Jan. 22 (Bloomberg) -- Financial companies must receive another $1 trillion of equity capital before stocks can stage a sustained recovery, said Amit Rajpal, an asset manager at London- based hedge fund firm Marshall Wace LLP.

Governments will have to provide the money by buying common shares to restore confidence and encourage private investors to step back in, said Hong Kong-based Rajpal, who manages the Marshall Wace Global Financials Fund.

The world’s largest financial institutions have raised more than $920 billion to boost capital eroded by $1 trillion of asset writedowns and credit losses since the credit crisis began, according to data compiled by Bloomberg. The 354-member MSCI World Financials Index plummeted 58 percent in the past year, the worst-performing group on the MSCI World Index.

“You’ve got weakness in credit, a very thin capital position; there’s no way to actively value these stocks until you get the right amount of capital in these businesses,” Rajpal said in an interview Jan. 20. “Until the governments see the light and provide common equity to these institutions, I don’t see financial stocks turning around.”

The market-neutral Marshall Wace Global Financials Fund, which seeks to generate profits regardless of the direction of markets, began investing on Nov. 3. Its size hasn’t been disclosed.

The fund gained an estimated 6 percent through Jan. 20 by buying stocks set to benefit from central banks’ interest rate cuts and short-selling those that will be hurt by them, Rajpal said. The MSCI World Financial Index lost more than a third of its value in the period.

Sovereign Wealth Funds

The fund bought Morgan Stanley, which traded below its tangible book value even after the Wall Street firm reduced its balance sheet and boosted capital, according to a December newsletter sent to investors.

Companies including Citigroup Inc., Wells Fargo & Co. and Bank of America Corp. still need $50 billion each of common equity, said Rajpal, 35, a former global financials research head at Morgan Stanley. He made the assessment before the U.S. government on Jan. 16 said it would invest $20 billion in Bank of America and guarantee another $118 billion of its assets.

Financial institutions will be unable to tap more capital from sovereign wealth funds in China, the Middle East, Norway and Russia as those funds focus on shoring up domestic markets, Rajpal said. He described the U.S. government’s plan to rescue financial companies as an “abject failure.”

“Either the government should have bought out the weaker- quality assets from the banks to help improve their balance sheet quality, or they should have committed common equity to help improve their capitalization,” he said. “What it has done is in between.”

Market-Neutral Fund

Analysts don’t count preferred shares bought by the U.S. government in firms including Citigroup, Goldman Sachs Group Inc. and Wells Fargo as core Tier 1 capital, a key measure of banks’ financial strength which includes mainly common equity.

“It doesn’t provide confidence to common equity shareholders because the government is sitting above you,” Rajpal said. “The stock can go to zero and the government can still get its dividend.”

Stocks Rajpal’s fund holds include U.S. real estate investment trusts including Annaly Capital Management Inc., which invests in mortgage-backed securities issued by Fannie Mae and Freddie Mac.

Rajpal said he prefers banks such as Hong Kong-based Hang Seng Bank Ltd. because they can sustain earnings and high dividend payouts. Their share prices may rise as investors look for investment alternatives after deposit rate cuts, he said.

He is shorting life insurance companies because falling interest rates mean they won’t be able to generate investment returns high enough to match yields guaranteed to policy holders. Rajpal is also selling short Japanese and U.S. regional banks.

Short-selling involves selling borrowed securities in the hope of buying them back later at a lower price.

Marshall Wace, which oversaw about $14 billion in June last year, declined to disclose its latest assets under management.

To contact the reporter on this story: Bei Hu in Hong Kong at bhu5@bloomberg.net

Last Updated: January 21, 2009 19:58 EST