What do sovereign funds, which are state-run investment funds, know that Wall Street doesn’t? Sovereign funds have been huge investors, to the tune of more than $51 billion since the beginning of this year, in companies that are being tossed aside by global stock markets.
Most recently they have been investing in the most shunned sector of the stock market, financials. Taking a closer look at the temperament of these investors, what they are buying and how they are investing, it appears to me they are taking a page right out of the value investor’s playbook. Stock investors’ fears are their gain. Before exploring sovereign funds, it is important to understand the context of their investments.
Since January 2006, sovereign funds have been buyers of Western financial companies. Unless you have been living on an island for the past year and have had no communication with the outside world, you know that the bursting of the housing bubble has created all sorts of problems for financial companies. During the housing boom,mortgage banks lowered their credit standards and gave a mortgage to anyone who had a pulse. Many of these homebuyers had no business buying homes due to bad credit or insufficient income; that didn’t seem to matter,banks were all too eager to give them mortgages with adjustable rates that zoomed to the sky after the first several years. Wall Street then packaged these mortgages into securities and sold them to banks,hedge funds and institutions.
All seemed fine until homeowners started defaulting on their mortgages.This caused problems for everyone involved, because no one knew what value to place on these mortgagebacked securities. Financial institutions began writing down the values of these securities, causing their balance sheets to weaken. It seemed like every other day another institution was writing down the values of these securities,causing their balance sheets to look even sicker. In addition, nobody knew exactly how many of these securities were out there and how much each financial institution had on its books.
Wall Street’s Reaction
Traders on Wall Street reacted as you would expect: they sold first and asked questions later. Multibillion-dollar financial behemoths traded 30 to 40 percent lower, and their share prices bounced around like penny stocks (Table 1). Just to give you an idea of the panic, on November 27,2007,193 million shares of Citigroup changed hands ---- close to 4 percent of the total volume on the NewYork Stock Exchange.
Company
Symbol
Performance
Market Cap
Barclays PLC
BCS
-30%
$67 billion
UBS AG
UBS
-24%
$88 billion
Citigroup, Inc.
C
-46%
$150 billion
White Knights
Throughout the year, sovereign funds and other savvy investors were buyers while most others were sellers. Warren Buffett once gave the advice to“be greedy when everyone is fearful and fearful when everyone is greedy.” That is exactly what sovereign funds were doing. It is estimated that sovereign funds have $7 trillion pools to invest. In addition to favorable terms they can negotiate from companies seeking their investments, they also are able to hire a lot of brainpower to advise them where to invest. Their investments over the short term might look stupid, but keep in mind this is a very sophisticated group of investors. One more important advantage they have is patience. WhileWall Street is concerned with a company’s quarterly results, they are interested in the company’s results over the next five years. What appear as huge potholes to short-term investors are viewed by sovereign funds as nothing more than speed bumps over the long term. Observing how they have been allocating money over the past year has led me to believe they must be following the advice of Benjamin Graham. Graham’s three principles were :view stocks as parts of businesses, ignore the day-today fluctuations of the stock market and buy when you have a margin of safety.
Taking a look at three recent investments by sovereign funds, I’m sure you’ll agree with me that they are truly value investors.
Most traders looking at Barclays last summer probably focused on a bank that was struggling with its credit card and mortgage lending divisions. They also took notice of the increase in bad debts and credit deterioration on its books. In July 2007, Singapore’s Temasek Holdings invested $2 billion, for a 1.8 percent share of Barclays. The investors probably viewed the company as one of the three largest banks in the U.K. that was expanding throughout the world. In addition, they most probably focused on the company’s large market share in asset management as well as investment banking.
On November 26, 2007, rumors were swirling that Citigroup might have to write off an additional $15 billion as mortgage losses continued to weigh on the bank. Citigroup shares tumbled and were now off close to 30 percent from the preceding five weeks. The next day it was announced that the Abu Dhabi Investment Authority would make a $7.5 billion investment, giving it a stake just a hair shy of 5 percent.
While Wall Street saw a money-center bank that had more than $17 billion in losses in its securities portfolio, the potential for further write-downs of assets and the likelihood of having lower earnings over the next several quarters, the Abu Dhabi Investment Authority saw these events in a different light.
It saw a company that has a global banking franchise with a presence in more than 100 countries trading at a valuation not seen in years. Since the Authority has a longterm outlook, it probably saw this as a great company suffering from a temporary problem that it was able to buy at an attractive price.
