Morgan Stanley has a new report (PDF) out that argues SWFs are likely to outsource around 20% of their assets to external managers in the near future. They estimate that SWFs may grow by $1 trillion annually over the next 5 years, meaning that about $200 billion per year may be placed with outside investors. Also, in the next 2 years recently established SWFs in Russia, Chile, and China will likely contribute $700 billion to the existing $2.88 trillion stock of SWF money, adding another $150 billion to the amount that will be farmed out.
The 20% figure is derived using assumptions, which are based on the behavior of Norway’s SWF, the Government Pension Fund (GPF) and Canada’s Caisse de depot et Placement du Québec (CDQ), a sovereign pension fund. The investment portfolios of these sovereign investors are disclosed to the public.
The arguments Morgan Stanley makes are somewhat self-serving (benefits of outsourcing alpha, management costs, supposed SWF lack of staff and sophistication), which isn’t surprising.
There are a myriad of reasons why Morgan Stanley’s analysis doesn’t tell us very much:
- The methodology of using the Norwegian and Canadian sovereign funds as proxies upon which generalizations and assumptions about SWF behavior can be made is deeply flawed. The current levels of SWF deal volume and deal dollar value are unprecedented in SWF history. I don’t think past SWF behavior predicts much at all about current or future SWF behavior.
- The sophistication of funds such as the Abu Dhabi Investment Authority, the many Dubai SWFs, and the up and coming Chinese SWF rivals that of any Wall Street firm or the largest hedge funds. In fact, the largest SWFs recruit a good portion of their talent from private asset managers.
- It’s cheaper, easier, and more profitable for SWFs to buy outright stakes in asset managers rather than investing in their actual funds.
- The use of the Canadian CDQ fund doesn’t make much sense given that it’s a pension fund and doesn’t exactly have the same investor profile (investment objectives, time horizon, risk tolerance, accountability) as a traditional sovereign wealth fund.
For some of the smaller and newer players in the SWF arena (Brazil, Libya, Chile) it may make sense to outsource most of their investments. Even if these funds outsource all of their investments, you don’t get anywhere near the over $200 billion (for the next 5 years) total annual figure that Morgan Stanley predicts will be farmed out.
Deriving the 20% figure on such flimsy data (essentially the past behavior of Norway’s GDF) makes Morgan Stanley’s “estimate” seem like a guess more than anything.
