Sovereign Wealth Fund Institute

Several sovereign wealth funds invest a portion of their assets to capture and harvest the illiquid premium. Hence the improved aggregate demand for private equity, real estate, and infrastructure investments. Given their long-term nature, more and more SWFs are searching for means to capture this premium and capitalize on it.

Take for instance Europe’s largest sovereign wealth fund, the Norwegian Government Pension Fund – Global (GPFG) which allocates most of its assets into fixed income and public equities. Norway’s GPFG has greater liquidity compared to most other similarly-sized sovereign wealth fund peers, university endowments, and larger pension plans. The fund has taken strides to invest in more illiquid assets such as its gravitation towards institutional real estate.

Other SWFs have been more aggressive by using the illiquid premium such as Singapore’s GIC which makes direct company investments into companies and the Qatar Investment Authority.

Over the long haul, some studies have shown that illiquid assets can generate amazing returns; this was seen in the early endowment model that many private university endowments followed. Sovereign investors need to advance with caution as the illiquid premium cost is contingent on the liquidity demands of liabilities. Unfortunately in 2008-2009, the crisis caused severe strain and turmoil rendering some fire sales and generating losses. Illiquid assets can be a major burden for investors. Sovereign funds on the other hand, especially ones without contingent liabilities can weather out longer holding periods.

In general, 2011 was a tough year for sovereign investors. A major lack of public investor confidence combined with structural economic issues coming to roost depressed valuations in capital markets. Our staff has compiled a list of the top ten game-changers that will set the tone for sovereign wealth funds in 2012.

10.) Continual Low-Yield Environment – Pushing Allocation

Central banks and sovereign wealth funds are dealing with a low-yield fixed income environment. We saw a trend of the nearly full migration out of American MBS towards safe haven sovereign debt such as the United States, Germany, and the United Kingdom. Credit funds are generating major buzz. Bottom line – Liquidity – Safety – Flight

9.) Goldbug

Gold markets stayed liquid throughout the financial crisis.

Gold is up this year and it is seen mostly as an inflation hedge. Many sovereign investors have exposure to gold in ways such as funds, investing in gold mining companies, and derivatives. A few governments have actually purchased physical gold. The Qatar Investment Authority created a sovereign wealth enterprise to invest in gold, commodities, and other metals. Some investors see gold as comparable to a bond that never matures.

8.) Real Estate (Europe & U.S.)

Norway’s GPFG pulled the trigger in real estate. Granted they look expensive, core real estate in the United States and Europe are seen as a safe inflation hedge and cash flow generator. In 2012, we might see a more substantial move out of the “popular” markets such as London and Paris to secondary markets.

7.) Private Equity and the Sovereign Investor Relationship

Co-investment deals are increasing in frequency creating indirect competition for private equity firms. Private equity firm investing is a growing strategy among larger sovereign wealth funds and public pension funds. The secondary market is appealing to SWFs allocated in alternatives. More and more governments are creating joint venture country funds.

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

It is a nebulous swamp for private equity firms to navigate nowadays. Fee compression, competition from other public investors, regulatory changes, quality deal flow, and the challenge of raising non-redeemable capital commitments to new and successor private funds are just a few of the tough challenges private equity firms are dealing with. Tighter financing is crimping the buyout industry. The final slap is the anemic IPO market.  Public investors are still upbeat about private equity.  War chests are still being raised.

The model of private equity is slowly morphing, especially as sovereign wealth funds and public pension funds desire a preference to alternative private equity fund structures such as managed accounts, smaller funds, and co-investment vehicles. To go even further, increasingly several large public investors are insourcing their own investment professionals and make direct investments in alternative investments without the use of private equity advisers. Public funds that can compete with compensation packages in the private sector are more likely to build their own internal deal team. It is simple economics. In fact, they may become the private equity firm’s competitors in the long run.

