Silence not necessarily golden for sovereign funds

Henny Sender
Financial Times
19 Jan 08

Sovereign wealth funds are suddenly the capital provider of first and last resort for ailing US financial institutions, investing at least $30bn in some of Wall Street’s biggest banks and brokerages.

In many ways the SWFs are a dream investor: not only do they come flush with money but also “they are massive, passive and patient”, as Mark Bradley, who heads Morgan Stanley’s relationships with private equity firms and other large pools of capital, tells Sender. In other words, they lack the motivation and the resources to demand swift and radical change.

But their arrival also poses another question: is the presence of these “passive” investors good for the US economy?

The finance from the SWFs comes with few strings attached. Yet some observers are beginning to fear that this very passivity – which seems such a blessing to Wall Street – might have a negative side to it. It could mean there will be little pressure for real change at institutions that, after incurring large losses on subprime mortgages are arguably in dire need of reform.

Larry Fink, the founder and head of BlackRock, one of the world’s largest investors with some $1,300bn under management, notes that in the past, when firms had losses of this magnitude, “they would not have survived independently. But now we may not be taking out excess capacity.”

Naturally, the SWFs see their patience and passivity as an advantage rather than a weakness. Most notably, they view themselves as “friendlier” stakeholders than western private equity groups, which need to be rigorous owners to produce the high returns demanded by their investors. Indeed, the sovereign funds present themselves as almost antithetical to the private equity houses and hedge funds that form that other big pool of global capital.

Their passivity arises for several reasons, notes Sender. For a start, as arms of foreign governments, SWFs increasingly feel they need to minimise any political backlash or concerns about national security. Two years after a furore over a bid for US port facilities from Dubai Ports World and an offer by China’s CNOOC for Unocal, the US energy company, foreign wealth funds have forsworn an active, interventionist stance.

When the embryonic China Investment Corp announced last May that it was taking a minority stake in Blackstone, it said it would be passive and would not seek to sit on the board of the buy-out group. That has become the template for subsequent deals, whether dealing with healthy or troubled companies.

But in addition to political imperatives, there is a more practical constraint: few SWFs have the capacity to be active investors even if they wished. In most cases, these organisations are still building the human infrastructure to handle their bulging coffers. CIC has yet to celebrate its first birthday and few have the experience or specialised organisational structure of the Kuwait Investment Authority or Singapore’s Temasek.

Meanwhile, private equity firms today have little interest in taking minority stakes in troubled banks, both because they lack the deep pockets of the sovereign funds and because they prefer full control.

“The scale of these companies dwarfs our ability to make a meaningful contribution,” Stephen Schwarzman, Blackstone chief executive, said of institutions such as Citigroup on a recent conference call.

Blackstone, the largest private equity firm in the world, has more than $100bn of assets under management. But the Abu Dhabi Investment Authority, which is merely one investment arm of the Gulf emirate’s government, albeit the largest, has almost $1,000bn of firepower – more than the combined $700bn that private equity controls.

The sovereign funds have other advantages as shareholders. For example, because they do not depend on borrowed money nearly as much as private equity firms do to finance their stakes, the companies in which they invest do not become loaded with debt.

To the sovereign funds, the meltdown in the credit markets since mid-2007 is a once-in-a-lifetime opportunity to acquire stakes in big US financial institutions at bargain prices. The wealth funds “are taking the long-term view”, says one banker, who works with a group that deals with private equity firms and sovereign funds out of London. “They believe that the markets will come back in 18 months.”

But the $30bn question that now hangs over Wall Street is what will happen if the markets do not recover, the banks and brokerages have to take further big writedowns and share prices continue to slide. Would the sovereign funds, in other words, be able to do anything more than monitor their losses? In that eventuality, if not before, they might need both the capability and the courage to speak out.

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