The return of Ireland to the bond markets in 2013, marked a watershed in the country’s transition to normality following the EU/IMF bailout programme. And the planned Ireland Strategic Investment Fund (ISIF) is intended to assist with that long transition.

The ISIF will eventually invest all of the discretionary portfolio assets of the National Pensions Reserve Fund (NPRF), which was established in 2001 to invest proceeds from the sale of Telecom Eireann with a specific mandate to finance the country’s long-term pension obligations from 2025. Its assets were valued at €6.8bn at the end of 2013.

Following the 2008-09 financial crash, part of the fund was liquidated to bail out the domestic banks, whose shares are held in the so-called directed portfolio. The assets of this portfolio, comprising ordinary and preference shares in Allied Irish Banks and Bank of Ireland, is now valued at €13.1bn. The National Asset Management Authority, a further separate entity, is the ‘bad bank’ that holds the toxic property loans that took the banks under.

But as a state-sponsored entity the ISIF will navigate new territory. It will need to prove its credentials both as a body independent from government and as a commercially savvy investor if it is to attract co- investors. Their capital will be vital if the planned fund is to meet its economic objective of supporting employment and economic activity in Ireland.

To bolster its independent credentials, the National Treasury Management Agency (NTMA), which previously fell under the direct authority of its chief executive, is to have its own board. This will be chaired by Willie Walsh, former CEO of British Airways and the International Airlines Group.

“We recognise that if we are not able to demonstrate independence of our governance arrangements, we have no hope of attracting co- investors alongside us,” says Eugene O’Callaghan, investment director at the NPRF. “A crucial element to the future success of ISIF is independent governance.”

The board of the NTMA will hold ultimate responsibility for the investment strategy of the ISIF, but sub-committees will be responsible for approving each investment transaction the ISIF under- takes. These sub-committees may have external members.

“The structure will not be the same as the NPRF commission, in that the investment strategy and decisions will be the responsibility of a group with a majority of independent professional people,” says O’Callaghan.

While it awaits the required legislation, the NPRF has allocated 20% of the discretionary portfolio to the domestic economy over the last 18 months and is currently close to its target with €1.3bn invested or committed, according to the NTMA in a statement from early January 2014. “Coming out of the crisis there are significant opportunities in Ireland,” as O’Callaghan puts it.

So far, investments have been made in infrastructure, SME finance and venture capital, with a focus on technology and life sciences, involving a total of nine fund or project commitments. Other opportunities in the pipeline, including €375m in three long-term funds that will in total provide €875m of credit, equity or restructuring capital for Irish SMEs.

The first equity fund is a business turnaround strategy that typically uses around two-thirds of the capital raised to fund a new business plan for each target investment. This is a joint venture with John Moulton’s private equity company Better Capital, through a UK-listed vehicle called Better Capital (Ireland).

“Better Capital have put in a team on the ground in Dublin and they would expect to do a relatively small number of transactions,” says O’Callaghan. They have not completed any investments yet but they have been very active and have become part of the Irish corporate finance scene. We’re happy that they’re active and its important they don’t overpay.”

The second equity fund is a combination of traditional growth capital and equity refinancing, funding companies where the underlying operating business is usually good but overleveraged and there may be a lack of capital to invest to grow the business. This is a joint venture between the Irish corporate finance boutique Cardinal and the Carlyle Group, whose London office is supporting Cardinal on the ground.

“That fund has been engaged in fundraising during the year which has been going well, comments O’Callaghan. “Again there have been no transactions but it’s in the marketplace and they are gaining traction.”

The credit fund, managed by BlueBay, invests in larger SMEs and mid-sized corporates, and closed in mid-2013. It has attracted a co- investment from the Irish Construction Workers Pension Scheme.

In 2012, NPRF also announced a transaction with Silicon Valley Bank (SVB), a leading provider of finance to the technology sector. “We made a commitment to SVB’s global venture capital fund and separate to that they agreed to lend $100m to indigenous Irish technology companies,” says O’Callaghan. “They have completed a few transactions in the last couple of months.”

The NPRF has also provided a €250m bridging loan to the new Irish Water company to cover start-up costs and meter installation as well as €129m standby credit facility to facilitate two public-private partnership infrastructure projects to build schools and roads.

In the future, O’Callahan expects a mix of internally managed investments and outsourcing to third-party managers. “The business plan will help us to define how much we do through managers and how much we do directly,” he says. “Direct investment is much more cost effective in terms of expense ratio but we have to consider all the questions around expertise and resourcing as part of that consideration and will have to make a classic management trade-off.”

A key objective will be to achieve a diversified portfolio in terms of capital structure but also duration. “It would be bad to put all the eggs in one basket in that regard, in terms of the success of the fund over time, both from an investment and economic impact perspective,” says O’Callaghan, who adds that he expects both short and longer-term duration investments because “clearly the stakeholders will not expect us to come back in 20 years to tell them how we have got on. We will have to deliver results both near term and over time”.

The mandate of the ISIF will differ from that of the NPRF in that it will be required to demonstrate its positive impact on the domestic economy, alongside achieving positive returns. The NPRF’s current objective dates back to 2000 and targets return maximisation subject to risk in a globally diversified portfolio.

“We have been assigned a second objective, which is to support economic activity and to support employment in Ireland,” explains O’Callaghan. “We have a double bottom line – an investment objective and an economic impact objective and we have to achieve all that by investing in Ireland, which is clearly a big challenge. There are very few funds around the world that have this dual objective. The concept of impact investing is emerging, but for sovereign funds to have both return objectives and to support economic activity is quite a new development.”

O’Callagahan says the NPRF is currently working on a plan to develop an appropriate portfolio design and business model to achieve the new objectives. “It’s a complex issue that we are facing and the business planning process is not easy because we are investment managers, and integrating a second objective of economic impact is a significant new element to our activity,” he comments.

“We will need to find ways to estimate in advance and monitor the economic impact our investments are having and to report this to the trustees. We are working with a firm of economic consultants and are consulting with key stakeholders, government departments and agencies on this to avoid re-inventing the wheel.”

The fact that the fund can act as a stable co-investor should also assist in achieving the economic impact objective by allowing it to ‘leverage’ it’s capital, so to speak. So far, the capital the NPRF has committed to the various funds and projects have been more than matched by third-party commitments, to an overall multiple of 2.1 times.

O’Callaghan says 75% of the current NPRF discretionary portfolio can be liquidated in under 30 days in current market conditions. But there will be considerable scrutiny on the transition process given that State Street was forced to repay €2.65m in commission charges that it wrongly levied following the disposal of €4.7bn-worth of assets from February to May 2011. State Street was subsequently suspended from the NPRF’s transition manager panel, which now comprises BlackRock, Citigroup and Russell Investments. John Corrigan, NTMA chief executive, publicly expressed misgivings about State Street’s internal governance arrangements in early 2013.

“We have a panel of transition managers that we re-tendered under the EU public procurement rules” comments O’Callaghan. “We were conscious of conflict-of-interest issues and we have structured arrangements with the members of our panel in a way that is absolutely best practice in terms of avoidance of conflict.”

He would not comment on recent press reports that NPRF has appointed UBS to manage the sale of over €700m in private equity assets. As for the future, O’Callaghan concludes: “The team here is working on a pipeline to help us hit the ground running when our legislation is completed and our business plan is signed off by all the stakeholders which we hope to achieve in the next few months.”

Certainly, there will be close scrutiny of NPRF and the new ISIF in coming years, both domestically and from abroad, as the new entity navigates the tricky balance of its dual objective, and also keeping politics at arm’s length from sovereign wealth.