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Special report

SWFs evolving into competitors from clients

Northern Trust’s Wayne G. Bowers believes the expansion of in-house investing reflects, in part, the ‘supply-demand conundrum’ large investors face.

Sovereign wealth funds continue to expand in-house management capabilities, a trend that could see them morphing — in the eyes of private markets money management firms — into competitors or collaborators from clients.

“Sovereign wealth funds are becoming scale direct investors,” a trend that's seen them moving away from the fund and co-investment vehicles they focused on for past investments, said Suvir Varma, a Singapore-based partner with Bain & Co. SE Asia Inc., in a recent interview.

“Like any changing relationship ... both sides need to find a balance as they move forward,” he said.

The move by official institutions away from funds when investing in private equity, real estate and infrastructure, with co-investment as the initial step, is a sensible one from the asset owners' point of view in many cases, noted Terrence Keeley, a New York-based managing director and head of BlackRock (BLK) Inc. (BLK)'s official institutions group.

That evolution is partly an issue of scale, some market veterans contend.

Sovereign wealth funds are absolutely building internal capabilities as they become both bigger and more mature, in part reflecting the “supply-demand conundrum” of finding enough managers for the sizable allocations they're looking to make now to capacity-constrained, private market segments, said Wayne G. Bowers, London-based executive vice president and CEO, asset management — EMEA & APAC, with Northern Trust Global Investments Ltd.

Larger sovereign wealth funds “don't have the option” of emulating David F. Swenson, the chief investment officer of Yale University's $24 billion endowment funds, in his exclusive reliance on external managers to invest the endowment's targeted 78% allocation to private markets, agreed David Neal, Melbourne-based managing director of Australia's A$117 billion ($89.5 billion) Future Fund.

The commitment to internalization among sovereign wealth funds and other big institutional investors shows no signs of abating, even if that growth is still coming off a fairly low base, said Mr. Neal.

"Competing head-to-head'

SWFs at a glance

For managers, the concern would be if sovereign wealth funds “start competing head-to-head” with their general partners for the same transactions, Mr. Varma said.

“We haven't seen a lot of that,” but private equity firms would have reason to worry about their ability to bid against sophisticated investors unconstrained by the same fee and carry structures they operate under, he said. Time will tell, he added, if such fears were warranted.

Mr. Varma said there's reason to believe sophisticated sovereign wealth funds will opt to move forward in a way that preserves their ability to work with “the world's biggest investors” such as TPG, Bain Capital, Carlyle and KKR.

A number of managers, meanwhile, report seeing big sovereign wealth funds taking on a more collegial, collaborative role in recent years — increasingly tapping general partners they've worked with to join in on private equity, real estate and infrastructure deals they've sourced independently.

“They're bringing deals to us,” to vet opportunities they've identified, said Jon H. Zehner, London-based global head of client capital group with real estate heavyweight LaSalle Investment Management. That, in turn, can lead to work structuring deals and managing properties, he said.

Sovereign wealth funds increasingly “have their own deal flows,” but still turn to trusted general partners to pursue those deals — a trend that's leading to more “comprehensive, two-way relationships,” agreed Kevin Lu, Singapore office head for Zug, Switzerland-based private markets investment firm Partners Group.

In the past year, sovereign clients have asked LaSalle to look at three such deals, two of which turned into mandates — a “really interesting” development, said Mr. Zehner. He declined to identify the clients.

While examples of limited partners bringing deals to GPs weren't unheard of in the past, the last year or so has seen a material pickup in that activity, he said.

Bain's Mr. Varma pointed to two deals in the Philippines last year by GIC Pte. Ltd., a sovereign wealth fund set up by Singapore in 1981 with an investment portfolio estimated now at well more than $300 billion, as “virtuous” examples of that direct investment trend.

GIC was able to “find, package and do these deals” directly because — as a sovereign-linked investor in Singapore — its access to and knowledge of the Philippines is superior to that of most of the funds in which it invests, said Mr. Varma. GIC brought some of its long-standing GPs into those deals — “a very good use of LPs or sovereigns going direct, because they had the know-how and they brought capital with them,” he said.

If “what do you take in-house” is the question facing the growing ranks of sovereign wealth funds now, Singapore's GIC — which has boasted a deep, broad bench of internal managers for decades — might be the poster child for what a lot of sovereign funds would like to achieve, said Nicholas Hadow, Singapore-based director, business development, Aberdeen Asset Management Asia Ltd.

