Archive for September, 2008

Russian SWF to Propose Strategy

By Brett Keller

Oxford Analytica’s “The World Next Week” has an article up entitled “Russia: 32 billion dollars in search of a manager.” Excerpts:

On Thursday, the [Russian Finance Ministry] (known as MinFin) plans to issue a series of proposals to the Kremlin on how Russia should manage its nascent sovereign wealth fund (SWF).  Capable (and liberally-inclined) Finance Minister Aleksei Kudrin has said that Russia needs to attract top-flight talent to manage its oil and gas wealth, and the guidelines issued by his ministry will be key to understanding how Russia will develop its investment strategy.  MinFin does not have the in-house expertise properly to manage the fund, nor does the Central Bank.  Russia’s willingness to take on external managers would be a crucial step towards improving the transparency and professionalism of the fund, and could reassure the West that it does not intend to use its reserve of hydrocarbon wealth as a means of exercising undue political influence.

Some background on Russia’s SWF:

Russia’s fund, which has been christened the National Wealth Fund (NWF), grew out of the larger Stabilisation Fund (abbreviated in Russian as Stabfond), the total value of which is approximately 162 billion dollars…. On January 31, then-President Vladimir Putin signed a decree splitting the fund into the NWF and the Reserve Fund, the latter of which is subject to strict guidelines about where and how it can be invested.  The 130 billion dollar Reserve Fund can only used to purchase fixed income, top-rated securities… The 32 billion dollar NWF has been earmarked for higher-risk — and, Moscow hopes, higher-return — investments…

Q&A with Victor Fleischer, Professor at the University of Illinois College of Law

By Ashby Monk

This blog is a source of open discussion and engagement on the topic of SWFs. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the sixth instalment of our routine segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Victor Fleischer of the University of Illinois College of Law. While Prof. Fleischer’s views are his own, his perspective helps to further debate and facilitate understanding.
Ashby Monk: Thanks for joining us today, Victor. Can you begin by briefly explaining your interest in SWFs?
Victor Fleischer: My research over the last five years has focused on how tax policy affects institutional investment, especially in venture capital and private equity.  And so I first became interested in SWFs as investors in private equity, both as limited partners in private equity funds and as direct investors in private equity sponsors.  As a tax person, I was curious about how SWFs are taxed, and at that point I started to research section 892, which grants SWFs a unilateral, categorical exemption from tax.  My paper on this topic, A Theory of Taxing Sovereign Wealth, will be published next year in the NYU Law Review.  You can download it here.
Ashby Monk: You note in your recent paper an interesting contradiction: On the one hand, SWFs want to be treated like any other private investor. On the other hand, the U.S. treats them (for tax purposes) as “sovereigns acting to further political, diplomatic or humanitarian agendas…” Can you give a brief explanation of the benefits afforded sovereigns under the U.S. tax code, and how this affects SWFs?
Victor Fleischer: Historically, foreign governments were exempt from tax in the United States according to the international law principle of sovereign immunity.  Over time, the international law doctrine narrowed to exclude commercial transactions.  But the relevant tax provision, section 892, has never been revised appropriately, and sovereign wealth funds continue to enjoy a unilateral, categorical exemption for tax for non-controlling investments.  Private foreign investors, by contrast, face withholding taxes as high as 30% on dividends and other forms of periodic income.
This actually isn’t quite a big deal as it seems, as a lot of a foreign investor’s portfolio income, like interest and capital gains, is exempt from U.S. tax.  The big difference is for dividends.  One concern is that by allowing SWFs to avoid the withholding tax on dividends, the tax code could create a “clientele effect” that crowds out private investment in dividend-paying stocks.
Ashby Monk: The Joint Committee on Taxation recently published a report on this issue. They argued that, “it is difficult to conceive of any reasonable justification for modifying the existing rules to treat SWFs, or foreign governments more generally, less favorably than foreign corporations.” Do you agree with this conclusion?
Victor Fleischer: I disagree.  I think, at a minimum, Congress should repeal section 892 and treat SWFs like private investors.  Under current law, the tax code subsidizes state-controlled investment to the detriment of private investors.  Allowing private investors to compete on a level playing field would dampen any potential clientele effect.
There are also reasonable arguments for imposing a higher rate of tax on SWFs.  In my paper, I talk about the range of negative externalities that follow from SWF investment, including encroaching on the autonomy of U.S. enterprise, limiting our foreign policy options, and encouraging U.S. companies to partner with autocratic regimes.  I don’t think that SWF investment should be prohibited, but there is a pretty good case for imposing an excise tax on SWF investment in U.S. equities.  The tax could have a conditional exemption for funds that meet best practices of transparency, accountability, and professionalization.    

