By Martin Hutchinson
Director of Global Investment Research
When Britain’s Barclay Bank PLC (NYSE: BCS) boosted its bid for Dutch Bank ABN AMRO Holding NV (NYSE: ABN) to more than $93 billion in the world’s largest-ever takeover battle, it did so thanks to a financial boost from state-run investment funds in China and Singapore.
The $20 billion investment in Barclays by the China Development Bank and Singapore’s Temasek Holdings is merely the latest in a series of deals announced in the past few months by equity funds that export-rich countries have established to invest their rapidly soaring currency reserves.
In the midst of a private-equity-led takeover boom that sent U.S. stocks into record territory, watchful international investors cheered as such countries as China, Singapore and Dubai unveiled these funds. These new players, investors reasoned, would help keep stock prices high, if not send them even higher.
But let me tell you how I see this: I’m not at all sure that, as a shareholder, you should welcome them. Let me explain…
Foreign Reserves 101
Traditionally, a country’s foreign-exchange reserves were held by its central bank as a kind of contingency fund. For instance, the capital might be used to fend off a financial crisis – if the international bond market went into a tailspin, for example. Conservative institutions by nature, central banks invested these reserves in safe, short-term investments such as U.S. Treasury bills, maybe diversifying as far as the Treasury bond market, or even into Federal Agency bonds.
But with the massive growth of Asia, and the soaring oil prices of recent years, some countries have seen their reserves get so big that no imaginable crisis could ever cause the entire amounts to be used. Singapore and some Middle Eastern countries reached that level as far back as the 1970s. More recently China, with an estimated $1.3 trillion in reserves (an amount that’s rumored to be growing by an additional $200 billion every six months), and Japan, with $900 billion, have decided to direct part of this hoard into longer-term investments, figuring they’ll get much-better returns than are available via T-bills.
At first glance, this development will leave you feeling as if you want to jump for joy. Singapore’s Temasek Holdings has invested part of that country’s dollar reserves since 1974, and now has about $80 billion under management. Kuwait, Dubai and Saudi Arabia have strategic investment funds that have become quite huge in the past few years, as oil prices have surged.
And now China has announced that it intends to invest a substantial portion of its ever-spiraling reserves into stocks, as well as “strategic” foreign assets. You’ll find Japan’s investment pool is even more mouth-watering: In addition to its $900 billion of foreign exchange reserves, it is considering foreign investments for the $1.6 trillion held by Japan’s Postal Savings Bank and the additional $1.3 trillion that’s in its Government Pension Investment Fund. On a note that I find a bit more sinister, Russia said it will strategically invest a portion of its $250 billion in reserves.
We’re talking about a gigantic amount of money here – between $5 trillion and $6 trillion in total, for those of you who stopped counting. Even if most of this capital gets invested through private deals like China’s $3 billion investment in The Blackstone Group LP (NYSE: BX) in May or the Barclays deal, it still allows Blackstone to buy more companies, or Barclays to make a higher takeover bid than would otherwise have been possible. What’s more, if there’s $6 trillion to invest, there aren’t enough really special private deals to go around. At some point, the investment manager will surely have to pick up the phone to the trading desk and yell, in the classic Hollywood manner: “Buy!! And keep on buying ‘til I tell you to stop!” Surely that must be great for all of our stock portfolios, correct?
Not necessarily, as it turns out.
Public-Sector Contestants, Private-Sector Rules
If we could depend on these folks to buy stocks indiscriminately – in essence, placing a giant-suction pump atop the market, and slurping shares across the board to higher levels – we could at least expect a nice short-term jump in share prices. However, what you and I must keep in mind is that these folks aren’t free-market operators: The funds are run by politicians, and several are steered by governments most of us wouldn’t want to live under – and definitely not governments any of us would want to “fail” under.
The problems of having major companies owned by the likes of China or Russia have now dawned on the EU bureaucrats and the Bank of England, both of whom have sounded the alarm regarding the dangers of strategic assets being controlled by foreign governments.
In that context, it wouldn’t seem that Barclays – a fairly simple commercial bank, despite its heft – would be problematic. And yet even the Financial Times, a committed friend of free-capital movements, raised this most-vexing question: What if Chinese interests took over Barclays altogether, and then proceeded to lend out the deposits of British savers with the same care they’ve lent out their own money back at home in China?
There are at least $1 trillion in bad debts sloshing around in the labyrinthine Chinese banking system. I don’t know about you, but I surely wouldn’t want to see British savers being forced to bail out a rotting mess like that. Or, in an example a bit closer to home, consider the U.S. banking system, where bank accounts are insured by the federal government? Taxpayer bailout, anyone?
Because the funds – and the countries that back them – run the gamut in terms of size, experience and ultimate objectives, it’s tough to apply a single yardstick in evaluating them. Singapore, for instance, is probably fine. True, the country has a reputation for flogging teens that drop bubble-gum wrappers on the sidewalk, or mischievously set off car alarms. But none of that will affect its investment results. And those results have presumably been decent, given that it’s been around for more than 30 years. Besides, it’s “only $80 billion” that we’re talking about here. And that’s not even enough to finance the ABN AMRO buyout on its own.
Dubai, on the other hand, has had to navigate some rougher waters. The Middle Eastern country – the home of the world’s only “7-star” hotel and the world’s tallest building – saw its investment fund get into trouble last year when it bought the British-owned Peninsular and Oriental Steam Navigation Co. (which, alas, no longer runs ocean liners “port-out, starboard home” through the famed Suez Canal, but instead held the management contract on roughly two-dozen of U.S. ports).
The Dubai fund’s DP World business unit requested – and received – the approval of U.S. regulators to assume management of the American ports. But after some major huff-and-puff by Congress, which opposed the deal on security grounds, Dubai agreed to sell the U.S. port contracts to a U.S. firm, which turned out to be the asset-management arm of insurer American International Group Inc. (NYSE: AIG). In the end, both U.S. relations with Dubai and Dubai’s appetite for U.S. assets were dented. For details on Dubai’s shrewd new private-equity plays in Europe and Asia, click here.
As you can see, at best it’s a crapshoot, and at worst it’s a can of worms.
At one extreme, Singapore and Japan are so benign (and, in Japan’s case, so cautious), that as an investor, you would welcome both as fellow shareholders. But at the other end of the spectrum, Russia’s track record is currently so bad that you’d probably find yourself just waiting for it to loot the company, or to pull some other shenanigans that would wreck your investment. China and Dubai are somewhere in between, although we’ve already seen how easily they, too, could spawn problems in your investment portfolio, or with your national economy.
Overall, it looks to me like the emergence of state-run venture funds is a trend that we’re going to have to deal with for some time to come. Aside from the occasional messy political spillovers, and the occasional required investment disclosures, they’ll often be able to operate well below the radar of the world’s supervisory bodies.
That will make them exceptionally tough – if not impossible – to regulate. And that makes it highly probably that you’ll wake up one day to discover one’s become your partner. The decision of what to do then will be entirely up to you.