The changing macro environment, characterised by inflation and interest rate risk, is driving a pivot towards equities and private credit for sovereign wealth funds (SWFs), according to Invesco.
A recent Invesco report – Invesco global sovereign asset management study 2024 – explored how sovereign investors navigated a shifting investing landscape in 2024, adapting their strategies to seize opportunities and mitigate risk.
The report showed that following a tumultuous 2022, when the majority underperformed their return targets, SWFs and central banks rebounded strongly in 2023, with over half outperforming.
However, the report showed that SWFs remain cautious about the future, as many of the risks that made 2022 a tumultuous year, such as inflation and geopolitical conflicts, continue to cast a shadow over the investment horizon.
In light of these concerns, SWFs are actively reassessing their asset allocation strategies, seeking to reduce their exposure to duration risk and capitalise on the diversification opportunities presented by emerging markets.
The Invesco analysis showed a “notable reversal” in certain allocation trends of recent years, with net increases expected for equities, infrastructure and commodities but net decreases for cash, as well as less liquid investments such as private equity and real estate.
Infrastructure leads the way as the most popular asset class over the next 12 months, according to the research, with a net asset allocation intention of 21%, followed by listed equities (19%) and absolute return funds/hedge funds (12%).
By contrast, SWFs’ sentiment towards cash (-11%), real estate (-6%) and private equity (-3%) has diminished.
Last year the most popular asset class was fixed income with 28%, followed closely by infrastructure (25%) and private equity (21%).
It said that the appeal of equities reflects a broader trend among institutional investors, as they seek to capture long-term growth opportunities and hedge against inflation.
A SWF noted: “A higher equity allocation can help us to safeguard our portfolio’s purchasing power if inflation remains a concern.”
In contrast, heightened interest rate risk and uncertain future borrowing costs have dampened SWFs’ perception of the highly leveraged private market assets.
A SWF stated: “Private equity opportunities are simply not there,” while another added: “Private equity has been impacted by rate hikes and narrowing opportunities. Real estate is also facing the same headwinds and does not look as attractive as before.”
SWFs have also shown increased appetite for hedge funds as they aim to enhance portfolio diversification and achieve returns that are not tied to broader market movements.
Hedge funds’ capacity to manage risk in turbulent markets has made them particularly attractive in the present landscape, with credit-oriented strategies garnering particular attention due to their potential to capitalise on inefficiencies arising from the elevated yield environment.
Private credit
This outlook has also boosted the appeal of private credit, which has emerged as a compelling alternative to traditional fixed income, offering attractive yields and access to opportunities that do not exist in public markets.
More than one-third (36%) of SWFs have reported better than expected returns from their private credit investments, with just 5% indicating that the asset class had performed worse than expected.
Private credit is also seen as offering attractive diversification from traditional fixed income, highlighted by 63% of investors, and good value when compared to conventional debt (53%).
One SWF explained: “We like the diversifying opportunity with exposure to certain markets that you don’t find in public markets.” The growing appetite for private credit is reflected in broader market trends.
SWFs also recognise the challenges that come with investing in this increasingly competitive market. Finding high-quality opportunities (78%), aligning interests with partners (47%), and valuation and pricing (44%) are among the most frequently cited concerns, Invesco’s research disclosed.
To navigate this competitive landscape and maximise value creation, many SWFs are building out internal private credit teams with specialised expertise and capabilities. They are also focusing on identifying top-performing funds and positioning themselves strategically to gain access to attractive co-investment opportunities.
SWFs are also leveraging their unique strengths to gain a competitive edge in the private credit market. For example, their long-term investment horizons allow them to be patient and selective in their deal sourcing, focusing on opportunities that align with their strategic objectives and risk tolerance.
Additionally, many SWFs are forming strategic partnerships with leading private credit managers, using their scale and influence to secure favourable terms and access to exclusive deal flow.
One SWF from the Middle East highlighted the importance of these partnerships, stating: “We work closely with a select group of top-tier private credit managers who have a proven track record of delivering strong returns. By aligning our interests and leveraging our combined expertise, we are able to identify and execute on the most compelling opportunities in the market.”
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