In a new paper, we show with a large sample of international data that sovereign wealth funds (SWFs) earn lower returns and are slower to fully liquidate their positions relative to other types of institutional investors. The data comprise 538 SWF investments in venture capital, private equity, and real asset funds from 52 countries from 1995-2020. Prior work has not considered the performance of SWF investors in these funds and has suggested that endowment funds perform better than other investors. The much larger dataset in our paper shows that other institutional investors, like endowments, do not overperform; on the contrary, one needs to look at SWFs among the different classes of institutional investors. The data show that SWFs are underperformers.
SWFs are large institutional investors that manage billions of dollars worldwide. According to the Sovereign Wealth Fund Institute￼￼, in October 2022, the top 100 largest SWFs had more than $10 trillion of assets under management. SWFs are known for being extremely large and operating with a long-term view that mixes political and financial goals. SWFs make direct investments in many asset classes, including publicly traded and privately held firms. SWFs also invest in private companies through intermediaries such as private equity and venture capital funds. Despite their massive scale and importance, evidence is scarce on the nature and performance of SWF investments in private equity, venture capital, and real asset funds. The source of capital in private equity funds has long been known to influence how that capital is deployed (￼Mayer et al.￼, 2005). As such, we focus our research questions on the horizon and returns to SWFs investments into these alternative funds.
Limited partners generally prefer a shorter investment horizon as they may have liquidity constraints. However, the investment horizon of the alternative asset fund may be longer when SWFs are involved if there is a political and strategic benefit to delay investment. That is, if the alternative investment fund is making investments that facilitate political goals and those goals have not yet come to fruition or would be more appropriately harnessed in a political context that has not yet come to fruition, then there could be political reasons to delay winding up the fund. Alternatively, the fund’s investment horizon may be shorter if there is political pressure to show short-term financial results. Our data indicate that SWFs are longer-term investors when compared to their counterparts, including pension funds, endowments, insurance companies, and banks. The longer horizon is observed even among the top quartile of institutional investors, signifying a unique inference that SWFs pursue a longer horizon for political and strategic objectives, consistent with the real option hypothesis. The finding is likewise robust to matched samples, including controls for vintage years, investment size, asset classes, industries, and other controls.
There are competing theories about how SWFs might influence the performance and duration of their VC/PE investments. On the one hand, we might conjecture that SWFs are large stable long-term investors that are unlikely not to honor capital commitments on time and provide certification of the quality of their investees. Consistent with Dewenter et al. (2010), Fernandes (2014), Bertoni and Lugo (2014) in other contexts, we would therefore expect that SWFs positively affect VC/PE performance. Also, with their political leverage, SWFs have access to superior information that enables VC/PE fund managers to carry out due diligence and improve investment returns. On the other hand, we might conjecture that SWFs are politically motivated investors, using the funds to push non-pecuniary objectives, possibly including political objectives, green mandates, and/or labor policies. If so, SWFs would influence their VC/PE fund managers in respect of delaying liquidations and pursuing other strategic and political objectives consistent with the SWF mandate. This latter prediction is consistent with the larger literature in some contexts and with Johan et al. (2013) in the context of SWF investment in private equity. Moreover, this latter prediction should be more pronounced for SWFs classified as having strategic motives (as opposed to savings motives for a country).
Our data indicate that the involvement of SWFs as a limited partner is associated with a lower Internal Rate of Return (IRR) and Total Value Paid-In (TVPI) relative to the capital invested. The negative performance of SWFs is particularly pronounced for SWF investments in venture capital funds. Relatedly, our findings show that SWF investment in venture capital funds is more likely in countries with lower disclosure requirements. These findings point to possible strategic reasons for SWF investment in early-stage companies whereby political benefits outweigh the financial losses. SWF buyout fund investments are more common and fit with the larger SWF investment mandates.
Prior research has shown superior endowments in venture capital and private equity funds; however, that evidence does not consider SWFs as a separate institutional investor class. When we account for SWFs, we do not find consistent evidence of superior endowment performance in venture capital and private equity funds, and we find that SWFs perform worse than other types of institutional investors. Our evidence contributes to this literature by providing a global analysis of different types of institutional investors in venture capital and private equity investments and showing the unique decisions and performance features of SWF investors in venture capital and private equity funds.
Douglas Cumming is the DeSantis Distinguished Professor of Finance and Entrepreneurship at the College of Business of Florida Atlantic University.
Pedro Monteiro is an Assistant Professor of Finance in the Department of Finance and Economics in the Kania School of Management at The University of Scranton, Pennsylvania.
This post was adapted from their “Sovereign Wealth Fund Investment in Venture Capital, Private Equity, and Real Asset Funds”.