If M&A had a lemon law, the sovereign wealth funds could make a pretty good case for the U.S. courts.
Temasek Holdings, which runs a $134 billion portfolio for the government of Singapore, for example, lost billions on Merrill Lynch & Co., while China Investment Corp., or CIC, poured $3 billion into the Blackstone Group ahead of the firm’s IPO. The private-equity firm’s shares have fallen from $31 to as low as $3.55.
One might assume the sovereign wealth funds would be a little gun shy when it comes to U.S. investments, and for the past year most funds have retrenched.
News in June, however, that CIC is looking to invest another $500 million into Blackstone suggests the healing process could be over.
While much was made about the $400 billion in dry powder still available to private-equity funds, the combined $3.5 trillion that the world’s sovereign wealth funds are sitting on makes such an amount almost laughable.
Harvard University’s Josh Lerner, the Jacob H. Schiff professor of investment banking at Harvard Business School, perhaps understates it when he says: “In a world that’s starved for liquidity, sovereign wealth funds represent an attractive [source].”
The problem, however, is that few truly understand what drives SWF activity.
Lerner, along with Shai Bernstein and Antoinette Schoar, sought to uncover the impulses directing SWF investments in a recent study, “The Investment Strategies of Sovereign Wealth Funds.” Transactions considered by the academics on average totaled $351 million; Mideast fund investments, though, averaged just over $600 million.
Examining 2,662 investments by 29 SWFs made between January 1984 and December 2007 — most SWF deals were made after 1991 — the team at Harvard arrived at some interesting conclusions.
“Projections, while inherently tentative due to the uncertainties about the future path of economic growth and commodity prices, suggest that they will be increasingly important actors in the years to come,” the trio of authors noted in their study.
For starters, SWFs tend to be slower in identifying trends. They are more likely to deploy capital at home when domestic equity prices are higher, and more likely to take their money abroad when foreign prices are higher.
Meanwhile, SWFs that include politicians as part of their governance are substantially more likely to invest at home.
Political exposure also lends itself to a propensity to invest in industries with higher price-to-earnings ratios. Alternatively, externally managed sovereign wealth funds are less likely to stay anchored to the home market and tend to target industries with lower P/E ratios.
On average, when funds invest in their home markets, they’ll target lower P/E ratios than when they look abroad.
As might be expected, the politically influenced sovereign wealth funds also tend to under-perform. “This could be an outcome of less sophisticated decision structures within these funds or outright distortions in the investment process due to political or agency problems,” the co-authors wrote.
As an example of the second point, the authors cited Norway’s Government Pension Fund, which shorted the shares of Icelandic banks, but abandoned the strategy after it created a political uproar.
In hindsight, the investment proved prescient if not as profitable as it could have been given the maelstrom that has engulfed the tiny nation’s banking system.
While it’s the billion-dollar deals that generate the headlines, SWFs will just often dole out investments in smaller increments.
Western vehicles, on average, commit less than $100 million per deal. The Middle Eastern funds, however, spend roughly $600 million on average, per investment.
The 10 largest SWFs reside in Abu Dhabi, Norway, Singapore, China, Libya, Russia and South Korea, according to a Bureau of National Affairs report authored by Michael Bleier, a partner with global law firm Reed Smith.
“Asia is developing and growing,” Bleier says, noting that it makes sense the local SWFs will seek to play a role in the ongoing development.
To wit, China’s national stimulus package aggressively concentrates on developing its own infrastructure similar to the development of the U.S. post-World War II, making it a prime target for growth plays.
Still, while the financial community can sympathize with the collective reluctance of the SWFs to return to the fray, most believe it’s only a matter of time before others follow CIC and tiptoe back into Western markets.
Already, there are signs that all is forgiven if not forgotten.
When the U.K.’s Virgin Group Ltd. sold its mobile unit to Sprint, the company also divested a stake in its Virgin Galactic commercial space travel business. The buyer was Abu Dhabi’s Aabar Investments, which paid $280 million for almost a third of the business.
Only a few months earlier, Aabar picked up a stake in electric carmaker Tesla Motors.
It will be a while before the funds shake off the memory of Sept. 15, 2008, but the fact that they’re testing the water on U.S. shores is a welcome sight for domestic dealmakers.