Faced with a challenging investment environment, official institutions globally are adapting their investment and operating models to be more agile, according to latest research by State Street Corporation.
Official Institutions: Transforming to Meet the Needs of a New World, a global survey of more than 100 official institutions, defined as central banks, sovereign wealth funds (SWFs) and government pensions, highlights the challenges stemming from an uncertain investment climate. Seventy-seven per cent of surveyed central banks are most impacted by potentially rising interest rates, while 90 per cent of SWF and government pension fund respondents say an equity market correction will have a moderate or significant impact on their investment strategy over the next three years.
As uncertainty persists, official institutions are diversifying their portfolios and looking at new asset classes and markets. In particular, SWFs and government pension funds are showing strong appetite for alternative investments, with 68 per cent of the surveyed SWFs looking to increase allocation to commodities, and 88 per cent of surveyed government pensions to real estate in the next three years, in the hope of achieving returns that beat equity markets.
Despite the weakened outlook for growth in China, Asia remains the most attractive region for investment with 89 per cent of Asia-Pacific (APAC) institutions and 63 per cent of institutions from other regions planning to increase their investments there.
“A volatile investment environment calls for organisational agility and official institutions are learning to adapt and become more agile,” says Kevin Wong (pictured), senior managing director and head of Sector Solutions for State Street’s Global Services and Global Markets business in Asia Pacific. “They demand strong, flexible investment teams supported by a nimble operating model that help them identify opportunities, manage risk exposure, and take corrective action.” In recognition of the need to respond quickly to opportunities and threats as they arise, official institutions globally have embarked on a journey to build a number of adaptive skills into their organisational DNA.”
Over half (58 per cent) of the institutions surveyed have changed their risk management approach over the last three years, and two-thirds of all respondents are planning to make changes over the next three. SWFs in particular have expanded the use of risk factor analysis over the last three years (82 per cent vs. 69 per cent of central banks), along with the use of derivatives (64 per cent vs. 33 per cent of central banks). Seventy four per cent of institutions in APAC say they are most likely to improve their risk management over the next three years, followed by 61 per cent in EMEA and 56 per cent in North and Latin America. In APAC, 74 per cent of surveyed official institutions plan to increase their use of currency hedging strategies (vs 53 per cent in North America and 52 per cent in EMEA).
Both central banks and SWFs are beginning to disclose more data about their investment priorities, risks, and holdings. About half (52 per cent) of all institutions expect to increase the amount of data they disclose publicly and the frequency of their reporting (53 per cent), while 75 per cent view increased reporting and communication as a way of conveying the value they generate to their stakeholders and wider public.
Effective technology is critical in helping official institutions achieve their objectives. Still, many official institutions struggle with ineffective systems where more than two-thirds (71 per cent) say that integrating legacy systems is a common problem, and only 16 per cent believe their institution is very effective at sharing data internally. Cybersecurity, data warehousing and integrating performance and risk analytics are cited as particular priorities. More than two-thirds (69 per cent) of central banks and 78 per cent of other institutions are investing in upgrading their cybersecurity over the next year.
Official institutions are examining cost-effective ways to invest, such as building their own in-house resources or seeking different relationships with external fund managers. They demonstrate strong intentions to hire in key areas — investment (70 per cent), technology (61 per cent) and risk and compliance (60 per cent).
“Official institutions play a vital role in safeguarding the world’s economic growth and stability; the extent to which they are shifting tactics is sure to differ as a result of their different mandates, objectives, and circumstances,” adds Rod Ringrow, senior vice president and head of Official Institutions EMEA. “Above all else, they need to be more adaptable than ever in a continually shifting investing environment to ensure long-term success.”