SWFs struck at financial crisis epicentre: $50b in losses from financials

For their biggest public market investments in the last two years, sovereign wealth funds (SWFs) zeroed-in on the most dogged companies in the worst-performing sector: Western financials. These decisions incurred paper losses of $US56.3 billion, accounting for most of their public market losses for the period.

As the financial crisis broke out with big subprime credit write-downs in the US and Europe, SWFs went on a buying spree, making 12 of their largest investments in recent years between November 2007 and February 2008.

From these investments, the biggest 10, worth US$56.9 billion, were direct allocations to distressed Western financial institutions. By March 2009, their cumulative paper value had shrunk by 78 per cent to US $11.5 billion.

The largest 24 transactions in public markets by SWFs brought paper losses of $US56.3 billion from inception through to March 27, 2009. The funds initially put up US$92 billion for the deals. In the same period, the total paper losses from all public market investments by SWFs stood at US$57.2 billion.

The damage is severe. For example, the Abu Dhabi Investment Authority (ADIA) pumped US$7.5 billion into Citi in November 2007. The investment has shrunk disastrously by -90.8 per cent to $684 million.

“It is clear that the massive hole in sovereign wealth fund portfolios today resulted from a mere handful of disastrous stock picks in the Western financial industry,” write Veljko Fotak, Bill Megginson and Hui Li in a recent report by Monitor/FEEM on SWFs and the crisis.

The largest SWF investments in recent years were “extremely clustered, both over time and in terms of target industry”.

“Not only did SWFs invest disproportionately in a poorly performing industry, but they have consistently picked stocks that have underperformed even within that industry.”

The authors put forward some reasons explaining these investment decisions. The SWFs could be passive, long-term investors that unfortunately built positions in stocks at precisely unfortunate times, or they could be active investors that made rotten stock calls. Since many of them originated from emerging economies without advanced financial markets, they may have relatively inexperienced investment staff, however anecdotal evidence suggests these funds are paying top dollar for good talent. Other forces may have been at play.

Not knowing the SWFs motives for investing, minority shareholders in target companies might have sold-down positions and consequently depressed share prices. Or perhaps the big funds were swayed by political pressures to invest in the distressed industries of target economies, to “minimise target-country regulatory and political opposition”.

The 10 largest SWF investments in public companies, and the subsequent investment returns to March 27, 2009, are as follows:

1. Government of Singapore Investment Corporation (GIC) invested US$14.4 billion in UBS in August 2008. The investment has shrunk by -69.87 per cent to $4.3 billion.

2. GIC invested US$9.7 billion in UBS in October 2007. The investment has shrunk by -78.27 per cent to $2.1 billion.

3. ADIA invested US$7.5 billion in Citi in November 2007. The investment has shrunk by -90.8 per cent to $684 million.

4. GIC invested US$6.8 billion in Citi in January 2007. The investment has shrunk by -65.5 per cent to $2.37 billion.

5. ADIA invested US$5 billion in PrimeWest Energy Trust of Canada in September 2007. The investment has returned 7.43 per cent to $5.37 billion.

6. China Investment Corporation (CIC) invested US$5 billion in Morgan Stanley in December 2007. The investment has shrunk by -49.1 per cent to $2.5 billion.

7. Temasek invested US$4.4 billion in Merrill Lynch in December 2007. The investment has shrunk by -88.3 per cent to $515 million.

8. Kuwait Investment Authority invested US$4 billion in Dow Chemical Company in July 2008. The investment has shrunk by -70.8 per cent to $1.17 billion.

9. Temasek invested US$4 billion in Standard Chartered in March 2006. The investment has shrunk by -41.37 per cent to $2.3 billion.

10. Temasek invested US$3.4 billion in Merrill Lynch in July 2008. The investment has shrunk by -48 per cent to $1.76 billion.

The authors compared the performance of each SWF’s public market investments with those made by investment firms from the same countries, and of the nearest size. They found the average performance of SWFs in listed companies was 15.5 per cent lower than the average returns from the matched firms.

“The average SWF is profitable, but underperforming. Yet the largest investments are clearly not profitable, leading to substantial overall portfolio losses.”

Putting the US taxpayer aside, the funds have provided more capital to ailing banks than any other investor or entity in recent years. SWFs invested US$90 billion in the stock of US and European financial institutions between July 2005 and October 2008, and the CIC, launched in late 2007, pumped an additional US$40 billion into state-owned banks.

“Collectively, these funds have invested more new capital into the world’s financial institutions recently than any other single entity except the entire US government.”