Manager growth linked to SWFs

Growth for institutional money managers is being tied to the rise in number and size of sovereign wealth funds, providing a potential treasure trove of new assets to manage and changing how managers win new business.

The assets up for grabs from sovereign wealth funds are vast. According to a May report from PricewaterhouseCoopers LLC, New York, called “U.S. Asset Management: Strategic Imperatives for Asset Managers,” wealth fund assets have jumped 59% since 2007 to $5.184 trillion as of Dec. 31, citing data from the Sovereign Wealth Fund Institute.

Continued asset gains will present what the report called “massive growth prospects” for money managers. The PwC report said the increase in sovereign wealth funds was one of five macro trends in money management along with demographic change, social and behavioral changes, changes in technology and increasing interconnectivity of emerging markets.

There's more than just sovereign wealth funds in state-directed savings, noted Wayne Bowers, Northern Trust Global Investments' executive vice president and head of asset management for Europe, Middle East and Africa and Asia Pacific, and London-based chief investment officer for international markets. Examples include the £11.1 million ($16.8 million) National Employment Savings Trust, the U.K's national defined contribution plan; Australian superannuation funds; and Swedish and Norwegian government retirement funds, all of which provide opportunities for investment markets. “The assets in this segment are huge and continue to grow,” he said. NTGI had $758.94 billion in assets under management as of Dec. 31, including $52.56 billion for sovereign wealth funds, according to Pensions & Investments data.

But getting this business for money managers isn't easy. Rather than waiting for RFPs, SWFsrequire a more direct, individual approach “If you're a sovereign wealth fund, everybody and their brother are calling you,” said John Siciliano, PwC managing director, global asset management consulting practice, based in New York. “If you're not calling, you won't get the business.”

SWFs aren't the easiest clients to work with, added Benjamin Phillips, partner, Casey Quirk & Associates, Darien, Conn. “Sovereigns are very service-intensive, often asking to 'co-locate' some of their analysts in a manager's shop to learn more about portfolio management. They also tend to be brutal in demanding fee concessions, given their size and the competition they generate — check out how packed the waiting rooms of (the Abu Dhabi Investment Authority) or (the China Investment Corp.) can be at any given time. Asset managers with capacity-constrained product are becoming increasingly nervous about big mandates from sovereigns that may not prove, over time, to be the most profitable use of their incremental capacity.”

Getting that business requires money management firms to understand the funds' idiosyncratic nature. “Sovereign wealth funds understand what they do, why they do it, and have the luxury of a long time horizon to reach their investment goals. They use synthetic products, overlays, interest rate protection; they've made a dramatic shift in smart beta. A manager needs to know this,” said Firas Mallah, BMO Global Asset Management, managing director, Middle East and North Africa, Abu Dhabi, United Arab Emirates. BMO Global managed $109.27 billion in assets as of Dec. 31, including $1.018 billion in SWF assets, according to P&I data.

Mr. Mallah listed three things managers need to know when marketing to SWFs:

• Sovereign wealth funds aren't very transparent. “They disclose only indicative information,” he said. “The disclosures aren't as detailed as with pension funds.”

• “Sovereign wealth funds don't talk unless they're solicited, so you need to know their structure and organization, plus have good direct contacts with them,” he said.

• Internal contacts “are just one piece of the puzzle. Investors like them have seen it all. Ninety percent of the top 100 money managers have shown them their products. Ultimately what you need is something with a proven track record.”

The bottom line for SWFs, as with any manager-client relationship, is what a manager can do for them. “At the end of the day, it's all the same,” said Mr. Mallah. “You need to be able to do what the sovereign wealth funds want and need.” Added Mr. Siciliano: “Ultimately a money manager's ability to get performance will be more crucial than the size of the firm. If you're good at what you do, I don't care what size you are, you'll get the business.”

Still, small boutiques “need to go in with their eyes wide open,” said Mr. Bowers. “Sovereign wealth funds aren't just interested in returns; they need to have a level of service and frequent, direct contact with investment fund managers and risk professionals.”

In the case of high-yield fixed-income manager DDJ Investment Management LLC, one wealth fund called the firm rather than waiting for the firm to call on it. The Waltham, Mass.-based firm was called out of the blue by a wealth fund and has been managing a portfolio for the client for the past six months, said David Breazzano, president. He wouldn't name the fund or provide the size of the portfolio. “The client is a sophisticated entity that had scanned databases and had been following us for a while,” Mr. Breazzano said. “They did their own due diligence. I assume they did that with other managers.” DDJ Capital had $6.1 billion in AUM as of June 30.

Mr. Breazzano thinks that wealth funds look for smaller boutiques “because they're looking for alpha. Sovereign wealth funds seeking beta would probably go with the bigger firms. With alpha, the best in class isn't always the big guys.”

Casey Quirk's Mr. Phillips said what wealth funds want from managers is a “highly differentiated product that provides excess return or a specific outcome; most sovereign funds don't focus on benchmarks. The rest depends on the sovereign's own approach. Some sovereigns want to partner with managers that provide significant levels of thought leadership and act as intellectual partners in designing the overall portfolio. Others are quite happy seeking out innovative boutiques to 'test-drive' with initial allocations. And some have either regulatory or conventional restrictions to focus on large, brand-name asset managers.”

Strategic partnerships between managers and wealth funds will drive business going forward, several sources said.

“I think overall, strategic partnerships with broad and deep sets of solutions really will drive growth,” said Phillip Enochs, Chicago-based managing director and head of relationship management for BMO Global Asset Management U.S. “Sovereign wealth funds want to look at large financial institutions that have broad investment applications.”

Added PwC's Mr. Siciliano: “The era of style boxes is going away. A single-strategy manager is at a distinct disadvantage. There are very few 'haves' and many 'have-nots,'” which is why larger firms with broad capabilities have a leg up on wealth fund business. “But there are ways to become a money manager (for SWFs) if you have a very good strategy,” he said, with examples such as emerging markets bond managers that can branch into high-yield bonds and convertibles, which larger firms might not be able to do. “But they'll have a hard time being successful in getting business unless the strategy is outstanding.”

Mr. Enochs also said wealth funds are looking for outcomes-based offerings, though exactly what those outcomes are vary by fund, investment strategy and asset allocation. “The outcome could be large and broad, and it could also be small and focused on one particular strategy.”