Tuesday 14 October 2008

Sovereign Funds Now Prefer Hoarding Cash to Rescuing U.S. Financial Firms

Don’t expect Middle Eastern sovereign wealth funds to jump on the bailout bandwagon.
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Sovereign Funds Now Prefer Hoarding Cash to Rescuing U.S. Financial Firms

By LANDON THOMAS Jr.
14 October 2008

LONDON – Don’t expect Middle Eastern sovereign wealth funds to jump on the bailout bandwagon.

Given the recent volatility in the stock markets, some large sovereign wealth funds have been hoarding cash, much like the hedge funds and institutional investment funds that have been running for cover.

The oil-rich emirate of Abu Dhabi oversees the world’s largest government-sponsored fund, for example, and has been steadily adding to its cash position, which is at its highest in years. According to people who have been briefed on its investment strategy, 10 to 20 percent of $550 billion controlled by the Abu Dhabi Investment Authority is now in cash.

Very little of that is expected to go to wounded financial institutions in America, these people say.

The second-largest fund in the region, the Kuwait Investment Authority, with assets of about $250 billion, has also been accumulating cash. The fund’s director, Bader al-Saad, told bankers in New York last week that he had no interest in buying distressed financial companies.

That means the cash-hungry American and British governments, which together plan to borrow about $800 billion to invest in flailing banks, will have fewer options. About all that can be expected of the cash-rich wealth funds, analysts said, is that they will lend some money to the American government on a short-term basis because they can count on it to be paid back.

“Sovereign funds are piling up cash because there has not been a big reward of putting your money to work,” said Brad W. Setser, an international finance analyst at the Council on Foreign Relations. “But what I find to be more worrisome is a complete unwillingness on the part of sovereigns to hold anything else but supersafe Treasury bills.”

That sovereign funds appear to have the same buyers’ fright as the portfolio manager of a mutual fund should not necessarily be a surprise, given their aversion to assets with even the slightest risk. But with their longer-term investment horizons, the funds were expected to be more willing to ride out the stomach-churning ups-and-downs of the market.

The plunge in the value of oil, along with fears that the global economic downturn is likely to be deeper and longer-lasting than expected, has probably been the most significant factor in changing that thinking.

Mr. Setser points to data showing a spike in the holdings of Treasury bills by foreign institutions since the credit downturn began about 15 months ago. At the same time, the funds have reduced their purchases of riskier securities, like the equities and bonds issued by corporations and the mortgage lending giants Fannie Mae and Freddie Mac.

In the 12-month period that ended in July, the net purchase by foreigners of American long-term securities almost halved — to $456 billion for the period ended in July, from $751 billion in the year to July 2007.

Both Kuwait and Abu Dhabi, which has a mandate to invest overseas, were early buyers of big Wall Street financial firms. Abu Dhabi invested in Citigroup and Kuwait purchased a stake in Merrill Lynch and a subsequent position in Citigroup.

The investment returns have been poor — Citi closed at $15.75 Monday, down from $31 when Abu Dhabi invested. What is worse, economic troubles are now cropping up closer to home.

In Kuwait, the stock exchange has stumbled badly, prompting its sovereign fund to promise to invest $1 billion to prop it up.

As for Abu Dhabi, it may become distracted by a slowdown in Dubai, its neighboring emirate. Dubai has attracted global renown for its debt-fueled development boom, which was undertaken through heavy reliance on now-stricken international loan markets. Unlike Abu Dhabi, Dubai does not sit on a large oil reserve.

This week Moody’s released a report in which it estimated Dubai’s liabilities to be about $46 billion, the size of its gross domestic product. With many ambitious development projects depending on rising property prices, the combination of a price correction and an inability to borrow could lead to problems similar to those plaguing the American and British economies.

“Cumulative liabilities are currently rising faster than investments are able to generate returns,” said Philipp Lotter, a Moody’s analyst and co-author of the report.

While the Abu Dhabi Investment Authority’s international orientation makes a bailout of Dubai less feasible, analysts say that Dubai’s difficulties and lower oil prices will slow what had been a growing flow of petrodollars to Western stock and bond markets.

Indeed, Gulf Arab states took emergency measures to support their financial systems Sunday. These included a rare cut by Saudi Arabia in its benchmark lending rate and a vow by the United Arab Emirates to protect national banks and guarantee deposits.

More starkly, the Qatar Investment Authority, the sovereign fund for Qatar, committed $5.3 billion on Monday to buying stakes of 10 to 20 percent in the country’s banks.

Gulf stock markets have been falling for weeks now, driven lower mostly by the decline in oil prices.

Wealth funds outside the Middle East are facing similar pressures.

The $5 trillion explosion in global dollar reserves during this decade was driven by an export boom in Asian countries including China, South Korea and India, which relied largely on satisfying consumer demand in the United States and Europe. As a recession takes hold, demand will flag and foreign institutions in these counties are likely to be more concerned with using their surpluses to stimulate their own economies, analysts say.

In recent months, many troubled financial firms made the pilgrimage from Abu Dhabi to Singapore in search of an investment lifeline. They went home empty-handed.

“These funds are risk-averse like others are now,” said Edwin Truman, a long-time observer of global finance at the Peterson Institute for International Economics in Washington. “Because of the attention paid to them in the past two years, they may be even more so.”