Invesco Global Sovereign Asset Management Study 2016
This study is not intended for members of the public or retail investors. Full audience information is available inside the front cover.
2 Important info Welcome Summary of key themes This document is intended only for Over the past couple of years sovereigns Qualified Investors in Switzerland have been operating in an environment 1 and for Professional Clients and Financial of increased volatility, whether it be in A positive outlook in a challenging Advisers in other Continental European financial markets, commodity prices or environment countries, Dubai, Jersey, Guernsey, currencies. Low interest rates have added A sustained low oil price and falling Isle of Man, Ireland and the UK, for further complexity, however sovereign government bond yields have affected Institutional Investors in the United States investors remain broadly confident in returns but sovereigns remain confident and Australia, for Institutional Investors their position as long-term investors. and continue to take a long-term view. and/or Accredited Investors in Singapore, Our 2016 Sovereign Asset Management for Professional Investors only in Hong Study seeks to build on the findings from 2 Kong, for Qualified Institutional Investors, previous years’ studies by analysing long- Growth in sovereign real estate pension funds and distributing companies term trends as well as uncovering new investments in Japan; for Persons who are not insights from face-to-face interviews with Fewer execution challenges have made members of the public (as defined in chief investment officers or strategy unit real estate a more attractive asset class the Securities Act) in New Zealand, executives at 77 leading global sovereign to sovereign investors than infrastructure for Accredited Investors as defined under wealth funds, government pensions funds and private equity. National Instrument 45-106 in Canada, and central banks, covering more than for certain specific Qualified Institutions/ US$ 7 trillion of assets (as at March 2016). 3 Sophisticated Investors only in Taiwan The first theme in this year’s report Sovereign capital flow from BRIC and for one-on-one use with Institutional looks at how the challenging investment to frontier markets and the US Investors in Bermuda, Chile, Panama environment has impacted both current Weak economic performance of major and Peru. and future expected returns. Despite the emerging markets has driven allocations clear challenges sovereign confidence has to higher growth frontier markets and to remained stable with many sovereigns the US based on positive economics and continuing to receive new funding. And public policy changes. with time horizons increasing we see sovereigns as sophisticated, strategic, 4 long-term investors. Growing interest from sovereigns in In previous years we’ve noted strong factor-based investing allocations to alternatives. Today’s low Sovereigns understand macro factors return environment has seen this trend but would like more information on style continue however we note a change in factors and their potential applications the preferred asset class with real estate within their portfolios. becoming the primary driver of increasing alternative allocations. We explore the 5 drivers for these changes and highlight Central banks to become important how sovereigns are accessing real estate. sovereign investors We highlight how weak economic The presence of investment tranches performance of major emerging markets with significant corporate bond and has driven allocations to higher growth equity allocations suggests that frontier markets in our third theme. central banks are becoming long-term Despite this the US is now the most the sovereign investors. attractive market to sovereigns. We explore the role of public policy in influencing sovereign investment and highlight the opportunity for governments globally. We look in detail at sovereigns’ growing interest in factor-based investing. With levels of perceptions, awareness and adoption varying, we explore how asset managers can help sovereigns overcome perceived barriers to entry. We conclude the report by focusing on central banks. This year we’ve increased our central bank sample and classified them as a separate segment of sovereign investor. We explore the relative importance of different investment objectives and focus on the development of investment tranches. We hope the unique, evidence-based findings in this year’s report provide a valuable insight into a fascinating and important group of investors.
Alexander Millar Head of EMEA Sovereigns & Middle East and Africa Institutional Sales [email protected] +44 1491 416180
igsams.invesco.com Visit the study webpage to Cover photography view more content on this Tokyo cityscape Marunouchi year’s themes.
1 A positive outlook in a challenging environment A sustained low oil price and falling government bond yields have affected returns but sovereigns remain confident and continue to take a long-term view.
12 3 The low return environment means Investment and liquidity sovereigns face Many investment some sovereigns have missed their the largest return gaps target returns The size of the return gap, defined as sovereigns are now We completed our fourth annual cycle the difference between target and actual comfortable operating of executive interviews with leading returns, varied for different sovereign sovereign investors covering more investor segments. These differences in an environment with than US$ 7 trillion of assets in March are displayed in figure 2 showing the limited new funding. 2016. Over the course of the last four current 1-year return gap for 2015 years sovereign investors have faced and the expected return gap in 2016. an increasingly challenging investment Investment and liquidity sovereigns have environment driven by a sustained fall the largest return gaps (3.9% and 2.3% in the oil price and an unprecedented respectively) compared to liability and low return environment. Low returns development sovereigns (1.0% and 1.7%) continued in 2015 as developed market who noted reporting benefits. Most liability central banks continued extensive sovereigns were based outside of the US quantitative easing programmes. Between and reported in local currency. the end of Q1 2014 and Q1 2016 the These portfolios typically had oil price fell by more than US$ 60 per significant exposure to US fixed income barrel1 and yields on 10-year German and (notably Treasury bonds) and so these Japanese government bonds fell from investments and the broader portfolio 1.5%2 and 0.6%3 to 0.1% and -0.1% benefited from the strengthening of respectively. Furthermore, at the time the US$ against their local currency. of our field work, sovereigns remained Indeed 28% of sovereigns had left their cautious on the medium term outlook for portfolio overweight US$ (figure 3) oil given uncertainty with respect to OPEC in order to benefit from the currency discussions and on the outlook for the appreciation relative to their reporting risk free rate based on recent guidance Fig 1. Average current, target and expected currency. In contrast fewer investment Fig 3. Overweight currency positions from central banks. future annual returns for sovereign investors and liquidity sovereigns benefited from (percentage of sovereign investor citations for each category), Q1 2016 This challenging macro environment currency movements because more of has impacted sovereign investment 5-year 3-year 2015 2016 these sovereigns report in US$ or hedge Actual Actual Actual 1-year target 1-year expected 1-year target Local US$ EUR JPY/CNY GBP performance. Across the sovereign 45 45 49 52 43 54 their currency exposures. Development investors we interviewed, average actual sovereigns benefited from significant annual portfolio returns fell from 6.6% on 6.6 private equity holdings which were 6.4 a 5-year view to 4.1% on a 1-year view not marked to market and so had not current 5.9 to December 2015. Actual 2015 annual 1-year return Expected 5.7 fallen to the same extent as public returns of 4.1% represent a return gap gap future 1-year equity investments. gap return of 1.8% from average sovereign investor targets of 5.9% and because target 4.4 However sovereign investor assets returns are rarely reviewed, sovereigns 4.1 continue to grow on a net flow basis expect to miss their target returns again Despite high profile withdrawals from next year. Figure 1 sets out the decline in major investment sovereigns, our study average portfolio returns and the size of reports that on average more money current and expected future return gaps. is entering a typical sovereign investor portfolio. Across all our