With that being said, what are a few essential factors for being a successful, long-lasting private equity firm in today’s market?[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Over the past few years, solar energy has been in demand driven by government subsidies, rising cost of fossil fuels, shifting regulatory environments, and organizations wanting to go greener. Aggressive public policy from various states and nations have further increased stimulus and awarded tax credits in the renewable sector to foster industry growth. Then in 2008, the financial crisis hit, causing meltdown in the capital markets. Some solar companies had trouble accessing capital; not all solar manufacturers experienced this. Through market distortion, these global subsidies coupled with the financial crisis, created the environment for an oversupply of solar panel manufacturers. The effect was a major decline in the price of solar panels, thus eroding profit margins in the solar manufacturing sector. In fact, on Wednesday Germany solar company Solar Millennium filed for insolvency which is probably not the last to file for bankruptcy. In the United States, the headline solar company to fail was American taxpayer-backed Solyndra based out of Fremont, California. Yes, solar energy was losing its luster in 2010, but if priced right, it can be a reliable investment.

Polysilicon prices have plunged more than 90% percent in three years.

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

Some countries have multiple sovereign wealth funds. Some states have multiple public pension funds. Does it make sense to consolidate these governmental investment authorities to achieve greater economies of scale and be more cost effective? Due to its vast size in terms of geography and population, California is a state that has many different public pension funds and systems. Some public pensions are managed by CalPERS, while others remain independent, like LACERA. There is also CalSTRS, the public teachers’ pension fund. Yes, one can already make the argument that CalPERS is in effect the mega authority fund since it manages a significant portion of public employees’ pensions, but what if it combined with the other major pensions in California? Imagine if all the key pension authorities in California merged into one public mega authority.

In Canada, the Alberta Investment Management Corp and Caisse de dépôt et placement du Québec (CDPQ) are examples of consolidating or offshoring fund management to a central governmental authority. Ontario is one of the exceptions with five major governmental investment authorities. In Australia, there are organizations like the Queensland Investment Corporation (QIC) and Victorian Funds Management Corporation (VFMC) that were created to provide investment management services in a commercially effective and efficient manner.

Sources: Latest public available sources

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

Italy has a much larger economic footprint than Greece, Ireland, and Portugal. The Southern European nation is a crucial member of the European Union. Many governmental investors hold Italian debt in their fixed income portfolios, directly or indirectly. For example, as of September 30, 2011, according to their 3Q report, Norges Bank Investment Management held around US$ 7.8 billion in Italian sovereign debt. Investors are changing their view on Italian debt as capital markets are moving quicker than the drawn out labored political consensus-building process. Investors across the spectrum unloaded Italian government bonds today, since Italian government bonds moved above 7% today. In general, investors are beginning to lack confidence in the Italian bond market. This week has brought substantial political change in Europe, including Italian Prime Minister Silvio Berlusconi planning to step down. Will a Greek tragedy play out in Italy?

Printing money to buy Italian bonds might seem like a way out.

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

Over the past century, the United States has made a tremendous effort to persuade foreign investor participation in the American capital markets. With the advent of quasi-governmental investors, the Internal Revenue Service (IRS) is seeking to clarify rules regarding taxation exemption pertaining to sovereign wealth fund investors. The thorny issue that needs clarification is commercial activity which is currently not covered for tax exemption. The IRS has released proposed regulations that provide clearer rules governing when the U.S. activities of sovereign wealth funds are exempt from taxation.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Hedge funds have bounced back from the doldrums of the financial crisis. The global hedge fund industry is yearning for capital inflows. With this in mind, it is becoming increasingly vital for hedge funds to understand how sovereign wealth funds operate. Major equity management and investment consulting firms have already developed so-called sovereign wealth fund account teams to handle the extra needs of them.

Not all sovereign funds invest in hedge funds or have a desire to. Newly created sovereign funds or funds that require vast amounts of liquidity shy away from these types of alternatives. As sovereign funds grow in asset size and have the ability to take on more portfolio risk, they usually see hedge funds as a possible asset class.

