Sovereign wealth funds (SWFs) are a relatively new form of government-owned investment vehicle, with a majority being set up over the past 15–20 years. One of the mandates of SWFs is to invest outside national borders. Investments by SWFs tend to have an important implication for the credit risk of the portfolio companies. Such investments can lead to an implicit guarantee from the SWF’s government to creditors. The authors find that this implicit guarantee increases when the SWF’s government is stable and authoritarian and the relationship between the investor and investee countries is neither too strong nor too weak.

Most of the prior research on the impact of SWF investments has been focused on the stock returns and operating performance of the portfolio companies. The authors study SWFs from a credit risk perspective and thereby contribute to the understanding of the impact of this relatively new form of investment vehicle on the financial markets.

Typically, SWFs take a minority interest and are passive investors; previous empirical studies have confirmed that SWF ownership does not significantly affect creditors because of the impact on financial performance, increased organizational risk, or shareholder–bondholder conflicts. The authors explore a fourth channel—that is, the presence and scale of the implicit governmental guarantee to creditors in SWF investee companies.

To the extent that investment is driven by political motives, SWF governments tend to provide an implicit commitment to ensure achievement of such political motives. This form of guarantee is enhanced because unlike other institutional investors, SWFs generally do not have any explicit liabilities and thus can pursue long-term goals even at the cost of short-term losses.

The authors conduct the study on a sample of 391 SWF investments in 198 companies during 2003–2010. The impact of SWF investments on credit risk is assessed by measuring the change in the credit default swap (CDS) spread of a target company around the time of the investment announcement, adjusted by the change in the CDS spread of companies in the same rating category. The findings confirm that the target companies’ CDS spreads decrease when an SWF investment is announced. In a (−1, +1) window around the investment announcement, the mean CDS abnormal decrease is 1.608 bps, 1.424 bps, and 1.135 bps for one-, three-, and five-year maturities, respectively.

The evidence is also robust when using an alternative benchmark comprising all the companies (not only those with the same credit rating) and factoring for endogeneity by using the main firm-level determinants of SWF investments and a different event window.

The authors find that the size of the reduction in the CDS spread is higher when the implicit guarantee provided by the SWF is stronger (i.e., when the originating country is stable and authoritarian and the relationship with the host country is neutral). The results also suggest that the reduction in CDS spread is higher when SWFs are more transparent.

The authors statistically link the improved credit risk profile with the implicit guarantee by the SWF predicated on the political motives involved with the investments and the SWF’s ability to achieve those motives. It would also be helpful to explore whether there are any additional factors contributing to the improved credit profile of the target company. One such explanation could be signaling. An investment by a professionally run and well-managed SWF may act as an endorsement of the quality of the target company and thereby has the potential to reduce the risk perceived by the creditors.