Sovereign Wealth Fund Institute

Increasingly, sovereign wealth funds are embracing direct investing. Elephantine, aged public funds are the type of institutional investors that partake in these investment activities. Direct investors usually have massive amounts of capital that need to be put to work. On May 8, 2013, OMERS Private Equity, the private equity arm of the Ontario Municipal Employees’ Retirement System finalized their purchase of Civica Group PLC from U.K buyout firm 3i Group for an enterprise value of £390 million. Public investors like OMERS Private Equity and Government of Singapore Investment Corporation are competing for companies just like other private equity managers.

Evolution of Direct Investing[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

This is an interview between Michael Maduell, President of the Sovereign Wealth Fund Institute and Vijoy Chattergy, CIO of the Employees’ Retirement System of the State of Hawai’i at the Institute Fund Summit 2013 Americas in Dana Point, California.

Norway’s Government Pension Fund Global (GPFG), the largest sovereign wealth fund in Europe, wishes mainland China to open up their domestic capital markets to foreign institutional investors. Several mega sovereign wealth funds have stepped up allocation to Chinese public equities.

China’s State Administration of Foreign Exchange (SAFE) has taken steps to accommodate sovereign fund investors in China. [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

According to the press release, “The Government Pension Fund Global (GPFG) posted a 5.4 percent return on its equity holdings, or the equivalent of NOK 219 billion, in the first quarter.

“The favourable performance reflects the strong push in equity markets, particularly in January and February. Among the major stock markets, the US and Japanese markets made the largest contribution,” says Yngve Slyngstad, CEO of Norges Bank Investment Management (NBIM) responsible for managing the GPFG.

Equity investments returned 8.3 percent, while the return on the fixed-income portfolio was 1.1 percent. The return on the GPFG was 0.3 percent higher than on the benchmark index. In the first quarter, NBIM took several initiatives to promote active ownership, and will in future participate in the election of board members at some companies.

“Participation is in line with our long-term intention of establishing closer contact with company boards with a view to safeguarding the fund’s values,” says Yngve Slyngstad.

The krone exchange rate weakened against many of the major currencies through the quarter, contributing to an increase in the value of the GPFG of NOK 93 billion. In addition, capital in the amount of NOK 60 billion was transferred to the GPFG. The total value of the GPFG stood at NOK 4,182 billion at 31 March, with 62.4 percent allocated to equities, 36.7 percent to fixed-income securities and 0.9 percent to real estate.”

Norway’s Government Pension Fund Global (GPFG) had their second best performance ever in 2012, generating 13.4% in returns. As Europe’s largest public equity investor, the sovereign fund returned 18.1% in equity investments. Part of the returns can be related to actions enacted by the European Central Bank (ECB) that were declared in July 2012.

According to a release by the Norwegian Ministry of Finance, “The Ministry presents analyses of several aspects of the strategy, but does not present plans for major changes to the investment strategy of the Fund.”

Norway’s GPFG is a major passive investor. The sovereign fund also believes in a level of active management. Around 60% of the sovereign fund’s assets are in public equities. In addition, 3.7% of fund assets are managed externally at the second quarter of 2012. Equity investment mandates are awarded to external managers with expertise in specific markets such as niche markets in developed economies or emerging market investments.

According to Finance Minister Sigbjørn Johnsen in the press release, “Active management has over time contributed to an excess return well in line with the expectations we have communicated.”

The Federal Reserve is stuck in an impasse and continues to pursue easy monetary policies, a sharp reversal from the 1980s. The purchasing of U.S. government bonds by central banks have helped interest rates reach new lows. From a central banker’s perspective, an increase in long-term rates will have dramatic implications for financial stability. Examining falling bond yields, not just in the United States, institutional investors must question their current bond allocations. Public chief investment officers feel there is no great strategy in traditional fixed income investments.

U.S. Long-Term Government Bond Yield – Click on Image to Enlarge

Sources: Federal Reserve, Park Alpha
Pre-1953 – yield data from Sidney Homer A History of Interest Rates.

North Dakota’s Legacy Fund is nearing US$ 1 billion in fund assets. Voter approved in 2010, the commodity fund receives 30% of North Dakota’s oil tax collections. Fund money cannot be spent until 2017 and a two-thirds vote of the state legislature must approve. Most of the fund is currently invested in short-term low-risk U.S. bonds. The seven-member advisory board of the Legacy Fund is looking to allocate 50% of assets into stocks and other investments.

