Can e-Trading Revitalize Corporate Bonds?

$118 Trillion and Counting: Taking Stock of the World’s Capital Markets

July 15, 2008 | by John Olivier, Chief Investment Officer

The past year has seen much financial unrest, but three players—Asian sovereign investors, oil exporters, and private equity firms—have helped stabilize the market.

Many market participants have struggled to cope with the financial turmoil of the past year. But three players have continued to grow in wealth and clout: Asian sovereign investors, oil exporters, and private equity firms. Moreover, several of these actors gained new prominence by using their vast pools of capital to help recapitalize the balance sheets of other financial institutions and help contain the crisis. Their actions highlighted the benefits they offer—but also heighten concerns about the potential risks they pose.

Much of this gain reflects the Asian countries' swelling trade surpluses and the oil exporters' soaring petro-profits. Additionally, both private equity and hedge funds saw their assets under management grow in 2007, but had to adjust to a sudden loss in the leverage they had used to amplify returns. Private equity survived in reasonably good shape by employing new investment strategies—including taking minority stakes in publicly traded companies and expanding in emerging markets. Overall, private equity continues to attract investor capital. But hedge funds were harder-hit; several closed, many posted large losses linked to credit products, and fund-raising slowed to nearly nothing by early 2008.

The Stabilizers

Clearly, the power brokers have financial influence because of their sheer size. Three individual institutions in this group—the central bank of China, the Bank of Japan, and the Abu Dhabi Investment Authority (ADIA)—rank among the top 10 largest asset managers in the world. And Russia's oil revenues have made it the third-largest holder of foreign reserves, after Japan and China.

But it was by using their riches to help recapitalize and stabilize other financial institutions that the power brokers emerged as key players in the crisis. We calculate that together, Asian and oil-based sovereign investors invested $59 billion in Western financial institutions from March 2007 through June 2008. ADIA, for example, provided Citigroup © with $7.5 billion in emergency capital. Sovereign wealth funds such as the Kuwait Investment Authority and Korean Investment provided new funding for Merrill Lynch (MER). And the Qatar Investment Authority is injecting $3.5 billion into Barclays (BCS).

Private equity also has helped stabilize troubled institutions. The private equity firm TPG, for example, took a stake in the struggling mortgage lender Washington Mutual (WM). Private equity firm Corsair Capital pumped millions into ailing National City (NCC). And several private equity firms have found new investment opportunities in buying banks' distressed debt. Private equity funds announced fund-raising of $84 billion in new distressed debt funds in the first quarter of 2008—more than triple the total in all of 2007. These debt purchases will enable the banks to improve their balance sheets, which should help them resume lending.

These combined actions helped prevent the credit crisis from spreading, and demonstrated some of the benefits offered by the power brokers. They were able to tap large reservoirs of liquidity. They have spurred the increasing availability of private financing as an alternative to troubled public markets, which should make the financial system more resilient and efficient. And the flexibility of their investment strategies and long time horizons allowed them to provide infusions of capital at a time when they were not attractive short-term investments. Indeed, we calculate these stakes have lost approximately $14 billion in value, but are likely to generate positive returns over time.

These qualities have proven valuable not just to the institutions that received the capital infusions, but also to the broader financial system. It is doubtful Western governments could have provided taxpayer-funded financial assistance to the banks on the same scale without triggering a public uproar. It is unlikely the banks could have raised as much capital through the public equity and debt markets amid such turbulence.