Past experience

Mr. Lu said Partners Group's own journey from limited partner, as a fund-of-funds firm working with leading private equity firms, to general partner with its own direct investment business as well, leaves it well placed to work with sovereign wealth funds treading a similar path.

He predicted growing opportunities to work with sophisticated sovereign wealth funds on their proprietary deals. Bigger managers might be in a better position to enjoy those fuller partnerships, but there should be opportunities for firms of whatever size that are capable of adding value for those clients, he noted.

Some market veterans speculate that managers focused on infrastructure investments — which typically offer lower yields than private equity investments — could have more to fear from sovereign wealth funds looking to invest directly in order to save on fees.

But Anthony Fasso, Hong Kong-based director, international, with AMP Capital, Sydney, said his firm — with business focuses in infrastructure and real estate — is “finding more opportunities with sovereign wealth funds globally” now.

The biggest sovereign wealth funds going direct still turn to firms like AMP Capital to manage the assets they buy, while their midsize counterparts continue to invest in fund vehicles, which still make up a healthy 75% of AMP Capital's infrastructure and real estate businesses, said Mr. Fasso. If a decline in fund investments as a proportion of those businesses leaves fees under some pressure, that has been more than offset by the continued expansion of the pie over the past six or seven years, he said.

Private market managers say they're tweaking their institutional sales and client service capabilities to better take advantage of opportunities to work with big investors doing direct deals.

In recent years, LaSalle has appointed senior “strategic partnership” executives for the U.S., Europe and Asia to help bulge-bracket global investors looking to make direct investments in real estate around the world.

“We needed more people finding opportunities” — outside of any particular mandate — and matching them with our clients,” said Mr. Zehner.

Money management executives predict a continued buildup of internal management capabilities as sovereign wealth funds become increasingly sophisticated.

“Broadly speaking, the resources and skills those bulge-bracket investment organizations are adding give them the choice to internalize, and many are building up capabilities now to manage not just private market investments but public market investments as well, said the Future Fund's Mr. Neal.

Korea Investment Corp., a Seoul-based sovereign wealth fund with $86 billion in assets, is one of several big funds launched a decade ago that is pledging now to bring more capabilities in-house, after the internally managed portion of its portfolio rose to 73.2% from 69.6% during the year.

In March, Rhee Keehong, KIC's deputy chief investment officer and head of the centralized research center the fund launched at the start of 2014, said KIC will look to open offices in the Middle East, Singapore and China as it moves to start investing directly in private markets and, possibly, also in commodities, public equities and corporate bonds.

Meanwhile, KIC's latest annual report said the fund will launch an active quantitative equity strategy in-house in late 2015, as well as an active, fundamental equity strategy in 2016.

At the end of the day, money managers focused on publicly traded equities and bonds as well as private markets said they're confident they'll continue to find opportunities to work with sovereign wealth funds, which should account for an expanding chunk of their assets under management.

Other ways to collaborate

Sovereign wealth funds have grown to account for a “massive” piece of the institutional opportunity set, particularly in Asia, and Aberdeen should benefit from their continued growth, predicted Mr. Hadow.

“We are relaxed about sovereign wealth funds increasingly investing direct, because we find other ways of partnership with them,” said Patrick Thomson, London-based managing director, global head of sovereigns, at J.P. Morgan Asset Management (JPM). “It is about finding the right thing to talk about. They may start going direct with the more traditional asset classes — like government bonds — but they wouldn't necessarily in mezzanine financing, or European real estate.”

For MFS Investment Management, sovereign wealth funds “have been our focus,” accounting for more than 60% of the firm's AUM in Asia ex-Japan, and roughly 16% globally, said Jonathan Tiu, CEO of MFS International Singapore Pte. Ltd. and senior managing director, Asia ex-Japan. Five years ago, those funds accounted for roughly half of the more recent totals.

The mix between sovereign wealth funds' internal and external allocations can be expected to ebb and flow, reflecting healthy competition. “As an active manager, we welcome that,” said Mr. Tiu.

Rachel Farrell, Hong Kong-based head of sovereign and institutional, Asia Pacific ex-Japan, with J.P. Morgan Asset Management, pointed to a strong pickup recently of interest among sovereign wealth funds in external managers' multiasset-class offerings as one example of that ebb and flow.

