Korea And Russia's Sovereign Wealth Funds To Build Private Equity Together

Forbes.com, 14.11.2013

Three days ago, I reported that while Yale and Harvard appeared to be cooling on private equity, sovereign wealth funds in the emerging world were deploying more and more assets into this area.

Yesterday, the trend was illustrated in an announcement by the Korea Investment Corporation that it will build a new platform for cross-border private equity investment with its counterpart in Russia, the Russian Direct Investment Fund. Each sovereign fund will put in $250 million to start with, and the fund is envisaged to rise to $1 billion at some unspecified stage.

It appears that the fund will focus on private equity investments in Russia more than Korea, and in this respect, it tells us something interesting about the Korean sovereign fund’s evolution, which in turn is broadly representative of a lot of other sovereign wealth funds in Asia and the Middle East.

For an in-depth look at the KIC ’s background, read this article I wrote for Euromoney magazine in 2011 following a detailed interview with then CIO Scott Kalb. But the potted version is this: the KIC is one of the newer major sovereign wealth funds in the world, founded in July 2005, and only really investing since November 2006. Like many new sovereign funds it started out with the simple stuff, putting as much as 70% of its assets into fixed income, and then gradually spread into equity and, from June 2009, alternatives. Also like many new sovereign funds, it started by outsourcing almost everything, then gradually built expertise in-house and steadily started bringing the more mainstream asset classes – again, principally fixed income – in-house.

One of the more interesting parts of this evolution has been a growing role for private equity. When Kalb became CIO, he was an eye-catching appointment, firstly because he was not Korean (although he had worked in Korean institutions, married locally and spoke the language), and secondly because he was from a hedge fund background: he had been principal and CEO of Black Arrow Capital Management and a senior equity portfolio manager at Tudor Investment. From the outset, Kalb spoke of the opportunities in alternative assets, and in my 2011 interview with him spoke of 20% of the portfolio as a natural target. Alternatives have steadily grown in the portfolio since, from nothing in 2008 to 1.7% in 2009, 4% in 2010, 5.5% in 2011 and 6.1% in 2012, on top of a ‘special investments’ division with some alternative characteristics which accounts for a further 3.2% of the fund. Along the way, Kalb ’s term came to an end, and he was replaced by a Korean, Dong-ik Lee – whose background is in private equity.

Along the way, the fund has also taken strides towards direct or private equity investment – and not just in the west, but in emerging peers (if one considers Korea emerging; many think it fully emerged). In September 2012 the fund launched direct investment into mainland China, and this new deal with Russia should be seen in the same context.

As for the RDIF, that is a trickier institution to understand, lacking the KIC’s transparency. It was created in 2011, apparently with about $10 billion in assets, and it, too, has built similar deals with the China Investment Corporation prior to the Korea deal. An example of the sort of transaction the Russia-China platform has conducted is a co-investment, in two tranches so far, in Russian Forest Products. Forestry and infrastructure deals are also likely to appear in the new Russia-Korea platform; Asian Investor magazine reports today 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. Russia has also inked deals in the last 12 months with the Japan Bank for International Cooperation and Abu Dhabi’s department of finance.

In making investments like these, the KIC is taking a risk: tying up capital in illiquid investments in markets not known for great governance. But then again, given the time horizons sovereign funds work to, if they can’t make investments like these, then who can?