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Invesco Global Sovereign Asset Management Study
2017
This study is not intended for members of the public or retail investors.
Full audience information is available inside the front cover.
Important information
This document is intended only for Professional
Clients and Financial Advisers in Continental Europe
(as defined in the important information); for
Qualified Investors in Switzerland; for Professional
Clients in, Dubai, Jersey, Guernsey, Isle of Man,
Ireland and the UK, for Institutional Investors in
the United States and Australia, for Institutional
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for Professional Investors only in Hong Kong, for
Qualified Institutional Investors, pension funds and
distributing companies in Japan; for Wholesale
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Act) in New Zealand, for accredited investors as
defined under National Instrument 45–106 in Canada,
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Investors only in Taiwan and for one-on-one use with
Institutional Investors in Bermuda, Chile, Panama
and Peru.
Cover
Aerial view of Midtown
South, New York
Introduction
We published our first report on the sovereign
asset management industry in 2013 following
interviews with 43 sovereign investors. This year
marks our fifth annual study with evidence-based
findings based predominantly on face-to-face
interviews with 97 leading sovereign wealth funds,
state pension funds and central banks with assets
in excess of US$12 trillion.
Over the past five years we’ve noted a number
of factors influencing sovereigns such as low
interest rates, the falling oil price and reduced
funding. This year however we note geopolitical
shocks in developed markets are shaping decision
making. When coupled with uncertainty over the
end of quantitative easing, the commencement
of quantitative tightening and ongoing volatility
in currencies and commodities it’s clear sovereign
investors are faced with a challenging macroeconomic
and therefore investment environment.
The first theme in this year’s report addresses
the aforementioned factors and notes a continuing
return gap between target and actual returns with
asset deployment challenges limiting the ability for
sovereigns to match strategic asset allocation targets.
We note sovereigns are increasingly looking to evolve
their business models through internalisation or
investment partnerships to reduce management
costs and improve placement efficiency.
Geopolitical risks have led to an increased
concentration on perceived ‘safe haven’ international
markets such as the US, India and Germany as well
as an increasing focus on home market allocations
in an effort to reduce foreign currency exposure.
We focus on real estate in our third theme,
highlighting accelerated growth in the asset class.
We examine the drivers for these allocations as well as
setting out how and where assets are being deployed.
Despite sovereigns being well placed to implement
Environmental, social and governance (ESG)
strategies due to their size and long-term orientation,
the uptake of ESG practices by sovereigns appears
to have varying success. We highlight sovereigns’
polarised perspectives on ESG investing across
various regions.
We conclude with a theme focused on central
banks. This year we have expanded and segmented
our central bank sample to understand differences
in strategy and pace of change with respect to
investment tranches across developed and
emerging markets.
We hope the unique, evidence-based findings
in this year’s report provide a valuable insight into
a fascinating and important group of investors.
Key themes
Shift from investment strategy to business model
The gap between target and actual portfolio returns
along with declines in investment commitments are
reshaping sovereigns’ strategic agendas.
Increasing appeal of perceived ‘safe haven’ markets
Geopolitical uncertainty is leading to a focus on
perceived ‘safe haven’ international markets and
home markets.
Attraction to real estate for matching and
flexible participation
Sovereigns are increasing allocations to high-quality
direct real estate given perceived return, matching
and flexibility attributes.
Environmental, social and governance (ESG)
growth dependent on performance data
Perspectives on ESG are polarised with supporters
moving to further embed and integrate ESG in
investment processes while non-supporters wait
for evidence of investment implications.
Central bank risk appetite driven by financial
market exposure
Central bank investment priorities and risk
appetite vary according to the size of the country’s
reserves and to the level of exposure to financial
market shocks.
Alexander Millar
Head of EMEA Sovereigns & Middle East
and Africa Institutional Sales
alexander.millar@invesco.com
+44 1491 416180
igsams.invesco.com
to view more content
on this year’s themes
01
Sovereign segmentation is crucial to understanding
attitudes and responses to external themes
Economic challenges affect sovereigns differently,
according to their liabilities, risk appetites, funding
dynamics and other factors. We use the framework
in figure 1 to categorise sovereign investors. We will
explore the unique implications of the themes in
this report for each of these segments.
Investment sovereigns
Investment sovereigns do not have any liabilities,
allowing for long time horizons and high exposure to
illiquid asset classes. Due to this investment freedom,
return targets are high – investment sovereigns have
responded to falling returns by targeting greater
illiquid asset exposure (to generate higher returns)
and developing internal management capability
(to capture more of the value chain), however many
funds are reaching limits on these allocations.
Liability sovereigns
Liability sovereigns are split into funds with existing
outflows (current liability sovereigns) and funds with
future liabilities (partial liability sovereigns). While
partial liability sovereigns have similar strategies
to investment sovereigns (due to their long time
horizons), matching outflows is a key concern
for funds with current liabilities. The return gap
is therefore of particular significance to liability
sovereigns and many funds expect their target rates
to eventually increase as they update models to
lower ‘risk free’ rates and increasing life expectancy.
To manage these concerns, many current liability
sovereigns are seeking greater exposure to highyielding
asset classes.
Fig 1. Sovereign profile segmentation
Sovereigns and central banks
Primary objective
Investment only
Investment & liability
Global sovereign profile
Investment sovereigns
(INV)
Liability sovereigns
(LIA)
Sovereign investors
1
Central banks have secondary liquidity objectives as well as primary capital preservation objectives. They are distinct from sovereigns through their role in local market
money supply and their regulatory function.
02
Liquidity sovereigns
Liquidity sovereigns manage assets to stimulate
economies that are highly dependent on commodity
prices during a market shock. Due to the unpredictable
and sudden nature of outflows, liquidity sovereigns
have extremely short time horizons and prioritise
portfolio liquidity above investment returns. Despite
low yields of government bonds, liquidity sovereigns
are unable to seek higher returns from alternative
asset classes due to the inherent liquidity risk.
Development sovereigns
The asset and geographic allocation of development
sovereigns is driven by the requirement to encourage
local economic growth (rather than investment
return). Development sovereigns take large (often
controlling) stakes in companies of economic
significance in order to grow their presence in
the local market. While other sovereigns adjust
allocations to maximise their asset growth and yield,
development sovereigns consider their success
in economic metrics such as GDP growth and job
creation, working closely with their investments to
grow long-term strategic assets. This means that
development funds are relatively unreactive to
return shortfalls and asset allocation trends.
Central banks
Central banks are ‘lenders of last resort’ – managers
of a large foreign reserves portfolio to bail out
financial institutions of public importance. Due to
the importance of maintaining reserves to sufficiently
cover such requirements, preservation of capital
is of greatest importance. Central banks also have
high levels of public accountability and disclosure,
encouraging risk aversion through short time horizons
and highly liquid investments. While other sovereigns
invest in home market assets, central bank reserve
managers hold the majority of their assets in foreign
securities, increasing the importance of currency
exposure relative to other sovereigns.
