Sovereign wealth funds (SWFs) cut back on direct investment into private markets and poured more capital into listed assets last year, reversing a trend of recent years. Yet they are doing more direct deals in less traditional illiquid assets, such as emerging-market infrastructure and non-core property.
These were findings from the first annual review* by the International Forum of Sovereign Wealth Funds (IFSWF), released yesterday.
They reflect the argument made in a report by State Street Global Advisors (SSGA) in February this year that SWFs are likely to hit an allocation limit for illiquid assets. Indeed, some state investors, such as Singapore’s Temasek, have suggested recently that their pace of deal-making could slow in the months to come.
Last year the volume of direct investments by SWFs into private assets totalled $36.6 billion, down from $37.3 billion in 2016 (see figure 1 below). The amount of listed investments made rose to $16.04 billion from $14.1 billion, according to data from London-based IFSWF.
The drop in unlisted market investment from 2015 to 2016 was far more marked – from $71.2 billion to $37.3 billion – but it was not accompanied by a rise in SWF flows into listed assets.
These shifts come after SWFs have in recent years steadily raised their allocations to private markets, particularly real estate and infrastructure, in search of higher yields, stable income and greater portfolio diversification.
But as demand for illiquid assets has grown, so they have become more expensive and generated steadily lower returns, making institutional investors more wary.
HITTING THE LIMIT?
Now it seems SWFs may have reached their private market allocation limit, as valuations are high, competition intense and such institutions have reached their target exposure, said IFSWF. Such a development was foreshadowed in a 2016 survey of IFSWF members that suggested allocations could be peaking, said the Forum in a statement.
Moreover, Elliot Hentov, head of policy and research in the official institutions group at SSGA, told AsianInvestor: “The IFSWF report by and large vindicates my predictions that we were reaching peak allocation to private markets by sovereign wealth funds.
“Private equity funds trying to pitch business to sovereign funds have been trying to make the case that this [private market allocation growth] is a secular trend that will continue uninterrupted,” Hentov said. “I kept saying there would be a break in the trend – and I felt like I was taking away the punchbowl.”
SWFs had around $6 trillion in assets under management as of the end of 2016,** of which 27.3% was invested in non-public assets, according to SSGA research. That figure had risen steadily from 7.7% in 2002.
“Sovereign wealth funds private market allocations have probably peaked,” Hentov added, “and investment [into these assets] is unlikely to bounce back this year or in 2019.”
All this does not indicate that the appeal of private markets is waning, rather that many SWFs seem to have reached a level of investment they are happy with.
Invesco’s annual global survey of sovereign wealth and pension funds, released this month, showed that such institutions remain keen to retain or increase their alternatives allocations, with Asian funds particularly keen on infrastructure and real estate.
Even some of the very biggest investors want to substantially increase their exposure. Japan Post Bank, for instance, plans to increase its allocation to alternatives – above all, private markets – to 4% (¥8.5 trillion, or $76 billion) of its $1.7 trillion portfolio by the end of March 2021, from 0.7% at end-March this year.
Indeed, SWFs in general are still increasing investment into less mainstream areas of private markets. For instance, close to half the $8 billion of SWF flows into infrastructure last year went into EM assets ($3.8 billion). This was close to the $4.2 billion that went into developed markets, which has typically been by far the more popular sector.
The IFSWF report suggested two factors were driving this trend: greater resistance from regulators in Europe and the US to foreign direct investments in strategic projects; and increased competition and thus higher valuations for mature assets in developed markets.
Meanwhile, when it comes to real estate, despite the drop in investment in core property – such as commercial, hotels and retail assets – less conventional areas have received more investment from SWFs. These include industrial/logistics, parking and residential assets. This reflects a general trend among investors globally and in Asia, as they seek higher returns and diversification.
Hentov confirmed that many SWFs had been looking at “tier two”, non-core property, underscoring the property trend highlighted by IFSWF.
He was also “not surprised” by the increased interest in EM infrastructure and expects that trend to continue. Firstly, this reflects the fact that many SWFs operate in EM environments, so they have strategic interests in those markets. In addition, SWFs’ appetite is generally very high for infrastructure, he noted.
*This is based on data taken from IFSWF member institutions, which include most, but not all, of the SWFs across the globe.