Last week, Norway’s government made headlines by prohibiting the nation’s $1 trillion Sovereign Wealth Fund from investing in private equity – the first nation to do so.
The Norwegian government cited lack of transparency and high fees as reasons for this unprecedented decision – with the finance ministry arguing that Private Equity is “unsuitable” as an asset class due to a lack of “openness, information we can share with the public.” In its white paper on the decision, the ministry also raised concerns over high costs of up to 6 percent of assets under management.
The Financial Times argues that Norway’s decision “represents a significant snub”, and may prompt further scrutiny over private equity’s suitability for sovereign wealth funds.
However, in the rest of the world, Sovereign Wealth Funds’ love of private equity shows no sign of slowing down. Q1 of 2018 saw sovereign investors take part in a record $41 billion worth of deals worldwide, far outstripping the previous record of $37.5 billion in the third quarter of 2016.
Asian sovereign funds are currently dominating in terms of deal volume and size. Singapore fund GIC’s involvement in the two biggest transactions accounted for $29.6 billion combined last quarter, and GIC and Temesek were involved in a combined 25 deals.
PwC estimates that SWFs now allocate almost a quarter (23%) of their assets under management to alternative investments such as private equity. As we highlighted in a recent blog, Sweden’s sovereign fund, worth $150 billion, updated their investment policy last July, and now hold just 20% of their assets in the safest bonds, rather than 30%.
Many sovereign funds are increasingly drawn to alternative investments to boost returns, and to diversify in the wake of adverse conditions and slower asset growth since 2014. The tech sector is particularly appealing (with Norway’s fund expressing an interest in Uber and Airbnb specifically) due to high growth rates that are not easily replicable in publicly listed companies.
With such huge sums of capital available, SWFs are undeniably influential and play a key role in private equity fundraising. The fact that these sums are held by just a few major players compounds this. For the private equity world, avoiding another situation like Norway is crucial.
Sovereign funds, particularly pension funds, often hold high standards of transparency and accountability, and so Private Equity funds must demonstrate excellent transparency and shake off any reputation of being “opaque and fee-heavy.” Investors should also demonstrate that they have fully considered the Environmental & Social Governance (ESG) of any portfolio company.
With higher fees under scrutiny, extensive diligence should be undertaken to ensure that the returns of a company are enough to justify them. Digital diligence is key to understanding growth strategies, market penetration and the commercial strength of an asset. Given their long-term focus, Infrastructure projects are more likely to appeal to sovereign funds, given the sector’s record of providing stable, long-term returns. Similarly, longer than average investment cycles are likely to appeal.
For now, Norway’s government seems to be the exception rather than the rule, and private equity investors that can demonstrate high standards of transparency and growth rates are likely to see continued significant interest from sovereign funds throughout 2018.