Hedge funds must come to a realization that receiving money from a SWF is far different than a typical high net worth client, pension fund, or insurance company. If a sovereign fund loses money being managed by a traditional fund manager with a clear defined strategy, it is easier to sell the loss story to the public. Hedge funds bear a risk connotation to them. The media and American political class has done a fantastic job on enhancing that risky black box image of hedge funds. This leads to a possible conclusion that sovereign funds that require less public accountability are also more likely to invest in hedge funds.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

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

This 5 page report is avaliable for download for SWFI subscribers.  This report gives a brief overview on Brazil’s current situation and sovereign wealth fund involvement.

Latin America is a premiere destination for economic growth. In this particular study we are going to purely focus on Brazil. Brazil is a South American country with a young demographic, has increased trade liberalization, burgeoning manufacturing hubs, and has a large sector of natural resources. The general macroeconomic trends for Brazil have been a gradual decrease in interest rates, greater accumulation of foreign reserves, and positive year-over-year real GDP growth.

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

A number of sovereign wealth funds are lowering allocation from bonds to more risky, illiquid assets, such as direct investment in companies.  Their position sizes have increased and they are now providing more capital for public and private companies across various industries.  SWFs have made generous profits from investing in direct investment / PIPE investments in numerous industries such as natural resources, materials, real estate, financial institutions, and energy.  Furthermore, there is growing collaboration among SWFs, whether investing in an IPO, PIPE, or even venture capital deal.  Private back room deals with favorable investment terms are enhancing returns, rather than purchasing shares in the public markets.  In general, institutional investors are relying less on public markets for returns.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

The majority of sovereign wealth funds continue to rely on external managers and consultants for various reasons.  Over time asset managers have evolved their product offerings to accommodate sovereign wealth investors.  Whether they create sustainable alpha generating portfolios, enhancing risk management, or creating stable pools of liquidity, external managers will persist to provide a suite of products to perspective SWFs.  This was not the case in 2001, 2002, and even 2003.  Pension funds in the United States were the darlings of fund managers.

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

Sovereign wealth funds are patiently dipping their toes in these so called frontier markets.  Frontier markets are even more risky than emerging markets.  It is a subset of emerging markets.  Some examples of Frontier markets include: Argentina (defaulted on their debt), Kazakhstan (former USSR), Lebanon (Cedar Revolution), Sub-Saharan Africa, and Pakistan (political instability).  Sovereign wealth funds that have direct investment experience in frontier markets have been making significant plays recently.  [Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

Sovereign wealth funds and other institutional investors are lukewarm when it comes to Asian real estate investment. Asian sovereign investors are becoming more risk averse to non-core real estate and dumping portfolios of non-core and opportunistic real estate.[Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view site content.]

BP is not a new investment for SWFs, especially Middle Eastern sovereign wealth funds.  Already the Kuwait Investment Authority is a large holder of the security, including many others.  In the past, numerous SWFs have taken small equity positions in BP.  Now with the possibility of a takeover from oil rivals and the need to increase their capital base, SWFs may come to the rescue at the right price and structure.  BP also has the option of selling assets in its oil producing portfolio as well.

According to the AP, “BP may be looking to sovereign wealth funds in the oil-rich Middle East to fend off takeover bids amid mounting costs from the Gulf of Mexico oil leak disaster, according to reports published Sunday.

The National, an Emirati newspaper, cited unnamed “informed sources” in the region saying that Mideast financial institutions have submitted proposals to BP advisers and are waiting for a response. Among the options being considered are the acquisition of key assets or a direct cash injection to help strengthen the oil giant’s balance sheet, according to the English-language paper.

The paper quoted a person it called an informed source as saying that “BP knows there is potential support from the Middle East.”

The National is owned by the government of Abu Dhabi, one of seven emirates that make up the United Arab Emirates federation. The sheikdom hosts the country’s capital and controls nearly all the OPEC member state’s oil reserves.

BP spokeswoman Sheila Williams in London declined to say whether the company had been approached by investors from the region.

“We don’t comment on financial issues,” she said.”

Source: AP

see video: BNN