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New Insights into Sovereign

Wealth Funds:Clues and Mysteries

Josh Lerner

Harvard Business School

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Important questions

Where are sovereign wealth funds investing?

How successful have these investments been?

What drives the key differences in sovereignfund performance? Critical because of

Size.

Future growth. Role in economic development.

Politicians concerns.

Potential to supplant other intermediaries.

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Limited insights

Relative limited information on groups and

their activities.

Secrecy as a response to political controversy.

Secrecy as an optimal investment strategy.

At same time, lack of clarity can unwarranted

suspicions and doubts.

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But recent insights

In last year, flurry of research into sovereign

funds:

About one dozen papers released.

Have illuminated many aspects.

Have exploded a number of myths about these

funds.

But leave a number of open issues.

This talk will highlight the key new insights

from these works.

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The agenda

A (very brief) history.

The new insights and surprises.

The open questions where research can addvalue.

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Early days

Pioneering awareness of Kuwait and others in

1950s of need to prepare for the future.

Variety of roles:

Sources of capital for future generations:

Like a university endowment.

Provides an ability to smooth out cycles in

commodity prices.

Holding company for strategic investments by

government.

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Very different outcomes

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Very different outcomes (2)

Kiribati:

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Significant players

40-70 funds, depending on how you count.

$3.5 trillion of assets:

Morgan Stanley estimate, mid-2008.

Big relative to hedge funds ($1.4 trillion).

Only 1.2% of all investible assets world-wide:

But rapid growth projected.

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Insights from recent research

Sovereign fund investments are good news for

targets.

Many concerns about investment strategies

misplaced.

Appear not to change firms in their portfolios.

The troubled track record of domestic

investments.

The importance of fund governance.

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1. Sovereign fund investments are

good news for the target firms

Dewenter, Han and Malatesta [2009] look at

196 purchases and 47 sales of stock by SWFs.

Adjusted stock price rises on news of

purchase:

Stock price up 1.7% on announcement.

The bigger the stake, the more positive a

reaction to a point.

Sales trigger a 1.3% drop.

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Reaction around stock purchase

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Evidence

Miracky, et al. (2009): Sovereign funds primarily focus on emerging markets,

not developed nations.

Real estate and old economy industrial firms have

been among most popular sectors. Appear to deliberately avoid sensitive industries and

firms.

Chhaochharia and Laeven (2009):

Sovereign funds tend to invest in countries with similar religion and culture.

with different industries than those in home country.

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3. Little support for claims of

distortions at portfolio companies

Many complaints that SWFs may distort firms

in unseen ways.

Sovereign wealth funds are their own worst

enemies. Most are not transparent or publicly

accountable, and we know little about their

governance structures or fiduciary controls. Senator Charles Schumer, Joint Economic Committee,

February 13, 2008.

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Change in P/E ratio in country and

industry in year after investment

P/E change

after domestic

investment

P/E change

after foreign

investment

Asian

sovereign

funds

-4.3 +0.7

Middle East

sovereign

funds

-5.3 -0.9

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Troubling domestic performance

Asian and Mid-Eastern funds have negative

industry P/E returns in year after deal at home

(though about zero abroad):

Similar results hold for the returns of the subset

of publicly traded firms.

Moreover, since many investments made at

relative peak, unlikely to be rescuingcompanies.

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5. The funds organizational

structure matters a lot

Can governance structures help to explain the

differences in investments across SWFs?

Would like to look at a broad array of measures.

For now, focus on whether political leaders

involved in the decision-making:

Data collected by JP Morgan as of 2008.

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Example: Alaska Permanent Fund

Emil Notti, appointed February, 2007Emil Notti is an engineer, prominent Alaska Native leader and Alaska public servant. He

graduated from Northrop University with a dual degree in aeronautical and electrical

engineering, and also holds an Honorary Doctorate degree from the Alaska Methodist

University. He was first president of the Alaska Federation of Natives, past president of

Doyon Limited, former Commissioner of the Department of Community and Regional

Affairs; 30-year board member with the National Bank of Alaska; and Veteran of the

United States Navy. In February, 2007,Governor Palin appointed Mr. Notti Commissioner

of the Department of Commerce, Community and Economic Development, and to serve

on the APFC board. Mr. Notti also held his commissioner's position, and served on the

APFC Board, from1985 to 1986.

