Aurora Borealis
1 February 2017 CFA Institute Journal Review

Who Is the Sovereign among Sovereign Wealth Funds? A Network Analysis of Co-Investments (Digest Summary)

  1. Vassilis Efthymiou, CFA

Evidence shows that the style of the co-investments of sovereign wealth funds (SWFs) is determined by the size, industry, and country of the targeted companies, whereas the choice of co-investor is driven by the SWF’s location and interconnectivity in the entire network of SWFs.

How Is This Research Useful to Practitioners?

Following the financial crisis in 2008, co-investments among sovereign wealth funds became more popular than ever before. A sovereign wealth fund (SWF) is a state-owned fund that invests the surplus of public funds in equity of companies located around the globe, either as a single investor or in co-investments with another SWF. Overall, 64 SWFs worldwide are involved in 4,262 deals, including co-investments in 97 firms. The authors address two fundamental questions pertaining to SWFs:

    What is the degree of direct or indirect connectivity in the network of co-investments among SWFs?

    What are the main determinants of the conditional probability of co-investment in a particular capital-seeking company?

Regarding the first question, the authors find that the entire SWF network is segmented into several clusters of funds that constitute investor alliances in which a single SWF dominates the investment decisions of the rest. Regarding the second question, co-investment by two or more SWFs seems to be geared toward larger companies operating in the transport, telecom, energy, and financial services industries and located in the same country as the investing fund. But the GDP growth, religion, and legal framework for minority shareholder protection of the targeted country seem to affect neither the propensity of SWFs to proceed with a combined investment nor their preferences regarding the profile of the end beneficiary.
The authors’ evidence provides insights for equity fund managers seeking to raise capital from SWFs in the course of expanding total assets under management. These insights shed light in two directions: (1) Equity fund managers need to identify and reach out to the key player in the SWF cluster operating in their territory rather than try all the cluster’s affiliated funds; (2) equity fund managers will increase the likelihood of their receiving SWF co-investments by gearing their investment mandate to the target firm, industry, and country preferred by particular SWFs.

How Did the Authors Conduct This Research?

To map both the surface and the depth of connectivity among SWFs, the authors use the metrics of social network analysis (SNA) to draw conclusions about the strategic alliance of SWFs that resulted in several co-investments in the same entities. The network of alliances among members of the SWF ecosystem is depicted diagrammatically as a set of nodes, each representing a single SWF, connected together based on whether a co-investment exists between a single node and the rest of the SWF population. The authors then calculate three centrality measures: (1) degree centrality, (2) betweenness centrality, and (3) eigenvector centrality, which capture, respectively, the number of direct connections per SWF, the relevance of the position of several SWFs in terms of their direct and indirect connections with adjacent funds, and the ultimate prominence of a single fund in the entire network. Twelve funds are found to be highly influential and connected, with the most prominent being those in Norway, Singapore, and South Korea.
The authors also examine the role of firm-specific and country-specific factors expected to affect the choice of SWF co-investment by running univariate and multivariate logistic regressions on a sample of 1,433 invested companies involved in 4,262 deals funded by SWF capital. More specifically, a dummy variable for whether or not a co-investment existed in the sample deal was regressed against a series of independent factors: the total assets and industry code of the target company, same-country bias, same-religion bias, degree of affiliation with the prospective SWF manager when voting for policies decided at the UN General Assembly, and the GDP growth and shareholder protection rights in the selected country. According to the logit regression results, the probability of receiving an SWF co-investment is higher for a larger company that provides transportation, utility, or banking services and is located in the sovereign that owns the SWF. It is likely that co-investments take place with SWFs in which the views at the United Nations may be very different; for example, an SWF may be seeking assistance in navigating a different system of regulations or beliefs.

Abstractor’s Viewpoint

Admittedly, in the aftermath of the 2008 global financial crisis, SWFs played a stabilizing role by contributing significantly to the bailout of financial institutions whose prospective failure to restore capital adequacy posed a serious threat in the capital markets. Yet, today some are concerned that sovereign wealth funds serve such policy objectives as regional business development or political diplomacy rather than seeking to maximize risk-adjusted returns on investments.
Future research needs to examine relevant empirical evidence to determine the motivations of SWF investments and whether SWF corporate governance structures truly and clearly convey their reason for investing in selected companies. Moreover, SWF ex post performance, which may be measured and evaluated both qualitatively and quantitatively, will be the ultimate judge of whether investment choices were profit oriented in the first place. If they prove not to be so, the next time equity fund managers consider partnering with a sovereign wealth fund, they would be wise to review carefully the imperatives of its investment mandate and to pay heed to its track record.

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