North Dakota Annual Oil Production

Source: State of North Dakota – Drilling and Production Statistics

Globally, the mega asset owners are progressively analyzing the pros and cons of allocating capital to external managers, especially in active strategies and alternative investments. Would public capital earn greater returns after fees on a direct basis versus external management? In board meetings and offsite discussions, the issue of fees has been a popular theme for asset owners, particularly with regard to private equity. With growing statistics of lackluster private equity fund performance and the awakening of zombie funds, public investors are questioning their allocation to private equity funds. In fact, buyout firms are raising less money from institutional investors. Democratization in alternative investments is occurring; one can wonder why many private equity firms went public? Sovereign funds like the Abu Dhabi Investment Authority, China Investment Corporation and Australia’s Future Fund are pursuing direct opportunities in developed infrastructure. Recent data statistics from the Sovereign Wealth Fund Transaction Database displays a higher frequency of direct transactions undertaken by sovereign wealth funds.

Stepping away from alternative investments, the asset managers most at risk are fixed income and long equity managers. [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Skilled hedge fund managers can demonstrate they can go both long and short volatility. Volatility specialists thrive on uncertainty. They are excited when things blow up. These hedge funds are waiting for another “Lehman” event aka black swan. Institutional investors have been analyzing relative value hedge funds and funds that have a long volatility strategy for quite some time. A number of prominent public investors and endowments are seeking to carve out volatility management strategies as a separate asset class. Skeptics cite volatility is not yet an asset class. This class contends that volatility is purely a statistical measure of dispersal of returns, not an asset class, but a derivative of other asset classes.

It is nearly impossible to contain downside risk while not surrendering upside potential.

Sovereign funds that have low levels of portfolio leverage, high liquidity and long investment horizons may not want to buy equity tail-risk insurance. Allocating capital to volatility managers or embracing dedicated tail-risk hedging strategies can be costly and challenging to execute. As market risk increases, the costs of tail-hedging increases. These “insurance” costs are a drag on portfolio performance. Some sovereign funds like the China Investment Corporation (CIC) have rejected tail-risk hedging strategies after conducting studies, but would consider allocating capital in separate accounts to volatility managers. On average, tail-risk strategies performed poorly since 2009, while many public investors regained traction after the major market downturn of 2007.

The China Investment Corporation (CIC) generated a 10.65% return on overseas investments for 2012. Since inception, the CIC’s total overseas investment return is above 5%. Public equities compose 25% of their global portfolio, down from 48% at the conclusion of 2010.

Public investors that have restrictions participating directly into credit swaps or desire access to a diverse pool of credit investments are choosing to invest some capital in credit-linked notes (CLN). Public pensions such as CalPERS have classified credit-linked notes as an opportunistic asset class given the historical level of risk associated with structured investments. In Europe, cash-focused public pension funds have been gobbling up CLNs. Historically, credit-linked notes have been purchased by financial institutions, high net worth individuals, and opportunistic institutional investors. CLNs tend to have higher yields and customized maturity structures, a unique benefit for smaller pension funds, but not for investors keen on liquidity. The lack of counterparties makes it challenging to get out of credit-linked note trades. Banks like credit-linked notes because they can effectively sell certain credit exposures.

Are synthetic credit products making a comeback?

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Temasek Holdings and other sovereign funds are taking big bets on Asia. Temasek has taken positions in Chinese banks such as China Construction Bank and the Bank of China; understanding that investing in financial institutions can be a profitable undertaking for a burgeoning economy. Confidence and optimism in China’s long-term economic growth play into Temasek’s investment themes. The Chinese government has made strides on making it easier for foreign investors to invest in domestic markets by lessening capital controls.

China, India, and Indonesia, along with other Asian nations are developing large middle classes, creating vast pools of consumers. In fact, it is projected in the next decade as much as 67% of global growth of the middle class will be derived from China and India. Annual household income levels continue to rise in the region; however, household incomes still dwarf nations such as Spain or the United States. On the other hand, the consumer credit market of Asia is beginning to expand, augmenting consumer spending. The West will still account for greater consumer spending power in the next decade, but Asia is providing a noteworthy alternative for multinational corporations.

