Wanted: SWF, with appetite for risk and lots of money to spend. Discretion a plus. Serious inquiries only.
No, Compliance Week has not become a sleazy supermarket tabloid replete with personal ads for questionable dating practices. As readers no doubt know, SWFs, or Sovereign Wealth Funds, are government-owned mega-pools of money, often fed by petrodollars. And lately, they’ve been the most popular girl at the institutional investor ball—deep-pocketed investors of choice for the major global banks, whose balance sheets were weakened by the sub-prime mortgage and subsequent credit crisis.
It’s easy to see why SWFs are today’s “it” girl of the institutional investor world: They can consummate billion-dollar deals quickly. UBS raised $12 billion from the Government of Singapore Investment Corp. and an unnamed Middle Eastern investor in just four days. Citicorp received $7.5 billion from the Abu Dhabi Investment Authority. The China Investment Corp. recapitalized Morgan Stanley’s balance sheet for $5 billion. Merrill Lynch and Bear Stearns also sold multibillion-dollar stakes in themselves. In fact, when you add it all up, SWFs have recently contributed more than $60 billion to recapitalizing some of the world’s most important financial institutions.
But lust after an attractive balance sheet is a far different proposition than long-term happy marriages between investors and corporations. If you are considering whether to approach an SWF as a strategic investor, or if you wake up one morning to find an SWF among your major shareowners, you will want to know what makes for successful long-term partnerships with this crowd.
What’s crucial: Understanding the motivations, expectations, and investment cultures of the SWFs, along with the regulations that surround them.
First, let’s debunk some perceptions. Sovereign wealth funds aren’t a new phenomenon. The Kuwait Investment Authority was founded in 1953. Nor they are all in the Gulf or the Far East. The second largest SWF is in Norway. In fact, the United States has at least two SWFs: The Alaska Permanent Fund, worth some $40 billion, and the Thrift Savings Plan, the $210 billion plan for federal employees. And, of course, every Compliance Week reader is familiar with public pension funds in this country, such as CalPERS. They are, effectively, sub-national SWFs. Indeed, with assets of more than $260 billion, CalPERS could be considered the third largest SWF in the world.
Nor are SWFs new to international investing. As Stephen Schwartzman, co-founder of the Blackstone Group (which itself is partially owned by China Investment) noted at the Davos World Economic Forum, Blackstone has been dealing with SWFs for decades. KIA has invested in DaimlerBenz since 1969; even we Compliance Week columnists had SWFs as investors in hedge funds we helped run a decade ago.
What is new is size, both absolute and relative. SWF assets are now estimated to be approaching $3 trillion, and Reuters estimates that they will reach $12 trillion in just seven years—about 10 percent of all wealth in the world. Moreover, the growth in SWF assets occurs at a time of U.S. dollar weakness, making American assets particularly attractive.
So it’s easy to see why the infatuation with SWFs is so strong: With lots of cash, the ability to make decisions quickly, and a long-term investment horizon, they seem the ideal partner for companies seeking large inflows quickly. But are they?
Of course, generalizing about any type of investor is inherently flawed. Not all hedge funds are the same, not all mutual funds are the same, and not all sovereign wealth funds are the same. But there are two similarities amongst all SWFs: They are “sovereign” (that is, creations of the state), and “wealthy.” While that may seem obvious, the implications when “sovereign” fuses with “wealthy” are anything but clear. Here are just a few.
Do-Not-Invest Screens. Greek philosopher Heraclitus said it 2,500 years ago: Character is destiny. SWFs’ characters are, by definition, creations of the states in which they are domiciled. While they may desire to avoid politics, the fact remains that they cannot invest in a way that is anathema to the parent state, even if such investments may be legal in much of the world. Norway’s Government Pension Fund, for instance, only invests according to ethical standards developed by Norway’s Ministry of Finance. It has studiously avoided investing in stocks of 25 companies accused of child labor or in making nuclear weapons. In 2006, the GPF divested from more than $400 million of Wal-Mart stock due to concerns about labor rights abuses at that company’s suppliers. Closer to home, Colorado’s Public Employees Retirement System recently announced a divestment policy for companies doing business in Iran. And a number of umbrella organizations representing trillions in American public fund assets just wrote to the Securities and Exchange Commission asking it to maintain its list that identifies companies in countries the United States calls “sponsors of terrorism,” to facilitate do-not-invest programs.
Our prediction: The vast majority of SWF investments will not have any strings attached. But expect constraints on an SWF’s investment in companies or geographies where issues present a conflict with the political priorities of the sponsoring nation.
Activism. Bader al Sa’ad, the managing director of KIA, recently said SWFs are just like other large investors: “We look at the bottom line; we don’t look at anything else. We have been passive in all our investments.” Of course, to take an example familiar to U.S. companies, public pension funds are also bottom-line investors. Even the most activist, such as CalPERS, is only active in a small minority of its investments. But when you have hundreds of billions, even a small percentage allocated to activism makes a big splash in the global capital markets. Just ask Sainsbury, the British retailer, which saw a bid from the Qatar Investment Authority last year.
Our prediction: By and large, al Sa’ad got it right. SWFs don’t want to be active. Activism plus size plus cross-border investing equals high odds of a backlash (see below). However, with the size of their investments in various companies effectively making those investments illiquid, being an activist may be the only way to protect the bottom line if at some point things don’t work out. So, while we don’t expect SWFs to be leading corporate governance players, it seems clear that being long-term investors with the need to place large amounts of money to work will force them into activism, even if quiet and behind-the-scenes in specific situations in the future.
Dealing With the Backlash. No matter your economic philosophy about open borders and free trade, if you’re a realist you accept that some types of cross-border investments spark backlashes. Often they involve national security issues, such as were cited in opposition to the failed Dubai World Ports bid for P&O, which would have given the Dubai company control over managing some U.S. ports; or when Chinese-owned CNOOC bid for Unocal. But remember, “national security” is a term that expands and contracts. France made yogurt an issue of national defense in protecting Danone from Pepsi. And French President Nicholas Sarkozy recently warned that he would consider using the French government-controlled bank, CDC, to protect French national business champions against cross-border poaching. Think that’s just Gallic nationalism? Consider this: The original mandate of the Committee on Foreign Investment in the United States (CFIUS), a federal interagency task force, was to review how cross-border deals would affect the Department of Defense’s ability to award contracts. Recently, however, Senate Banking Committee Chair Chris Dodd and ranking Minority Member Sen. Richard Shelby wrote to Treasury Secretary Henry Paulson saying that “foreign ownership interests in assets in the U.S., including through sovereign investment funds, may have national security implications.” In other words, national security tends to be a concept that expands and contracts; right now it’s expanding in reaction to the unprecedented cross-border investments into the United States—and, in particular, the SWF investments into investment banks.
Our prediction: U.S. companies seeking investment from SWFs will have to “lawyer up” to get through increased CFIUS reviews and “lobby up” with K Street clout to navigate any Washington politics. Moreover, American companies seeking to form partnerships with SWFs to accomplish major cross-border strategic investments may spark backlashes beyond U.S. borders, necessitating merger and acquisition specialists with political and public relations skills as much as capital market skills.
One thing is certain: SWFs are poised to become one of the greatest concentrations of wealth in history. That dowry makes them attractive to cash-strapped U.S. companies. But smart boards will want to dust off and use their kid gloves to make sure the partnership works out over time, not just at the moment of attraction.