Daniel W. Drezner

Sovereign wealth funds aren’t investing in the United States — and why that might be a good thing

Love them or hate them, sovereign wealth funds helped to bail out a lot of U.S. financial institutions over the past 18 months.  According to McKinsey, these funds invested $59 billion into Western financial institutions from March 2007 to June 2008.  Since Freddia Mac and Fannie Mae hit the fan, however, sovereign wealth funds have ...

Love them or hate them, sovereign wealth funds helped to bail out a lot of U.S. financial institutions over the past 18 months.  According to McKinsey, these funds invested $59 billion into Western financial institutions from March 2007 to June 2008.  Since Freddia Mac and Fannie Mae hit the fan, however, sovereign wealth funds have stayed on the sidelines.  Indeed, when the Kuwait Investment Authority announced that it wasn’t ploughing more money into the United States and was instead focusing on China and India, a lot of people freaked.  Am I one of the people freaking out?  No, because I’m not convinced that sovereign wealth funds are all that good at picking winners in equity markets.  Which leads me to this SSRN paper, “The Financial Impact of Sovereign Wealth Fund Investments in Listed Companies,” by Veljko Fotak, Bernardo Bortolotti, and William L. Megginson.  Here’s the abstract:

This paper initiates empirical research on the financial impact and wealth effects of Sovereign Wealth Fund (SWF) investments in the stock of listed companies around the world. SWFs have recently gained media attention because of concerns about their large size (USD 3.3 trillion), extremely rapid growth rates, and lack of transparency. We analyze asset allocation by fund and find a significantly positive 1% mean abnormal return upon announcement of 75 SWF acquisitions of equity stakes in publicly traded companies around the world. We note that SWFs are typically long term investors who, due to both political pressures and size of holdings, are often unwilling to quickly unwind their positions. However, two-year abnormal returns of SWFs average a significantly negative 41%, suggesting equity acquisitions by SWFs are followed by deteriorating firm performance. 

I’m not sure how robust their findings are — the N is under 60, and there are selection effects all over the place — but if their finding holds up, it suggests that sovereign wealth funds are hardly the master of the markets that some people believe them to be.  It also suggests, perversely, that their decision not to send more money into the U.S. might be a good thing in the long run. 

 Twitter: @dandrezner

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