- Geopolitical tension becomes sovereign investors’ primary concern, followed by inflation
- Appeal of private credit in the Middle East rises, while interest in fixed income, equities, and private equity softens
- Region’s sovereign wealth funds and central banks embrace AI in their investment process
- Investors align portfolios with global climate goals
- Middle East’s central banks turn to gold to diversify reserves
Geopolitical tension has surpassed inflation as the primary concern of sovereign investors and is prompting greater interest in allocating to emerging markets, according to the twelfth annual Invesco Global Sovereign Asset Management Study (link here).
Geopolitical tensions were cited by 83% of sovereign investors, including 95% of those in the Middle East, as the most serious risk to economic growth over the next 12 months. This trend reflects concerns over competition between the major powers and the potential for trade disruption.
Inflation remains a significant concern, with 43% of sovereign wealth funds (SWFs) and central banks globally and 68% in the Middle East expecting it to settle above central bank targets.
Almost three-quarters of investors – 71% worldwide and 70% in the Middle East – anticipate interest rates and bond yields to remain in the mid-single digits over the long term, indicating a shift in expectations.
Invesco’s study, which has become the leading bellwether for sovereign investor activity, is based on the views of 140 chief investment officers, heads of asset classes, and senior portfolio strategists at 83 SWFs and 57 central banks, who together manage $22 trillion in assets.
Shifting investment landscape drives changing allocations in the Middle East
SWFs are looking to reshape their portfolios to reflect the new macro environment, with 27% globally and 50% in the Middle East planning to increase allocations to infrastructure over the next year.
Only 6% of SWFs – none in the Middle East – expect to cut allocations.
Emerging markets (EMs) are growing in attractiveness. More than a half (54%) of SWFs, including 71% in the Middle East, expect EMs to benefit by playing off competing great powers, and 54% (86% in the Middle East) believe EMs are becoming more attractive due to near-shoring and regionalisation.
Of the emerging market regions, Asia (excluding China) is leading the way, seen by 83% of SWFs, including 100% of those in the Middle East, as a priority.
India remains in the spotlight, with 88% of SWFs worldwide and 100% in the Middle East viewing it as an attractive market for increasing EM debt.
“Amid an unpredictable macro environment, sovereign investors are recalibrating their portfolios, pivoting towards equities, private credit, and hedge funds,” said Josette Rizk, Head of Middle East and Africa at Invesco. “Emerging markets are gaining traction, with funds adopting a selective approach.”
The rise of private credit: a compelling opportunity
Private credit is gaining popularity among SWFs, with 56% investing via funds and 30% directly (67% and 44% in the Middle East). Only 35% of SWFs globally and 22% in the Middle East currently have no investments in private credit. More than two-thirds (69%) of SWFs, including 71% of those in the Middle East, plan to increase allocations to private credit, reallocating from fixed income, equities, and private equity.
The appeal of private credit is driven by diversification from traditional fixed income (63% overall and 50% in the Middle East) and its relative value compared to conventional debt (53% and 50% respectively).
The US is the most attractive market for private credit (rated as very attractive by 64% of SWFs worldwide and 71% in the Middle East), followed by Western Europe (41% and 50% respectively).
However, there is growing interest in emerging market private debt. Half of the respondents, including 58% in the Middle East, believe the opportunity in emerging markets is equal to or greater than in developed markets.
“Private credit is increasingly attractive to SWFs, with many investing through funds and direct deals,” said Rizk. “SWFs in the region favour developed markets but are also exploring emerging markets while balancing defensive and opportunistic strategies to navigate the competitive landscape.”
The AI awakening: Middle East’s sovereign investors embrace the future
One-third of sovereign investors globally are using AI in their investment process, including 6% employing it extensively.
These numbers are even higher in the Middle East at 40% and 15% respectively. The vast majority – 93% worldwide and 100% in the Middle East – believe AI will eventually play a role in their organisation.
