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Sovereign WealthQuarterly

The Source on Sovereign Wealth Funds and Other Long-Term Public Investors

April 2013

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content

Notes From the Editor 5

1st Quarter SWFI Commentary 6

People on the Move 38

Quarterly Briefings 53

Top 10 Sovereign Wealth Fund Game-Changers of 2012 70

Asset Allocation & Strategy

Sovereigns Funds Transition from Acquirer to Monitor 10

Hedge Funds Peak Sovereign Wealth Fund Interest 18

Diversifying Massive Reserves, SAFE Co-Financing is Created 30

Public Investors’ Tepid Embrace of Emerging Managers 36

CalPERS Shifts Hedge Fund Strategy 68

Real Assets

Domestic Private Equity Programs, New Mexico Increases Allocation 14

Institutional Real Estate Updates 21

Alaska Permanent Fund Amends Investment Guidelines in Infrastructure 25

Peru’s AFPs Allocate 11% to Infrastructure 28

Exclusive Interview

Q&A with Niels Veldhuis, President, Fraser Institute 54

Features

Terminating Public Equity Asset Managers, Public Investor Perspectives 16

London Dominates SWF Overseas Real Estate Core Portfolios 22

Are Credit-Linked Notes Dangerous for Public Funds? 24

The Anemic Rotation, Strategies for Public Funds 26

Currency Wars, Boon for Sovereign Fund Asset Growth 32

CIC Focuses in on European-China Investment Strategy 34

Asset Owners Cautiously Pursue Volatility Strategies 46

Japan Successfully Extracts Natural Gas from Underwater Deposits of Flammable Ice 49

Governance & Legal

CA State Senators Propose Oil Permanent Fund to Pay for Education and Parks 12

Regulatory Risk in Infrastructure, Norway to Cut Tariffs 20

Oregon Takes Page from the Canadian Public Pension Model 45

Deals & Joint Ventures

Temasek Holdings Buys Stake in Repsol SA 40

Temasek Buys Stake in Evonik and Healthcare Global Enterprises 41

Singapore’s GIC Sells Large Stake in Global Logistic Properties 68

Singapore’s GIC SWE Invests in Greenko 72

Khazanah Seeks to Bid for Bank of Ayudha 73

Country & Geopolitics

Eastern Sovereign Funds Bullish on Asian Transformational Economies 42

United Arab Emirates and Malaysia Strengthen Energy Investment Ties 50

SOFAZ Analyzes Funding for Trans-Anatolian Pipeline 57

Nigeria Targets 5 Billion for SWFs, Catching up to Angola 69

Data

Largest Sovereign Funds 47

Sovereign Wealth Fund Deal Tables 48

First Quarter Transparency - 2013 51

Sovereign Wealth Fund Directory 58

2013 Event Schedule

April 24 - 26, 2013Institute Fund Summit 2013 Americas Ritz-Carlton, Laguna NiguelDana Point, CA, United Stateswww.ifsummit2013.com

October 29 - 31, 2013Institute Fund Summit 2013 EuropeJumeirahFrankfurt, Germanywww.ifsummiteuro.com

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he beginning of 2013 displayed rays of hope and promise for institutional investors. Massive

quantitative easing measures have positively influenced market performance in equity markets, regardless of lackluster macroeconomic fundamentals. The balance sheet of the Federal Reserve surpassed US$ 3 trillion, a milestone in world history. With all the economic headwinds, the drawn out situation in Europe with regard to market confidence appears to have improved. Investors have acclimated themselves to the new financial environment, feeling bold to start investing and spending.

Another signpost for public investors is analyzing demographics and incorporating it into an investment theme. In Japan, birth rates have fallen and the mean age of the population accelerates. Demographics shape consumer behavior and spending patterns. Will Japan be able to maintain adequate exports to feed growth? Around the world, this appears to hold true that an aging population equates to a decline in bond rates. Wealth accumulation turns to spending. With regard to real estate, public investors see property opportunities in Japan. Tokyo’s population is diverse in

terms of age dispersion, while the rest of Japan ages, making real estate opportunities in Tokyo attractive.