Steve Rieger, appointed July, 2009

Steve Rieger currently operates his own management and finance consulting businesses

in Anchorage, and is a state-registered investment adviser. He earned a bachelors

degree in economics from Harvard University, and a masters degree in business

administration from Harvards Graduate School of Business Administration. Mr. Riegerserved three terms in the Alaska House of Representatives and one in the Senate,

representing south Anchorage. A member of both House and Senate finance

committees, his extensive legislative experience included the state operating and capital

budgets, economics, banking, and the Permanent Fund. As a legislative staffer before his

election, Rieger helped develop the legislation establishing the Alaska Permanent Fund

Corporation, and worked with Wall Street firms regarding its investment guidelines and

governance. He was appointed to the APFC board in July, 2009 by Governor Palin, for a

four-year term.

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Example: Alaska Permanent Fund

Emil Notti, appointed February, 2007Emil Notti is an engineer, prominent Alaska Native leader and Alaska public servant. He

graduated from Northrop University with a dual degree in aeronautical and electrical

engineering, and also holds an Honorary Doctorate degree from the Alaska Methodist

University. He was first president of the Alaska Federation of Natives, past president of

Doyon Limited, former Commissioner of the Department of Community and Regional

Affairs; 30-year board member with the National Bank of Alaska; and Veteran of the

United States Navy. In February, 2007,Governor Palin appointed Mr. Notti Commissioner

of the Department of Commerce, Community and Economic Development, and to serve

on the APFC board. Mr. Notti also held his commissioner's position, and served on the

APFC Board, from1985 to 1986.

Steve Rieger, appointed July, 2009

Steve Rieger currently operates his own management and finance consulting businesses

in Anchorage, and is a state-registered investment adviser. He earned a bachelors

degree in economics from Harvard University, and a masters degree in business

administration from Harvards Graduate School of Business Administration. Mr. Riegerserved three terms in the Alaska House of Representatives and one in the Senate,

representing south Anchorage. A member of both House and Senate finance

committees, his extensive legislative experience included the state operating and capital

budgets, economics, banking, and the Permanent Fund. As a legislative staffer before his

election, Rieger helped develop the legislation establishing the Alaska Permanent Fund

Corporation, and worked with Wall Street firms regarding its investment guidelines and

governance. He was appointed to the APFC board in July, 2009 by Governor Palin, for a

four-year term.

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Sovereign fund investment type

and performancePoliticians on

Investment

Committee

Politicians Not on

Investment

Committee

Share of deals in home

country 44% 31%Share of deals in home

country or region75% 60%

Average deal size($MMs) 190 148

Change in P/E ratio in

industry and country

in year after deal

-2.6 -0.8

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Governance and investment

choices

SWFs are more likely to invest at home if

politicians are involved in investments

Politician-influenced SWFs:

Invest in industries with higher P/E ratios.

Obtain a negative change in industry P/E

the following year.

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Open issues where research can

add value How to should respond to changing conditions:

E.g., natural resource price changes and investmentstrategies?

What are consequences of more transparencyabout investment strategies?

What incentive schemes are best at attractingand retaining professional staff?

How can continue to generate returns as growlarger?

Particularly challenging in alternative investments.

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Taking stock

So far, much of research has told us what we

know already.

But important because it provides

Ammunition to address critics.

Underlines areas where opportunities to change.

But more work is surely needed:

Much of which should be more useful to funds.

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Josh LernerRock Center for Entrepreneurship

Harvard Business School

Boston, MA 02163 USA

1-617-495-6065

josh@hbs.edu

www.people.hbs.edu/jlerner

mailto:josh@hbs.eduhttp://www.people.hbs.edu/jlernerhttp://www.people.hbs.edu/jlernermailto:josh@hbs.edu