NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Investment Strategies of Sovereign Wealth Funds


SWFs with political figures involved in their governance have a much greater likelihood of investing domestically, while funds relying on external managers are less likely to do so.

The state-owned investment portfolios known as sovereign wealth funds (SWFs) have grown impressively over the past decade to a total estimated value in 2008 of $3.5 trillion. In The Investment Strategies of Sovereign Wealth Funds (NBER Working Paper No. 14861), co-authors Shai Bernstein, Josh Lerner, and Antoinette Schoar find that politicians’ involvement affects the funds’ success levels.

Drawing on three different investment databases, the researchers focus on 2,662 investments made by 29 SWFs between 1984 and 2007; this includes acquisitions, venture capital and private equity investments, and structured minority purchases in public entities. Bernstein, Lerner, and Schoar note that the average transaction is $351 million, but there is substantial variation among the funds. Middle Eastern funds make the largest deals on average, around $604 million, while western funds make the smallest deals on average, at $97 million per transaction. Similarly, the average acquisition stake of SWFs is substantial (56.6 percent), with the stake of Middle Eastern funds averaging 62.2 percent as compared to an average of 25.7 percent for western funds.

The analysis reveals that SWFs located in Asian, Middle Eastern, and western regions do not differ greatly in the average price-earnings (P/E) levels of the sectors in which they invest. Asian and Middle Eastern funds typically invest at significantly lower P/E ratios domestically and at higher P/Es abroad, while the opposite is true for western funds. SWFs are more likely to invest at home when domestic equity prices are higher, and more likely to invest abroad when foreign prices are higher. Perhaps as a consequence, Asian groups, and to a lesser extent Middle Eastern SWFs, experience a drop in the industry P/E ratios of their home investments in the year after investment and a positive change in the P/E ratio in the year after their foreign investments.

The data also show that SWFs with political figures involved in their governance have a much greater likelihood of investing domestically, while funds relying on external managers are less likely to do so. Domestic investment might be propelled by politicians’ sensitivity to their nations’ social needs, the researchers theorize, but they note that this does not square with the propensity to invest in the high P/E industries, especially in view of the negative returns that characterize these sectors. Moreover, controlling for the differing propensity to invest domestically, the researchers find that SWFs with external managers tend to invest in lower P/E industries, while those with politicians involved in the governance process invest in high P/E industries. In addition, the former tend to be associated with a more positive change in industry P/E in the year after the investment, while the politically controlled funds trend toward the negative.

Their analysis suggests that high levels of home investments by SWFs, particularly those with the active involvement of political figures, are associated with trend chasing and worse performance. Politician-influenced funds invest in the highest P/E industries. The researchers note that SWFs are commonly perceived as tools for furthering the geopolitical and strategic economic interests of their governments. The emphasis of Singaporean SWFs on investing in India and China, for example, has been interpreted as a means of Singapore’s forging strategic ties with its much larger and more powerful neighbors. But accomplishing political goals while maintaining strong financial returns appears challenging indeed.

-- Matt Nesvisky


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