Vehicles of the state

SOVEREIGN WEALTH FUNDS HAVE BECOME some of the most hotly-discussed investors in Asia Pacific, with every move made by the likes of Temasek Holdings and Government of Singapore Investment Corporation (GIC) thoroughly parsed. Are their repeated protestations that strategies are driven by financial rather than political priorities to be believed? And, as direct investors or participants in GP vehicles, are they really so different from state pension funds?

SWFs are well aware of the confusion that surrounds them. "There is a dichotomous tension in many views of the roles and treatment of SWFs," observed David Murray, chairman of the board of guardians of Australia's Future Fund and inaugural chair of the International Forum of Sovereign Wealth Funds (IFSWF), in Beijing for the IFSWF's third annual meeting in May. "On the one hand, the SWF group is seen as homogenous, requiring uniform standards and benchmarks. On the other hand, when compared with institutional investors generally, SWFs are seen as peculiar and in need of differential treatment. Both views are misplaced, and stem from a series of myths and misinformation about SWFs."

SWFs and Asia Pacific

SWFs as a new grouping are arguably heavily represented - and influenced - by Asian bodies. Out of the IFSWF membership of 23 nations, only three - Ireland, Norway, and Russia - are European, though Canada and the US are also represented (by the Alberta Heritage Savings Trust Fund and the Alaska Permanent Fund Corporation respectively). Asia Pacific members, in contrast, include China Investment Corporation, the Korea Investment Corporation, and Singapore's GIC and Temasek, as well as Australia's Future Fund and the New Zealand Superannuation Fund.

These funds are rarely absent from any list of Asia Pacific's largest private equity deals, though arguably quasi-sovereign entities can't be compared to independent, value-driven, truly private equity vehicles. The leading single deal of 2010 - the $3.8 billion pre-IPO investment for a 2.9% stake in Agricultural Bank of China - featured Temasek, the Kuwait Investment Authority and Qatar Investment Authority. China's state pension fund, the National Council for Social Security Fund, was also involved, spending $2.27 billion on a 3.7% holding via the Shanghai track of the bank's dual listing.

Continue down the list of the 2010's largest deals and SWFs account for five of the top ten. These include: Malaysia's Khazanah Nasional picking up 71.3% of Singapore's Parkway Holdings hospital group for $2.35 billion; the Abu Dhabi Investment Authority and Queensland Investment Corporation, alongside other purely financial investors, participating in a $2.13 billion investment in Australia's Port of Brisbane; and the Kuwait Investment Authority and Malaysian pension fund Kumpulan Wang Persaraan taking a $1.2 billion slice of AIA Group's Hong Kong IPO. If Canada Pension Plan Investment Board counted as an SWF, then with its $3 billion August 2010 investment in Australia's Intoll Group, four out of the year's top five deals were SWF affairs.

But the landscape is markedly different elsewhere. Preqin's list of the top ten global buyouts in 2010 produces not one SWF, although the Canada Pension Plan Investment Board was involved in the July 2010 $4.5 billion privatization of the UK's Tomkins. Arguably, SWFs' high representation in Asia Pacific's direct deals indicates as much about the relative immaturity of the region's private equity ecosystem as it does about their power and importance. It is also relatively easier for SWFs to dominate Asia Pacific due to weak competition: Many of the region's institutional pools of capital are either conservatively allocated to public markets or fragmented and poorly institutionalized, with some essentially still private family affairs.

It is important to note that Asian SWFs are often directly funded by the underlying growth drivers of the region, and have the capability to continue investing at a rate to match the growth of their capital base. The role of CIC in managing a portion of China's foreign exchange reserves is one obvious example, as is the role of Middle East and Asian SWFs in managing wealth derived from natural resources. "As long as those trends continue, whether it's petroleum or foreign exchange, these guys have money to deploy," affirms David Pierce, CEO of regional fund of funds Squadron Capital, which just launched a $150 million investment vehicle with Finnish pension fund Keva. "That allows them to pick up opportunities where others don't have the capabilities to access, especially in Asia where there are plenty of inefficiencies."

