereign wealth funds expect infrastructure yields to remain attractive, said Nick Tolchard, London-based head of Invesco Middle East and co-chair of Invesco's sovereign investor group, in a June 13 telephone interview.
Still, even with yields softening, real estate continues to attract growing interest from sovereign wealth funds. In fact, Mr. Tolchard said London's popularity as a target for trophy real estate investment might account for the U.K. emerging as the survey's most attractive country overall for sovereign investors, with its score of 7.4 out of 10. That edged out Germany, which scored 7.2, and the U.S., with 6.6.
Invesco's report showed sovereign wealth funds looking to boost allocations to all alternatives categories in 2014 — including global private equity, hedge funds and global commodities — with some of that money coming from global bonds, home-market bonds and cash.
In part, Mr. Tolchard said, that shift reflects a rapid growth of sovereign wealth fund investment portfolios that effectively boosts their appetites for risk and leaves them less concerned about liquidity.
That trend even applies to central banks — or “liquidity sovereigns,” in the four-pillar taxonomy of sovereign wealth funds developed by Invesco. (The other three categories are “investment sovereigns,” such as Middle East-based future generation funds; “development sovereigns,” which have broader economic development objectives; and “liability sovereigns,” such as Western pension funds.)
In its latest report, Invesco noted signs of an evolution of liquidity sovereigns from an initial phase, where assets are predominantly invested in cash and bonds, to a second phase, where investment returns are a higher priority and the investment portfolio becomes a more “conventional” mix of fixed income and equities, with a sliver of alternatives.
Interviews with executives at liquidity sovereigns for the latest report pointed to that trend leading eventually to a third “alternatives investor” phase, as economic growth and trade surpluses swell their asset bases, said Mr. Tolchard. In that third phase, combined equity and alternative allocations could come to outweigh allocations to bonds and cash.
For now, he called that a hypothesis, and noted that changes in a country's economic outlook — such as a shift to deficits from trade surpluses — could prompt a reversal of that evolution at any time.
For the broader array of sovereign wealth funds, Mr. Tolchard said their shift into alternative strategies appears set to continue. Considering how short their actual allocations remain in comparison to the targets they've set in recent years, “I think there's quite a ways to go,” he said.
And while Invesco's survey didn't yield exact numbers on how much of those alternatives allocations involved direct investments by internal teams in areas such as real estate, private equity or infrastructure, Mr. Tolchard predicted the scale of allocations needed to meet those targets should leave sovereign wealth funds under pressure to expand their internal capabilities.
“If you just take the larger funds, with $100 billion-plus, and look at the percentage points they're looking to shift into alternatives, that's way beyond what the current private equity industry offers, so I think we're going to see much more direct stake holding,” Mr. Tolchard said.
In other results, the latest survey found sovereign wealth funds moving away from home-market bias — in part, said Mr. Tolchard, because the growth of many funds is outpacing their ability to put capital to work in their home markets. n
