Governments Get a SWF Financial Kick

By Bill Powell

To banks and other financial-services companies starved for cash by the subprime-credit crises, where they obtain bailout money is less important than the fact that it's available at all. Just ask investors in Citigroup or UBS. The big Swiss bank had to take a $10 billion write-down--it had already taken a $4.4 billion hit--on the value of its "super-senior" subprime portfolio, those formerly top-rated bonds. To restore its capital base, UBS sold $8.9 billion in convertible notes to the Government of Singapore Investment Corp. (GIC) and an additional $1.8 billion to a mystery Middle East investor.

In other words, up to 12.4% of a conservative Swiss bank was sold to foreign entities. Weeks before, shaky Citi, also in need of capital to repair its subprime-holed balance sheet, was handed a lifeline by a similarly unlikely rescuer. The Abu Dhabi Investment Authority, a $625 billion sovereign wealth fund (SWF) run by the tiny Persian Gulf emirate, announced it was forking over $7.6 billion for a 4.9% stake in Citi. Though Citi still faces difficulties, the cash infusion helped stabilize its plunging stock price and signaled to rattled markets that money was available to help subprime victims survive the turmoil.

Is it ever. The investments by GIC and Abu Dhabi, part of the United Arab Emirates, marks a turning point of sorts for SWFs. These enormous pools of wealth, controlled by governments in countries that have been getting fat off high oil prices and a booming global economy, are viewed suspiciously by those who fear foreign powers might use them to gain competitive advantages or push political agendas. But now, thanks in part to the bank deals, some fears have been allayed; companies in need of capital are courting investments from oil- and gas-rich states such as Abu Dhabi and Russia as well as from rising economies like China, which recently formed a $200 billion SWF to help the government invest its burgeoning foreign exchange reserves. SWFs, says a senior banker at JPMorgan Chase, "are the new It girl of global finance. Everyone wants a piece of them."

The reason for that is clear enough. At a time of extreme stress in global-equity and credit markets, many governments have surplus foreign exchange to play with--and because of the falling U.S. dollar, they are increasingly interested in investing their cash where it can earn greater returns than it would from U.S. Treasury debt, the traditional haven. The largest SWFs--the so-called Super Seven, comprising China, Russia, Abu Dhabi, Kuwait, Norway and two Singapore funds--control up to $1.8 trillion. By 2011, assets held by SWFs worldwide are projected to grow almost fourfold, to nearly $8 trillion, according to Merrill Lynch. By comparison, hedge funds--unregulated private investment pools--control a paltry $1.5 trillion to $2.6 trillion, according to estimates.

The rush of SWF money into Western markets is making bankers a lot happier than it is governments and politicians. At a G-7 meeting of finance ministers held in Washington in October, SWFs were a major topic of discussion, partly owing to concern about their potential impact on markets. SWF "investment policies, minor comments or rumors could spark volatility," said Clay Lowery, assistant secretary for international affairs at the U.S. Treasury Department, in a speech last summer. "It is hard to dismiss entirely the possibility of unseen, imprudent risk management with broader consequences." Even presidential candidate Hillary Clinton weighed in recently, saying in a Financial Times interview that SWFs pose a potential threat to U.S. economic sovereignty. "I think vigilance is in order when the investor is a foreign government," Clinton said. "My principal concern is to increase transparency so that there is a clear understanding of where these funds are coming from ... and what the potential downsides might be of having a foreign government control certain assets in our country."

Clinton is merely voicing concerns shared by others. In Europe, where the concept of "national champions" in a variety of industries is still taken seriously, some of the countries that have established huge SWFs, such as China and Russia, are not necessarily "friendlies, as far as the West is concerned," as a Democratic staffer on a key House committee overseeing international trade puts it. Even U.S. Securities and Exchange Commission chairman Christopher Cox, an avowed free trader, has acknowledged that government investment funds could use "the vast amounts of covert information" their spy agencies collect, making it "the ultimate inside-trading tool."

Investments by SWFs can be politically risky too. In 2006, Temasek Holdings, an investment arm of the Singapore government, bought Shin Corp., Thailand's major telecommunications company, for $3.8 billion from the family of Thaksin Shinawatra, who at the time was Thailand's Prime Minister. Public outrage in Thailand over the sale of what was considered an important national asset to a Southeast Asia rival contributed to Thaksin's ouster as Prime Minister in a military coup in September 2006.

The U.S. is trying to lay down an informal road map for increasing SWF transparency. At the October G-7 meeting, with support from the other participants, Washington urged SWFs to make public their annual reports, to offer detailed descriptions of their investment philosophies and to provide assurances that good returns--and not murky foreign-policy objectives--are what's driving them.

In other words, the U.S. wants the new kids on the block to be more like Norway. Oslo's Government Pension Fund-Global, which invests up to 60% of its $353 billion in equities, has money in 3,500 companies around the world, including Google and General Electric. But it owns no more than 1.5% of any single one, and it spells out all its investments in an annual report.

But even if such policies were in place, trade hawks in the U.S., Europe and Japan wonder why they should throw themselves open to investment arms controlled by governments that limit foreign access to their own markets. Beijing, they point out, has strict limits and an opaque review process for foreign companies that seek to buy significant stakes in many Chinese companies. "So we're just supposed to roll over and let them buy whatever they want here?" says the congressional staffer. "Why would we do that?"

Some SWF officials say they are adjusting their investment plans to match a world in which protectionist sentiment is rising. Singapore's Temasek has already said it is becoming more cautious. "In every country, whether it is in Asia or Europe, there is an increasing tide of nationalism," Temasek chairman Suppiah Dhanabalan told Singapore's Straits Times. "We've got to take various factors into account, such as whether the company or the activity is iconic for that country, whether it will arouse all kinds of emotional sentiment."

It isn't just the prospect of riling trade partners that is persuading SWFs to curb high-profile foreign investments. To much fanfare, China's fledgling SWF, China Investment Corp. (CIC), earlier this year invested in the Blackstone Group shortly before the big New York City private-equity firm went public. But Blackstone's share price has sunk 38% below its June 2007 listing price of $31, costing CIC more than $1 billion. That pratfall appears to have prompted CIC to rein in its ambitions. Instead of making splashy investments in the U.S. and Europe, the fund is now looking closer to home. It recently bought into Central Huijin Investment Co., a government agency with stakes in several of China's biggest state-run banks and brokerages, and will reportedly plunk an additional $66 billion into the Agricultural Bank of China. To the extent that CIC looks for investments abroad, its chairman, Lou Jiwei, said in a late-November speech, it will stick to index funds--equities linked to the performance of entire markets, not individual companies.

That's a conservative strategy, considering the bargains that may be available from investing in subprime-stressed financial institutions in the West. After all, Abu Dhabi's SWF will reap an 11% annual yield from its Citigroup stake, nearly double the dividend yield currently available to ordinary shareholders. Having been burned once by Blackstone, the Chinese are now twice shy. But other sovereign wealth funds out there are flush with cash--and fortune favors the bold.n