2013 Q1 Report - M&A

June 21, 2013 by Loch Adamson

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Many sovereign wealth funds claim that they are unaffected by short-term, cyclical market trends and primarily seek to profit from secular trends that align with their long investment horizons. But judging from their behavior in the first quarter of the year, they are just as constrained by the short-term market environment as other investors.

During the first three months of 2013, our research shows that sovereign wealth funds spent $8.7 billion on 34 investments, a 30 percent decline in value compared to the same period last year and a 44 percent decline over the fourth quarter of 2012. This notable weakening in deal flow follows the same trajectory as global mergers and acquisitions activity, which fell 26 percent year-over-year to its lowest ebb since the third quarter of 2005, according to London-based global data provider Dealogic. The downward trend was particularly noticeable in cross-border M&A (the type of investment activity in which sovereign wealth funds are predominantly involved), which accounted for 24 percent of total deal volume — the smallest share since the fourth quarter of 2009.

This correlation demonstrates that although sovereign wealth funds seek to invest countercyclically to take advantage of discrepancies between assets’ market prices and their fundamental valuations, prevailing economic conditions often stop them. During the first quarter of 2013 a wave of money flowed through international markets as global investors hunted for yield. Fresh capital poured into emerging economies (many sovereign wealth funds increased their allocations to those markets in 2012) and dividend-paying stocks. Consequently, valuations rose in public and private markets. Sovereign wealth funds faced increasing competition for deals and found it harder to take advantage of discrepancies.

Two other factors contributed to weak deal flow in the first quarter of the year. The first pertains to China Investment Corp.’s diminished investment activity. CIC has always been an active direct investor, often making three or four large acquisitions per quarter since 2010. But since its initial capitalization with $200 billion from China’s foreign exchange reserves in 2007, the fund has only received another $30 billion from the State Administration of Foreign Exchange (SAFE), the central bank body responsible for managing the country’s reserves. SAFE doesn’t have any known plans to dispense more money and, despite CIC’s international profile, it is stepping up its own diversification drive. Since 2011, SAFE has actively invested in global infrastructure, listed stocks, private equity and real estate to increase returns, effectively competing with CIC. Consequently, CIC is now almost fully invested: The Sovereign Wealth Center has recorded a total of 52 direct investments with a combined value of $310 billion. With relatively little spare capital, the fund can’t allocate much and will probably be more discerning when it does.

The commodities market may also have helped to reduce direct investment by sovereign wealth funds. In the first six months of 2013, commodity prices declined across nearly all asset types, with only natural gas holding up. This slump has had two effects on sovereign wealth funds’ investment activities. Many funds (particularly those from Asia) have invested heavily in commodity-producing companies over the past two years. With commodity prices falling and analysts casting doubt on the long-term durability of the more than decadelong commodity price supercycle, companies that produce and supply raw materials may not appear as attractive as they did in 2011 and 2012.

Therefore sovereign wealth funds have started to look to other sectors for investment opportunities. Like oil tankers, these giant funds take a long time to slow down and turn, and the break in activity may signal that some are refocusing their strategies.
Second, the decline in commodity prices may have raised questions about future inflows for sovereign wealth funds that receive income from commodity revenue surpluses. With uncertain near- to midterm funding streams, they may have chosen to slow their rate of investment so they can meet other future obligations.

Although sovereign wealth funds may be buffeted by market cycles, some keep following secular growth trends, most notably rising discretionary incomes in emerging countries. These investments largely fell into two camps: companies providing goods and services to the growing emerging-market financial elite and those providing consumer goods to the expanding middle class.
The first trend was largely pursued by the Qatar Investment Authority (QIA), which is looking to invest luxury hotels and high-end consumer goods worldwide. In March, QIA upped its stake in New York–based jeweler Tiffany & Co. to more than 11 percent. This acquisition is a good example of sovereign wealth funds looking to profit from emerging markets through companies that carry developed-market risk: Tiffany saw 15 percent year-over-year growth in the Asia-Pacific during the first quarter, while its sales outside the Americas, Europe, Japan and emerging Asia-Pacific tripled during the same period, from $9 million in to $27 million, largely thanks to the United Arab Emirates.

Other funds — particularly Singapore’s Temasek Holdings and Government of Singapore Investment Corp. (GIC) — are looking to provide goods and services to the rising middle classes in Southeast Asia and India by investing in retail. Temasek and GIC participated in the initial public offering of Indonesian retailer Matahari Putra Prima and Bangalore, and Temasek invested $26 million in India–based cancer specialist HealthCare Global Enterprises.

Sovereign Wealth Fund Foreign Direct Investment, Geography/Industry Q1 2013

Source: Sovereign Wealth Center

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