The Wall Street Journal-20080123-Business World- Sovereign Wimp Funds
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Business World: Sovereign Wimp Funds
Hillary Clinton test-marketed worry about "sovereign wealth funds" at last week's Nevada debate, but the polls didn't jump and neither did her Democratic rivals. Give her and her fellow political professionals credit for quickly moving on to the more politically remunerative issue of a droopy economy.
There is wisdom here. Dollars are dollars. Unless we want to ruin our currency, we have no business limiting its usefulness to foreigners after we've traded it for oil or DVD players. Off-hand, it's hard to think of a more benign use for money they earn than taking equity stakes in U.S. businesses. Would we prefer they spent it patronizing the global arms industry, especially after this week's temperamental market ructions?
In a sunshine and gumdrops world, of course, allocating capital would be a job left to the private sector, and we'd see no sovereign investors or, for that matter, state and local pension funds. But that's not reality. Nonetheless a backlash may be brewing, since it would be unlike Congress to miss an opportunity to disapprove of wealthy foreigners in funny hats. Such a backlash would only exacerbate the real dilemma with sovereign funds: Are they smart money or dumb money, helping or hurting corporate efficiency?
Take the case of Citigroup. Its stock price had been stagnant for five years, before plummeting in the subprime follies. Expenses were growing faster than revenues. Every passing scandal, from Enron and the dot-com bubble to the mortgage disaster, seemed to leave a smudge on the Citi brand.
Yet U.S. fund managers who've publicly agitated for a breakup to unlock value won't look upon the Abu Dhabi Investment Authority, Kuwait Investment Authority or Government of Singapore Investment Corporation as natural allies. These funds, which injected $20 billion to help Citi through its subprime writedowns, were necessarily recruited as "friends" of current management. How could it be otherwise? Any CEO who felt his position threatened by a sovereign investment would find it all too easy to send up a flare to Congress, summoning aid against suspect "foreign" meddling.
Worse, every incendiary article, news report and political speech about the "danger" posed by sovereign investment reinforces the instinct of such funds to be headline-shy, controversy-averse, and unwilling to join other shareholders in pushing noisily for change, even needed change. As if to underline the point in Citi's case, the latest sovereign infusions were matched to symbolic investments by Sandy Weill, who built the current Citigroup model, and Saudi Prince Alwaleed, both of whom have publicly derided the notion of a breakup.
That sovereign investors might provide support for maladaptive corporatism is among the reasonable (as opposed to many unreasonable) fears about such funds, and we don't pooh-pooh those like BlackRock's Larry Fink who've recently given voice to it. But let's catch our breath. Non-aggressive, management-friendly ownership has already been the rule for big mutual funds, index funds and state pension funds, and has not impeded the market for corporate control and corporate accountability (in fact, a much bigger problem has been legal shackles on hostile takeovers).
Passive means passive: Holders don't determine share prices -- buyers and sellers do, including short sellers. And Citi's management, if it can't make its business model work, won't find Abu Dhabi any proof against a falling share price and harsh pressure from the markets to change direction.
New CEO Vikram Pandit is rightly focused on the immediate job of bailing out a leaky ship (for which sovereign funds have played an incontestably useful role), but the debate about Citi's future will return soon enough. Nor is the breakup case the no-brainer it sometimes seems. A new McKinsey study of global banking offers at least a semi-endorsement of Citi's current strategy of a finger in every pie: "More than in other major industries, it appears, long-term success in banking hangs on being in the right place at the right time."
Then again, the report also notes the highly promising "math of wealth accumulation" in the developed and developing worlds. Ammunition for the breaker-uppers? You bet. A Citi that focused exclusively on being the highest-tech, lowest-cost, most-trusted producer of financial services for the world's burgeoning middle class might well capture a satisfactory share of global banking's profits without so much scandal and volatility. As it once led in adopting automated teller machines, Citi could lead the next wave, integrating personal finance with mobile Web access on the cell phone. It could become, in the words of former chief John Reed, one of those magical four-letter marketing wands -- like "Coke," "Sony" and "Nike."
Which path is best? Hosting such arguments is what capital markets do, and whether a big holder chooses to sit on the sidelines (as, say, index funds do) matters little. If a company can't convince the broader market of its future earning potential, capital will drain away faster than sovereign funds can add it. Any management that might be tempted to hope otherwise (say, Citi's) would only be kidding itself.
