Four yardsticks for sovereign wealth funds
Sovereign wealth funds, a $3 trillion industry managing windfall revenues for future generations, arguably need a set of benchmarks different from those used by other private investors as they are state-owned. Andrew Ang, an associate at U.S. National Bureau of Economics and a professor at Columbia Business School, proposes the following four benchmarks in a recent paper distributed to SWFs.
The Benchmark of Legitimacy. Whatever the source of wealth, the SWF exists to transfer the benefits of that wealth from the present to the future. Without this benchmark, the money in the SWF is at risk of being immediately depleted. A necessary condition to maintain legitimacy is to have well-developed legal institutions in place.
The Benchmark of Integrated Policy and Liabilities. A critical part of this benchmark is detailing how and under what conditions the money can be distributed from the fund. Clear, yet flexible, spending rules must be set to meet well-defined liabilities.
Governance Structure and Performance Benchmark. There is no single optimal governance structure or performance benchmark, but creating a culture of professionalism and market discipline ie key. For many SWFs, the ideal mandate is a real return target plus some spread.
Long-Run Equilibrium Benchmark. Their long-term horizon may require SWFs to pay attention to issues that are not on other investors’ immediate investment strategy, such as climate change, child labour, or water management. In fact they may be in a unique position to profit from the market’s mispricing of these externalities.
Euro zone crisis and sovereign wealth funds
Two academics from the Fletcher School at the Tufts University have written a special guest blog for Macroscope on the impact of the euro zone debt crisis on sovereign wealth funds.
Dr. Eliot Kalter is a senior fellow, The Fletcher School at Tufts University, Sovereign Wealth Fund Initiative, and president of E M Strategies, Inc. Thomas F. Holt, Jr. is an adjunct professor of law, The Fletcher School and partner in the global law firm K&L Gates LLP.
“While Sovereign Wealth Funds (SWFs) vary widely in their size and investment objectives, continuing tensions in the euro zone and in global markets more generally can only accelerate their concerns about investing in the West. Significantly, in a last month’s meeting of SWFs in Sydney, the political focus shifted from questions raised by recipient countries about SWFs’ accountability and transparency to the risks inherent when investing in heavily indebted countries and the need to improve existing risk management frameworks. Although SWFs account for less than 6 percent of total assets held by global institutional investors, they are an important barometer of global capital flows because of their clean balance sheets, long-term investment horizons and ability to invest large and growing amounts of capital quickly.
The European Union’s $1 trillion bail-out plan is a significant effort to prevent Greek contagion, but its ultimate success will depend on the ability of countries vulnerable to market uncertainties to confront not only the immediate liquidity threat but also more deeply rooted insolvency issues. The need to reduce dependence on financing unsustainable fiscal deficits cuts deep, even prompting France earlier this week to join the Mediterranean countries in making difficult policy decisions with the announced intention to raise the minimum retirement age to 62. But even if such measures are implemented, there is no guarantee that they will have the desired effect. Concerns must then be raised about the financial, social and political impact of the required fiscal austerity on already vulnerable economic recoveries, falling real wages and weak financial systems.
The ongoing shift of financial and economic power away from the traditional centers of the U.S. and Western Europe has been accompanied by increased SWF investment in emerging market countries. Whereas SWFs have been amenable to risk adjusted returns in Western countries, the euro zone crisis can be expected to accelerate this migration to markets with higher potential growth rates than those of their Western counterparts.
The ongoing euro drama makes it clear that in assessing risk SWFs will need to go beyond traditional quantitative modeling and thoroughly examine countries’ socio-political dynamics. This includes the need for a clear-eyed assessment of a country’s political ability to confront growing public sector indebtedness and the willingness of its citizens to accept fiscal austerity. SWFs and investors more generally must now deepen their understanding of recipient countries socio-political risks and develop strategies that take into account countries’ financial, political and social interests and priorities.”
Sovereign wealth fund and a remote island
Little Diomede, a remote U.S. island in the Bering straits only 2.5 miles from Russia, has 129 people living in a traditional Ingalikmiut Eskimo village.
On an island surrounded by rocky slopes and harsh storms with the sea frozen for half a year, employment is limited to the city and school whereas seasonal mining, construction and commercial fishing positions have been on the decline.
