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Sovereign investors cut bonds, seek returns in frontiers, property-study

* More interest in frontier markets such as emerging Asia

* Real estate (OTC BB: REACD - news) growing strongly at expense of fixed income

* Overall confidence resilient, net inflows prevailing

By Claire Milhench

LONDON, June 13 (Reuters) - Sovereign investors have cut their exposure to global bonds, preferring higher-yielding alternatives such as real estate, and are also adding to frontier market holdings, a study by asset manager Invesco showed on Monday.

Sovereign investors, a category that includes everything from state pension funds to domestic development funds and future generation funds, are falling short of their return targets due to volatile stock markets and near-zero or even negative interest rates in many Western markets.

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The Invesco study, which covers 77 sovereign investors and reserve managers representing $8.96 trillion of assets, found that the average annual return of 4.1 percent had undershot investors' original target of 5.9 percent last year.

Returns are expected to undershoot again in 2016 by 1.3 percentage points.

"It (Other OTC: ITGL - news) 's been a difficult environment over the last 12 months with market volatility, and some of them are funded from commodities, and there's been volatility there too," said Alex Millar, head of EMEA sovereigns, Middle East and Africa institutional sales at Invesco (NYSE: IVZ - news) .

The disappointing performance is prompting sovereign investors to rotate out of listed equity and bond markets into more illiquid assets. Global fixed income allocations for the average sovereign investor portfolio fell to 16 percent in 2015, down from 20 percent in 2014 and from 25 percent in 2012.

Meanwhile, the average exposure to real estate, infrastructure and private equity rose to 13.8 percent, up from 9.2 percent in 2014.

Real estate is the fastest growing sector in this segment, as it is easier to access. More than 62 percent remain underweight infrastructure relative to their target allocation, whilst 52 percent are underweight private equity.

"Most sovereigns have found it difficult to deploy assets in these areas," Invesco noted. As a result, fewer sovereign investors now expect to increase their actual allocations to private equity and infrastructure.

"The practicalities of accessing infrastructure are challenging," said Millar, highlighting issues such as sourcing deals and winning bids.

He added that on average it took three-and-a-half years from making the decision to invest in infrastructure to actually getting it done, compared with two years in real estate.

Sovereign investors showed a growing interest in frontier markets, with allocations to emerging Asia standing at 2.3 percent in 2015, up from 1.6 percent in 2014. The allocation to Africa grew to 0.9 percent from 0.6 percent, despite problems in markets such as Nigeria.

But sovereign investors became less willing to overlook political and regulatory concerns in Brazil, Russia and China in order to hit target allocations, Invesco said.

From year-end 2014 to 2015 the average asset allocation to Russia and central Europe fell to 1.5 percent from 1.9 percent, whilst China fell to 1.7 percent from 2.2 percent.

However, beyond a few switched or consolidated mandates, sovereigns do not appear to have withdrawn existing assets from any emerging market, Invesco said.

"They are quite strategic, they won't flip their portfolios around tactically year-on-year ... but we are seeing some fine tuning," Millar said.

The study also found that investor confidence remained relatively high, with the average sovereign investor withdrawing or cancelling only 3 percent of assets.

This is Invesco's fourth annual survey of global sovereign asset management, which covers 66 percent of sovereign assets and 25 percent of foreign reserves. (Reporting by Claire Milhench)