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Those Fickle Sovereign Wealth Funds

NEW YORK – Two years ago, sovereign wealth funds (SWFs) were the bogeymen of world finance. Then came the global financial crisis, and worries about them seemed to vanish. Now that the crisis is abating, concerns about the SWFs and their behavior are returning.

SWFs like to portray themselves as politically independent, commercially motivated investment vehicles. But the last couple of years have proved that, in a crisis, they are not immune from political pressures to re-focus their portfolio allocations towards domestic investments. This tendency at times of economic downturn suggests that SWFs are not the long-term, stable shareholders of foreign firms that they (and some commentators) claim themselves to be.

In the years following 2000 but before the financial crisis hit, the proportion of SWF equity investments allocated to foreign markets had been increasing, reaching a peak of 90% during the second quarter of 2008. During the second half of 2008, however, a clear retreat of SWFs towards domestic markets became visible. Indeed, as the financial crisis spread to the emerging markets that host most SWFs, the proportion of foreign investments within SWF portfolios fell to about 60%.

Over the second half of 2009, with the world economy recovering, this trend reversed. But the message is clear: when domestic economies require stabilization, SWFs will shift their focus to domestic investments. In case of a worldwide economic event, such as the recent crisis, this can mean pulling out of foreign markets when they are most vulnerable.