$5 trillion industry - and growing.

Summary: The landscape of Sovereign Wealth Funds (SWFs) in the Global Private Equity (PE) space is evolving. Vikas Papriwal, a partner at KPMG and Head of SWFs and PE, explainsC*.

This year will mark the first time that Global SWFs increase their 'assets under management' to over $5 trillion, according to the SWF Institute. While SWFs were not immune to the impact of the global financial crisis, these funds appear to be emerging more robust and more active than before.

This is particularly relevant for the MENA region which is home to three of the top six global SWFs, by assets under management (see chart). Therefore, SWFs have and will continue to play a key role in the region's investment landscape.

Historically, the relationship between PE and SWFs has been complementary with SWFs in many cases investing into PE firms as Limited Partners (LPs) and assuming the role of a passive investor. While the relationship between PE and SWFs continues to grow, the nature of the relationship has changed. Whether in response to the global financial crisis or as simply a sign of evolution, SWFs are becoming increasingly willing and equipped to either invest directly or co-invest alongside PE funds.

Following a number of years of restrained investment activity, SWFs in the MENA region have started to invest in their own PE capabilities. Large SWFs in the region have adopted a strategy of increasing their internal PE headcount and have recruited key individuals from around the world to drive this new investment strategy. As a result, SWFs increasingly feel as though they now possess the capabilities and expertise to achieve positive returns.

The most fundamental development in the relationship between SWFs and PE is that SWFs are often no longer willing to assume the role of the silent provider of capital. In many cases where PE and SWFs do form a partnership (whether a Limited/General partner relationship or as co-investors), SWFs are seeking more visibility and control over where and into which assets their funds are invested.

Therefore in order to continue to benefit from sovereign wealth, and in particular given the current liquidity constraints and difficulty in raising capital, the challenge for the PE industry is to embrace the new role sought by SWFs. The question is then, what are SWFs looking for in a successful partnership?

It has become increasingly clear that in situations where SWFs invest alongside fund managers, they need to have complete confidence in the ability of fund managers to produce results (both financial and structural). SWFs have therefore become more selective in deciding who their investment partners are.

Through our involvement with SWFs we have noted three common principles upon which SWFs tend to focus when deciding which PE firm to invest in (in circumstances where they invest as a Limited Partner) or alongside (as co-investors):

1. SWFs are giving increased consideration to a fund manager's ability to demonstrate a proven track record of success over an extended period of time. This is not only limited to financial returns but also to a fund manager's ability to demonstrate good portfolio management. This in turn would add to returns especially given the change in the PE model post the global financial crisis.

2. Where SWFs are investing directly into a PE fund as a Limited Partner, it is apparent that they require more certainty and control over the investment strategy of these funds. In many cases this means certainty in relation to geographic and sector focus. PE funds with a focused approach may be preferred to those which have a wide investment mandate.

3. Finally, SWFs are now more than ever, focusing on maximising their returns. As previously mentioned, SWFs are increasingly viewing direct investment as a preferred means of doing so. In order to attract SWF investment, PE firms must look to be more competitive with the returns achievable through direct investment. Therefore, fund managers may need to revisit the traditional fee structure or at least demonstrate willingness to be flexible in this area.

As the global economy continues its recovery, one cannot deny that the investment landscape has permanently changed and the relationship betweenPE and SWFs is no exception. While SWFs are increasing their PE capabilities internally, the relationship between the two investing groups continues to evolve. It is evident that SWFs are becoming increasingly selective of whom they partner with and require more control over where and into what assets their funds are invested. In order to gain access to SWF funding, fund managers must appreciate and embrace how the role of SWFs has changed in recent years. nBME

TOP 10 SOVEREIGN WEALTH FUNDS (As of May 2012)

Abu Dhabi Investment Authority $627 bn

Government Pension Fund (Norway) $611 bn

China SAFE Investment Company $567.9 bn (est)

Saudi Arabia's SAMA Foreign Holdings $532.8 bn

China Investment Corporation $ 439.6 bn

Kuwait Investment Authority $293.3 bn

Hong Kong Monetary Authority Investment Portfolio $296 bn

Government of Singapore Investment Corporation $247.5 bn

Singapore Temasek Holdings $157.2 bn

National Welfare Fund (Russia) $149.7 bn (est)

Vikas Papriwal

Partner and Head of Sovereign Wealth Funds and Private Equity, UAE and Oman

KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 152 countries and have 145,000 people working in member firms around the world. KPMG in the UAE was established in 1974 and has grown to more than 750 professional staff led by 31 Partners, across six offices.

2012 CPI Financial. All rights reserved.

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