Seizing the future: State-owned investment funding for the new era

9 min readApr 19, 2024

Sovereign wealth funds have grown significantly in number and value in recent years.
Professor Bill Megginson, Price Chair in Finance at the University of Oklahoma’s Michael F. Price College of Business, USA has conducted a comprehensive survey, finding an appetite for speculative, longer-term investment.
These funds have become increasingly important to financiers of new high-technology businesses and infrastructure projects.
Megginson’s evidence indicates that these state-owned investors are purely looking for high future returns and are not seeking political influence.

Sovereign wealth funds (SWFs) are state-owned investment funds that have become major players in global financial markets. At the turn of the century, there were 62 sovereign wealth funds (SWFs), with around $1 trillion of assets under management (AUM). That has now risen to over $11 trillion managed across 176 funds. Mostly from non-Western countries, SWFs have become major sources of funding for companies worldwide, particularly for new enterprises in the capital-intensive technology and healthcare industries.

Professor Bill Megginson, Price Chair in Finance at the University of Oklahoma’s Michael F. Price College of Business, has led a comprehensive review of the research on SWFs to produce a study into the evolution and impact of this increasingly influential category of investor.

Thinking ahead

A state establishes an SWF with cash surpluses that come from either commodity sales — mainly oil and gas — or from manufacturing export earnings. Over half of the largest SWFs are still oil-based funds. Funds tend to fall into one of three categories. There are stabilisation funds that hold invested capital as a precautionary buffer to protect the domestic economy from any financial shocks. These tend to follow a prudential investment style, investing in a diversified global portfolio of publicly traded stocks and bonds.

Most SWFs are savings funds that invest for future generations. These prioritise investment in assets with potentially higher risks but with higher future returns, particularly alternatives to public stocks and bonds such as private equity and direct infrastructure ownership. The world ranking of SWFs (in terms of AUM) is dominated by these savings funds, with only one stabilisation fund in the top five.

There are also strategic, development funds. These allocate capital to supporting the domestic economy, similar to a state development bank, but using equity investment rather than loan funding. This is a particularly common approach to development in the Gulf states and in sub-Saharan Africa.

Megginson does however draw attention to the capacity of all SWFs to switch to domestic support during times of economic crisis, as evidenced by the COVID-19 pandemic period, when SWFs spent $57 billion bailing out domestic companies.

Shifting preferences

SWFs are global investors. Megginson highlights that the largest 35 funds have allocated around half of their capital abroad. The five largest are mainly invested abroad, as these huge funds need to invest around the world to find enough places for their cash pool. Megginson highlights two key trends: developing markets have been attracting an increasing proportion of stock market (public equity) purchases, and since the 2007–2008 Global Financial Crisis (GFC), there has been a big move away from public stock market investment. This has been mirrored by a significant increase in the amount of private equity deals.

A state establishes an SWF with cash surpluses that come from either commodity sales — mainly oil and gas — or from manufacturing export earnings.

This is a shift towards higher-risk investment that offers the possibility of higher returns. Private equity (PE) is more risky than public equity (Eq) because it is issued by young companies that are currently not making much (if any) money. But the stock price of a success story has far more potential to grow than a mature public corporation.

Infrastructure investment has also increased significantly. This is another asset class that only offers investment returns years in the future because of the amount of time needed for construction. The other main asset class, Fixed Income & Treasuries (FIT) — that is, government debt and investment grade corporate bonds — constitute the safest investment. These assets provide low returns in exchange for the promise of a reliable income. SWF investment in Fixed Income & Treasuries has fallen from over 40% before the Global Financial Crisis to 35%, further evidencing SWFs’ increased risk appetite and time horizon.

Waiting for more

Both developed and developing country SWFs have been switching to a higher private equity allocation, although developed country funds have invested more cash globally into more companies. Developed markets have been the main beneficiaries of fund inflows but developing country SWFs also tend to support their own domestic PE sector. In the most speculative, highest-risk PE — the support of startups, called venture capital (VC) — Megginson highlights the importance of India and China, which received 40% of total VC funding in 2021.

Developing markets have been attracting an increasing proportion of stock market (public equity) purchases, and since the 2007–2008 Global Financial Crisis, there has been a big move away from public stock market investment.

SWFs have great freedom to invest in PE because they do not have an immediate need for income. The big private sector funds are pension and life assurance companies who require cash now to pay their beneficiaries. This means their funds need safe, reliable income. SWFs do not have this performance pressure, so they can wait for PE to pay off. The private companies likewise benefit from stability provided by long-term SWF shareholders.

Is there an alternative agenda?

