Sovereign Investors Shift Focus to Emerging Markets

Geopolitical tensions now overshadow inflation, driving sovereign investors to explore emerging markets, reveals Invesco's latest study.

In a significant shift in investment priorities, geopolitical tensions have overtaken inflation as the foremost concern for sovereign investors, according to the latest findings from the twelfth annual Invesco Global Sovereign Asset Management Study. This year’s survey reveals that a staggering 83% of sovereign wealth funds (SWFs) view geopolitical risks as a major threat to global economic growth over the next year, a notable increase from 72% in 2023. This growing apprehension is largely attributed to escalating competition among major powers and the potential for disruptions in global trade.

The study, which serves as a critical barometer for sovereign investor behavior, is based on insights from 140 chief investment officers, heads of asset classes, and senior portfolio strategists across 83 SWFs and 57 central banks, collectively managing assets worth approximately $22 trillion. The findings underscore a pivotal moment for sovereign investors, who are increasingly looking towards emerging markets as potential beneficiaries of these geopolitical dynamics.

Emerging Markets: A New Frontier for Investment

Sovereign wealth funds are beginning to see emerging markets as fertile ground for investment, particularly in light of trends such as near-shoring. This strategy involves relocating supply chains closer to home, thereby reducing reliance on distant manufacturing hubs. As a result, 67% of SWFs anticipate that emerging markets will either match or outperform developed markets over the next three years. This optimism is further bolstered by the fact that SWFs reported an average return of 7.2%, a significant rebound from the -3.5% return recorded last year—the first negative return since the inception of the survey in 2013.

The strategic competition between the United States and China is viewed as a catalyst for investment opportunities in emerging markets. A majority of respondents, 54%, believe that this competitive landscape will favor emerging markets, while only 12% disagree. The potential for these markets to attract investment and forge new partnerships is seen as a critical advantage in an increasingly interconnected global economy.

Regional Insights: Asia and Latin America in Focus

Within the realm of emerging markets, Asia (excluding China) has emerged as the most attractive region for investment. India, in particular, is capturing the attention of sovereign investors due to its expansive domestic market, burgeoning middle class, and increasing competitiveness on the global stage. The interest in India is reflected in the survey, where 88% of SWFs expressed a desire to increase their exposure to Indian debt, a significant rise from 66% in 2022. This surge in confidence underscores the improving economic fundamentals and policy reforms that are enhancing India’s creditworthiness.

Latin America is also gaining traction, especially among Middle Eastern and Asian funds, with Mexico and Brazil identified as prime candidates for US near-shoring initiatives. Despite the challenges posed by regulatory shifts and geopolitical tensions, China remains a significant market for SWFs, albeit with a more cautious approach.

The Appeal of Emerging Market Debt

Emerging market debt is increasingly viewed as an attractive asset class for sovereign wealth funds seeking to diversify their portfolios. The potential for higher yields compared to developed market bonds makes this asset class particularly appealing. The improving economic conditions and policy reforms in various emerging markets have bolstered their credit ratings, thereby reducing perceived investment risks.

Invesco’s study highlights that SWFs are keenly interested in EM debt, with many viewing it as a viable option for enhancing portfolio income. The growing confidence in emerging market debt is indicative of a broader trend among sovereign investors to seek out opportunities that offer both growth potential and risk mitigation.

Central Banks Turn to Gold Amid Geopolitical Uncertainty

The impact of geopolitical tensions is not limited to sovereign wealth funds; central banks are also adapting their strategies in response to these challenges. A notable trend is the increasing interest in gold as a means of diversifying reserves and hedging against various risks. The survey indicates that 56% of central banks find the potential weaponization of reserves to be a compelling reason to invest in gold, while 48% cite rising US debt levels as a factor enhancing gold's attractiveness.

As geopolitical tensions persist, central banks are motivated to bolster their reserves, particularly in anticipation of upcoming elections in key markets. The survey reveals that 53% of central banks plan to increase their reserves over the next two years, with only 6% indicating a desire to reduce them. This proactive approach reflects a growing awareness of the potential for election outcomes to trigger market volatility and currency fluctuations.

Inflation and Interest Rates: A Long-Term Perspective

Invesco’s study also sheds light on the prevailing sentiment regarding inflation and interest rates. A significant portion of respondents, 43%, believe that inflation will remain above central bank targets, while 55% expect targets to be met. Furthermore, 71% of SWFs and central banks anticipate that interest rates and bond yields will stabilize in the mid-single digits over the long term. This outlook is influencing SWFs’ long-term asset allocation strategies, prompting a more cautious approach to highly leveraged and growth-oriented investments.

Asset Allocation Trends: Infrastructure Takes the Lead

As sovereign wealth funds navigate this complex landscape, certain asset classes are emerging as favorites for the upcoming year. Infrastructure tops the list, with a net asset allocation intention of 21%, followed closely by listed equities at 19% and absolute return funds/hedge funds at 12%. Conversely, sentiment towards cash, real estate, and private equity has diminished, reflecting a shift in investment priorities.

The appeal of private credit has surged as an alternative to traditional fixed income, offering attractive yields and unique investment opportunities. More than one-third of SWFs reported better-than-expected returns from their private credit investments, with only 5% indicating underperformance. This asset class is increasingly recognized for its ability to provide diversification and value compared to conventional debt.

The Energy Transition: Challenges and Opportunities

The ongoing energy transition presents both challenges and opportunities for sovereign wealth funds and central banks. The study reveals that 30% of SWFs and central banks consider the energy transition a high-priority allocation theme, with an additional 27% holding investments in renewable and cleantech sectors. This growing focus on sustainability reflects a broader recognition of the importance of aligning investment strategies with global environmental goals.

The findings from Invesco’s Global Sovereign Asset Management Study highlight a significant shift in the investment landscape for sovereign wealth funds and central banks. As geopolitical tensions rise, these investors are increasingly turning their attention to emerging markets, viewing them as potential beneficiaries of global economic shifts. With a renewed focus on emerging market debt, gold reserves, and infrastructure investments, sovereign investors are adapting their strategies to navigate an increasingly complex and interconnected world. The evolving dynamics of global finance underscore the importance of strategic foresight in investment decision-making, as sovereign wealth funds and central banks seek to position themselves for future growth and stability.

Sovereign Investors Shift Focus to Emerging Markets

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