Why Institutional Investors Who Go Direct Need to Think About Disruption

Posted on 06/21/2016


Michael Maduell, President of the Sovereign Wealth Fund Institute
Michael Maduell, President of the Sovereign Wealth Fund Institute

According to data from the Sovereign Wealth Fund Transaction Database (SWFTD), the pace of direct investing remains positive for both larger wealth funds and public pensions as allocating capital straight into companies and assets enables the possibility of greater control. In addition, the benefits of co-investing entails lower fees and expanding access to information asymmetry. Asset owners, such as life insurance companies or sovereign investors, can have a level of input on how the company or property is operated, financed and eventually disposed. All of this sounds fantastic at first glance. However, direct investing requires considerable amount of upfront dollars, long-term buy-in from appropriate stakeholders, such as the board of directors, and the wherewithal to bear risk in concentrated, illiquid positions. Typically, the successful asset owners in direct investing are able to define and understand the key return drivers of the particular investment.

Before parking down hundreds of millions on an asset there is a question: how will disruption affect my large purchase?

In addition, as more public funds go direct, the competition for companies and assets increases – cue bubbles. Discovering high-quality investments, identifying the value edge and goals of realistic upside are tantamount, requiring at minimum talented personnel and financial resources. The competitive bidding process could leave pensions with inadequate resources on the shorter end of the stick. Also, the ongoing management of the company or property requires a bit of executive expertise. When does the asset owner refinance or decide to divest from the investment?

The Effects of Disruption

Market and technology disruption can have both positive and negative impacts when it comes to large-scale infrastructure investing. Before parking down hundreds of millions on an asset there is a question: how will disruption affect my large purchase? The concept of technology disruption impacts all asset classes. For instance, the shale gas revolution in the United States and Canada dynamically shifted the global supply production balance of fossil fuels, driving down global energy prices. The disruption impacted sovereign funds, oil-producing countries in the East, while altering commodity supply routes and shipping patterns. These shifts impacted the profitability of terminals and pipelines globally. Disruption can also take the form of investment products like smart beta and factor-based investing. This has forced traditional asset managers to buy up firms practicing in the space or entering the market themselves organically. Exchange-traded fund (ETF) investors have embraced smart beta and other alternative index products due to lower fees, enhanced transparency and the ability to own more of the investment process.

Disruption typically goes through four cycles. Is the trend detectable? Driverless cars seem to be gathering some level of interest. The next stage is moving the disruption idea into a clear purpose. Is this beyond a novelty or niche service? Will reinsurance investing and direct lending become more mainstream for institutional investors? Last is the inevitability. Many business professionals use some form of social networking whether it’s Linkedin, Facebook, or Snapchat. Last is critical mass adoption, investors who fail to see the first two levels often miss out on gigantic returns or opportunities. As fiduciaries of public assets, our readers and clients must truly focus on acquiring the right knowledge when embarking on massive investment decisions.

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