This content is from: Portfolio

A Sovereign Wealth Fund and an Asset Manager Open a Region

Alaska Permanent Fund has partnered with McKinley Capital to create new vehicle to invest across the Middle East, Africa, and South Asia.

When Russell Read, now the chief investment officer of the Alaska Permanent Fund Corp., was getting his PhD in political economy at Stanford University, a professor told him that he would have three or four big ideas in his career and each would take about 10 years to complete. It wasn’t until Read was well into his career that he thought back to his professor’s words. It took him about 10 years to develop the first funds to securitize commodities risk in the 1990s and get the concept broadly accepted. It took him a decade overseeing the Korea Fund before South Korea opened for the first time to foreign investment.

Now the CIO of the State of Alaska’s sovereign wealth fund is on to his next big idea: Doing for the Middle East, Africa, and South Asia what his investment team at Scudder did for the Korean capital markets, helping to propel the country from an emerging market to a developed one. Read wants to help open the vast region to more foreign investment through a new fund that Alaska Permanent has created with McKinley Capital Management, a quantitative growth manager based in Anchorage. “We wanted the best features of the Korea Fund, namely providing sticky and friendly capital to their capital markets,” says Read. Of course, Reed also wants the Permanent Fund to profit from being an early provider of capital to these countries and prompt other investors to follow.

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Over the last several years, Read has been working on a design to capture the growth of the region through publicly traded stocks, tackling challenges including nascent regional exchanges, thin and illiquid trading, a lack of infrastructure such as custody banks, and countries that may fear foreign investors and their hot money.

Unlike other sovereign wealth funds, Alaska had no interest in doing the investing itself; it wanted to develop the fund in partnership with an asset manager. Reed talked to several managers in the Middle East and the U.S. about the project, before choosing McKinley. “We had the opposite of a dog-and-pony show. We had the idea and then found the manager which would be most suitable,” he says. Read emphasizes that Alaska, with a small staff of 25 investment people, will get its edge through alliances like the one with McKinley as well as a similar existing private equity partnership. It will never have the in-house capabilities of an organization like the Canadian Pension Plan Investment Board, with its staff of almost 1,500. “This is how we’re going to be great,” he says. 

After a year of development with Read and his team, McKinley launched the MEASA Stock Fund last week with money from Alaska and two other institutions. Among other benefits, it’s one of the first funds to get approval to invest in Saudi Arabia. The institutional fund also shares revenue with Alaska. The fund has already invested $100 million in about 500 companies. 

Robert Gillam, president and CEO of McKinley, which has long managed money for the Permanent Fund, says the quant firm viewed the new fund’s creation as an engineering project. If it could solve the liquidity and data access problem, it could effectively invest in a region he views as the next BRIC — Brazil, Russia, India, and China — which became the darling of foreign investors in the early 2000s. Gillam says the MEASA markets offer investors characteristics not found elsewhere. “The companies in the region are very different from those in other emerging markets. These are levered to local economies and geographies and provide a little bit of nirvana in low correlation.”

Read is also taking some of his ideas from his work on the Korea Fund while at Scudder, including structuring it as a closed-end fund to address concerns about foreign investors flitting in and out of the market and distorting prices. With a closed-end fund, investors can’t withdraw their money; they have to sell their shares on an exchange to a willing buyer. As a result, the underlying investments aren’t affected by the change in ownership. Alaska and McKinley hope to eventually list the MEASA product as a closed-end fund, offering the strategy to a broader universe of investors, including private clients. The partners also are planning to put an arbitrage mechanism in place for institutional investors, preventing the fund from trading at a discount, which was one of the Korea Fund’s flaws. Read thinks the fund could grow to between $5 billion and $10 billion, a size that would make it the largest foreign investors in five to 10 countries. At that point, finance ministers will have incentives to modernize their capital markets to qualify for the long-term capital that the fund can offer. 

The MEASA region has compelling statistics. It has 44 percent of the world’s population, 12 percent of the world’s GDP, and is growing three times faster than developed economies in the Organization for Economic Cooperation and Development (OECD), yet represents 6 percent of the world’s market capitalization. The region only accounts for 2 percent of world stock market indexes. That last fact is particularly appealing to Alaska Permanent and McKinley. If the fund can ignite growth and attract more investors to the region, index providers may ultimately add these countries to their benchmarks, which guide managers around the world, and more money would follow and drive up prices.

The region is predicted to be home to 56 percent of the world’s population by 2050. “As long as you have growth, that’s the linchpin,” Read says, adding that growth will require robust capital markets. The MEASA fund, like the Korea Fund before it, is designed to build them. 

Read started thinking about the investment opportunities in the region when he was CIO and of the Gulf Investment Corporation in Kuwait. GIC, a regional development investor, is owned by Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain, and Oman. “It’s then that I appreciated my professor’s old story,” he says. 

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