Official institutions are looking to new markets and a broader range of assets as they search for greater returns, according to a report by State Street.
The report, “New Horizons for Official Institutions”, surveyed more than 60 senior executives at official institutions, defined as central banks, sovereign wealth funds (SWF) and public pension reserve funds.
In a fluid and volatile investment environment where regulatory sands are continually shifting, official institutions are required to be more adaptable than ever to new risks and new opportunities.
Despite concerns about the challenges associated with new markets and asset types, 80 per cent of official institutions surveyed expect to increase their exposure to new markets, and, where they have the appropriate mandate, to alternative assets such as hedge funds, private equity, real estate and infrastructure.
This move into new asset types is creating new levels of portfolio complexity and within this uncharted territory are fresh challenges.
Other findings include:
· 73 per cent say keeping up with the changes in regulation across global markets is a challenge
· 51 per cent say the biggest challenge is correctly measuring and monitoring the amount of currency risk they are taking; this emerged as the biggest concern for APAC respondents with 44 per cent saying it is a challenge to combine different risk measures across asset classes
· 38 per cent cite higher interest rates as a hurdle
· 37 per cent are most concerned about emerging market volatility
· 35 per cent are concerned about the cost of execution going up given collateral issues and additional reporting requirements
· 25 per cent say their biggest investment challenge is managing the complexity associated with alternative investments
“Official institutions are at different stages in terms of how and where they can invest, but it is clear that those institutions with a more flexible investment mandate are recalculating their approach and looking to new markets and asset classes as they search for yield,” says Joe Antonellis, vice chairman of State Street. “The resulting portfolio diversity presents fresh challenges, and official institutions will need the right teams and supporting solutions to manage these strategies.”
Official institutions need to measure the moving targets of risk, complexity and efficiency and be more adaptable than ever. Overall, managing risk was the biggest challenge for survey respondents with market risk cited as a major concern for 86 percent and operational risk just behind at 73 per cent. But confronting these risks requires greater investment. Almost two thirds of respondents (60 per cent) plan to increase investment in their risk management systems and processes over the next two years and 32 per cent of respondents report difficulties hiring employees with risk, compliance and reporting skills.
Improving operational efficiency is considered a significant challenge by 47 per cent, but focusing on lowering costs will help official institutions to become more agile. Institutions can achieve operational efficiency by:
· Reducing costs: the importance of reducing costs is rated the highest level of priority by survey respondents
· Building capabilities with the right people: 32 per cent say it is difficult to recruit the talent they need for effective risk management; 29 per cent say the need to develop talent is a challenge; 13 per cent cite it as their most significant challenge
· Meeting the data challenge: 50 per cent say managing data is a challenge. Integrating performance and risk analytics and protecting data security are paramount. In APAC, that statistic rose to 55 per cent
“To meet the challenges identified in this research, official institutions must create an efficient, streamlined, yet resilient, operating model,” says Rod Ringrow, senior managing director and head of official institutions for Europe, Middle East and Africa region at State Street. “This means reducing costs while not compromising on standards, finding the right combination of people, process and technology to support investment needs and operational challenges, and using data to generate insights that support better-informed investment decisions. Across all these areas, institutions must retain the necessary rigor in their decision-making and remain truly accountable under ever-greater scrutiny.”