Sovereign wealth funds are turning to joint ventures to give them more investment control, writes Shayla Walmsley

Sovereign wealth funds (SWFs) are changing what they invest in and how they invest. These investors, with aggregate assets under management of around US$3-4,000bn (€2,200-2,900bn), have traditionally focused on stabilisation, long-term savings and economic development. Now they're looking for returns - and with a very different approach to risk.

The reason? Like many other institutional investors, SWFs examined how their funds performed and found that performance wanting.

"What sovereign wealth funds did before the crisis was to invest in a broad mix of direct and indirect investments and structures — for example indirectly through funds, whether those were blind or discretionary, and across the spectrum of degrees of control," says Joe -Conder, partner at law firm Linklaters. "But having committed to a number of different funds, they found themselves locked into the commitment and effectively required to support the model even once the funds had ceased to perform."

Not all SWFs have ditched funds. Last year, for example, the US$280bn National Pension Service of Korea (NPS) committed $400m to a fund managed by Rockspring to invest in core-plus European real estate, topping up a mandate originally signed in 2006. Around the same time, the Korean fund awarded a mandate to the Townsend Group to invest $300m in the Americas, notably in distressed funds and acquisitions via a secondary market, as well as joint ventures and club investments.

So if not funds, what? Going direct is not for everyone, says George Kay, senior vice--president at GIC Special Investments, which invests in infrastructure assets. The sale of one asset last year involved almost daily board meetings. "I think it's sometimes underestimated how much effort you have to put in," he says.

More visible is a trend towards joint ventures - sometimes between SWFs - and smaller club deals, to give them greater influence in the decision-making process. Australia's AUS$69bn (€51.5bn) Future Fund, the Korean NPS and the Abu Dhabi Investment Authority (ADIA), which does not disclose its AUM, have each acquired stakes in Gatwick, the UK's second-largest airport. The Future Fund, which now has a 17.2% stake in the airport, also has a 10% stake in Melbourne airport.

"There is an emphasis on moving away from blind pools and directly underwriting the assets," says Andrew Wood, executive director at MGPA, the private equity advisory firm that has several SWFs among its clients. "It's a different process and it involves different types of investment."

Even where the acquisitions have been trophy assets, many SWFs tend to have an investment rationale familiar to pension schemes and other investors. Earlier this year, Norges Bank, which manages the assets of the NOK2.8trn (€342bn) Norwegian Government Pension Fund - Global, acquired its first real estate asset with a 150-year lease on a 25% stake in the Crown Estate's Regent Street 113-asset portfolio in London. This - effectively a joint venture with the state - cost the fund £452m in return for 25% of the properties' net rental income.

"Those opportunities globally would be few and far between," says Andrew Hynard, chairman of JLL's UK business, which advised on the deal - not least because of the size of the ticket.

"For the time being we'll focus on the European market, but other markets will come later," says Siv Meisingseth, communications director at Norges Bank. "We had to start some place but we will expand. We're a long-term investor. If you look at the Regent Street acquisition, we own it for something like 100 years. Is that a good thing? It's a good thing to be a long-term investor but I really don't know necessarily whether longer is better."

Risk rethink
Admittedly, the oil fund is a peculiarly cautious real estate investor. A government-commissioned report in December called for it to add more risk to its US$502bn (€370bn) portfolio via illiquid assets such as infrastructure. But risk aversion is the new black, at least for some SWFs.

It isn't just performance and asset risk, either. Reputational risk is moving up the agenda - not as fear of the vocal disapproval of protectionist lobbies abroad but fear of press criticism at home in the event of negative performance. According to John Nugée, senior managing director of State Street's official institutions group, the crisis taught SWFs that there is a reputational limit to losses; it reminded them that "their reputation for competence is a major asset of their fund, and one which is lost, may not prove easy to recover". Nugée's group manages $450bn (€331bn) in assets for central banks and governments, as well as SWFs.

Yet some SWFs are content to take on political risk with a geographical shift eastwards, the reaction against property funds they have in common with other institutional investors. Likewise the increased focus on emerging property markets. There may be a difference here, in that many of these funds come from emerging markets, but they are nonetheless (like other institutional investors but without developed-world intermediaries) replacing performance risk with emerging market risk. As Raphael Arndt, Australian Government Future Fund head of infrastructure and timberland, said at a recent infrastructure investment event: "Europe is not a sector, economy or place we have to invest in."

Ng Kok Song, chief investment officer at $100bn GIC, one of Singapore's two SWFs, which only invests outside its domestic market and at the end of March 2010 had 9% in real estate recently announced that the SWF had established offices in Shanghai, Beijing, Tokyo, Seoul and Mumbai in order to develop expertise and access investment opportunities directly - even though its Singapore headquarters could adequately cover Asian markets. "While publicly listed equities is likely to remain GIC's main implementation vehicle for our emerging market strategy, our view is that the private markets such as real estate and private equities will present even more rewarding opportunities," he says.