Unlike sovereign investors, central banks have
objectives outside of reserves management, including
local market liquidity management and maintenance
of currency pegs. Since these external factors have
influence over the foreign reserves, in this study we
consider central banks separately from sovereign
investors. However, as many government bonds have
negative yields, certain central banks have looked to
invest in non-traditional asset classes (e.g. equities)
to preserve their capital, closer aligning their foreign
reserves investment strategy to that of sovereign
wealth funds.
Funding challenges
and the low return
environment have
unique implications
for each sovereign
segment.
Investment & liquidity
Investment & development
Capital preservation
Liquidity sovereigns
(LIQ)
Development sovereigns
(DEV)
Central banks 1
(CB)
03
Shift from investment strategy to business model
The gap between target and actual portfolio returns
along with declines in investment commitments are
reshaping sovereigns’ strategic agendas.
1
Worlds highest and longest
glass Bridge as of 2016 in
Zhangjiajie, China
The outlook for macro policy and for the geopolitical
environment remains uncertain
Our fifth annual cycle of interviews took place
between January and March 2017. In speaking with
leading sovereign investors and central banks (with
assets in excess of US$12 trillion) we identified a
number of critical themes that shaped interview
responses. Unsurprisingly, we noted that the outlook
for macro policy and the potential for further
geopolitical shocks dominated discussions.
– Sovereigns see the end of QE (Quantitative
Easing) without a clear indication as to the form or
timeframe for further QT (Quantitative Tightening).
While the US has begun to raise interest rates, the
Federal Reserve is engaged in parallel measures
that may reduce the quantum and pace of further
increases; and there is uncertainty whether and
when other major markets will follow suit
– The bifurcation of the US and other developed
markets (notably the UK, Germany and Japan)
had significant implications for currency rates,
challenging sovereign geographic allocations
– Political change in developed markets (notably
Brexit and the US election) created volatility in
sovereign portfolios, challenging the robustness
of sovereign risk models. As policy changes are
worked through governments (e.g. the terms of
Brexit and US corporate tax reform), there will be
wider implications for long-term geographic and
asset allocation
– Emerging markets face various macro challenges,
with commodity prices recovering slowly (e.g. oil,
natural gas and copper) and an increasingly unstable
political outlook in Brazil and South Africa
Sovereigns face a continuing ‘return gap’
These dynamics suggest a continuation of the
‘lower rates, lower return’ environment over at
least the next 24 months. While the lower return
environment has been a consistent theme in past
years, in 2017 the implications are compounded,
with low interest rates the factor of greatest
importance to both strategic and tactical asset
allocations in figure 2. Risk asset valuations have
inflated over a number of years, while the nearuniform
tilt to alternatives such as infrastructure
has resulted in supply challenges and delays.
In 2016, all sovereign profiles displayed a
return gap (figure 3), driven by the low interest rate
environment, however this shortfall was greatest
among investment sovereigns. Traditionally, liability
sovereigns have hedged fixed income against
inflation (due to the focus on matching outflows
to beneficiaries), while investment sovereigns have
left their inflation exposure open. This has led to
investment sovereigns having the greatest return
gaps, as developed economies return to growth
and inflation rises. While liquidity and development
sovereigns are also suffering from low interest
rates, respondents noted that investment returns
were of secondary importance, relative to liquidity
and development objectives. Furthermore, liquidity
sovereigns noted that their long-duration fixed
income assets had increased in value as rates fell.
Against this, sovereigns are challenged by fixed
return targets, which are typically set to match
potential liabilities and do not adjust to market
conditions. Despite return challenges, we do not
see a concurrent shift in investment activity
year-on-year (as we go on to explore).
The challenges
of the return gap
are most severe
among investment
sovereigns.
06
Fig 2. Importance of macroeconomic conditions to strategic and tactical asset allocation
• Importance to SAA
• Importance to TAA
8.1
Low interest rates
9.1
7.4
US election
8.5
7.1
Commodity prices
6.6
6.9
Brexit, EU break
7.5
6.5
Stock market volatility
7.5
5.7
Terrorism
5.9
5.6
War in Syria
5.5
5.5
Emerging market
6.9
5.1
Climate change
7.0
5.0
Chinese volatility
6.1
Sample is based on sovereign investors and excludes central banks. SAA=Strategic Asset Allocation. TAA=Tactical Asset Allocation.
Sample=20.
Fig 3. Past year returns and target returns (% AUM)
• Past year returns
• Target returns
4.1 Sovereign sample
57
6.1
2.6
6.3
Investment sovereigns
12
4.9
6.0
Liability sovereigns
27
2.4
3.3
Liquidity sovereigns
7
4.6
7.7
Development sovereigns
11
Sample is based on sovereign investors and excludes central banks. Sample size shown in grey. Data is not weighted by AUM.
07
Fig 4. Expected time (years) to deploy assets
• 2016
• 2017
Infrastructure Private equity Real estate Hedge funds
4
3.5
2.3
2.4
2 2
1.7
1.5
Sample is based on sovereign investors and excludes central banks.
Sample: 2016=21, 2017=35.
08
Deployment challenges are limiting sovereign
ability to match targets
In previous reports, we observed sovereigns' return
gaps, driven by low interest rates and challenging
targets for fixed income allocations. We have also
noted how appetite for alternatives has grown as
sovereigns seek greater returns from private markets.
In last year’s report, we demonstrated that high levels
of competition in infrastructure and private equity
were causing sovereigns to shift deployment of real
assets towards real estate.
Competition for infrastructure and private equity
deals has accelerated in 2016, with deployment
times increasing across alternative asset classes
(figure 4). While the growth in these times is small,
it is significant: sovereigns are increasingly dependent
on their alternative investments to generate yields,
however, growing levels of undeployed capital for
alternative investments are being held in cash and
money market funds, so that sovereigns can respond
quickly when real asset opportunities arise. These
highly liquid investments offer limited returns,
particularly in comparison to sovereign targets for
real asset investments, causing further growth in
the return gap.
Risk of fund withdrawals is slowing further
illiquid asset investment
The ability of sovereigns to respond to the return
gap is being limited by the increasing likelihood of
withdrawals. Over the past three years, governments
have responded to economic volatility by reducing
new funding to sovereigns and, in some cases,
drawing down from sovereign reserves, as seen
in figure 5.
While previously only liability sovereigns
experienced regular drawdown of funds (in the form
of outflows to beneficiaries), an increasing propensity
for government withdrawals is encouraging
investment and liquidity sovereigns to consider the
liquidity of their portfolio. Liquidity sovereigns were
comfortable in their ability to withdraw from their
portfolio at short notice, however, many sovereigns
stated that liquidity management was an entirely
new objective, with certain investment sovereigns
responding by creating tactical allocations to cash
and money market funds. This has led to conflicting
liquidity requirements: sovereigns have to manage
withdrawal risks by shortening time horizons while
simultaneously seeking to access illiquidity premia
to generate greater returns.
