Like most investors over the past year, sovereign wealth funds appear to have been hit by the global economic downturn. While the amount of assets under management with sovereign wealth funds still totals an estimated U.S. $3.22 trillion, up from $3.05 trillion in 2008, the growth is due largely to the entrance of new funds, estimates Preqin Ltd., a research and consultancy firm. (Given that sovereign wealth funds don’t release a great deal of information, it’s difficult to pinpoint exactly how they’re faring.)
About half of sovereign wealth funds are estimated to invest in private equity, according to Preqin. Over the past twelve months, that proportion has remained steady, says Tim Friedman, head of publications and marketing with Preqin. Private equity investing is more prominent among the larger funds, as they tend to have more sophisticated asset allocation strategies and can include riskier assets, like private equity, within their portfolios, he adds.
Going forward, sovereign wealth funds’ interest in private equity is likely to continue, says Michael Laveman, partner with Eisner LLP. Their recent losses notwithstanding, the sovereign wealth funds still have massive pools of cash. Moreover, investing via private equity, rather than taking direct stakes in public companies, allows the funds to “fly below the radar,” and hopefully avoid some of the controversy that’s ensued when the funds have taken direct stakes in companies, he notes.
One reason for the funds’ more circumspect approach is the drop in theprice of oil, Cox says. In 2008, the price of a barrel of crudeaveraged nearly $100; in 2009 to date, it’s at $71, according to theU.S. Energy Information Administration.
However, their investment approaches likely will shift, experts say. The large deals of several years ago, such as the Chinese government’s $3 billion stake in Blackstone, probably won’t recur for a while, says Michael Maduell, president of the SWF Institute in California. “We haven’t seen anything like that on the radar.”
Thus, while sovereign wealth funds will remain a source of capital for private equity, their share of the funds may be smaller than in the recent past, says Donn Cox, managing director and founder of LP Capital Advisors in Sacramento. “The imbalances in the amount of capital (from sovereign wealth funds) versus, say, pension funds, seems to have abated.”
Oil revenue accounts for about 60 percent of all sovereign wealth funds, estimates Preqin. A case in point is the Abu Dhabi Investment Authority, considered the largest sovereign wealth fund on the planet. It boasts between $625 and $875 billion in assets, according to a September 2008 report by the U.S. Government Accountability Office (GAO).
For instance, in May the Government Investment Unit of Indonesia, a de-facto sovereign wealth fund, formed a private equity fund of its own, the Indonesia Clean Technology Fund. It will invest in alternative energy, water distribution and treatment and agriculture technology within Indonesia.
The losses, at least on paper, that sovereign wealth funds have experienced from some of their past investments – not necessarily in private equity – also is likely to alter their investment style going forward, as their stakeholders question previous decisions. For example, according to several reports in March, Singapore’s GIC wanted to move its investments to property and private equity, after its bank holdings dropped 25 percent.
One area of private equity investing that’s attracting more interest among various investors, including sovereign wealth funds, is the secondary market, Friedman adds. As many investors have watched the values of other holdings in their portfolios drop, some have found themselves over-committed to private equity. As a result, “there has been a flurry of interest on the secondaries market in the past few months,” as investors rebalance their portfolios, he says. “Sovereign wealth funds certainly have the potential to be significant players in this market.”
Monitor Group, in a study of sovereign wealth firms, also concluded that the funds are not investing based on political motives. To the contrary, sovereign wealth funds have taken on an important role in providing liquidity to the global financial system during the financial crisis, Monitor concluded.
These shifts should benefit PE firms, given that sovereign wealth funds likely will remain invested in private equity, even if their role going forward differs from that in the past. Many sovereign wealth fund managers “continue to see private equity as an important and integral part of their investment portfolio and it is likely that the proportion of SWFs investing in the asset class will rise over time,” Preqin’s Friedman says.