Zurich-based Bank Sarasin has roughly $80 billion in assets and saw share prices rise almost 20% last year. With branches already in Bahrain, Dubai and Qatar, it will likely open a representative office in Beirut within two years. Executive interviewed Burkhard Varnholt, Sarasin’s Chief Investment Officer, about his bank, the political situation in Lebanon and the regional economy.
E What does Bank Sarasin offer current and potential clients in the region?
Our bank offers dedicated client wealth management services and asset management for private and institutional investors. We have no integrated banking model because we feel it strengthens our franchise as there is no conflict of interest. We one-sidedly look after our client’s assets. We do no brokerage, no securities underwriting, no private equity, no corporate advisory or any other kinds of business often combined with private banking.
E Why is Sarasin thinking about opening an office in Lebanon?
We have shared visions and principles in the way we look at the world and investments. Lebanon has a very old and rich culture of economic heritage. So does our bank, which has been around for a good 160 years. When you bring that cultural heritage to the table, it results in a similar way of looking at the importance of preserving assets across generations. Lebanon being a small country and economy with a large diaspora around the world is obviously much more open, not only in its economy, but also in its society. This is a similarity that we share; Switzerland is also a small but open economy. It changes the way you look at the world and the global economy, it forces you to be more open-minded and more international in your aspirations.
E What affect does the current political and economic situation have on your plan to open an office here in Lebanon?
The political stalemate is one thing, but it is telling that the Lebanese economy, after those various external shocks of 2005, 2006 and this year, has always found its feet. And even this year it is likely to grow at 1.5-3%, which is well below its potential, but is still more than many countries in Western Europe or even the United States. If you look at the Lebanese banking sector, for decades it has been exceptionally strong. The government has always been able to maneuver itself through what in other parts of the world are considered unwieldy positions, with debt-to-GDP ratios far in excess of 160%. It speaks to the strength of the underlying real Lebanese economy and how well it is connected, not only in this part of the world but globally.
E How did Sarasin avoid the impact of the subprime crisis? And what do you look for when analyzing potential investments?
We are very old-fashioned investors. We prefer to buy and hold securities that we understand rather than invest in structured products that we sometimes have to admit we do not understand. This is what allowed us to dodge that bullet. We simply did not understand the structures well enough to invest in them.
E That is saying a lot for someone with a PhD in Economics.
When you see triple-A rated securities promising on average 1% higher returns than government paper and you don’t understand the structure, my intuition would be “Don’t invest. Something has to give.”
E Does this speak to a problem with the rating agencies?
Absolutely. Their business model is built upon credibility. Rating agencies’ capital is entirely the credibility that they have built with investors and that has taken a big beating. It will take more than just a few years to repair that.
E Sarasin’s Chief Executive, Joachim Straehle, suggested that subprime crisis losses would likely reach $400 billion. One hundred twenty billion have been accounted for already. Where might the rest of the losses come from?
That number probably comes from adding up all those securities and then taking a discount factor, a conservative discount factor. If you do that you come up with a number of $400 billion, but it could be $200 billion or it could be more. Nobody really knows. The market could stabilize to where investors would stop selling and hold the paper up until maturity. And if that was the case prices would not continue to decline. The trouble is, it only takes one market participant to try to sell those positions and the rest of the market will have to adjust. So it is a very fragile and delicate equilibrium, which can take different paths from here.
E Switzerland’s leading economic indicators fell to the lowest level in five years in June 2008. How is Sarasin dealing with this and where are they looking next?
I think it was to be expected. The United States leads in many things — they led in the financial market crisis, they led the world into recessionary territory. So, much of the time Europe follows the US and now they are following on the path into economic stagnation. They will also follow on the path to somewhat higher inflation. But this is only natural and has happened consistently in post-war history.
I do take some comfort in the fact that the most recent negative economic indicators from the US were lagging indicators. When you see unemployment go up, you should not be concerned because unemployment always comes last in any economic slowdown or upswing. You should be concerned about the leading indicators and it could be that the US economy has seen the worst for this year and is finding a bottom at this point, whereas unemployment will naturally catch up toward the end of the year.