Fig 5. Expected new funding and cancelled investments (% AUM)
• New funding
• Cancelled investments
Sovereign sample Investment sovereigns Liability sovereigns Liquidity sovereigns Development sovereigns
2015
37
2016
56
2017
58
2015
9
2016
10
2017
10
2015
17
2016
26
2017
27
2015
14
2016
6
2017
8
2015
7
2016
14
2017
13
15
9
8 8
7 7
6
6 6
5 5
4 4
3 3
-1
-1
0
0
-2 -2
-2
-3 -3
-3
-3
-4 -4
-5 -5
Sample is based on sovereign investors and excludes central banks. Sample sizes shown in grey. Data is not weighted by AUM. Periods shown reflect past year new
funding/cancellations.
09
Fig 6. Change in past year allocations by asset class (% citations)
• Decrease
• Stay the same
• Increase
Global equity
2013
52
24
24
2014
20
46
34
2015
12
52
36
2016
20
55
25
2017
13
63
23
Home market equity
2013
40
30
30
2014
18
41
41
2015
23
50
27
2016
25
57
18
2017
23
67
10
Global bond
2013
55
27
18
2014
25
64
11
2015
22
63
16
2016
23
65
13
2017
17
69
13
Home market bond
2013
42
25
33
2014
45
45
10
2015
53
47
2016
36
57
7
2017
25
73
3
Sample is based on sovereign investors and excludes central banks.
Sample: 2013=22, 2014=36, 2015=33, 2016=44, 2017=60.
10
Uncertain market direction has challenged
response to return gaps through asset allocation
Political change across developed markets challenges
high conviction geographic allocations outside a small
number of perceived ‘safe haven’ markets. Similarly,
the staggered shift to QT is creating uncertainty over
sovereign forecasts for asset class performance.
Additionally, in many cases allocations to illiquid
assets were approaching restrictions put in place by
investment boards, with little room to further tilt to
risk classes.
Such uncertainty over investment strategy means
that very few sovereigns are willing to adjust strategic
asset allocations, and internal restrictions are a
challenge to those that are seeking to change. This can
be seen in figure 6, in which an increasing number of
sovereigns state they have ‘frozen’ asset allocations
to traditional asset classes.
A focus on business model to drive implementation
efficiency and liquidity premium capture
As willingness to take active positions in geographic
and asset allocation decreases, the effects of the
return gap are compounded. Sovereigns are unable to
respond to growing shortfalls through asset allocation
alone, and are instead looking at how to evolve their
business models to drive more efficient realisation
against portfolio objectives, notably through
internalisation or investment partnerships to reduce
management cost and improve placement efficiency.
However, sovereigns acknowledged that any
changes to business models carried trade-offs against
execution and investment risk:
– Many respondents have struggled to reach target
alternative allocations and the shift to internalise
or move to co-investment or operating partnerships
may create further constraints
– Over-investing in privately listed assets puts
sovereigns at risk of future valuation adjustments
while utilisation of alternative deployment models
(working directly with operating partners) has
implications for governance processes and disclosure
– Reducing intermediation while potentially improving
line-of-sight to placement also reduces external
objective inputs to asset selection and valuation
– Finally, the tilt to internalisation may not be
consistent with geographic diversification objectives,
and there is some evidence of an increasing ‘home
market’ bias despite stated objectives to the contrary
While the motivation for business model changes
is clear and aligned, there is an acknowledgement
amongst participants that not all sovereigns will be
successful in executing, with the potential for risk or
investment shocks where execution is unsuccessful.
As willingness to take active positions in geographic
and asset allocations slows, sovereigns must engage
with investment boards to include consideration of
market conditions (as well as potential outflows) in
their return targets to continue to work towards their
long-term objectives.
With limited
scope to act
through allocation
sovereigns are
focused on
alternative levers.
11
Increasing appeal of perceived ‘safe haven’ markets
Geopolitical uncertainty is leading to a focus on
perceived ‘safe haven’ international markets and
home markets.
2
Construction of subway
system extension,
New York
Sovereigns are targeting markets offering security
and growth
Traditionally sovereigns have grouped countries by
economic development or geographic region to form
their overall geographic allocations. Indeed, last
year, we highlighted increased allocations to North
America, based on perceptions of the US as a ‘safe
haven’ for sovereign assets, driven by the strength
of its currency and positive tax changes for
international investors.
While at a high level, sovereigns have been
unwilling to adjust regional allocations (as outlined in
theme 1), idiosyncratic geopolitical risks are causing
sovereigns to reweight to countries within these
allocation bands. In developed markets, uncertainty
over global interest rates is shifting this focus to
identifying markets to shelter assets (as shown by
the increased attractiveness of the US and Germany
in figure 7), with Brexit and the US election cited as
the factors of fastest growing importance to asset
allocation (growing importance cited by 82% and
68% of sovereigns respectively). Similarly, emerging
markets sovereigns are identifying countries with the
greatest potential for long-term economic growth.
Fig 7. Attractiveness of markets to sovereign investors
US
7.7 8.2 8
Brazil
6 5.6 5.4
Sample is based on sovereign investors and excludes central banks.
Rating on a scale from 1 to 10 where 10 is the most attractive. Rating scored as of Q1 of the given year.
Sample: 2015=26, 2016=44, 2017=58.
Sovereigns are
seeking greater
exposure to
perceived ‘safe
havens’ within each
key region.
14
• 2015
• 2016
• 2017
UK
Russia
7.6 7.5 5.5
4.1 4.7 5.1
Germany
Japan
7
7.6 7.8
5.5 6.4 6.6
France
China
6.2 6.6 6.1
5.8 5 5.2
Italy
India
5.6 5.9 6.1
5.6 5.9 7.1
Emerging markets
Developed markets
5.4 5.2 5.7
6.9 7 6.7
15
Growth of the US for both returns and protection
The attractiveness of the US has been driven by
interest rate rises (with expectations for further raises
this year) and bond yields lagging in other developed
markets (figure 8). There is also market confidence of
a ‘pro-business’ corporate tax regime following Trump
taking office in January 2017, causing sovereigns
to note the growth potential of US equity markets
(with 40% of sovereigns expecting to increase North
American allocations in 2017), as other developed
market stocks remain flat. Currency strength
underlies this optimism (USD up 3% against EUR and
20% against GBP in 2016 1 ), with some sovereigns
deliberately targeting dollar exposure through their
international investments. Liability sovereigns noted
the dual benefit of the open currency position, both
eliminating hedging costs and generating additional
returns relative to home market currency.
In our 2015 sovereign study, we highlighted the
attractiveness of real estate investments in developed
markets. Under FIRPTA (Foreign Investment in
Real Property Tax Act), sovereign appetite for real
estate investment in the US has further grown. Most
notable, however, is the growing optimism around
the potential for new infrastructure deals in the
US following political campaigning suggesting an
investment opportunity of US$1 trillion.
Despite positivity, sovereigns in Europe and Asia
noted that successful US real estate investments
gave no guarantee of similar opportunities within
infrastructure. Many respondents were concerned
about growing protectionism in the US, questioning
if it might both limit access to infrastructure and real
estate investments for foreign sovereigns and would
have long-term economic implications as foreign
relations are strained.
Currency strength
underlies optimism
for the US.
1
Source: XE currency data. Data from 01 January
2016–01 January 2017.
