Sovereign wealth funds-Global overview - FLAR

SWFs
-
Global Overview

FLAR Legal Seminar

August 29
-
39, 2013

Why sovereign wealth management?


Revenues from extractive industries


Fiscal smoothing of expenditures


Permanent wealth/inter
-
generational equity


Funding of future pension
obligations


Reserves accumulation from balance of payments
surpluses

Non
-
commodity funds

Source: Sovereign Wealth Fund institute 2011


1/ Central Banking Publications

•

Cumulative

f
iscal or balance of payments surpluses
fund US
$2.1
trillion in long term
investment funds for investment income and to meet future pension liabilities

0
100
200
300
400
500
600
China -SAFE Investment Company
China Investment Corporation
Hong Kong Monetary Authority Investment Portfolio
Government of Singapore Investment Corporation
Canada-Caisse de Depot et Plecement du Quebec
Singapore- Tamasek Holdings
Canada- CPP Investment Board
China- National Security Fund
Australia-Future Fund
Korean Investment Corporation
Kazakhstan National Bank 1/
Malaysia- Khazanah Nasional
Ireland - National Pension Reserve Fund 1/
France- Strategic Investment Fund 1/
New Zealand Superannuation Fund
Brazil - Sovereign Fund of Brazil 1/
China-Africa Development fund
US$ Billions


Commodity funds (oil and gas)

0
100
200
300
400
500
600
700
Abu Dhabi Investment Authority
Norway- Government Pension Fund
Saudi Arabia- SAMA Foreign Holdings
Kuwait Investment Authority
Russia- National Welfare Funds
Quatar Investment Authority
Lybian Investment Authority
Algeria - Revenue Regulation Fund 1/
UAE-International Petroleum Investment Company
Alaska Permanent Fund
Kasakhstan National Fund 1/
Brunei Investment Agency 1/
State Oil Fund of the Republic of Azerbaiiyan
Iran- National Development fund
Chile- Social and Economic Stabilization Fund 1/
Investment Corporation of Dubai
Alberta's Heritage Savings Trust Fund
Bahrain - Mumtalakat Holding Company 1/
Oman-State General Reserve Fund
Botswana-Pula Fund 1/
Timor-Leste Petroleum Fund
Saudi Arabia - Public Investment fund 1/
Permanent Wyoming Mineral Trust Fund 1/
Trinidad & Tobago -Heritage and Stabilization Fund 1/
Source: Sovereign Wealth Fund institute 2011


1/ Central Banking Publications

•

Revenues from extractive industries fund

US$2.7
trillion

US$ Billions

Commodity Funds


Objectives


Fiscal stabilization


Protect
tradeable

sector from currency appreciation


Support current spending while investing long term for
intergenerational equity


Two types of funds


Integrated fund that both supports current fiscal spending and
invests long term for capital preservation and intergenerational
equity


Earmarked funds


Stabilization fund for to smooth fiscal spending


National pension fund to cover future pension liabilities


Future funds (unpopular)



Commodity Fund
-
Integrated

All commodity
revenues

Fund

Budget

•
Funds structural budget deficit

•
Guidelines on withdrawals to preserve capital
over time

Norway

Abu Dhabi

Saudi Arabia

Kazakhstan

Azerbaijan

Alberta

Timor
-
Leste

Botswana


Stabilization fund
-
earmarked

Commodity
revenues

Fund

Budget

Government establishes a threshold price level based on the expected long term average

When the current prices exceeds the long term threshold price, “excess” revenues are
paid into the Fund and can be drawn down during periods of below normal prices.

Chile

Mongolia

Russia


Pension fund
-
earmarked


National pension funds funded by contributions (plan) or by
fiscal surpluses to meet future government pension
obligations and invested in overseas assets


New Zealand Superannuation Fund


Australia Future Fund


Chile Pension Reserve Fund


Russia National Welfare Fund


SWF Governance


Fiduciary
-
beneficiary relationship


Government as “sponsor”


Enabling legislation


Investment policy


Investment process


Transparency and reporting


Oversight


Statutory regulations and standards of care


SWF Institutional
A
rrangements



Legislative


Body

Ministry

Govt

Auditor

Executive Board

Supervisory council/external auditor

Asset Manager

Risk, Control &Compliance

Regulation &
delegation of
authority

Risk and
performance
reporting

Norway
’
s Government Pension Fund Global

11

Authorizing legislation

Government Pension Fund Act 2005

Ministry of Finance

Management mandate and Ethical
Guidelines

Norges Bank Executive Board

Investment mandate and selection of CEO

Global
Custodian

Council of
Ethics

Internal
Managers

External
Managers

Auditor General

Governance
Committee

CEO

Norges Bank Investment Management

Implementation of Investment Policy

New Zealand Superannuation Fund

12

CEO

New Zealand Superannuation Fund

Implements Investment policy

Global Custodian

Equity Managers

Alternative
Managers

Fixed income
Managers

New Zealand Superannuation
and Retirement Income Act 2001

Ministry of Finance

Appoints Board and sets strategic
investment objectives

General Audit

Board of Guardians

Sets Investment Policy, responsible investment guidelines, budget
and appoints CEO

Asset manager can be dedicated
government agency or central bank


Most governments have set up a dedicated government
investment agency with its own governance, pay scale and
specialized skill set


Central bank as asset manager:


Norway whereby the investment management corporation was
embedded within the central bank


Emerging market countries with little international investment
infrastructure (East Timor, Botswana, Trinidad &Tobago)


Stabilization funds that are invested in low risk strategies similar
to investment of foreign currency reserves (Chile, Peru, Mexico)

