A new Working Paper published by Harvard Business School examines the direct private equity investment strategies of sovereign wealth funds (SWFs) 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.
Taken as a whole, two competing interpretations can be offered for these results, the paper concludes.
It may be that funds investing more heavily in their domestic markets, particularly those with the active involvement of political leaders, are more sensitive to the social needs of the nation. As a result, they might be willing to accept investments which have high social returns but low private ones. Since the social returns are not easily observable to us, it would appear that these funds are investing in industries with lower performance.
The alternative interpretation would suggest that greater investment at home is a symptom of poor investment decisions, since the funds are prone to home bias or else to have decisions distorted by political or agency considerations.
The Investment Strategies of Sovereign Wealth Funds
Shai Bernstein, Josh Lerner, and Antoinette Schoar