Study: Middle East sovereigns increase private equity

The increase in allocation to private equity is driven by a greater need for sovereign wealth funds to diversify from public equities and to achieve higher returns, according to a study.

Middle Eastern sovereign wealth funds are increasingly considering private equity as an investment strategy, according to the fourth Invesco Middle East Asset Management Study. 

The study looked at investment behaviours of sovereign wealth funds in the Gulf Cooperation Council region, which account for 35 percent of global sovereign wealth flows and represents $1.8 trillion.  

Sovereign wealth funds want to diversify from public equities into private equity as they aim to achieve higher returns, according to the report.

Invesco looked at the difference between ‘investment SWFs’, which aim to preserve and grow a country’s assets – and ‘development SWFs’ – which seek to boost economic growth and local employment. 

Among ‘development SWFs’, approximately a third of new assets were allocated to private equity in the last 12 months, which increased from 10 percent in 2012. ‘Investment SWFs’ allocated 13 percent on average of new assets, which is an increase from 9 percent in 2012.  

A lot of SWFs are establishing in-house private equity teams. It’s not private equity is too expensive or that the fees are too high, it’s just that in the great scheme of things investing in themselves is a value add that is worthwhile, particularly if they are going to be more active in private equity – a trend we think will continue

Nick Tolchard

“We were told that the target returns for development SWFs were about 14 percent, so to get that level of returns, they have to use the private equity model, which generates a higher return [than other markets],” Nick Tolchard, head of Invesco Middle East, told Private Equity International

But while SWFs like the asset class, they seem to prefer direct and co-investment strategies to committing to funds. Nearly all SWFs started out investing into funds but many have moved or are considering a move to co-investments or direct models, the report found. 

“Clearly many feel they can compete with private equity directly or want to access particular strategies not aligned to the large private equity houses. It will be interesting to see how the private equity community responds to this shift,” Tolchard said. 

“A lot of SWFs are establishing in-house private equity teams. It’s not private equity is too expensive or that the fees are too high, it’s just that in the great scheme of things investing in themselves is a value add that is worthwhile, particularly if they are going to be more active in private equity – a trend we think will continue,” he added. 

SWFs are increasingly becoming a growing force in private equity. The global reserves of sovereign wealth funds were approximately $5 trillion in 2007; in 2012 they had risen to about $10 trillion and they are expected to reach $11.5 trillion by the end of 2013, James Burdett, head of investment funds at Baker & McKenzie told PEI in a recent interview. 

Quite a lot of SWFs started by investing in a funds of funds, but “as they get more ambitious and sophisticated, they’ll tend to increase exposure to primary funds – and, in some cases, move away from the fund of fund model. Perhaps because they feel, rightly or wrongly, that the layering of fees is weighing on their returns,” he said, adding that “in a growing number of cases, SWFs will be more interested in co-investing”.