Ashby Monk: If I’m not mistaken, you are of the opinion that SWFs are investing to achieve political goals. Where do you see evidence for this?

Victor Fleischer: SWFs invest out of mixed motives – they seek financial returns, but fund managers are subject to the influence and oversight of political leaders.  So it’s not that most SWF managers have a political axe to grind, but rather that, when push comes to shove, foreign governments are more likely to influence fund managers to pursue non-financial motives than regular market investors.

The big concern isn’t that most current investment is politically motivated.  Rather, it’s that China or Russia or Abu Dhabi or some other state that we are currently friendly with will accumulate strategic positions in U.S. companies … and in 10 or 20 years we find ourselves enemies with that country.  Obviously that may compromise our foreign policy options.

Ashby Monk: What should Congress do?

Victor Fleischer: The most important step is to support the efforts of the IMF to establish best practices of transparency, accountability, and professionalization of the funds.  Tax policy is of secondary importance, but it’s also worth pursuing.  Congress should repeal section 892, and it may want to consider backstopping the IMF efforts with an excise tax on funds that do not comply.  

Ashby Monk: Thanks, Victor, for taking time out of your busy schedule to chat with us today.

Victor Fleischer: My pleasure, and keep up the good work here – I have found this blog to be a wonderful resource.

SWFs in the UNCTAD 2008 World Investment Report

By Brett Keller

UNCTAD (United Nations Conference on Trade and Development) has released its 2008 World Investment Report (UNCTAD). The report is available for free online as a 411 page, 4.8 MB PDF. Report pages 20-26 (PDF pages 47-53) deal specifically with sovereign wealth funds and include these two figures:

Figure 1. FDI flowsa by sovereign wealth funds, 1987-2007. Note: a. Cross border M&Ss only. Green field investments by SWFs are assumed to be extremely limited.

Table 1. Twenty selected large cases of FDI by sovereign wealth funds, 1987-2007.

For more on these figures, click here or download the report (above).

Sovereign Funds and Sustainability

By Brett Keller

WWF, the global conservation organization, just released a WWF/ Innovest Strategic Value Advisors study: “Fund Management in the 21st Century: The role of sovereign wealth funds in contributing to a low carbon future,” authored by Karina Wong, Andy White, Dennis Pamlin and Rasmus Reinvang. The study has a special emphasis on the Norwegian Global Pension Fund. Lead author Karina Wong can be contacted at

You may have trouble downloading the 86-page report from the WWF site, so it is available here (1.07 MB PDF). This study applies general ideas about socially responsible investing (SRI) to sovereign funds and advocates a stronger focus on such investment.

An investor can employ a combination of three main strategies in SRI:

  • Negative screening to exclude undesirable companies or sectors
  • Positive screening to select companies with better ESG [environmental, social and governance] performance
  • Shareholder advocacy and engagement to improve company behavior

Their press release on the subject (“Sustainable investing can pay off for sovereign wealth funds”) summarizes nicely:

The analysis found that funds using socially responsible investment through positive screening strategies and using their influence as large investors to encourage improved company behavior enhanced investor returns, risk management and reputation.

Report lead-author Karina Wong, senior consultant at Innovest, said “Socially responsible investment can no longer be seen as a purely ethical exercise that reduces profit while doing good.

“Rather, in an increasingly resource restricted world sustainable business models are a crucial indicator for long-term profitability and risk reduction.”

Figure 2 from the report (page 10) compares SRI practices of several SWFs and pension funds:

Interestingly, while some are calling for SWFs to make investments with an eye on exclusively maximizing profit as a means of safeguarding against politically-motivated investing, others are advocating that investments not be made for pure profit maximization. In this case the socially-responsible investing is said to be more profitable as well, but it isn’t hard to imagine that in some cases investing in more responsibly-governed or environmentally-conscious investment choices could yield lesser returns.