Policy alternatives to a sovereign
wealth fund


Domestic investment in state owned enterprises,
development banks and jobs creation (not a good record
but back in vogue)


Public investment in infrastructure


Direct dividend to citizens (or reduction in taxes) to foster
private savings and investment


National asset/liability management
—
foreign direct
investment in
“
deficit
”

sectors; eg Chinese acquisition of
commodity producers and agricultural land


Sovereign
Fund Investment Strategies

Official
Reserves/
Central Bank


•
External assets for
directly financing
international
payment
imbalances



•
Highly liquid,
often OECD
government
bonds


Stabilization
Funds


•
Funds to insulate
budget &
economy from
excess volatility,
inflation, Dutch
disease, & other
macro economic
threats


•
Low
-
risk, liquid
assets: cash,
government
bonds


Pension Funds



•
Investment
vehicles to meet
government
’
s
future pension
obligations


•
Funded and
denominated in
local currency


Sovereign
Wealth Funds


•
Investment
vehicles by
foreign exchange
assets

•
Managed
separately from
official reserves

•
Typically have a
higher tolerance
for risk


State Owned
Enterprises


•
Companies in
which the state
has significant
control

•
May make
investments in
foreign assets


Increasing
investment
h
orizon and investment
r
isk

Source:
Monitor 2010 SWF Report

SWF Strategic Asset Allocation

Australia
Future Fund

Norway Global

Singapore GIC

ADIA

Alaska

New Zealand

Peru Stab

Trinidad

Chile Stab

Expected return

Risk

Equities

Fixed income

Alternatives

Chile
Pension



SAA is main driver of wealth generation and investment
income

17

Source: World Bank Treasury calculations based on data from Ibbotson Associates and Bloomberg

Balanced equity/bond
vs

government bond/cash portfolio (
1979
–

2011)

Typical Central Bank Portfolio: 100% US Government Bonds between 1
-
3yr ;

Diversified Portfolio: 40% Developed Global Stocks/10% EM Stocks/5% EM Debt/5% Commodities/20% US Treasuries/20% US Corporat
e B
onds

Source: World Bank Treasury calculations based on data from Ibbotson Associates and Bloomberg

-20%
-10%
0%
10%
20%
30%
40%
0
5
10
15
20
25
30
Jan-79
Jan-80
Jan-81
Jan-82
Jan-83
Jan-84
Jan-85
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Return on a typical Central Bank Portfolio
Return on a diversified Portfolio
Cumulative Return on a typical Central Bank portfolio
Cumulative Return on a Diversified Portfolio
Annual Return

Cumulative Wealth

Diversification and modern capital
markets theory

But divide your investments among many places,

for
you do not know what risks might lie ahead
.

Bible, Ecclesiastes, 935 BC

A portfolio of uncorrelated investments has a lower risk than
any single investment

Harry Markowitz, Modern Portfolio Theory, 1957



Modern paradigm of the prudent person rule

“Prudence is to be found principally in the process by which investment


strategies are developed, adopted, implemented, and monitored in light of


the purposes for which funds are held, invested, and deployed. Prudence


is demonstrated by the process through which risk is managed, rather


than by the definition of specific risks that are imprudent. Under a


modern paradigm, no investment is imprudent per se. The products and


techniques of investment are essentially neutral. It is the way in which


they are used, and how decisions as to their use are made, that should be


examined to determine whether the prudence standard has been met.


Even the most aggressive and unconventional investment should meet


that standard if arrived at through a sound process, while the most


conservative and traditional one may not measure up if a sound process is


lacking.
”

Longstreth
, B. “Modern Investment Management Theory and the Prudent Person Rule”,1986


Investment strategy by statute or
regulation

Blunt tool that may dictate


A
llowable asset classes


Minimum rating for allowable investments


Maximum exposure to a sector or investment (diversification
by regulation)


Portfolio diversification
is
required
to meet long term risk
-
adjusted return
targets

21

Real Estate

Developed
Equities

Commodities

Cash

US Corporate
Bonds

US Govt. Bonds

Developed
Equities

Commodities

Cash

US Corporate
Bonds

US Govt. Bonds

US High Yield
Bonds

Developed
Equities

Commodities

Cash

US Corporate
Bonds

US Govt. Bonds

US High Yield
Bonds

EM Debt

EM Equities

Developed
Equities

Commodities

Cash

US Corporate
Bonds

US Govt. Bonds

US High Yield
Bonds

EM Debt

Developed
Equities

Commodities

Cash

US Corporate
Bonds

US Govt. Bonds

US High Yield
Bonds

EM Debt

Real Estate

Real Estate

Real Estate

EM Equities

EM Equities

Real Estate

Highest
return

Lowest
return

1976
-

1983

1983
-

1990

1990
-

1997

1997
-

2004

2004
-

2011

Source: World Bank Treasury calculations based on data from Bloomberg

World Bank Treasury estimates

How does the legal environment impact
the SAA?

Australia
Future Fund

Norway Global

Singapore GIC

ADIA

Alaska

New Zealand

Peru Stab

Trinidad

Chile Stab

Expected return

Risk

Equities

Fixed income

Alternatives

East Timor

Azerbaijan

Chile
Pension

Threat of liability and impact on portfolio
management


Contemporary application of the prudent person rule (NZ, Alberta,
Alaska, Australia)


Focus on investment process


Role of diversification


Standards of behavior


Statutory regulation of allowable investments


Bright line that provides more protection and less scope for interpretation


Asset allocation by parliament as “fiduciary” rather than by investment
manager (Norway)


Where the government is risk adverse or unprepared, can lead to highly
sub
-
optimal portfolios (East Timor, Russia, Azerbaijan)


Combination