The stakes aren't always major ones. A GIC subsidiary is one of three partners (and reportedly a 25% shareholder) in a joint venture to invest in prime real estate development in Ho Chi Minh City, Vietnam's capital. Tawreed Investments, a subsidiary of Abu Dhabi Investment Authority (ADIA), is a 19% shareholder in a 99-year lease, sold for AU$2.3bn, on the Port of Brisbane. The consortium includes two of the country's largest superannuation funds via Industry Funds Management.

"We've taken some big bets in that respect," says Kay. "We went to cash as a broad portfolio, then got back into markets we found attractive - India and Latin America, as well as the US."

Pramerica Real Estate Investors (PREI) managing director Mark Chamieh, which is involved in joint ventures with Gulf SWFs, including ADIA, claims there's more interest from capital wanting to stay in the region as Middle East markets mature - although ADIA has a policy of not investing in its domestic market, or in Gulf Cooperation Council markets. "When you're working with a sovereign wealth fund, you're dealing with a very, very sophisticated organisation that invests globally. It has also hired talented people from around the world so it has a terrific talent base," he says.

Earlier this year, China Investment Corporation head Gao Xiqing identified (non-Chinese) protectionism as one reason why the SWF was changing its investment focus from mature to emerging markets. He said at a Davos event that CIC, set up in 2007 with US$200bn in foreign reserves, "should be the most welcome investor" in Western markets - but isn't always.

Speed to markets
Will all this change require a change in current decision-making processes? Nugée claims SWFs, having used the recent crisis as a stress test, are rethinking their investment decision-making processes because they found it difficult to react "when markets were going everywhere". "They're slow - and they recognise it," he said at a recent briefing. "Some are working to speed up, but we're talking about public sector institutions".

Not always that slow - at least not when it comes to spotting an opportunity. The US$37bn Korea Investment Corporation (KIA) last August awarded a mandate to Partners Group to invest across real estate opportunities generated by market dislocation. In the same vein, GIC has begun to rethink the contours of its long-term strategy, introducing an element of flexibility with a medium-term strategy that will allow it to "make calibrated departures from the policy portfolio" in order to respond to significant risks and opportunities.

If in the past one way of making sovereign wealth fund activity more palatable was to emphasise that SWFs were buying assets other investors couldn't afford, that's clearly no longer the case, if it ever was. The real estate arm of US$85bn Qatar Investment Authority, a SWF, in December said it would seek to buy and manage half of London's Olympic village. It also plans to manage the asset - a departure, perhaps, from the earlier tendency of sovereign wealth funds to keep a low profile and invest passively.

But it's regulators, rather than SWFs, that are driving some of this shift towards more active ownership, including of listed property assets. "Greater shareholder involvement is likely. The question is whether it will be encouraged or mandated," says Nugée. "For sovereign wealth funds, there's a thin dividing line between active shareholding and interfering."

He adds: "Sovereign asset owners have not yet completed the dialogue among themselves, let along with other stakeholders, on the best way to resolve this issue," pointing out that shareholder involvement was an issue he had to raise with SWFs: they didn't bring it up.

Little in common
The problem with talking about sovereign wealth funds as a category is that, for every claim you make of them, you have to add "except". For every SWF expanding to or focusing on emerging markets, another is looking to a London trophy or infrastructure asset.

"It's still quite a broad mix of assets sovereign wealth funds are investing in — from core central London to longer-term developments that are more akin to opportunistic investments," says Conder. "There is no one size that fits all. Different houses will have different investment styles and strategies. Each will form its own strategy depending on where it thinks it should be in the market. The commonality is the reason for investing in real estate as an asset class. How they go about it and which asset classes they invest in will be specific to each fund."

There's a broader definitional reason not to overplay the changes sovereign wealth funds are making to what they invest in and how they invest. Even to speak of sovereign wealth funds as a single category is potentially misleading.

In contrast to pension funds, which are always defined by their fiduciary responsibility to their beneficiaries, sovereign wealth funds have as their sole common factor a desire to generate returns. There are some that appear in both categories, of course, such as CPPIB in Canada and the Norwegian oil fund, which is nominally a pension fund, although, as Nugée points out, "no-one knows when it'll ever pay out any pensions".

You see a divergence, for example, between ‘pure' SWFs and hybrid SWFs with potential short-term claims on their cash. For the latter, the strategy remains long-term but the assets won't necessarily be for reasons of liquidity. "Theoretically we're a long-term investor - but you can't really function on a10-year horizon [in the current market]," Gao Xiqing said at Davos.

According to State Street, SWFs - in all their diversity - are in their sixth phase. Before 1995, they were unknown shadows; in 2006, they were unwanted raiders; in 2007, when they bought into capital market institutions, they were unexpected saviours; in 2008 they were unrivalled titans; in 2009 they were uncertain mortals; in 2010 they were undaunted survivors.

Within those broad perceptions, each has its own processes, structures and decision-making mechanisms. "There are more-or-less reliable and more-or-less fickle ones," says Wood. "You can't make gross generalisations about them. There are well-managed ones with clear strategies and they execute on the strategies successfully and reliably. They're good partners - good to do business with. Others are less clear about what they want to achieve. It's a large enough category to look at them all individually."