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Sovereign wealth funds are suddenly the capital provider of first and last resort for ailing US financial institutions, investing at least $30 billion (Dh110.34 billion) in some of the biggest banks and brokerages on Wall Street, including Citigroup, Merrill Lynch and Morgan Stanley.
They are in many ways the 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, puts it. 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 American economy? The finance from the sovereign wealth funds comes with few strings attached. Yet some observers are beginning to fear that this very passivity might have a negative side to it. It could mean there will be little pressure for real change at institutions that are arguably in dire need of reform.
"One of the reasons the US has been so strong is because we have always been cathartic and have purged ourselves. We have consolidation through failure," says Larry Fink, the founder and head of BlackRock, one of the largest investors in the world with some $1,300 billion under management.
Emotive
The issue is particularly emotive on Wall Street because a hallmark of American capitalism in recent decades is a belief that the strong can truly flourish only if the weak are allowed to disappear. This adherence to the creed of "creative destruction" - as the economist Joseph Schumpeter famously termed it - contrasts with more gentle economic models elsewhere, such as in Japan, where the impulse is to bail out troubled groups.
Naturally, the sovereign wealth funds 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.
Unlike them, sovereign wealth funds "don't seek to take advantage of mispriced assets using high leverage", says Badar Al Sa'ad, head of the Kuwait Investment Authority, which has just committed a total of some $5 billion to Citigroup and Merrill Lynch. Instead, the funds "are long-term in nature; they are not speculative".
Their passivity arises for several reasons. For a start, as arms of foreign governments, sovereign wealth funds increasingly feel they cannot afford to be intrusive, since they need to minimise any political backlash or concerns about national security.
Two years after a furore over a bid for port facilities in the US 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 sovereign wealth funds 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.
China Investment Corp has yet to celebrate its first birthday (and is advertising on its website for staff) while the Qatar Investment Authority is only slightly older. Few have the experience or the specialised organisational structure of the Kuwait Investment Authority or of Temasek in Singapore.
Until now, the disadvantages of this stance have not attracted much attention since sovereign wealth funds have generally steered clear of troubled companies. However, the reason the sovereign funds have been given the opportunity to invest in Wall Street's financial groups is precisely because of misjudgments by managements that were either ignorant of risks and contingent liabilities or tolerant of them.
These are conditions in which private equity has long claimed to flourish - because it makes a virtue of being intrusive and is quick to replace management if it is not up to the job. Indeed, in earlier cycles, private equity firms have been aggressive about trying to reform ailing financial groups. But today they 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. "We can't finance them with our limited resources."
Blackstone, the largest private equity firm in the world, has more than $100 billion of assets under management. But the Abu Dhabi Investment Authority, which is merely one investment arm of the emirate's government, albeit the largest, has almost $1,000 billion of firepower - more than the combined $700 billion 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. "The sovereign funds are safer and less risky owners than private equity because they can live with lower leverage and lower returns," says a senior banker in New York.
Meltdown
To the sovereign funds, the meltdown that has taken place 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 $30 billion 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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