It seems that different constituencies are pushing SWFs towards very different investment strategies. Is it possible to have an investment strategy that maximizes profits through socially responsible investments that are non-political, or is SRI inherently political? I think that while some SRI could be aptly labeled as politically motivated (similarly to the idea that SWFs should reserve a certain percentage of investments for sub-Saharan Africa) this is not the kind of motivation that has or should raise the suspicions of legislators and the media.

Q&A with Rachel Ziemba, lead analyst for oil exporting economies and China at RGE Monitor

By Ashby Monk

This blog is a source of open discussion and engagement on the topic of SWFs. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the fifth installment of what is now a routine segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Rachel Ziemba of RGE Monitor. While Ms. Ziemba’s views are her own, her perspective helps to further debate and facilitate understanding.

Ashby Monk: Thanks for joining us today, Rachel. It’s clear from some of your writing over at RGE Monitor that you have taken a keen interest in SWFs. Why?

Rachel Ziemba: It’s wonderful to join you – For us at RGE Monitor, the management of sovereign wealth (investment funds, central bank reserves, state investment vehicles) epitomizes a very important macro and financial trend- the change in capital flows from developed to developing countries – a reversal from a decade ago – which has made many sovereign investors  key actors in the global economy. Shortly after I joined RGE, my work with Brad Setser (now of CFR) tracking petrodollars, and later China’s reserves, plunged me into the study of the sovereign wealth universe.  While sovereign funds are not new, the growth in their assets under management and evolution of investment strategies have given them a higher profile.  Many take private sector models like endowments, pension funds and private equity, increasing their risks and adding exposure to commodities etc.  In the last year, with some private actors on the sidelines, they took a major role in recapitalizing global banks. Some of the largest new flows now come from countries that are competitors to the U.S. and Europe – though the U.S. allies in the Gulf still account for some of the largest flows today after China – and these are countries with a large state role in the economy – has led to some unease from recipients. Furthermore, sovereign wealth fund investment exposes key issues of corporate governance, asset management strategy and economic policy at home and abroad.

The more we (collectively) learn about sovereign funds, the more they have to be assessed individually – and the more their asset allocation (in aggregate) resembles those of other institutional investors or alternative asset managers.  Sovereign investors are one of many pools of capital seeking to increase risk to meet future liabilities, increasing exposure to equities, alternative asset classes, making more direct investments and commodities.

Ashby Monk: What’s your view of the IMF International Working Group on SWFs? Are you encouraged by the recent accord in Santiago?

Rachel Ziemba: Well the accord details haven’t been made public yet, so its hard to assess its impact. Its likely to be a relatively loose set of principles, perhaps an extension of those agreed upon by the US, Singapore and Abu Dhabi last fall, so the process itself may bear more fruit than the principles themselves. Hopefully this was an opportunity for sovereign funds to (in some cases) improve risk management. The fact that it took place amid wealth destruction in the global markets, in which sovereign funds were unlikely to have survived unscathed, probably added to the pressure to improve risk management. The IMF process is only one prong of a policy regime being pursued by recipients – the other involves national level responses. The other involves national level responses in which foreign investment, tax and other policies are being assessed.

We are in the midst of a crisis triggered in part by inadequate regulation and transparency, so more information about all actors is beneficial in my view – and I think many funds are discovering that a bit more transparency pays off. We may see a number of funds issuing annual reports in the next few months. The other major outcome has been the release of some aggregate data on sovereign funds collected from the 20-some members of the working group – for example how many invest in leveraged funds.

Ashby Monk: Much of the concern voiced about SWFs revolves around the issue of investment objectives-whether SWFs are investing to pursue commercial or strategic ends. As someone who knows a great deal about SWF investment targets, what’s your view on this debate?

Rachel Ziemba: In my view, sovereign wealth funds are commercial actors, pursuing commercial objectives. However the commercial objectives of say Abu Dhabi Inc or China Inc are different from a public company. In other words there is a fine line between commercial and strategic aims when a nation state is involved, particularly one that is not subject to democratic oversight. A strict financial return on an equity stake might be only one of the hoped for objectives – others might include jump starting a local sector, perhaps the sports or financial sector- meaning an investment in an exchange might be intended as a way of increasing market share, gaining expertise etc. The direct investments of government investment companies like Mubadala and the investment arms of Dubai World include investments in sectors prioritized for economic development at home, a fact that poses some conflict of interest worries. However, it probably makes them better partners for those that receive their funding.  But many sovereign funds could face pressure to support the foreign investment of domestic companies abroad.