On December 11, UBS, long known as a conservative Switzerland-based bank, announced it would take a $10 billion write-down. Its stock price, already off 18 percent on the year, fell another 5 percent that day. It also announced that Singapore’s government investment arm and an unnamed Middle Eastern investor would invest $11.5 billion for a 9 percent stake in the bank.
During the past year, management changed its conservative ways and took large risks on subprime debt. The new investors probably see this as a temporary event and focused on the bank’s large operating margins, its position as the largest asset manager in the world ($2.6 trillion in assets) and its excellent management.
Back Home
While the latest investments by sovereign funds have made headlines, this shouldn’t be anything new for longtime proponents of value investing. When traders are selling shares in a company that is experiencing short-term problems, value investors roll up their sleeves and get to work. They ask, “Is the problem short term and fixable, or terminal?” If the problem is short term and fixable, they get to work and come up with an intrinsic value for the company. If the stock price is trading below the company’s intrinsic value, offering a margin of safety, they back up the truck and buy.
Warren Buffett did exactly the same thing in 1973 with the Washington Post. While share prices were falling sharply in the bear market of 1973-74, Buffett was buying. His total investment in the Washington Post was $10 million. That share, which he still owns, is now worth more than $1.3 billion.
On October 25, Wellcare Health Plans (WCG, Financial) announced that the FBI raided the company’s Florida headquarters. The stock price, which closed on October 24 near its 52-week high of $115, plunged to $22 by November 1, an 80.1 percent loss! Once again, traders sold first without regard to the value of the company or the extent of the problem. Value investor Bruce Berkowitz of the Fairholme Fund recently disclosed that his fund invested 4 percent of its assets in WCG. Knowing Berkowitz’s excellent track record and painstaking research, it is fair to say that the problems at WCG appear short term and fixable and he bought a good company at an attractive price.
Conclusion
It will be very interesting to revisit Barclays, Citigroup, UBS and Wellcare Health Plans a few years from now. I would say there is a high probability that investors will look back on this period as an excellent entry point and kick themselves because they didn’t pull the trigger.
Sovereign funds and other savvy investors continue to follow the principles laid out by Ben Graham so many years ago. They view stocks as businesses, do not allow the stock market to value the company and buy only when there is a margin of safety. In the preface to Graham’s book The Intelligent Investor, Warren Buffett wrote, “Ben’s principles have remained sound-their value often enhanced and better understood in the wake of financial storms that demolished flimsier intellectual structures.” I guess that is why they are called principles.
Most recently they have been investing in the most shunned sector of the stock market, financials. Taking a closer look at the temperament of these investors, what they are buying and how they are investing, it appears to me they are taking a page right out of the value investor’s playbook. Stock investors’ fears are their gain. Before exploring sovereign funds, it is important to understand the context of their investments.
Since January 2006, sovereign funds have been buyers of Western financial companies. Unless you have been living on an island for the past year and have had no communication with the outside world, you know that the bursting of the housing bubble has created all sorts of problems for financial companies. During the housing boom,mortgage banks lowered their credit standards and gave a mortgage to anyone who had a pulse. Many of these homebuyers had no business buying homes due to bad credit or insufficient income; that didn’t seem to matter,banks were all too eager to give them mortgages with adjustable rates that zoomed to the sky after the first several years. Wall Street then packaged these mortgages into securities and sold them to banks,hedge funds and institutions.
All seemed fine until homeowners started defaulting on their mortgages.This caused problems for everyone involved, because no one knew what value to place on these mortgagebacked securities. Financial institutions began writing down the values of these securities, causing their balance sheets to weaken. It seemed like every other day another institution was writing down the values of these securities,causing their balance sheets to look even sicker. In addition, nobody knew exactly how many of these securities were out there and how much each financial institution had on its books.
Wall Street’s Reaction
Traders on Wall Street reacted as you would expect: they sold first and asked questions later. Multibillion-dollar financial behemoths traded 30 to 40 percent lower, and their share prices bounced around like penny stocks (Table 1). Just to give you an idea of the panic, on November 27,2007,193 million shares of Citigroup changed hands ---- close to 4 percent of the total volume on the NewYork Stock Exchange.
Company
Symbol
Performance
Market Cap
Barclays PLC
BCS
-30%
$67 billion
UBS AG
UBS
-24%
$88 billion
Citigroup, Inc.
