Strange bedfellows

Money managers may partner with SWFs to grow in developing markets

Sovereign wealth fund deals raise stakes for firms seeking new markets

A new business model is emerging for money managers expanding in developing markets — form a joint venture with a sovereign wealth fund to lock in a key relationship that's essential for growth.

In the latest tactical maneuver to gather assets from the Middle East, Mesirow Financial Holdings Inc., announced plans earlier this month to form a money management firm with Mubadala Development Co., Abu Dhabi, a sovereign wealth fund with about $15 billion in assets.

“The view of most asset managers looking to access the region is to have sovereign wealth funds as clients,” said Gary Klopfenstein, senior managing director and head of currency management at Mesirow, a Chicago-based financial services company with about $51 billion in assets under management at year-end 2010, about half of which come from overseas clients including SWFs.

“We already have access to (SWF) clients,” he continued. “We didn't need a joint venture to access those clients.

“What we wanted to do is to think outside of the box and figure out how we can build the business for the next 20 years,” said Mr. Klopfenstein, who was part of the management team leading the negotiations with Mubadala. “We're not just looking at the very large players, but also other institutions and traditional high-net-worth investors.” Part-ownership of money managers by SWFs has become more prevalent in the past several years, notably with the $332 billion China Investment Corp.'s 2007 purchase of a $3 billion stake in Blackstone Group. Several other funds have followed suit, including Mubadala, which bought a 7.5% stake in the Carlyle Group that same year. Such stakes have largely been passive investments that allow SWF officials more control and access to investments.

Joint ventures rare

But joint ventures between money managers and sovereign wealth funds are rare, and recent plans move both Mesirow and Mubadala into relatively new territory, sources said. The agreement is the second for Mubadala, which announced a joint venture with Prudential Real Estate Investors (also known as Pramerica Real Estate Investors in some overseas markets), in July.

“It's a case of asset managers raising their stake — higher risk for higher rewards,” said Stuart Leckie, chairman of Stirling Finance Ltd., a research and consulting firm based in Hong Kong. Mr. Leckie has written several research papers on Asia's SWFs. “A lot is being discussed at the moment ... and I can see more (joint ventures between sovereign wealth funds and money managers) happening in the near future.”

Benjamin F. Phillips, partner at Casey, Quirk & Associates, a money manager consultant based in Darien, Conn., said SWFs are looking for ways to cut costs and enhance performance by closely aligning their interests with managers. While Mr. Phillips declined to comment on specific transactions including the Mesirow-Mubadala agreement, he said alliances between SWFs and managers generally reflect efforts of sovereign wealth funds “to get the most out of external managers in return for a guarantee to (provide) some sort of exclusive access” to the fund.

Both sides in such deals will face significant challenges, sources said. On top of any additional costs, an alliance with one SWF could backfire if other potential clients view the manager as being too closely aligned with one client. “Managers are giving up a degree of independence” in partnering with an SWF, Mr. Phillips said.

“It's a double-edged sword,” Mr. Leckie added. “For the fund, it's a smart move if the manager does well. If the manager does badly, you're not only stuck with a depreciating asset, but also a stake in a company that you may not be able to sell quickly.”

According to Mr. Klopfenstein, Mesirow executives have discussed the joint venture with clients, who see it as “a great opportunity” that will enhance the firm's capabilities.

In the announced plan with Mubadala, Mesirow initially will provide passive and active management in currency and commodities strategies. Through the venture, the firm will establish “on-the-ground presence” in Abu Dhabi and also help develop local talent in money management, including launching an apprenticeship program for young professionals in the emirate, according to Mr. Klopfenstein. (Under Abu Dhabi's Economic Vision 2030, a business development initiative launched in 2006 by the government, a key responsibility for Mubadala is to help diversify the emirate's economy from oil and gas into areas such as health care, technology and financial services, including asset management.)

“This initiative is part of a broader strategy in financial services to leverage international best practices in asset management and build Abu Dhabi's investment management capabilities and infrastructure base,” Laurent Depolla, executive director of Mubadala's Services Ventures Business unit, said in an e-mailed response to questions.

For Mesirow, a major benefit is access to Mubadala's extensive resources and expertise in the region. While Mubadala is relatively small compared with other SWFs, it is owned by the Abu Dhabi government, which also owns other investment companies and SWFs, including the Abu Dhabi Investment Authority, the largest SWF globally with an estimated $625 billion in assets.

“This is a new paradigm in how to expand in the region,” Mesirow's Mr. Klopfenstein said. Clients are generally seeking one of three categories of services: passive hedging of the risk embedded in their investment portfolios; active risk management of currency and commodities exposure; and absolute-return strategies. In the medium term, the new company will also offer multistrategy investment solutions tailored to institutional investors.

Mesirow executives began actively looking for partnerships in the Mideast in 2009, and approached Mubadala to form a joint venture last year.

“Historically, the region has lacked some capabilities in risk management, as local investors and corporations had limited familiarity with managing downside risk,” according to Mr. Depolla. “Since the global financial crisis, regional investors have become increasingly focused on managing their exposures to risk more effectively.”

Negotiations intensified in the past several months, culminating in the agreement announced Feb. 10. Pending regulatory approvals and related licensing, the joint venture is expected to launch later this year.

In 2010, Mubadala also entered into a 50/50 joint venture with PREI to form Mubadala Pramerica Real Estate Investors, which raises capital to invest in real estate projects both in the Middle East and elsewhere globally.

Dale Taysom, PREI's chief operating officer, met some of Mubadala's executives on a business trip more than three years ago when he first discussed the idea of a joint venture. The two companies engaged in more serious talks over the past two years, Mr. Taysom said.

“Obviously there are always some risks involved in a joint venture, and we've had lots of time to work through all of the issues and due diligence,” said Mr. Taysom, whose company — PREI — manages $25.7 billion in assets under management globally. “We're very excited about the business model.”

Ravi Nawal, senior analyst covering the financial services industry for consulting firm Celent LLC based in Haryana, India, said sovereign wealth funds “want greater interaction and say in wealth deployment strategies,” leading to “innovative business models.”

“Regional financial institutions would also look at this kind of partnership to help develop asset management expertise in the region,” Mr. Nawal said. “Providers are looking at such partnerships to gather greater market share and credibility.”