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Institutional investors - In-house revolt

Big pension and sovereign-wealth funds are cutting out the middleman

Nov 1st 2014

HEY finance hotshot! Want to trade in the London penthouse and 90-hour working

week for something totally different? Do you prefer big mountains to big

buildings, long summer evenings to long commutes and yet want to pursue a

rewarding career in finance? Why not move to Juneau! You will find all these

things and more at the Alaska Permanent Fund Corporation, promises the website

of the government agency which manages the oil revenue Alaska is setting aside

for the future. Sovereign-wealth funds and other big institutional investors

from Ottawa to Oslo and if icefishing isn t your thing Abu Dhabi to Auckland

are hiring. The intention is to lure talent from private-equity firms and hedge

funds in order to make the same sort of investments in-house.

Sovereign-wealth funds made direct investments of around $186 billion last

year, nearly triple the level of 2012, according to the Sovereign Wealth Fund

Institute, a consultancy. Pension funds, insurers and family offices are doing

the same a response in part to the exorbitant fees and disappointing returns of

many asset-managers. ADIA, Abu Dhabi s sovereign-wealth fund, with assets of

$773 billion, now employs 1,500 people. South Korea s National Pension Service

($430 billion) will boost its investment team by 60 people this year. Canada s

Pension Plan Investment Board recently opened a fourth international office, in

S o Paulo, to enhance its ability to source and manage complex, sizeable

investment opportunities .

The trend is a logical extension of the practice of co-investing, in which

institutions put money directly into specific deals alongside funds in which

they have also invested. Institutions have demanded such opportunities both to

cut the overall cost of investing via private-equity funds and to gain

experience that might help them initiate deals of their own in future.

The next step is to ally with other like-minded investors. A Canadian pension

fund, a British one and Kuwait s sovereign-wealth fund last year bid

(unsuccessfully) for Severn Trent, Britain s second-largest publicly traded

water company. Some big institutional investors are now going it alone: a

Singaporean sovereign-wealth fund recently bought a significant share in RAC, a

British car-breakdown service, outbidding private-equity firms such as

Blackstone, CVC and Charterhouse.

The financial crisis made big investors realise they had little understanding

of their own portfolios, were overpaying middlemen fees of 2% of the sum

invested and 20% of profits were once common and were working to different

schedules (sovereign-wealth funds invest for generations; private-equity funds

for five years). A long investment horizon is the institutional investor s

greatest competitive advantage, yet asset-managers cycles have become ever

shorter, says Ashby Monk, an adviser to such investors.

Insourcing is easier said than done, counters one private-equity manager, who

says his clients all claim to want to co-invest but most do not really have the

capability or nerve to assess deals. Building an investment team is too

expensive for all but the biggest. Attracting top talent is also hard when

government salaries are restrained by law (as in America), or when the investor

is based in a desert or by a glacier. But lay-offs during the financial crisis

left lots of experienced moneymen willing to consider jobs in Juneau or Abu

Dhabi.

Whether internal asset managers earn higher returns is another question. A

study released earlier this year by CEM, a Canadian research firm, showed that

internal private-equity investments (including co-investments) outperformed

external ones by over three percentage points and beat funds of funds by five.

This was almost entirely due to lower costs.

Things can easily go wrong: the Korea Investment Corporation s $1 billion of

direct private-equity investments underperformed those it made through

private-equity funds by nine percentage points last year. But when they go

right, institutional investors tend not to look back. Mark Redman left 3i, a

private-equity firm, to head the private-equity arm of OMERS, the Canadian

pension fund that bid for Severn Trent, drawn by the extreme attractiveness of

permanent and patient capital . Over the past five years, gross returns from

its direct private-equity investments have exceeded those it has made through

external funds by 44%. As a result, OMERS reduced the share of private-equity

investments it farms out from 59% in 2007 to 27% by the end of 2013 and plans

to cut it even further. Even the private-equity types who have not moved north

of the Arctic Circle will shiver at such figures.