Fig 8. 10-year government bond yields
US UK Germany Japan
2.5
1.3
0.2
0.0
Source: US – US Treasury Resource Center, UK – Bank of England Data, Germany – Bundesbank
Statistics, Japan – Ministry of Finance Interest Rate Index. Data taken as daily average yield on
30 December 2016.
16
UK challenges centred on currency, but future role
as European hub is unclear
While the UK has faced short-term challenges over low
interest rates (relative to the US), the Brexit decision
poses a threat to the long-term attractiveness of
the UK. Brexit is seen as a significant negative for
UK investment, and investment sovereigns with
European interests questioned the future of the UK
as an ‘investment hub’ for Europe, given uncertainty
over taxes on imports and market access. Liquidity
sovereigns also noted their concern that demand for
UK government bonds would drop, challenging the
liquidity of their holdings.
Despite this negative sentiment, UK allocations
remain relatively stable with stated declines
likely linked to currency fluctuations rather than
withdrawal, as demonstrated in figure 9. Furthermore,
the fall in value of the pound has led to a rally in UK
stocks as export-linked businesses benefit from more
competitive pricing. The low value of the pound also
allows UK asset managers to offer their services at
a discount to international competitors. This low
entry price into the UK represents an opportunity
for UK managers who can demonstrate local market
expertise and robust currency hedging processes to
international sovereign investors.
There has also been a demonstration of ongoing
sovereign commitment to long-term alternative
investments in the UK. Many sovereigns noted that
they were unlikely to cancel UK real estate assets
in the near future and there have been several
high-profile statements of renewed commitment to
UK infrastructure investments following the Brexit
decision, including Thames Water and Heathrow
Airport. However, respondents noted that these are
long-term investments which are unlikely to move
until the outlook of the UK as a preferred investment
destination (comparable to the US or Germany)
becomes clearer.
Fig 9. Exchange rate, geographic allocations to the UK (% AUM)
GBP/USD exchange rate
(External data)
1.48
Geographic allocations
to the UK (% AUM)
(Sovereign sample)
4.5
1.23 3.8
• 2016
• 2017
LHS: Source – XE currency data. Data as of beginning of given year. RHS: Sample is based on
sovereign investors and excludes central banks. Data is not weighted by AUM.
Sample: 2016=55, 2017=57.
17
Positivity towards Germany amidst concerns
for Continental Europe
Brexit has raised awareness of the related threat
of wider EU disbandment, although this has had
a relatively small effect on Continental European
allocations on the whole (from 12.8% of AUM in 2016
to 11.2% in 2017). Instead, it has caused sovereigns
to focus on the more stable countries within the EU.
Sovereign investments in Germany have increased
based on its economic strength (with its attractiveness
increasing year-on-year in figure 10), and many
respondents attribute this to Germany’s industrial
sector (an estimated 30.3% of GDP relative to 19.2%
in the UK, 19.4% in France and 23.9% in Italy).
However, investment sovereigns identified German
financial markets as an area of potential growth
post-Brexit, offering a stable platform for investments
across Europe. Furthermore, liability sovereigns
explained that if the eurozone were to disband,
Germany’s role as the financial hub of Europe would
have significant upside for the German currency,
with many funds building currency hedging strategies
to take this into account.
Fig 10. Attractiveness of continental European markets
to sovereign investors
• 2015
• 2016
• 2017
Germany France Italy
7.8
7.6
7.0
6.6
6.2
6.1
6.1
5.9
5.6
Sample is based on sovereign investors and excludes central banks.
Rating on a scale from 1 to 10 where 10 is the most attractive. Rating scored as of Q1 of the given years.
Sample: 2015=26, 2016=44, 2017=58.
Germany is seen
as a stable platform
for investments
across Europe.
18
Sovereigns see potential in Indian private markets
Despite tactical switching between developed
markets, increasing investment into emerging markets
remains a long-term strategic objective for many
sovereigns (as stated in our 2016 report). Stock
markets have relatively small coverage of emerging
market economies, driving greater emphasis on
illiquid real asset categories. In fact, many sovereigns
use infrastructure deals to manage near-term macro
and geopolitical risk, as outlined in our 2015 study.
However, challenging placement dynamics and
uncertainty over commodity prices mean sovereigns
are being more selective in their emerging market
investments, focusing on the identification of highgrowth
markets.
While many emerging markets have struggled with
slow commodity price recovery and political instability,
India has experienced consistent growth in GDP (figure
11). However, India’s economic structure is complex
and publicly listed investments have relatively low
coverage of the wider economy (with stock market
capitalisation 65% of GDP in India, relative to 146% in
the US and 112% in the UK). Indeed, many sovereigns
are focusing on opportunities within Indian private
equity (as seen in India’s increasing private sector
attractiveness in figure 12), seeking returns from its
rapid urbanisation.
Typically, in emerging markets sovereigns have
faced considerable regulatory and governance
challenges to direct private equity investment, leading
them to seek assistance from external managers.
However, in 2016 India introduced reforms to foreign
direct investment, loosening government restrictions
on investment in certain sectors, with wider reform
expected in 2017. This has enabled large investment
and liability sovereigns to invest heavily in Indian
private equity, and many funds are developing internal
management expertise based in India to have greater
access and control over private equity investments.
Despite sovereign desire to invest directly in Indian
private equity, the development of local management
capability is often complex and deployment of assets
to meet targets will be lengthy. While concerns
remain over governance and liquidity of private equity
investments in emerging markets, sovereigns note
that local management teams are best equipped to
deal with these concerns.
Fig 11. Gross domestic product of
emerging markets (US$, trillions)
0.37
0.35
1.33
1.86
2.03
2.09
2.47
2.46
1.8
2.23
2.05
• 2015
• 2016
• 2017
India
Brazil
Russia
South Africa
0.31
Source: World Bank Data – GDP (Current US$) data as at 17 April 2017.
Fig 12. Opportunity of Indian private sector
and attractiveness of India to sovereign investors
• 2015
• 2016
• 2017
Private sector opportunity
Attractiveness to sovereigns
6.1
6.8
7.1
5.9
5.9
5.6
Sample is based on sovereign investors and excludes central banks.
Rating on a scale from 1 to 10 where 10 is the most opportunistic/attractive. Rating scored
as of Q1 of the given years.
Sample: 2015=26, 2016=44, 2017=58.
19
Fig 13. Geographic allocations to home market (% AUM)
• 2015
• 2016
• 2017
47
45
40
Sample is based on sovereign investors and excludes central banks. Data is not weighted by AUM.
Sample: 2015=39, 2016=55, 2017=57.
20
Home market investment allows for greater
internalisation and reduced hedging costs
Given recent increases in the likelihood of outflows,
figure 13 shows how sovereigns are growing their
focus on home market allocations to reduce foreign
currency exposure. While home market investment
aligns to greater internalisation, it also grows
correlations between sovereign portfolio performance
and local economic performance. Since sovereign
funding is also heavily dependent on the local market,
sovereigns are at risk of increasing cashflow strains
(from both investment returns and new funding) when
the local economy underperforms.
Sovereigns may need to revert to greater
geographic diversification, at the cost of shortterm
returns
The combination of continuing home market tilts,
along with a concentration in a small number of ‘safe
havens’, threatens to squeeze allocations to markets
that lack clear growth or stability attributes. As the
granularity of geopolitical risk models increases,
sovereigns are at risk of being overly selective in their
geographic investments and becoming dependent
on single markets within geographic regions.
