NEW YORK (Fortune) -- After months of relative silence, sovereign wealth funds, the huge, state-owned vehicles that export-rich countries use to invest their reserves, are on the prowl again.
"[Funds] are researching deals and trying to get things lined up," says R.P. Eddy, CEO of Ergo, a research firm that advises some of the world's biggest sovereign wealth funds. "They're standing on the edge of the pool and waiting to see who's going to jump in first."
Sovereign wealth fund managers have reason to be hesitant. A notoriously secretive bunch with an estimated $3 trillion in assets, they have received unwanted attention over the last couple of years for making public missteps.
Several funds acted as white knights at the beginning of the downturn, pouring billions into Western financial institutions. Some profited: the Kuwait Investment Authority recently announced a gain of $1.1 billion from its investment in Citigroup (C, Fortune 500) (the fund hasn't released specifics about the deal, but its preferred stock -- which reportedly came with a conversion premium -- was priced at $17 in early December).
Many, however, saw their investments go downhill. Earlier this year, Singapore's Temasek sold its stake in Bank of America (BAC, Fortune 500) at an estimated loss of more than $3 billion. The Abu Dhabi Investment Authority (ADIA), the world's biggest sovereign wealth fund, is currently battling with Citigroup over its commitment to convert $7.5 billion worth of Citi bonds into shares priced at upwards of $31. Citi stock is now worth about $3.40.
In the wake of the financial crisis, sovereign wealth fund spending ground to a halt for most of 2009. The funds collectively reported just 11 deals worth $11 billion in the second quarter, the lowest amount since 2004, according to British consulting firm Monitor Group.
Yet even as deal flow hit a low, there were signs of life: In the second quarter (the most recent quarter for which data is available) 19 new deals were announced or pending. Now, sovereign wealth funds are getting ready to make big moves again. Eddy estimates a new wave of investments will kick off in the second quarter of 2010.
Indeed, several managers are in talks now with the world's biggest pensions and hedge funds to make investments in coalition, says Eddy. This time, he says, the state-owned funds have an edge over less well-capitalized private investment funds. "Every major hedge fund...is open to new structural relationships," he says. "Sovereign wealth funds can demand a lot more for their money. They're the belles of the ball."
One reason sovereign wealth funds are on the move again is that conditions in their home economies are improving. While the funds typically invest outside their own countries, they depend on domestic revenue -- typically from manufacturing or oil exports -- for inflows.
At the beginning of the recession, that spigot dried up, and funds in countries like Russia had to pour money into their native capital markets. "[Russia's] national reserve fund was being used to plug a hole in [its] deficit," says Rachel Ziemba, an analyst at Roubini Global Economics. She adds that some sovereign wealth funds, like Kuwait, faced pressures to invest in their domestic markets.
Now that oil prices have stabilized and exports are rebounding, countries in Asia and the Middle East are better able to divert money to their investment funds, says Rachel Ziemba, an analyst at Roubini Global Economics. "The second half of 2009 was met with a significant increase in global reserves," she says. "The funds of the gulf -- ADIA, Kuwait -- aren't quite at 2008 levels, but they're just about there." Ziemba says China Investment Corp. is reportedly going to receive more capital for spending.
The next wave of sovereign wealth fund investments is likely to look very different from the flurry that occurred before the crisis. For one, the funds have drastically cut back on banking assets. Just 16% of the deals they made this year involved the financial sector, down from 48% in 2008, according to Barclays data.
Meanwhile, including China Development Bank, which received a capital boost from China Investment Corp., more than 50% of sovereign wealth funds' investments were in the natural resources sector, up from a mere 8% the year before. Huey Evans points to the Chinese government's investments in Rosneft and Petrobras (PZE), oil companies that agreed to send the country fuel in exchange for loans.
"China was the clear leader in making direct investments," she says. "We're seeing much more of that." China Investment Corp.'s last three reported investments were in a Chinese alternative energy business, an American power seller, and a Russian oil producer.
While sovereign wealth fund managers, like most investors, have started allocating more assets to emerging markets this year, Steffen Kern, an economist at Deutsche Bank, thinks they'll continue to invest in the U.S. and Europe. ADIA, for example, recently bought a 10.9% stake in U.S. hotel operator Hyatt (H).
"Intra-regional investments -- especially Asian funds investing in surrounding economies -- are extremely dynamic right now," he says. "But the interest in European and American assets is unbroken."
Sovereign wealth funds are not only rebalancing their portfolios but also their management teams, says Eddy. Several countries, spooked by the sudden losses they incurred over the last couple of years, have taken a hard look at their funds, calling for due diligence. "One of the funds we worked with basically cleaned house," he says. "There's a whole new professionalism to the investment process.
For example, he says, many countries have endeavored to improve coordination between their sovereign funds and other state-owned investment vehicles. In the past, he says, one fund would short a company while the other was buying it.
Fund managers are also starting to collaborate more than they did before, with teams in different countries making investments together. Barclays' Huey Evans says the funds are creating new venues to meet, like the International Working Group of Sovereign Wealth Funds' inaugural forum in Azerbaijan this October.
Other funds are partnering to find buyers for large divestitures. In September, Singapore's Temasek sold its controlling stake in Chartered Semiconductor to Abu Dhabi's Advanced Technology Investment Co. for $1.8 billion.
While Eddy disavows the notion that sovereign wealth funds move in lockstep ("they have more dissimilar than they have in common"), he says he has seen a surge in "extremely creative investments." His clients are looking at the transportation and agriculture sectors, as well as large infrastructure projects in the developing world. "They're the type of deals only large investors can do."
But however creative the funds get, Deutsche Bank's Kern expects the increased scrutiny from their parent governments to continue. "[The governments] had gotten used to high dividends and were surprised -- and disappointed," he says. "The fact that things could turn around so negatively and quickly left a serious impression on them."