Sovereigns continue to increase China allocations, focus further on ESG through pandemic

  • More than a third of sovereign investors saw drawdowns in 2020
  • Investors cut allocations to fixed income, increased to equities and private markets
  • Allocations to China assets resume, seeking alpha and diversification
  • ESG moves up in priority for sovereign investors 

Hong Kong, 12 July 2021 – Invesco today released its ninth annual Global Sovereign Asset Management Study (link). The study detailed the views and opinions of 141 chief investment officers, heads of asset classes and senior portfolio strategists at 82 sovereign wealth funds and 59 central banks, who together manage $19 trillion USD in assets.

Impacts from the COVID-19 pandemic are major themes among sovereign investors surveyed this year. One primary impact to sovereigns was drawdowns by their respective governments to support economies and public services; as such, more than a third of sovereigns saw drawdowns during 2020, including 78% of liquidity sovereigns and 58% of investment sovereigns. Among Asian and Western sovereigns, about one fifth noted they had registered drawdowns. 

The scale and speed of withdrawals impacted allocations, specifically a shift towards cash, with portfolio cash reserves more than doubling during 2020, as some sovereigns continued to focus on liquidity in anticipation of possible further withdrawals. 

The study also revealed a shift in asset allocation. Fixed income allocations fell from 34% to 30%, while allocations to equities rose by 2% from 2020 to 28% this year. A further 30% of respondents expect to increase their allocation to equities over the next 12 months.

Terry Pan, Chief Executive Officer for Greater China, Southeast Asia and Korea at Invesco commented: “It would be an understatement to describe the coronavirus pandemic as unprecedented for financial professionals across the globe, although we observe from this year’s study that similar themes and trends among sovereign investors remained intact despite the extraordinary circumstances, with allocations to traditionally more-risky assets such as global equities and China bonds continuing to increase. Liquidity and a focus on cash reserves are likely to remain top-of-mind for sovereign investors given that many governments are still managing the virus, and sovereigns will want to be well prepared if governments need their support.”

Sovereigns and central banks accelerate allocations to China, despite risks 

China’s appeal has steadily increased over the past four years, driven by attractive local returns and opportunities for diversification. With its successful response in managing COVID-19 apparent to investors, 40% of investment sovereigns and 56% of liquidity sovereigns see China as a more attractive investment destination than it was prior to the pandemic. 

Over the next five years, 40% of sovereigns plan to increase allocations to China. 75% of sovereigns were attracted to invest in China due to the prospect of attractive local returns, and a further 57% saw China as an important portfolio diversifier. Sovereigns expect to finance increased allocations to China both with new capital and by drawing on North America and Developed Europe allocations. 

Aligned with sovereigns, central banks have also continued increasing allocations to Chinese assets, driven by diversification away from the US dollar. While all currencies benefited from this diversification, the RMB was one of the main beneficiaries, with average allocations at 2.3% as of end 2020 versus 1.9% a year ago. More than half (53%) of central banks in the study now hold RMB, versus 40% in 2018. 

Looking ahead, 40% of central banks are considering new asset classes in the next two years, with EM debt as the most popular new asset class. This is driven by banks making their first allocations to China. 

Terry Pan added: “China sovereign bonds are likely to be a key asset class for sovereigns and central banks going forward, especially with these bonds included in major global indexes and as initiatives such as the bond connect between the mainland and Hong Kong make cross-border trading more accessible and efficient. Although most central banks maintain their RMB holdings within their longer-term investment portfolios, the study indicates that investors are increasingly comfortable with this currency and see benefits of maintaining exposure.”

Despite China’s growing appeal there are some notable obstacles to investing. 86% of sovereigns point to the rising political tensions with the US as a significant barrier to investing, and political risk was the top obstacle cited as having changed for the worse in the past two years. Other obstacles investors noted include the inability to convert RMB (cited by 50% of sovereigns), a lack of alignment of investments with ESG considerations (45%) and the perceived comparative lack of investor rights (41%).

The pandemic increases ESG adoption

This study has tracked a significant increase in the incorporation of environmental, social and governance (ESG) principles into sovereign and central banks portfolios since 2017. In just four years the proportion of respondents adopting an ESG policy at the organisational level has increased dramatically, rising from 46% to 64% among sovereigns and from 11% to 38% among central banks.

The Covid-19 pandemic broadly acted as a catalyst for sovereigns and central banks to prioritise ESG; nearly a quarter (23%) of sovereigns and 44% of central banks increased their focus on ESG as a result of the pandemic. 

Sovereign investors saw diverging approaches in their ESG commitments based on their investment style. Only 13% of liquidity sovereigns have a formal ESG policy, in contrast to liability sovereigns of which 79% have an ESG policy. Most sovereigns however agree that the market has not priced in the long-term implications of climate change (57%), which could create opportunities for alpha generation.  

Real Estate in Transition

Sovereigns see opportunities in real estate, with 72% agreeing that “it is currently an ideal time to invest in property as a long-term investment”. Nonetheless, the study noted the first year-over-year decline in allocations to real estate since 2018 at 8.3% of portfolios.

Sovereigns acknowledge the shift from office to flexible working arrangements will impact real estate portfolios, but they generally disagree (55%) that office city centre investments represent potentially stranded assets, and broadly believe that occupancy and usage of commercial real estate will return to pre-Covid-19 levels in two years (56%). 

83% of Asia sovereigns ranked North America as the top region for real estate investment, while 75% ranked industrial properties as having the most attractive yields over the next five years, considerably higher than the 34% among all sovereigns. Notably, 0% of Asia sovereigns saw residential and retail segments offering the most attractive yields.

Climate change is the most significant risk to sovereigns’ real estate portfolios, ahead of falling yields, and 84% of sovereigns are increasing their consideration of climate when making real estate investments. Asia sovereigns were most likely to report that climate change considerations were “fully incorporated” into due diligence when making property investments at 30% versus 28% among Western sovereigns and 0% for Middle East sovereigns. 

Terry Pan concluded: “The widespread adoption of ESG as a core tenet of investing has only accelerated in the past year. Asian investors across the region have moved rapidly to incorporate these considerations into portfolios, notably in their real estate investments. This represents both opportunity and risk for investors, with those that have not developed an ESG framework potentially exposed to significant downside as policy changes and broader market moves may take them by surprise, particularly in fast-moving markets like China.” 

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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 ninth sovereign asset management study. In 2021 we conducted interviews with 141 funds: 82 sovereign investors and 59 central banks. The 2021 sovereign sample is split into three core segmentation parameters (sovereign investor segment, region and size of assets under management). Sovereign investor segment is determined by primary investment objective, e.g. investment & liquidity, investment & liability funding, investment & development, etc.  Details of sovereign profile segmentation are available in the full report.

The fieldwork for this study was conducted by NMG between January and March 2021. Total assets of those participating was US$19 trillion as of March 2021.

All data are sourced from Invesco dated 31 December 2020, 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.

The distribution and offering of this document in certain jurisdictions may be restricted by law. Persons into whose possession this document may come are required to inform themselves about and to comply with any relevant restrictions. This does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer is not authorized or to any person to whom it is unlawful to make such an offer or solicitation.

Where Terry Pan 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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