What is critical to this whole development is the inflation scare, which has really been muting financial markets and investor’s risk appetite. I am not so concerned about oil prices at $140 or $150. What is more damaging is the momentum of oil prices. When oil prices double in less than 12 months, it is not good for investor sentiment. I believe we are more likely to see oil prices at $180 than at $140. So if anything, oil prices will go another $40 higher. That does not necessarily mean that it is the end of the world economy. At some point, moving on towards another $40 higher, people will finally be convinced that high oil prices are real. By that time we will be seeing very strong substitution effects, mostly from increases in fuel efficiency.
Beyond that, the world economy remains in better shape than the current investor sentiment suggests. I take comfort, not so much from any recent batch of statistics, but rather from a firm belief that markets are currently underestimating one of the oldest drivers of any economy: human ingenuity and creativity, the ability to innovate our way out of any crisis. Scientific and technological progress will accelerate dramatically over the next decade and mainly for the better, largely to make the world less fossil fuel and commodity dependent than it is today.
E It sounds as if you do not agree with the commonly espoused theory that speculators are pushing up oil prices.
I think that notion is nonsensical. I have looked at both anecdotal evidence and publicly available statistics about institutional investors’ asset allocation and they all tell me that most institutional investors are bearish on oil prices rather than bullish. They expect prices to correct after the recent parabolic increase, rather than to overshoot. One thing that’s so dangerous with bull markets, like this current oil bull market, is that they tend to surprise investors by lasting longer and leading higher than people think is possible. I look at financial speculators among those and I can’t make sense of the assertion that financial speculators are driving it. I think it is something much more fundamental.
Spare daily available production has declined from about three million barrels a day three years ago to less than a million barrels a day, excluding heavy, high sulfur product. That is very little. If the Middle East sees another heat wave, like it did last year, they would siphon off probably a million barrels a day to power their air conditioning. Gulf states cannot live without air-conditioning. In today’s environment, siphoning off a million barrels a day is not possible because that exceeds global spare capacity. It did not exceed global spare capacity last year. There are many other scenarios like this and investors are complacent about these risks. If they do happen, we will likely see contagious behavior such as cues at gas stations just as we saw under President Carter in the United States and that will be the last leg of this oil bull market.
E Does this relate to other commodities that have seen exceptionally high prices?
Yes, they are all related. Whether you talk about oil, water or food, it is really all the same. The global food crisis is really a crisis about water. The world, of course, does not have too little water — the problem is that 98% of it is too salty so we can’t use it. Three quarters of all fresh water goes to agriculture. It is really the increasing desertification of formally arable land, which is causing the food crisis. If you want to solve this, you have to desalinate water. However, more than 50% of the operating cost of a desalination plant is energy.
That just illustrates how food, water and energy really are three sides of the same problem. I think the next big resource scarcity will be water. We have come to the end of cheap water. Water is vastly underpriced in virtually every rich economy because it is administered by public utilities. It has never been priced properly. The only place where it is expensive is in slums where the poorest pay the most for it. One of the greatest investment booms, where investors will continue to do spectacularly well is by investing in the entire infrastructure around food, water and energy. It is the world’s biggest boom for the next couple of years.
E How is all of this related to the developing world and your Global Village fund?
If you look at the four BRIC countries — Brazil, Russia, India and China — together they will contribute four times as much incremental consumer demand over the next five years as the G8 combined. That number in itself says so much about the change in global economic order and it is here to stay.
The Global Village fund tries to capitalize on some of our strongest convictions, which we have held for many years. The world economic order is changing faster than many people would ever have thought possible. Investors can no longer apply the 1980s asset allocation model of allocating funds according to regions or statistics that are biased towards developed economies, simply because they never bothered with emerging economies. It is about the strong belief that in an increasingly interconnected world, which looks more and more like a village than one fragmented by nation states, investors are well advised to take thematic investment tilts, such as the food energy and water theme, which cut across countries.
