Financial institutions weigh up business opportunities

"We would like to see Korea National Pension Service making the most efficient use of its assets" David Blumer, Credit Suisse

The challenge is that, as many of these funds are new and as more crop up, it will take time to understand what their investment strategies are.

"Many of these funds haven’t quite decided how they will be set up; they are still figuring out their mandates," says Joyce Chang, head of emerging markets research at JPMorgan. "Some are still developing their investment mandates, which need to be clarified before Wall Street can fully engage them as clients."

Most financial institutions’ coverage of sovereign funds is an extension of their coverage of other official institutions, such as central banks. However, this is not necessarily the best strategy as sovereign wealth funds and central banks are very different animals. "In general, investment banks are trying to understand how they can better help these institutions," says Alex Patelis, an economist at Merrill Lynch, "but they have yet to fully figure it out because sovereign wealth funds are fundamentally different to central banks."

One difference is that central banks are not profitable clients and, according to one source, that is why most financial institutions have not been very successful in their coverage of them. "For political, economic and practical reasons financial institutions need to have a relationship with central banks but they are not very profitable. They usually have a dialogue at trader and chief executive levels but not much in between. They don’t have a web of relationships throughout the institution."

Products are pushed that are often irrelevant; the whole process is labour-intensive. Sovereign wealth funds, in contrast, are much more interesting clients and, more important, are engaged in higher-margin trades. But the model that many of the financial institutions have is for the old world. Given that sovereign wealth funds are unique clients distinct from central banks, some firms are debating internally whether to create a separate department to cover them.

Others are creating specific positions with their organizations or hiring specialists. In March, HSBC Investments, for example, appointed Cynthia Sweeney Barnes to the newly created position of global head of sovereigns and supranationals. More recently, in August, Morgan Stanley Investment Management (MSIM) announced the appointment of Dino Kos as managing director and head of central banks and sovereign wealth funds. Kos says his role is to help improve the firm’s coverage of these increasingly important clients. "It’s about engaging with the clients to understand their needs and then providing tailored investment solutions," he says.

That service includes managing funds on behalf of sovereign funds, many of which outsource mandates if they do not have the expertise internally. For example, between 70% and 80% of Abu Dhabi Investment Authority’s assets are managed outside. For Norway’s Government Pension Fund – Global the figure is much less at about 28%, through 50 third-party bond and equity asset managers. "One of the reasons why sovereign funds are important to us is because it’s new business, it’s new money," says Deborah Hazell, a managing director and head of international business at Fischer, Francis, Trees & Watts in New York. She makes the contrast with the US pension funds market, which is very mature. The sovereign fund market is still in its infancy in comparison.

Track record is the most important criterion sovereign funds consider when choosing external fund managers but often other issues are taken into account. "Many sovereign wealth funds look for knowledge transfer. Technical assistance is an important part of the offering," says Richard Kushel, a managing director at Blackrock in New York. "For most funds it means educating their staff on investment management and risk management techniques. It can also include working with local financial institutions to help develop the financial sector."

As the competition for sovereign fund mandates gets more intense, asset managers need to find other ways of servicing these clients’ needs. This goes back to Kos’s statement on delivering solutions. For example in July, MSIM, together with the asset management arm of Credit Suisse, won a mandate to help Korea National Pension Service diversify its $200 billion plus portfolio internationally. "At the time, a large part of the fund’s portfolio was invested in domestic bonds and equities," says David Blumer, chief executive of the asset management business at Credit Suisse. "We would like to see the fund making the most efficient use of its assets."

Credit Suisse and MSIM are providing a number of different services in helping the fund to increase its international exposure. "We are helping the fund with its asset allocation; in diversifying its portfolio; in managing some sub-portfolios; in its risk management; in its reporting and technology capabilities; and in educating its employees," says Blumer.

"For global asset managers," he adds, "it’s important that you deliver investment performance and solutions."