However, many of the driving forces behind
concentrated geographic allocations are unlikely
to last. Interest rate disparity in developed markets
is expected to reduce if European and Japanese
quantitative tightening begins, suggesting that
increased fixed income allocations to the US are
tactical. Similarly, while growing emerging market
allocations is a strategic initiative, India has been
targeted due to its recent economic growth, relative
to other major emerging markets.
While sovereigns are willing to be overweight
individual countries to capture additional returns
(either through short-term tactical allocations or
greater internalisation), they may shift their focus
back to managing risk across diverse geographic
allocations, fulfilling their aim to make government
reserves independent of local economic performance.
These is an
inherent risk in
overcommitting to
individual markets.
21
Attraction to real estate for matching and
flexible participation
Sovereigns are increasing allocations to high-quality
direct real estate given perceived return, matching
and flexibility attributes.
3
Trains arriving at
Liège-Guillemins train
Station by Santiago
Calatrava, Belgium
Real estate is perceived as attractive based
on supply of investment opportunities
In last year’s report, we monitored sovereign
investment in real estate, with its perceived superior
supply-side dynamics relative to other real asset and
alternative categories. While asset allocation shifts
have slowed this year, the trend towards real estate
has accelerated, driven by capacity for sovereign
investment. For example, it is noted that while
relatively few countries offer private investors access
to a wide range of investment-grade infrastructure
investments, there is broad access to commercial and
office sectors across major developed and emerging
markets, causing sovereigns to cite real estate as
the asset class with the fewest execution challenges
(figure 14).
Furthermore, investment sovereigns with large
internal teams noted that real estate was unique
in its scope for greenfield investment. Sovereigns
continue to develop internal asset management
capability in real estate (figure 15 highlights the
high levels on internal management within real
estate), enabling them to generate investment
opportunities themselves, rather than source and
compete for real estate deals with other investors.
In an environment where challenges executing
against target real asset and alternative allocations
drag on investment returns, supply depth is a key
differentiator for real estate.
Target illiquid
alternative
allocations have
increased, despite
deployment
challenges.
Fig 14. Underweight asset classes due to
execution challenges (% citations)
Infrastructure Private equity Real estate
• 2016
• 2017
70 71
60
54
45
27
Sample is based on sovereign investors and excludes central banks.
Sample: 2016=20, 2017=41.
Fig 15. Internal management of international
illiquid alternatives (% AUM)
• Real estate
• Private equity
• Infrastructure
50
15
22
Sample is based on sovereign investors and excludes central banks. Data is not weighted by AUM.
Sample: Real estate=31, Private equity=26 Infrastructure=24.
24
Real estate offers income generation and
access optionality
This year, sovereigns cited a range of reasons for
increasing target real estate allocations, including
the scope to capture liquidity alpha, the potential
to generate income matching mid- to long-term
liabilities and the potential for internalisation and
control. With lower interest rates, lower funding
commitments to sovereigns and a lack of appetite
to vary asset allocations, the potential for leveraged
participation in real estate (equity and debt) appeals
to sovereigns seeking alternative means of scaling
‘frozen’ asset allocation to match liabilities.
In addition, while there are few alternatives to
third-party management and fee structures across
infrastructure and private equity (with co-investment
in many cases challenged by fund governance and
risk appetite), sovereigns have a broad range of
options to participate in the development, acquisition
and management of real estate. Indeed, there was
no consensus among sovereigns on the best placed
real estate manager, with internal and external
managers, developers and operators cited as
preferred real estate partners in figure 16. Sovereigns
are also attracted to the flexibility of real estate value
chain participation as it reduces upfront funding
commitments and allows for a gradual internalisation
of expertise and resource.
Low fixed income
yields means
sovereigns are
beginning to view
property as a
reliable source of
income.
Fig 16. Preferred manager for
real estate investments (% citations)
• Real estate developer
• Real estate operator
• Internal investment team
• External asset manager
36
29
21
14
Sample is based on sovereign investors and excludes central banks.
Sample=28.
25
Fig 17. Allocations to international and home market real estate (% AUM)
• International real estate
• Home market real estate
2015 2016 2017
4.7
4.4
3.4
2.8
2.2
1.2
Sample is based on sovereign investors and excludes central banks. Data is not weighted by AUM.
Sample: 2015=44, 2016=57, 2017=62.
Fig 18. Primary factor driving real estate investment (% citations)
Generate higher yields Accessing liquidity premium Diversification from
traditional assets
Long-term investment
58
18
15
9
Sample is based on sovereign investors and excludes central banks.
Sample=33.
26
Property allocations are concentrated in
‘home market’ to match liabilities
While real estate allocations account for a small
portion of sovereign portfolios, there has been
significant relative growth in allocations, particularly
in sovereign home markets (figure 17).
Home market real estate is attractive for liability
and investment sovereigns, as there is no need to
hedge currency exposure, as outlined in theme 2.
The increase in home market allocations is mirrored
in sovereign appetite for income-generating real
estate assets (with yield generation the lead factor for
increased allocations shown in figure 18), matching
home currency-denominated liabilities at higher yields
than domestic fixed income. Consequently, the tilt to
real estate in home markets is substantially funded
from lower allocations to fixed income (figure 19).
Home market allocations also benefited from the
trend to internalisation of real asset management.
With limited capability to source and manage real
estate globally, sovereigns noted that internal
investment teams focused more on the local market,
particularly in respect of greenfield or residential
investments. Domestic real estate investment was
greatest among Western and Asian sovereigns (4.9%
and 3.1% of assets respectively), due to the depth
of high-quality domestic real estate markets. Home
markets were viewed as more familiar and accessible;
there was a view that proximity facilitated oversight
and control, which in turn afforded greater comfort
in higher risk categories. Many respondents were also
more confident in their ability to pitch for real estate
deals locally, given the positive reputation
of sovereign investors.
Fig 19. Primary source of funds for new real estate investments (% citations)
Fixed income
48
Equities
23
Liquid alternatives
16
New contributions
13
Sample is based on sovereign investors and excludes central banks.
Sample=31.
27
International real estate focused on key markets
with potential for long-term investment
International real estate allocations also grew in
the period to 2016, though at a lower rate than
home market. Sovereigns reported that increased
international allocations in many cases represented
tactical factors such as restrictions in domestic
market or challenges achieving target allocations in
infrastructure or private equity.
As a result, increases in international allocations
were relatively concentrated in terms of asset quality
(tier-1 assets offering a comparable return profile
of private equity and infrastructure). This has led
sovereigns to expect greater growth in high grade
office and commercial real estate (figure 20), with
long-term tenancies underpinning income generation,
over industrial or residential categories which offer
asset growth and development potential.
The importance of quality to international real
estate allocations is also evident in geographic
allocations. Sovereigns prefer ‘safe haven’ markets
such as North America and Western Europe when
investing in overseas real estate, with developed
markets leading sovereign citations for preferred real
estate locations shown in figure 21.
