US, Germany top choices for Middle East sovereign wealth funds

Amid the global uncertainty, Middle East sovereign investors prefer the US, perceive safety in investing in Germany, and view the UK as less attractive in the wake of Brexit, a study has revealed. In investors from the Middle East, who account for a combined over $3 trillion in assets according to Sovereign Wealth Fund Institute, along with their peers from other parts of the world are also putting major asset allocation decisions on hold amid the persistent uncertainty around interest rates and quantitative tightening. 
A study by Invesco, a US-based investment management company, found that real estate is being perceived by most sovereign investors as income-generator, with Middle East sovereigns. The fifth Invesco Global Sovereign Asset Management Study shows that geo-political uncertainty and limited options to increase risk asset allocations are causing sovereign investors in the Middle East and globally to make fewer allocation changes than at any point in the last five years, despite target return gaps increasingly widening.
This year's study, conducted among 97 individual sovereign investors and central bank reserve managers across the globe representing $12 trillion of assets, asked sovereign investors to rate the importance of various economic and geopolitical factors on their investment strategies.
Middle East and other sovereign investors see low interest rates as the greatest tactical asset allocation factor, driving increasing allocations to real estate as sovereigns look for alternative sources of income generation.
However, the longer term implications are less certain with expectations of a gradual return from quantitative easing to quantitative tightening. Instead Brexit and the US election results are expected to grow in importance for future allocations (set to increase in importance by 82 per cent and 68 per cent respectively), as the implications of political shifts on investment performance becomes clearer.
Sovereign investors have ranked the US as the number one market in terms of attractiveness for the past three years, and this year the country retains its top spot with a score of 8.0 (out of ten). The US is also the winner in terms of actual allocations, with 37 per cent of respondents reporting overweight new flows to North America in 2016 relative to their total portfolio - higher than any other region - and a net 40 per cent are planning to overweight further in 2017.
This attractiveness is driven largely by interest rate rises as well as market confidence of a "pro-business" corporate tax regime following Trump taking office in January 2017. However, long term confidence is still restricted by uncertainty around whether Trump will deliver on policy promises, and positive views on potential infrastructure investments in the US are hampered by concerns about growing protectionism limiting access for foreign sovereigns.
Alex Millar, Head of EMEA Sovereigns, Middle East and Africa institutional sales at Invesco, said despite the apparent negative sentiment around the UK, many sovereigns confirmed their long-term commitment to existing UK investments post-Brexit - especially real estate and several high-profile UK infrastructure investments, including Thames Water and Heathrow Airport. These are unlikely to move until the outlook for the UK as a preferred investment destination becomes clearer.
"While for continental European allocations, the strong German economy was seen as an attractive 'safe haven' by Middle East sovereigns. However, the strength of the US is of particular relevance to Middle East sovereigns as liabilities in local currencies are pegged to dollar," said Millar. The UK saw the biggest drop in attractiveness to sovereign investors, down to 5.5 from 7.5 last year. Brexit is seen as a significant negative for UK investment, and investment sovereigns with European interests questioned the future of the UK as an "investment hub" for Europe, given uncertainty over taxes on imports and market access, said Miller.
"Last year was a challenging year for sovereign investors with concerns surrounding funding levels and return expectations remaining front of mind amidst added macro-economic and political uncertainty. Demand for alternatives like infrastructure has been a consistent theme in past years, but this year the challenge of increasingly scarce supply is compounded," said Miller.
Whilst investors have fewer asset allocation levers with which to respond, they are delving deeper into more supply-rich real estate markets, and looking to the US and Germany for opportunity and economic strength. With limited domestic opportunities, Middle East sovereigns interestingly gave the greatest asset allocation among sovereigns to international real estate, he pointed out.
- issacjohn@khaleejtimes.com