Home / Analysis / Sovereign funds charting inflationary path through recalibration: Invesco

Inflation is likely in a transitory phase, yet remains stuck on high settings. Sovereign funds around the world are adjusting accordingly, Invesco says, with 5 major themes charting the course of institutional investors.

Institutional managers at sovereign wealth funds across the world are navigating an “altered macroeconomic environment”, according to Invesco’s head of official institutions Rod Ringrow (pictured), marked by surging inflation and higher real interest rates.

The global investment manager said the confluence of factors is affecting the market in five thematic ways, with the first of those being the way investors are being forced to recalibrate portfolios according to the current market paradigm. Fixed income has become de jour due to attractive rates and as a hedge against the threat of volatility, while India has emerged as a darling of the emerging market sector.

Recalibrating portfolios, however, means accounting for what is seen by sovereign wealth managers as the biggest risk to global growth – inflation. Eighty three percent of respondents to Invesco’s Global Sovereign Asset Management Study marked inflation as the biggest threat to growth in the next 12 months, with 47 per cent saying it was the biggest threat over the next ten years.

“Respondents noted inflation has historically been very difficult to tackle and that central banks in developed markets were currently trying to thread a needle by bringing down inflation through higher interest rates without causing a hard landing/major recession,” observed researcher NMG, which compiled the data for the report.

“This meant that respondents saw a lot of uncertainty around the future path of interest rates. There was risk that central banks will overshoot the target (leading to a hard landing/deep recession) or do the opposite and not be strong enough meaning that interest rates would have to stay higher for longer (with negative implications for borrowing costs and consumption etc).”

The second major theme Invesco identified is the growing appeal of private assets. The market has become more discerning, however, with valuation disparities inflating the value of the best managers and attractive transactions. “Despite market volatility, these alternative investments retain their allure,” Ringrow said.

The third theme is the proliferation of funds coming up with robust strategies for accelerating the energy transition, with climate change and geopolitical tension between Russia and the Ukraine, as well as The US and China, highlighting the need for sustainable and secure energy supply chains.

Sovereign funds, joined by central banks, are increasingly favouring direct green infrastructure investments and green bonds to align with their ethical charter.

“The mounting significance of ESG for sovereign investors initially stemmed from climate-driven long term risks to returns – ‘improving returns’ and ‘reducing risk’ were primary motivations for adopting ESG policies in 2020,” Invesco stated. “The emphasis has since shifted due to the intensifying necessity of environmental action. Russia’s invasion of Ukraine has underscored the criticality of energy security, further compounding the urgency.”

The fourth theme Invesco identified is one of collaboration, with new sovereign funds looking to partner up with more established peers and benefit from being close to their robust governance processes. Experienced funds are bring used to overcome “capability gaps”, Invesco said, with requirements expected to grow as funds mature.

The final theme identified by the global investment manager is that central banks are increasingly turning to safe haven assets like gold in order to soften volatile yields and inflation risks, resulting in a record amount of gold purchases during 2022.