Little Diomede villagers are part of tens of thousands of qualified Alaskans who receive dividends from regional wealth fund Alaska Permanent Fund.
At least 25 percent of resource-related revenues are placed in the fund, which invests its assets of over $34 billion in a diversified portfolio of public and private assets. Currently their asset allocation consists of 38 percent in stocks, 22 percent in bonds, 12 percent in real estate, 6 percent in private equity and 2 percent in cash.
Alaskans enjoyed the highest-ever dividend of $3,269 in 2008 when a one-time $1,200 Alaska Resource Rebate was added, at a time global markets were tumbling with the collapse of Lehman Brothers. But in 2009, the dividend fell sharply to $1,305.
For Little Diomede villagers, the fall in dividend must be a blow. The fund may need to make a lot more profit to finance a possible mega-infrastructure plan: according to the village website, some residents are interested in relocating the village, due to the rocky slopes and harsh storms, lack of useable land for housing construction, and inability to construct a water/sewer system, landfill or airport.
For more stories on sovereign wealth funds, click on: http://r.reuters.com/dem56h, http://r.reuters.com/caj36h, and http://r.reuters.com/dah75h
I live in a terrible place, please pay me much money to move to a better place. Do people in Detroit get this aid as well? 
Chile, Singapore among most transparent SWFs
Chile, UAE, Singapore, Azerbaijan, Ireland and Norway claim top rankings on the latest transparency index, published by SWF Institute. At the bottom of the ranking is Venezuela, Oman, Nigeria, Mauritania, Kiribati, Iran, Brunei and Algeria.
The Linaburg-Maduell index is calculated with 10 principles — such as whether the fund provides up-to-date, independently audited annual reports, or whether it provides clear strategies and objectives. It also gives points on whether the fund gives ownership percentage of company hodlings, total market value, returns and management compensation.
Enhancing transparency is a key task for sovereign wealth funds, whose often opaque operations have come under heavy criticism by some Western politicians who suspect them of investing with political, rather than commercial, motives.
In fact in the recent meeting of the world’s leading sovereign wealth funds, only Norway, Chile, New Zealand agreed in advance to speak to Reuters on the sidelines; when contacted on the ground China also spoke. Others either declined to comment at all or did not return email.
(Source: SWF Institute; www.swfinstitute.org)
Australia’s SWF lags in returns
Australia’s Future Fund reveals that the fund’s mixed asset portfolio (excluding Telstra holding) returned 5.6 percent in the third quarter.
The fund has just over 10 percent in Australian equities, 22.8 percent in global equities. Safer instruments dominate, with debt holdings at 24 percent and cash at 31 percent.
The mixed-asset fund significantly underperforms an equity-only portfolio. For example, the MSCI world equity index has risen more than 17 percent in the Q3 alone.
The Future Fund is a rare SWF which reports results quarterly, like a public-listed firm. The underperformance might outrage the public though — so is this worth it?
Recall remarks last month by David Murray, the fund’s chairman of the board of guardians , which highlighted some downsides in reporting quarter after quarter.
“We are happy to report but it does create some significant difficulties. If forces the community to take very short term views in returns in the fund and causes management of the fund to be concerned about media and community responses,” he said at a SWF meeting in Azerbaijan earlier this month.
SWFs in Baku: Tables turning?
Sovereign wealth funds may have turned the tables on the rest of the world.
Wrapping up their inaugural meeting in the capital of Azerbaijan, 20 leading sovereign wealth funds urged host countries to make their investment regimes more transparent and discriminatory and keep investment borders and flows as open as possible. (For the story click here).
This comes after years of host countries — the West — asking them to open their books.
Much of the two-day meeting which ended on Friday was held behind closed doors, but the organisers — Azerbaijan’s state oil fund — let media in with cameras and video recorders to film the final 5 minutes of the meeting.
Watch what David Murray, chair of the International Forum of Sovereign Wealth Funds and also chairman of Australia’s Future Fund said at the end of the meeting (with some holiday advise) and at the start of the news conference.
SWFs by the Caspian
The world’s leading sovereign wealth funds are gathering in Baku, capital of Azerbaijan, for a two-day inaugural meeting which ends on Friday.
