MIDDLE EAST SOVEREIGN INVESTORS PIVOT AWAY FROM EUROPE TOWARDS CHINA

Tuesday 16 July 2019
Josette Rizk, Client Director, Institutional Sales, Invesco Middle East and Africa
Dubai - MENA Herald:

Invesco today released its seventh Invesco Global Sovereign Asset Management Study*, an annual in-depth report on the complex investment behaviour of sovereign wealth funds and central banks, which this year shows disenchantment with Europe among sovereign investors and increased interest in emerging markets, particularly China.   According to the study, 88% of investors in the Middle East have exposure to China, versus 73% for all investors globally.

This year’s study was conducted face-to-face amongst 139 individual sovereign investors and central bank reserve managers across the globe representing $20.3trillion** of assets, of which 71 are central banks (62 in 2018), reflecting their growing status as sovereign investors. 

Sovereigns optimistic on China

China’s attractiveness rating for sovereign investors has improved more than any other major region since 2017. 

The unique competitive dynamics of China are appealing for sovereigns seeking more diversification, the survey found, with equities continuing to be the asset class most favoured. 

Approximately 100% of sovereigns in the Middle East with China exposure held Chinese equities, showing that the government’s measures to open the market to foreign investors are bearing fruit. Middle East respondents have focused on building their expertise in China by investing in partnerships, developing in-house proficiency and setting up dedicated Asian offices.  

For sovereigns in the Middle East, investment risk is seen as the biggest challenge to investing in China. Transparency remains a significant obstacle to higher allocations in China for global sovereigns, while for those sovereigns with no existing allocation to China, investment restrictions and currency risk are seen as the main impediments (Figure 2).

Despite the fact that the study was carried out during a period of ongoing rhetoric on a trade war, those surveyed saw China’s pledge to improve safeguarding of intellectual property as grounds for optimism that some resolution of tensions would be reached. 

Middle East investors are also increasing allocations to Asia as a region, with 75% having increased allocations in 2018 compared with 47% for all investors surveyed.  Indications are that this trend will continue in 2019. 

Investors don’t see economic attractiveness in Europe

A combination of slowing economic growth and perceptions of rising political risk have led to a decline in the perceived attractiveness of major European economies. Brexit is now influencing asset allocation decisions for 64% of all sovereigns (Figure 3), though this is higher in the region with 78%. Continental Europe is seen as increasingly uncertain with the ascendance of populist movements in major European economies such as Germany and Italy, and is impacting asset allocation decisions for 46% of all respondents. 

This has resulted in Europe falling out of favour, with half of sovereign investors in the Middle East decreasing allocations to Europe in 2018 and a similar number planning further decreases in 2019. Only 13% of global sovereigns plan on increasing allocations to Europe this year, compared to a 40% allocation to Asia and 36% to Emerging Markets (Figure 4). 

Fixed income displaces equities as largest asset class for sovereigns, while Middle East investors allocate resources to infrastructure  

2018 was a challenging year for sovereigns as weak and volatile equity markets led to a decline in overall investment returns. On average, sovereign investors achieved returns of 4% in 2018 compared to 9% in 2017. Despite the decrease in returns, sovereigns performed well given negative returns from global equities, which fell 8.7% in US dollar terms during the year, according to MSCI World Index. 

The majority of sovereigns (89%) anticipate the end of the economic cycle within the next two years. This combined with volatility concerns and the prospect of negative returns from equities has led to increased fixed income allocations and more diversification in allocations to infrastructure, real estate and private equity markets.  

Fixed income allocations increased to 33% in 2019 from 30% in 2018, becoming sovereigns’ largest asset class.  However, in the Middle East, allocations to illiquid alternatives was particularly prominent with 75% increasing allocations to infrastructure, 63% to private equity and 38% to real estate, a marked difference in strategy to the global sample. The region is particularly exposed to global economic cycles due to a reliance on oil revenues and therefore has even greater incentive to invest in such assets for diversification.

Middle East sovereigns lead as technology investors and adopters

Sovereigns in the Middle East recognize technology as a large and broad-based investment opportunity, with 89% of Middle East sovereigns having a dedicated technology portfolio or team, compared with 48% globally. Given the dominance of tech companies in terms of contribution to equity returns and economic development over the last few years, it is no surprise that 75% of the Middle East respondents cited enhancing investment returns as the most important reason for placing emphasis on the sector. 

Middle East sovereigns have been leaders in utilizing technology investments for the benefit of domestic society.  As part of several regional initiatives to create a more 

sustainable economy, technology and innovation play a significant role.  In 2015, the UAE announced a US$80 billion investment plan in the Emirates Science Technology and Innovation Higher Policy, and Saudi Arabia has made technological innovation central to its Vision 2030.

According to the survey, 100% of the respondents in the Middle East have implemented technology innovation in the investment strategy space in the last 12 months, in areas such as risk management, monitoring and artificial intelligence.  

Environmental considerations move ESG firmly into the spotlight 

ESG is an increasingly important issue for sovereigns and Central Banks. Since 2017, the percentage of sovereigns with a specific ESG policy rose from 46% to 60% (Figure 5). 20% of Central Banks now have an ESG policy, compared to 11% in 2017. In the Middle East, 67% of sovereigns have an ESG policy, ahead of the global average (60%) but behind sovereigns based in the West (76%).

Approaches to ESG are increasingly sophisticated, having moved beyond screening to incorporate more advanced forms of integration.  

There has also been a shift in focus of the nature of ESG activity. While asset owners have, in the past, focused on issues of governance due to clearer risk and return benefits, these factors are now often assumed by ESG adopters. For sovereigns, environmental concerns are increasingly becoming the lead focus, with carbon emissions and climate change the single most important ESG issue.

Josette Rizk, Client Director, Institutional Sales, Invesco Middle East and Africa, commented: “We are observing an interesting shift in terms of both geographic and sector allocation from the Middle East. The need to balance global exposure is leading many of the regional investors to explore opportunities in emerging markets and Asia, especially due to the attractive emerging market fundamentals and valuations. Whilst increasing allocation to China remains on the radar for regional investors, investment risk is seen as the biggest challenge to investing in the country.”

“Another interesting trend we have observed is that technology and innovation is becoming an important part of their overall portfolio. This is primarily driven by attractive returns that tech companies offer and is also aligned with the agendas of many of the regional governments, particularly of the UAE and Saudi Arabia, who want to ultimately develop a knowledge economy to drive economic development in their countries.”

“Finally, the conversation around ESG or responsible investing has picked up momentum. 

Much of this has been driven by large institutional investors in the region, and in particular by the sovereign wealth funds, notably on core themes that have an impact on sustainability and the signing of the One Planet Initiative.”

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