The Canadian model of public pension management is taking hold in America. Oregon State Treasurer Ted Wheeler is in favor of a bill that would change the Oregon Investment Council (OIC) into a public corporation, giving the US$ 80 billion public pension greater autonomy. Ted Wheeler and employees at the OIC believe the proposal would save money on management fees, increase in-house investing and clarify the structure of Oregon’s investment arm. Arthur Towers, the Service Employees International Union Local 503 political director, testified to some concerns about the structure and accountability of the proposed corporation. He said the union was taking a neutral position on Oregon Senate Bill 120.

Chasing fixed income yield, sovereign wealth funds are looking to lend money and participate more in the mortgage space. Earlier in 2013, the Government of Singapore Investment Corporation (GIC) provided capital to Laxfield Capital who launched a commercial lending program in the United Kingdom.

notes from the editorT

Sovereign Wealth

QuarterlyQuarter 1 - Year 2013

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No statement in this issue is to be considered as a recommendation to buy or sell any security or other investment. Neither this issue nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system, without prior written permission of the Sovereign Wealth Fund Institute, Inc. Please read the disclaimer at the end of the quarterly for specifics.

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The Sovereign Wealth Fund Institute is a registered trademark of the Sovereign Wealth Fund Institute.

Michael MaduellPresident, Sovereign Wealth Fund Institute

he first quarter of 2013 for sovereign wealth funds has been slower in terms of direct

investments than in recent years. The vast majority of sovereign funds haven’t been acquiring as much in assets as forecasted. On the other hand, dolling out mandates to external managers has increased in 2013. As public

investors shift from fixed income and equities to real estate and private equity, more money will be managed outside the confines of the sovereign wealth fund.

Sovereign fund and public pension plan performance in 2012 provided relief to board meetings and discussions. Financial media hushed, unless the fund underperformed their respective benchmarks. After several

barren patches, the market in 2013 appears promising. The S&P 500 reached highs unseen since 2008. Encouraging signs such as oil price growth and greater manufacturing numbers in the U.S. and China have been reflected in the equity markets. At the moment, all is calm; it will take a nasty news headline to send shockwaves to various assets classes. Indeed, asset managers

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BETTER THAN 2011Sovereign wealth funds had positive returns for 2012; many funds were above 8.5%.

6 Sovereign Wealth Quarterly | April 2013

seem to be tepidly optimistic, while public investors have low expectations for 2013. An informal survey by the Sovereign Wealth Fund Institute, reflect this sentiment. Sovereign investors have a long-term investment horizon; month to month in negative portfolio fluctuations fruit unpleasant discussions and governance stress.

Given updated economic

statistics from the developed world, the great rotation has propped itself up in headlines again. Identifiable risks are being grinded through. Experts foresee the way to sustainable equity market performance is consistent U.S. economic growth, moving past the fiscal cliff issues, and China’s ability to maintain the massive workshop. BBB- rated debt in January traded at

around 3%, A-rated debt at 1%, if public equity can give some price appreciation, plus a 4 to 5% dividend; this would increase public investor capital into equity markets. In Pensionland, this would be music to their ears. It takes quarters and quarters for the great rotation to occur in the world of public investor money.

Some allocation predictions for 2013 include greater money flows to real assets and the gradual crawl toward

public equities again.

1st Quarter SWFI

commentary

7April 2013 | Sovereign Wealth Quarterly

Sovereign funds continue to set up offices to expand their investment capabilities. Within Europe, the choice is London for most sovereign funds. The city is well-established as an international finance hub. Advantages include an unrivaled foreign exchange and gold bullion market.

Moreover, particularly in the last year, direct sovereign wealth investments in properties have increased. Sovereign wealth funds are beginning to reach out of the core to invest in real estate. Norway’s sovereign wealth fund made significant inroads in institutional real estate. They embarked on a deal with TIAA-CREF, anchoring their first real estate investment in the United

BRAZILSovereign wealth funds and public pensions are active in Brazilian commercial real estate.

