The $20 Trillion 'Investment Elephant' Revealed

In a new report, UBS analyst Paul Donovan discusses one of the biggest influences in global markets that rarely gets discussed in the media and among investors: sovereign reserves. The size and influence of central banks and sovereign wealth funds rival those of institutional investors such as pension funds and insurers.

According to the report, the current value of global central bank reserves and sovereign wealth funds is more than $20 trillion. In his report, Donovan discusses the changes in sovereign reserves in recent years and exactly what the future holds for sovereign wealth funds.

Traditional role
Traditionally, foreign exchange reserves were held in an effort to stabilize currencies. In that sense, reserve levels and trade volumes were usually closely tied. However, Donovan notes that the relationship between trade volume and reserve levels has completely disappeared in the past decade.


What changed?
Donovan believes that the Asian crisis of the late 1990s was the trigger for the divergence of reserve levels and trade levels, as many countries seem now to prescribe to the theory that “more is always better” when it comes to the safety.

The scare of the Financial Crisis of 2008 likely provided support for the theory that countries and central banks can never be too careful when it comes to reserve levels.

What does the future hold?
Donovan makes two major points about the future of sovereign reserves. First, after an environment of extremely aggressive sovereign reserve accumulation over the past 25 years, reserve growth will likely cool in the near future.

Second, Donovan sees an increasing focus on diversification when it comes to sovereign reserve investments.

“The combination of quantitative policy and financial repression has left the returns on traditional sovereign reserve investments (i.e. government bonds) extremely low and in some cases negative,” he explains.

Donovan notes that inflation-protected securities are one asset class that has gained favor in recent years among sovereign reserve managers.