Sovereign wealth funds have been buying up stakes in troubled US and European money-centre banks, brokers and other financial institutions at such a rapid pace that you have to wonder: Do they know something other investors don’t or are they just spending too much, too fast?
A few months ago, the funds were regarded as the bogeymen of global finance, intent on using their affluence to acquire strategic industries in the West. By the year-end, they were its Santa Claus. In the past two years, these funds and Chinese financial institutions invested at least $77 billion in Western banks and money managers. Nearly $67 billion of that was placed in the last three quarters of 2007, accelerated by the banks’ need for capital infusions after a battering by the subprime mortgage crisis and related credit crunch.
The bigger deals include Government of Singapore Investment Corp.’s $9.7 billion investment in UBS AG and Temasek Holdings Pte’s 18% stake in Britain’s Standard Chartered Plc. for $9.2 billion. The Abu Dhabi Investment Authority paid $7.5 billion for a 4.9% holding in Citigroup Inc., while Temasek invested $4.4 billion in Merrill Lynch and Co. with an option to buy an additional $600 million of stock. China Investment Corp. bought $5 billion of Morgan Stanley.
With more than $2.5 trillion in capital, “not too long ago, these new masters of the universe were more feared than favoured,” says Joseph Quinlan, New York-based chief market strategist at Bank of America Capital Management. By providing capital to banks and financial institutions, “sovereign wealth funds emerged as a source of financial stability rather than instability.”
Maybe so. But these banks aren’t charitable institutions.
“We don’t know why anyone would want some of these financial institutions, as their franchises aren’t worth much; and they have big, complicated messes that won’t be fun to try to unravel,” Ray Dalio, Westport, Connecticut-based president of Bridgewater Associates Inc. with $150 billion under management, said in a late November report.
“Why would you want a bank as your platform, especially when the quality of portfolio managers working there are those who built the portfolios that yielded these results?”
The managements of these banks and brokers are nothing to cheer about. Just look at their losses. And by taking minority stakes, opting not to sit on boards and surrendering voting rights—as they have in several instances—the funds are betting on the same folks responsible for the red ink.
Bottom line: “Owning a big American bank is a bit like owning a big American automobile company, or a big American newspaper, or, for that matter, the US dollar,” Dalio said. “For all of them, the memory of what it was carries a certain cache that tends to make it trade for more than its real value in the modern world.”
Perhaps the most telling evidence that sovereign funds may be buying pigs in a poke is Warren Buffett’s rebuff to US financial institutions. “So far, we have not seen a deal that causes me to start salivating,” the chairman of Omaha, Nebraska-based Berkshire Hathaway Inc. said in a December 26 interview on CNBC. Of course, he isn’t averse to all. Berkshire Hathaway is the biggest shareholder in Wells Fargo and Co. and the second largest in M&T Bank Corp.
Two days later, the company said it was buying the reinsurance unit of Holland’s ING Groep NV and setting up a company to guarantee municipal debt in competition with bond insurers struggling to retain their AAA credit ratings.
Sovereign fund investments have focused on Western financial institutions with large presences in emerging markets, strong securities businesses and modern asset management capabilities, says Huw van Steenis, head of banking and diversified financials research for Morgan Stanley in London. Much of the investment is predicated on expectations of growing middle class wealth, especially in Asia. Initially, the investments look smart. The stocks are mostly very liquid and cheap. The shares are often sold at large discounts. Temasek purchased Merrill Lynch stock at a 12% discount to its share price a week before the announcement.
Sovereign funds can afford to be long-term investors. And being government entities, they aren’t required to constantly mark their investments to market. Even so, the stocks aren’t cheap relative to the financial sector’s long-termvaluation multiples, Dalio said. “We also believe that the credit problems that lie beneath the surface are much larger and more threatening than the ones that have surfaced,” Bridgewater said in a 21 November report.
When a crisis hits, it’s almost reflexive for financial institutions to understate losses and postpone acknowledging them. Nonetheless, “2008 will likely present the best buying opportunity for high-quality financials in the last decade,” Lehman Brothers Holdings Inc. said in a 7 December report.
Three problems: One, figuring out which ones are high quality. Two, in July, Lehman was wrong when it said the worst of the global credit market rout was over. Three, 7 December isn’t a very lucky date in US history.
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