interviews the 28 average new funding is 7% of assets 20 while only 3% of assets are withdrawn 11 11 or cancelled. Oil and commodity 8 dependent investment sovereigns face the most challenges but these are offset Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. by continued new funding, as well as Data is not weighted by AUM. growth in new funding from liability and Sample is based on sovereign investors and excludes central banks. development sovereigns as shown in Fig 2. Average actual, current and future target 2015 • Actual returns figure 4. Defined benefit state pension Fig 4. Sovereigns views on funding and • New funding 1-year returns by sovereign investor profile • Target returns funds in emerging markets are cancellations as a % of AUM, full year 2015 • Cancelled investments 2016 Forecast returns the most significant contributors to • Sovereign sample 56 INV 10 LIA 26 LIQ 6 DEV 14 • 1-year return/future gap • Target returns growth although current portfolio sizes remain relatively small. We also note 9 Investment sovereigns Liability sovereigns Liquidity sovereigns Development sovereigns that a couple of development sovereigns 9 10 8 12 24 23 19 23 5 6 5 6 11 13 11 13 received large one-off government 7 7 contributions during 2015. Many investment sovereigns are now 5 comfortable operating in an environment with limited new funding. Some sovereigns 4 have ceded assets to governments 6.8 6.7 without cancelling long-term investments. 6.4 5.9 Furthermore a number of sovereigns 5.6 5.8 5.4 5.3 expecting withdrawals have not been called upon over the last 12 months. 4.3 -2 4.1 These institutions are now feeling more 3.7 -3 -3 confident in their funding outlook and 1 -4 Monthly spot price of West Texas Intermediate Crude oil. 2.5 2.5 2.4 are increasing the importance of their Source: US Energy Information Administration – Short investment objectives relative to their -5 Term Energy Outlook, 12th April 2016. 2 short-term liquidity needs. Monthly secondary market rate of 10-year German 0.2 government bond. Source: European Central Bank 0 Statistical Data Warehouse 3 Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. Monthly secondary market rate of 10-year Note: all responses are from the 2016 study. Sample is based on sovereign investors and excludes central banks. INV = Investment sovereigns, LIA = Liability sovereigns, LIQ = Liquidity sovereigns, DEV = Development Japanese government bond. Source: Ministry of Finance Japan data Sample size show in grey. sovereigns. Data is not weighted by AUM.
4 5 And sovereign investors continue to take Despite a challenging environment Sovereigns are shifting their focus from Consistent sovereign 91% a long-term view overall sovereign confidence has been strategic issues to investment trends We indicated last year that sovereign stable since 2013 and execution confidence despite short- 91% of sovereigns investors were better prepared in terms Consistent sovereign confidence despite These capability improvements indicate term underperformance expect their time of investment capability and governance short term underperformance relative to that liability and development sovereigns horizons to either for the challenging macroeconomic target returns is a key theme this year. In are successfully addressing some of relative to target returns stay the same or environment following the global financial 2014 we created the Invesco sovereign the investment capability gaps we have is a key theme this year. increase in 2016. crisis. Our discussions this year reaffirm confidence index based on perceptions identified in our previous reports. The this finding. Despite the existing return of historic investment performance and results also explain why our 2016 themes gap and a less positive funding outlook, current capability. in this report move from strategic portfolio sovereigns are increasing their average This year we have updated the index to level issues to execution challenges or 7. 6 y r s time horizons for investing. Figure 5 shows be weighted equally between performance emerging investment trends. We will that, over the past four years, average and capability, and aggregate capability discuss some of these challenges and Average time time horizons have increased from 6.4 scores were developed from 13 underlying emerging trends and the implications for horizon across our years to 7.6 years across our sovereign capabilities across investment strategy, the industry throughout the rest of sovereign sample sample with increases amongst all asset management, governance and the report. was 7.6 years. sovereign investor profiles. Increased time operational factors (figure 6). The Invesco horizons are linked to continued interest sovereign confidence index in figure 7 in diversification benefits and illiquidity shows that overall sovereign confidence premiums via alternatives which we has increased from 7.4 to 7.8 between will explore in more detail in the 2014 and 2016. next theme. Meanwhile figure 8 shows that the negative impact of performance within investment and liquidity sovereigns is more than offset by small increases in perceived performance and capability among Fig 5. Average time horizons by sovereign • 2013 liability and development sovereigns. Fig 7. Invesco Sovereign Confidence Index • 2014 investor profile, Q1 2013 and Q1 2016 • 2016 Furthermore, the underlying analysis of (historic performance plus aggregate capability • 2015 individual capabilities shows that liquidity equals overall confidence), 2014 – 2016 2016 Sovereign Investment Liability Liquidity Development • sample sovereigns sovereigns sovereigns sovereigns and development sovereigns have remained confident across all investment Historic performance Aggregate capability Overall confidence 34 59 9 12 10 26 6 6 9 15 capabilities (including asset allocation and 43 44 51 37 35 50 43 44 51 investment risk management), despite a challenging investment environment.
7.8 7.9 8.0 7.8 9.3 7.4 7.6 7.4 7.6 7.1
7.6 7.8 7.2 6.8 6.9 6.9 6.4
3.8
2.5
Performance rated on a score from 1 to 10 where 10 = highest performance. Capability rated on a score from 1 to 10 where 10 = highest capability. Average across all capabilities where the importance and performance 2013 Data calculated as the weighted average of the horizon band. 2016 Data is based on absolute time horizon. scores are greater than or equal to 6 Invesco sovereign confidence index methodology is explained in figure 6. Sample size shown in grey. Sample is based on sovereign investors and excludes central banks. Sample size shown in grey.
Fig 6. Invesco sovereign confidence index methodology Fig 8. Invesco sovereign confidence • 2014 index by sovereign investor profiles, 2014 – 2016 • 2015 Aggregate capability2 Aggregate capability components • 2016
Investment Historic Aggregate Overall Historic Aggregate Overall 4 performance capabitlity confidence performance capabitlity confidence 25% expertise 50%
People and talent5 8.4 25% 8.1 8.1 Invesco Sovereign 7.7 7.8 7.8 7.9 7.9 7.7 7.7 7.8 Confidence Index1 7.4 7.5 7.5 7.4 Historic performance3 7.1 7.2 Governance and 6.9 6 25% operations
50% Use of third parties7 25%
1Invesco Sovereign Confidence Index is based on the average of sovereign capability and performance scores.2 Capability scores are based on the average score of each of the capability components. 3Performance scores are based on each sovereign’s 2015 performance score of their primary capability (e.g. Investment return for Investment Investment & liquidity sovereigns Liability & development sovereigns sovereigns, Liability matching for Liability sovereigns etc.). 4Investment expertise scores are based on each sovereign’s 2015 capability performance score for a range of benchmarks, asset allocation, investment risk management, currency management, internal asset management, internal private equity.5People and talent scores Performance rated on a score from 1 to 10 where 10 = highest performance. Capability rated on a score from are based on each sovereign’s 2015 capability performance score for people (expertise / knowledge / talent). 6Governance and operations scores are based on each 1 to 10 where 10 = highest capability. Average across all capabilities where the importance and performance sovereign’s 2015 capability performance score for investment reporting, governance, transparency, operational risk management. 7Governance and operations scores scores are greater than or equal to 6. Invesco sovereign confidence index methodology is explained in figure 6. are based on each sovereign’s 2015 capability performance score for use of asset consultants / advisers, fund manager selection. Sample is based on sovereign investors and excludes central banks.
