Russia-Korea SWF tie up: win-win?

Financial Times (blog), 14.11.2013

Wednesday’s announcement that Russia and South Korea would work together on an economic project in North Korea slightly overshadowed another significant announcement linked to Putin’s Seoul visit: a new cross-border investment fund between Korea Investment Corporation and its Russian sovereign wealth fund counterpart, the Russian Direct Investment Corporation.

The fund will start out at $500m, with commitments of $250m apiece, but is expected to reach $1bn in time. It also gives an illustration of how the two sovereign wealth funds are evolving.

Both are young institutions. The Korea Investment Corporation was founded in July 2005 and began investing in November 2006. The RDIF is newer still, founded in 2011.

However, they have rather different mandates. Most of the world’s sovereign wealth funds were formed as a method of diversifying wealth from a hydrocarbon bounty: the Kuwait Investment Corporation, Abu Dhabi Investment Authority and Norway’s sovereign fund, now called the Government Pension Fund Global, all started out with this imperative. The idea is to build a portfolio to provide for the country’s needs once the oil runs out.

Other sovereign funds exist either to diversify foreign exchange reserves, or for some nebulous and often ill-defined sense of the national future good: a rainy day fund, you might say. The Government Investment Corporation of Singapore is a long-standing example, as well as the China Investment Corporation. The KIC fits into this second camp: it is funded by two sources, the finance ministry and central bank (an arrangement that creates its own complications), and its investments are mostly international, and funded out of the country’s reserves.

Russia’s fund is different again, since it is mandated chiefly to make equity investments within the Russian Federation, and with no need for international diversification. The RDIF model is to secure co-investment to at least match its commitment into any new investment, so securing international direct funding into the Russian economy.

So where does the new deal fit with those priorities?

In Korea’s case, direct investment into Russia – if one sees it as private equity, which it almost certainly will be – fulfills a long-standing ambition to boost alternative investments by the fund. Successive chief investment officers at the KIC have sought to do this. Scott Kalb, the previous CIO, came from a hedge fund background, and spoke of having as much as 20 per cent of the KIC’s portfolio in alternatives (when last disclosed in the 2012 annual report, the figure stood at 6.6 per cent, although a separate category, called special investments, accounts for a further 3.2 per cent and might be considered alternative). When Kalb’s term ran out, he was replaced by Dong-ik Lee, whose background is in private equity.

The tie-up with Russia is reminiscent of a deal the KIC struck in September 2012 to commence direct investment into mainland China. That, in turn, looks similar to a deal that RDIF also struck with China, through the China Investment Corporation, and which has so far yielded one significant co-investment, into Russian Forest Products. RDIF has inked similar deals with Japan and Abu Dhabi.

That Russian Forest Products deal is worth noting, because it is likely that Korea-Russia deals may well be similar, with a focus on forestry and infrastructure. Asian Investor magazine reported on Thursday that investments are likely to focus on the flooded areas around Vladivostok in the Russia’s east, closest to Korea, and on regeneration of infrastructure in the affected areas.

It is easy to see why the Russia-Korea tie-up has appealed to both sides. Russia gets more direct investment from a stable near-neighbour with significant reserves; South Korea gets diversification of assets into potentially high-growth fields, and can wait patiently for results, since it is a sovereign wealth fund without defined liabilities.

On the down side, of course, they have the considerable uncertainty of putting funds into illiquid assets in an emerging country with governance issues. But perhaps that’s when investing as a sovereign wealth fund rather than a mainstream private investor has its uses: nobody wants to burn a major trading partner with a dud investment, and besides, co-investment aligns interests. Expect to see more of these tie-ups being announced.