Google to Start Venture Capital Fund

Google officially announced yesterday the creation of Google Ventures, a $100MM venture capital arm of the company. Unlike VC funds at other companies like Cisco and Intel, the fund will not limit investments to startups that are related to Google's business. The Google Ventures website explains that the fund's purpose is not to foster companies for later acquisition or to push Google products; rather, it appears that Google simply believes that it can earn a healthy return from the fund because Google's in-house personnel and resources put the company in position to effectively evaluate and grow new companies. Is this deviation from Google's normal line of business just another example of the company's innovative mindset or could the company be starting to lose sight of who it is? Read More......

Treasury Announces Public-Private Investment Funds

As I discussed as a possibility in a previous post, the Treasury has officially announced its plan to create public-private investment funds (PPIFs) for the purchase of toxic bank assets. The plan calls for five funds with the possibility of more based on the quality of the applications received by the Treasury for the fund manager positions. Details of the plan include private control over fund asset management with FDIC oversight, FDIC guarantees on qualified assets purchased by the PPIFs, a 6-1 leverage limit, and a 50-50 split of private and public fund equity capital. Notably the Treasury has not provided any indication of how the private fund managers will be compensated. Apparently the market is satisfied with the level of detail provided by the Treasury this time around as the Dow is currently up over 250 points. See this link for Treasury Secretary Geithner's piece about the plan in the Wall Street Journal.

[UPDATE] The Dow has closed with a gain just shy of 500 points. Read More......

Congress Has Some Interesting Plans for Financial Regulation

Jim Hamilton reported yesterday on Congress’s plan to reform financial market regulation, as delivered by Barney Frank, Chair of the House Financial Services Committee. The two-pronged approach will (1) address the creation of a systemic risk regulator and (2) strengthen investor confidence by increasing investor protection. Two particular components of the plan stood out to me.

First, to prevent loan securitization from shifting the risk of default completely off the shoulders of loan originators and securitizers, Congress would place a limit on how much of a loan may be securitized.

In order to restore the discipline of the lender-borrower relationship that was substantially weakened by securitization, the legislation will make it illegal for anybody to securitize 100 percent of anything. The exact percentage of retention is open for debate, said the oversight chair, but whatever percentage Congress decides to allow must follow the principle that the first dollar of loss is borne by the securitizer. This principle is correct, he reasoned, because securitizers are the ones who have to do some checking. But some liability will also be put on the originators.

This type of limitation would force the entities that purchase loans from originators in order to securitize and sell off the loans in parts to retain some portion of the purchased loans, which causes the securitizers to suffer some losses if those loans go bad. This retention of risk should cause the investment banks, hedge funds, and other securitizers to be more wary of the quality of the loans they purchase from originators, which in turn will cause originators to use tighter, more responsible lending standards.

Second, Congress intends to revisit the notion that “sophisticated” investors do not need the protection of the federal securities laws. This notion is the basis of numerous exemptions in the various securities laws that have allowed private investment funds to avoid most federal regulation by restricting access to investors with large amounts of money/financial sophistication. However, thanks to massive frauds pulled on these “sophisticated” investors by the likes of Madoff Investments and Stanford Financial, this notion has been seriously challenged.

If the exemptions for sophisticated investors are removed and all investors are treated the same, that could spell the end of hedge funds and possibly private equity funds as we know them. Hedge funds could be forced to disclose their trading strategies and take on less risk, which would basically turn them into mutual funds. Private equity and venture capital funds could be forced to give up their long lockup periods on investor funds, which could make their long-term investment strategies far less stable. Even if the only reform is that the standard of what makes someone a sophisticated investor is raised, that could cause a permanent contraction of the private investment fund market as the pool of potential investors shrinks. Read More......

Government-Sponsored Investment Funds?

The Wall Street Journal reported yesterday that the Treasury’s leading idea for removing “toxic” assets from bank balance sheets would involve the creation of government-sponsored investment funds. Under the potential plan, the government would purchase $500 billion to $1 trillion worth of bad bank loans and other distressed assets in a partnership with the private sector. The government’s funds would be run by investment managers who place certain amounts of their own capital into the funds, thereby aligning the interests of the government and the managers. Other private investors would also be able to invest in the funds.

