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11 October 2018 CFA Institute Journal Review

Sovereign Wealth Funds’ Investments and Corporate Bondholders (Digest summary)

  1. Mark K. Bhasin, CFA

Equity investments made by sovereign wealth funds have a positive effect on the value of the target companies’ bonds. The market reacts to the investment in the initial days after the announcement and maintains positive trends in the subsequent months.

How Is This Research Useful to Practitioners?

Sovereign wealth funds (SWFs) currently manage global assets valued at $7.4 trillion, which is significantly higher than the amount managed by hedge funds and private equity. The two largest SWFs today are Norway’s Government Pension Fund Global, which has $922 billion in assets under management, and Abu Dhabi Investment Authority, which has an estimated $828 billion in assets under management.

During the 2008–09 global financial crisis, several SWFs began to allocate resources to recapitalize troubled companies. Whereas the existing academic literature focuses on how SWF investments affect the share price of target companies, the authors seek to quantify the wealth effects for bondholders of those companies.

Previous researchers have determined that bond prices of target companies increase when a SWF assumes the role of anchor equity investor. This dynamic may occur because the SWF is viewed as a guarantor of the company’s future solvency. SWFs’ preference for investments in highly leveraged multinational companies allows the funds to achieve abnormal returns through a reduction in liquidity risk.

The authors conclude that variables related to the target company’s credit risk (e.g., credit rating of its bonds) and variables related to the dimension and disclosure of the funds (e.g., SWF size and level of transparency) have a meaningful role in determining the extent of the market reaction of traded bonds issued by firms targeted by SWFs.

How Did the Author Conduct This Research?

The authors obtain data from the Sovereign Wealth Fund Transaction Database on investments in which an SWF acquired an ownership interest in a target company. The initial sample of 1,254 deals from the period 2000–2016 is whittled down based on certain required characteristics—for example, the targets having listed bonds and liquid debt instruments and the SWF owning at least 10% of the target. The final sample includes 166 deals (closed by a total of 26 sovereign wealth funds), 128 companies, and 691 debt instruments.

To account for companies that have more than one bond in their portfolio, the authors create a “synthetic bond” using a weighted average of each bond by weighting, among other things, its market value three months prior to the announcement date. To quantify the wealth effect for bondholders, the authors conduct an event study using different time windows and calculate a positive cumulative average abnormal return (CAAR). Using statistical tests, the authors conclude that these results are statistically significant at various confidence levels.

To discover what determines the positive effect of SWF investments on bondholder value, the authors run three regressions using the ordinary least-squares method. The dependent variables are the fund’s variables, the target company’s variables, and the deal’s variables. The independent variables are, in turn, the SWF’s characteristics, the target company’s characteristics, and the deal’s characteristics.

Based on these regressions, the authors conclude that the bonds’ CAARs are higher for larger SWFs, lower when the credit rating of the target company’s bonds is lower, and higher when the SWF acquires a larger ownership interest.

Abstractor’s Viewpoint

Since the 2008–09 financial crisis, SWFs have redesigned their investment strategies by broadening their investment process perspectives and diversifying their portfolios. The authors provide relevant research about SWFs, which are an important global asset manager today, with at least 26 funds having assets under management of more than $1 billion. Because the current US economic expansion is mature, it will be fascinating to see what role SWFs play in the next US or global economic downturn.

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