Wharton@Work

January 2017 | Finance

How Sovereign Wealth Funds Can Make the Most of Private Equity

Sovereign wealth fund managers must be increasingly adept when adjusting the investments in their portfolio, and particularly when considering investing in private equity. Making the right choices requires skill in analyzing whether their returns will beat the realized return (after fees) offered by venture capital and private equity (PE) firms, and whether to take a more direct role in their investments.

Their main strategies are:

1. Direct investments, effectively competing with private equity funds
2. Co-investments, in which the sovereign wealth fund (SWF) invests alongside a private equity partner; this offers enormous potential as an SWF does not pay the high fees generally assessed the limited partner, and the private equity firms — or general partner (GP) — have deep resources to pursue larger assets
3. More passive and traditional investment as a limited partner
4. Investment in the secondary market

The first two paths require skills to evaluate the investment opportunities; a sovereign wealth fund manager must learn how to think like a GP. But both allow more control over the timing of actual investments. They also allow the sovereign wealth funds to have more flexibility in their portfolio construction. And most importantly, there are significant savings on management and performance fees.

The third, more passive path involves selecting the right GP and skilled portfolio construction. The fourth option, the secondary market, is similar but has some advantages as well as some pitfalls one has to avoid. The secondary market usually puts the money at work right away, instead of waiting for the capital call. Additionally, it allows more flexibility in portfolio selection. Because the secondary market is full of inefficiencies, a skilled investor can find opportunities.

Through the Wharton School’s new four-day Executive Education program for industry professionals, Private Equity: Investing and Creating Value, fund managers will acquire the skills to evaluate these investments with a greater level of knowledge and learn the best practices used by leading GPs when they source deals. Fund professionals will also learn about the secondary market for private equity deals.

This is a highly technical program to address these issues. “Sovereign wealth fund managers will receive training on due diligence, how to structure a PE deal, and how to think like PE firms,” says Wharton finance professor Bilge Yilmaz. “This will give them an advantage when partnering or even competing with PE firms. We hope that SWFs will see this program as a smart investment.”

“This is a unique opportunity to make an investment in your skills,” notes Yilmaz. “You will tap into the expertise of some of the top senior partners in leading investment organizations, who will not only share the latest trends, but also evaluate deals that participants put together. You will learn how they add and create value, and how the private equity business model varies due to regulations and market forces in different countries and regions. SWF managers in particular, as they increasingly move toward direct investments, need this kind of knowledge now.”