By William Patalon III
Executive Editor
Money Morning/The Money Map Report
Critics of sovereign wealth funds say there are sinister motives behind the multibillion investments the state-run investment pools are making in U.S. and European companies.
Investing guru Warren Buffett says that theory is bunk.
And we agree.
In his Feb. 29 letter to shareholders, Buffett, the chairman of Berkshire Hathaway Inc. (BRK.A, BRK.B), wrote that the foreign governments in control of these sovereign funds are amassing the massive stakes in U.S. companies as a direct result of our deficit-creating trade policies - and not because of some deeply sinister motives.
"This is our doing, not some nefarious plot by foreign governments," Buffett wrote to Berkshire shareholders. "Our trade equation guarantees massive foreign investment in the U.S. When we force-feed $2 billion daily to the rest of the world, they must invest in something here."
Sovereign funds currently control between $3 trillion and $3.5 trillion, experts estimate. That's already more than the entire world's hedge funds currently control. But it's the accelerated activity and ultimate projected dollar values of these massive pools of investment capital that has so concerned many government leaders in both the European region and the United States.
The International Monetary Fund (IMF) and other experts predict the state-run venture funds could control $12 trillion by 2015. But Money Morning Investment Director Keith Fitz-Gerald thinks the total will actually be nearer $20 trillion by the middle of the next decade.
The growth rate is certainly accelerating. The U.S. Treasury says that 20 new funds have been created since 2000 - more than half of them since 2005 - bringing the total to nearly 40. In the last 12 months alone, sovereign funds have invested roughly $70 billion in financial institutions worldwide, most of them in the West.
Citigroup Inc. (C), Merrill Lynch & Co. Inc. (MER), UBS AG (UBS), and Morgan Stanley (MS) are among the financial-sector heavyweights that have received major capital infusions from sovereign wealth funds after their balance sheets were eviscerated by the subprime-spawned global credit crisis.
Both the U.S. government and the European Commission are concerned the foreign governments will use their investment stakes to advance their own geopolitical objectives. The funds don't always disclose details on their holdings and rarely explain their investment objectives.
In the United States, The Wall Street Journal last week reported that a delegation from the U.S. Treasury Department has met with executives from the Abu Dhabi Investment Authority and from Singapore's Government Investment Corp., to discuss their embracing a set of promises to not utilize their wealth for geopolitical gains. The talks are part of global negotiations to draft rules to oversee the behavior of such funds without discouraging them from investing in the United States, Europe and other developed markets at a time when the capital is badly needed because of a credit crunch and accelerating global financial turmoil.
The governments of Dubai, Saudi Arabia, China, Russia and Norway operate some of the biggest investment pools. The Middle East nations amassed their capital chiefly through crude oil sales, and with crude oil continuing to flirt with record highs, those funds continue to grow in size. Asian nations such as South Korea, Singapore and China built up their war chests mainly with the trade surpluses they've been running with Europe and the United States.
The global debate about sovereign funds has been escalating almost as fast as the funds' holdings have grown.
Back in December, Securities and Exchange Commission Chairman Christopher Cox said the state-run investment firms don't adequately disclose why they're buying stocks and other assets. Then in a Bloomberg Television interview late last month, U.S. Treasury Secretary Robert Kimmitt said that "both the growth in size and number of these funds is such now that vigilance is required."
However, even as the Eurozone pursues a governing code of conduct for the sovereign funds, European Commission President José Manuel Barroso last week argued that the funds "are not a big bad wolf at the door. We want to maintain an open investment environment, in Europe and worldwide."
In the shareholder letter that was dated Friday, Buffett, 77, said overt hostility on the part of the U.S. government could backfire - something the U.S. economy can ill afford because of the stabilizing effect the sovereign-fund investments have had.
Even if the foreign investors don't retreat because of a perceived hostility, they might back off out of confusion: The signals we're sending out are at least contradictory - if not downright hypocritical.
"Why should we complain when [foreign governments] choose [U.S.] stocks over bonds?'' Buffett wrote. "Our country's weakening currency is not the fault of OPEC, China, etc. In defending a sensible trade policy, the U.S. should not single out countries to punish or industries to protect. Nor should we take actions likely to evoke retaliatory behavior."
For years, as the United States has routinely run the twin deficits [budget and trade], we've just as routinely relied upon foreign central banks to finance those shortfalls with their ongoing purchases of dollar-denominated debt.
The U.S. trade deficit was nearly $709 billion last year, down about 7% from the record deficit of $758.6 billion in 2006.
We're only too happy to have Japan, China, Korea and others buy our bonds to [effectively] balance our budget, or to finance our trade gap. And the theories about the economic horrors that will result both here in the United States and in many economies abroad if those foreign central banks decide to stop buying our debt are well known.
