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You should know by now that European banks are on shaky ground. Because of their ownership of troubled European sovereign debt -- bonds they are reportedly marking to model rather than market (i.e., they're making up what they think they're worth) -- they are going to need truckloads of new capital as sovereign defaults by the likes of Greece, Spain, Italy, or Portugal start flowing through the system.
And the sector's recent stock market performance reflects this massive risk. Over the past year, the Bank of Ireland (NYSE: IRE ) is down almost 90%, National Bank of Greece (NYSE: NBG ) is down more than 60%, and Spain's BBVA (NYSE: BBVA ) and Banco Santander (NYSE: STD ) are down more than 25%.
Thus, I found it curious that all of those bank stocks were up sharply, with NBG up more than 30%, on the news that Greece's second- and third-largest banks, Alpha Bank and Eurobank, planned to merge and get new capital from the Qatar Investment Authority, that Middle East state's sovereign wealth fund.
Big money is not necessarily smart money
Perhaps the optimistic reaction to this deal is not surprising given that it came in the wake of Berkshire Hathaway's (NYSE: BRK-A ) (NYSE: BRK-B ) decision to inject $5 billion into troubled Bank of America (NYSE: BAC ) on very preferential terms, a move that restored some confidence in B of A and caused its stock to rise as high as 25% the day of the announcement. When smart money moves in, it may be true that things are not as bad as they appear.
But there is a big difference between Berkshire's Warren Buffett and the Qatar Investment Authority. One has amassed a fortune while building a 50-year track record for making superior and contrary investments. The other was set up in 2005 to find something to do with the billions and billions of state reserve funds that Qatar has amassed simply by being lucky enough to have been founded atop massive reserves of oil and natural gas.
In other words, one can rightly claim to be an investing and financial expert (that's Buffett). The other (the QIA) is at best unproven and at worst has no idea what it's getting into. Just because it is managing $85 billion does not necessarily mean it's a fund worth following.
All important evidence
Frankly, Qatar, like other investors in Greek and European banks, is going to lose money on this deal. The sovereign debt issues are too significant on the continent, and politicians there will ultimately either run out of the money or political will to keep propping themselves up. Cracks, in fact, are already appearing in that facade, with Finland demanding collateral to provide new loans to Greece. Finnish Prime Minister Jyrki Katainen simply can't stay in power if he's seen as setting money on fire by sending it to Greece. Other European politicians, facing dwindling popularity, are soon to start demanding the same terms, and leaders in Germany and France may not be able to keep them all in line.
Furthermore, although the concept of "too big to fail" may have helped some U.S. financial institutions avoid demise, the fact is that adding bad assets to more bad assets does not improve a bank's balance sheet. The only thing this deal may accomplish is reducing the number of banks from which Greeks can withdraw their deposits!
Of course, losing money is nothing new for a sovereign wealth fund. A recently released 25-year study of SWF investing revealed that while "announcements of SWF investments yield significantly positive abnormal stock price returns ... most investments lead to deteriorating firm performance over the following two years, with significantly negative mean abnormal returns." More incredibly, that "abnormal performance worsens the larger the stake acquired" [emphasis added]. Put simply, the market believes SWFs are smart money even when they're not.
Qatar may be OK with that
There are a number of hypotheses that attempt to explain why SWFs are such bad investors. The aforementioned study, for example, suggested that because SWFs are state-owned, they don't properly monitor their investments or local management teams for fear of upsetting authorities in the countries in which they've chosen to invest.
While that may be true of some SWFs, I think it might be different when it comes to an SWF like China's or Qatar's. These countries appear to be using their surpluses to influence authorities in other countries rather than risk upsetting them. After all, neither country needs more dollars to spend -- as both countries investments in extravagant and perhaps unnecessary infrastructure (like air-conditioned stadiums to host the World Cup) makes clear. What they want rather than investment gains, is to build a foundation for more stable long-term GDP growth.
Why, then, would Qatar risk losing money on a deal to prop up two Greek banks? Reuters opined, and I think it's spot-on, that "Qatar has a sizeable interest in shoring up relations with Europe, as it seeks to become the region's preferred provider of gas."
The global view
Europe is facing serious financial problems -- problems that are plain to see and that will likely further punish investors in the continent's banks. That said, you may continue to see the Qatar Investment Authority and others such as the China Investment Corp. or Abu Dhabi Investment Authority "invest" in this "special situation."
I, however, would hesitate to follow them. As SWFs for countries that would suffer severely if there were a downturn in developed market demand for oil and manufactured consumer goods, they likely have an agenda that goes beyond merely earning acceptable investment returns. In fact, SWFs are notorious for their willingness to take and tolerate losses. But unlike you and even unlike real smart money like Warren Buffett, they may make up for those losses in ways others cannot.