(January 21, 2014) — As pension plans and sovereign wealth funds take on more active roles in the investment process, they’re increasingly looking to expand geographically closer to the financial centers of the world, according to a study.
It’s about “getting closer to the action,” wrote Qais Al-Kharusi of the State General Reserve Fund of Oman, Adam Dixon of the University of Bristol, and Ashby Monk of Stanford University in a paper. “In large part, this is an attempt to better align interests across the investment production chain and re-root finance and investment back in the real economy.”
As the more removed and “frontier” funds continuously seek to diversify risk exposures and capture alpha—largely from new asset categories—they have become motivated to open satellite offices in international financial centers (IFC) and non-financial centers (NFC), the researchers wrote.
IFCs are locations such as New York, London, Hong Kong, and Singapore. NFCs, according to the paper, include Beijing, Chennai, São Paulo, and San Francisco, among other metropolises.
“This increased involvement of these investors can be described as an attempt to reduce the agency problems that are pervasive in the functional and spatial structure of the investment management industry,” the authors said.
From these locations, investors aim to rely less on external managers and garner crucial local expertise. Lower management costs and increased investment opportunities could also entice investors to open more offices.
“The hope, then, among these beneficiary institutions is that the adoption of new models of institutional investment will result in better long-term performance,” Al-Kharusi, Dixon, and Monk said.
With an investment staff in the same location as the opportunities, investors stand to benefit from natural face-to-face interaction with on-site managers, and the trusting relationships it can foster. This, the authors found, would be especially useful in regions where “informational asymmetries” persist.
“A key factor underpinning the success of these funds’ new strategies will be the collection of data, the processing of information, and the formulation of knowledge upon which investment decisions can be based,” the study said.
Institutions have been compelled to open IFC outposts for access to deeper talent pools, improved monitoring and due diligence capacity for new managers, stronger network formation, smoother knowledge transfers, and quick facilitations of co-investment opportunities, the paper noted.
The expansion is not without challenges, according to the authors. Investors should take into account opening costs, possible culture and governance clash between the main and satellite offices, and potential loss of talent.
“The non-local offices can become a revolving door for staff; a sort of holding tank for individuals before they move back to the private sector opportunities,” the researchers said.
For a foreign fund, establishing an NFC office could improve access to local knowledge and foster closer relationships with the regional government and local power networks.
The biggest challenge in setting up a satellite in an NFC is scalability, according to the paper.
“Many NFCs in emerging markets, while growing, have a long way to go before offering the depth of market that is found in more advanced economies. The initial setup and ongoing operating costs of the satellite office need to be weighed against the scale of investment opportunities,” the authors said.
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