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Global Official Institutions Are Becoming More Agile in Face of Economic Uncertainty

New Research from State Street Shows Official Institutions are Focusing on Risk Management, Governance, Technology and Talent as They Diversify Their Investment Portfolios 

Faced with a challenging investment environment, official institutions globally are adapting their investment and operating models to be more agile, according to latest research titled, “Official Institutions: Transforming to Meet the Needs of a New World,” by State Street Corporation (NYSE:STT).

The 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 percent of surveyed central banks are most impacted by potentially rising interest rates, while 90 percent 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 percent of the surveyed SWFs looking to increase allocation to commodities, and 88 percent 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 percent of Asia-Pacific (APAC) institutions and 63 percent of institutions from other regions planning to increase their investments there.

Diversification Requires New Ways to Manage Risk

 “A volatile investment environment calls for organizational agility and official institutions are learning to adapt and become more agile,” said Kevin Wong, 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 organizational DNA:

  • Upgrade risk management approaches — Over half (58 percent) 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 percent vs. 69 percent of central banks), along with the use of derivatives (64 percent vs. 33 percent of central banks). Seventy four percent of institutions in APAC say they are most likely to improve their risk management over the next three years, followed by 61 percent in EMEA and 56 percent in North and Latin America. In APAC, 74 percent of surveyed official institutions plan to increase their use of currency hedging strategies (vs. 53 percent in North America and 52 percent in EMEA).
  • Improve governance structure and transparency — Both central banks and SWFs are beginning to disclose more data about their investment priorities, risks, and holdings. About half (52 percent) of all institutions expect to increase the amount of data they disclose publicly and the frequency of their reporting (53 percent), while 75 percent view increased reporting and communication as a way of conveying the value they generate to their stakeholders and wider public.
  • Invest in information capabilities — 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 percent) say that integrating legacy systems is a common problem, and only 16 percent 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 percent) of central banks and 78 percent of other institutions are investing in upgrading their cybersecurity over the next year.
  • Develop the right talent — 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 percent), technology (61 percent) and risk and compliance (60%).

“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,” added 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.”

On behalf of State Street, Oxford Economics, a global research firm, conducted a survey of official institutions during September and October 2015. The survey captured 102 responses from senior executives around the world. Of these, 52 came from central banks and the remaining 50 from sovereign wealth funds (SWFs) and public pension reserve funds.