Sovereign investors turn to emerging markets as geopolitical tensions rise

• Geopolitical tension becomes sovereign investors’ primary concern - compounded by upcoming elections in key markets - prompting moves towards greater geographic diversification and ‘safe haven’ assets.
• Competition between major powers is seen to create opportunities for emerging markets to attract investment and benefit from trends such as ‘near-shoring’.
• ‘Higher for longer’ outlook boosts appeal of listed equities and private credit.
• Energy transition becomes high-priority theme for long-term investment.
   

Hong Kong, 22 July 2024 – Geopolitical tension has surpassed inflation as the primary concern of sovereign investors and is prompting greater interest in allocating to emerging markets, according to the twelfth annual Invesco Global Sovereign Asset Management Study.

Geopolitical tensions were cited by 83% of respondents as a major risk to global growth over the next year, up from 72% in 2023, reflecting concerns over competition between the major powers and the potential for trade disruption. Sovereign wealth funds (SWFs) regard emerging markets as potential beneficiaries, pointing to the opportunities presented by trends such as near-shoring. As a result, 67% of SWFs expect emerging markets to match or beat the performance of developed markets over the next three years. 

Sovereigns also saw an average return of 7.2% a significant improvement from the -3.5% reported last year, which was the first time since the survey started in 2013 that sovereigns had experienced negative returns.

Invesco’s study, which has become the leading bellwether for sovereign investor activity, is based on the views of 140 chief investment officers, heads of asset classes and senior portfolio strategists at 83 SWFs and 57 central banks, who together manage $22 trillion in assets*. 

Emerging markets primed to benefit from multipolar world

SWFs view strategic competition between the US and China as likely to create opportunities for emerging markets to attract investment, forge new partnerships, and assert their economic and political influence on the global stage.

The majority (54%) expect this competitive dynamic to work to the advantage of emerging markets - versus just 12% that disagree – as they benefit from trends such as ‘near-shoring’ whereby major economies strengthen their global supply chains and manufacturing and procurement strategies across multiple locations. SWFs expressed interest in exposure to these opportunities, either through direct investment in companies based in these markets or via multinational companies expanding their presences within them.

However, SWFs are increasingly adopting a nuanced approach to investing in these markets, considering their unique risks and opportunities and reflective of each country’s positioning in an increasingly complex and interconnected geopolitical landscape. Within emerging markets, Asia (ex-China) is seen as the most attractive region overall, with a particular interest in India, with its large domestic market, growing middle class and increasing global competitiveness. Latin America is also in the spotlight, particularly for Middle Eastern and Asian Funds with Mexico and Brazil seen as well placed for US near-shoring. China remains a large and important market for SWFs, while they navigate regulatory shifts and geopolitics.

Within Emerging markets, EM debt is viewed as an attractive asset class for SWFs to diversify their portfolios. It is seen as offering attractive spreads over developed market bonds, providing a potential boost to portfolio income. Meanwhile, the improving economic fundamentals and policy reforms in many important emerging markets have enhanced their creditworthiness, reducing the perceived risks associated with investing in these markets. SWFs identified India as the most attractive destination for investing in emerging market debt; 88% are interested in increasing their exposure to Indian debt, up from 66% in 2022, reflecting improved confidence in the country’s economic prospects.

“Respondents in this year’s study continue to navigate a complex investment landscape, most immediately around geopolitical risks but also notably around climate change and increasing levels of public debt,” said Martin Franc, CEO, Asia ex Japan.  “These longer-term risks have become more salient as inflation has fallen back towards central bank targets.  Meanwhile, elections across major markets over the past year have proven difficult to predict, with such uncertainty clearly impacting investor sentiment.  In this environment, we should expect investors to remain cautious at least until we have more political and policy clarity among the major world economies.”

The allure of gold in an uncertain world

The impact of geopolitics has also been felt by central banks, which are increasingly turning to gold to diversify their reserves and hedge against various risks.

The majority (56%) of central banks agree that the potential weaponisation of central bank reserves makes gold more attractive, while 48% believe that rising US debt levels have increased its appeal.

Central banks are also looking to bolster their reserves over the next two years, motivated not only by long-standing geopolitical tensions but by upcoming elections in key markets. Central banks are mindful of the potential for election outcomes to trigger market volatility, currency fluctuations and changes in investor sentiment, leading 53% to indicate their intention to increase the size of their reserves over the next two years, with only 6% looking to reduce them. 

‘Higher for longer’ outlook prompts caution on leveraged asset classes 

Invesco’s study also revealed a widespread view that inflation and interest rates are set to stay higher than previously expected (43%) of SWFs and central banks expect inflation to settle above central bank targets, with just over half (55%) expecting targets to be met.

In total, 71% of SWFs and central banks anticipate interest rates and bond yields to remain in the mid-single digits in the long term, which is having a significant impact on SWFs’ long-term asset allocation plans by prompting greater caution on highly leveraged and growth-oriented investments due to uncertain borrowing costs.

Infrastructure leads the way as the most popular asset class over the next 12 months, 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.

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%).

“The ‘higher for longer’ rate environment is a major paradigm shift for sovereigns,” added Franc.  “Financial conditions have been generally accommodative around the world since the Great Recession in 2007-2008, and some investment professionals have not experienced an era of high inflation and relatively restrictive interest rates.  We can see how this dynamic is changing the investment outlook for sovereigns especially when it comes to private credit.  It’s also impacting the risk-reward calculation around listed equities.” 

Energy transition a priority theme for long-term investors

The energy transition continues to present challenges and opportunities for SWFs and central banks.

This year’s study revealed that the energy transition is viewed as an increasingly attractive investment opportunity, with 30% of SWFs and central banks considering it a high priority allocation theme and a further 27% holding some form of renewable and cleantech investments.

“In Asia we see that investors are increasingly incorporating ESG considerations into their manager selection and even analyzing physical climate risks in the investment process, but they are also generally avoiding outright divestment from conventional energy assets,” mentioned Franc.  “The energy transition will be driven by how global investors navigate this landscape.  I continue to expect an ‘all-of-the-above’ investment approach where both renewable and conventional energy assets remain part of the allocation mix, and ongoing engagement with energy players will be an essential element in the transition journey to reach net-zero targets.” 

-ENDS-

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Important information

This article is for trade press for informational purposes only. Circulation, disclosure, or dissemination of all or any part of this article to any person without the consent of Invesco is prohibited.

This is Invesco’s twelfth sovereign asset management study. In 2024 we conducted interviews with 140 funds: 83 sovereign investors and 57 central banks. The 2024 sovereign sample is split into three core segmentation parameters (sovereign investor segment, region, and size of assets under management). The 2024 central bank sample is broken down by region. The fieldwork for this study was conducted by NMG between January and March 2024.

* Sourced by NMG Consulting: total assets of those sampled stands at $22 trillion as of March 2024. 

All data are sourced from Invesco dated 31 December 2023, unless otherwise stated. This document contains general information only. It is not an invitation to subscribe for shares in a fund nor is it to be construed as an offer to buy or sell any financial instruments. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. While great care has been taken to ensure that the information contained herein is accurate, no responsibility can be accepted for any errors, mistakes or omissions or for any action taken in reliance thereon. Investment involves risks. Past performance is not indicative of future performance.

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Where Martin Franc has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

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