This year shows geopolitical uncertainty and limited options to increase risk asset allocations are causing sovereign investors in the Middle East and globally to make fewer allocation changes than at any point in the last five years, despite target return gaps increasingly widening.
Middle East and other sovereign investors see low interest rates as the greatest tactical asset allocation factor, driving increasing allocations to real estate as sovereigns look for alternative sources of income generation.
However, the longer-term implications are less certain with expectations of a gradual return from quantitative easing to quantitative tightening. Instead, Brexit and the US election results are expected to grow in importance for future allocations (set to increase in importance by 82% and 68%, respectively, as the implications of political shifts on investment performance becomes clearer.
US on top
Sovereign investors have ranked the US as the number one market in terms of attractiveness for the past three years and this year, the country retains its top spot with a score of 8 (out of 10).
The US is also the winner in terms of actual allocations, with 37% of respondents reporting overweight new flows to North America in 2016 relative to their total portfolio – higher than any other region – and a net 40% are planning to overweight further in 2017.
This compares to only 4% who were underweight on new flows in 2016, and 4% who plan to do the same in 2017 – the rest (59% for 2016 and 56% for 2017) did not change or plan to change the weighting. This attractiveness is driven largely by interest rate rises as well as market confidence of a “pro-business” corporate tax regime following Trump taking office in January.
However, long-term confidence is still restricted by uncertainty around whether Trump will deliver on policy promises and positive views on potential infrastructure investments in the US are hampered by concerns about growing protectionism limiting access for foreign sovereigns.
Falling allocations to the UK
The UK saw the biggest drop in attractiveness to sovereign investors, down to 5.5 from 7.5 last year. Brexit is seen as a significant negative for UK investment and investment sovereigns with European interests questioned the future of the UK as an investment hub for Europe, given uncertainty over taxes on imports and market access.
Sovereign allocations to the UK were down in 2016 where 33% of respondents reported being underweight on new flows (higher than any other region) compared to 13% who reported new overweight positions to the UK, while the rest (54%) cited no change.
However, when the fall of the sterling is taken into account, UK allocations remain relatively stable, with stated allocation declines of 15% likely linked to the corresponding drop by 16% in the value of the GBP relative to the USD, rather than withdrawals. Furthermore, the fall in the value of the pound has led to a rally in UK stocks.
Moving forward, 41% of sovereigns expect to introduce new underweight positions in 2017, compared to just 5% who are planning new overweight positions to the UK. The majority (54%), however, do not intend to making any changes to their allocation weightings as they wait to assess the likely longer-term impact of Brexit.
Alex Millar, head of EMEA sovereigns, Middle East and Africa institutional sales at Invesco, said: “Despite the apparent negative sentiment around the UK, many sovereigns confirmed their long-term commitment to existing UK investments post-Brexit – especially real estate and several high-profile UK infrastructure investment.”
He added: “These are unlikely to move until the outlook for the UK as a preferred investment destination becomes clearer. While for continental European allocations, the strong German economy was seen as an attractive ‘safe haven’ by Middle East sovereigns. However, the strength of the US is of particular relevance to Middle East sovereigns as liabilities in local currencies are pegged to USD.”