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 m
ain 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.
Part of the problem is that these funds are flushed with so much cash they need some place to park it. In recent years, central banks around the world have been plowing money into their funds funded primarily through increases in foreign exchange reserves and oil exports and observers expect this trend to continue given America’s cheapened dollar and ongoing dependency on foreign oil.
Today, the estimated value of all sovereign wealth funds is now said to exceed $3 trillion, dwarfing total assets in hedge funds by a large margin. UAE’s is the grand-daddy of them all with more than $875 billion in assets alone but they are by no means the only player on the block. The newest kid in the neighborhood is the China Investment Corp. (CIC) which opened it doors just last year with about $200 billion in cash reserves. And CIC wasted no time in making a name for itself by investing $3 billion in the Blackstone IPO. We all know how that has turned out.
The sudden rise of sovereign wealth funds as major players in the global economy presents an interesting conundrum from an investment standpoint. If inflows into SWFs over the next few years increases at the same rate as they have since 2002, where will all this money go and won’t there be a risk of big pots of money chasing fewer and fewer good investment opportunities? Certainly, today’s volatile markets present a buying opportunity for these sophisticated investors, if we can call them that. And surely there will always be those market contrarians with the right kind of nerves and temperament who will buck the status quo by going “all in” when things look most bleak (think of Buffet).
Of late, we have seen some of this among some private-equity and hedge funds which have recently shifted their investment focus away from pursuing large-scale leveraged buyouts into acquiring high-risk distressed debt and mortgage-backed securities. A risky bet for sure, but one that could reap significant gains if the floor of the housing bubble has been reached. At this point, no one can say. Will the sovereign wealth funds that have recently been burned by their investment in Wall Street pay to play this high risk game?
At the time, the chances of winning big seemed too good to pass up. In hindsight, I would imagine that the sovereign wealth funds which have dumped billions dollars into U.S. investment banks over the past few months wish they never stepped up to the table in the first place. “In today’s turmoil, making multi billion-dollar investments is beyond risky,” said Arif Naqvi, CEO of Dubai-based private equity firm Abraaj Capital, in a recent interview with BusinessWeek. “It is almost like rolling the dice.”
Indeed, my point exactly.
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