“They’re on everyone’s radar,” agrees Nick Tolchard, head of Invesco Middle East and managing director of Invesco Perpetual’s international development division.
Sadly, not all SWFs are as open as Norway’s Government Pension Fund – Global, which lists its size, performance and investments on its web site, and so it is hard to put a precise figure on assets under management in SWFs. However, there can be little doubt that the AuM attributable to SWFs have increased in recent years in the wake of a natural resources boom and economic expansion in developing markets.
A frequently quoted figure for SWF assets available to manage today is $2.6trn (€1.9trn), up from an estimated $500bn in 1990. It’s a considerable opportunity and one that the IMF expects to expand to as much as $10trn over the next five years. However, ‘contestable’ SWF assets is a shifting number and one that is not always on a relentless upwards trajectory.
“SWFs are a rapidly growing asset pool, but in terms of the percentage of assets that is contestable by firms like ours that has decreased,” says Tolchard. “Sometimes the pool decreases, sometimes it increases.”
A July 2010 report on Global Sovereign Wealth Funds from Cerulli Associates attempted to quantify the portion of each of the largest SWFs’ assets that is outsourced. The results showed divergent behaviours with the Abu Dhabi Investment Authority outsourcing 80% of its assets, while the Korea Investment Corporation outsources around one-third its assets and Norway’s Pension Fund – Global just 13%.
A lot of SWFs have become more risk averse over the past couple of years, with increased allocations to passive. “They are looking for more liquidity generally and time horizons have shortened,” says Tolchard. “It’s the kind of behaviour you would expect from retail investors rather than SWFs, but in the case of SWFs this behaviour is driven by sophistication rather than panic – they have been profit taking.”
Widening asset pool
However, as the worst effects of the crisis abate, this same sophistication may lead SWFs into a wider range of assets. Around 40% of all SWFs invest in hedge funds of which around 35% are in the Mena (Middle East, North Africa) region with another 25% in Asia, according to Judith Posnikoff, a founder of Paamco, a California-based independent fund of hedge funds (FoHF) manager. Fifteen to twenty per cent of Paamco’s $9.5bn AuM is now attributable
“SWFs are getting more active in the FoHF sector,” says Posnikoff, “and they are starting to return to small and start-up hedge funds in the hope of spotting talented managers.”
This is perhaps only to be expected from funds which, in many cases, do not have to match liabilities. Indeed, perhaps the single biggest distinguishing factor between SWFs and the larger pension funds is this absences of liabilities. That means it’s all about returns.
“They are looking to maximise the real return on their assets,” says Patrick Thomson, the newly appointed head of sovereigns at JP Morgan Asset Management, which currently manages some $50bn for SWFs. “Most pursue that as an explicit policy. It can get pretty intensive for those funds that are held in the public domain if there is a high-profile unhappy outcome or they fail to meet their targets.”
Thomson suggests that many of the larger SWFs are becoming a bit like a global asset management firm such as his own in terms of their investment profile. That is to say, they encompass a wide range of investments, including non-traditional assets.
“With the growth in reserves generally and as SWFs have gained a deeper appreciation and understanding of their ability to optimise the returns on reserves, they are managing their portfolios in a more optimal way,” says Thomson. “Not that many have invested in non-traditional assets as yet, but some are looking actively at it. The broad trend is to move away from a conservative approach.”
The question remains then: how to target and serve this – by and large – growing pool of assets? The term SWF is a broad church. It encompasses funds that have been established for decades and funds that are very new, funds with highly sophisticated in-house investment teams and funds run by one person, funds that can pursue unfettered absolute returns and those that do have to meet national liabilities of various sorts. Can SWFs be approached as a market segment?
“Seeing SWFs as homogeneous is a mistake,” suggests Cerulli Associates in its recent report. “In fact, SWFs have as little in common with one another as any other institutional investors, and perhaps even less. They differ markedly in mandate, sources of funds, scale of assets, transparency and investment technique.”
Tolchard suggests that SWFs also differ by geography. “Some of our competitors have SWF teams, but we believe there are significant regional variations,” he says. “We wouldn’t view them as a homogeneous entity.”
While a recently established SWF may need assistance with asset allocation, a long-established SWF that has a track record of using third-party managers will typically use consultants more and as a fairly sophisticated entity, will have a view on asset allocation. It might, for example, know how much it wants to allocate to private equity.
“Our role then becomes very investment specific,” says Tolchard.
At the same time, with the bulk of SWFs targeting returns above all, there is a unifying criterion when it comes to choosing managers: performance. The recent Cerulli report shows performance as the main fund manager selection criterion across the Middle East, North Asia and South-east Asia.
SWFs also seem to see themselves increasingly as a more homogeneous group. There is now an International Sovereign Wealth Fund Forum, and there is convergence among SWFs in terms of governance and operating methods. The IMF has issued guidelines on transparency and governance, known as the Santiago Principles, which were adopted by leading funds in 2008.
“They will get together to look at best practices, and it will be interesting to see how that is turned on asset managers,” says Tolchard.
And one area where there is perhaps already homogeneity is in the type and level of service demanded by SWFs. Whether they are new to the game or old hands, SWFs are typically looking for more than just products. They want assistance that amounts to something resembling a partnership.
In the case of Thomson’s SWF clients at JP Morgan Asset Management, that can involve partnering on issues such as risk management, both portfolio risk and, for example, reputational risk. “It’s not necessarily the case for all the funds,” says Thomson. “Some are perfectly well equipped to look at these issues themselves, but we want to offer our clients access to these resources.”
At Paamco, SWFs that have initially invested in a FoHF may later want assistance with a wider hedge fund portfolio. “Rather than just a FoHF, they are looking for more of a partner who will help them to put together an overall allocation, including standalone funds,” says Posnikoff.
The standalone fund allocations can grow out of an initial FoHF allocation. “After a certain point a manager may be a good fit as direct investment,” says Posnikoff.
Meanwhile, in the less liquid alternative asset classes, such as real estate and infrastructure, that many SWFs are looking to get into, the SWF will often look to co-invest. “That’s a good strategy for SWFs because it gives them the ability to expand,” says Posnikoff.
Amongst more recently established SWFs, partnership may take a different form. “They see themselves as exporters of capital and importers of knowledge,” says Tolchard. “If you’re going to do business with them, you need to provide something in return.”
That creates new challenges and new opportunities. “It’s more of a strategic advice relationship,” says Tolchard. “It’s a great opportunity for independent
asset managers such as ourselves to put together programmes.”
Ultimately, many of these emerging SWF funds want to learn how to do it themselves. It’s not called knowledge export for nothing. But Tolchard says he expects all large SWFs to need to use third-party managers in the long run.
“I don’t believe they will all be run on a proprietary basis,” he says.