6 7 Growth in sovereign real estate investments Fewer execution challenges have made real estate a more attractive asset class to sovereign investors than infrastructure and private equity.
28 9 The ongoing shift from international Major execution challenges in private Sovereigns have consistently cited Real estate has become the primary fixed income to alternatives equity and infrastructure ‘sourcing deals’ as the primary challenge driver of increasing alternative Since 2013 we have monitored major Over the past two years, most sovereign 2.8% for private equity and infrastructure allocations changes in investment strategy, investors have focused on the importance Over the last three investment. The 2016 Preqin Global Our analysis of sovereign allocations benchmarks and strategic asset allocation. of increasing infrastructure and private years infrastructure Private Equity & Venture Capital Report shows that real estate has contributed to Following the global financial crisis, equity investments within their strategy allocations have estimates that US$ 755 billion of assets increases in alternatives. Figure 10 shows sovereigns noted high levels of correlation for growing alternative assets. Large increased each year (or 24% of all private equity assets) that portfolio allocations have risen from 4 between asset classes. This observation ticket sizes, long time horizons, the but total allocations were yet to be deployed by the industry . 3.0% to 6.5% (a 29% compound annual increased the shift towards alternatives ability to move quickly and accommodate remain low at 2.8% For infrastructure, supply is varied and growth rate) over a three-year period. This which seek to diversify returns and give flexible deal structures were some of the on average of total dependent on multiple third parties means that real estate allocations have access to liquidity premiums. This shift reasons why sovereigns felt they had portfolio assets. including support from governments. increased faster than private equity and to alternative assets accelerated as competitive advantage in these asset These challenges are validated by our infrastructure combined despite more quantitative easing drove down returns on classes. However, we noted sovereign research on deployment times and asset sovereigns forecasting future growth in government bonds and put pressure on attitudes have changed in 2016. Most class allocations relative to target. On private equity and infrastructure during portfolio returns relative to targets (as we sovereigns have found it difficult to deploy < 5% average sovereigns estimated that the the same period. have noted in the previous theme). Figure assets in these areas. Figure 10 shows that time from increasing allocation targets 9 shows that international fixed income over the last three years infrastructure Private equity to actual deployment of assets takes allocations for the average sovereign allocations have increased each year but allocations have more than two years for private equity investor portfolio have fallen from 25% to total allocations remain low at 2.8% on increased but remain and approximately three and a half for 16% over the last four years. average of total portfolio assets. Similarly below 5% of average infrastructure, as shown in Figure 11. private equity allocations have increased portfolio assets. Furthermore, in figure 12 more than but remain below 5% of average portfolio 62% of sovereigns explained they were assets. underweight infrastructure and 52% underweight private equity relative to their target allocations. Perhaps more importantly, the number of sovereigns expecting to increase actual allocations to private equity and infrastructure has fallen for the first time this year. There is now a sub-segment of sovereigns who do not plan to increase allocations to these asset classes even though they are underweight relative to their strategic asset allocation targets.
4The 2016 Preqin Global Private Equity & Venture Capital Report. Data as at 30 June 2015.
Fig 9. Average global fixed income Fig 11. Average time for sovereigns to Fig 12. Percentage of sovereign allocations for sovereign investors, full deploy capital in infrastructure, private investors underweight relative to target year 2012-2015 (%) equity and real estate (years), Q1 2016 asset allocation for selected asset classes, Q1 2016
Infrastructure Infrastructure 25 FY12 3.5 14 62 34
20 FY13 48 Fig 10. Average sovereign investor portfolio exposures to • Real estate private equity, infrastructure and real estate (%) Infrastructure • Private equity • Private equity Private equity 2.3 17 52
FY12 FY13 FY14 FY15 34 48 44 57 1CAGR FY12 to FY15 20 FY14 44 6.5
Real estate 29 38 4.3 4.1 Real estate 2.0 13 16 FY15 57 3.0 2.8 25 Hedge funds 1.5 2.1 24 1.4 4.5 3.6 3.1 3.0 13 High–yield debt 14 FY = Full year, assets stated at end of given year. Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. 1CAGR = Compound Annual Growth Rate. FY = Full year, assets stated at end of given year. Sample is based Sample is based on sovereign investors and excludes Sample: 21. Sample is based on sovereign investors Data is not weighted by AUM. on sovereign investors and excludes central banks. Sample size shown in grey. Data is not weighted by AUM. central banks. Sample size shown in grey. and excludes central banks.
10 11 Sovereigns explained that real estate Execution challenges and sourcing deals In comparison to Greater emphasis on development Recognition that global asset managers achieves the diversification benefits and remain a challenge for alternatives and direct partnerships as real estate have an important role to play and long- absolute returns they desire with fewer The trend of fewer execution challenges private equity and allocations grow term relationships matter execution challenges than private equity on a relative basis is also supported by infrastructure, there As average sovereign investor allocations Many sovereigns recognised that a or infrastructure. Figure 13 shows that shorter deployment times (two years to real estate have increased, there growing portfolio of direct activity, joint only 34% of sovereigns cite challenges for real estate in Figure 11) and the fact were a greater have been changes to where and how venture partnerships and asset manager sourcing direct deals for real estate that fewer sovereigns are underweight number of credible sovereigns invest. Some of the large mandates creates complexity. Sovereigns compared to 55% for infrastructure and real estate (38% in Figure 12) relative to investment sovereigns explained that cited growing operational risk and the 58% for private equity. Sovereigns also private equity and infrastructure. However global asset managers they were diversifying away from high- need for internal resources to manage real explained that, in comparison to private the results for real estate also confirm in real estate. profile assets in gateway cities (such as estate partnerships. There is also growing equity and infrastructure, there were a that execution remains a challenge for a New York and London) and taking a more competition between different parties greater number of credible global asset number of sovereign investors. Two years global perspective. Sovereigns also cited representing the same sovereign investor, managers in real estate as well as a long for deployment is a long time in absolute growing interest in partnerships with a theme also evident in infrastructure and list of developers and operators to partner terms even after considering a lengthy developers and more complex real estate private equity. Sovereigns recognised that with on a more direct basis. asset manager selection process or the debt structures which have the potential while partnerships with developers and creation of a joint venture partnership with to deliver higher returns. In general operators increased control and potential a real estate operator or developer. sovereigns in the Middle East and North returns, large global asset managers America were more focused on direct often had access to the best deals. As investing while those in Asia and Africa competition for real estate investments placed more emphasis on global expansion increases, a number of sovereigns cited beyond gateway cities. the importance of moving from a purely Sovereigns also expected the transactional basis to a longer term percentage of real estate investments relationship-based model with a subset of via direct investments or operator and asset managers. developer partnerships to increase. Currently 50% of real estate investments Fig 13. Execution challenges for private equity, infrastructure and real estate • Private equity were placed on a direct or partnership (percentage of sovereign investor citations for each category), Q1 2016 • Infrastructure basis and 35% of sovereigns expected • Real estate this percentage to increase in the future. Not only has real estate grown fastest but more sovereigns expect to increase global and local allocations to real estate than any other asset class (see figure Sourcing direct deals 59 55 34 14). Sovereigns explained that as their real estate allocations increase and competitor intensity grows, they will seek to participate further along the value chain to maintain returns.