Sovereigns acknowledged the benefits
of external asset managers, particularly
for international allocations
The success of domestic real estate investments in
matching liabilities and the scope to capture liquidity
alpha through internal models is reflected in the pace
of home market allocations over the past three years.
However, looking forward sovereigns appreciate
that further increases may be constrained by asset
allocation or the maturity and depth of the local
market. Many sovereigns also noted that there were
risks associated with further internal investment in
home market real estate:
– Despite a focus on high-quality assets, liquidity
is a challenge for real estate investors and many
sovereigns are approaching limits on the size of
their investments
– Growing internalisation leaves sovereigns without
third-party support in governance and compliance
for their real estate investments
– If interest rates rise, demand for real estate is
expected to slow, with implications for both asset
pricing and liquidity
However, on the assumption that interest rates
globally remain lower near-term, we expect that
sovereign demand for real estate will grow faster
than sovereigns are willing or able to deploy to
home markets. As a result, we expect that over
the next three years allocations to international
markets will grow, and diversification outside
preferred geographies and classes will accelerate.
Despite success in greenfield investing in their home
market, sovereigns are less able to influence supply
of real estate opportunities overseas, providing an
opportunity for external asset managers to support
sovereigns in sourcing and managing real estate deals.
Developed market
sovereigns have
access to a wide
range of highquality
domestic
real estate assets.
Fig 20. Future increase in real estate sub-asset class allocations (% citations)
40
Office
40
Commercial
28
Residential
16
Industrial
Sample is based on sovereign investors and excludes central banks.
Sample=25.
28
Fig 21. Preferred location for real estate investments (% citations)
• UK
• Western Europe
• North America
• Home market
Residential Commercial Office Industrial
5
5
9
9
24 27
10
48
62
24
36
47
43
32
19
Sample is based on sovereign investors and excludes central banks.
Sample=22.
29
Environmental, social and governance (ESG)
growth dependent on performance data
Perspectives on ESG are polarised with supporters
moving to further embed and integrate ESG in
investment processes while non-supporters wait
for evidence of investment implications.
4
The Hoover Dam on
the Colorado River,
Arizona, US
In the absence of long-term risk and performance
data, the role of ESG is unclear for many sovereigns
Environmental, social and governance (ESG) investing
looks to incorporate ethics and sustainability into
the investment process. Sovereigns are well placed
to implement ESG strategies (or component substrategies)
due to their scale, reach, size and longterm
orientation. In addition, many investment and
liability sovereigns have a clear basis to consider
sustainability factors in delivering their objectives,
given their own mandates and through their growing
internal management capability.
However, contrary to early expectations, uptake
of ESG practices appears to be less broad than
initially anticipated. On the one hand, established
sovereigns across Europe, Canada and Australia have
been pivotal to the evolution of ESG investing among
institutional investors. Many of these sovereigns were
crucial in the development of sovereign investment
strategies over past decades, and continue to have
high levels of influence over sovereign models globally
relative to their size. Against this, funds in the US
and emerging markets have been reluctant to commit
to ESG (figure 22) in the absence of objective data
on the investment risk/return trade-offs implicit in
these strategies.
While uptake of ESG has not increased in line
with historical expectations, there is a clear appetite
for perspectives and analysis from adopters, asset
managers and academics. In fact, among institutional
investors globally ESG is cited as the most important
area for thought leadership (NMG’s Global Asset
Management Study 2017), highlighting investor
demand for greater understanding.
Qualified support for ‘environmental’ and ‘social’
screens given reputational risks of non-adoption,
however further commitment depends on emerging
evidence of investment implications
For sovereigns looking to adopt ESG investing, the
most common step is to introduce negative screens
on managers and securities which fall below ethical
standards (figure 23). This process lends itself to
environmental and social factors, given growing
levels of disclosure of carbon footprint and employee
diversity within public markets. Indeed, environmental
factors are among the ESG issues of greatest
importance to sovereigns shown in figure 24.
Certain sovereigns noted that negative
environmental and social screens can be simply
inserted into the investment process as an extra step
within security selection, with minimal additional
costs of management and expertise. Respondents
also stated that the measurement of the investment
impact of negative screens was simple, as the social
investment strategy was most often constructed
from a fully inclusive benchmark.
Despite some non-users citing analysis showing
the negative effect of ESG screening strategies
on short-term returns, there was a sense among
interviewees that greater levels of disclosure
increased reputational risk of non-adoption relative
to high-profile ESG adopters.
ESG adoption
has been driven
by established
sovereigns across
Europe, Canada
and Australia.
32
Fig 22. Sovereign adoption of ESG factors (% citations)
West (ex-US)
Rest of world
91
32
Sample is based on sovereign investors and excludes central banks.
Sample: West (ex-US)=11, Rest of world=44.
Fig 23. ESG screen usage (% citations, ESG users)
Security negative screen Manager negative screen Manager positive screen Security positive screen
45 32 23 18
Sample is based on sovereign investors and excludes central banks. Multiple responses.
Sample=22.
Fig 24. ESG issue importance (ESG users)
• Environmental factor
• Social factor
• Governance factor
7.9
7.8
Climate change
Sustainability
7.2
7.2
Financial disclosure
Energy resources
6.9
6.9
Human rights
Executive remuneration
6.4
Diversity
5.8
Water scarcity
Sample is based on sovereign investors and excludes central banks. Rating on a scale from 1 to 10 where 10 is the most important. Rating scored as of Q1 of the given year.
Sample=22.
33
Fig 25. Current approach to investment management by size of assets (% citations, ESG users)
• Attend AGMs
• Board representation for
majority of investments
• Actively engage with board
• Don't actively engage
11
26
AUM < US$ 25bn
19
58
5
25
29
AUM > US$ 25bn
35
23
23
Sample is based on sovereign investors and excludes central banks. Sample sizes shown in grey.
Fig 26. Effect of ESG on investment costs/long-term returns (% citations, ESG users)
• Increase in returns
• Decrease in returns
• No difference
Effect of ESG on long-term returns
Effect of ESG on investment costs
70 52
17
13
48
Sample is based on sovereign investors and excludes central banks.
Sample=25.
34
Leading adopters are embedding governance-based
engagement, with an expectation of improved longterm
returns
While non-adopters wait on the evidence of ESG
investment outcomes, leading adopters are moving
further down the path of integrating ESG principles
into investment allocation and management
decisions, including through active engagement with
or participation in investee company decision-making.
Larger sovereigns with internal asset management
capability were most confident in their ability to
execute their ESG strategies, due to their higher levels
of engagement with their investments (figure 25).
