Sovereign wealth funds have steadily sought to insource investment management over the past decade and more but this shift is likely to slow for publicly traded assets and could even reverse.

That's the view of Elliot Hentov, the London-based head of policy and research in the official institutions group of US fund house State Street Global Advisors.

“I’m of the belief that this trend is about to turn,” he told AsianInvestor, referring more to traditional asset classes than to alternative investments. “We have not yet reached the peak of [the insourcing] trend, but my assumption is that some funds may realise that not all investment strategies are optimised by internal staff.”

Active management fees for public-market assets have been falling in recent years, under pressure from cheaper passive investment strategies such as exchange-traded funds, Hentov noted. “[So] I think the value proposition will change again,” he said.

“It’s very compelling to think that one could save the [management] fees by bringing the investment in-house. But it’s not always an apples-to-apples comparison between the external manager fee and the cost of doing it in-house.”

That's partly because insourcing also means bringing the operational risk and other challenges in-house, along with the investment management.

The insourcing trend among SWFs accelerated notably after the 2008 financial crisis, said Hentov. The buildout was particularly marked in respect of private markets expertise, as large institutions upped their allocations to alternatives.

And asset owners will likely continue to seek external managers for new or niche asset classes, he said. “As SWFs have moved up the risk spectrum and gone into new assets, it’s been a great market for boutique alternative fund providers.”

Specialised asset classes such as private debt and infrastructure require a certain level of expertise that cannot quickly or easily be insourced, Hentov added.

CO-INVESTMENT SHIFT

Even the most well-resourced entities tend to take the ‘outsource first’ approach but tend to shift into direct or co-investments over time.

Norges Bank Investment Management (NBIM), which manages Norway’s $1 trillion state oil fund, said in a letter to the country’s Ministry of Finance in January that it should be allowed to invest in private equity up to a limit of around 4% of its total assets under management.

NBIM said it would initially look to invest in private equity funds but that it would ultimately aim to co-invest alongside them as doing so is cheaper and it has the economy of scale to do it effectively.

Similarly, Japan Post Bank, with ¥200 trillion ($1.8 trillion) under management, started investing in private equity in 2016 and has made some overseas private equity allocations via funds. But in January this year it said it was setting up a private equity fund with up to ¥120 billion ($1.1 billion) to invest in domestic buyout deals. Japan Post Investment Corp — half owned by Japan Post Bank and half by Japan Post Insurance — will also reportedly invest overseas.

Abu Dhabi Investment Authority too has historically made most of its private equity investment via funds, but in the past few years has been building its capabilities with a view to doing more principal investments.