Asia has indeed been disproportionately influential in the formulation of SWFs, but Pierce warns against treating funds as a single group with common priorities. How a fund chooses to exercise its mandate, and the nature of the underlying economic drivers, may be very different from case to case. "Small-population, resource-dependent, non-diversified economies must use SWFs to convert resource windfalls into permanent financial assets through tightly controlled savings," Murray points out. "Alternatively, countries with different fiscal profiles may require resource windfalls for more urgent present expenditure needs. Of course, there is also a cohort of funds whose revenue flows from trade surpluses and which are therefore subject to different considerations."

SWFs and private equity

Given their importance as direct investors and as financial investors across a wide spectrum of asset classes, it is no surprise that SWFs are closely associated with private equity, quite apart from their investment track records. Above all, for private equity, a proverbially longer-term asset class, "the one important point is that SWFs tend to have a much longer time horizon," says Pierce. "Their ability to take longer views and ignore short-term market fluctuations make them in many ways an ideal partner." And, as Carlyle supreme David Rubenstein, pointed out publicly in October 2010, SWFs rarely have the expenditure requirements of their large pension fund peers, and have every incentive to allocate from their growing accumulations of capital.

Some Asian SWFs are conspicuous latecomers to private equity, but are developing programs rapidly. As well as the success of their peers, some funds may be driven by worrying negative signs around some of their former favorite asset choices. "We face the possibility of another major financial and economic crisis if the world's risk-free asset, hitherto US bonds, loses its AAA credit rating in a disorderly manner," warned Dr. Tony Tan, executive director and deputy chairman of GIC, earlier in May.

Not every SWF subscribes to this view. Anders Lande, assistant director general with the communication unit at the Norwegian Ministry of Finance, notes that his country's Government Pension Fund Global (GPFG) does not invest in private equity because its managers believe the asset class is richly priced and does not always deliver the claimed outperformance. "Historical returns figures indicate that this has not been the case," he points out. "Very high external management costs are one important reason for this. Even if the GPFG could achieve profit and cost advantages compared to smaller investors, the high cost level associated with this type of investment means that it is still uncertain whether the risk-adjusted return after costs would be satisfactory."

According to several LPs, SWFs that do commit to the asset class can behave differently, and worse, than mainstream LPs, squeezing fees and terms to an unprecedented degree, and sometimes being conspicuously arrogant. One AVCJ LP source notes that the performance of these funds is difficult to gauge, as there is little transparency and most SWFs have other criteria beyond pure financial returns in their investment considerations. The move by some SWFs to take shares in the management companies of major private equity firms has become practically a cliché, with TPG Capital selling 4.5% to GIC and the Kuwait Investment Authority in May, following the example of Apax's sale of stakes in itself to GIC, CIC and the Future Fund last year. In these cases, some fear the SWFs are looking ultimately to learn from and supplant their investees. Murray, though, argues that "to date, there is simply no clear evidence of SWFs pursuing narrow political, strategic or non-commercial investments."

Have SWFs a particularly privileged relationship to private equity? As investors with broad interests, there is no ostensible reason why they should be especially associated with private equity on strictly commercial terms. But, given their non-commercial agenda, SWFs may simply value private equity-style techniques in terms of building businesses in their parent economies. "[They] seem to have a hybrid mission. The policy is clearly not so much about getting returns as a development fund," says Pierce.

There is every precedent for private equity and venture capital as agents for development financing in Asia. Temasek, an actual holding company for, and operator of, major businesses is again, the prototypical example. Whether this makes Asian SWFs any more acceptable on the world stage as truly neutral, commercially-driven investors is arguable: it will certainly assure them continued support at home.

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• Topics
• Southeast Asia
• Greater China
• Australasia
• GIC Special Investments
• Temasek Holdings
• CIC
• Squadron Capital Advisors
• Future Fund