A significant allocation shift by large institutions towards less risky assets and markets is underway, according to a major new study of institutional investor and sovereign wealth fund activity by State Street Corporation and the International Forum of Sovereign Wealth Funds (IFSWF).
The report, entitled ‘Post-pandemic shift’, analyses the aggregated activities of long-term institutional investors representing more than USD43 trillion in assets under custody and administration at State Street. It also includes insights from interviews with a number of the world’s largest sovereign wealth funds across Asia, Australasia, and North America.
The report reveals institutions’ growing risk aversion over recent months, as evidenced by the fact that State Street’s Behavioural Risk Scorecard – an aggregate measure of risk appetite derived from the capital flows and holdings by institutional investors across multiple asset classes and factors – turned negative in early February 2022 and reached its lowest point in two years.
Institutional investors’ capital flow decisions have become more broad-based, according to the report’s authors – with evidence of risk-off behaviour increasingly being seen across investors’ equity, fixed income, foreign exchange, and asset allocation decisions.
“As economies around the world emerged from the long shadow cast by the Covid-19 pandemic, investors are faced with new risks,” says Neill Clark, head of State Street Associates, Europe, Middle East and Africa (EMEA). “Today, risk assets are repricing due to international conflict, inflation, and central bank policy responses.”
“Following a period of opportunistic rebalancing and selective risk-taking during 2020, the past year has seen institutional investors moving towards safer assets and markets. Their asset allocation decisions suggest they are no longer adding to their equity exposure – which they had been doing since Q1 2020 – and instead, are adding to their fixed-income and cash balances.”
The new report reveals that strong capital outflows from emerging markets – constituting the largest level of selling seen in the past five years – have been matched by robust demand for stocks in developed markets.
“When it comes to the investment strategies of sovereign wealth funds, most are taking the long view, which can sometimes mean a contrarian stance,” says Duncan Bonfield, chief executive at ISFWF – a global network of sovereign wealth funds from 40 countries.
In fixed income, the report reveals that heightened geo-political risk has seen capital outflows from emerging-market sovereign debt, while high-quality, developed-market sovereign bonds are maintaining stable capital inflows despite rising domestic inflationary pressures.
Euro and US dollar-denominated corporate credit has also seen outflows, driven by a challenging combination of rising rates, high inflation and slower growth, tapering of quantitative easing from global central banks, and potential ripples from Russian sanctions as well.
According to the report, one beneficiary of the credit uncertainty and rising inflation pressures is the US Treasury Inflation Protected Security (TIPS) market, where there has been renewed appetite from institutional investors – while, in terms of foreign exposure, institutions are favouring currencies that have displayed less negative sensitivity to the developing international conflicts.
“A broader set of factors are now driving financial markets, which present institutional investors with new challenges and risks on the horizon,” says Clark. “International conflict and rising inflationary pressures now dominate the key market narratives against a backdrop of high global equity market turbulence but low systemic risk, with global equity market returns becoming driven by a wider set of factors.”