For a while, many sovereign funds had decided to do all of their asset allocation work in-house, but “increasingly they're looking to leverage asset managers that are good at allocating across asset classes to capture alpha,” in search of knowledge transfer and best practices, she said.

And even when they build internal capabilities, they'll still look to external managers for “benchmarking purposes,” she added.

Paul Price, the London-based global head of distribution with Morgan Stanley (MS) Investment Management, said newer sovereign wealth funds have shown demand for MSIM's multiasset class capabilities, while sovereign funds more broadly are looking for tactical capabilities in fixed income as part of total return/absolute return strategies.

Mr. Price said sovereign funds and official institutions account for between 15% and 20% of MSIM's AUM, up from 5% a decade ago. He noted the flurry of new sovereign wealth funds being launched now in Africa and Latin America as yet another reason to anticipate more opportunities in the future to serve sovereign clients.

Northern Trust's Mr. Bowers, meanwhile, noted a pickup in sovereign wealth fund interest in ESG strategies and factor-based indexes — which Northern calls “engineered beta”— as a reason for his firm to be confident in pursuing opportunities serving that client segment.

“We're absolutely on message with two of their biggest themes,” he said. n

The largest sovereign wealth funds
Ranked by total assets, in U.S. millions, as of Dec. 31, 2014.
RankFundCountryAssets
1Government Pension Fund GlobalNorway$817,957
2Abu Dhabi Investment AuthorityUnited Arab Emirates$773,000
3China Investment Corp.China$650,000
4State Administration of Foreign ExchangeChina$567,900
5Kuwait Investment AuthorityKuwait$548,000
6Hong Kong Monetary AuthorityHong Kong$414,661
7GICSingapore$320,000
8Qatar Investment AuthorityQatar$304,000
9National Social Security Fund – ChinaChina$247,866
10Temasek HoldingsSingapore$160,674
11Abu Dhabi Investment CouncilUnited Arab Emirates$90,000
12Korea Investment Corp.South Korea$85,000
13Future FundAustralia$83,071
14Samruk-Kazyna National Welfare FundKazakhstan$78,000
15Reserve FundRussia$77,050
16National Wealth FundRussia$75,000
17National Fund of the Republic of KazakhstanKazakhstan$71,703
18International Petroleum Investment Co.United Arab Emirates$68,400
19Alberta Investment Management Corp.Canada$66,257
20National Development Fund of IranIran$62,000
21Mubadala Development Co.United Arab Emirates$60,785
22Libyan Investment AuthorityLibya$60,000
23Revenue Regulation FundAlgeria$55,000
24Alaska Permanent Fund Corp.U.S.$53,065
25Khazanah NasionalMalaysia$39,305
26Brunei Investment AgencyBrunei$39,300
27State Oil Fund of the Republic of AzerbaijanAzerbaijan$37,104
28BPIFranceFrance$34,635
29Texas Permanent School FundU.S.$31,000
30Government Pension Fund NorwayNorway$22,513
31New Mexico State Investment CouncilU.S.$20,161
32New Zealand Superannuation FundNew Zealand$20,128
33Wyoming State Treasurer's OfficeU.S.$19,485
34Alberta Heritage Savings Trust FundCanada$17,200
35Timor-Leste Petroleum FundTimor-Leste$16,539
36Emirates Investment AuthorityUnited Arab Emirates$15,000
36National Development FundVenezuela$15,000
38Economic and Social Stabilization FundChile$14,688
391Malaysia Development BerhadMalaysia$13,875
40State General Reserve Fund of the Sultanate of OmanOman$13,000
40Dubai International CapitalUnited Arab Emirates$13,000
42Bahrain Mumtalakat Holding Co.Bahrain$10,664
43Peru Fiscal Stabilization FundPeru$9,159
44Pension Reserve FundChile$7,943
45Ireland Strategic Investment FundIreland$7,614
46Latin American Reserve FundColombia$6,500
47Oman Investment FundOman$6,000
47Oil Income Stabilization FundMexico$6,000
49Fundo Soberano do BrasilBrazil$5,791
50Arab Petroleum Investments Corp.Saudi Arabia$5,699
Source: PricewaterhouseCoopers from Preqin data

This article originally appeared in the July 13, 2015 print issue as, "SWFs evolving into competitors from clients".