Are All Sovereign Investors Becoming More Activist?

Are All Sovereign Investors Becoming More Activist?

Morgan Stanley announced a $5 billion investment from the Chinese Investment Corporation (CIC) which will convert to a 9.9% share in the company. This is now the third purchase by a relatively large sovereign wealth fund in a major US or EU financial institution in the last month or so.

Last week, Singapore's GIC and an undisclosed middle eastern investor invested in UBS helping take its Tier 1 capital ratio to 12%. Two weeks before that Abu Dhabi Investment Authority (ADIA) paid $7.5 billion for a stake in Citi. Other smaller investors such as Qatar and Dubai's Istithmar suggests that this is an ideal time for investment in western financial institutions.

In a time when the heady dealmaking of only half a year ago has slown, the purchases by these sovereign funds have stood out. However, the increasing willingness to make and announce these strategic stakes has reached a new level. and clearly these funds are big enough to move markets...

It seems a simple story– banks needing to shore up troubled balance sheets meet cash-rich sovereign investor seeking higher returns/distressed assets. In fact their cash holdings helped make them attractive capital sources. Morgan Stanley data had already suggested that in 2007, SWFs bought $46 billion in western financial institutions – and Chinese banks another $8 billion.

These financial sector recipients have an interest in disclosing the funding. They lock in long-term investors for a considerable period rather than a series of smaller, potentially shorter term ones to shore up capital base amid write downs – in an attempt to persuade investors of their solvency. In a sense they are borrowing both the capital and the reputation of these long-standing long-term investors. But is their strategy shifting?

Wessel noted last week in the WSJ:

The best, oldest SWFs are at least as shrewd as Citigroup, UBS and Merrill Lynch, and that is scary enough. The new ones, swollen with oil revenues or proceeds of currency-market dealings, are like teenagers with more inherited wealth than they can handle.

the most challenging thing is what we don't know about these funds. We don't yet know the effect of sovereign funds being a key capital source and what strings are attached. of course many sovereign funds were already large contributors to funds - and certain asset classes. But surely the nature of the investors affects the intermediary role of their targets.

Such deals do build on pre-existing relationships. In many cases these asset managers had already been involved in managing some of the funds, so it is natural who to turn to in a time of need. But there are challenges. These funds are not transparent. ADIA may be a long-standing investor about whom we know almost nothing. Will the availability of such funds that do not demand a board stake affect corporate governance? Influence is possible without management stakes.

What is somewhat surprising for me was the relatively significant stake size - about 9% for GIC's stake in UBS and just under 5% for ADIA's citi stake. Surprising because these two funds have tended to take only small stakes and to avoid disclosure.

When I tried to categorize the sovereign investment universe sometime ago, both GIC and ADIA seemed fit in a more conservative sovereign wealth fund category, in contrast to the more strategic, activist new investment vehicles in the gulf which modeled themselves on private equity firms.

perhaps with the number of splashy deals these more reticent-to-disclose investors are more willing to make their holdings public and seek higher returns like their counterparts are doing. but does it mean the line between the likes of Temasek and GIC is blurring?

Even ADIA may be becoming more activist. In addition to the Citi stake, ADIA has made a few other larger purchases, stakes in Apollo, EFG-Hermes among others. None are management/controlling roles. It also made its first significant London purchase in decades. Perhaps it is taking somewhat larger stakes, perhaps it is also more willing to disclose the stakes it has.

yet, ADIA's investments remain different from those of more active investment vehicles in the gulf but because of its size (arounf $650?) any move is significant.

But what about China? Where does it fit in?

CIC's strategy is an unknown quantity. Lou Jiwei, its main manager has stressed that the CIC will be a stabilizing investor and noted the role of SWFs in supporting financial institutions. So perhaps today’s news about the stake in Morgan Stanley should not come as a surprise. But Keith Bradsher suggests that the decision to invest in Morgan Stanley came from the highest levels of Chinese government– perhaps reminiscent of the Blackstone deal which happened before CIC was officially launched. Quick, nimble decision making is thought to have characterized the but given the lack of transparency and political oversight, it may become clearer where the buck stops on China’s investment.

CIC's ultimate goal may be to be a coordinating body for Chinese foreign investment. 2/3 of CIC’s initial $200 billion are spoken for - 1/3 accounted for central Huijin - its stakes in state banks another 1/3 will recapitalize policy banks. And CIC is seeking bids to manage part of the remaining $60 or so billion from asset managers. Overall, given its stakes in the banks and other holdings, CIC has a considerable financial sector weighting. So far not very diversified?

the CIC is clearly under pressure not to invest in a loss-making investment and to make enough money to cover its financing costs. Especially as more funds may be sent its way as China seeks to farm out its dollars to a variety of institutions (state banks are now holding more reserves in dollars) rather than just the central bank. And equity investment outflows are still in early stages.

In the case of both China and Abu Dhabi, investment in US financial institutions may reflect a shift between dollar assets. Both tend to have significant dollar holdings, especially on a flow basis, though China has much more than Abu Dhabi. In China’s case, they might prefer to own part of a US investment bank rather than US treasuries, especially if there are potential for spinoffs. After all, overall the chinese government and most gulf states have to collectively buy a lot of dollars or watch their currencies appreciate.

Several funds are or may support the outward investment of national companies or strategically investing in sectors in which they might hope either to gain technology transfer or synergies with SOEs and financial institutions. several questions emerge - how effective are governments at picking winners? there is also a risk that the sovereign investors might be expected to bear the greater risk of such investment and if so. what will be the implications of their broader strategy? and this might increase asset protectionism.

Some Chinese officials have suggested it support external purchases of Chinese funds. It was recently suggested that CIC along with several Chinese companies might bid for Rio Tinto, though this was denied.

Libya's fund suggested that it plans to invest in foreign (US) companies that were best placed to help Libya develop and diversify its economy. Little information is available but some form of joint venture is not impossible. Whilst in Paris, Qaddafi suggested investment of as much as $100b abroad.

Brazil's foreign ministry has touted a fund that would support Brazilian investments abroad – and reduce further reserve accumulation and possibly reduce. But the institutional structure is uncertain – current plans include using a national development fund. and the central bank has opposed using reserves.

Many GCC funds are investing abroad in sectors of strength or future development for their states. These joint ventures include aluminum, manufacturing, consumer goods of interest in the gulf. Watch this space for a closer look.

Finally - While these strategic stakes are considerable and have significant political and regulatory implications… including the impact of sovereign funds as the new go-to capital source, the imbalances are so significant that these strategic stakes show only part of the story. Because of exchange rate policies – ie a reluctance to allow currencies to appreciate against a falling dollar, many countries are scaling up central bank intervention to neutralize speculative inflows – adding to their reserves. As such they are adding to their conservative - primarily dollar - assets. In a paper released yesterday, Brad Setser and I argue that on the whole, currency diversification by the GCC investment funds this year has been offset by – largely dollar – reserve accumulation. A trend that will likely remain unless official and de facto dollar peggers allow more appreciation and slow their dollar purchases.

Rachel Ziemba | Dec 19, 2007