Finding quality 48 34 38 Sovereigns also asset managers cited growing interest in partnerships with developers and more complex real estate debt structures which have the potential to Winning direct deals 31 31 24 deliver high returns.
Fig 14. Change in future asset allocation to alternatives • Increase (% of sovereign citations), Q1 2016 • Decrease Global Home market Global Home market Global Home market private equity private equity infrastructure infrastructure real estate real estate 25 23 22 17 30 22 67 64 Asset managers costs 34 24 24
43 45 40 41
Asset managers 24 21 24 deploying capital
-12 -13 -3 -5
-23 -29
Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. Future asset allocations are those which are due to be placed within the next 12 months relative to those placed within the Sample: 29. Sample is based on sovereign investors and excludes central banks. last 12 months.
12 13 Sovereign capital flow from BRIC to frontier markets and the US Weak economic performance of major emerging markets has driven allocations to higher growth frontier markets and to the US based on positive economics and public policy changes.
314 15 A move away from BRIC and emerging Sovereign concerns over the Performance issues have impacted Larger investment market terminology performance and outlook for Russia, sovereign allocations to Brazil, China Over the last four years, we have observed Brazil and China and Russia sovereigns and two primary strategic themes on sovereign Large export markets like Brazil and In comparison to 2013 and 2014, sovereigns in emerging asset allocation. The first has been Russia have struggled with the slump in sovereigns indicate that they are now less increasing alternatives allocations, the commodity prices and stock markets have willing to overlook political and regulatory markets appear to be second has been increasing allocations fallen annually by an average of 17.9% concerns in Brazil, Russia and China in leading investment to emerging markets. In the previous and 11.7% respectively over the past order to hit target allocations. These theme we identified a trend of alternative three years (see figure 15). Sovereigns concerns are evidenced by low or declining into frontier markets. assets shifting towards real estate. This explained that China is also under pressure scores by sovereigns for economic theme explains the changing geographic with stock markets down 18.7% in the performance, stock market attractiveness focus of sovereign investors. Sovereigns last 12 months to March 2016, despite and sovereign investor attractiveness. are now reluctant to talk about emerging growth of 1.2% over the past three years5. Figure 17 shows that Russia has scored markets or BRIC (Brazil, Russia, India, While the Chinese economy is larger and below 5 out of 10 in terms of market China) as a collective due to divergent more diversified than Russia or Brazil, attractiveness to sovereign investors economic performance. To substantiate a shrinking labour force is driving up for the last three years while Brazil and this view, sovereigns typically cite strong manufacturing costs and squeezing private China have declined to 5.6 and 5.0 out of performance in India and certain frontier sector margins. Figure 16 shows that GDP 10 respectively. In contrast India scores markets versus weaker performance in per capita growth across Brazil, Russia and 5.9 out of 10 in terms of attractiveness Brazil, Russia and China. China has declined from 6.4% in 2010 with a positive year-on-year trajectory, to just 1.7% in 2015. Certain sovereign largely attributable to increasing GDP investors explained that lead indicators from growing domestic consumption. such as low steel productivity in China The developed market average is higher were additional concerns on top of recent than any of the BRIC markets (7.0 out performance statistics. of 10) indicating that these regions have benefited from growing uncertainty around some of the BRIC economies. China
Lead indicators such as low steel productivity in China were additional concerns on top of 5MSCI China Index, one-year gross returns. Value based recent performance on US$ price of index. Returns as of 31 March 2016. statistics.
Fig 15. Overall annualised gross stock market return for BRIC, frontier and Fig 16. Aggregate annual GDP Fig 17. Sovereign perceptions of market attractiveness for sovereign investment • 2014 developed markets, 31 March 2013 to 31 March 2016 (%) per capita growth for Brazil, Russia (Brazil, Russia, China, India, developed markets), Q1 2014 to Q1 2016 • 2015 and China, full year 2010 to 2015 (%) • 2016 Brazil Russia China India Frontier Developed Brazil Russia China India Developed markets market market FY10 FY11 FY12 FY13 FY14 FY15 26 26 44 26 26 44 26 26 44 26 26 44 26 23 43
7.0 6.9
6.2 6.0 6.4 5.9 5.9 6.3 5.8 5.6 5.6 5.6
5.1 7.4 5.0 4.8 3.8 4.7 2.2 1.2 4.1 4.4 4.3
3.4
-11.7
-17.9 1.7
Source: MSCI Indexes. Values based on US$ price of index. Developed market returns based on MSCI World Index. Returns as of 31 March, 2016. Frontier Markets: Argentina, Bahrain, Bangladesh, Bulgaria, Croatia, Source: OECD. FY = Full Year. Data - Level of GDP per Estonia, Jordan, Kenya, Kuwait, Lebanon, Lithuania, Kazakhstan, Mauritius, Morocco, Nigeria, Oman, Pakistan, capita and productivity 2015 data includes OECD and Romania, Serbia, Slovenia, Sri Lanka, Tunisia and Vietnam…and can include Mexico, Indonesia, Turkey and NMG estimate (Chinese 2015 GDP per capita estimated Developed markets is the average score of allocations to US, Japan, Germany, France, UK and Italy. Rating on a scale from 1 to 10 where 10 is the most attractive. South Africa. based on a 7.3% linear growth of 2014 GDP). Rating scored as of Q1 of the given year. Sample is based on sovereign investors and excludes central banks. Sample size shown in grey.