States. The largest SWF invested in U.S. real estate is shaking structures to the core. In fact, large sovereign funds are emulating real estate managers in terms of buying large portfolios at some price discount. Sovereign wealth funds will have to compete against REIT dollars for trophy assets along with other real estate managers.

Absolute return portfolios continue to gain traction among public investors. An absolute return portfolio may perform better than a fixed income portfolio in a scenario of rising interest rates. Public investors desire to partner with external managers for insight into markets, risk appetites and opportunities. Absolute return strategies are geared to generate


returns with low beta and perform well in stressed scenarios. Many public investors assign various benchmarks. For example, CalPERS utilizes Treasury Bills plus a 5% target for their absolute return program. This is a generally accepted benchmark for the hedge fund industry. For public investors, designing let alone, managing an absolute return program is complicated from a governance and management viewpoint.

Denmark’s ATP has come to a realization that alpha and beta to a degree rely on exposures to systematic risk factors. Their thinking is that alpha and beta should not be separated and managed in the same portfolio. The alpha portion is being wrapped

per capita continent in the World has the potential to have the greatest number of sovereign wealth funds. Over the past two decades, African countries increased control over resource revenue like oil. Some African nations have taken the arduous task of developing sovereign wealth funds to professionally manage national resource assets. African sovereign funds most likely will be managed and invested differently than their East Asian and European global neighbors. In fact, African sovereign funds will behave more closely with some MENA sovereign funds like Mubadala, focusing on domestic development and social returns. uu

up into the beta framework. ATP alpha is being restructured which includes loss of staff. Six years ago, ATP decided to separate alpha and beta in their investment portfolio. The separation transformed ATP with the beta team being managed from the head office, while the alpha team was located at another location. The alpha team was made up of smaller risk-taking clans. The small risk-taking teams were a challenge to manage due to the challenge of scaling total risk in alpha exposure. There was over-diversification. From a financial standpoint, it was a costly endeavor. Costs have been an integral decision for managers operating in a low-yield environment.

Paradoxically, the poorest


rom a funding perspective, sovereign funds receive their initial capital through various means. Fiscal

stabilization funds often receive trickles of money flow initially, thus limiting investment options. These sovereign funds tend to have a conservative allocation, most limited to cash and fixed income investments. Sovereign wealth funds like Australia’s Future Fund or the China Investment Corporation received a substantial initial infusion of capital. Having a hefty initial allocation enables the public investor to build a larger organizational infrastructure and be able to seize on certain opportunities. Since their inception, these sovereign funds were buyers of assets and allocators of capital.

During the financial crisis, both sovereign funds had decently-sized positions in cash and fixed income instruments. As cash was spent on investments and allocated to money managers, the sovereign funds entered the phase of monitoring assets. In this ongoing phase, sovereign funds are constantly evaluating and monitoring their current portfolio. They are also engaged in decisions to acquire, keep or dispose of asset holdings. With regards to external managers, whether to hire, keep or terminate manager mandates. uu

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In general, when people think of sovereign funds what usually comes to mind is a mega pool of government capital that wants to purchase something big.

Categorizing sovereign funds is a difficult task, since many vary in size, scope, mandate, investment style and origin.

Putting Sovereign Funds in Boxes

When do you sell your best assets; are they overpriced?

Sovereigns Funds transition from

Acquirer to Monitor


LOVE REAL ESTATE Loose monetary policies

by Occidental nations have smashed interest rates.

Selling is a tough decision psychologically for many investors. Whether markets are softening or the rush to sell when the iron is hot, the ultimate decision to sell to maximize profit is a challenging endeavor.

The large sovereign funds with incoming flows have strategic advantages regarding their asset holdings, waiting for the right time to sell.

Macroeconomic pressures can be exerted on sovereign funds, thus forcing them to sell assets at distressed prices, case in point, Ireland’s NPRF.

Selling can be Tough

Bigger Enables More Choices

Local Economic Failure is Risky


On February 12, 2013, California State Senator Noreen Evans (D) introduced SB 241, a bill that will fund higher education and state parks in California. The bill would impose a severance tax on oil producers in California. The bill is co-authored by fellow State Senator Mark Leno (D) who is Chair of the California Senate Budget Committee.

