A Hole in the Bucket

How petrostates lost big in the Great Recession.

By Veljko Fotak and Bill Megginson

August 22, 2009, 9:40 PM

What a difference 18 months can make. As recently as the beginning of 2008, sovereign wealth funds owned by governments flush with massive oil revenues appeared to be the rising titans of global finance, leading some commentators to decry the rise of a "sharecropper economy" in the United States.

Buoyed by high oil prices and the bubbles they fueled, the funds purchased massive equity stakes in several Western investment and commercial banks, such as Abu Dhabi Investment Authority’s $7.5 billion purchase of a 4.9 percent stake in Citigroup in November 2007 or Qatar Investment Authority’s decision in October 2008 to increase its stake in Credit Suisse to 8.9 percent, becoming the company’s biggest shareholder. The 32 funds we studied (13 of them tied to Middle Eastern petrostates) collectively made 12 very large stock purchases, totaling $63.33 billion, between November 2007 and February 2008 — and 11 of the deals in this period, worth $61.33 billion, involved direct purchases of stakes in distressed Western financial institutions. Surprisingly, these stock purchases were for the most part cheered by European and American governments and investors; the funds were even hailed as saviors for "rescuing" banks from the financial fallout of the subprime mortgage crisis.

But the good times came to an unhappy end by the beginning of this year. The sovereign wealth funds’ listed stock investments plummeted in value as the financial crisis wiped several trillion dollars in market capitalization off the world’s markets, with banking stocks by far the worst hit. At the same time, fund managers made some disastrously bad choices about the stocks they picked, clustering their purchases within a small handful of moribund Western companies. According to our research, sovereign wealth funds lost a staggering $66.88 billion on their publicly disclosed investments and experienced a total return of negative 53.23 percent from the date the investments were made through March 27, 2009. The $42.67 billion of losses on the 11 ill-timed financial investments of late 2007 and early 2008 accounted for two thirds of this total.

It’s not simply the managers’ fault. These are, after all, state-owned investment funds. As our data suggest, poor stock picking could have been the result of pressures that forced managers to invest in distressed industries and firms for political reasons. Whatever the case, it’s clear that the next time a Western company needs bailing out, the Abu Dhabis and Qatars of the world won’t be so quick to show up with a bucket.

<p>Veljko Fotak is a research associate at Fondazione Eni Enrico Mattei (FEEM). Bill Megginson is professor and Rainbolt chair in finance at the University of Oklahoma and a research fellow at FEEM.</p>