Strong Sovereign performance provides liquidity and stability to Governments through the pandemic
Invesco today released its ninth annual Global Sovereign Asset Management Study, which details the views and opinions of 141 chief investment officers, heads of asset classes and senior portfolio strategists at 82 sovereign wealth funds and 59 central banks, who together manage USD19 trillion in assets.
With Covid-19 top of mind, impacting both operations and investment strategies, the impact of the ongoing pandemic is a major theme running throughout this year’s report.
In response to Covid-19, governments rushed to implement policy measures designed to prop up their economies and public services such as health, as well as providing support for businesses and households at a time when tax revenues retreated with depressed economic activity.
The impact on public finances led some governments to tap their sovereign wealth funds for capital to fund spending and plug budget deficits with more than a third of sovereigns seeing drawdowns during 2020, including 78 per cent of liquidity sovereigns and 58 per cent of investment sovereigns.
Many sovereign funds had learned the importance of building large liquidity reserves, following the global financial crisis, and were successful in supporting local economies and large companies in need of stabilisation finance. But the scale and speed of withdrawals for those that hadn’t, meant a significant impact on allocations, and led to a rethink on liquidity risk management. This has prompted a shift towards cash, with portfolio cash reserves more than doubling during 2020, as some sovereigns continued to focus on liquidity in anticipation of possible further withdrawals.
However, sovereigns also noted that the pandemic had shone a spotlight on the importance of liquidity more generally, both as a buffer for future black swan events and to afford the flexibility to take advantage of market opportunities when they arise, such as the early run in equities at the start of 2020.
The challenge of drawdown also varied across economies and geographies; 57 per cent of funds in the Middle East and 82 per cent in Emerging Markets registered drawdowns, notably due to their predominately commodity-based economies. In Asian and Western markets around a fifth of sovereigns registered drawdowns, with many stepping in to support businesses that might otherwise have struggled to find financing during the challenges of the pandemic.
The study also revealed a shift in asset allocation as sovereigns were forced to look elsewhere in the face of falling fixed income yields, as the widespread easing of monetary policy pushed rates lower. Fixed income allocations fell from 34 per cent to 30 per cent as concerns about stimulus-driven inflation returned. The volatility present in markets through the first quarter of 2020 caused an uptick in equites, reversing a two-year trend of declining allocations. Sovereigns increased their allocations by 2 per cent from 2020, rising to 28 per cent. A further 30 per cent of respondents expect to increase their allocation to equities over the next 12 months.
Rod Ringrow, Head of Official Institutions at Invesco, says: “Governments, faced with fiscal challenges, have turned to sovereigns to help plug their spending deficits. While some funds were well prepared, others have had to make rapid adjustments to generate liquidity. Sovereigns have also become aware of the importance of maintaining liquidity in order to take advantage of market opportunities as they arise. At the same time, generating sufficient returns in the face of an extremely low interest rate environment is having a substantial and potentially long-lasting impact on strategic asset allocations and perception of market risk.”
This study has tracked a significant increase in the incorporation of environmental, social and governance (ESG) principles into sovereign and central banks portfolios since 2017. In just four years the proportion of respondents adopting an ESG policy at the organisational level has increased dramatically, rising from 46 per cent to 64 per cent among sovereigns and from 11 per cent to 38 per cent among central banks.
The Covid-19 pandemic broadly acted as a catalyst for sovereigns and central banks to prioritise ESG; nearly a quarter 23 per cent of sovereigns and 45 per cent of central banks increased their focus on ESG as a result of the pandemic. The more mature and experienced an investor is in their ESG integration, the greater the likelihood the pandemic increased their focus on ESG considerations. Of the respondents integrating ESG for at least five years some 50 per cent increased their focus on ESG due to the pandemic.
Sovereigns’ ESG commitment is in stark contrast to the attitudes observed in the 2017 edition, which pointed to persistent reluctance by some to pursue ESG considerations at all, let alone during a crisis that exacerbates competing priorities. Yet there are idiosyncrasies arising from differences in the purpose of sovereign wealth funds which influence ESG adoption.
For example, liquidity sovereigns are more focused on maintaining liquidity to assist funding budget shortfalls and only 12 per cent of liquidity sovereigns have a formal ESG policy. In contrast 79 per cent of liability sovereigns have an ESG policy, reflecting their longer investment horizons and need to take into account long-term risks such as climate change, as well as a need to reflect the views and priorities of their beneficiaries.
Sovereigns have also accelerated their research for sustainable investment opportunities. A growing appreciation of the opportunities in climate-related investments has contributed to a shift in their motivations for ESG integration towards improved investment returns (Figure 6), with 57 per cent of sovereigns believing the market has not priced in the long-term implications of climate change, offering opportunities for alpha.
China’s appeal has steadily increased over the past four years, driven by attractive local returns and opportunities for diversification. In the first few months of 2020 when the implications of the Covid-19 pandemic were still unclear, sovereigns were among those investors making tactical shifts away from markets perceived as vulnerable, including China, to less risky investments, notably the relative quality and safety of North America, and US bonds in particular.
The rapid response to the Covid-19 pandemic enabled emerging APAC nations and economies to bounce back, and, as a result 40 per cent of investment sovereigns and 56 per cent of liquidity sovereigns see China as more attractive than pre pandemic level. Increased allocations to the region though came at the expense of Europe, the Middle East and other emerging markets such as Latin America and Africa, which were deemed to have presented a less appealing investment case.
Despite China’s growing appeal there are some notable obstacles to investing. 86 per cent of sovereigns point to the rising political tensions with the US as a significant barrier indicating that the tensions are influencing their asset allocation decisions. As well as being the most significant barrier to investment, political risk was the obstacle most commonly cited as having changed for the worse in the past two years.
Other obstacles investors noted include the inability to convert RMB (cited by 50 per cent of sovereigns), a lack of alignment of investments with ESG considerations (45 per cent) and the comparative lack of investor rights (41 per cent).
Looking ahead the study found that in 2021 sovereigns expect to finance increased allocations to China both with new capital and by drawing on North America and Developed Europe allocations. The rise of China as an economic and political powerhouse with favourable consumer themes – including an emerging middle class and a highly digitalised economy – all contribute to the prospect of attractive local returns for sovereign allocations. The survey found that 75 per cent of sovereign’s were attracted to invest in China due to the prospect of attractive local returns, a further 57 per cent saw China as an important portfolio diversifier.
Many investors remain bullish on China and are looking to build on existing allocations. Over the next five years 40 per cent of sovereigns plan to increase allocations, including 71 per cent of liquidity. A liability sovereign explained that China still offers the largest markets for sustainable energy, infrastructure, and development property and 32 per cent of liability sovereigns plan on increasing allocations to China over the next five years.
Ringrow says: “China’s increasing appeal comes from improved access and growing opportunities for attractive returns. This is being buoyed by innovations in areas such as technology and increased openness to foreign investment in sectors such as infrastructure. Chinese companies are making improvements in addressing environmental issues. However, transparency around corporate governance continues to be an area of concern and a rise in operational obstacles demonstrates the unique nature of the Chinese market."