Are Mega Funds Making Trigger-Happy Investing Decisions?

The $7 billion TPG-led recapitalization of Washington Mutual. The $5-8 billion Corsair-led syndicate to support the ailing National City (NCC). The tens of billions invested by sovereign wealth funds (SWFs) in Citigroup (C), Merrill Lynch (MER), Morgan Stanley (MS) and UBS (UBS). These are stunning numbers for firms that are in a lot of trouble.

Now, being a contrarian, I applaud the guts-of-steel necessary to invest in the face of financial panic. The problem is, I just don't see the panic reflected in the U.S. stock market, notwithstanding all the issues with the global credit markets. And I know that these private equity firms and the SWFs say that they are getting quality assets on the cheap. But I worry about the conflict between the ability and desire to write a big check and the best time to write such a check.

Because it seems to me that some funds are a little trigger-happy, pushing money out the door while they can in order to justify their existence and to spend time managing dollars instead of deploying them. And if I am right, this is a very worrisome trend, indeed.

Mega-funds, be they of the hedge, private equity or SWF variety, face pressures of scale. It is necessarily difficult to invest such massive sums, and it takes incomprehensible amounts of discipline to let ok deals (from a risk/return perspective) go by in order to wait for the truly great deals with solid margins of safety to present themselves. Because it can get pretty embarrassing sitting on $10 billion (or in the case of SWFs, $100 billion or more) of commitments, getting paid management fees and not putting money to work.

There is a natural pressure to pull the trigger, because it may be more painful waiting for the right deal to come along than doing a deal that ends up being mediocre but being busy in the process. And it certainly is impossible to raise a fund V, VIII or XII if one can't even get past 50% of committed capital for the current fund. This would bring the whole asset gathering operation to a screeching halt. And we can't have that, can we?

Why am I picking on these deals? Because the dollars are so large and the sector being mined so troubled. I get the argument about the value of WaMu (WM) and NatCity's core deposits and branch networks; I was once a Financial Institutions M&A specialist and spent lots of time looking at such things. But so much of the value of these deals turns on asset side of the balance sheet and the massive mortgage and commercial lending books. In my opinion we are early in the credit down-cycle, and even if one doesn't agree with my assessment, I think it is hard to argue that things will be rosy any time soon. And further, there is much uncertainty about the depth, breadth and timing of the credit downturn.

With all of these unknowns, clearly the investors in these deals are looking at the price they're paying and saying "This is my margin of safety; I'm buying cheap." But does anyone really have enough information yet to make such an assessment? Is buying at a 30% discount to market the right number? Is fair value really 20%? Or is it 50%? I certainly don't know. Maybe they do, and they could be right. But the risk/reward calculus seems kind of skewed at the present time.

If the deal sizes weren't so large I'm not sure I'd raise my eyebrows quite as high. It's just that the pressures of size are so great that I can see it adversely impacting rational decision-making. I'll be keeping careful watch on these deals. And I'll be interested to see the next series of mega-ticket deals getting done for exactly the same reasons.

Comments

[buyitcheap]

Is this a "fund manager mentality" on exhibit where the SWFs and PE funds have so much money to put to work they're taking a sophisticated, yet nonetheless, WAG, as to whether relative values, over the next 5-8 years, are such that it is not "that" risky and are committing massive sums on the assumption that their cash will continue to flow in, and maybe, that notion is actually lowering their required rate of return in the face of "stagnant cash balances?"

[globalmacro]

To be fair, the types of funds you describe have fairly long time horizons (particularly SWFs and some PEs) and it's probably bit early to comment in any meaningful way

[Pj568]

Intriguing question. Some deals have been previously questioned, but not all of them.

Is it possible the only investment with an adequate margin of safety made during the last six months is the JPM/BSC/FED deal?