Infrastructure investing is also an avenue for sovereign funds to capitalize on the growing middle class populations of India and China. On February 18, 2013, the United Arab Emirates and India created the India-UAE High Level Taskforce on Investment. The vehicle will be used to push through investments in industries such as infrastructure and the food supply chain.

Terminating public equity asset managers is a cumbersome act to do for sovereign wealth funds and public pensions. It sticks to the forefront of public investors’ conscience. It is less complicated than terminating private equity relationships, but still requires significant time resources. Fund manager retention and termination decisions involve high costs. Public investors need assurances that if they proceed to terminate a fund manager, they are not doing it prematurely. Some investment strategies require a cycle or two to see results. Timing is everything for a trader, not for a long-term oriented fund manager.

The step before termination involves a watch list step. The targeted fund manager is usually informed of the situation or current concerns held by the public investor. In reality, public pensions and sovereign wealth funds desire their external managers to succeed in managing their assets. Like picking trophy race horses at the track, senior public investment officers and investment consultants hope their picks to be successful. Several noteworthy factors in motion can affect termination of an external manager. The first obvious reason that comes to mind is under-performance. This is a common cause for termination.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Global financial media have been reporting the great rotation as public equity markets had a resilient month in January 2013. It seems the rotation story comes up every couple of months once news is silent about the Euro crisis or fiscal cliff issues. Does the great rotation have merit today?

Investors pumped billions into stocks in the first month of January 2013; a strong sign after years of equity sell offs. For sovereign funds, many have continued to plow money into equities, earning scorn for lackluster performance in 2010 and 2011, but in 2012 factors were different. By looking at press releases, some public funds left off 2011 and 2010 performance figures.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Stichting Pensioenfonds UWV based in the Netherlands is growing its allocation to alternatives to 17%. This was from 9%. The implementation of the augmented allocation will be around three years. In addition, pension fund management costs are expected to increase from €14 million to €20 million.

The allocation increase in alternatives will decrease allocation to fixed income.

In 2003, the fund was created as a result of a merger between the pension funds of UWV, GAK Nederland BV and CADANS.

CPPIB Credit Investments Inc., a wholly-owned subsidiary of the Canada Pension Plan Investment Board (CPPIB) joined as a joint venture partner and investor in MerchCap Solutions LLC, formerly known as KKR-SPC Merchant Advisors. CPPIB Credit Investments Inc. is joining KKR & Co. L.P. and Stone Point Capital in the middle-market credit platform. Mark Jenkins, Head of Private Debt for CPPIB, will join the board of directors of MerchCap Solutions LLC.

CPPIB is using its asset size and strength to access middle-market credit opportunities.

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The US$ 252 billion California Public Employees’ Retirement System (CalPERS) had a positive performance in 2012 of 13.26%. The 2012 annual return was slightly below the 14.43% benchmark return. 2012 private equity returns attributed to the lower return.

CalPERS has an annual target rate return of 7.5% to meets its obligations; it was lowered in February 2012 from 7.75%.

In 2007, CalPERS at its apex was valued at US$ 260 billion and dropped as low as US$ 160 billion in March 2009.

Some 2012 Asset Class Returns

• Global Equities – 17.18%
• Private Equity – 12.24%
• Fixed Income – 7.64%
• Real Estate – 12.79%

A new investment policy was adopted by the State Oil Fund of Azerbaijan (SOFAZ) with the purpose of enhancing profitability and diversification. SOFAZ can now invest up to 5% each in gold, equities, and real estate. In the month of December 2012, SOFAZ made a number of European real estate purchases. Beginning February 1, 2012, SOFAZ began the purchase of 25 gold bars (conforming to London Bullion Market Association standards) per week from market-maker member banks of the LBMA.

As of December 31, 2012, SOFAZ has 480,146 troy ounces of gold in their portfolio. The gold is temporarily stored in vaults at JP Morgan in London as SOFAZ plans to import physical gold into the Azerbaijan. SOFAZ plans to build a vault for such holdings.

This article is written by Adrián Blanco Estévez, an economist. He is at the University of Santiago de Compostela. These are the views of the contributor, not of the Sovereign Wealth Fund Institute.

