Fixed Income Makes a Comeback in Sovereign Wealth Fund Portfolios

Although sovereign wealth funds expect inflation to fall, they believe it will remain elevated and are looking to adapt their portfolios to a new, higher-inflation environment, according to Invesco’s Global Sovereign Asset Management Study for 2023.

The report surveyed 142 CIOs, heads of asset classes and senior portfolio strategists from 85 sovereign wealth funds and 57 central banks that collectively oversee approximately $21 trillion in assets. It found that in a higher-interest-rate environment, funds are looking to rework their portfolios, which includes a transition back to fixed income and an increase in private debt investments.

“Amid persistent high inflation and real interest rates, investors are recalibrating portfolios,” Invesco’s report stated. “Sovereign wealth funds favor fixed income and private debt, while emerging markets—with solid demographics, political stability, and proactive regulation, particularly India—have emerged as prime investment destinations.”

Fixed-income allocations have slightly rebounded after two years of decline and now account for, on average, approximately 28% of the funds’ portfolios, up from 27%, while equity allocations have declined to 30% in 2023 from 32% last year.

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According to the report, some of the institutional investors surveyed said they bought as much fixed income as possible within their asset allocation limits and were considering revising their framework to accommodate the new interest rate environment. However, investors also said they have changed their approach to investing within the asset class after fixed income failed to provide a safe haven during the 2022 asset price correction.

“Respondents are instead adopting a more tactical stance, utilizing all available asset classes and believing that significant value can be added to a fixed income portfolio by actively rebalancing across different fixed income segments,” the report stated, adding that among alternative fixed-income segments, emerging market debt and high-yield bonds are the most widely held investments.

“However, we observed a strong appetite for private credit funds, with sovereign investors emphasizing the favorable risk-return profile of the asset class and high liquidity levels,” the report summarized. “Sovereign investors also noted that holdings are transparent and generally offer good diversification within the fund, as most funds are large-scale and invest in a wide range of issuers.”

Sovereign wealth funds have also continued to increase allocations to alternative investments, which now account for approximately 27% of their portfolios, excluding direct strategic investments, according to the report. It also said that allocations to infrastructure increased over the past 12 months, with the asset class now accounting for 7.1% of portfolios, offsetting a decline in real estate investments.

“Sovereign wealth funds continue to find private assets appealing, but performance disparities have prompted investors to exercise more judicious selection,” the report asserted. “Infrastructure, especially renewable energy, has emerged as the preferred sector. Evaluating debt metrics and prioritizing organic growth over leverage-dependent returns have become critical components in investment decision-making.”

Among the different private asset segments, according to the report, the most significant hurdle for funds is securing deals and accessing the best managers, particularly for new and smaller sovereign wealth funds. Over the past year, large sovereign wealth funds, such as those funded by energy reserves, have been well-positioned to develop a strong pipeline and secure additional access to top-tier funds, while more capital-constrained investors have fallen by the wayside.