Catalysing growth in emerging markets through sovereign co-investments

By managing local market complexities and sharing investment risks, sovereign funds can help to attract global institutional investors to emerging markets, writes Arief Budiman, deputy chief executive officer, Indonesia Investment Authority.

Many emerging economies have realised the need to access global capital to sustain and accelerate their economic growth. While bilateral and multilateral support – both through government-to-government relationships or through multilateral development institutions – can help, sustained capital is needed particularly from the private sector.

Institutional investors – pension funds, insurance companies and sovereign funds – form a significant portion of investment capacity globally. It is estimated that global institutional assets could surpass $120tn by 2027. Historically, much of this capital, especially when invested indirectly, is focused on developed markets (Figure 1) – a consistent trend across various asset classes.

Figure 1. Global assets under management in North America and Europe
Alternatives AuM by region of focus in 2023


Source: Preqin

Emerging markets can offer higher growth and returns compared to developed markets. Between 2001 and 2010, the MSCI Emerging Markets Index had annualised returns of 13.8%, compared to 2.2% for the MSCI World Index. However, emerging markets have underperformed in the last decade due to slower than expected growth, a stronger dollar and other macroeconomic factors. Public investors, such as sovereign funds and public pension funds, have instead shown a shift towards emerging markets in recent years after scaling back during the Covid-19 pandemic.

Figure 2. North America still favoured in public investor shift towards EMs
Investments by public investors by region

Source: GlobalSWF

There are a number of challenges that global institutional investors face as they evaluate investments in emerging markets. At the macro level, challenges such as gross domestic product growth, economic and political stability, foreign exchange fluctuation and others have been well understood. Institutional investors also have access to instruments that can mitigate some of these risks. At the micro ‘deal-by-deal’ level, however, the challenges are much more complex and less homogeneous.

The lack of scalable, ‘investment-ready’ deal pipelines also pose a problem. Sectoral regulatory frameworks that are often different from those encountered in developed markets play a role, particularly in sectors whose businesses are highly sensitive to regulation such as infrastructure. Aside from valuation expectations, the lack of understanding from asset owners in emerging markets regarding the typical governance required by global institutional investors is also a major challenge. In many markets, such challenges are also exacerbated by the inability of global institutional investors to find trusted local partners who can navigate such complexities.

For large emerging markets, such as India or China, global institutional investors can justify building up a local or regional presence or investing to understand and develop their capability to manage such complexities. Then, as they become more familiar and comfortable, investors can gradually scale up their investment commitments. However, for many other emerging markets, even those with sizeable economies and strong growth such as Indonesia, many global funds have yet to be able to justify such a presence.

In recent years, innovations such as the creation of sovereign funds to act as co-investors – who not only understand and can help manage local market complexities but can also deploy their own capital and share investment risks – have started to emerge. Such institutions, while leveraging their domestic knowledge and networks, must also be equipped with the ability to effectively communicate with and understand the perspectives of global institutional investors to be able to achieve common ground.

The Indonesia Investment Authority (INA), established in 2020, is one example. While still relatively young, INA has been able to deploy more than $3bn of investments across key sectors, half of which comes from reputable global investors – a significant increase from historical direct investments from global financial institutions into the country.

This early success can be attributed to various elements. First is the basic setup: from rigorous governance to ensure the right level of decision-making independence, to recruitment of talent to ensure professional execution. Second is a focus on areas that are both crucial to the development of the Indonesian economy and are consistent with the investment appetite of global investors, i.e., energy transition, digitalisation and digital infrastructure, transport and logistics and healthcare. These are sectors where global investors have been evaluating opportunities but were yet to make significant investments. Finally, the effort to continuously build domestic networks. This is not limited to regulators and state-owned companies, but also private players that could not only provide a continuous ‘deal pipeline’, but also become partners to help manage and to create value within our investments.

Innovations, such as sovereign co-investing institutions that are trusted by, and collaborate with, global investors have shown an ability to facilitate more capital deployment to emerging markets. When such investors can work with local partners to navigate complexities, identify and mitigate key risks, the high growth and returns that the markets offer are more likely to be unlocked.



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