SWFs Going Single

"The perfect bureaucrat everywhere is the man who manages to make no decisions and escape all responsibility."

Brooks Atkinson (1894 - 1984)

The future of sovereign wealth funds (SWFs) in the single hedge fund business model looks bright. Reports from Bloomberg that Temasek Holdings, the Singapore-based investment house is about to launch a fund of its own should come as no surprise. Combined assets of the 60 or so global SWFs topped $3.8 trillion in 2008 with an additional $5.5 trillion in pension reserve funds, development funds and state-owned corporations.

Before we consider this as new money entering the business (as presumably they are in the best position to seed these new ventures) a better assumption may be that they are simply reducing their allocations to HFoFs. The reason for this may be related to: the bad performance of a vast majority of HFoF vehicles in 2008 (down at least 20%); gating and fee issues; and, the fact that many of these operations have now recruited a vast number of skilled individuals (mainly from multi-strategy single managers) and are now in a position to replicate those models on their own dime (or euro)! This cannot be underestimated.

Going single makes cents. It drives out the HFoF middle-man, it captures more of the hedge fund value-chain, and it could also lead to additional fees generated as some of these SWFs extend their models into the distribution of financial instruments.

The Asian opportunities are vast. With considerable financial muscle behind them it is conceivable that many of these SWFs will get access to illiquid or distressed, or even private equity-type of deal flow in the equity markets. Of course, to make this really scalable it requires that there be a massive upgrading in the exchanges and the hedging instruments offered not only in equities but also in fixed income as well as in derivatives. If not, this money will inevitably chase the limited number of deals in the developed world which though liquid, tend to offer a lower return on investment. In this instance, do not be surprised if these SWFs step up their activity in the ETF markets using leverage.

An interesting development will be how the international monetary authorities react to monitor the activities of SWFs across various markets such as recently via big positions in oil ETFs on NYMEX or in grain markets.

It may not be too long before the biggest and most aggressive multi-strategy funds in the world are those run by SWFs, and not traditional players like Citadel, D.E. Shaw, Soros or many others. The key will be to find a set of scalable investment strategies, which is no mean feat! Mahalo.