David Rubenstein, co-founder and co-CEO of Washington
D.C.-based Carlyle Group
Sovereign wealth funds are pouring more money into
non-listed assets, especially private equity. The biggest and
most-established firms are the ones likeliest to
David Rubenstein, co-founder and joint CEO of Washington,
D.C.-based Carlyle Group
, sounded bullish last week about future sovereign wealth fund
investments in his firm. "What we have seen is that the large
sovereign wealth funds are now coming in to the market in very
large sizes and making very, very large commitments, much more
than we’ve ever seen before," he said in a
conference call after the private equity firm reported record
Sovereign Wealth Center data certainly backs the
notion that state-owned investors are deploying more capital in
alternative investments like private equity. Part of that,
naturally, is just due to the breakneck growth of Sovereign
Wealth funds themselves. "Many of the largest institutional
investors in the world have seen substantial increases in their
assets in recent years," Rubenstein said.
Since 2002, state-owned investors’
total assets have more than quadrupled and the percentage of
their assets they allocate to unlisted assets has more than
doubled. That trend has only accelerated over the past two
years as interest rates remain at historic lows, and some stock
markets have become expensive. So investors of many stripes are
seeking alternatives, sending a wave of money into private
markets, especially from the Middle East and Asia.
Total Sovereign Wealth Fund Assets Under Management by
Asset Class, 2002–’12
Source: Sovereign Wealth Center.
But is this phenomenon benefitting private equity
managers like Carlyle as Rubenstein claims? Over the past half
decade, sovereign wealth funds have become more active direct
investors. In 2014, they committed $38.7 billion to unlisted
assets, including real estate, infrastructure, unlisted
companies and loans. This represents a 153 percent increase on
2010, when they invested just $15.3 billion in these types of
Indeed, investments outside the publicly traded
stock and bond markets accounted for almost 70 percent of
sovereign wealth funds’ foreign direct investments
(excluding indexed strategies) in 2014, up from 41 percent in
2010, according to Sovereign Wealth Center data.
Sovereign Wealth Fund Investment in Public and Private
Source: Sovereign Wealth Center.
But burgeoning direct private market dealmaking
doesn’t necessarily mean sovereign wealth funds
are abandoning private equity managers. State-owned investors
still need PE firms.
Since they rarely get preferential access to
deals, if they choose to only invest directly in private equity
sovereign wealth funds are forced to rely on other
intermediaries, such as investment banks to build their
pipelines. That increases the risk of being brought into a deal
late in the process, when the upside potential is more limited
— a particular danger in the technology sector where
some state-owned funds have invested steep valuations.
Instead, some sovereign wealth funds have decided
to work with their private equity managers, investing alongside
them, rather than through their funds. And it’s
not only about cutting fees.
"Investing directly is not just about the
disintermediation of the market," says a senior private equity
professional at a major sovereign wealth fund.
"It’s about finding good deals." While direct
private market investing can increase profits, he says a less
obvious benefit is developing a sovereign wealth
fund’s internal expertise. Among other things, it
helps in recruiting higher quality staff. "It becomes easier to
attract talent, because these people want to work on the most
interesting and challenging deals."
So the rise in direct private market investments
is partly due to closer relationships between manager and
investor. There are benefits for private equity firms too: They
don’t need to shop deals to rival firms. There is
also a better alignment of interests, which may lead to better
profits for both.
In some cases, sovereign wealth funds have bought
positions in the private equity firm to seal that relationship.
For example, Abu Dhabi’s
Mubadala Development Co . is a major investor in Carlyle,
Hong Kong Monetary Authority Exchange Fund ,
GIC , and the
Kuwait Investment Authority (KIA) all own stakes in
London-based CVC Capital
Partners , and GIC and KIA, both own stakes in Fort Worth,
Texas-based TPG Capital .
Rising sovereign wealth fund allocations to
private equity are favoring larger firms because of their scale
and perceived abilities. Newer state-owned investors look at
private equity as a way to benefit from the diversification
provided by unlisted assets. Such funds consider large firms
more attractive because they see them as lower risk.
There’s some easy money to be
harvested. As Rubenstein said during the earnings call,
sovereign wealth fund commitments to Carlyle’s
funds are rising across the board. The firm raised 37 percent
of its new committed capital from state-owned investors in
2014, versus a historical average of 17 percent. Such a large
rise is not just a result of new sovereign wealth money, or
existing investors accelerating their allocations.
With interest rates likely set to remain low,
sovereign wealth funds are now seeking out more esoteric types
of private assets. In 2014, for example, Carlyle started
raising its second energy mezzanine fund and its first Asia
structured credit fund. The two funds, Rubenstein believes are
"likely to hit their target levels fairly quickly."
Big, reputable private equity firms that offer a
range of strategies and flexible investing relationships will
continue to attract sovereign wealth fund capital.
Don’t forget the most crucial element: skill. Our
sovereign wealth fund private equity manager says "Good
managers will always justify their fees."