Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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Maybe sovereign funds do use leverage after all

by Brad Setser
June 3, 2008

Kuwait – per Henny Sender of the FT — has developed a taste for discounted mortgage-backed securities. That is a bit of a change. Up until now, at least based on the visible flows, investors in the Gulf have preferred Treasuries and Equities to mortgage-backed securities and corporate debt.

Sovereign wealth funds have provided more than half the equity for the BlackRock fund that bought $15bn of troubled mortgage debt from UBS this month, people with knowledge of the matter say ….

BlackRock raised $3.75bn in equity for the fund that bought the UBS mortgage debt. The rest of the money was borrowed from UBS itself, UBS has said. Some of the more sophisticated sovereign wealth funds, such as Kuwait Investment Authority , have been looking at acquiring real estate assets in the US, either directly or indirectly. KIA also has acquired stakes in real estate investment trusts, which are trading at bargain levels.

Kuwait — and any other fund that participated in the deal — could have bought UBS’s mortgage-backed securities outright. It isn’t short of free cash. Not with oil trading above $125.

It didn’t though. Instead it put up equity capital for a BlackRock managed vehicle that then borrowed funds — in this case from UBS — to buy a portfolio of riskier debt securities. That sounds a bit like a credit hedge fund.

Kuwait’s investment authority isn’t the only investor in this vehicle, but it seems to be the biggest one. Sovereign wealth funds can not really argue that they don’t use leverage when they are investing heavily in structures that do. Ted Truman wrote in his recent – and highly recommended — Peterson Institute policy brief:

Sovereign Wealth Funds [SWFs] invest in hedge funds, private equity funds and in other highly leveraged financial institutions such as banks whose activities, including the use of leverage, are indistinguishable from hedge funds and private equity funds. In effect, SWFs provide the capital for firms subsequently to leverage and to generate high rates of return for the funds themselves. …. They [SWFs] should be held accountable for the investment behavior of the institutions in which they invest.

He is right.

This isn’t meant as criticism of KIA’s investment in the BlackRock vehicle that bought the mortgage debt UBS wanted to unload. The KIA is bringing new money into a market that needs it.

It is, though, a criticism of the argument that the big sovereign funds are always unleveraged investors who take a long-term view. Sometimes that is an accurate description. Sometimes it isn’t.


  • Posted by Judy Yeo

    Thought leverage refersto the source of finance not the use of finance?

  • Posted by Judy Yeo

    What a way to generate business- you sell off what you don’t want to the take-all secondhand dealer to whom you incidentally lent money to so he can afford to take the trash you offloaded. Hmm, you have a cleaner BS (in all senses of BS ) and the ability to “create an illusion” of major new business, thw wonders of creative banking!

  • Posted by bsetser

    Judy — yes, finding a SWF to put up equity and then lending to a SWF financed vehicle to buy your trash is modern creative banking at its best (or worst).

    Leverage is rarely defined clearly. a real money investor that invests in a leveraged fund is, I would argue, using leverage.

  • Posted by glory

    and the UK (and US 😉 are ‘leveraged funds’!