Macro and allocations

Ageing cycle sees sovereigns defend, diversify and explore new opportunities
Sovereigns are preparing for the end of the economic cycle with allocations to fixed income rising in 2018. Portfolios are becoming more diversified; geographically sovereigns have allocated away from Europe to emerging markets, notably China.

Macro & allocations

Following several years of strong returns on the back of steady global growth and rising equity markets, a more challenging 2018 has prompted sovereigns to take stock and consider whether they are well positioned to contend with a global downturn. This has led some to rethink their assumptions, particularly with regards to passive and factor equity allocations. Some sovereigns have interpreted market volatility as highlighting the limitations of low intervention strategies, shifting away from market cap-weighted passive and ‘set and forget’ factor strategies in favour of more dynamic factor approaches.

More generally it has accelerated the existing trend towards better diversification, both by asset class and geography, and while an end to the economic cycle is considered to be in sight, this is likely to remain the principle driver of asset allocation.

Last year’s study highlighted rising allocations to equities and the displacement of fixed income as the biggest asset class for sovereigns. This year sovereigns have tilted back to fixed income (Figure 1), arresting a five-year trend during which average fixed income weightings fell from 35% to 30% as equity markets posted very strong gains. Fixed income is back on top, now averaging 33% of sovereign portfolios.

Figure 1. Asset allocation, Sovereigns only (% AUM)

Figure 1. Asset allocation, Sovereigns only (% AUM) Figure 1. Asset allocation, Sovereigns only (% AUM)

Sample size: 2013: 33; 2014: 48; 2015: 44; 2016: 57; 2017: 62; 2018: 63; 2019: 53. Alts: alternatives.

Increasing diversification can be seen in further increases in allocations to private markets – a trend we have been tracking for a number of years – and also geographically where sovereigns have allocated away from Europe towards emerging markets (Figure 2), notably China. The prevailing view is one of concern about the prospects for the European economy amid rising populism in major economies including Germany and Italy, and the uncertainty of Brexit.

Figure 2. Change and expected change in allocation, Sovereigns only (% citations)

Figure 2. Change and expected change in allocation, Sovereigns only (% citations) Figure 2. Change and expected change in allocation, Sovereigns only (% citations)

Sample size: 45.

On average sovereigns now rate the investment attractiveness of the largest emerging market economies materially ahead of their developed market counterparts - a substantial reversal from 2017. Many are making long-term commitments via increases in strategic asset allocations to, albeit while expressing caution about their prospects in a slower growth environment. China has seen the largest improvement in its attractiveness rating, despite heightened trade tensions transpiring at the time our interviews were conducted. Sovereigns are weighing this and other China risks against potential returns available from investing on the mainland, and large sovereigns are establishing specialist teams to do so. Many feel comfortable about the preferred status of their capital and were increasing allocations to equities, fixed interest and private market assets.