A little over two years ago, I wrote a series of posts on SWF collaboration, co-investing and clubbing. At the time, I was of the opinion that this sort of behavior would become increasingly common, believing that SWFs could fruitfully work together to bolster their returns. In large part, the economic geographer in me was convinced that the local knowledge and asymmetric information (not to mention access to deals and elites) that would come with partnering would have real commercial value for SWFs. And — no need to hide your shock at hearing this — it turns out I was right. In particular, CIC, GIC, KIA, KIC, Khazanah, Mubadala, and a few others have been actively partnering with other funds. And, recently, news about collaborative ventures has been spiking. Here is just a snippet of the collaborative ventures I’ve come across (or been told about offline) in the past month or so:
- ADIC and Japan’s SBI launched a $100 million private equity venture focused on Turkey.
- Singapore’s GIC linked up with Australand Property Group.
- CPPIB is working with ADIA on an investment in Norwegian gas infrastructure.
- Khazanah has just linked up with India’s Infrastructure Development Finance Company in a joint venture to develop road projects in India.
- Gulf SWFs are collaborating with a local partner in Morocco.
- Kuwait and Bulgaria started a new company to make investments in Bulgaria’s agriculture industry.
In addition, the New Zealand Superannuation Fund’s newly released statement of intent goes public with the fund’s plans to collaborate with peers:
“We are actively pursuing co-investment and research opportunities and partnerships…Co-investment is our particular focus as it is a potentially valuable access point to investment opportunities.”
With all this activity, I thought it an opportune time to revisit the subject and add some conceptual logic to this increasingly popular trend. As I see it, there are a variety of factors at play here:
- Direct Investing: You’ll note that many of the funds collaborating are also in-sourcing asset management functions. You are no doubt aware of the growing trend towards direct investments among SWFs. What you might not be aware of, however, is the considerable burden that in-sourcing places on SWFs in terms of governance, management and operations. One mechanism to overcome these challenges (or at least minimize them) is to collaborate with like-minded investors facing the same challenges.
- Frontier Finance: The center of gravity of global financial markets is shifting away from New York, London and Tokyo to frontier outposts in Abu Dhabi, Auckland, Beijing, Edmonton, Juneau, Oslo, Santiago and Seoul, among others. (Be honest, asset managers, I bet you’ve all been to one of these cities in the past year.) But how do the SWFs in these locations attract the human capital they desperately need to manage hundreds of billions of dollars? There isn’t a ready pool of financial laborers in these places as there would be in the global financial centers. So, successful investing in these locations requires knowledge sharing, collaboration and co-investment among SWFs. And that’s what is happening.
- Economies of Scale: Scale brings competitive advantages in financial markets. The CEO of the KIC recently summed up this point nicely by saying that ‘size matters most’ for doing direct deals. Working together allows funds to reap the benefits of scale while also keeping a diversified portfolio.
- Information Asymmetries: In asset classes in which there are considerable informational advantages to having local partners, working together with local funds can offer considerable advantages. Research shows that local knowledge can translate into as much as 2% per year in additional returns.
- Benefits of Club Deals: Academic research also shows that there is a discount on pricing (specifically in private equity deals) when institutional investors club together; this can be as much as 10% of the purchase price in a transaction.
- Political Cover: In certain jurisdictions and industries, gaining access to the best assets requires having a local partner to mute headline and political risk.
That’s not a complete list of why SWFs are working together, but it’s at least a start. And it gives you a sense for why this is taking place. After all, many people might expect these funds to behave like competitors with one another (which they are), but there is clearly still room for collaboration.
Now, to be fair, we should acknowledge some downsides to all this. For one, coordination costs in co-investments can be quite high. (A wise man once told me that the factor of complexity of a co-investment is the square of the number of co-investors; I still think that’s a fair assessment.) In addition, because of the asymmetric information among the collaborators, there are obvious agency issues to be considered in the design and governance arrangements.
Notwithstanding these constraints, however, I expect this trend to continue and become more popular. Working together offers a mechanism to grow their sovereign assets more quickly. Welcome to the era of SWF collaboration!