• Sovereign wealth funds experience their first year of negative returns since the survey started in 2013 after a sharp correction in listed asset prices
• Middle Eastern SWFs and central banks drive green investment surge amidst widespread adoption of ESG policies
• Middle Eastern SWFs are looking to increase their allocation towards fixed income assets over the next 12 months
• Middle East investors capitalize on India's rising star in emerging market debt investments
• Middle Eastern SWFs prioritize private equity, infrastructure investments; show specific interest in industrial real estate, renewable energy
• A new generation of sovereign wealth funds has emerged, with the energy transition front-of-mind
Dubai, UAE, 10 July 2023 – Sovereign investors are adapting their portfolios to the new macroeconomic environment, characterised by sticky inflation and rising geopolitical and climate risk, according to the eleventh annual Invesco Global Sovereign Asset Management Study (link here).
The swift rise in interest rates and sharp correction in listed asset prices led most sovereign wealth funds to report negative returns for 2022, and the vast majority (86%) anticipate inflation to be higher in the coming decade than in the last. This includes 88% of sovereign investors based in the Middle East. In response, many are fundamentally rethinking the way they invest in fixed income and private assets, alongside a renewed interest in emerging markets.
Invesco’s study, which has become the leading bellwether for sovereign investor activity, is based on the views of 142 chief investment officers, heads of asset classes and senior portfolio strategists at 85 sovereign wealth funds and 57 central banks, who together manage $21 trillion in assets.
Middle Eastern SWFs and Central Banks drive green investment surge amidst widespread adoption of ESG policies
From 2017 to 2023, the adoption of Environmental, Social, and Governance (ESG) policies by SWFs witnessed a substantial rise, increasing from 46% to 79%. For central banks, this growth was even more significant, jumping from a mere 11% to a robust 59%. In the Middle East, 90% of SWFs and 22% of central banks have now embraced ESG policies.
“Geopolitical fluctuations and the urgent issue of climate change have underscored the necessity for secure and sustainable energy supply chains, thus amplifying the importance of renewables in investment strategies,” commented Josette Rizk, Head of Middle East and Africa at Invesco.
Two-thirds (67%) of SWFs and central banks affirm that sovereign investors can substantially contribute to financing the energy transition. This belief is also echoed by 56% of their Middle Eastern counterparts.
To align with their objectives, SWFs and central banks are increasingly focusing on direct green infrastructure investments and green bond allocations. Nearly 69% of central banks and 44% of SWFs globally are putting their resources into green bonds. In the Middle East, this trend involves 57% of central banks and 25% of SWFs.
However, greenwashing poses a significant challenge to ESG investing, with 89% of sovereign investors (including both SWFs and central banks) identifying it as a concern.
“This sentiment is even more pronounced in the Middle East, where 94% of investors see greenwashing as a hindrance. To combat this issue, SWFs are taking a proactive approach: they are welcoming development risks and issuing green bonds themselves to ensure authentic alignment with ESG principles,” further added Rizk.
Middle East sovereigns are looking to increase their allocation towards fixed income assets over the next 12 months
Fixed income is the asset class sovereigns are most likely to increase in their strategic asset allocation over the next 12 months, with a 28% net allocation intention surpassing infrastructure (25%), private equity (21%), listed equities (15%), and real estate (9%).1
In response to evolving macroeconomic conditions, SWFs are strategically reassessing their portfolios to better align with the current financial landscape. A notable 39% of SWFs globally, and 14% in the Middle East specifically, are proactively planning to augment their allocations towards fixed income in the forthcoming 12 months.
However, fixed income’s failure to shelter portfolios from the 2022 asset price correction has changed the way sovereign investors perceive the asset class.
Rather than a ‘set and forget’ position for diversification purposes, they now favour a more active and tactical approach, creating value by actively rebalancing across different fixed income segments and utilising a wide range of strategies, similar to listed equities. Alternative fixed income segments can therefore play a greater role, with private credit, high yield and infrastructure debt seen as the most attractive options.
Historically categorised as private equity by many sovereign investors, private credit has now matured into a distinct asset class, often supported by dedicated investment teams. Investors have been attracted by the funds’ favourable risk-return profiles and high liquidity levels, as well as the transparency of the holdings and good levels of diversification within funds, as most are large-scale and invest in a wide range of issuers.
