Saudi Arabia

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

Rolling Snake Eyes

For those of you who have played craps, you know that it can be a pretty easy game to win at, even when you really don’t know what you’re doing. When someone is on a hot streak, everyone at the table can partake in the winnings. A main nemesis in the game is rolling the dreaded “snake eyes” (what’s known as a pair of pips among gamblers). Interestingly, and perhaps not coincidentally for our purposes here, the etymology of the reference traces back to 1929 – the onset of the Great Depression.

Several months ago, sovereign wealth funds (SWFs) from Singapore, Kuwait, Saudi Arabia, Abu Dhabi and Korea stepped up to the table to test their luck. These five government-sponsored funds went high stakes with their chips by collectively pouring nearly $60 billion into Citigroup, UBS and Merrill Lynch. These “experts” (bolstered by their outside advisors) were confidant that the sell-off which had rampaged Wall Street beginning in mid-2007 and continuing into early 2008 had reached its end. They thought they were correctly timing their purchase at the bottom of the downturn. No such luck. There was more carnage to come. Snake eyes all around.

Still smarting from their dramatic losses, many of these funds were invited in June to return to Casino High Finance, this time by Lehman Brothers. But unfortunately for Richard Fuld and his band of con artists, the managers at these funds had learned their lesson and declined the invitation to return to Las Vegas for one more roll of the dice. We will never know if that second roll would have brought more misery or good fortune, but something tells me the odds favored the house.

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BAE Systems is Europe’s largest defense contractor and the largest foreign player in the U.S. defense market. Despite (or perhaps “because of”) its global presence, the company remains a troubling enterprise because of its business profile and its lack of transparency with respect to its global arms dealing in the third world. These factors make this company as risky investment from a human rights perspective.

Profile

BAE’s offerings include avionics, military aircraft, armored vehicles, air-defense systems, missiles, artillery locators, communications and navigation systems, radar, ships, space systems, and aerospace electronics. The company’s fighter aircraft include the Harrier, Hawk, Tornado, and the next-generation Eurofighter Typhoon. BAE operates in the U.S. through BAE Systems, Inc. In 2006 BEA divested its 20% stake in Airbus when it sold its shares back to EADS.

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In today’s Financial Times, it was announced that a long awaited report commissioned by BAE Systems is to be released by Lord Woolf. The report will call for a yearly audit of the company’s business practices in order to ensure it meets certain ethical standards.

Lord Woolf’s report, published on Tuesday, calls for a yearly independent audit of BAE’s business processes to ensure they meet the highest ethical standards. The company also has to adopt certain principles and procedures to ensure its business conduct is seen to meet the highest standards. BAE has pledged to follow the recommendations in the report, so the next time a sceptical investor asks whether the company has behaved ethically, Mr Olver will be able to point to the Woolf initiative.

While it’s too early to tell what impact if any this audit will have on the company, our experience in observing such assessments it not dissimilar to putting lipstick on a pig. At the end of the night, its still a pig.

Perhaps shareholders will notice that all of the social responsibility fluff is just that and that the company’s true measure is in its actions.

Stay tuned.

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