Sovereign wealth funds' recent acquisitions of stakes in listed financials may only be the beginning of a broader phase of investing in public equities, says Huw van Steenis, Head of EMEA Banks and Financials Research at Morgan Stanley.

Van Steenis and his team suggest that SWFs will be targeting "best-in-class cash generative players" that have exposure to growth in Asia or emerging markets, banks or financials with strong securities businesses, and modern asset management, such as private equity shops.

For instance, Temasek [the direct-investment fund for the Singapore government] — a role model for some of the SWFs — has ~38% of its portfolio in financials," van Steenis explains in the report. "The strategic angle of partnering with players who can develop domestic capital markets is also critical. Moreover valuations and the need by some financials to raise fresh equity is creating a new range of opportunities."

The report goes on to look at those names that may fit the profile of future SWF investment. Interestingly, the report estimates that around 93 percent all the investments in financials to date have come from just five countries — Singapore, China, Abu Dhabi, KIA and Dubai. About this quintet, van Steenis notes that "their interest in strategic stakes will not be limitless and so most banks will need to look for other self-help solutions such as asset and division sales, regulatory capital trades and other balance sheet reduction."

But SWFs will likely not have the run of the shop when it comes to taking stakes in financial institutions on the cheap. "We also think private equity's role in picking up cheap FIG assets this year will grow materially," van Steenis writes, citing intense funding pressure into 2008.

Even with some rumblings of federal opposition to these stakes, van Steenis and team argue that, "given a need for capital by some Western financials and other entrepreneurial partnerships seeking to ally themselves with deep pools of capital, we think 5-20% stakes will be target range in most cases acceptable."

Customers may obtain this report in its entirety at www.morganstanley.com/equityresearch or by calling 800-624-2063.