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JP Morgan: With Dip in Equities, Sovereign Wealth Funds Review Traditional Asset Allocation

Sovereign wealth funds are reconsidering their investment strategies following low performance in equities against low-yielding fixed-income, a JP Morgan analysis reveals.

(September 28, 2011) -- Sovereign wealth funds may soon be shifting out of equities toward alternative investments such as infrastructure and property.

“Ten-year returns on government bonds have been generally superior to those of public equities. However, these returns have been driven by large falls in bond yields," Patrick Thomson, Global Head of Sovereign Wealth at J.P. Morgan Asset Management, said in a statement. "This fall in prospective government bond returns, combined with continued sovereign credit crisis and the ongoing volatility in equity markets, has encouraged many sovereigns to take a fresh look at the way they invest.”

Thomson continued: “Analysis of recent market events has also highlighted the fact that returns cannot be adequately modeled using normal distributions, therefore, investors need to consider the impact that ‘non-normal’ returns have on asset allocation.”

According to JP Morgan's analysis, more than 50% of sovereign wealth fund assets are typically invested in publicly-listed equity. Meanwhile, 31% are in bonds and cash, with the remaining amount in alternatives, including hedge funds, commodities, property or infrastructure.

Thomson concluded: "As one of the largest active managers of sovereign assets in the world, we are able to identify certain investment themes that have become more pronounced in recent times. These include an increased appetite for non-traditional investments such as infrastructure, real estate, commodities and private market investments. Even with recent volatility, corporate and emerging market debt assets have provided respectable returns and we continue to see opportunities in these areas.”

JP Morgan asserted that long-term investors such as sovereigns will be able to take advantage of attractive mezzanine financing opportunities, particularly with diversified companies with strong cash flows. Within equity portfolios, the firm asserted that it is recommending US equities with strong balance sheets and attractive dividends, as well as equities that derive a lot of their returns from emerging markets.

JP Morgan's analysis echos findings from a March report by Preqin that concluded that sovereign wealth fund assets swelled 11% in the previous 12 months to about $4 trillion, fueled largely by intensified alternative investment programs.

“Following global economic stabilization, many sovereign wealth funds that had delayed plans to diversify their holdings as a result of the economic downturn have now resumed these plans," Sam Meakin, Managing Editor of the 2011 Preqin Sovereign Wealth Fund Review, said in a release. "Therefore we expect the proportion of sovereign wealth funds moving into the various alternative asset classes, as well as the amount invested by sovereign wealth funds in alternatives, to continue to increase in the coming year. The significant collective assets under management of sovereign wealth funds means that they represent an important potential source of capital for fund managers across all asset classes.”

With their longer-term investment horizons compared to other investors, the report found that despite the challenging financial climate, sovereign wealth funds have been better able to commit larger proportions of their portfolios to longer-term and alternative investments.