The plan to buy up distressed bank assets was originally offered by former Treasury Secretary Henry Paulson, but the first round of bailout funds were instead injected directly into banks in hope of unfreezing the credit market. The main issue that blocked the Treasury’s plan to purchase distressed assets was the pricing of these assets in an illiquid market. Taxpayers do not want the government to overpay for these assets, but banks are not willing to accept the marked-to-market prices for these assets because doing so could annihilate their balance sheets. Additionally, the government wants to make sure that the purchase of these assets provides sufficient capitalization to allow banks to resume lending.

The Obama administration’s idea of the creation of a “bad” bank to purchase these assets would force money into the markets, but pricing of these assets would be problematic because the bad bank would be one of the only participants in the market. The idea of creating multiple investment funds carrying large amounts of government funds potentially solves the illiquid market pricing problem by allowing the private-sector to price the assets through the competition of the funds’ investment managers over those assets.

The creation of this system creates a number of new questions. How many different funds would be necessary to create sufficient competition over bank assets? How will the funds’ investment managers be compensated? What are the performance expectations of the investment managers? Will the funds have boards of directors and who will select the directors? Will taxpayers have any say in this process? If the Treasury does go forward with this plan, it will need to provide a specific plan that covers all of these questions and more or else uncertainty could again cause investors to retreat from the markets as they did last month when Secretary Geithner outlined a plan to fix this problem that was simply too vague. Read More......

Index Funds Losing Popularity?

The Wall Street Journal reports that E-Trade will be closing down all four of its index-linked mutual funds. E-Trade claims that the company is financially healthy, so this step may be a response to a reduction in investor demand in index funds.

Index funds seek to replicate market returns, instead of attempting to generate absolute returns. This means that unlike an actively-managed fund that aims to "beat the market" by picking winning stocks and to turn a profit whether or not the market is in a slump, an index fund's purpose is to match the market return, even when that return is negative. Investing through an index fund allows an investor to eliminate much microeconomic, company-level risk through the high level of diversification achieved by investing in an entire index of stocks rather than just a few stocks.

However, index funds are still subject to the macroeconomic risks that affect the entire economy like inflation and credit illiquidity. As the current economy continues to sink into recession, stock indicies are unlikely to see much growth in the near future, making index fund investing a losing strategy in the short run. Index fund investors may now be heading for the doors to gain short-term gains through actively-managed funds or to prevent further losses by retreating from the capital markets entirely. Either way, this trend may only last as long as the recession because once investor optimism returns (however long that takes), investors will likely once again see index funds as the best way to ride the wave of a rising economy. Read More......

Countries as Investors - by Nick Holland

Markets and exchanges are filled with individual and institutional investors, but what happens when countries want to get involved?

One possibility is that they are just another participant, and nothing is wrong. They are looking for profits just like the next investor. But is that always the case? What if a country is using investing as a tool for foreign policy? What if a country is investing heavily in a different country in order to gain political influence?

Sovereign Wealth Funds (SWFs) are raising these questions. Essentially, they are a country’s investment portfolio of foreign assets. Some SWFs have been for decades, but many have popped up in recent years. They typically earn the funds they invest from natural resources, predominantly oil. Soaring gas prices partially account for the recent increase in the numbers of these funds.

Even though there have not been any SWF abuses as contemplated in the questions above, domestic and European politicians are still worried. The uncertainty of whether SWFs are investing for economic or political reasons bothers them. The Committee on Foreign Investment in the United States, commonly referred to as CFIUS, already evaluates some foreign investment within this country. But some may think that more legislation is necessary. To help allay these fears, the International Monetary Fund (IMF) and a SWF international working group brokered a set of guiding principles for SWFs and published them last October. These principles are called the Generally Accepted Principles and Practices (GAPP) or the Santiago Principles (the IMF negotiated and adopted them in Santiago, Chile). GAPP advocates disclosure and transparency in the SWF, but they are entirely voluntary.

SWFs represent trillions of dollars of wealth, but politicians and others are skeptical of the SWFs’ motivations because there is much uncertainty about them. Hopefully, GAPP will close this information gap, and allay people’s fears. Only time will tell.
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