What about the financial economy? In the U.S., Lehman Brothers (NYSE: LEH), Merrill Lynch (NYSE: MER), and Goldman Sachs (NYSE: GS) all report earnings this week. If you are a Sovereign Wealth Fund that decided to recapitalize Wall Street in the last six months, we recommend a cheap bottle of Scotch to go with your wasted capital. Wasted and wasted.
In fact, let us raise the prospect that the entire model of making money by managing and flogging assets is now in jeopardy. Case in point, Macquarie Capital Alliance Group (ASX: MCQ). Three years ago the investment fund raised a $1 billion from investors and had itself listed on the ASX. Now Macquarie is buying it back for $830 million and taking it private.
Macquarie took a $295 million write down earlier this year on its listed Australian real estate investment trusts, according to Brendan Swift in yesterday's Australian Financial Review. Some of its listed funds are selling at nearly 35% discounts to net asset value, according to Swift. Does that mean the assets are worth less than what Macquarie says they are, or what it paid for them?
Well, it could mean there's a lack of confidence in the listed fund model and that it's a great time to pick up Macquarie funds for a song. Or it could mean that using debt to finance asset purchases and earn money on fees and underwriting works really well when interest rates are low, and not as well when rates are high. You but assets with borrowed money, earn money on the assets, and fees on packaging them up and selling them again.
Babcock and Brown (ASX: BBC) made the mistake of financing much of its asset growth with short-term debt. When the debt had to be rolled over at higher interest rates, the flaw in the model was exposed. You can be the best asset manager in the world. But if the asset doesn't generate enough income to cover your debt payments, you have a problem.
Is the Macquarie model dead? No. But it is not an easy model to replicate either (or make work when borrowing money is no longer cheap and easy). You have to be discrete about the assets you buy and not over pay for them. And frankly, not many people can make money trying to be like Warren Buffett, buying assets and managing them better than people who work in the business full time.
Wall Street operatives invaded the boardrooms of global corporations over the last ten years, preaching the gospel of aggressive financial management. This meant selling "lazy assets" and stripping down companies to basic functions, shedding jobs and vertically integrated supply chains.
It worked very well for the investment banks that generated fees from the spin-offs, which they might later put together in some new shape. But did it work so well for the businesses? Probably not. An economy driven by the fee-making potential of asset managers does not necessarily end up being more competitive, efficient, or productive.
Dan Denning
The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
Related Articles:
- French Model of Economy Allows Meddling from the State
- Mainstream Financial Press is Finally Catching on to Hedge Funds
- Heirs to A.W. Jones
- The Problem With a Well-Diversified Portfolio
- The “China Story” is Not Dead Yet
About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by Coffee Addict on 18 June 2008:
Hmmm... can't disagree with anything Dan says above. A key issue is how much debt is directly held by B&B and Macq. for these ventures.
I had heard that many fund managers were pushing client money into utility and infrastructure vehicles of this type to avoid market volatility elsewhere. To what extent are these investments contingent upon the continued health of the investment house? I don't really know. If investment funds are set up properly, trust instruments should insulate investor funds from the financial health of the trustee. Investors should not be exposed but there can always be a few devils in the fine print. One devil is the involvement of the trustee (or trustee's parent) in the underlying business. A second devel is the profit potential of the enterprise itself particularly given the impact of rising fuel prices.
For most infrastructure projects, governments assign the commercial risk to the operators while continuing to control (or greatly influence) prices charged to users. It all works well when interest rates, energy prices and consumer demand remain stable. However where this is not the case and an operator acually defaults, some assets may (through contractual clause) be transferred back to government. Investors would be wiped out.
Macquarie is a much larger fish for another bank to swallow than B&B. If it ever needs to be swallowed it may need to be broken up first.
Comment by Pete on 18 June 2008:
Isn't Babcock & Brown ASX:BNB? Excuse my ignorance if I am wrong...
(as against some of their other products, eg ASX:BBI)