Sovereign wealth funds (SWFs) are moving away from fixed income and favouring equities and private markets, according to Invesco.

The company’s ninth Global Sovereign Asset Management Study revealed that SWF fixed-income allocations fell from 34% in March 2020 to 30% a year later, as concerns about stimulus-driven inflation returned.

Meanwhile, in a reversal of recent trends, equity allocations had risen from 26% to 28% at March 2021, in part reflecting the buying opportunities presented by the market volatility seen in the first quarter of 2020.

A further 30% of respondents intend to increase their allocation over the next 12 months.

The survey covers 141 chief investment officers, heads of asset classes and senior portfolio strategists at 82 SWFs and 59 central banks managing US$19trn as of March 2021.

Rod Ringrow, head of official institutions, Invesco, told IPE: “With very low interest rates and some fixed income on negative yields, SWFs have nowhere else to go. However, they have been able to mitigate the risk of high equity valuations by tilting towards active allocations and lengthening their time horizons.”

A key trend behind the flight to equity has been the need to safeguard liquidity, enabling a continuing response to COVID-19.

Policy measures to prop up economies and health services in the wake of the lockdowns led to drawdowns for over a third of SWFs during 2020.

“The good news is that these funds have done exactly what they were set up to do at times of stress”

Rod Ringrow, head of official institutions, Invesco

The corollary, according to the report, was the recognition by SWFs of the importance of liquidity more generally, both as a buffer against future “black swan” events and to provide the means to exploit market opportunities when they arise.

“The good news is that these funds have done exactly what they were set up to do at times of stress,” said Ringrow, although he pointed out that SWFs can fall into different categories, such as buffer/liquidity funds to meet exceptional budget swings, or funds to subsidise future pension deficits.

Climate risk, China, real estate

Meanwhile, environmental, social and governance (ESG) investing continues to increase in importance, with 64% of SWFs now adopting an ESG policy at the organisational level, compared with 46% in 2017.

“Last year, climate risk was seen as important but now it is a key theme underlying the whole sovereign investment process,” Ringrow told IPE. “Most said COVID-19 has not been a driver as such, but has accelerated what was already under way.”

He added that sustainable investing is also seen as providing opportunities to improve investment returns, with 57% of SWFs saying the market has not fully priced in the long-term implications of climate change, offering opportunities for alpha.

Meanwhile, the shift towards China continues: the rapid response to the pandemic enabled emerging Asia Pacific (APAC) economies to bounce back, and 28% of SWFs now consider China a more attractive investment prospect than before the pandemic, with a further 51% saying the pandemic has had no impact on their view.

The survey found that 75% of SWFs were attracted by the prospect of attractive local returns, and 57% by the country’s importance as a portfolio diversifier.

A further theme is the continuing appeal of real estate, with 72% of SWFs saying that now is an ideal time to invest, especially with depressed valuations.

Furthermore, 55% do not believe that office city centre investments represent potentially stranded assets; they consider that occupancy and usage of commercial real estate will return to pre-COVID-19 levels in two years, as spaces are re-purposed.

SWFs are now reporting that the most significant risk to their real estate portfolios is that of climate change. At present, only 23% of sovereigns fully incorporate climate risks at the due diligence stage, but 70% of respondents plan to increase their consideration of climate risks over the next five years.

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