Sovereign wealth: Getting creative on co-investment

The sovereign wealth funds of China and Russia make for odd yet strangely complementary bedfellows. China Investment Corporation (CIC) was established to diversify some of the country’s foreign exchange reserves. The $941 billion fund subsequently took on a large portfolio of passive domestic financial services investments, but its other divisions are outward-facing and generally internationally oriented.

While CIC’s mission is in part to pursue better returns in overseas markets, the Russian Direct Investment Fund (RDIF) has a mandate to catalyze direct investment in the Russian economy. It claims to have implemented projects with foreign partners totaling more than $23.2 billion over the past seven years. CIC’s existing collaboration with RDIF – the Russia-China Investment Fund (RCIF) – is designed to meet these objectives, with 70% of the capital allocated to Russia and former Soviet countries.

Last week, the two sovereign funds announced a joint vehicle that will support the development and commercialization of new technologies in core sectors of both countries. RDIF also confirmed a direct investment in a joint venture that will combine Alibaba Group’s online shopping platform in Russia with social and digital businesses owned by local champions Mail.ru Group and MegaFon. It will invest $100 million for a 5% stake, rising to 12.9% if a call option against a portion of Alibaba’s shares is exercised.

The contrasting natures of CIC and RDIF serves as a reminder that to view sovereign wealth funds as homogenous is to misunderstand them. While the International Forum on Sovereign Wealth Funds (IFSWF) has an underlying set of principles, its membership varies considerably by funding source, governance structure, age, and political circumstance. This impacts objectives, risk appetite, geographies and asset classes of interest, and preferred mode of investment.

They are not all going to want to do the same thing at the same time and direct investment into private markets – something that has gained traction within the sovereign wealth fund community in recent years – should be viewed in this context.

Research released by the IFSWF last month showed that direct investments in unlisted companies rose from 126 in 2017 to 147 last year. Their share of total sovereign deal flow was nearly 65%, compared to 54% in 2017. At the same time, co-investment is flourishing, with more than 200 deals completed in each of 2017 and 2018. The total failed to break 150 in either of the previous two years. This comes as solo deals appear to be on the wane. Fewer than 100 last year, down from 148 in 2016.

In US dollar terms, unlisted direct investments have not increased. For this, blame a decline in large-ticket consumer, financial and energy transactions, which have historically accounted for the bulk of capital committed. The increase in deal activity was overwhelmingly concentrated in the healthcare and technology sectors. These are relatively small bets on high-growth companies – which corresponds with partnerships with VC managers emerging as the dominant co-investment category.

The IFSWF also identified a spike in sovereign participation in start-up funding rounds. There were 19 Series A and B deals (up from nine in 2017), 27 at Series C and D (up from 19) and 14 at Series E and F (up from one). They are clearly betting on new economy private market plays becoming the global growth engine in coming years, although it remains to be seen whether enough of these investments in illiquid, often unprofitable start-ups blossom into lucrative IPOs to meet return expectations.

However, the rise in co-investment – led by VC, but also featuring financial, fellow sovereign, strategic and PE counterparties – suggests a greater sophistication in approach that might help ameliorate risk. Not everyone is opening an office in Silicon Valley and going solo. Sovereign wealth funds are increasingly forming investment platforms that focus on specific sectors or geographies and place some of the deal-sourcing and monitoring burden on an experienced partner.

RDIF’s recent activities, though they ring of political expedience, could be a case in point. The joint technology fund with CIC may leverage access and influence in the investors’ respective markets, while hanging on to the coattails of seasoned operators like Alibaba and Mail.ru in a direct deal is not the same as taking a punt on a random start-up.

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• Topics
• Greater China
• Europe
• Buyouts
• Expansion
• Technology
• Healthcare
• China
• Russia
• CIC
• Sovereign wealth fund
• TMT
• Co-investment
• Direct investment