A year after adopting the Santiago Principles of best practice guidelines, they are meeting next to the Caspian sea to review investment activities and assess how regulation and efforts to open up are helping them gain wider acceptance in a still-sceptical world.
The participants include SWFs from China, Kuwait, Azerbaijan, Australia, Libya, Ireland, Singapore and New Zealand. The meeting is hosted by the State Oil Fund of Azerbaijan – which made a record (and rare for SWFs) profit last year thanks to a conservative investment strategy. The $11-billion fund, which made a record profit of around $300 million, or 3.7-3.8 percent in 2008, has said it wants to add riskier assets back onto the portfolio gradually.
The meeting comes as a report to be published this week shows a sharp fall in investment activity in Q2. According to global consultancy Monitor Group, SWfs made 11 investments totalling $3.5 billion in Q2, the lowest spending since the final three months of 2004.
Nineteen deals have been either announced or pending completion during the three months ending June, suggesting that activity might improve later this year. Monitor says the funds returned to investing in real estate after they had steered well clear over the previous two quarters.
“SWFs are cautiously returning to the market with a long-term approach to their investments, putting their losses behind them and resuming the business of investing abroad,” it says.
(Photo by Natsuko Waki)
SWFs and ethical investing: serving multitude of objectives
Sovereign wealth funds, eager to be accepted in the West, are increasingly interested in showing the world that they care about environment and governance by investing in socially responsible firms.
It all sounds good, but the biggest shortfall of Socially Responsible Investing (SRI) is that it lacks convincing performance details. Therefore, SRI or ethical investing for SWFs is not just about returns: It allows them to combine a multitude of objectives, such as portfolio diversification, enhancing transparency, meeting social goals and gaining acceptance even among critics who suspect they operate politically.
SRI, already a $2.71 trillion industry in the US, involves buying shares in companies that manage environmental, social and governance risks. For example, firms which make clean technologies are in, while businesses that pollute the environment, abuse human rights or produce nuclear arms are out.
Norway is leading the pack with its $400-billion sovereign wealth fund. It names and shames companies the fund expels for not meeting its criteria and pushes the management to be greener.
For more read the analysis here.
Gordon Clark and Ashby Monk, Oxford University researchers and SWF experts, say that the fund-which only invests abroad-seeks to give global effect to national values and commitments with its ethical investment policies.
from Global Investing:
Sustainable investing and SWFs
Government-owned institutions are becoming big drivers of sustainable investing -- or buying firms which are socially and environmentally responsible, or sectors which tackle climate change or resource scarcity.
Norway's $400-billion-plus sovereign wealth fund, which is the world's second largest, is a big advocate of "green" investing, naming and shaming companies which do not fit the investment guidelines set by the government.
The guidelines rule out holding investments in certain firms, for instance those that produce nuclear arms or cluster munitions, or that damage the environment or abuse human rights.
It has just expelled Israel's Elbit Systems for supplying surveillance equipment for the West Bank separation barrier.
RCM, equity-management arm of Allianz Global Investors, says that sustainable investment is gaining momentum and offers investors a unique diversifier.
RCM's sustainability investment fund, which has the French public pension scheme ERAFP among its clients, likes firms which manage Environmental, Social and Governance (ESG) risks or sectors which are engaged in trends such as demographic trends, climate change (eg solar power) or resource scarcity.
Tale of two SWFs
As the world moves closer to the end of the credit crisis, sovereign wealth funds around the world are experiencing mixed fortunes.
Good news comes from Singapore’s SWF Temasek, which springs back into gains with its portfolio climbing 32 percent between April to end-July after a 30 percent loss in the year to end-March.
Announcing its annual performance report (which should please the country’s taxidrivers), Temasek said it is open to investing in financials and resources in the long term and it has bought stakes in South Korea’s ENK, cylinder suppliers, and Brazil’s oilfield services firm San Antonio.
Moving towards the Middle East, Dubai World, a state-owned holding company, is struggling to restructure its subsidiaries.
It has moved several executives to its Istithmar unit, which owns struggling high-end retailer Barney’s New York, from its real estate unit Nakheel, which is trying to refinance $3.52 bln Islamic bonds maturing in December.
Istithmar is seen as sovereign private equity, which takes a high leverage to invest in firms, with some estimates that the capital was levered up up to 7-10 times.