Democrats hold a majority in the state senate. Currently, there is no statewide severance tax on oil and gas production in California, but there is a small statewide assessment on oil and gas produced in the state.

cA State Senators Propose oil Permanent Fund to Pay for education and Parks


dividend to the state budget to fund certain programs.

The state of California is unique in that it does not have a permanent fund like the states of Alaska, Wyoming, New Mexico, North Dakota, and Texas. California has among the highest gasoline prices in the United States; this is primarily driven by refiners’ capacity, consumer demand, taxes, and the global price of oil. The state of Alaska has a petroleum profits tax (PPT) which can range from 25% to 50% depending on net value of oil and gas. This value is derived from the point of production minus certain lease expenditures. uu

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CALI DREAMIN’Kern County is the most productive oil producing county in California.

93% of the revenue generated would fund higher education,

while the 7% would fund parks.

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Creating a tax revenue source from a non-renewable resource can be a risky proposition for state fiscal budgets. Oil tax revenues can vary year-to-year, especially with production and the price of oil being the key variables.Many countries and states have created sovereign funds or fiscal stabilization funds from preventing shocks to their fiscal budget. Another avenue for California would be to collect and invest the tax revenue for a few years. After a period of time, the fund could pay a

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he bill would enable the California Education and Resources Reinvestment Act

(CERRA) which would impose a 9.9% severance tax on the extraction of oil from the ground or water within California’s jurisdiction. To be precise, the 9.9% severance tax would apply to the gross value of each barrel of oil severed. The tax revenue, along with interest and penalties, would funnel into a proposed Oil Severance Fund. California’s Board of Equalization estimates SB 241 would generate approximately $2 billion a year in revenues.


Domestic Private equity Programs, new Mexico

Increases AllocationLocal private fund programs can be a boon for a region,

but they must behave commercially. The region must have enough opportunities to justify the allocation.

(NMSIC) has deemed that up to 5% of the US$ 3.7 billion Severance Tax Permanent Fund can go to the New Mexico Private Equity Program which started in 1993. Since inception to 2003, the New Mexico program had a return of -18.2%. In 2004, new consultants were brought on and the focus was modified more towards financial returns as a primary driver.

In 2008, during the global financial crisis, the program was sidelined. This strategic development investing program invests in private equity through

ey stakeholders at sovereign wealth funds and public funds slowly push the mandate of domestic

strategic investing to stimulate local development. This is not a new concept and usually gains traction when unemployment is high.

Two significant hurdles include proper return measurement mechanisms and the size of the state, region, or country. Socioeconomic return measurement is subjective in nature compared to measuring pure

financial returns.Within the United States,

more than 40 states have adopted domestic private equity programs. This noble concept to jumpstart regional economics many times, fails to generate positive portfolio returns.

On the other hand, these programs tend to allocate capital to bring economic vitality to certain industries. These industries also tend to be scientific in nature, like clean technology where salaries are greater compared to other job types. In turn the state, region, or country benefits with higher tax revenue at the likely expense of fund portfolio performance.

The $16.27 billion New Mexico State Investment Council

K

SDSWFStrategic Development Sovereign Wealth Fund (SDSWF) – It is a sovereign wealth fund that can be utilized to promote national economic or development goals.

There are obstacles in

implementing such a domestic private equity investment program.

“

limited partnerships to enhance the economic climate in New Mexico. Uses of the funds include startup capital, or growth capital. These investments are long term, normally 12 to 15 years. uu

New Mexico

Pop. 2012 Est. - 2,085,538

Bachelor‘s degree or higher, % persons age 25+, 2007-2011

25.4% vs. U.S. Average 28.2%

Source: U.S. Census


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terminating Public equity Asset Managers, Public

Investor PerspectivesThis is probably one of the most important decisions a

pension fund or sovereign fund official can make.

reason that comes to mind is under-performance. This is a common cause for termination.