The rise of generative AI has prompted 66% of SWFs and central banks globally and 83% in the Middle East to reevaluate their current AI strategies and explore new applications for this technology.
Lack of expertise (cited by 45% of sovereign investors overall and 54% in the Middle East) and AI model explainability (45% and 38%) are the top barriers to incorporating AI.
To address this challenge, organisations are investing in training and partnering with external experts.
SWFs and central banks that are using AI are finding a wide range of applications, with data processing (used by 71% worldwide and 80% in the Middle East), risk management (62% and 73%), and forecasting (53% and 53%) being the most common use cases.
Half of sovereign investors globally and 80% in the Middle East are confident that AI can generate alpha and enhance returns.
While 59% of SWFs and central banks, including 82% in the Middle East, believe that AI will be deflationary, the majority of respondents expect this to take effect only after at least five years.
“Sovereign investors in the region are increasingly adopting AI in their investment processes, recognising its potential to become an essential tool,” added Rizk.
“While challenges exist, funds are investing in training and partnerships to overcome barriers.”
ESG factors grow in importance
As ESG investing matures, so do the expectations and challenges that come with it.
Greenwashing is seen as the biggest challenge, cited by 84% of sovereign investors worldwide and 94% in the Middle East.
Data and ratings quality (cited by 81% of SWFs and central banks overall and 94% in the Middle East) and measuring impact (81% and 94% respectively) are the next most significant challenges.
In response, sovereign investors are moving towards greater accountability, with 48% (50% in the Middle East) modelling and tracking their portfolios against global climate goals, and another 32% (30% in the Middle East) intending to do so.
ESG aspects are an important factor in manager selection and oversight for 81% of respondents worldwide and 70% in the Middle East. In addition, 45% overall and 20% in the Middle East have robust ESG due diligence in place for external managers and drive ongoing engagement.
Meanwhile, 61% of SWFs and central banks globally and 44% in the Middle East incorporate physical climate risk considerations into their investment processes. T
o drive the transition to a low-carbon economy, sovereign investors generally prefer a combination of allocating to renewables and clean technology (88% overall and 80% in the Middle East) and engagement (63% and 70% respectively).
“ESG adoption continues to rise among the Middle East’s central banks, while SWFs refine their approach as the market matures,” said Rizk. “Investors are increasingly recognising climate risk as a material factor, and aligning portfolios with global climate goals.
Engagement with and allocation to renewables are preferred over complete divestment to drive the energy transition.”
The allure of gold in an uncertain world
Central banks are bolstering and diversifying reserves amid uncertainty, with 53% worldwide planning an increase in the size of their reserves and 52% planning additional diversification. Both numbers stand at 56% in the Middle East.
Rising US debt levels have a negative impact on the global role of the US dollar according to 64% of respondents globally and 33% in the Middle East.
Meanwhile, 18% of central banks, including 20% in the Middle East, believe that the position of the US dollar as the world reserve currency will be weaker in five years’ time.
On the other hand, gold is gaining appeal, with 35% of central banks worldwide having increased gold allocations in the last three years, and 37% planning to do so in the next three years.
In the Middle East, these numbers are even more pronounced at 70% and 78% respectively.
The weaponisation of central bank reserves makes gold more attractive for 56% of central banks overall, while 48% agree that rising US debt levels have boosted gold’s appeal. Both numbers stand at 88% in the Middle East.
The proportion of central banks with an allocation of 5% or more to EMs (excluding China) is projected to reach 34% globally and 22% in the Middle East in five years’ time.
India, in particular, is witnessing keen interest, with 83% of central banks worldwide and 100% in the Middle East seeing the country as an attractive market for increasing exposure.
“Amid global uncertainties, central banks in the region are strengthening and diversifying reserves,” added Rizk. “Gold’s appeal is growing due to concerns about rising US debt levels. Allocations to emerging markets are increasing as central banks seek to enhance returns and mitigate risks.”
