Middle East sovereign funds reposition portfolios amid surging inflation

Investors switch from equities to real estate, private stocks and infrastructure for better yields, Invesco survey finds

The Riyadh skyline. Surging global inflation has prompted sovereign funds in the Middle East to re-examine their asset allocations. AFP

About 55 per cent of sovereign wealth funds in the Middle East have repositioned their portfolios in anticipation of further interest rate rises, international asset manager Invesco has said in a report.

Surging inflation has prompted sovereign funds to re-examine their asset allocations, with private markets the main beneficiary, Invesco said in its 10th annual Global Sovereign Asset Management Study.

“While most markets ended 2021 with a cautiously optimistic outlook for 2022, the start of the year presented a perfect storm of challenges for investors,” said Zainab Kufaishi, head of the Middle East and Africa at Invesco.

“Inflation is surging, global growth is slowing and geopolitical tensions are rising. Where the macro environment had once been relatively predictable, it is now more uncertain, sending sovereigns to rethink how to position their portfolios as they look ahead.”

Inflation in the US reached 9.1 per cent annually in June, the largest gain since 1981, figures released the US Labour Department last week showed.

The rising risk of a recession, broad-based inflation and subsequent interest rate increases are weighing on the economic recovery, which will force the International Monetary Fund to downgrade its global economic growth projections again for this year and the next, the Washington-based lender said on July 13.

In April, the IMF lowered its growth forecast for the global economy to 3.6 per cent in 2022 and 2023, revising it down 0.8 and 0.2 percentage points from its January forecast, respectively.

While global sovereign funds' fixed income allocations have declined steadily in recent years, they are no longer being redirected to listed equities, Invesco said.

Instead, they are going to private market alternatives, such as real estate, private equity and infrastructure, according to the study, which surveyed 139 chief investment officers, heads of asset classes and portfolio strategists at 81 sovereign wealth funds and 58 central banks that cumulatively manage $23 trillion in assets.

About 82 per cent of respondents in the Middle East said that real assets are effective hedges against inflation and offer higher yields.

“Private markets remain attractive to long-term investors in the region because they provide a long-duration play and shelter from volatility,” Ms Kufaishi said.

Fifty per cent of sovereign wealth funds in the Middle East plan to increase allocations to private equity, 20 per cent to real estate and 20 per cent to infrastructure over the next 12 months, the study found.

Globally, private assets constitute on average 22 per cent of sovereign funds’ portfolios, the highest proportion on record, Invesco said. Sovereign investors now own $719 billion in private assets, up from $205bn in 2011.

Meanwhile, sovereign wealth funds globally grew their total assets under management to $10.5tn in 2021, up from about $8tn in 2018, the study said.

Although the increased interest in private markets has come at the expense of reduced allocations in fixed income for sovereign funds globally, some respondents, including those in the Middle East, are looking to take advantage of opportunities arising from the equity market correction, Invesco said.

They are also looking for the right entry-points for fixed income as rates begin to rise.

About 40 per cent of Middle East sovereigns plan to reduce allocations to “developed” Europe and 30 per cent to “emerging” Europe over the next 12 months amid Russia’s continuing military offensive against Ukraine, the study said.

To counter the withdrawal from Europe, 70 per cent of Middle East sovereigns are likely to increase their exposure in North America, 40 per cent in the Middle East, and 40 per cent in emerging Asia-Pacific countries.

While many central banks globally sought liquidity following the outbreak of Covid-19, leading to an increase in cash deposits, this trend has reversed as demand for greater liquidity of reserves dried up post-pandemic, the study found.

Cash deposits are now being reallocated into government bonds and non-traditional asset classes, it added.

Meanwhile, only 7 per cent of global sovereign investors have exposure to digital assets — and much of this is through investments in underlying blockchain companies, Invesco said.

About 78 per cent of Middle East sovereign funds cite volatility as the biggest concern of digital assets, while 78 per cent highlight regulatory pressure and 67 per cent refer to transparency worries, the study said.

Only 20 per cent believe that digital assets have a role as a diversifier in asset allocation, while 70 per cent of Middle East sovereigns are more interested in investing in companies involved in the infrastructure behind digital assets, Invesco said.