Sovereign wealth funds and other top-tier investors are increasingly looking to do solo or club deals in private markets rather than allocate to pooled funds. But while direct investing solves issues such as opaqueness of asset pools and manager fees, they point out, it poses its own challenges.
While sovereign funds have been developing their in-house private markets capabilities, what hasn’t changed is the challenge of sourcing the right deals and working effectively with other investors and general partners (GPs).
Co-investment with other official institutions is seen as a practical way of managing the risks of private markets investment, especially as more investors go in search of such arrangements.
“It works because the long-term ambitions are truly aligned,” said Adrian Orr, chief executive of the $24 billion New Zealand Superannuation Fund. “But it brings problems of its own. Sustainable, successful partnerships are rare.”
With direct investments, asset owners have a different set of problems: how to access deals, how to create stable deal pipelines, how to deal with the high costs of due diligence, and the relationship management all this entails.
But the upside is more control. In particular, direct investing avoids the issue of GPs’ lack of transparency. Despite their size, sovereign funds struggle like everyone else against the opacity of blind pools that dominate the GP landscape.
Orr said: “On what basis does one proceed if established market practice is to attach two-and-twenty to nearly every ‘black-box’ investment strategy?
“We have no basis for comparison, especially in the unlisted markets," he added. "Working together we can, at the very least, share data and compare notes on whatever lies behind that veil.”
Another issue hindering the development of direct investing is how deals are structured. For instance, it's a seller's market for trophy assets in gateway cities, and Asian buyers are now at the stage where they are willing to walk away if the terms and conditions are too restrictive.
And while sovereign investors' pools of patient capital seem perfectly matched to infrastructure projects in need of substantial funding, the reality is less straightforward.
Tomas Franzen, CIO of the $35 billion Swedish pension fund AP2, said the investment structures available did not always match investors' objectives.
When assessing infrastructure funds, the AP2 board feels that most vehicles do not reflect the true characteristics of the asset class, Franzen told AsianInvestor. “What you end up with is an investment that is not as long term in nature, that is levered to a high degree and that is more correlated to equity markets."
He concluded: “if you want to do it properly you need to go direct, but we concluded we were not willing to build the rather large institution necessary to do it that way.”
Certainly, the $37 billion State Oil Fund of Azerbaijan (Sofaz) takes the view that the collaborative approach is still the best option, given the limited scope for direct investing. A spokesman for the fund said: “I believe co-investment amongst like-minded investors today is more effective than ever before.
"By pooling resources – not just financial, but administrative and operative as well – JV partners can underwrite larger-ticket-size investments, penetrate markets where they previously lacked access and leverage on each other’s networks and know-how. All of these factors increase the chance of success [compared to] if we had acted alone.”
Sofaz is a relatively new player in private markets, only adding private equity and real estate to its portfolio in 2011. Its approach to gaining such exposure has been both by making direct acquisitions, in the case of real estate, and using the platforms of closed-end third-party asset managers.
Sofaz has recently assigned a separate discretionary account to manage exposure to developed market funds and private deals. The $200 million portfolio represents approximately 0.6% of Sofaz’s current assets under management.
A feature article on this topic will appear in the November edition of AsianInvestor magazine, which will be available soon.