Middle East sovereign investors eschew Europe in favour of China

No evidence that trade tensions are denting China’s attractiveness to SWFs, says Invesco

Middle East sovereign investors cool on Europe in favour of China, says Invesco. Pawan Singh / The National

Sovereign investors in the Middle East are ramping up investment activity in Asia – especially China – while rowing back on Europe as political uncertainty in the eurozone abounds, a report says.

Some 88 per cent of investors from the Middle East have exposure to China, versus 73 per cent for all investors globally, according to the seventh annual Global Sovereign Asset Management Study from asset management firm Invesco.

At the same time, continental Europe is falling out of favour with regional sovereigns. Around a third (31 per cent) of those surveyed for the study said they expect to reduce their allocations to Europe in 2019, while half said they had already decreased their allocations last year.

“We are observing an interesting shift in terms of both geographic and sector allocation from the Middle East,” Josette Rizk, client director of Institutional Sales, Invesco Middle East and Africa, said on Monday.

“The need to balance global exposure is leading many regional investors to explore opportunities in emerging markets and Asia, especially due to the attractive emerging market fundamentals and valuations.”

Europe's investment landscape looks increasingly fragile – and not only because of uncertainty surrounding Britain's potential departure from the European Union, Ms Rizk told The National.

Brexit is influencing asset allocation decisions for 64 per cent of all sovereigns and the figure is higher for Middle East investors at 78 per cent. However, the ascendance of populist movements in major eurozone economies such as Germany and Italy is also impacting asset allocation decisions for 46 per cent of respondents.

“A combination of slowing economic growth and perceptions of rising political risk have led to a decline in the perceived attractiveness of major European economies,” Ms Rizk said.

Only 13 per cent of global sovereigns said they plan to increase allocations to Europe this year compared to 40 per cent planning to increase allocations to Asia and 36 per cent to emerging markets generally.

This year’s study was based on interviews with 139 sovereign investors and central bank reserve managers across the world between January and March, which represent $20.3 trillion of assets, according to NMG Consulting. Of the respondents, 71 were central banks compared to 62 in 2018, reflecting their growing status as sovereign investors, Invesco noted.

Despite the ongoing trade dispute between China and the US, China’s attractiveness to sovereign investors has improved more than any other major region since 2017, the report said. The world’s two biggest economies have imposed reciprocal tariffs on various exports since last year, hampering trade flows.

Late last month, US president Donald Trump and Chinese president Xi Jinping agreed to restart trade negotiations that had earlier broken down and the US agreed to put no new tariffs on Chinese goods. The truce ended a six-week stalemate that had unnerved companies and investors. However, it remains unclear whether the two countries can permanently resolve the dispute. A previous accord reached at last year’s G20 summit collapsed earlier this year.

“The feeling we get from the study is that any continuation of the trade war will not affect just China but other global markets too, so sovereigns are not rowing back from China because of this,” said Ms Rizk. “They are well aware of such risks and factor them into their investment analyses.”

Middle East investors are also increasing allocations to Asia overall, with 75 per cent saying they grew allocations to the region in 2018 compared with 47 per cent for all investors. Indications are that this trend will continue in 2019.

Sluggish economic growth in the past 12 months, together with weak and volatile equity markets, led to a challenging 2018 for global sovereigns, who achieved returns of 4 per cent compared to 9 per cent in 2017, according to Invesco. The decline led them to pivot from equities allocations into more secure asset classes such as fixed income, and diversify investments as they anticipate the end of the current economic cycle.

Fixed income allocations increased to 33 per cent in 2019 from 30 per cent in 2018, becoming global sovereigns’ largest asset class.

However, in the Middle East, allocations to illiquid alternatives such as real estate was particularly prominent, with 75 per cent increasing allocations to infrastructure, 63 per cent to private equity and 38 per cent to real estate – a marked difference in strategy to the global sample.

“The region is particularly exposed to global economic cycles due to a reliance on oil revenues and has even greater incentive to invest in illiquid assets for diversification,” Ms Rizk said.

Middle East sovereigns are also more proactive than the global sample in seeking technology investments. A sizeable 89 per cent said they have a dedicated technology portfolio or team, compared with 48 per cent globally.