We can’t have it both ways – one part of being a commercial actor is that these funds will seek out good returns and they are unlikely to invest for good will alone. Sovereign investors flight from U.S. Agency bonds is a good example seen in July and August. We can’t expect foreign governments to keep on buying assets that might lead to a loss.

Furthermore, as ostensibly long term investors, these funds could be the ideal investors, not subject to redemptions, willing to take a long-view, increasingly seeking out partnerships. But on the other hand, the willingness of some to be passive investors may weaken the role of other stakeholders.

Ashby Monk: Are you worried about a protectionist trend emerging in response to SWFs?

Rachel Ziemba: I think we are already seeing a protectionist trend – and with the global economy slowing, such backlash against trade and investment flows would not surprise me. A few dozen countries are engaged in a reassessment of foreign investment  regimes – the U.S. Canada, Australia and many European countries included. Many developing countries are also protectionist – having obstacles to investment and blocking off some sectors. Despite the sell off in Asian equities, everyone wants to invest more in Asia, given its growth rates – however, its not clear that Asian countries are ready to accept more net investment, particularly if it pushes prices up. Even Europe has been wary of the effect of inflows on the euro. However as I’ve argued, the costs of doing business in Germany are probably a greater determinant of investment than the obstacles.

More predictability from recipient countries- rather than having loose requirements that a takeover have net benefits for the country (as the Canadian law reads) that would be a positive outcome for all investors The U.S. has been lucky in that it has been able to have incredible power to set the terms in which foreigners invest – sovereign investors have needed to place funds as much as the U.S. needed to attract funds. And much of the petro-wealth remains in dollars. But that leverage (or co-dependency) is based on the size of the U.S. market and its ability to create financial assets to recycle the revenues of oil-exporting and Asian economies.

Ashby Monk: What, in your view, is the path towards SWF acceptance in the West? Investing through credible intermediaries? Partnerships with highly respected actors?

Rachel Ziemba: I think SWFs are becoming more familiar to many officials (and vice versa) and to a lesser extent the public (they were already familiar to some regulators and asset managers). This process has eased some concerns.  The six or seven Congressional hearings are part of this process – as is a willingness to meet with officials. The countries with the newest and untested funds, like Russia and China have prompted the biggest concerns. And new funds Their sovereign funds have been proceeded by activist state owned enterprises – though my hunch is that Russia’s national wealth fund will not resemble Gazprom when it finally diversifies its assets away from the government bonds it now holds (a new investment strategy is due to emerge in the fall, though the freefall in the Russian equities may discourage funds from investing abroad). One clear way to get legitimacy is to be more transparent about risk management., overall strategy, becoming a more predictable actor and that comes with time and building up a track record. But that doesn’t mean that all funds need to or should resemble Norway. There are about three reasons that few worry about Norway’s investments 1) its purchases tend to be small 2) it discloses its holdings and asset allocation 3) it has domestic oversight, even though its risk management may have revealed some flaws in recent quarters (like private sector counterparts). While it may not seem fair, government actors are held to as high or higher standard, in part because they are political actors.

Partnerships are a key way to do so they can provide political cover, investment expertise and open doors. Such benefits don’t just accrue in the West, sovereign funds have been seeking out partnerships in developing countries too.

Ashby Monk: How have recent market events (collapse of Lehman and AIG) affected sovereign wealth funds and their role in the financial sector?

Rachel Ziemba: Since we’re talking in the midst of a heightening crisis emanating from the U.S. financial sector, many people are asking what role sovereign investors will play. Sovereign funds have been virtually absent from recapitalization of key financial institutions in recent months, being in wait and see mode-sovereign investors have been present-mainly in the form of central banks whose purchases provided a stream of capital to the U.S. Several reasons might explain their absence-Losses on equity and alternative assets, sufficient exposure to the global financial system and worries that this crisis is more protracted than many hoped. Furthermore despite being relatively cash rich, sovereign funds aren’t really equipped to take on management roles in foreign banks. And with contagion spreading to domestic markets, many governments may prefer to invest at home – though funds would probably be better spent on developing productive capacity than propping up domestic equity markets. Furthermore, a fall in the oil price does reduce the potential future resources available for investment.   With $90 a barrel, less than half the revenues are saved by big oil exporters – and overtime the share will fall further unless the oil price reaccelerates. However the biggest implication is that the failures of these major institutions reveal how pervasive the weaknesses are in the financial system, how difficult it is to price assets and institutions and indicating how far we may be far from the bottom of this market, something that would make sovereign funds (and many non sovereign investors) reluctant to step in the water.

