Politicized government investors are bad for business

By Matthew Biddle

BUFFALO, N.Y. — While stock markets tend to react positively to news of any major financial investment, new research from the University at Buffalo School of Management shows the reaction is weaker for investments by most sovereign wealth funds (government-owned investment funds).

In particular, the research, published this month in the Review of Financial Studies, found the lowest returns came from investments made by highly politicized sovereign wealth funds—those under strict government oversight, usually by nondemocratic regimes.

“We found the worst returns were associated with funds whose governance structure allowed for significant government interference, especially when those funds acquired large or controlling stakes and took a seat on the company’s board,” says co-author Veljko Fotak, PhD, assistant professor of finance in the UB School of Management.

With investable assets well over $4 trillion, sovereign wealth funds are a major player in the world economy. Their investments are everywhere, with stakes in such major corporations as Microsoft, Google, Citigroup, MGM Resorts International and Apple. One fund, the Abu Dhabi Investment Authority, even owns a 25 percent share of Chicago’s private parking system.

The researchers studied 1,018 sovereign fund investments from 1980 to 2012 and compared them with a sample of nearly 6,000 stock purchases from private investors in the same period. They found the average difference between initial returns from sovereign wealth funds and private sector investments is $60 million.

“In contrast to previous research, our results show that, on top of lower short-term returns, most sovereign wealth fund investments also lead to deteriorating long-term operating performance, both in absolute terms and relative to private-sector investments,” says Fotak.

Over the past few years, as these funds have grown at a dramatic pace, debate over the proper regulatory action has intensified. In the study, investments from Norway’s government pension fund were not associated with any negative effects; therefore, Fotak says any policy response must treat sovereign funds individually, rather than as a unit.

“Policy response should be fact-based—not a panicked reaction to rising foreign investments,” he says. “Though these funds are often grouped together, we cannot treat Norway’s government fund the same as funds from less democratic regimes. We must recognize differences in their behavior and provide incentive for them to act as transparent, conscientious investors.”

Fotak collaborated on the study with Bernardo Bortolotti, PhD, associate professor of economics, University of Turin, Italy, and William L. Megginson, PhD, professor and Price Chair in Finance, University of Oklahoma.