Despite the key differences between sovereign wealth funds and public pension plans, the two institutional investors are quite similar in that they’re large, state-owned, sophisticated pools of capital.
However, on average, the two types of organizations approach their real estate investments differently, according to a new paper by McKay Price, Collins-Goodman chair in real estate finance at Lehigh University; Nathan Mauck, associate professor of finance at the University of Missouri; and Peng Liu, Singapore Tourism Board distinguished professor in Asian hospitality management at Cornell University.
“People are familiar with public pension funds,” Price says. “There’s been a lot of work on public pension funds, they’re visible and prominent.”
However, this isn’t the case for sovereign wealth funds. “We wanted to understand them better. And, in that context, they share a common characteristic — both sovereign wealth funds and public pension funds are essentially government-owned or controlled entities. That makes them both unique relative to other large institutional investors.”
The paper found sovereign wealth funds have a lower best practice score than public pensions when considering fund structure, governance, transparency, accountability and behaviour.
“One of the biggest drivers is the fact that sovereign wealth funds, on average, tend to be pretty opaque in their dealings,” Mauck says. “There’s a lot more secrecy about their process and their holdings relative to pension funds, where the average there is a lot more transparency, a lot more openness about their investment process and their specific holdings.”
The increased transparency may be explained by the fact that pension funds have large pools of pensioners to report to, whereas sovereign wealth funds just report to the government that owns them. “By nature, public pension funds are going to be more open than the sovereign wealth [funds],” says Price, though he notes each of these buckets have exceptions.
The paper also found that while both types of funds are increasing their levels of cross-border real estate investments, sovereign wealth funds are significantly more likely to invest across international borders. Further, compared to pension funds, they’re more willing to invest in a broader range of countries, including those with lower transparency around real estate.
This result was expected, since some sovereign wealth funds were created specifically to diversify exposure for the home country, Price says. “Take an oil rich nation that wants to hedge . . . against maybe not having oil revenues indefinitely. They’re taking some of the money they have now and they’re investing it in other ways. And so, if you’re trying to diversify, then I start to think about going somewhere else — that naturally leads to investing abroad, I think, in many cases.”
The results are consistent with other research showing sovereign wealth funds have also had a high amount of cross-border deals in public and private equity, Mauck says, although, in real estate, these deals were more prevalent compared to the other asset classes.
“We found about 92 per cent of the sovereign wealth fund real estate deals were across borders,” he adds. “That compares to . . . around [a] 70 per cent proportion of cross-border deals for public and private equity. So it’s definitely an effort to diversify out of the country that the sovereign wealth fund is located in, and it seems to be that that effort is even stronger in real estate.”
Unfortunately, despite understanding the differences between the two types of institutional investors, there isn’t data on which type of funds produce better real estate returns. “If we had that data we would be writing that paper right now,” Price says.