Some people suspect that SWFs invest abroad for national, political purposes and this can cause uneasiness in the host country, especially when SWFs move into what are considered to be strategically significant sectors, such as IT. The prevalence of private equity in SWF portfolios belies that fear. New technology companies typically rely on PE/VC for early-stage funding. Megginson finds that the growth of the technology sector since the GFC has been the main reason why SWFs have shifted further into PE.

Megginson speculates that SWF’s support for developing country infrastructure may be part of a wider strategy to diversify their supply chain from disruption.

SWFs often invest in private companies through specialist, third party PE firms that take the management decisions. Megginson highlights that this indicates that SWFs have no strategic agenda other than to maximise returns. This mirrors other research showing that SWFs generally do not use their equity stakes to influence company management, but instead hold shares solely for the income or capital gain.

This view of SWFs as passive investors is reinforced by Megginson’s survey of their attitude toward environmental, social and governance (ESG) matters. Although well-placed as shareholders to influence company management, two notable studies conclude that whilst SWFs do use ESG credentials in their stock-screening selection process, they choose not to be activist investors.

Investing in the future

Megginson finds that the move into longer-term assets is not restricted to equity. He notes a shift into holding more infrastructure assets, with SWFs investing $71.6 billion globally in 2021, a 60% increase since 2020. Infrastructure is a highly capital-intensive sector with projects that take many years to start earning money. Ownership offers long-term investment returns in the form of a relatively secure income stream from rents and fees. As such, this is another sector ideal for a sovereign fund that does not have the short-term performance pressures faced by private sector investors.

Megginson highlights an increase in fund flows to developing country infrastructure projects, with only 28% of new deals post 2020 in developed economies. Megginson speculates that this support for developing country infrastructure may be part of a wider strategy to diversify their supply chain from disruption.

By following a long-term investment strategy, SWFs are predominantly providing risk capital to support new ventures from infrastructure projects to speculative high-technology enterprises. Across both developed and developing countries, SWFs are becoming increasingly significant funders of the future.

Personal response

What first drew you to studying the investment behaviour of SWFs?

I have been researching state ownership of business enterprises — as owner/operators and as investors — for over 30 years. So, when sovereign wealth funds (SWF) stepped in to attempt a rescue of the Western banking system before the Global Financial Crisis of 2008, I became very interested in assessing what SWFs are and how they operate. Since then, I have followed with great interest the continuing growth of SWF size (assets under management), global diversification, and their remarkably passive investment management strategy, particularly outside their home countries.

Is there any research that has traced how historic investment returns have been used? If so, does this tell us anything useful about sovereign spending priorities? Or have returns mainly been reinvested?

There has been surprisingly little ‘published’ academic research examining SWF investment patterns and performance, though many working papers have been written. Extant research — including a paper I co-authored that appeared in the Review of Financial Studies in 2015 — shows that there is a positive stock market reaction (a ‘positive abnormal return’ in finance-speak) when an SWF purchases stock in a publicly traded company. But this return is half that observed when private companies and investors make such purchases. The handful of studies examining long-run stock returns after SWF stock purchases suggest these are even more negative than the long-run return after private stock purchasers. As a class, SWFs have not proven themselves particularly astute investors.

You highlight the issue of governments’ suspicion of foreign SWF equity investment. Does this apply more to public than to private equity ownership? In other words, do lawmakers feel less sensitive about SWF stakes in small, private firms rather than in large, well-known, possibly strategically significant corporates — despite the number of promising high-tech PE ventures?

I have always believed that SWFs should funnel their international equity investments through Western private equity (PE) funds, given the political hostility that stock purchases of listed companies by SWFs (particularly those based in non-democratic countries) has long engendered. Over the past decade, SWFs have indeed channelled far more of their cross-border equity investments through PE, either as co-investors with PE funds or in the form limited partner participation, and I expect this trend to continue. Besides the inherent political opposition that SWFs face when investing directly, most have very small (and relatively inexperienced) investment staffs, so it makes sense to partner with investment ‘insiders’ in Western countries, particularly since PE funds on average have a superior investment track record.

Contact Details

e: wmegginson@ou.edu
t: +1 (405) 325–2058
w: www.ou.edu/price/finance/faculty/billmegginson
w: papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=145311
LinkedIn: www.linkedin.com/in/william-megginson-phd-4b672222

Collaborators

Asif I Malik
Xin Yue Zhou

Cite this Article

Megginson, B, (2024) Seizing the future: State-owned investment funding for the new era, Research Features, 151.
DOI: 10.26904/RF-151–6090300111