Sovereign Wealth Funds to Outsource 20% of Assets to External Managers?

Morgan Stanley has a new report (PDF) out that argues SWFs are likely to outsource around 20% of their assets to external managers in the near future. They estimate that SWFs may grow by $1 trillion annually over the next 5 years, meaning that about $200 billion per year may be placed with outside investors. Also, in the next 2 years recently established SWFs in Russia, Chile, and China will likely contribute $700 billion to the existing $2.88 trillion stock of SWF money, adding another $150 billion to the amount that will be farmed out.

The 20% figure is derived using assumptions, which are based on the behavior of Norway’s SWF, the Government Pension Fund (GPF) and Canada’s Caisse de depot et Placement du Québec (CDQ), a sovereign pension fund. The investment portfolios of these sovereign investors are disclosed to the public.

The arguments Morgan Stanley makes are somewhat self-serving (benefits of outsourcing alpha, management costs, supposed SWF lack of staff and sophistication), which isn’t surprising.

There are a myriad of reasons why Morgan Stanley’s analysis doesn’t tell us very much:

• The methodology of using the Norwegian and Canadian sovereign funds as proxies upon which generalizations and assumptions about SWF behavior can be made is deeply flawed. The current levels of SWF deal volume and deal dollar value are unprecedented in SWF history. I don’t think past SWF behavior predicts much at all about current or future SWF behavior.

• The sophistication of funds such as the Abu Dhabi Investment Authority, the many Dubai SWFs, and the up and coming Chinese SWF rivals that of any Wall Street firm or the largest hedge funds. In fact, the largest SWFs recruit a good portion of their talent from private asset managers.

• It’s cheaper, easier, and more profitable for SWFs to buy outright stakes in asset managers rather than investing in their actual funds.

• The use of the Canadian CDQ fund doesn’t make much sense given that it’s a pension fund and doesn’t exactly have the same investor profile (investment objectives, time horizon, risk tolerance, accountability) as a traditional sovereign wealth fund.

For some of the smaller and newer players in the SWF arena (Brazil, Libya, Chile) it may make sense to outsource most of their investments. Even if these funds outsource all of their investments, you don’t get anywhere near the over $200 billion (for the next 5 years) total annual figure that Morgan Stanley predicts will be farmed out.

Deriving the 20% figure on such flimsy data (essentially the past behavior of Norway’s GDF) makes Morgan Stanley’s “estimate” seem like a guess more than anything.

Weekend Links (13 January 2008)

Some recent stories of interest:

• Gulf States to stay on trail of foreign companies: (Financial Times)
• A Closer Look at Sovereign Wealth Funds – Secretive, Powerful, And Huge: (Knowledge @ Wharton)
• Buffet says he turned down investments in financials: (Bloomberg)
• Sovereign funds invest where Buffet won’t: (Bloomberg)
• China and the Arabian Peninsula as market stabilizers: (Stratfor)
• The price of oil and nationalism: (Economist)
• Canada is ‘anxious’ to have investment from China: (Bloomberg)
• No sovereign wealth fund for Canada: (Bloomberg)
• Bush’s “New Middle East”: (Time)
• Abu Dhabi – East Leans West: (City Journal)
• The Dubai phenomenon: (Bitterlemons-international.org)
• How Arab Countries are Coping with Globalization: (Knowledge @ Wharton)
• Can the Middle East Sustain Democracy?: (Middle East Strategy at Harvard)
• The Arabs should stop whining: (Haaretz)
• Sovereign Wealth Funds making ‘good’ investments in US banks: (Emirates Business 24/7)
• Americans sold out to foreign firms at record rate: (Bloomberg)

News Roundup (10 January 2008): Banks seek more SWF capital, China approves Blackstone purchase of BlueStar

WSJ: Merrill and Citi Seek Foreign Capital

As subprime related losses continue to mount the two firms that are expected to be hardest hit, Merrill Lynch and Citi, are looking for additional investments from SWFs (WSJ, subscription required also Bloomberg for summary):

Merrill is expected to get $3 billion to $4 billion, much of it from a Middle Eastern government investment fund. Citi could get as much as $10 billion, likely all from foreign governments.

