Asian sovereign investors are increasingly adding non-public firms to their portfolios amid pricey stock markets, a strategy that could be risky as they compete head-on for such deals with cashed-up private funds.
Such investments of China Investment Corp (CIC) and Singapore's Temasek Holdings, two of the biggest state investors in Asia, were in the spotlight this month at the investors' annual performance reviews where they warned of pressure on returns from a challenging environment for equities investing.
Temasek is increasing investments in unlisted firms, while CIC is looking to expand its U.S. direct investments.
"Today when the public markets are very expensive, we are more towards the private side," said Rohit Sipahimalani, joint head of Temasek's portfolio strategy and risk group.
The share of unlisted assets in Temasek's S$275 billion ($200.88 billion) portfolio rose to a record S$110 billion, or 40 percent for the year ended March 2017, up from 22 percent in 2011. This included an $800 million minority investment in Verily Life Sciences, a spin-off from Google's Alphabet.
CIC agreed to buy Logicor, Blackstone's European logistics business for 12.25 billion euros, outbidding an Asian private group and a state investor in the region's biggest private equity real estate deal, sources said.
Globally, sovereign wealth funds (SWFs) are trying to make their assets work harder as returns are under pressure. Singapore sovereign wealth fund GIC said it is prepared for a period of protracted uncertainty and low returns.
As funds fight for negotiated deals, risks are rising in a crowded market place, analysts said.
"Sovereign wealth funds tend to have long time horizons and no explicit liabilities, which makes them the ideal investor for illiquid instruments. So yes, I do believe that they will be turning more to private deals," said Veljko Fotak, assistant professor of international finance, University at Buffalo.
"I think SWFs will enjoy pretending to be venture capitalists, and will get burned for it, because too much capital is already playing in a field that is simply too small."
Asia-focused private equity firms, which have also stepped up investments in non-public companies, have raised huge funds, adding to $136 billion in so-called "dry powder" as of last year. But they are not the only competitors to sovereign investors.
"It's not just the dry powder that PE firms have, it's the dry powder that sovereign wealth funds have, pension funds have, family offices have. It's definitely a challenge to get returns with that sort of competition," said Dilhan Pillay Sandrasegara, joint head of Temasek's investment group.
Negotiated deals offer Temasek an opportunity to build its portfolio away from the heat of competition.
"We almost never win in an auction. We are very bad at auctions," said Sipahimalani, referring to Temasek's investments in U.S. and European firms in the latest year.
Amid the growing competition for deals, co-operation may be the way forward, some analysts said.
Last year, GIC said it would become a minority owner of U.S. tech firm Neustar Inc (NSR.N) after the company said it would be acquired by a private equity-led group.
State funds are co-investing with private equity funds and family offices, said Javier Capapé, director at the Sovereign Wealth Lab research center at the IE Business School in Madrid.
A partnership with private-sector entities signals a commitment to shareholder value over political priorities, said Fotak, who is also a senior researcher at the Sovereign Investment Lab of Italy's Bocconi University.
"Of course, there is an element of if you can't beat them, join them."
