Editor’s note: This article is the third installment in a four-part series on the rise of sovereign wealth funds and what they mean for U.S. investors. Part IV will appear next Friday on GIW.

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Riches in the Sands of Syriana

If only T. E. Lawrence were alive today, he no doubt would be smiling. The British intelligence officer memorialized as “Lawrence of Arabia” for leading the successful Arab revolt against the Ottoman Turks during World War I would surely need a tour guide if he were to return to his old stomping grounds of Cairo, Amman or Damascus. What was once a backwater of political in-fighting among warring Arab clans has emerged a century later as one of the geopolitical “hot spots” of the modern world. Today’s Middle East is a far cry from the world Lawrence of Arabia knew and loved.

The reason, we all know, is simple – oil. And lots of it. The Persian Gulf states are in fact so flushed with it that their export earnings from the commodity has been the single largest source of wealth creation in modern history. Virtually every major oil-bearing country in the region sponsors its own sovereign wealth fund to help manage these growing reserves. Current estimates suggest that those funds derived from oil and gas export revenues account for one-half of the total assets held by all SWFs around the world.

While sovereign funds have existed since the 1950s (the Kuwaiti Investment Authority was the first to be established in 1953) their size and influence worldwide has increased dramatically over the past two decades. In 1990, sovereign funds held about $500 billion. Today, the current total is estimated to be $3 trillion and based on the likely trajectory of current accounts this sum could surpass $10 trillion as early as 2010.

It may surprise some to learn that the Middle East, not China, is at the epicenter of this growth trend. The Carlyle Group declares that the Middle East is now the primary destination for private equity deals and the British bank HSBC estimates that as much as one-third of all project finance involves Middle Eastern projects. According to the U.S. Government Accountability Office (GAO), 28 of the 48 SWFs have been created since 2000, primarily in countries whose foreign exchange reserves are growing through oil revenues or trade export surpluses. The preponderance of those are in the Middle East.

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You might think that a Danish Bank would have long been squeaky clean in terms of Corporate Social Responsibility (CSR), but Danske has really been sudsing itself up in recent months. The fact is that the bank probably was already “clean” relative to many others around the world, but under the close scrutiny of a highly vigilent populace, they have been pushed to take a number of signifigant measures.

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A number of Japanese corporations that we monitor at JMR Portfolio Intelligence have been in the news lately. As reported in a September 23, 2008 article by Marcus Gee, the Asia-Pacific Reporter for Canada’s The Globe and Mail, “When the Japanese asset bubble burst in the early 1990s, Japanese banks retreated to their own shores to lick their wounds. But the caution fed by that trauma meant they were hurt less by the U.S. subprime credit crisis than many U.S. and global lenders because they were less exposed. As a result, they are flush with cash at the very time that U.S. financial institutions are desperate for investment.” More recently it has become clear, however, that Japan is less unscathed than previously thought as evidenced by turmoil on the the nation’s benchmark Nikkei. Yesterday BBC News reported that Japan’s Nikkei 225 index fell 6.36% to its lowest close since October 1982 amid concerns at the yen’s high value.

Nevertheless, here are some highlights of the major activity that is taking place currently:

• Mitsubishi UFJ Financial Group (MUFG), Japan’s largest bank, is set to acquire 10-20% of Morgan Stanley
• Nomura Holdings Inc., Japan’s largest stock-broking firm, will acquire the Asian remnants of Lehman Brother’s
• Tokio Marine Holdings, Japan’s biggest property insurer, has acquired the U.S. insurer, Philadelphia Consolidated
• Mizuho Financial Group Inc. Japan’s second-largest bank by assets, announced plans to invest $1.2-billion in Merrill Lynch and $120-million in Evercore Partners, a U.S. mergers adviser.

And the list goes on. In his report Mr. Gee states that “With savings-obsessed Japanese holding more than $15-trillion in household assets, Japan has a huge pool of capital that could, in theory, help bail out a credit-starved Western world.” Yet, he goes on to explain that there are two schools of thought. Japan may be making moves that could re-establish the country as a financial powerhouse. On the other hand, it is possible that “Japanese banks are seeking to expand abroad because conditions at home are so poor. After suffering through the “lost decade” of the 1990s, then recovering in the earlier part of this decade, Japan is in economic straits again.”

Time will tell how things will shake out in this ever-shifting global financial landscape. In the meantime, perhaps we should all brush up on our Japanese…just in case.