Friday Letter: Sovereign defence

Blackstone’s Stephen Schwarzman has joined in a chorus of approval for the sovereign wealth funds invested in their companies.  

Speaking at Davos on a World Economic Forum panel, the Blackstone chairman and chief executive Stephen Schwarzman this week depicted sovereign wealth funds as benign institutional investors.

Both Schwarzman and Michael Klein, chairman and co-chief executive of the markets and banking unit at Citi, the world's biggest bank, appear to be following the advice of a famous Welsh rugby coach to “get their retaliation in first” before the political backlash begins in earnest.

Schwarzman said his firm had worked with SWFs for years and that they were “model investors”. Blackstone’s chief, who sold a 9.9 percent stake in his firm to China’s Government Investment Corporation for $3 billion ahead of his firm’s initial public listing last June, said he welcomed investment from such funds.

“The difference of going to a sovereign wealth fund for money and going to a state pension fund in the United States, which is the largest source of money for a lot of the alternative investment activities, is veritably nothing,” he said. “Our experience with the sovereign funds is that they’re smart, they’re long-term, they’re highly professional. All they’re looking for is to earn the highest rate of return that they can.”

Earlier in the week, Citi’s Klein said the funds’ investment into financial institutions was “the greatest single benefit to the longevity of the US and UK financial structure”. They have of course also been a great benefit to the longevity of Citi itself. The bank, in an effort to repair its balance sheet after the credit crisis, has sold a 4.9 percent stake in itself to the Abu Dhabi Investment Authority for $7.5 billion, as well as a 4 percent stake to the Government Investment Corporation of Singapore for $6.9 billion.

Yet despite their role as white knights to sub-prime stricken US banks, sovereign funds have aroused suspicion among some in the West who fear the funds will use their financial clout to further political agendas. France’s Nicolas Sarkozy and Germany’s Angela Merkel have both said they would push legislation to give their governments the power to block sovereign wealth fund investments that are deemed a threat to national security.

This is one of the real dangers that sovereign wealth funds present: they may spur protectionists and nationalists into action, particularly while the funds’ motives remain relatively opaque. With a few exceptions, most do not even reveal what their goals are – let alone their investments.

UK magazine The Economist also highlights another issue: “Despite their disruptive market power, their managers have little accountability to regulators, shareholders or voters. Such conditions are almost bound to produce rogue traders.” All the more pertinent in the week French bank SocGen fell foul of the most rogue trade in industry.

It’s because of these issues and concerns that financial luminaries have taken it upon themselves to throw their weight behind the SWF movement. Schwarzman made sure to the importance of a financial return to sovereign investors, and he described as “prototypic” of sovereign funds their preference for passive investment and their disinterest in voting rights. “They’re not trying purposely to influence our activities,” he said.

This is a debate that has only just started. Expect other heavyweights to speak out before long, be it in favour or in fear.