Companies do badly after foreign sovereign wealth funds buy their shares, according to”Sovereign Wealth Fund Investment Patterns and Performance” by Bernardo Bortolotti, Veljko Fotak and William Megginson, reports the FT.
When an SWF invests, the target company’s share price often jumps in the days surrounding the investment, the research found, but over the following year or two, the share price significantly underperforms its peer group.
SWFs usually take significant stakes in companies – the median stake, according to the research, is 8%, the average 14% – and frequently buy the shares directly from the companies rather than on the open market. After two years, the average investment had lagged its peers by 10%.
“They’re giving cash to the companies and taking a large passive stake. All the literature shows this is a bad idea,” said Prof Megginson. The exception that proves the rule is the Norwegian Government Pension Fund, which makes small scale investments in publicly traded shares.
When its results are stripped out of the data, the negative impact of SWF investment looks worse, with an average underperformance of 13.55%.
The findings support the academics’ “Constrained Foreign Investor Hypothesis”, which predicts that foreign investors, particularly SWFs, will find it difficult to hold directors of companies to account because political considerations make them reluctant to antagonise management.
Political concerns may also deter them from selling shares in companies that are not performing according to expectations, removing another possible feedback mechanism that might improve the management of a company.
The underperformance that follows such passive ownership is a problem for other shareholders as well, said MrPeter Butler, chief executive of Governance for Owners.
“It’s the free-rider problem. SWFs are relying on other shareholders [being engaged owners] and holding directors to account. Either they get something for nothing, or nobody does it and the shareholders suffer,” Mr Butler said.
The new research will likely cause some debate, particularly as it flatly contradicts other studies that showed companies benefiting from SWF investment. Nuno Fernandes, professor of finance at IMD and a Lamfalussy research fellow of the European Central Bank, recently published a paper showing SWF investments led to a significant outperformance by the company. Prof Fernandes reported that further research led him to conclude SWFs were actually very good at monitoring companies where they had invested, as well as opening up new markets for the companies and helping them lower the cost of capital.
So Temasek and GIC be warned.