2nd Quarter 2013 M&A

September 27, 2013 by Loch Adamson

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Sovereign wealth funds have a reputation as long-term investors whose horizons are unaffected by cyclical market swings. However, Sovereign Wealth Center data shows that they can be opportunistic. As assets in developed markets looked increasingly overvalued and commodity prices softened in the second quarter of 2013, sovereign wealth funds seem to have invested in simpler instruments, such as indexed-replicating equity strategies and exchange-traded funds. Many of them may have simply hoarded cash as valuations in developed markets rose and they struggled to find attractive investments.

This behavior isn’t unique to sovereign wealth funds. Global cross-border merger and acquisition activity fell by more than 26 percent, to $512.5 billion, in the second quarter, from $696.3 billion during the previous three-month period, according to London-based data provider Dealogic.

Our research shows that sovereign wealth funds spent a total of $8.8 billion on 35 foreign direct investments in the second quarter, a decline of more than 10 percent from the first quarter’s already low $9.8 billion. Sluggish deal flow follows a broader theme of heightened competition as sovereign funds are battling harder with private equity firms for a smaller number of attractive deals.

In a quarter when traditionally active funds such as China Investment Corp. (CIC) didn’t make any new investments, Norway’s Government Pension Fund Global (GPFG) was the biggest spender. GPFG allocated a total of $2.3 billion, including $1.6 billion in a deal announced in December 2012 to purchase a 50 percent interest in the European commercial property portfolio of San Francisco–based real estate investment company Prologis.

Q2 2013 Sovereign Wealth Funds’ Foreign Direct Investments by Region

Source: Sovereign Wealth Center

As we also observed in the first quarter of the year, CIC’s diminished investment activity contributed to a weak direct investment showing by sovereign wealth funds. For the first time since its foreign acquisition spree of 2009 and 2010 — when it invested $11.8 billion, primarily in financial services and commodities — CIC doesn’t appear in the quarterly transaction data compiled by the Sovereign Wealth Center. CIC’s absence has certainly affected sovereign wealth funds’ deal flow, considering that the fund used to make three or four large acquisitions per quarter.

Since its initial capitalization in 2007 with $200 billion from China’s foreign exchange reserves, the fund has only received an additional $49 billion from the State Administration of Foreign Exchange (SAFE), in 2011 and 2012. Without the promise of future cash inflows from the People’s Bank of China, CIC must become more self-reliant. Although the fund’s long-term strategy is to increase its exposure to assets that yield predictable cash flows, it didn’t make any direct investments during the second quarter of 2013.

As they have over the past two years, sovereign wealth funds focused on companies providing services to the expanding middle classes in BRICS countries and other emerging markets, investing about $3.1 billion during the second quarter to follow this secular trend.

Still, a single deal accounted for almost half of that total: In May, Norway’s GPFG, Qatar Holding (a Qatar Investment Authority subsidiary) and the State Oil Fund of the Republic of Azerbaijan (Sofaz) participated in a 102.5 billion-ruble ($3.25 billion) capital increase by St. Petersburg, Russia–based VTB Bank (which along with its subsidiaries forms VTB Group). Combined, the three funds took up half of the offering, contributing $1.7 billion to VTB’s capital.

The remaining $1.4 billion that sovereign wealth funds invested in emerging markets during this quarter was deployed by Temasek Holdings, which raised its stakes in major Chinese banks to help prevent a slowdown in the Hong Kong stock market from becoming a crash. In May, Temasek boosted its total holding of Beijing-based Industrial and Commercial Bank of China’s Hong Kong–listed shares to 8.07 percent from 6.71 percent. The Singaporean fund doesn’t appear to be too concerned about market instability, although such events may hurt its portfolio in the short term.

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