Archive for June, 2009

Alaska Permanent ‘Mini’ Funds

Ashby Monk

Steve Frank, Chairman of the Alaska Permanent Fund Corp. board, outlined the APF’s new investment strategy on Sunday. The article is an attempt to stave off further criticism among APF stakeholders, as some had voiced their confusion about the sudden change in policy.

One item that I found interesting was the decision to set up three “mini funds” of $500 million each to invest in stocks, bonds and real estate with a ‘real return mandate.’

“These “mini-funds” will allow the Permanent Fund board to see the approach that external managers take to asset allocation, and how it differs from the board’s standard approach. The board will compare the results of these portfolios with each other and against the fund as a whole, which may lead to adjustments and improvements in how we allocate all our assets.”

I interpret this to mean that the APF has set up a series of internal funds to generate additional competition and knowledge transfer. This will then allow the APF to refine its new strategies over time. It’s an interesting strategy, which seems to suggest that APF will be bringing more of the asset management in house. Perhaps the APF sees the CPPIB as a role model.

Weekend Reading

Ashby Monk

New SWF research papers are still popping up.

First, Laura Badian and Gregory Harrington just published a paper called “The Evolving Politics of Sovereign Wealth Funds.” The paper evaluates the various regulatory challenges that SWFs present.  (h/t LinexLegal)

Second, Bertrand Blancheton et Yves Jégourel just published a paper (in French) entitled, “Les fonds souverains : un nouveau mode de régulation du capitalisme financier?” It’s an interesting article that evaluates the extent to which we should view SWFs as stabalizing forces in the markets. Their conclusion is not all that surprising, these funds have a beneficial influence on markets but they also engage in opportunistic trading. Basically it fits with the view that these funds are commercial entities and not motivated by extra-financial criteria.

SSTF: A New American SWF?

Ashby Monk

Elizabeth Stauderman and Jonathan Weisberg of Qn, a publication of the Yale School of Management, recently interviewed Larry Summers on the topic of SWFs. It’s a great interview, as Summers talks candidly about a variety of topics. Of particular interest to me was his discussion of pension reserve funds. Summers defined this type of SWF as:

“…funds that are accumulated in the context of pension arrangements of one kind or other, where countries quite reasonably seek the benefits of international diversification.”

While he acknowledges that other countries “quite reasonably” have set up these types of SWFs to invest retirement assets, Summers also lists the reasons why such a fund was deemed inappropriate in the United States:

“We’ve made a decision in the United States that the Social Security trust fund should not invest in equities, even through index funds…we’ve made that decision very substantially out of a judgment and concern about the politicization of the marketplace and the politicization of corporate decision-making.”

Summers is referring to the late 1990s when the Clinton Administration considered investing the U.S. Social Security Trust Fund in equities. The proposal was torpedoed due to fears that politicians would have influence over the investments, intrude on the Trust Fund’s operations, and engage in ‘stock picking’ so as to use Trust assets for personal or political gain.

To be sure, the specter of politicians interfering in huge public investment funds is unappealing. However, some evidence from outside of the United States suggests headway has been made on the political issue. Since the 1990s, numerous OECD countries, such as Australia, Canada, France, Japan, Ireland, Korea, New Zealand, Norway, and Sweden, have all decided to pre-fund and invest their SS assets in equities (most of them actively). In this process, all of these countries designed and implemented new governance practices that explicitly sought to immunize their reserve funds from political influence.

Take Canada as a case study: many Canadians raised similar political concerns during the 1997 debates that created the Canada Pension Plan and its corresponding Investment Board. In response, the politicians that designed Canada’s system did their best to make the CPP a largely autonomous entity with investment decisions placed well beyond the reach of any politician or interest group. In fact, the 1997 legislation explicitly rejected all political or social investing objectives and defined the welfare of plan participants as the singular focus of the CPPIB. In addition, the founding legislation requires changes to the CPP program – including changes to the set-up of the CPPIB and its investment mandate, or to CPP benefits and contribution rates – be approved by the federal government and two-thirds of the provinces representing two-thirds of the population. This is a level of exigency greater than that required to change the Canadian constitution.

In sum, Summers’ comments about the Trust Fund reminded me of two things: 1) The idea of diversifying SS Trust Fund assets was taken quite seriously in the 1990s until political concerns thwarted the effort; and 2) there exists today governance practices designed explicitly to deal with these same political concerns, which means the main roadblock that stopped the policy in the 1990s isn’t necessarily a road block today.

This then leads to an interesting thought experiment: could the US borrow and modify the the new governance practices developed by other countries to transform the Social Security Trust Fund into a pension reserve fund? Probably not. The possibility of such a policy being taken seriously (especially after the financial crisis) in Washington today is beyond remote. But I think the idea is worth revisiting. If other countries are pre-funding and diversifying their SS assets so as to manage population aging all the while limiting the influence of politics, why can’t the US?

