Public asset owners seek more boldness, creativity in search for yield: BNY Mellon 

SOME central banks have taken a hit to their reserves amid inflationary pressures and geopolitical tensions, prompting others to mull higher allocations to China and the yuan, as almost all public asset owners explore new asset classes, products and investment strategies in the search for yield, a white paper by BNY Mellon says.

“Central banks are extending into equities, while public pension funds increase allocations to alternatives and sovereign wealth funds test digital assets and take more active roles in shaping market structure,” BNY Mellon said in its report, titled The Evolution of Public Asset Owners. 

Old assumptions that helped guide the strategies of public asset owners - including sovereign wealth funds, public pension funds and central banks that collectively hold over US$40 trillion in investible assets - have started to lose relevance.

“Technology and innovation have created new demands while allowing public asset owners to reimagine what is possible. In addition, stakeholders and beneficiaries of public institutions have new expectations, such as sustainability and transparency,” BNY Mellon said.

The report, which surveyed more than 90 senior leaders from nearly 50 public asset owners globally - the first since Russia invaded Ukraine - showed how managers of central banks’ reserves are coping with inflationary pressures, geopolitics and environmental, social and governance (ESG) imperatives to preserve capital and maintain reserves.

Although central bank reserve portfolios are still primarily composed of high-grade sovereign bonds issued in reserve currencies, as well as gold and cash deposits, many central bank interviewees say they face significant challenges sustaining their assets through traditional fixed-income portfolios. As a result, some central banks have “taken a hit” to their reserves. 

Some central banks have recently increased allocations to developed market sovereigns and agencies, and many have bought corporate bonds. Mortgage-backed securities and emerging market debt also offer opportunities. Outside fixed income, many central banks are either already investing in equities or exploring the asset class. The most advanced central banks in this space have active equities desks or employ external managers, while others tentatively consider equities via exchange traded funds. 

There is strong interest in geographic diversification as well, with increasing allocations to Asia-Pacific and, most specifically, to China and the yuan despite a shifting geopolitical environment. In some geographies, there is an additional strategic rationale for increasing yuan exposure. However, not all central banks want to take direct exposure to yuan, and prefer indirect exposure via Bank of International Settlement funds.

In the search for yield, digital assets are one area of interest, but none of the interviewees are yet seeking to invest in cryptocurrencies directly, given the lack of regulatory certainty and investment security. Instead, public asset owners look to indirect investments in the digital currency space. Digital assets and tokenization attract more interest. Many see tokenized assets as a powerful way to increase market liquidity, especially in alternative asset classes such as real estate.

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Among emerging sectors, the space economy is also generating excitement. Institutions with equity investments are familiar with companies such as SpaceX and their ecosystems. In the Middle East, public asset owners are interested in the broader sector, such as satellite telecommunications.

Several institutions in Asia-Pacific also recognise carbon as an emerging asset class, with one suggesting it could become a core part of its portfolio. Carbon allowances or credits are a small and volatile market, currently worth around US$100 billion with an estimated US$250 billion in annual turnover and growing 20 per cent annually as emissions trading systems and regulatory regimes mature. Investors look to carbon and its derivatives (futures and options) as a tool to hedge the climate risk in their portfolios.

Securities lending is on the rise, and one-third of those surveyed will initiate or expand programmes over the next 5 years.

Nearly 70 per cent have taken on sustainability-themed or impact investing. While adoption and approaches vary widely, most are embracing an ESG obligation. However, the availability of reliable, transparent and comparable ESG data remains a challenge.