Sovereign wealth funds pile into bonds
State investors turn to fixed income in anticipation of bull market end
Sovereign wealth funds are piling into bonds as the world's biggest investors defend their portfolios in anticipation of the end of the decade-long bull market.
Fixed income has displaced equities as the largest asset class for sovereign wealth funds, which countries typically use to either save for a rainy day or to provide money for future generations. Most state-backed investors expect the end of the economic cycle within the next two years.
Fixed income allocations increased to 33 per cent this year from 30 per cent in 2018, according to an annual survey of 139 sovereign wealth funds and central banks that oversee $20.3tn, conducted by Invesco, the US fund manager.
This made it the largest asset class for sovereign wealth fund investors and the highest level in four years. Allocations to listed stocks, meanwhile, fell from 33 per cent to 30 per cent.
“They’re moving more to defend and diversify,” said Alex Millar, head of Emea institutional at Invesco.
Investors have ridden a wave of rising stock markets in the years since the financial crisis, supported by ultra-low interest rates and rising tech stocks. The S&P 500 recorded its longest period of uninterrupted gains in August last year.
However turbulence hit global equity markets in December as investors fretted about the health of the global economy and large central banks signalled a retreat from loose monetary policy.
Sovereign wealth funds returned 4 per cent on average last year, less than half of the 9.4 per cent recorded for 2017 due to weaker stock markets. About a quarter of state funds reported a negative return with those having higher allocations to passive equity strategies being worst hit.
The world’s largest sovereign wealth fund, Norway’s $1tn oil fund, posted a return of minus 6.1 per cent in 2018 while the €8.8bn Ireland Strategic Investment Fund returned minus 1.1 per cent.
Mr Millar, however, stressed that the survey was conducted in early 2019 as investors were still digesting a December rate rise from the Federal Reserve and the likelihood of further increases from the US central bank, a prospect that weighed on shares.
The Fed has since turned dovish again while large central banks elsewhere are also in easing mode. Last week the Reserve Bank of Australia cut interest rates for a second successive month, taking it to a record low of 1 per cent.
Central bankers are concerned about persistently subdued inflation and softer economic data, said Ben May, director of global macro research at Oxford Economics. “They’re prepared to take pre-emptive steps to loosen policy,” he said. The consultancy has forecast global growth of 2.7 per cent this year, down from 3.2 per cent in 2018.
Thirty two per cent of central banks expected to increase their gold reserves over the next year. Last year was the second highest on record for gold buying by central banks, but this was driven a by a minority of institutions — including those in Russia and Turkey — seeking to diversify their reserves away from the US dollar.
Concern over US-China trade tension emerged as the biggest worry, according to a sample of 50 of the state funds surveyed, but investors are still increasing their exposure to Asia’s largest economy, Mr Millar said.
“The number one cited risk is the US-China trade war but when you dig into where they’re allocating resources, China comes out very much on top,” he said.