Partnering emerging market SWFs has always carried risks

High-profile scandals like that engulfing Malaysia’s 1MDB have turned the spotlight on the risks of investing with state-backed funds from emerging economies.

The latest development in the multi-billion-dollar scandal involving the Malaysian state fund 1MDB took place last week when a court ruled that Najib Razak, the country’s former prime minister, will stand trial on corruption charges next February. Razak was charged for his alleged involvement in one of Malaysia’s biggest ever financial scandals – charges he denies.

The 1MDB probe, which envelops multiple countries, has caused repercussions, domestically and internationally. Those repercussions are in the same bucket as the Paradise and Panama Papers data leaks.

One has been a heightened perception of risk in transacting with some emerging market sovereign wealth funds. Indeed, PERE’s conversations with industry executives this week suggest an enhanced degree of reputational and execution risk is nowadays associated with capital backed by countries that find themselves making headlines for the wrong reasons.

In one anecdote, PERE was told how a Middle Eastern sovereign wealth fund’s equity was rejected by a real estate fund manager because some of the SWF’s directors’ names were mentioned in the Panama Papers. It was a rare instance of a marquee investor being turned away.

In another, a US manager selling business park assets did not consider a particular Malaysian institution’s offer because of the potential execution risk arising from the political climate in Malaysia.

It demonstrated how private real estate is alive to the knock-on effects of the 1MDB probe into other Malaysian institutions, especially in the aftermath of May’s election upset when Mahathir Mohamad defeated incumbent Razak. The fallout saw all the board directors at Khazanah Nasional, Malaysia’s $39 billion state investment arm, resign, reportedly in response to Mahathir’s criticism about how government-linked companies were overpaying top executives. That will have impacted any ongoing transactions.

As some emerging market-focused managers remind PERE, doing business with government-linked entities in some of these markets has always carried risks. It is commonplace for international firms investing in long-term projects in, say, the mining, oil and gas, and infrastructure sectors, to engage in greater due-diligence work pre-investment. Sometimes they even demand a higher risk premium for doing business with emerging economy state entities on macroeconomic grounds. There is no reason the same should not happen in real estate.

In reality, there are limits to the scrutiny a manager can place on a state investor. Besides the fact many state funds insist on a high degree of discretion on the grounds of national security, most due diligence work will be based on past performance.

In any event, as with any transactional work, counterparty due diligence should be informed by their particular circumstances. Simply trusting a state entity is ‘good for it’ can never be the answer, whether they be bellwether sovereign investors or state entities just starting out. The latest events relating to 1MDB are an uncomfortable reminder of that.

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