MacroScope

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.

ECONOMY CHINA MEASURES

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. 

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 villagerberings are part of tens of thousands of qualified Alaskans who receive dividends from regional wealth fund Alaska Permanent Fund.

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.

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.

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.

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.

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.

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.

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.