“Although average returns in 2022 were negative, there was significant variation within these results”, said Rod Ringrow, Head of Official Institutions at Invesco. “The better performers were those that recognised the risks posed by inflated asset prices and were willing to make substantial portfolio changes. The key lesson from 2022 was that sovereigns need to be prepared to demonstrate greater flexibility and responsiveness to market conditions.”
Middle East SWFs Capitalize on India's Rising Star in Emerging Market Debt Investments
The higher interest rate environment has prompted a renewed appetite for emerging markets.
In recent years, as developed markets’ asset prices soared amid negative real rates, many funds found little need to pursue the extra research and risk associated with large emerging market allocations. However, the normalisation of higher rates looks set to change this, and many sovereign investors commented on increased resilience, institutional strength, and stability in key emerging markets. 71% of sovereigns expect emerging markets to either match or better the performance of developed markets over the next three years.
Almost a third (29%) of investors intend to increase their allocations to Emerging APAC in 2023, making it the joint most popular region alongside North America, and well ahead of Developed APAC (15%), Developed Europe (14%), and the Middle East (8%). At 22%, Latin America was the second most popular region overall.
India continues to be seen as a leading market: 76% of investors see it as an attractive opportunity for emerging market debt in 2023, well ahead of its closest competitor, South Korea, at 56%. Mexico (51%), Brazil (49%), Indonesia (44%) and South Africa (41%) have all seen significant year-on-year increases in their perceived attractiveness.2
“The magnetism of the Indian market is even more pronounced among Middle Eastern SWFs, with a unanimous 100% recognizing its appeal. These figures underscore the growing confidence in India's economic prospects and affirm its standing as a prime destination for debt investment among emerging markets,” added Josette Rizk, Head of Middle East and Africa at Invesco
Middle Eastern SWFs Prioritize Private Equity, Infrastructure Investments; Show Specific Interest in Industrial Real Estate, Renewable Energy
Globally, sovereign investors remain interested in private assets, with infrastructure seen as the overall most attractive asset class over the next five years, ahead of fixed income, private equity, and listed equity.3
Within infrastructure, there is considerable interest in renewable energy generation: 81% of sovereigns see it as an attractive area, followed in second by energy transmission and supply (65%). This was in part caused by the war in Europe and energy crisis that followed, which triggered a global surge in renewable infrastructure demand.
The valuation correction in 2022 revealed performance disparities across private assets, which has brought about a more selective approach. Investors are now more cautious about highly leveraged deals, with almost half of sovereign wealth funds reporting being dissuaded from recent real estate (48%), private equity (49%, 86% of those in the Middle East) and infrastructure (43%) deals due to unappealing debt structures.
For Middle Eastern SWFs, the preference is towards private equity and infrastructure, with real estate ranking lower, due to challenges in the office and retail sectors. When dissecting the real estate sector, SWFs in the Middle East demonstrate a clear preference for specific segments: industrial spaces, hotels/resorts, and data centres, each chosen by 83% of respondents from the region. In the infrastructure realm, a similar pattern emerges. Middle Eastern SWFs are primarily drawn towards renewable energy generation and energy transmission/supply, with both segments selected by 71% of respondents.
Real estate is currently perceived to be the least attractive private asset segment, mainly due to challenges in the office and retail sectors. Many sovereign wealth funds heavily exposed to these sectors have sought diversification in areas such as industrials, healthcare and data centres, which have risen in popularity due to the growth of digital technologies and remote work.
A new generation of sovereign wealth funds
The last decade has seen a surge in new sovereign wealth funds: since 2012, 27 new funds have been created, with Africa (11) and APAC (7) accounting for the majority.
Most are development funds, set up to drive economic growth and diversification. Many funds are also focused on the energy transition and, for some, this has become the leading development objective. In total, 65% of funds with development objectives aim to facilitate the energy transition, making it the most commonly held objective, ahead of employment (59%), GDP growth (57%) and social objectives, such as health and education (57%).
The challenge for new funds is building credibility alongside their more established peers. Demonstrating strong levels of governance will be key, alongside fact-finding partnerships with other funds and experienced asset managers to help build on their skills and knowledge.