Ashby Monk: Fascinating stuff. Thanks, Rachel, for taking time out of your busy schedule to chat with us today.

William Miracky at SAIS

By Brett Keller

William Miracky followed Edwin Truman at the September 17th lunch panel hosted by the International Finance Club at the Johns Hopkins School of Advanced International Studies (SAIS), an event titled “Sovereign Wealth Funds: Assessing the Risks and the Opportunities.” (Read the post on Truman’s comments). Miracky is a senior partner at the Monitor Group, which released its report on SWF behavior in June 2008.

Much of what Miracky discussed at first was summary of the Monitor report, which is an invaluable resource on the public behavior of sovereign funds. Miracky expressed that their desire was to “bring some actual facts to this issue, rather than speculating about investment behaviors.” In all, they examined 17 active funds making a total of 785 deals which included $250 billion in investments. As most of the media coverage and analysis focuses on “uphill” investment from sovereign funds from the Middle East and Asia, one notable finding is that sovereign funds do invest a substantial portion of their resources in emerging markets.

Miracky got a good laugh when describing the Monitor report’s requirement of actual sovereign state control for its definition of SWFs. He said, tongue-in-cheek, “So, we excluded Alaska, which is notwithstanding the current surge in the level of interest in the activities of the government of Alaska.”

This is one area where I think it’s difficult to generalize—as Miracky admitted, some of the data is skewed by the atypical behavior of one fund or another. For example, Temasek invests back heavily in Asia. But it is true that the funds aren’t all going to OECD countries.

Miracky said that SWFs are actively avoiding a “PR problem or a regulatory backlash,” and that part of the evidence is “where and when they take controlling stakes.” In general, SWFs avoid taking controlling stakes in industries that would alarm OECD citizens. Also, the Monitor report concluded that recent heavy investments in financial services in the US and Europe were “atypical and opportunistic,” reflecting the 2007-8’s credit crunch.

The most interesting part of Miracky’s talk came when he previewed some Q2 2008 data that Monitor hasn’t released yet. More on that data as soon as it is released.

In conclusion, Miracky noted that he thinks the risk that is being underplayed is the financial risk of investment by sovereign funds, not the political risk. Policy makers should be “driving the policy remedies to help guard against the potential impact of those risks.” Also, voluntary or regulatory frameworks must deal not just with transparency, but also with accountability, risk management, and professional accountability. Overall, Miracky sounded confident that, with the proper agreements in place, sovereign funds can be a “force for good and a force for the flow of capital around the world.”

Edwin Truman at SAIS

By Brett Keller

The International Finance Club at the Johns Hopkins School of Advanced International Studies (SAIS) hosted a lunch panel today on the subject of “Sovereign Wealth Funds: Assessing the Risks and the Opportunities.” The panelists were Edwin Truman, senior fellow at the Peterson Institute for International Economics and William Miracky, senior partner at the Monitor Group, which released its report on SWF behavior in June 2008.

Edwin Truman at SAIS

Truman started off with a general summary of the definition of sovereign wealth funds, then talked about his own SWF Scoreboard. Truman’s Scoreboard incorporates four categories of information: 1) structure, 2) governance, 3) transparency and accountability, and 4) behavior. Truman includes pension funds in his analysis, unlike some other SWF scholars and in general the pension funds fare better on Truman’s Scoreboard than the more strictly defined SWFs. Also, of the items on which Truman scored the funds, 96% of the funds had a well-defined objective, whereas only 17% publicly announce adjustments to their portfolios.

Next, Dr. Truman briefly discussed several SWF-related questions for policymakers in OECD states:

  1. How much should a country invest abroad?
  2. What should be the role of the government?
  3. If the government has a role,what should be its investment strategy?
  4. What mechanisms should the government use to demonstrate is accountability?
  5. How does increases transparency contribute to accountability?
  6. How does an investing government keep host countries open?

Truman, who has written extensively on the IMF before, seemed generally positive about the International Working Group’s progress, pending the release of the actual agreements. He said the developments were “encouraging” but worth watching closely. In conclusion, Dr. Truman again advocated the idea of reciprocal responsibility.

More on William Miracky’s comments and the Q&A session in my next post.


This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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