Sovereign funds rush into alternatives

DubaiSovereign wealth funds are increasing their allocations to alternative investments, with growth fastest in Middle East, though much of the investment work will be done in-house.

Middle East sovereign allocations to alternatives such as real estate and private equity rose by an estimated 69% in 2012 to make up 9% of their portfolios, according to a survey commissioned by Invesco.

In contrast, sovereign funds in the West increased their alternative allocations by an estimated 26% to make up 21% of their portfolios.

“In the last 12 months, the Middle East has shown the biggest increase in investing in alternative assets of anywhere in the world.” says Nick Tolchard, head of Middle East, Invesco. “The wealth of the Middle East sovereign funds is about $2 trillion (€1.5 trillion). Increasing the allocation to alternatives represents a huge amount of money.”

The survey was based on interviews carried out by consultancy NMG in May and June with senior staff at 37 sovereign funds, which together control an estimated $4.7 trillion. This is equivalent to roughly 80% of the world's sovereign wealth assets, according to Tolchard.

The interviewees included sovereign wealth funds from the Gulf such as the Abu Dhabi Investment Authority as well as European state pension funds, Chinese sovereign funds and North American funds.

Tolchard says the move into alternatives is driven partly by sovereign wealth funds choosing to benchmark their portfolios against risk factors such as inflation, GDP growth and liquidity, rather than by geography. The survey found that 21% of sovereign funds now benchmark their portfolios against risk factors.

“We expect this focus on risk will increase in future, so we expect there to be more moves into alternatives,” he says.

Asset managers that provide alternative investment management might hope to benefit from the sovereign funds' demand for these products. However, these firms will have to compete with in-house teams at the sovereign funds.

A net 27% of respondents said they preferred to increase in-house alternative investment expertise rather than hire external managers.

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