16 17 Larger investment Sovereigns are shifting new asset The US is now perceived as the most Fig 19. Sovereign perceptions of economic performance, • US allocations to frontier markets attractive market for sovereign private sector attractiveness and attractiveness for sovereign investment • UK sovereigns and One of the key beneficiaries of reduced investment (US, UK, developed markets, emerging markets), Q1 2014 to Q1 2016 • Developed markets sovereigns in emerging allocations to the largest emerging We reported in 2013 that the UK had • Emerging markets markets are frontier markets. Figure 18 successfully positioned itself as an • 7.5 – 8.5 score markets appear to be shows that from year end 2014 to 2015 attractive developed market destination leading investment into average asset allocations to Russia (and for sovereign investment. This observation CEE) and China fell (from 1.9% and 2.2% is supported by data in figure 19 showing Private sector 6.8 14 frontier markets. to 1.5% and 1.7% respectively) while that in 2014 the UK scored only 6.5 out opportunity emerging Asia grew from 1.6% to 2.3% of 10 for economic performance but 8.3 15 and Africa increased to 0.9%. Sovereigns achieved an average rating of 7.4 out cited manufacturing capability, political of 10 for attractiveness to sovereign 8.5 16 stability and the quality of infrastructure investors. The US has always been viewed 6.5 14 as key factors driving their selection of as a leading economy with high private markets in emerging Asia and Africa. sector attractiveness but over the past 6.9 15 Sovereigns are using a range of products two years its attractiveness to sovereign and asset classes to increase this exposure investors has increased significantly. Some 7.3 16 to frontier markets. There were references sovereigns explained that the US appears to conventional equity and fixed income increasingly open to their investments 6.0 14 products with exposure to frontier following positive perceptions of sovereign markets but also to direct investments investments into the US financial sector 7.0 15 into a range of alternatives including real during the global financial crisis. Figure estate. Based on our interviews, larger 19 shows that sovereign perceptions of 7.1 16 investment sovereigns and sovereigns in the attractiveness of the US to sovereigns emerging markets appear to be leading has risen from 6.5 out of 10 in 2014 to 6.3 14 investment into frontier markets as they 8.2 out of 10 in 2016, making the US the 6.2 15 have the scale and confidence to increase clear preferred destination of sovereign allocations. Importantly, the changes in investment in 2016. 5.5 16 sovereign emerging market allocations are primarily linked to new asset allocations. Economic 7.0 14 Beyond a few switched or consolidated performance mandates, sovereigns do not appear to 7.7 15 have withdrawn existing assets from any emerging market. 8.3 16
7.2 14
7.2 15
7.7 16 Fig 18. Average sovereign investor portfolio allocations • FY14 to China, Russia, Emerging Asia and Africa, full year 2014 to 2015 (%) • FY15 7.0 14
7.1 15
China Russia and CEE 7.1 16
5.3 14
5.0 15
5.3 16
Attractiveness 6.5 14 2.2 1.9 1.7 1.5 to sovereigns 7.7 15
8.2 16
7.4 14 Emerging Asia Africa 7.6 15
7.5 16
6.2 14
6.9 15
7.0 16
2.3 1.6 5.8 14 0.9 0.6 5.4 15
5.2 16
Sample: 14 = 40, 15 = 37, 16 = 38. FY = Full year, assets stated at end of given year. Sample based on repeat participants from 2015 and 2016 only. Sample is based on sovereign investors and excludes central banks. Sample: 14 = 26, 15 = 26, 16 = 44. Sample is based on sovereign investors and excludes central banks. Rating on a scale from 1 to 10 where 10 is the highest CEE is Central and Eastern Europe. Data is not weighted by AUM. . performance/ greatest opportunity/ most attractive. Rating scored as of Q1 of the given year.
18 19 Public policy influences sovereign Fig 20. Infrastructure competitive rankings (top 15 markets), • North America investment and presents an opportunity World Economic Forum 2015 • Europe for governments globally • Asia Sovereigns explained that it is now easier • Middle East and more attractive to invest in the US. Canada For example, in early 2016 the exemption of ‘qualified foreign pension funds’ from the Foreign Investment in Real Property Tax Act (1980) was cited as a motive 5.7 for direct real estate purchases in the US. Figure 21 highlights the importance of governments in further increasing sovereign investment, showing citations for private ownership, shareholder rights, UK openness to sovereign investment and Hong Kong Japan political stability as factors which influence their geographic allocations. Perhaps 6.0 more importantly, sovereigns are bullish 6.7 6.2 on future opportunities, noting potential scope to invest in US infrastructure. The need for infrastructure investment is Netherlands UAE supported by a recent report on the asset class by the World Economic Forum. The Germany report analyses global competitiveness, 6.3 6.3 defined as “the set of institutions, policies, and factors that determine the 6.1 level of productivity of an economy”. Austria Singapore Within infrastructure the US is ranked 11th behind key Asian and European France markets in figure 20 indicating poor quality of infrastructure due to a lack of 5.7 6.5 competition and investment. This verifies sovereign difficulties in investing in US 6.0 infrastructure and suggests the potential for infrastructure upgrades. In conclusion, it is evident that sovereigns are quick to adjust perceptions Spain Switzerland of market attractiveness based on US 2015 changes in economic performance The US is ranked and public policy. In most cases these 11th behind key Asian investments by sovereigns appear to and European 5.9 5.9 6.2 be relatively tactical responding to the markets Taiwan South Korea latest market data or regulatory change. However sovereigns explained that market performance and public policy will also shape longer term strategic 5.9 5.8 asset allocations to different geographic regions. The ability of governments to attract sovereign investment via policy decisions is a key finding. It presents an Source: World Economic Forum, Global Competitiveness Report (http://reports.weforum. opportunity for governments globally to org/global-competitiveness-report-2015-2016/) attract significant long-term capital to support economic growth. Fig 21. Average sovereign investor ratings on the importance of selected non-investment factors in influencing geographic allocations, Q1 2016
7.5 Private ownership
7.5 Political stability
7.2 Openness to sovereign investment
6.9 Shareholder rights
6.3 Government relationship
5.9 Development objectives
5.6 Sovereign wealth fund taxation status
Sample: 40. Rating on a scale from 1 to 10 where 10 is the most important.
20 21 Growing interest from sovereigns in factor-based investing Sovereigns understand macro factors but would like more information on style factors and their potential applications within their portfolios.