They hope to finalize these deals before reporting worse than expected earnings next week:

Both Citi and Merrill are scrambling to nail down the details before they report earnings next week that are expected to include additional losses stemming from their exposure to mortgage-related investments. Together, these additional losses could reach as much as $25 billion.

Increased US regulatory scrutiny of both banks and SWFs is likely to follow. SWFs will also face more political pressures from US government officials:

Another risk is political. Lawmakers could try to force the investors to submit to more scrutiny by the Committee on Foreign Investment in the U.S., an interagency group led by the Treasury Secretary.

Does this type of scrutiny make sense given that a large portion of the US banking industry is in effect being bailed by SWFs? Do US lawmakers even realize that a bailout has occurred? Or are they just trying to score cheap political points? Who would be picking up the tab for the banks’ subprime-related excesses if not SWFs? The answer to that last one should scare any sane government official into thinking long and hard before trying to score easy political points at the expense of “foreigners”.

China approves Blackstone domestic purchase

China said Thursday it had formally approved US private equity firm Blackstone Group’s purchase of a 20-percent stake in chemical firm China National BlueStar.

Did China Investment Corp’s $3 billion stake in Blackstone make completing this deal easier? (Yahoo!)

UK Treasury asks GCC funds to bail out Northern Rock

No buyers have been able to raise the amount needed to rescue the troubled bank, the UK government hopes the GCC might step up to the table (Arabian Business News):

Goldman Sachs has been hired by the UK Treasury to help find a private sector solution for Northern Rock. Any objections to Middle East oil money being used to save the bank have now been removed, according to UK newspaper reports.

Current bidders, including Richard Branson’s Virgin Money and investment vehicle Olivant, are struggling to raise the necessary funding for an acquisition due to the subprime lending crisis.

Russia Stabalization Fund grows to over $156 billion in 2007

Russia’s Stabilization Fund, which collects windfall oil revenue, stood at just over 3.849 trillion rubles or $156.81 billion on January 1, 2008, the Finance Ministry said. (Interfax)

 

Weekend Links (6 January 2008)

Some recent stories of interest:

• Gulf investments to jump as economies grow: (Bloomberg)
• China Investment Corporation’s strategy is becoming clearer:(IHT)
• How much of a discount did Temasek get for the Merrill stake?: (DealBreaker)
• Eastern investors getting bargains on Western financial companies: (Seeking Alpha)
• Kuwait fund focusing on long-term opportunities: (MSNBC)
• Qatar’s real estate king: (Portfolio)
• Are oil prices heading down?: (CNBC)
• Interesting maps of the world adjusted for size of oil reserves and exports: (Middle East Strategy at Harvard)
• Gulf states, not wanting to jeopardize economic boom, no longer want to isolate Iran: (Christian Science Monitor)

News Roundup (2 January 2008): China SWF to invest $20bn, GCC economic union

China

China’s sovereign wealth fund announced that it will invest $20 billion of the at least $130 billion (from a total of about $200 billion) earmarked for domestic investments (Financial Times):

Beijing said on Monday that a unit of its new $200bn sovereign wealth fund would inject $20bn into China Development Bank in a move intended to smooth the policy lender’s transformation into a commercially-oriented institution.

Gulf Cooperation Council

The countries that make up the Gulf Cooperation Council (GCC) began a common economic market today (BBC):

The nationals of Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates are now to be seen as equal, economically, whichever country they chose to live in. They will be able to work, buy houses and companies, trade shares, go to school and receive medical treatment in all six states.

The move is also intended to pave the way for a common monetary union and a single currency by 2010. However, some have noted that this deadline is likely to be missed (Arabian Business News):

Gulf central bank governors and finance ministers have said on several occasions that the deadline was unrealistic and would likely be revised. UAE central bank governor Sultan Nasser Al-Suweidi said earlier that month that the GCC was unlikely to have a single currency by 2015. The timetable for the monetary union has been in doubt since Oman said last year it would skip the 2010 deadline over concerns that spending targets could constrain economic growth. Plans received a further blow in May when Kuwait broke ranks and ditched the dinar’s peg to the US dollar, claiming the rising cost of imports in non-dollar denominations was driving up inflation.