The Southern European countries began to suffer a deep economic crisis three years ago. The story is well known. First, the government of Greece was not able to meet its public debt obligations, and in April 2010 the Greek bond was downgraded to junk status. The following month, the IMF and the European Union agreed on a more than €100 billion bailout loan to save Greece. As a result, economic policy was transferred from Athens to Brussels, Berlin and Washington. After the Greek event the international funds (both public and private) started to differentiate between the countries in the North and South of Europe; therefore, countries such as Italy, Spain or Portugal had problems to allocate their public debt in the international markets. These countries began to experience strong increases in credit default swaps and bond spreads, as well as a huge pressure to refinance their public debt. As a result, in 2011 a €78 billion bailout was given to Portugal and in 2012 the Spanish government asked for a €100 billion loan for its financial sector. For Greece, the fiscal policy of Portugal and Spain started to be influenced by Brussels and Berlin, which had borrowed the money through different financial vehicles (mainly through the European Central Bank).

In this complicated economic context in Southern Europe, one very interesting question arises regarding sovereign wealth funds (SWFs); what does the current economic situation in Southern Europe offer to SWFs in terms of investment opportunities?

First of all, it is relevant to know SWFs have invested in Southern Europe since the beginning of the crisis. As far as Italy is concerned, some very relevant deals were made since then. In 2009, the Libyan SWF signed a MoU with Finmeccanica (aeronautic and defense) and also this year there was a rumor indicating a possible investment by the China Investment Corporation (CIC) over Enel (energy) but the transaction did not materialize. In 2010, Aabar and the Libyan SWF made two separate deals over Unicredit bank. In 2012, Qatar Holding bought luxury properties in Costa Smeralda and also the government of Qatar agreed to invest €1 billion in “made in Italy” companies (national industry leaders). In addition to SWFs, some state-owned enterprises, like Russian Lukoil (which acquired a 49% share in ERG’s oil refinery in Sicily), made important deals in Italy in recent years.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

2012 proved to be a dynamic year for sovereign wealth funds in terms of policy decisions and investment strategies. Notably, a number of sovereign funds were created, especially in resource rich nations like Angola. Our staff has compiled a list of the top ten game-changers that will set the tone for sovereign wealth funds in 2013.

10.) Sovereign Wealth Bankers

As Western banks are smacked with a surplus of regulations, banks are not lending as much, especially to projects and certain lines of business. Financial institutions are concerned about illiquid investments; Basel III makes it more challenging. Banks are cautious about adding illiquid liabilities on their balance sheets. Sovereign wealth funds have the chance of becoming the new bankers for the next decade. Many are creating offshore entities to begin lending operations.

Sovereign wealth funds are involved in the real estate lending business. For example, Singapore’s GIC was a lender for the resorts that Paulson and other investors owned. When Paulson & Co lost the resorts, Singapore’s GIC purchased them in bankruptcy.

9.) Capital Competition, Spreads Across Continents

The world is competing for capital, more so than ever before. Russia has constructed state investment vehicles like the Russia-Direct Investment Fund (RDIF) to boost their economy and give foreign investors access to opportunities in Russia untouchable in years past. A number of nations in the Middle East are developing policies to attract long-term investments, such as co-investing in government energy infrastructure.

Capital-starved Europe continues to sell off public assets to amass capital to pay down unsustainable deficits. Even, China has removed the QFII barrier for sovereign wealth fund investors to provide long-term capital in their domestic security markets.

8.) Fertilizer, Food and Milk

The world now has around 7 billion people. Population growth, modifications in tastes and preferences, limited resources, and environmental issues are factors pushing up the price of food. Mega institutional investors want access to agriculture and land as an asset class.

Fertilizer is in demand, as farmlands need to increase productivity. The China Investment Corporation invested Uralkali OAO, a global potash producer that possesses five mines and seven ore-treatment mills located in Perm Territory in Russia. There has been sovereign wealth interest in dairy farms in New Zealand. Middle Eastern SWFs and other public pension funds have been purchasing agricultural land and food companies in Latin America.

7.) Investing in Financials in Developing Middle-Class Economies

Singapore’s Temasek Holdings purchased a stake in a November secondary public offering in Turkiye Halk Bankasi AS, a government-owned bank in Turkey. It is Turkey’s second largest state-owned bank by assets. In September 2012, the Government of Singapore Investment Corporation Private Limited was subscribing to a Hong Kong H-share private placement by China Pacific Insurance (Group) Co Ltd (CPIC).

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