C
-46%
$150 billion
White Knights
Throughout the year, sovereign funds and other savvy investors were buyers while most others were sellers. Warren Buffett once gave the advice to“be greedy when everyone is fearful and fearful when everyone is greedy.” That is exactly what sovereign funds were doing. It is estimated that sovereign funds have $7 trillion pools to invest. In addition to favorable terms they can negotiate from companies seeking their investments, they also are able to hire a lot of brainpower to advise them where to invest. Their investments over the short term might look stupid, but keep in mind this is a very sophisticated group of investors. One more important advantage they have is patience. WhileWall Street is concerned with a company’s quarterly results, they are interested in the company’s results over the next five years. What appear as huge potholes to short-term investors are viewed by sovereign funds as nothing more than speed bumps over the long term. Observing how they have been allocating money over the past year has led me to believe they must be following the advice of Benjamin Graham. Graham’s three principles were :view stocks as parts of businesses, ignore the day-today fluctuations of the stock market and buy when you have a margin of safety.
Taking a look at three recent investments by sovereign funds, I’m sure you’ll agree with me that they are truly value investors.
Most traders looking at Barclays last summer probably focused on a bank that was struggling with its credit card and mortgage lending divisions. They also took notice of the increase in bad debts and credit deterioration on its books. In July 2007, Singapore’s Temasek Holdings invested $2 billion, for a 1.8 percent share of Barclays. The investors probably viewed the company as one of the three largest banks in the U.K. that was expanding throughout the world. In addition, they most probably focused on the company’s large market share in asset management as well as investment banking.
On November 26, 2007, rumors were swirling that Citigroup might have to write off an additional $15 billion as mortgage losses continued to weigh on the bank. Citigroup shares tumbled and were now off close to 30 percent from the preceding five weeks. The next day it was announced that the Abu Dhabi Investment Authority would make a $7.5 billion investment, giving it a stake just a hair shy of 5 percent.
While Wall Street saw a money-center bank that had more than $17 billion in losses in its securities portfolio, the potential for further write-downs of assets and the likelihood of having lower earnings over the next several quarters, the Abu Dhabi Investment Authority saw these events in a different light.
It saw a company that has a global banking franchise with a presence in more than 100 countries trading at a valuation not seen in years. Since the Authority has a longterm outlook, it probably saw this as a great company suffering from a temporary problem that it was able to buy at an attractive price.
On December 11, UBS, long known as a conservative Switzerland-based bank, announced it would take a $10 billion write-down. Its stock price, already off 18 percent on the year, fell another 5 percent that day. It also announced that Singapore’s government investment arm and an unnamed Middle Eastern investor would invest $11.5 billion for a 9 percent stake in the bank.
During the past year, management changed its conservative ways and took large risks on subprime debt. The new investors probably see this as a temporary event and focused on the bank’s large operating margins, its position as the largest asset manager in the world ($2.6 trillion in assets) and its excellent management.
Back Home
While the latest investments by sovereign funds have made headlines, this shouldn’t be anything new for longtime proponents of value investing. When traders are selling shares in a company that is experiencing short-term problems, value investors roll up their sleeves and get to work. They ask, “Is the problem short term and fixable, or terminal?” If the problem is short term and fixable, they get to work and come up with an intrinsic value for the company. If the stock price is trading below the company’s intrinsic value, offering a margin of safety, they back up the truck and buy.
Warren Buffett did exactly the same thing in 1973 with the Washington Post. While share prices were falling sharply in the bear market of 1973-74, Buffett was buying. His total investment in the Washington Post was $10 million. That share, which he still owns, is now worth more than $1.3 billion.
On October 25, Wellcare Health Plans (WCG, Financial) announced that the FBI raided the company’s Florida headquarters. The stock price, which closed on October 24 near its 52-week high of $115, plunged to $22 by November 1, an 80.1 percent loss! Once again, traders sold first without regard to the value of the company or the extent of the problem. Value investor Bruce Berkowitz of the Fairholme Fund recently disclosed that his fund invested 4 percent of its assets in WCG. Knowing Berkowitz’s excellent track record and painstaking research, it is fair to say that the problems at WCG appear short term and fixable and he bought a good company at an attractive price.
Conclusion
It will be very interesting to revisit Barclays, Citigroup, UBS and Wellcare Health Plans a few years from now. I would say there is a high probability that investors will look back on this period as an excellent entry point and kick themselves because they didn’t pull the trigger.
Sovereign funds and other savvy investors continue to follow the principles laid out by Ben Graham so many years ago. They view stocks as businesses, do not allow the stock market to value the company and buy only when there is a margin of safety. In the preface to Graham’s book The Intelligent Investor, Warren Buffett wrote, “Ben’s principles have remained sound-their value often enhanced and better understood in the wake of financial storms that demolished flimsier intellectual structures.” I guess that is why they are called principles.