These larger sovereigns noted that direct engagement
benefits substantially outweighed the cost of external
advisers and representation; notably
– The largest sovereigns drew a clear line from longterm
investor influence on corporate structure
and executive remuneration to ‘active’ investment
performance through the cycle
– Sovereigns felt able to better represent the interest
of government or non-government stakeholders
through direct engagement
– Finally, for sovereigns committed to ESG, direct
governance engagement provided a mechanism
to proactively drive an ESG agenda in future
investment and management decision-making
Future uptake of ESG integration requires more
performance data, while growth in active ownership
requires third-party assistance
The adoption of negative screens is encouraging
for ESG advocates; however, the majority of current
non-adopters are unwilling to move further in the
absence of strong objective evidence of positive
investment risk/return outcomes from ESG investing
relative to cost. ESG adopters overwhelmingly
observe a positive differential in long-term returns
(with 70% of respondents perceiving an increase
in returns from ESG as seen in figure 26), and
many adopters explained that they were seeking to
integrate systematic ESG risk measurement into the
investment process. However, ESG user and non-user
respondents acknowledge that there is a need for
robust data on integrated ESG strategies, which can
only be addressed through continued measurement
of the impact on performance.
Despite uncertainties around the impact of ESG
integration, there is a growing consensus among all
respondents on the positive effect of governance
on investment returns. However, there are many
challenges to developing and managing an active
ownership strategy:
– Many sovereigns have not defined their governance
principles and were wary of demanding levels of
transparency from their investees that the sovereign
fund itself did not provide
– The adoption of active ownership requires hiring
subject matter experts, and many investment
sovereign respondents were intent on using
recruitment budget to expand internal investment
teams
– Certain sovereigns did not hold shareholder voting
rights across the majority of their securities and
were wary of the costs involved in switching these
investments for those with voting rights
– Many respondents stated that they were challenged
by lack of engagement from consultants and asset
managers
While smaller sovereigns have been dissuaded from
investment engagement by these cost restraints,
evidence of benefits in returns and representation
of sovereign interests will be key in driving greater
uptake of sovereign active ownership. With some
sovereigns looking internally to invest, based on the
ability to embed government-based engagement,
asset managers must respond by offering sovereigns
the opportunity participate in the stewardship of
companies by means of voting rights.
There is a need
for robust data on
the performance
of integrated ESG
strategies.
35
Central bank risk appetite driven by financial
market exposure
Central bank investment priorities and risk
appetite vary according to the size of the country’s
reserves and to the level of exposure to financial
market shocks.
5
Postal employees filing
packages at parcel
sorting facility
While central bank investment tranches are
in some ways comparable to sovereign portfolios,
they are differentiated by the former’s broader
market functions
While there are similarities in the approach taken to
investment tranches (in terms of risk asset allocation
and development of internal capability), central banks
have a broader set of functions, including local market
money supply, the role of lender of last resort and
currency exchange rate regime management. These
factors have considerable influence over investment
strategy and capacity, and differentiate central banks
from sovereign investors.
In last year’s report, we focused on emerging
market (EM) central banks due to their increasing
use of investment tranches (reserves sub-portfolios
which prioritise investment return over liquidity),
which have similar allocations to sovereign investor
portfolios. We noted that many of the respondent
banks were moving up the risk spectrum in response
to achieving capital preservation in the face of low
and negative yields, and that reserve managers were
allocating higher levels of reserves to the investment
tranche. We explore how central banks in developed
markets with low financial market exposure have
followed emerging market reserve managers up the
risk spectrum.
Low banking sector exposure is accompanied
by lesser build-up in the levels of reserves and
a growing appetite for risk assets
In this year’s report, we have expanded our central
bank sample and segmented the central bank
universe into developed and emerging markets to
understand differences in strategy and pace of change
with respect to investment tranches. Within developed
market central banks, we further segmented them
into two categories: those with high exposure to
financial markets (DM High FME) and those with
low exposure (DM Low FME 1 ). We summarise these
classifications in figure 27.
While there are various means of calculating
reserves adequacy (with import coverage and shortterm
debt coverage most frequently cited in figure
28), all measures link level of reserves to potential
drawdown of funds. Following the Global Financial
Crisis of 2008, DM High FME central banks increased
estimates of the likelihood and size of potential
drawdowns, increasing the level of reserves over
the intervening years to better equip themselves as
‘lenders of last resort’. In 2016, this trend continued
with DM High FME central banks increasing reserves
more rapidly than DM Low FME and EM (figure 29).
DM High FME reserve managers rely on these large
net inflows to maintain high levels of liquidity (with
67% of respondents describing reserves as ‘ample’
in figure 30), and focus less on capital preservation
and investment returns. Furthermore, reserve
managers in High FME markets noted that they are
unwilling to invest in risk assets such as equities
or asset-backed securities as they are seeking to
diversify (not correlate) their reserves from local
financial market shocks.
1
Measure of financial exposure based on World Bank
Global Financial Development – Private credit by
deposit money banks and other financial institutions
to GDP (%), 24 June 2016.
Fig 27. Central bank segmentation
High financial
market dependency
(DM High FME)
Low financial market
dependency
(DM Low FME)
Emerging markets
(EM)
Market economic maturity
High
High
Medium
Financial market/GDP (%) High Medium/Low Medium/Low
Foreign reserves new flows High Medium Low
Reserves adequacy High High/Medium Medium
Foreign reserves risk
appetite
Low Medium High
38
Fig 28. Factors used to calculate reserve adequacy (% citations) • Rank 1
• Rank 2
• Rank 3
• Rank 4
42 45
Import coverage
29
33
6
6
Short-term debt coverage
3 6
6
GDP coverage
19 3
3
Money supply
3
6
13
Capital flight
3
6
3
Current account deficit
6
3
Exchange rate regime
Sample comprises of central banks only. Key denotes each factors' level of importance according to central banks. Rankings split into four categories in descending order
with rank 1=most important. Rating scored as of Q1 of the given year.
Sample=31.
Fig 29. Net increase in foreign currency reserves (% AUM)
DM High FME
4
DM Low FME
5
EM
18
Sovereigns
58
12
7.5
4.8
1.8
Sample size shown in grey. DM High FME=High financial market dependency. DM Low FME=Low financial market dependency.
Fig 30. Level of reserves adequacy (% citations)
• Ample
• Sufficient
• Insufficient
DM High FME
6
DM Low FME
6
EM
22
67
33 18
68
67
33
14
Sample comprises of central banks only. Sample size shown in grey.
39
Due to the lower capitalisation of local stock and
bond markets, economic performance in DM Low
FME countries is relatively less vulnerable to financial
shocks than in DM High FME markets, giving Low FME
central banks greater freedom to invest in higher risk
asset classes. Furthermore, whereas most High FME
central banks self-assess ‘ample’ reserves adequacy,
the majority of Low FME central bank respondents
describe reserve levels as ‘sufficient’, and are
therefore more likely to seek higher returns through
the investment tranche to improve their long-term
reserves adequacy position (figure 31).
Typically, emerging market central banks have the
lowest levels of reserves adequacy due in large part to
greater vulnerability to foreign shocks. Indeed, certain
emerging market central banks with a currency peg
noted that falling commodity prices had created
pressure on the local currency, causing a drawdown
of foreign reserves to maintain the peg. Countries
with more flexible exchange rate arrangements are
instead seeking greater exposure to risk asset classes
to generate positive returns to preserve capital and
maintain reserves adequacy.
Fig 31. Investment tranche usage (% citations)
• EM
• DM Low FME
• DM High FME
83
87
50
Sample comprises of central banks only.
Sample: DM High FME=6, DM Low FME=6 and EM=22. Note low sample.