But, as Buffet notes, when foreign countries opt to invest those same billions in the shares of some of our top companies, we suddenly cry "foul" and claim that it's a huge problem.
It is a huge problem - just not the one the government is worried about and would have us believe.
Some within the SEC, Treasury Department and both houses of Congress would have us believe that by investing billions of dollars in the stock of Citigroup and Merrill Lynch - America's largest bank and brokerage - governments in Asia and the Middle East have put themselves in positions of considerable potential influence.
The fact is, if that was the objective of these foreign states, they already hold the strategic high ground.
China - with its $1.3 trillion in foreign-exchange reserves - holds several hundred billion dollars of U.S. government debt. Believe me when I tell you that there's far more potential for China to exert influence or extract something it wants via this route than there is because of the few measly billions it invested in a bank or brokerage house.
China could dump dollars or dump debt and cause the greenback to plunge. That could cause inflation to skyrocket - at least until the U.S. Federal Reserve was able to crank interest rates up into the stratosphere, tipping the U.S. into a downturn unlike anything we can imagine.
And that's just one possible scenario.
When it comes to buying our stocks, China, Singapore, Kuwait and others have done us a massive favor. They've stabilized what was shaping up to be an even bigger sell-off in financial shares than we'd already seen. It was badly needed. Trouble is, that capital wasn't going to come from anywhere inside the U.S. capital markets.
And for the most part, the Asian and Middle East "Cash Barons," as we here at Money Morning have labeled them, have done so with little requested in return. They've not demanded seats on the boards of directors. They haven't demanded management say-so. They haven't made across-the-board demands for specially created classes of "preferred stock," or convertible preferred shares, that feature terms shareholders like you and I could never hope to get.
Indeed, in many cases - Dubai World's involvement with Las Vegas-based casino and hotel operator MGM Mirage (MGM) is a great example - the sovereign funds have set themselves up as a business partner, ensuring that both the target company and the sovereign fund have a long-term, unified view of the ultimate partnership goals.
Thanks to financing it's receiving from Dubai World - as well as the contacts the state-run fund can provide - MGM is actually a high-profit play on China.
Granted, the sovereign funds expect to make a profit - and a handsome one, at that. That may involve additional future investments. And it may involve a more-direct involvement with the company's management team. But if the sovereign funds make a profit, that should benefit U.S. investors, since ascension in the share prices of these companies means that one of several things occurred:
- A return to profitability, which fuels a rebound in the share prices.
- A buyout by another company that pays a nice premium over the market price for the right to make the deal.
- Or a broad U.S. economic rebound, which creates the proverbial "rising tide that lifts all boats."
Needless to say, all of those scenarios will benefit individual investors.
"Not only are [the sovereign funds] net buyers of some of the world's most-sophisticated companies, they're net holders, too," Money Morning's Fitz-Gerald says. "After all, they want many of the same things we do with our money - a stable, productive return."
There are a number of wild cards, of course, the "wildest" being Russia's newly promulgated pledge to become much more aggressive in the foreign investment space. Russia very like won't utilize such a "hands-off" strategy. But even its involvement will have a potentially big benefit, bringing more capital to the party and stoking demand - all bullish for the market value of the target companies.
Far from viewing these sovereign funds as a threat, U.S. investors should be looking to these as creators of a major investment opportunity.
Money Morning readers have known that for months. We've been tracking the Cash Barons and their forays since this service debuted. We detailed three promising profit plays in a special investment report that was part of our ongoing "Outlook 2008" global-economic-forecasting series. And it's a key topic that we'll continue to cover for years to come.
Money Morning subscribers should continue to view the Global Cash Barons as investment-opportunity indicators: As we noted, these savvy international investors aren't throwing their money around - and they're certainly not throwing it away.
They fully intend to get their investment back - with a substantial return.
"Many people feel threatened by SWFs," says Fitz-Gerald, the Money Morning Investment Director. "That's a mistake. They're long term investors, too, and they're buying many of the same companies we are recommending, which provides a stabilizing influence that's vitally important right now."
News and Related Story Links:
- Bloomberg News:
Buffett Blames U.S. Policy for Sovereign Funds' Rise. - Money Morning Special Investment Report:
Now That Warren Buffett is Crazy About the Loonie, Here are Seven Ways to Profit From a Strong Canadian Dollar. - Money Morning News Analysis:
Warren Buffett's Berkshire Hathaway Crafts Deals for Kraft Foods and GlaxoSmithKline. - Money Morning Economic Forecast Report:
Outlook 2008: Three Ways to Profit From Sovereign Wealth Funds - the "Next Wall Street." - U.S. Census Bureau:
U.S. International Trade in Goods and Services Highlights. - Wikipedia:
Balance of Trade. - Web Site:
Government Investment Corp. - Foreign Affairs:
How Scary is the Deficit?
About the Author
Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.