The first six months of 2014 marked a transition for sovereign
wealth funds as perceptions of frothiness ratcheted up concerns
in a range of markets. Many of the developments of 2013, such
as a competitive M&A environment and high real asset
prices, kept playing out. Meanwhile, some of the obvious trends
from the third quarter — particularly a drive to
invest in technology-based consumer and health
businesses — were gestating in the first half of
Moving Out of Real Estate
One trend stands out: a plunge in sovereign wealth
funds’ real estate investments. Here the adage
"location, location, location" has been replaced by "valuation,
valuation, valuation." Indeed, 2013 appears to have set a
high-water mark for sovereign funds’ direct
involvement in global property markets. During the first half
of 2014, they closed $5.9 billion worth of property deals, a 43
percent decline from their $10.4 billion total in the same
period last year.
Sovereign Wealth Fund Foreign Direct Investments:
Source: Sovereign Wealth Center
One key factor is rising competition. Since 2012 pension
funds and insurers have increasingly turned to prime commercial
properties in major cities with secure rental incomes,
so-called core assets, to replace the reliable revenue they
earned from high-grade bonds before the financial crisis.
Such institutional investors share the same long-term
investment horizons as sovereign wealth funds, but they often
have short-term liquidity needs. Their heightened activity has
pushed up bid prices of core assets, making the properties less
attractive to state-owned savings funds. But London still draws
state-owned investors, whose purchases of prime real estate
there continue unabated.
On the whole, though, sovereign wealth funds are looking
elsewhere, joining forces with real estate managers to find
less fashionable assets, such as logistics and retail
complexes, and even residential developments. These properties
don’t command the jaw-dropping prices of swank
office blocks in major international cities, but their values
are likely more sound.
Logistics and retail properties’ income streams
are being driven by tectonic shifts in consumer dynamics: The
boom in online shopping requires delivery hubs, a growing
middle class in the developing world is consuming more, and an
emerging-markets elite is traveling to luxury shopping
destinations to buy premium brands.
Although sovereign wealth funds haven’t
abandoned prime commercial real estate, they’re
winning fewer deals as other investors outbid them. So funds
are teaming up with partners in the sector by renovating and
redeveloping properties to improve those that may not be
considered top quality. The Abu Dhabi Investment Authority
(ADIA) and the Qatar Investment Authority have both agreed to
fund such projects in the hotel industry in 2014.
There is one sovereign wealth fund still in the market for
gilded properties — one with a very large checkbook.
Norges Bank Investment Management (NBIM), which manages the
world’s biggest sovereign wealth fund, published
its 2014–’16 investment strategy in June.
This document outlines a plan to sink at least 1 percent of the
Government Pension Fund Global’s now-$850 billion
portfolio into real estate each year through 2016. NBIM has
also stated that it will focus on prime commercial property in
major global cities, though it has dabbled in logistics and
No Longer Going It Alone
Another trend in 2014 is a shift in the relationship between
sovereign wealth funds and their asset managers. Since the
2008–’09 financial crisis ripped holes in
their balance sheets, many of the largest sovereign funds have
decided to manage a greater proportion of their portfolios
in-house. Frustrated by hefty fees, unfair incentives and
disappointing returns, they have moved to change the balance of
power by taking control of big chunks of their own
The shift hasn’t been easy: Sovereign wealth
funds have had to put in place the financial and human
resources to build the capability for running their own money.
In doing so, state-owned investors must fight for talent in a
competitive marketplace, introduce comprehensive risk
management and assume responsibility for returns.
Only a few of the most sophisticated funds have been
successful. Although ADIA, Singapore’s GIC and
NBIM have built effective internal investment teams,
particularly for private markets, others, such as Korea
Investment Corp. (KIC), South Korea’s $72 billion
pool, have struggled in more-complex, illiquid asset
For example, KIC’s direct private equity
investments have substantially underperformed its fund
investments in the same markets, gaining an annualized 1.4
percent from 2009 through the end of 2013, compared with 10.2
percent for the latter.
Sovereign wealth funds have sought new ways to tap the
expertise of asset managers that align both
parties’ interests and reduce fees. Instead of
hiring outside firms simply to manage money or committing to
commingled investment vehicles, they’re entering
strategic partnerships with money management organizations.
Some firms with which sovereign funds invest worry that
their state-owned clients will use an alliance to improve the
skills of their own staffs without paying full fees. Another
fear: The alliance may end with the state-owned investors
managing nearly all of their assets in-house, leaving external
managers out in the cold.
However, there are broader reasons for sovereign wealth
funds to establish such partnerships. The relationships can be
less about cutting out asset managers than becoming more
knowledgeable and effective investors. The goal is to deliver
better returns — whether on a macroeconomic, social or
purely financial basis.
The Sovereign Wealth Center has observed this trend across
real estate and infrastructure, private equity and hedge
funds. But for less seasoned sovereign funds, such as those of
Kazakhstan and Timor-Leste, building relationships with money
managers is also necessary in traditional asset classes.
As ties between investor and manager have become closer and
more complicated, the Sovereign Wealth Center has recorded
fewer direct investments by sovereign wealth funds, with the
exception of Singapore’s GIC and Temasek Holdings.
Still, we see a growing number of innovative co-investment
vehicles, joint ventures, partnerships and segregated funds
that allow sovereign funds to sink money into less-traditional
and difficult-to-manage assets. Doing so allows them to tap
private sector asset management expertise less expensively,
making them better stewards of their stakeholders’