DM High FME=High financial market dependency. DM Low FME=Low financial market dependency.
40
Emerging market central banks have pioneered
investment tranches to generate greater returns
and developed markets are exploring their ability
to follow suit
In last year’s report we identified that emerging
market reserve managers were developing an
investment tranche, to diversify away from lowyielding
government bonds and generate better risk
adjusted returns. This year, low interest rates again
led EM central banks to increase the level of the
investment tranche and invest in riskier asset classes,
targeting higher returns over time to support future
reserves adequacy. Additionally, certain emerging
market central banks had recently relaxed fixed
or managed exchange rate regimes, allowing
for greater freedom to allocate reserves to the
investment tranche.
As central banks (including DM Low FME)
expand the size and risk asset exposure of the
investment tranche, they also are assessing how
to best manage risk, return and cost, particularly
where higher levels of reserves and depth of internal
resources support developing internal management
expertise. Central banks have a range of resources
available in making their assessments, including
case studies and performance data from those EM
central banks reaching the end of the first cycle of
risk assessments, with many respondents indicating
their willingness to share such information with
peers. While we note the long timeline for the first
generation of EM central banks to establish their
investment tranches (an average of 22 months across
our emerging market sample), the availability of peer
support and information sharing has the potential
to create a positive network effect supporting
future implementations.
Central banks acknowledge the need for external
support as they move out the risk spectrum to
corporate bonds and equities
Typically, the development of the investment tranche
starts with asset-backed securities (figure 32). The
majority of central banks are comfortable managing
investment grade government debt internally and
perceive high grade asset-backed securities as
comparable in terms of management requirements
and risk profile.
However, reserve managers are moving up the
risk curve, primarily seeking to increase allocations
to equities and corporate bonds (figure 33). Many
respondents acknowledged they do not yet have
the necessary internal governance process or risk
management capability to manage these investments
internally. Respondents also noted that while
reserves management peers were able to assist
them in planning the development of the investment
tranche, their support often lacked technical detail
on investment governance and asset management
infrastructure.
Emerging markets
have led the
development of the
investment tranche
due to the relative
importance of capital
preservation.
Fig 32. First investment tranche asset class (% citations)
Asset-backed
securities
54
Equities Corporate bonds Alternatives
23
Sample comprises of central banks only.
Sample=30.
Fig 33. Investment tranche asset class future increase (% citations)
Equities Corporate bonds US agency MBS Agencies,
Multilateral debt,
Supranational
debt
20
3
68
57
39
35
Sample comprises of central banks only.
Sample=30.
41
Central banks are seeking external assistance in
building internal capability as well as for investment
strategy and execution
Central bank decisions on the allocation and risk
profile of the investment tranche allocations are
generally made internally. Reserves managers
are seeking wider assistance in building internal
investment frameworks to support their growing
appetite for risk asset exposure, whether through
asset management mandates or collaboration with
academic and multi-lateral institutions such as the
World Bank. Central banks will continue to look to
external managers for their technical advisory and
systems support (figure 34), as sovereigns have done
over many years.
While 87% of central bank respondents use an
asset manager within their entire reserves portfolio,
there is less usage when building the first investment
tranche (figure 35). This reflects a bias to first develop
internal capacity before outsourcing to external asset
managers for alpha generation and expansion into
new asset classes. Central banks are reluctant to
convert relationships into ongoing mandates until
they have developed the capacity to oversee the risks
incurred by external asset managers. Those that
elect to allocate assets to external managers include
requirements to continue supporting central banks in
developing their own internal management capability.
External managers must be patient and offer real
value through transfer of experience, processes
and technology, and must then have a sufficiently
compelling value proposition to sustain a long-term
commercial relationship.
Reserves managers
are seeking
assistance in building
internal investment
frameworks to
support growing risk
appetite.
Fig 34. Future asset manager support requirements
(% citations, current users of external managers)
Technology
advisory
83
Systems
support
Custodian
services
Broker
relations
63
46
21
Sample comprises of central banks who use external managers to manage assets.
Sample=24.
42
Fig 35. Use of external asset managers (% citations)
Entire foreign reserves portfolio
First investment tranche investment
• Yes
• No
87
59
13
41
Samples comprise of central banks only.
LHS Sample=27. RHS Sample=31.
43
Appendix
Pixel Cloud installation
in the atrium of an office
building, London
Sample and methodology
The fieldwork for this study was conducted by
NMG’s strategy consulting practice. Invesco chose
to engage a specialist independent firm to ensure
high-quality objective results. Key components of
the methodology included:
– A focus on the key decision makers within sovereign
investors and central banks, conducting interviews
using experienced consultants and offering market
insights rather than financial incentives
– In-depth (typically one-hour) face-to-face interviews
using a structured questionnaire to ensure
quantitative as well as qualitative analytics were
collected
– Analysis capturing investment preferences as well
as actual investment allocations with a bias toward
actual allocations over stated preferences
– Results interpreted by NMG’s strategy team with
relevant consulting experience in the global asset
management sector
In 2017 we conducted interviews with 97 funds:
62 sovereign investors (compared to 59 in 2016)
and 35 central bank reserve managers (18 in 2016).
The 2017 sovereign investor sample is split into three
core segmentation parameters (sovereign investor
profile, region and size of assets under management)
in figures 36 to 38. The 2017 central bank sample is
broken down by segment in figure 39.
Fig 36. Sovereign investor sample
By profile
Investment
sovereigns
Liability
sovereigns
26 28
Liquidity
sovereigns
Development
sovereigns
20 19
15
12 12 12
9 10 10
11 12 13
9 9
5 7 6 6
By region
• 2013
• 2014
• 2015
• 2016 • 2017
The West Asia Middle East Emerging
markets
21 22
19 19
16 16
13 13
11 12 13
10 10
8 7 7 9 8 8 9
By size of assets under management
US$
10bn
10–25bn 25–100bn >100bn
16
12
11 12
13
10 10 11
9
10
7
8
13
16
14 13 14
8
21 23
Sample=62.
Fig 37. Central bank sample by segment
DM High FME DM Low FME EM
23
6 6
Sample=35.
46
Invesco
Invesco is a leading independent global investment
management firm, dedicated to helping investors
achieve their financial objectives. With offices
globally, capabilities in virtually every asset class and
investment style, a disciplined approach to investment
management and a commitment to the highest
standards of performance and client service – we are
uniquely positioned to help institutional investors
achieve their investment objectives.
NMG Consulting – Shape your thinking
NMG Consulting is a global consulting business
operating in the insurance and investment markets.
Our specialist focus, global insights programmes and
unique network give us the inside track in insurance
and investment markets, translating insights into
opportunities. We provide strategy consulting, as
wellas actuarial and research services to financial
institutions including asset managers, insurers,
reinsurers and fund managers.
NMG’s evidence-based insight programmes
carry out interviews with industry-leading experts,
top clients and intermediaries as a basis to analyse
industry trends, competitive positioning and
capability. Established programmes exist in asset and
wealth management, life insurance and reinsurance
across North America, the UK and Europe, Asia
Pacific, South Africa and the Middle East.
47
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