Forget the Smart Money; These Stocks Are Still Losers

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.

Get Tim Hanson's top global stock picks by joining Motley Fool Global Gains. Tim's "Global View" column appears every Thursday on Fool.com.

Tim Hanson is the Fool's lead international advisor and co-advisor of Motley Fool Global Gains. He owns shares of Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 01, 2011, at 3:08 PM, Fliujniligui wrote:

    This is the brightest one. Fool criticizing QIA for unproven returns.

    I will explain you something Fools. If you have dozens of billions $. You can chose to recapitalize whatever you want and take majority control of it if there is a failing management.

    I would point out to a lot of sinking companies such as China Green Agriculture and AIB which were once on your ''Global Gains'' newsletter. Either QIA or Buffet could buy them all and recapitalize it, fix management where needed, but none did so.

    You fools can only recommend to buy high, say it might not work as planned on the downtrending period and then blast it hard like you now do with Irish banks and National Bank of Greece which were once recommendations from your letters.

    I even remember you had interviews with AIB's CEO, Eugene Sheehy, an incompetent manager at best on which you relied to tell you the truth about his company.

    Thus, be forewarned that if you read stuff on Fool Website, be extremely careful. NBG is a failure or at least a better buy now than it was anytime before when Fool's recommended it.

  • Report this Comment On September 01, 2011, at 3:33 PM, TMFMmbop wrote:

    We've certainly been wrong about some stocks in the past and will be wrong about others in the future. But if you look at our respective track record, we have been right more often than wrong with regards to both accuracy (>50%) and magnitude (beating the market).

    Tim

  • Report this Comment On September 01, 2011, at 5:13 PM, xetn wrote:

    What is the difference between NBG and the Fed?

    Answer: The fed can print all the money in the world out of thin air (and has flooded the world with its fiat), while NBG can not print any money.

  • Report this Comment On September 02, 2011, at 3:11 AM, bourse wrote:

    Thanks Tim for this article! This is exactly the point! European Banks are more dangerous than people think. Mrs Lagarde, now head of the IMF states that European banks need to be recapitalized immediately. When she still was French finance minister she did not tell this truth. This tells a lot about the quality of European politics....

  • Report this Comment On September 02, 2011, at 10:54 AM, devadason11 wrote:

    Is Banco Santander worth investing?

  • Report this Comment On September 02, 2011, at 1:47 PM, Duke5343 wrote:

    IRE is going to bouce back with a 16% injection from US investors last month and the Irish are recovering quicker then expected- bought more today at low price - long hold- what is Irish going to do- tell last one to leave to shut off the lightS? No IRE will make it

  • Report this Comment On September 02, 2011, at 11:09 PM, RetroAlum wrote:

    Some broad-brush painting up there... Lumping Spain together with Ireland and Greece?! Santander is in another league.

    True, the existence of the Eurozone means a "lowering tide lowers all boats", but the stronger ones survive. That's Santander; it's the largest bank in the Eurozone.

    It's the one picking up the pieces in Europe when the smaller guys get in trouble. Even in the 'States. Santander bought out Sovereign Bank in '09.

    In a "last man standing scenario" it'd be a fairly safe bet.

    And, it pays a >6% dividend.

  • Report this Comment On September 04, 2011, at 12:25 AM, Jazzenjohn1 wrote:

    It's crazy to equate WB's investment in BAC with an individuals. He's got preferred stock and it pays 6% while the common is now diluted and behind him if trouble happens. He also got 10 year leap options with the deal that are already in the money as a bonus. If anything, it would make me less likely to invest it that rat hole BAC. Look at Goldman after he exited. He got a 10% divi with that one and, I believe, a pre-payment bonus too. Good for a quick run up on the announcement, but not much more.

  • Report this Comment On September 06, 2011, at 2:23 PM, oilresearchguru wrote:

    Well, here we go again. Bashing an area that you have not properly researched. I have researched and advised extensively on IRE, NBG, and the European Union. I own IRE shares. I will be buying NBG shares. I am in for the long haul. The economy will turn around. These are "national banks" they will not be allowed to fail as a matter of national pride, just as BAC was not allowed to fail. Yes, Buffett stepped in, a Canadian insurance company stepped in, and now, the Quatar Investment fund is investing. I am sure that their advisers did their research as well.

    You have a responsibility to conduct thorough research before you go to press with something. I suggest that writers like you stop adding fuel to the fire in the EU and as my mother used to tell me, "If you can't say something nice, say NOTHING at all!"

    The EU's problems are merely interfamily squabbling anyway. Check the IMF website for future growth forecasts, then sit down.

    Consultant One

  • Report this Comment On September 07, 2011, at 12:32 PM, TMFMmbop wrote:

    "These are "national banks" they will not be allowed to fail as a matter of national pride"

    That's a very emotional thesis. I caution you that the bank can be saved while shareholders are wiped out in a recapitalization plan.

    Also, the point of this article is that SWFs apparently rarely do good research assessing risk and reward because they are investing with political, not financial motives.

    Finally, I am sitting down.

    Tim Hanson

  • Report this Comment On September 07, 2011, at 12:33 PM, TMFMmbop wrote:
  • Report this Comment On September 07, 2011, at 2:02 PM, NEMnyWtch wrote:

    Good article Tim! Something I have been pondering though - don't you think that the litigation risk on BAC is somewhat mitigated at these prices? I ask myself, what's going to happen when the rubber meets the road in court? "Honest your honor - I had no idea I was buying a house." Really? I don't think so. I think the bank(s) involved in robo-signing will have to pay "damages" but what are these damages really? At the end of the day, fines to pay the class action laywers, and not a lot for the homeowner who did, in fact, want to buy the home. I don't think it will massively devalue the shares from here. Personally I think Mr. Buffet is brilliant.

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