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Sovereign remedies and institutional interest?

Middle East sovereign wealth funds are raising their investments in unlisted companies and increasingly bypassing private equity funds as they do so. A recent report by asset management group Invesco differentiates, without naming names, between investment SWFs and development SWFs, noting that the latter 'must balance investment returns with development criteria such as employment, contribution to GDP, skills and intellectual property'.

Invesco's analysis suggests that investment SWFs in the region are now allocating 13 per cent of their new investment to private equity, up from five per cent in 2011.

Meanwhile, the need to deliver against development requirements has seen and is seeing development SWFs adopt the private equity model. Invesco notes, "This theory is supported by feedback from development SWFs in our study, suggesting a third of new assets, on an unweighted basis, were allocated to private equity in the last 12 months."

In the first instance, SWFs look to participate in existing private equity funds. However, models now being used include co-investment alongside private equity funds and direct investment as a standalone private equity operation. For a sovereign wealth fund to succeed either as a co-investor or through its own direct private equity operation requires a significant investment in capability.

But I am not here to discuss the issues facing SWFs moving down this path.

I am far more interested in raising the question of how the entry of such players into the private equity arena in a big way may be reshaping the market-place.

Invesco notes that one outcome of the shift to new models is increasing pressure on the economics of private equity houses. "In the past private equity firms were able to offer co-investment as an additional benefit on top of investments in the fund, but increasingly co-investors are seen as critical to deal-making and many SWFs are now able to co-invest without investing in standard funds."

This leaves me asking: does this development make it any easier for a firm seeking private equity participation to get it and what does it mean for the costs of doing so?

What's more, it is not just the region's SWFs climbing on the private equity bandwagon, large insititutional investors are also switching towards alternative investments such as private equity, according to Natixis Global Asset Management.

More than two-thirds of Middle East institutional investors told NGAM they expected to increase allocations to alternatives and other assets not correlated with the main global market trends during the rest of 2013. Jamal Sb, managing director and regional head at NGAM, said, "The study shows an acknowledgement by institutional investors that the old rules of investing no longer apply and confirms the need for new investment strategies to address the unique challenges of modern markets."

While the commercial banks appear more and more serious about funding the SME sector there is still a 'gap' between what is available for medium-sized firms and their larger brethren able to access the established capital markets.

It would be encouraging to think that an increasing focus by investors, whether sovereign or institutional, on the private equity sector would lead to improved funding for growing businesses.

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Date:Jul 21, 2013
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