Seasonal windfall that lingers

Michael R. Sesit

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, these funds were regarded as the bogeymen of global finance, intent on using their affluence to acquire strategic industries in the West. By year’s end, they were its Santa Claus.

In the past two years, sovereign wealth funds and Chinese financial institutions invested at least $77.2 billion in Western banks and money managers. About $66.6 billion of that was placed in the last three quarters of 2007, accelerated by banks’ needs for capital infusions after being battered by the subprime-mortgage crisis and related credit crunch.

The bigger deals include Government of Singapore Investment Corp’s $9.7 billion investment in Switzerland’s UBS, and Singapore-based Temasek Holdings’s 18 per cent stake in Britain’s Standard Chartered for $9.2 billion.

The Abu Dhabi Investment Authority (ADIA) paid $7.5 billion for a 4.9 per cent holding in Citigroup, while Temasek invested $4.4 billion in Merrill Lynch & Co. with an option to buy an additional $600 million of stock. China Investment Corp bought $5 billion of Morgan Stanley.

By providing badly-needed capital to banks and other financial institutions, “sovereign wealth funds emerged as a source of financial stability rather than instability,” says Joseph Quinlan, New York-based chief market strategist at Bank of America Capital Management.

Maybe so. But these giant piggy 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 with $150 billion under management, said in a late November report.

Many banks make money playing the gap in prices, or spreads, between different securities, currencies and interest rates. These strategies, however, can be replicated without banks’ large, expensive overheads.

Efficient portfolios

“We are all competing to create the most efficient portfolios to make our spreads over our cost of funds,” Dalio said. “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.

Sovereign-fund investments have focused on Western financial institutions with large presences in emerging-market economies, strong securities businesses and modern asset-management capabilities, according to 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.

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