Several years ago, academics Josh Lerner (Harvard) and Antoinette Schoar (MIT) published a paper about how LP returns are affected by the location of their general partners. Specifically, they found a negative proximity effect – that the PE portfolio performance of state pensions and public universities improved the farther away they invested from their home states. For example, UMass would do better if 70% of its GP commitments were to out-of-state funds, as opposed to if only 40% were.
Why bring this up today? Because Lerner and Schoar have just released a new working paper on the direct investment strategies of sovereign wealth funds, which features a strikingly similar conclusion. From an email Lerner sent over:
We examine nearly 2700 direct private equity investments by 29 sovereign wealth funds over the last two decades. We find that sovereign funds engage in a form of “trend chasing,” investing more at home when domestic equity prices are higher, and investing abroad when foreign prices are higher. Funds experience poor performance in the year after their domestic investments, while their investments abroad actually do better in the year after. Funds where politicians are involved have a much greater likelihood of investing at home than those where external managers are involved. Funds where with politicians are involved invest in higher valued industries, which have poor returns in the year after the investment, while the opposite pattern holds for funds with external managers.
Lerner and Schoar acknowledge that domestic investments may provide social or economic development benefits not reflected in ROI, but add that such an argument also contains its own problems. For example, if most domestic investments are made when domestic equities are high, then wouldn’t that also be a time when more domestic private capital is available (thus reducing the need for SWF investment)?
The paper is set to be formally released later this week, by Harvard, MIT and the National Bureau of Economic Research. But we’ve got it right here, for your perusing pleasure.