Sovereigns in alternatives: Watch the throne

Abu Dhabi Investment Authority (ADIA) has been a prolific investor in Australian infrastructure, participating alongside domestic and foreign players in multi-billion-dollar privatizations of two ports as well as the country’s largest high-voltage electricity transmission network. More recently, the sovereign wealth fund (SWF) has turned its attention to India, committing $1 billion to the government’s National Investment & Infrastructure Fund (NIIF).

This switch in focus from developed to developing markets has emerged as a common trend among global sovereign investors, according to the first annual review published by the International Forum of Sovereign Wealth Funds (IFSWF). The driving factors are regulatory resistance to their presence in the US and Europe and increased competition as investors flock to yield-generating assets in a low interest rate environment. This has pushed up valuations – as evidenced by the fiercely contested large-cap deals in Australia in recent years.

Infrastructure is not the only private markets asset class exhibiting these characteristics. IFSWF blames intense competition and high valuations – as well as target allocations being reached – for a pullback by SWFs from unlisted assets. Having pumped $71.2 billion into direct private markets deals in 2015, their commitments dropped to $37.3 billion in 2016 and $36.6 billion last year. 

The slowdown appears to endorse earlier predictions that SWFs’ alternatives exposure might be peaking. A State Street Global Advisors report in February observed that in 2002, private markets accounted for $61 billion – or 16.2% – of total sovereign assets and only nine out of 21 funds were participating in the asset class. By the end of 2016, 30 out of 37 players had invested $1.6 trillion in alternatives, or 28.7% of cumulative assets.

Three reasons were given for allocations hitting a ceiling: expectations of rising interest rates in the US; a slowdown in inflows; and competition eating into illiquidity premiums. The report also noted that there is a shortage of appropriate funds to accommodate large allocations in areas such as infrastructure, leaving SWFs with no choice but to invest directly or in partnership with other assets owners. “This would require a corresponding expansion of internal capabilities, including governance and expertise, and many funds may be approaching their institutional limits in this regard,” it added.

Partnership and consortium deals are certainly on the rise, and the ADIA-NIIF tie-up is an example of how SWFs can work together in the pursuit of long-term infrastructure assets. IFSWF recorded 203 direct investments by SWFs that were collaborative efforts last year, up from 142 in 2016, and more than double the number of solo deals. However, SWFs combined with peers on just 27 occasions. Most transactions were executed with VC, strategic or financial partners, underscoring the continued reliance on third-party expertise.

Invesco’s latest global sovereign asset management survey also identifies the challenges of getting private markets exposure – though more in the context of distributions outweighing capital calls and leaving SWFs underweight on alternatives. However, this dynamic speaks to the problems created by rising valuations, the overriding theme of all investor feedback. Capital calls are low because lofty entry multiples are prompting managers to hold back. Over 60% of survey respondents said private equity was overvalued; not one was willing to take the opposite view.

In contrast, only 6% believe private credit is overvalued, with 40% describing its as undervalued, a higher percentage than any other segment. Credit appears to be accumulating the bulk of the marginal gains as allocations to alternatives reached a new high of 20% in 2017 – twice the 2013 figure – while a minority of SWFs are paring their private equity exposure. Credit is also the only segment that sovereigns of all sizes still overwhelmingly prefer to access via third-party funds.

Invesco contends this reflects a rethinking of alternatives strategies as SWFs build portfolios that meet a variety of different objectives. This may be the case, but they are also gravitating to where they see pockets of value in an overvalued marketplace.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• LPs
• Fundraising
• Investments
• Sovereign wealth fund
• Abu Dhabi Investment Authority (ADIA)
• GIC Private
• Temasek Holdings