Video: Where are Middle East sovereigns investing?

Middle East sovereigns were well prepared for the Covid-19 crisis, with a drop in valuations and plenty of excess cash offering them an unprecedented buying opportunity.

That’s according to the eighth annual Global Sovereign Asset Management study conducted by wealth management firm Invesco, which analysed the views of 139 chief investment officers, heads of asset classes and senior portfolio strategists at 83 sovereign funds and 56 central banks, who together manage $19 trillion in assets.

In 2019, 75 per cent of Middle East sovereigns reported outperforming their targets. However, even before Covid-19 affected markets, investors exhibited caution. Average equity allocations as an overall proportion of the portfolio at the end of 2019 were 16 per cent, compared with 34 per cent to illiquid alternatives and 32 per cent to direct strategic investments.

The movement away from equities was motivated in part by end-of-cycle concerns that led to decreasing strategic allocations. Looking forward, 43 per cent of Middle East sovereigns expect to increase allocations to equities over the next 12 months at lower valuations, with 29 per cent of sovereigns aiming to decrease equity allocations.

Bullish on fixed income

Regional sovereigns remain bullish about fixed income, with 57 per cent indicating that they plan to increase their fixed income allocations over the next 12 months. The report also found that 86 per cent have allocations to real estate debt, 71 per cent to infrastructure debt and 71 per cent to asset backed securities/structured credit. Emerging market debt has wide appeal among regional investors, with 71 per cent of the respondents having EM debt allocations.

“We see investors looking at less traditional credit assets such as emerging market debt as they look for portfolio diversification to boost returns,” says Zainab Kufaishi, head of Middle East and Africa at Invesco.

“Emerging markets have become better developed and more accessible, which is driving increased interest.”

Sovereigns in the Middle East are also likely to be looking to Europe for bargains, with 38 per cent increasing exposure to emerging Europe and 38 per cent to developed Europe.

“The market turmoil in March and April saw asset prices fall considerably, especially as some investors sold securities to ensure liquidity. This presented opportunities to gain exposure to ‘blue chip’ companies at very good prices,” says Kufaishi.

Shining bright

The study saw both central banks and a small but significant group of global sovereigns increase their allocations to gold. On average, 4.8 per cent of total central bank reserve portfolios are now allocated to gold – up from 4.2 per cent in 2019 – with almost half (48 per cent) of banks citing a potential to replace negative yielding debt as a primary advantage.

This was seen as the most important reason for moving into gold, more so than commonly-understood reasons such as diversification, return and its role as an inflation hedge. While central banks often approach gold with a pre-existing allocation, the starting position for sovereigns is rarely the same, the report stated.

For many sovereigns, gold is seen as a powerful inflation and tail hedge, with positive correlations in risk-on scenarios but barely correlated/negatively during a risk-off scenario.

“Last year’s study found gold to be growing in popularity, but Covid-19 has revealed it as an asset class now staking a claim to a new role within sovereign portfolios,” says Rod Ringrow, head of Official Institutions at Invesco.

“We think the development of these alternative modes of investment is likely to increase interest in gold in the coming years.”

The study also revealed that 83 per cent of central banks and sovereigns globally believe immediate action is required to combat climate change, and this is increasingly being translated into investment strategies. Up to 77 per cent of Middle East investors consider themselves to be disproportionately affected by climate change, far more than the peers in the West.

“Many sovereign entities in this region are beginning to give these issues more attention through organisational-level commitments and membership of international bodies and government-sponsored initiatives,” says Kufaishi.

“Some of the largest funds are very prominent in their actions, but in many cases the commitments take time to feed down into the investment process.”