422 23 Factor-based investing is an emerging Sovereigns understand macro risk Sovereigns are uncertain about the Just over a quarter of sovereigns We have observed area of interest amongst sovereigns factors even if they haven’t aligned their definition and role of style factors within say they have invested in factor- In 2013 we described the introduction portfolios to these factors their portfolios based strategies ongoing interest in of risk factor benchmarks by leading Macro factors are defined as non- Style factors are defined as any factor Based on our interviews, 26% of factor-based investing sovereign investors in Europe and the US. diversifiable risks that generate (or set of uncorrelated factors) which has sovereign investors say they have We also noted sovereign challenges in investment returns. The theory was historically delivered a return premium and invested in factor-based strategies (see from sovereigns as migrating portfolios from asset allocation developed by Barra Inc. during the 1970s. the theory was established by Fama and figure 22). Our discussions indicated well as increasing to risk factors in terms of both portfolio Sovereigns were generally comfortable French7 in the early 1990s. Sovereigns that these investments into style factor reporting and market timing risks. These talking about ‘macro’ risk factors such were less comfortable talking about strategies were almost entirely placed commentary and findings are part of a broader theme as economic growth, liquidity, currency, ‘style’ factors and their role within their with external asset managers. We believe product development around the role of factor-based investing credit, inflation and political risk. While portfolios. These factors are typically this usage figure may be understated within sovereign portfolios. Since 2013 only a small number of sovereigns use behavioural or structural traits which have as the Chief Investment Officers and from asset managers we have observed ongoing interest in these factors as the primary building historically delivered outperformance such heads of strategy in our interviews in this space factor-based investing from sovereigns blocks for their portfolio, all sovereigns as value, momentum, quality, size and low explained that there may be factor- as well as increasing commentary understand these concepts and have an volatility. Whilst macro factor exposures based mandates within their passive and product development from appreciation for the exposure of their can be easily derived from traditional asset allocations that they were not aware asset managers in this space. This portfolio to these risks. As we have noted classes, many sovereigns felt that the of. For sovereigns who had invested in theme explores the current sovereign earlier in this report, the desire to diversify understanding of exposure to style factors factors there was a strong appreciation of perceptions, awareness and interest in risks from economic growth into liquidity was complex and had unclear benefits. the value of factor strategies. In contrast factor-based investing considering both (and other macro risk factors) has been Sovereigns struggled to understand a significant percentage of the non-user macro and style factors. a key driver for increasing alternative how the separation of returns into sovereign investors rated factor-based allocations since the global financial crisis. quantitative (style factors) and qualitative investing’s importance as low. Overall (manager selection skill) factors would the importance of external factor- work in practice and what it means for based investing was rated 5.5 out of 10 benchmarking. Some sovereigns have compared to 7.2 out of 10 for passive already separated asset class portfolios and 8.1 of 10 for traditional active Fig 22. Percentage of sovereign investors using factor-based investing into beta and alpha and into internal and management (see figure 23). manager selection divisions and felt that introducing style factors might create further complexity. 74 Not using
7Sources: The Cross Section of Expected Stock Returns – Fama & French (1992), Common Risk Factors in the Returns on Stocks and Bonds – Fama & French (1993)
Fig 23. Average importance of indexing, • Traditional active 24 active and factor-based strategies for external • Passive 24 asset manager allocations by sovereign investors, • Factor-based 22 Q1 2016
8.1
7.2
26 Using
5.5
Sample: 34 . ”Using” is defined as any sovereign stating a non-zero allocation to factor-based strategies. Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. Importance rated on a scale from 1 to 10 where 10 is the most attractive.
24 25 Some of the Positive growth outlook for factor-based Sovereigns are looking for support In the past we have noted several investing from existing and new users from asset managers to improve their 72% investment topics where sovereigns want more experienced The observation that factor-based understanding of factor-based investing more insight and support from the asset sovereigns are now investing is of relatively low importance We have observed positive sentiment The most management industry. Sovereigns are compared to active management and within existing factor users but this is a commonly cited large, sophisticated investors who are considering internal indexing is not a surprise given its small subset of sovereign investors. barrier by 72% quick to learn and lead other institutional factor-based investing. developmental phase. Instead the level To really gain traction amongst sovereigns, of sovereigns is investors into complex, emerging of factor adoption and direction of future factor-based strategies need to overcome a lack of in-house investment topics. This year we have factor allocations is more important. the perceived barriers of non-users. expertise and identified an information gap around Six out of the eight sovereign investors Figure 25 sets out a range of perceived understanding factor-based investing: sovereigns want to using factor-based strategies expected barriers to factor-based investing. The of factor-based understand how to approach factor-based allocations to increase over time, a strong most commonly cited barrier by 72% of investing. investing within their portfolios. Academic vote of confidence from existing users. sovereigns is a lack of in-house expertise research points to restructuring portfolios A further three sovereign investors and understanding of factor-based but this is not feasible for most sovereigns. planned to start allocating to factor-based investing. This presents an opportunity Looking forward, we expect sovereign investments in the future. Figure 24 shows for the asset management industry to investors to plug gaps in their knowledge that more sovereigns expect to increase help sovereigns understand factor-based quickly. We will monitor sovereign factor-based investing than passive or investing and support the implementation perceptions of factor-based investing and active allocations. of factor strategies. A lack of fit with objectively report on the industry’s ability Sovereigns also explained that wider strategy and a lack of interest to support the sovereign community in they were increasingly issuing tender from decision making bodies were also this space. documents for factor mandates in cited, which indicates further structural order to better understand the concept barriers to adoption. However even these and differences in approach between barriers can be overcome by effective asset managers. Sovereigns noted that communication of a compelling while certain asset managers have first value proposition. mover advantage, many managers were Identifying a requirement from Fig 25. Sovereign views on barriers to factor investing (% of sovereign citations, multiple answers allowed) investing heavily in this area. Some of the sovereigns for training and education more experienced sovereigns are now on factor investing is relatively considering internal factor-based investing straightforward. Delivering these (see figure 24) but nearly all of these programmes will be harder and we investors were continuing to use external note three challenges for the asset 72 Lack of in-house managers at the same time to keep pace management industry identified by expertise with industry change. sovereigns during our discussions: 1. The wide range of stakeholders within sovereigns who need to be engaged including the CIO, strategy units and 45 Lack of fit with asset class heads across internal and investment philosophy external management. 2. A tendency for asset managers to push their own strategies and products rather than considering factor-based 38 Lack of interest from investing from a sovereign perspective. decision bodies 3. The resources required for sovereigns to complete the investment process: understanding concepts, determining current and target exposures, signing off new factor-based investments and 38 Cost finally monitoring and benchmarking performance.
Fig 24. Expected change in active, passive • Traditional active 38 Weak theoretical basis and factor allocations over time for internally • Passive and externally managed portfolios (%) • Factor-based Internally managed Externally managed 27 25 24 23 23 20 31 Size of fund 48 45
35 29 24 Don't believe in concept
17
8
3 No barriers
-17 –17
-28
Sample: 29 Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. Sample is based on sovereign investors and excludes central banks.
26 27 Central banks to become important sovereign investors The presence of investment tranches with significant corporate bond and equity allocations suggests that central banks are becoming long-term sovereign investors.