Another popular reason for external fund manager termination is personnel change. When a sovereign wealth fund or public pension solicits external managers, a major attribute they take into consideration is the fund management team. The Abu Dhabi Investment Authority has ranking criteria on management teams. Personnel changes alert public investors for cause of worry. Asset managers need an appropriate

erminating public equity asset managers is a cumbersome act to do for sovereign wealth funds and

public pensions. It sticks to the forefront of public investors’ conscience. It is less complicated than terminating private equity relationships, but still requires significant time resources. Fund manager retention and termination decisions involve high costs. Public investors need assurances that if they proceed to terminate a fund manager, they are not doing it

prematurely. Some investment strategies require a cycle or two to see results. Timing is everything for a trader, not for a long-term oriented fund manager.

The step before termination involves a watch list step. The targeted fund manager is usually informed of the situation or current concerns held by the public investor. In reality, public pensions and sovereign wealth funds desire their external managers to succeed in managing their assets. Like picking trophy race horses at the track, senior public investment officers and investment consultants hope their picks to be successful. Several noteworthy factors in motion can affect termination of an external manager. The first obvious

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IT’S COMPLICATEDPublic investment officers are under pressure with limited resources to generate high returns.

Is the fund manager

performing below their benchmark? Are the returns positive?

“


wealth funds are ramping up internal operations in certain asset classes. On the other hand, U.S. public pensions are constricted by budgets and human resources, which limit internal staff growth. In other instances, public funds may wish to drop a strategy that is not working. For example, a clear majority of public funds are shunning venture capital as access to top-tier funds has been limited. IRRs for most venture funds have been weaker than private equity funds given the level of risk. uu

motivation system to attract talented employees. Is the asset manager firing the person? Is the individual jumping ship taking their skill with them? Is the portfolio manager moving on to a more lucrative part of the organization? If there is personnel change at a fund manager, it is imperative for public investors to make sure external managers have sufficient backup and resources to maintain positions.

There are a myriad of other reasons why fund managers get terminated, but the last reason to

bring up is structure change. In November 2012, New Mexico’s State Investment Council (SIC) went under a major change in fund managers. They shifted US$ 7 billion to new managers and terminated all of their public market external managers and consultants, except for one consultant. One major change includes a major shift into real assets, such as core real estate and master limited partnerships.

Often public funds may choose to bring certain investment activities in-house. Sovereign

THE NEEDExternal asset management is commonly found in instances where public investors have administrative budget restraints.

BENEFITSExternal management can be beneficial for public investors in numerous ways.


Hedge Funds Peak Sovereign Wealth

Fund Interest

The short-lived evolution of the hedge fund industry in the past

twenty years has been a boon to hedge fund managers. From being

a private pool of high net worth capital to becoming an asset class

suitable for institutional capital, the industry and its participants have augmented greatly in assets and

wealth.

rom an investor viewpoint, hedge funds are an expensive asset class to invest in. Despite the setback in 2008, hedge funds remain a key interest for a swath of sovereign wealth funds and public

investors. Generally speaking, sovereign wealth funds like the Abu Dhabi Investment Authority (ADIA) are long-term in nature; this is a powerful attribute for an investor in hedge funds.

2013 and BeyondThe type of sovereign wealth fund to invest in hedge funds includes one where capital preservation is not the highest priority. Sovereign funds with a propensity toward highly liquid investments will shun hedge funds. Sovereign funds that are managed by a central bank or having some thread of connection will usually not invest in hedge funds. Sovereign funds that select hedge funds choose the well-established firms, as fund returns are not the sole criteria when allocating alternative

HEFTY PRICEDiversification has its hefty price; furthermore, not many public funds can hire full-time professionals in every field.

FUND-OF-FUNDSA fund-of-funds can speedily grow exposure to hedge funds when opportunities arise.

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capital. Other critical factors include the quality of management, the infrastructure, a compelling strategy, and the investment platform. Sovereign investors seek large hedge funds. Big sovereign funds like the China Investment Corporation (CIC) need the large hedge funds to handle their giant capital allocations. Managing too many fund partnerships is costly and inefficient for some sovereign

funds. In addition, hedge fund due diligence and evaluation whether large or small takes around the same amount of work.

