By Patrick Thomson
Central bank monetary policy across the globe is significantly impacting markets around the world. In the Eurozone alone, more than a quarter (26%) of European government bonds are trading on a negative yield, over half (54%) of Germany Bunds are trading on a negative yield – with some 23% yielding less than the -20 basis points threshold for European Central Bank (ECB) bond buying eligibility.
Historically government fixed income has been an asset allocation staple of sovereign wealth funds (SWF). However, these unprecedented, low bond yields have pushed them to reassess their weightings and readjust their portfolios.
In recent years there has been a global proliferation of SWFs with 50% formed in the last eight years – 75% since 2000 – and a further 22 countries considering the introduction of a SWF. Additionally, since 2002, assets under management of this group of institutional investors has been growing annually at an unprecedented rate – over 15% – and this upward trend doesn’t look set to end, with assets forecast to grow from $7.1 trillion to $10 trillion by 2020*. The growth in SWFs and their assets, in a low yield environment, has meant an increased focus in diversification and a better understanding of the benefits of being a long-term investor.
SWFs are in a unique place to act as a long-term investor. Long-term investors can access a broader opportunity set than short term investors. They can invest in the entire short-term investment universe, and access a range of asset classes, factors and strategies that short term investors cannot. This combination can lead to greater diversification potential and has led to an expansion into newer asset classes, such as real estate, infrastructure and the private markets, as SWFs harness the premium associated with more illiquid assets and being a countercyclical investor.
In the traditional fixed income markets, areas of interest include high yield, emerging market debt and the broader credit markets. The private credit markets have also seen strong interest given the deleveraging of banks’ balance sheets at a time when corporate demand for credit has increased, especially in the area of loans and mezzanine finance. There has been a noticeable increase in allocations to equities, both public and private, especially in markets that have improving fundamentals such as the US and Europe. Emerging markets remain an area of strong focus, as well as new technologies that will have a significant impact of existing industries.
Real estate remains popular – offering excess spreads, inflation protection and stable yields. To access such assets cost-effectively, SWFs continue to leverage their asset manager relationships to source investments – direct transactions topped $50 billion during the first half of 2014, up 23% from a year ago**. However, competition continues to grow within this sector and bids for high quality, core real estate assets are hotly contested, most notably in London and New York. Consequently, SWFs are considering more opportunistic sectors, such as shopping malls and development projects, as well as looking in more peripheral markets. Interest in investing in international infrastructure continues to grow very noticeably, especially given the growing demand for long-term capital to finance these long-term projects, evidenced by a significant increase in both direct and co-investment transactions.
One other feature worth noting is the rapid growth in overseas offices set up by SWFs in order to capture these investment opportunities. For example, there are two sovereign funds from South-East Asia that have 11 and 9 overseas offices respectively. They are typically staffed with specialist investment professionals that are focused on capturing these broad investment opportunities. As SWFs continue their migration to proactive investment management around the world, the asset managers who wish to partner with them will need to evolve and understand the needs for global solutions combined with clear thought-leadership in order to serve this fast-growing segment of investors.
Patrick Thomson is global head of sovereigns at JP Morgan Asset Management
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