528 29 Central banks are distinct from other Growth in central banking reserves Central banks are struggling to meet sovereign investor profiles following currency crises their capital preservation objectives 18 Last year we interviewed a small number Central banking reserves went through As central bank reserve adequacy positions of central banks with large investment 10 a period of accelerated growth following improved, central banks have become portfolios in our sovereign investor study. crises in Asia (1997) and Argentina more confident in their ability to meet We analysed central banks together with This year we have 1998-2002. A large portion of these new stabilisation objectives. Figure 30 confirms stabilisation funds (defined as liquidity expanded our reserves were accumulated by central that the majority of central banks believe sovereigns) because both sovereign sample of central banks in emerging markets to support they have sufficient or ample reserves profiles prioritised liquidity and capital banks from 10 exchange rates and mitigate the risk of to meet their stabilisation objectives. preservation objectives over investment to 18, focusing on financial crises through self-insurance. Moreover, European Central Bank reserves return. This year we have expanded our progressive central Figure 27 shows that central banking assets are held for liquidity purposes throughout sample of central banks from 10 to 18, banks across grew from US$ 1.6 trillion in 2000 to US$ the system, the result of which national focusing on progressive central banks with Europe, Middle East 8.3 trillion at the high watermark in 2014. central banks in the Euro system can focus ample reserves across Europe, Middle and Asia. At the end of 2015 the total market value more on capital preservation and return. East and Asia. We have also separated of central bank reserve assets including However, central banks are struggling to these institutions from liquidity sovereigns gold was estimated at US$ 12 trillion of meet their capital preservation objectives because central banks have a broader remit which US$ 8.1 trillion is allocated within the in the current low return environment. and formal independence from government IMF official foreign exchange reserves. In figure 31 for example, 80% of central (see figure 26). This theme provides unique banks agree that low returns on traditional evidence-based findings on the investment Central banks have dual objectives of government bonds are a key driver of objectives and investment tranches of capital preservation and stabilisation increasing diversification into other assets. central banks and the implications for the Central banks have two primary objectives: assets. Given negative yields on certain asset management industry. capital preservation and stabilisation. Figure Eurozone government bonds this challenge 28 confirms the importance of capital is particularly acute for central banks where The emergence of central banks as preservation and stabilisation objectives the currency composition of reserves is independent institutions to manage with average ratings of 9.3 and 8.7 out heavily weighted towards the Euro. Where currency and financial crises Fig 26. Invesco's sovereign investor profile of 10 respectively compared to 5.7 out central banks measure capital preservation Fig 29. Central bank definitions of Before the late 1600s government funding of 10 for investment return. Stabilisation in real terms, the hurdle is even higher capital preservation (% of central bank relied on loans from the private sector. is most commonly measured by reserves given the negative real returns on US$ and citations attributed to each definition), During times of war and crisis, governments adequacy, a metric which compares the Euro government debt. Q1 2016 Global sovereign Global sovereign would face challenges in raising the capital investor objective investor profile actual level of central bank reserves to likely Capital preservation was a major required to run the country. The Bank of scenarios in which the government would challenge for central banks in emerging 46 No real terms loss England was the first central bank to issue draw down on central bank reserves. The markets managing a currency peg at the portfolio level debt to the government at the turn of the Investment only Investment sovereigns INV standard reserves adequacy formula is the because of the higher level of short-term 18th century and the terms of reference sum of national short-term debt coverage liquidity required to meet intervention drawn up during this process became and import coverage. In our study, central requirements. This accounted for 40% 46 No absolute loss the basis for a central bank which was Investment & liability Liability sovereigns LIS banks typically defined capital preservation of the central banks in the study. The at the portfolio level independent from government. Sovereign as no absolute losses at portfolio level or combination of the dollar’s strength and the During the late 19th and early 20th investors Investment & liquidity Liquidity sovereigns LIQ as no portfolio losses in real terms (see negative outlook for oil placed a strain on centuries a number of local financial crises sovereign responses to capital preservation the currency pegs, forcing intervention to 8 No loss of principal at highlighted issues with the banking system. definitions in figure 29). Only 8% of central maintain the value of the currency within the single asset level If a bank failed, it required other privately Investment & development Development sovereigns DEV banks in our study measured capital the bands of the peg. The high level of owned banks to step in. In response central preservation at the single asset level but we liquidity negatively affected their ability banks gradually adopted the role of lender note that our sample deliberately targeted a to meet capital preservation objectives. of last resort. This additional responsibility Capital preservation Central banks progressive group of central banks focused 0 No realised losses encouraged central banks to accumulate a on investment return. Globally we believe pool of reserves beyond the gold required the number of central banks measuring to match its notes issued. The move from capital preservation at the single asset level the gold standard to a fiat money system is higher than in our study. in the mid-1900s eliminated the need for 1Central banks have both capital preservation and liquidity objectives. banks to hold large levels of gold reserves. They are also distinct from other sovereigns due to their formal independence from government Sample: 13. Sample comprises of central banks only. Gold was replaced by financial assets (typically AAA-rated government bonds) Fig 27. Official Foreign Exchange Reserves (US$ trillions), 2000 – 2015 Fig 28. Average ratings for central bank Fig 30. Central bank views on their which enabled central banks to intervene objective importance, Q1 2016 level of reserves adequacy in currency pricing. Towards the end of the (% of central bank citations), Q1 2016 20th century the move from gold to fixed 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Capital Stabilisation Investment • Ample income accelerated and the US Treasury preservation return 8.3 • Sufficient note became the standard "risk-free" asset, 8.1 reflecting the importance of the US$ in 7.9 9.3 • Insufficient 7.4 8.7 international trade and its central role in the 14 international monetary system. 6.9 6.3
64 5.4 5.7 4.8 21 4.3
3.5 3.1 2.5 2.1 1.9 1.6 1.7
Sample: 16. Sample comprises of central banks only. Source: IMF International Financial Statistics - central bank foreign currency reserves in USD, ex-SDR and gold. only. Importance rated on a score from 1 to 10 where SDR=Special Drawing Rights. Data as at 31 December 2015. 10=most important. Sample: 14. Sample comprises of central banks only.
30 31 Central banks are Capital preservation challenges increase The development of investment tranches the importance of investment return within central bank portfolios increasing investment Central banks are increasing investment Allocations to new asset classes have forced 13 return objectives to return objectives to ensure they meet and central banks to reconsider the structure of All 13 respondents ensure they meet and exceed their capital preservation objectives. their reserves. Central banks now manage that had tranched Central banks explained that the rationale multiple objectives and there is clearly their reserves exceed their capital for promoting investment return objectives scope for conflict between stabilisation had included an were twofold: first to deliver an investment and investment return objectives. As Investment tranche. preservation objectives. return and second to minimise volatility a result central banks have split their through diversification into new asset reserves into tranches. Figure 33 shows classes. Many central banks focused more that central banks in our study operate up on diversification and reduced volatility to four tranches: liquidity tranche, hold to than on investment returns and yields. The maturity tranche, cash or working capital desire to diversify and seek higher returns tranche and investment tranche. This is illustrated in figure 32 by a number of dynamic is very different to other sovereign central banks expecting to shift assets from investors who do not generally split their low yielding deposits to increase allocations portfolio into formal tranches with different to corporate debt and equities in the future. objectives. In some cases central banks explained that The liquidity tranche is typically the they are continuing to sell off gold reserves largest tranche of reserves, comprised of and these assets would be redeployed low risk assets (typically AAA-rated, short into higher risk fixed income and equity duration government bonds) and primarily investments. responsible for stabilisation objectives. The hold to maturity tranche is a tranche of longer term fixed income which is held to maturity to generate return and guarantee Fig 31. Low government bond returns capital preservation. The cash or working Fig 33. Central bank allocations to different tranches • Liquidity tranche are driving diversification of central capital tranche represents cash balances (% of central bank assets), full year 2015 • Investment tranche bank portfolios (% of central bank required for operational purposes. The • Hold to maturity tranche citations), Q1 2016 investment tranche tends to hold riskier • Cash/working capital tranche assets such as corporate bonds and Agree Disagree Neither agree nor disagree equities. The investment tranche is typically smaller than the liquidity tranche with a primary objective of investment return. The 80 differences in asset allocation for liquidity and investment tranches are set out in figure 34. While there are higher allocations to corporate debt (18%) and equities (18%) in the investment tranche we note that a significant percentage of these assets remain allocated to sovereign debt. 18
13 7
Sample: 15. Sample comprises of central banks only.
