The 69th CFA Institute Annual Conference will take place in Montréal, Quebec. This event, held 8–11 May 2016, will feature top economists, prominent investors, bestselling investment authors, and governmental and regulatory leaders.
Financial intermediaries beware. Sovereign wealth funds (SWFs) have the size and scale to change the traditional model of investment management. Translation: they are growing quickly and have the power to start to dictate more favorable terms than asset owners had in the past.
Scott E. Kalb, former CIO of the Korea Investment Corporation (South Korea’s SWF), took the podium at the 68th CFA Institute Annual Conference to give delegates an overview — and possibly a wake-up call — that SWF influence around the world is growing. Quickly.
— CFA Institute (@CFAinstitute) April 28, 2015
Kalb offered a few statistics:
- At the end of 2014, the top 74 SWFs held $US 7.7 trillion, up from $US 4.4 trillion in 2010.
- The top 102 SWFs plus sovereign pension funds (SWPs) held over $US 12 trillion. (SWPs are pension plans owned by the federal government rather than a specific government agency.)
- 53 SWFs have been established since 2000, 40 of those since 2005.
- SWFs and SWPs average over $US 100 billion under management.
The International Monetary Fund (IMF) provides a nice overview of SWFs. The proliferation of these funds coupled with their size will change the dynamic of how institutional capital is managed. There are three well-established models for SWFs, SWPs, and other large asset owners, including endowments:
- The Norway model ostensibly follows an efficient market hypothesis (EMH) framework of passive investing and follows a benchmark (i.e., relative return orientation).
- The Canadian model follows an absolute return philosophy and manages a lot of its own capital directly rather than hiring managers exclusively.
- The endowment model relies heavily on alternative investments and hiring external managers.
Kalb suggested that the size of SWFs and their growing influence will create a fourth model that he tentatively labelled the “collaborative model,” which will seek to change the way SWFs invest capital. For a long time, pension funds were among the largest institutional investors and with assets under management (AUM) averaging $US 20–30 billion, they were very attractive clients for financial intermediaries (i.e., brokerages, mutual funds, private equity, and hedge funds). However, pension funds still were (and still are) subject to the terms the intermediaries dictated. SWFs are large enough to forge new models. Furthermore, SWPs invest for the long term and do not typically have any current liability streams, which opens up more investment possibilities.
One of the catalysts for a new model is the avoidance of fees and transactions costs. According to Kalb, SWFs have to put $US 150—200 billion per year to alternatives just to maintain current portfolio weights, so costs are a big variable when thinking about portfolio allocations. SWFs are positioned to capture a liquidity premium because of their long investment horizons. However, those premiums are largely offset by costs. Kalb suggested that a 5% liquidity premium can easily be swallowed up by “2 and 20” fees coupled with the cost of portfolio rebalancing. Since SWFs are so large, the aggregate amount in fees potentially justifies owning an asset management firm altogether.
Kalb politely chose to use the word “re-intermediation” to describe the new collaborative model instead of invoking the threat of disintermediation. However, disintermediation isn’t out of the question as more and more SWFs are choosing to invest directly in companies rather than buying funds or shares of those companies. According to the Sovereign Wealth Fund Institute (SWFI), SWF direct investments are up 10% in 1Q 2015 over 1Q 2014 to $US 22.85 billion. Furthermore, Kalb predicted that over the next 12–24 months, SWFs will be interested in allocating fresh capital not only to alternative assets, but also to infrastructure, private debt, and smart beta.
Kalb: cost of allocating to alternatives for SWFs is 5-6% a year. Might spend your whole illiquidity premium on fees. #FutureFinance
— Will Ortel (@willortel) April 28, 2015
One particular social benefit resulting from the proliferation of SWFs is the mitigation of corruption. Nigeria set up an SWF to protect the robust stream of petroleum cash flow. Lamido Sanusi, former governor of the Nigerian central bank, was removed after accusing the government of misappropriating oil revenue. Today, 25% of oil revenues are going to the SWF, which will help protect valuable natural resource revenue for the benefit of the country, not its politicians.
Kalb summarized his remarks by identifying five anticipated trends for SWFs in the coming years:
- Global expansion
- Growing AUM by $US 400–500 billion per year
- In-sourcing by growing internal capability
- More demand for alternative (less liquid) investments
- “Re-intermediation,” i.e., new collaborative investment models
Scott Kalb: 5 big trends in #SWF
Investing in alternatives
Using new biz models #FutureFinance
— Usman Hayat, CFA (@Usman_Hayat) April 28, 2015
A recording of Scott Kalb’s session at the 68th CFA Institute Annual Conference in Frankfurt is available in the CFA Institute Publications & Multimedia Library online.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Photo credit: W. Scott Mitchell