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Sovereign wealth fund hires no cinch

Richard Clarida says PIMCO’s sovereign fund clients are looking to emulate the successful flexible asset allocation policies used by many leading U.S. university endowments.

Potential treasure trove of business awaits, but getting to it won't be a walk in the park

Simple mathematics has put sovereign wealth funds at the top of large money management firms' VIP lists. Getting those funds to cross the velvet rope is another issue.

Funds vary widely in both their asset allocations and willingness to hire external money managers. But winning mandates from most sover-eign wealth funds requires more work than with other institutional clients, managers and consultants said.

Total assets for sovereign wealth funds already total $3 trillion, half again as big as the nearly $2 trillion hedge fund industry, according to the Council of Foreign Relations' website. The International Monetary Fund estimates sover-eign wealth assets could reach $10 trillion in the next five years.

Total global pension assets for the 11 largest pension markets totaled $23.2 billion at the end of 2006, according to Watson Wyatt Worldwide in Arlington, Va.

“Consider that this $10 trillion is in 100 accounts as opposed to tens of thousands of pension accounts, and you can see why they're important to the money management industry,” said a top executive at a money management firm, who works with sovereign wealth funds. He declined to be named.

The funds' assets have grown as a commodities boom fueled growth in many emerging economies. Global trade account imbalances between the developed and emerging countries have also built up the reserves, which typically are held at central banks.

New sovereign wealth funds are springing up and growing quickly. According to the Center for Emerging Market Enterprises at Fletcher School of Business, Tufts University, Medford, Mass., 12 sovereign wealth funds have started since 2005.

New funds are expected to launch in countries such as Brazil and Japan, and some countries with one sovereign wealth fund are setting up a second to invest assets in that fund more aggressively, said Eliot Kalter, a senior fellow for the Center for Emerging Market Enterprises. He previously spent 28 years at the IMF, working with central banks.

No two funds seem to be looking for the same types of money managers, with asset allocations all over the place.

The equity allocations of sovereign funds run between zero and 100%, with most allocating between 20% and 80%, said Richard Nuzum, business leader for the Americas for Mercer Inc.'s investment consulting practice in New York.

Pools of money in the Middle East tend to be more diversified and provide the broadest opportunity for external money managers, according to managers and a report from Cerulli Associates, Boston.

The Abu Dhabi Investment Authority, for instance, outsources between 70% and 80% of its assets, while the Kuwait Investment Authority outsources at least 50%, according to the report.

Sophisticated

“The pools of money in the Middle East have done this longer and are sophisticated and have a wider range of managers they employ,” said Richard Clarida, executive vice president and global strategic adviser at Pacific Investment Management Co., Newport Beach Calif.

He said his own firm's sovereign clients have shown more interest in sophisticated strategies such as absolute return or dynamic asset allocation. He said the funds want to emulate the success endowments like Harvard and Yale universities have had in being more flexible in their asset allocation.

PIMCO's Mr. Clarida said that countries in Asia had typically viewed their sovereign funds “as a liquidity management tool, but that's starting to change.”

The Cerulli report lists the outsourcing potential for Asian sovereign wealth funds as moderate.

One of those funds, the $200 billion China Investment Co., Beijing, will invest two-thirds of its assets domestically to replenish the capital of domestic agricultural and development banks, according to Mr. Kalter.

Another of those funds, the $330 billion Government of Singapore Investment Corp., hires external managers to run money, as well as to provide an external gauge for the fund's internal investments, said Flemming Madsen, director of Asia at T. Rowe Price Associates (TROW) Inc. (TROW), Baltimore.

The Cerulli report noted that North American sovereign wealth funds — which include the $40 billion Alaska Permanent Fund Corp., Juneau, and the $17 billion Alberta Heritage Fund, Edmonton — offer a moderate outsourcing opportunity.

Those funds invest aggressively in alternatives. The Alaska fund has a target allocation of 18% to alternatives while the Alberta fund has a total target allocation of roughly 26% to real estate, private equity and other alternatives, according to the report.

The 16 billion kroner ($3.12 billion) Government Pension Fund-Global in Oslo has moderate to high outsourcing potential. The fund invests broadly across 42 different markets, according to the Cerulli report.

The objective of a fund also plays a role in determining how it invests. Sovereign wealth funds seeking to preserve wealth for future generations tend to look for absolute-return strategies and invest in more specialist, or alternative-type, mandates, Mr. Kalter said.

Sovereign wealth funds set up to stabilize a country's economy from dependence on a single commodity will be more liquid, investing in global fixed income and global equity. “There will be an emphasis on being conservative and liquid for when the commodity price shifts,” he said.

As for money managers, winning business from sovereign funds requires more work than for typical institutional clients.

Training and educating the fund's staff often is expected to come with managing the assets. The funds also expect more disclosure about the money manager's own business.

Basic education

New sovereign wealth funds need basic education on investment policy, asset allocation and risk management.

Executives at even the larger, more established funds often demand training because they run some assets internally and want to compare their internal management process to that of external firms.

“We're giving them insight into how a firm like ours operates and goes about managing the risks inherent to being an investment manager,” said Mark Lazberger, president of State Street Global Advisors International, London.

Mercer's Mr. Nuzum said more than half of the mandates from sovereign wealth funds come with some type of technology transfer.

“In some cases they want to put a member on your staff to be trained for a year,” he said.

Some managers do not let the sovereign wealth funds sit in on investment committee meetings for fear of front-running trades, Mr. Nuzum said. In those cases, a manager might send videos of old committee meetings so the sovereign client gets a feel for what the meetings are like.

Executives for several money management firms said staff from sovereign wealth fund clients have worked in their London or U.S. offices.

At times, State Street has had people on site for one to three months at a time, Mr. Lazberger said. “They come in and sit next to our portfolio managers and they spend time with our compliance teams.”

Mr. Nuzum said managers often go over to the sovereign wealth fund's home country and hold weeklong training sessions covering middle and back-office issues.

“Boutique fund managers who want to go into this space have to consider what they want to do in terms of technology transfer and client service,” Mr. Nuzum said.

Contact Jay Cooper at jcooper@pionline.com