Sovereign wealth funds seek partnerships for direct lending in private markets
Asset owners are stepping up their deployments towards private credit, and looking to strengthen their direct investment capabilities, recent findings by the Sovereign Wealth Fund Institute (SWFI) and the International Forum of Sovereign Wealth Funds (IFSWF) showed.
The trend is exemplified by recent moves by sovereign wealth funds (SWFs), such as the Mubadala Investment Company, the Abu Dhabi Investment Authority (ADIA) and Singapore's GIC that have placed further emphasis on private lending strategies, according to the SWFI's September 2021 Global Asset Owners Survey.
For instance, the Mubadala Investment Company, in 2020 partnered with Barings to establish the Barings Mubadala Enterprise focusing on direct lending to mid-market European entities.
Similarly, the Abu Dhabi Investment Authority (ADIA) increased its allocation for private equity from 5% to 10% in 2020 from 2% to 8% in the previous year. Its Alternative Investments Department had a record year, completing more transactions in 2020 than ever before.
ADIA declined to comment, and pointed AsianInvestor to its stakeholder letters and annual reviews.
Government bond yields have been depressed, trading at or very near to their all-time lows, compelling investors to seek lucrative alternatives, the ADIA said in its 2020 review.
“For the past thirty years, government bonds have offered a powerful combination of market liquidity, portfolio protection and interesting returns, making them an essential tool in portfolio construction, ADIA managing director Hamed bin Zayed Al Nahyan wrote in a letter accompanying the Abu Dhabi fund’s review for last year.
“While they will continue to play a role, most investors will also be looking to expand their toolbox and rethink how they approach diversification,” he said.
GIC has been seeking niche partners for alternative lending strategies, the SWFI report wrote. Earlier this year, the fund sought to hire five new associate roles to cover private markets.
Mubadala and GIC both declined to comment for this article as well.
PRIVATE PARTNERSHIPS
Even as private credit trends upwards, the number of sovereign wealth funds that allocate to it remains small, Victoria Barbary, director of strategy and communications at the IFSWF told AsianInvestor.
"Although private debt has received a lot of attention only a few sovereign wealth funds allocate to it. In a recent survey of IFSWF members, only 13 allocated to this asset class at all, and only four invested directly in private debt," she said.
Those that do, are looking to strengthen their direct investment capabilities, the IFSWF said in its September newsletter. In a poll of 21 IFSWF members conducted by the body and PwC this year, 45% of the respondents displayed an affinity for investing in private markets with direct or principal investments, while 30% preferred closed-end funds.
Although funds are prioritising the development of specific expertise in growth equity, that is not to say that they are envisaging the entire gamut of origination-to-execution as an inhouse exercise.
As the Barings-Mubadala tie-up highlights, SWFs are instead on the lookout for collaborations that would see them invest alongside major buyout general partners, as opposed to competing with the latter for the same deals, the IFSWF said.
Funds seek to tap the dealmaking prowess and network reach of private equity firms, the firm wrote. While SWFs have the ability to invest directly in unlisted assets, the majority also lack the resources needed to lead a consortium or go solo, it said.
In addition to growth equity, fund activities remain largely geared towards the more traditional asset classes such as commercial real estate and mature infrastructure assets in developed markets.
However, Barbary noted that SWFs increasing allocation in private markets are "likely those with extensive private markets programmes and have the expertise to evaluate these strategies."
These funds are seeking higher returns and looking for diversification, she added. She also observed that most of these investments are in the more established markets such as Europe and the US, rather than Asia.
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SWFs also face challenges particularly in finding expertise and talent, she noted.
"Most sovereign wealth funds that do allocate to private debt are still relatively new entrants to the market. As a result, they are still building their teams and tend either to allocate to private debt funds, or create joint ventures with an experienced commercial partner."
POLICY UNCERTAINTY WEIGHS
In contrast to investors’ burgeoning interest in private firms, their outlook for listed companies appeared dimmer. The September survey by SWFI registered an increase in the number of participants anticipating no improvement in earnings for publicly traded companies in the next 12-months, the first time the total went up since December.
Proposals by the US Democrats that could lead to higher taxes, coupled with a forthcoming reduction in the Federal Reserve’s (Fed) quantitative easing undertakings, put a dampener on earnings this year, the SWFI explained. Investors were wary of the implications of rising interest rates, the SWFI survey found.
“SWFI institutional investors viewed an increase in interest rate risk as the greatest toward financial market stability for the second time in a row over a viral pandemic or outbreak risk,” the SWFI said.
Respondents were concerned that US inflation may prove to be sticky, prompting the Fed to start tapering, especially if Jerome Powell stays as Fed Chairman. In September, the Fed signalled that it could begin lifting interest rates from 2022, followed by three further rate hikes in 2023.
“There are numerous risks associated with the outlook, chief among them delays associated with vaccine distribution and the market reaction to any tapering of quantitative easing programmes,” the ADIA said in its 2020 review.
Investors are also pricing in a strong economic recovery this year, leaving them exposed to alternative scenarios given stretched valuations, GIC CEO Lim Chow Kiat warned in his 2020/2021 letter to stakeholders.
“Credit spreads are at historically tight levels implying low compensation for taking on default risk. Given the uncertain macro environment and stretched valuations, we expect returns from a broad range of asset classes to be low for the next five to 10 years,” Lim cautioned.