17 Apr 2009Working Paper Summaries

The Investment Strategies of Sovereign Wealth Funds

by Shai Bernstein, Josh Lerner and Antoinette Schoar

The role of sovereign wealth funds (SWFs) in the global financial system has been increasingly recognized in recent years, and many reports suggest that SWFs are often employed to further the geopolitical and strategic economic interests of their governments. The resources controlled by these funds—estimated to be $3.5 trillion in 2008—have grown sharply over the past decade. 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. Despite this significant and growing role, financial economists have devoted remarkably little attention to these funds. The lack of scrutiny must be largely attributed to the deliberately low profile adopted by many SWFs, which makes systematic analysis challenging. Bernstein, Lerner, and Schoar analyze how SWFs vary in their investment styles and performance across various geographies and governance structures. Taken as a whole, results suggest that high levels of home investments by SWFs, particularly those with the active involvement of political leaders, are associated with trend chasing and worse performance. Key concepts include:

Sovereign wealth funds (SWFs) present an ideal object of investigation to understand the interaction between finance and political economy.
The direct private equity investments analyzed here are one of the few dimensions of SWF investments on which it is possible to obtain comprehensive information.
SWFs seem to engage in a form of trend chasing, since they are more likely to invest at home when domestic equity prices are higher, and invest abroad when foreign prices are higher.
SWFs where politicians are involved have a much greater likelihood of investing at home than those where external managers are involved. Funds with politicians involved invest in higher P/E (price earnings ratio) industries, which have a negative valuation change in the year after the investment.
Much research remains to better understand the underlying investment objectives of SWFs, their investment strategies, and their organizational differences, as well as the constraints they face due to internal and external pressures.

Author Abstract

This paper examines the direct private equity investment strategies across sovereign wealth funds and their relationship to the funds' organizational structures. SWFs seem to engage in a form of trend chasing, since they are more likely to invest at home when domestic equity prices are higher, and invest abroad when foreign prices are higher. Funds see the industry P/E ratios of their home investments drop in the year after the investment, while they have a positive change in the year after their investments abroad. SWFs where politicians are involved have a much greater likelihood of investing at home than those where external managers are involved. At the same time, SWFs with external managers tend to invest in lower P/E industries, which see an increase in the P/E ratios in the year after the investment. By way of contrast, funds with politicians involved invest in higher P/E industries, which have a negative valuation change in the year after the investment. 53 pages.