Fig 32. Central bank views on future change in asset allocation (% of central bank citations), Q1 2016 • Increase • Decrease 5 77 11 6 14 12 6 7 8 5 Deposits with Deposits with Government Government US agency Corporate debt Gold Equities 0 central banks commercial banks bonds agencies, mortgage-backed 80 multilaterals and securities supra-nationals
58
43
29
9 0 -27 -50 0 -25 -7
Sample comprises of central banks only. Sample size shown in grey. Sample: 13. Sample comprises of central banks only. Data is not weighted by AUM.
32 33 Fig 34. Central bank allocations by tranche • Deposits with central banks • Corporate bonds Uncertainty over size and asset A major opportunity for the industry to (% of central bank assets), full year 2015 • Deposits with commercial banks • Gold allocation within the investment tranche support central banks on investment • Government bonds • Equities While every central bank in our study strategy • Agencies, Multi-Lats, Supra-Nats • IMF1 Reserve had an investment tranche, the creation Central banks account for more than • US Agency MBS of these tranches is a relatively new US$ 10 trillion of assets8. If the subset of phenomenon. Many interviewees were progressive central banks we interviewed in the process of designing or testing are a proxy for the wider central banking their allocations and there was no clear community, central bank could become Total reserves Liquidity tranche Investment tranche consensus on the target size for the major global investors and key clients investment tranche or the underlying asset for global asset managers. However, a allocation. Furthermore, there was also comparison of central banks with other 1 2 18 a lack of clarity on how these allocations sovereign investors confirms a significant related to risk-adjusted returns and gap in investment capability. Figure 36 6 3 volatility. Many respondents emphasised shows that central banks rated their 2015 that this was an experimental stage. asset allocation performance at 6.7 out 2 Limited allocations to corporate bonds of 10 compared to 8.0 for investment and 3 1 and equities were frequently attributed liability sovereigns. Central banks were clear 5 to inexperience rather than an evidence- that they need more support in growing 3 based view of strategic asset allocation. their portfolio of risk assets and they are Furthermore only 20% of central banks looking to peers, sovereign investors and 1 72 stated that investment guidelines were asset managers for help on their journey. 5 overly restrictive (see figure 35). This The challenge for the industry is providing support through tailored training, white 1 is a positive message for the asset management industry, as it suggests papers and, where appropriate, consulting, 18 68 that there will be limited opposition from given their unique context, portfolio executive committees to the ongoing structure and objectives. Fig 35. “Investment guidelines are development of the investment tranche. overly restrictive”, level of agreement or disagreement from central banks (%), Q1 2016
• Disagree • Neither agree or disagree • Agree
4
16 20
47
33
40 8Source: IMF International Financial Statistics – Official Reserve Assets, US Dollars Sample: 15. Date as at 31 December 2015.
Fig 36. Perceived performance on selected capabilities, • Central banks central banks versus investment and liability sovereigns, full year 2015 • Investment & liability sovereigns
8.2 6.1 Currency management
7.8 7.2 Investment risk management
7.7 7.6 Governance
7.4 7.4 People and talent
7.4 7.1 Investment reporting
7.1 7.1 Transparency 4 7.1 Operational risk management 3 6.9 11 6.7 7.3 Fund manager selection 10 6.7 8.0 Asset allocation
6.5 7.5 Range of benchmarks
6.5 6.6 Internal asset management 3 5.9 6.1 Use of consultants
2.3 5.6 Internal PE expertise
Sample: 15. 1IMF = International Monetary Fund, MBS = Mortgage-backed securities, Multi-lats = Multi-laterals, Supra-nats = Supra-nationals, CBs = central banks. Sample comprises of central banks only. Data is not weighted by AUM. Sample: 33. Rating on a scale from 1 to 10 where 10 is the highest performance. Capability deficit/ asset is defined as capability performance subtract capability importance.
34 35 Appendix Sample & methodology
A36 37 Sample and methodology Invesco NMG Consulting - Shape your thinking The fieldwork for this study was conducted Invesco is a leading independent global NMG Consulting is a global consulting by NMG’s strategy consulting practice. investment management firm, dedicated business operating in the insurance Invesco chose to engage a specialist to helping investors achieve their financial and investment markets. Our specialist independent firm to ensure high-quality objectives. With offices globally, capabilities focus, global insights programmes and objective results. Key components of the in virtually every asset class and investment unique network give us the inside track methodology include: style, a disciplined approach to investment in insurance and investment markets, – A focus on the key decision management and a commitment to the translating insights into opportunities. makers within sovereign investors highest standards of performance and We provide strategy consulting, as well as conducting interviews using client service – we are uniquely positioned actuarial and research services to financial experienced consultants and to help institutional investors achieve their institutions including banks, insurers, offering market insights rather investment objectives. reinsurers and fund managers. than financial incentives NMG’s evidence-based insight – In-depth (typically one hour) Alexander Millar programmes carry out interviews with face-to-face interviews using a Head of EMEA Sovereigns & Middle East industry-leading experts, top clients structured questionnaire to ensure and Africa Institutional Sales and intermediaries as a basis to analyse quantitative as well as qualitative [email protected] industry trends, competitive positioning analytics were collected +44 1491 416180 and capability. Established programmes – Analysis capturing investment exist in asset and wealth management, life preferences as well as actual insurance and reinsurance across North investment allocations with a bias America, the UK and Europe, Asia Pacific, toward actual allocations over South Africa and the Middle East. stated preferences – Results interpreted by NMG’s strategy team with relevant consulting experience in the global asset management sector Fig 37. Sample by sovereign investor profile In 2016 we conducted interviews with Investment Liability Liquidity Developement Central bank 77 different sovereign investors and central banks, compared to 59 in 2015. This year we have created a separate 26 central bank segment. The breakdown of the 2016 interview sample split by three core segmentation parameters 18 (sovereign investor profile, region 15 and size of assets under management) 12 is displayed in figures 37 to 39. 6
Sample: 77
Fig 38. Sample by region
West Asia Middle East Emerging markets
27
22
15 13
Sample: 77
Fig 39. Sample by size of assets under management
US$ < 10bn US$ 10 to 25bn US$ 25 to 100bn US$ > 100bn
26
20 17 14
Sample: 77
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3