'Sleeping with the Enemy' or 'An Ounce of Prevention': Sovereign Wealth Fund Investments and Market Destabilization

Abstract

We investigate whether the accusations raised by the popular press regarding the potential destabilizing force of sovereign wealth fund investment have merit. Specifically, we examine the effect of sovereign wealth fund (SWF) investment on return and volatility, both for the target firm and the local market index. We find evidence of both a reduction of target returns and risk, but find that risk is not sufficiently reduced to offset the change in return. We also find that the market wide return to risk ratios indicate uncompensated risk following SWF investment for the market as a whole. Firm volatility decomposition suggests that both total risk and idiosyncratic risk relative to returns are not compensated at the same level following SWF investment as they were preceding it. In a limited Granger causality analysis, we find that SWF investment Granger-causes the firm level return/risk relation to deteriorate. We do not, however, find that the media Granger-causes the poor performance. The decrease in return without a corresponding decrease in volatility suggests that sovereign wealth fund investment could be potentially destabilizing.