When they invest as a limited partner in a fund, they expect the hedge fund to possess the level of infrastructure required to properly manage a vehicle worth X billion in assets under management. For example, a US$10 billion hedge fund needs to have enough

organizational infrastructure capability to support the fund, not just line the pockets of hedge fund managers. Fund investors want to see the hedge fund reinvest in the business with investments in analysts, client service, back office, and risk management.

Sovereign funds perceive hedge fund investments as partnerships. For proper alignment, in the beginning, sovereign wealth funds will negotiate to the best of their ability on terms, but understand that in the end, one has to pay the freight to invest in certain hedge funds. uu

ALT. EXPOSUREMany sovereign investors need the capability to have exposure to an asset class quickly.

Hedge funds that follow a long-term strategy can benefit from

having sovereign funds as investors.

“


The Bank of Ayudhya being a large financial institution with high exposure to consumer finance has grown their retail

banking business.

alaysia’s Khazanah Nasional Berhad looks to purchase General Electric Co’s US$ 1.8 billion stake in

Bank of Ayudhya Public Company Limited, the fifth largest lender in Thailand. General Electric’s 25.3% stake in the bank has also attracted Mitsubishi UFJ Financial Group. Khazanah Nasional isn’t nearly active in pursuing international financial sector investments compared to Singapore’s Temasek Holdings. A noteworthy insurance purchase, Khazanah Nasional and Sun Life Financial Inc bought a 98% stake in an insurance joint venture between CIMB and Aviva Plc.

Bank of Ayudhya inorganically grew by buying credit card and consumer loan businesses from AIG, HSBC Holdings and GE

Capital. Retail loans make up the largest portion of total loans. In January 2007, GE Capital International Holding invested US$ 584 million in the Bank of Ayudhya for a 33% stake. Ever since the global financial crises, General Electric has been trying to shed non-core assets and shrink the size of GE Capital. In July 2012, GE Capital sold Business Property Lending Inc. to EverBank Financial Corporation.

Khazanah Nasional is financing these purchases by issuing exchangeable bonds. For example, in March 2012, Khazanah Nasional issued a US$ 358 million exchangeable bond linked to Parkson Retail Group Ltd. To increase Khazanah’s capital base to make more purchases, the Malaysian sovereign fund has invited financial institutions

Mto compete for proposals for an exchangeable Islamic bond. The future bond would be denominated in USD or SGD that could be exchangeable into one of four stocks. These include: Tenaga Nasional Bhd, Telekom Malaysia Bhd, Axiata Bhd or IHH Healthcare. uu

Khazanah Seeks to Bid for Bank of Ayudha

CONSUMERS +Thailand has a growing middle

class population.


DISclAIMerThese research reports and the information contained therein are for your internal use only and redistribution of this information is expressly prohibited. These reports, including the information and analysis, and any opinion or recommendation included in the reports are not intended for investment purposes and do not constitute investment advice or an offer, or an invitation to make an offer, to buy or sell any securities or any derivatives related to such securities. Nor do these reports constitute or contain legal advice. If you require legal advice, you should consult with your own counsel.

Sovereign Wealth Fund Institute does not warrant the accuracy of the reports for any particular purpose and expressly disclaims any warranties of merchantability or fitness for a particular purpose; nor does Sovereign Wealth Fund Institute guarantee the accuracy, validity, timeliness or completeness of any information or data included in these reports for any particular purpose. Sovereign Wealth Fund Institute is under no obligation to provide you with any current or corrected information. Neither Sovereign Wealth Fund Institute, nor any of its affiliates, directors, officers or employees, will be liable or have any responsibility of any kind for any loss or damage (whether direct, indirect, consequential, or any other damages of any kind even if Sovereign Wealth Fund Institute was advised of the possibility thereof) that you incur in connection with, relating to or arising out of these materials or the analysis, views, recommendations, opinions or information contained therein, or from any other cause relating to your access to, inability to access, or use of these materials, whether or not the circumstances giving rise to such cause may have been within the control of Sovereign Wealth Fund Institute.

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