According to Invesco’s Global Sovereign Asset Management Study 2024, geopolitical tensions, high inflation, and continued fallout from the Russia–Ukraine conflict remain top of mind for global sovereign wealth funds around the world in the short term and are becoming key considerations for funds when making allocations.
Gathering insights from 140 senior investment professionals, representing 83 sovereign wealth funds and 57 central banks, the study found rising geopolitical fragmentation and protectionism and climate change rise to the top of the list over the next decade.
“The heightened focus on geopolitical risks reflects the ongoing conflict in the Middle East as well as tensions between major powers and the uncertainty caused by the large number of elections taking place in 2024,” the study said, adding that one Western central bank respondent described the elections as a “real unknown for the world economy”.
“Climate change, too, is a central concern for sovereign investors and linked to concerns around inflation. As one Western central bank noted, ‘climate and geopolitical issues are putting pressures on pricing so inflation will remain a concern and interest rates will stay higher’.”
Inflation “clearly” remains a significant concern for sovereign investors, it said, and just short of half (43 per cent) of respondents expect inflation to settle above central bank targets.
This has impacted the outlook for bond yields, with around 70 per cent of respondents anticipating interest rates and bond yields to remain in the mid-single digits.
Just 14 per cent forecast a return to the low-interest rate environment of the previous decade.
“The higher-than-expected inflation readings during 2024 were front of mind for many respondents, prompting a re-evaluation of the timeline and magnitude of potential interest rate cuts and a concern that additional rate hikes may be necessary,” the study elaborated.
“The prevailing uncertainty surrounding the inflation outlook and the trajectory of interest rates was seen as posing significant challenges, with many respondents pointing to lessons learnt in 2022 and looking to adjust their portfolios to accommodate the heightened duration risk.”
According to the study, there was a notable reversal in certain allocations trends in the face of potentially high inflation and interest rates, 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.
Particularly, it found equities remained appealing, reflecting a broader trend among institutional investors seeking to capture long-term growth opportunities.
Private credit, too, proved to be attractive in a higher rate environment as a compelling alternative to traditional fixed income in offering diversification and appealing yields.
“The growing appetite for private credit is reflected in the broader market trends,” the study said, pointing to recent Bloomberg figures indicating the size of the private credit market reached approximately $1.4 trillion at the start of 2023, up from $875 billion in 2020.
It continued: “Sovereign wealth funds 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.”
This was attributed to hedge funds’ capacity to manage risk in turbulent markets, with credit-oriented strategies garnering attention “due to their potential to capitalise on inefficiencies arising from the elevated yield environment”.
Optimistic about EM
The Invesco study observed rising optimism for emerging markets, with sovereign wealth funds based outside of the West “particularly bullish” on the prospects of these markets over the next three years.
“Geopolitical tensions, often seen as a source of uncertainty and risk, are paradoxically expected to benefit emerging markets in the coming years. As the world becomes increasingly multipolar, with competing powers vying for influence and resources, emerging markets are expected to capitalise on the shifting dynamics,” the study clarified.
New opportunities look to emerge as strategic competition grows between the US and China, it said, allowing emerging markets to attract investment and assert economic and political influence on the global stage.
The study noted: “A focus on emerging Asia beyond China as a top regional priority reflects a growing belief in the region’s economic dynamism and potential.
“Investors are particularly interested in India, with its large domestic market, growing middle class, and increasing global competitiveness attracting significant investor interest.”
Latin America is also sharply in the sights of institutional investors, who foresee Mexico and Brazil to be well-placed to benefit from US nearshoring.
As investors navigate this challenging environment, the study observed emerging markets are “poised to play an increasingly vital role in the pursuit of growth and diversification”, adding that sovereign investors 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”.