To be sure, there are still other debates to consider when thinking about investing SSTF assets actively, such as risk adjusting (this is a biggie). But I expect such debates also took place in Australia, Canada, France, Japan, Ireland, Korea, New Zealand, Norway, and Sweden…

Alaska: Allocation Requires Additional Explanation

Ashby Monk

Pat Forgey of the Juneau Empire has a great story today on the Alaska Permanent Fund’s decision to change its asset allocation policy.

The new policy groups assets based on risk characteristics rather than by the type of investment. It is an approach that other large, long-term investors use. Because there are situations where corporate bonds behave like stocks, it is inappropriate to slap the “bond” label on these investments. This new policy will allow for a more nuanced understanding of the risks being taken by the fund, which in turn will ensure that the Fund is operating within its risk budget. If I had to guess, I would say that the Fund was overexposed to certain risky assets before the crash, and the new policy is designed to ensure this doesn’t happen in the future.

While the new asset allocation strategy is itself of interest, I was also intrigued by the internal (and indeed external) debate that this change is generating. Apparently, politicians and even some Trustees were unsure about the change:

“It may be fine, it may be legit, but we were totally caught off guard and nobody knows anything about it,” said Sen Kevin Meyer.

Given that the Trustees have oversight responsibilities for the Fund, it is surprising to see two of them expressing their concerns so publicly. From a governance perspective, this is significant; typically asset allocation within a large trust-based fund is the responsibility of the Trustees (the managers just implement the asset allocation policy and make the actual investment decisions). The remarks made by the Trustees in Forgey’s article seem to suggest that this is not the case, though more details are obviously needed.

So it will be interesting to see how this all turns out. Fund Executive Director Mike Burns will appear before the Legislative Budget and Audit Committee in August to explain the new system.

Misunderstood: Future Fund’s Governance

Ashby Monk

Alex Dunnin flagged up an interesting Future Fund governance story in the Financial Standard. He suggests that the rumor that former treasurer Peter Costello would be offered a position working for the Labor Government at the helm of the $60 billion Future Fund illustrates a deep misunderstanding of the Future Fund itself. Dunnin notes:

“For example, the board already has a chairman in former CommBank chief executive David Murray and six guardians. Any role for Costello would have only been to join the board as an additional guardian or to replace one of the incumbents, noting that guardian John Paterson whose term expires this year is yet to be formally renewed.”

In short, Dunnin views the Costello appointment rumor as evidence that Australian politicians are unfamiliar with the Future Fund’s governance. This seems a bit of a stretch, but, given the Fund’s youth, it is possible that the politicians who were pushing for Costello to take over the Future Fund were forced to familiarize themselves with the Fund’s appointment procedures; the very procedures that were set up to keep politicians like them from meddling in the Fund’s internal activities.

SWFs Working in Concert

Ashby Monk

SWFs are increasingly working together to achieve their objectives. Last week we saw CIC, GIC and KIA all come together to support the Blackrock acquisition of Barclays Global Investors. This week the KIC signed cooperation agreements with two foreign public funds–Malaysia’s Khazanah Nasional Berhad and Australia’s QIC–to “expand co-operation” and announced their intention to sign more such agreements.

Working in concert or clubbing on deals is to be expected. As I noted in a previous post, SWFs can fruitfully work together to facilitate local understanding in foreign markets. This in turn can lead to higher returns over the long term thanks to information asymmetries obtained by local investors. In short, by bringing together two or three funds with diverse backgrounds into a cooperative arrangement, the effectiveness of the investment function in a specific economic geography is maximized.

Ironically, during interviews with Western policymakers, the prospect of SWFs ‘working in concert’ was typically raised as an issue of concern. According to these individuals (who were perhaps stuck in the 2007/2008 protectionist mindset), the fear was that these funds could work together to achieve political objectives without any single fund raising red flags. However, the recent examples of SWF cooperation seem to be based on commercial criteria exclusively.

Indeed, KIC articulated the rationale behind its recent agreements as a way to increase investment opportunities and facilitate understanding so as to create and sustain national wealth. In addition, the recent collaboration between Mubadala and France’s Strategic Investment Fund is all about ensuring commercial success.

So, rather than representing “death by a thousand cuts” (as one Western policy maker once told me was a concern), these cooperative arrangements are more likely a sign that SWFs are maturing into more sophisticated investment funds; cognizant of their limitations and looking for the tools to overcome them.

KIC: Back in Action

Ashby Monk

The Korea Investment Corporation’s prospects are looking up, as it will be receiving roughly $5 billion dollars in additional capital in the coming months:

  • $3 billion will come from the SK government so as to enable the KIC to resume its overseas investing.
  • The Ministry of Finance will be allocating another $2 billion later this year in a bid to improve returns on reserves.
  • This will take the assets under management up to around $30 billion.

The KIC is apparently out of the penalty box. After its $2 billion investment in Merrill Lynch went sour, it basically decided to withdraw and regroup. This new injection of cash is a sign that they are ready (and the government trusts them) to start investing again. Indeed, $1 billion of the new capital is reported to be heading into high-risk assets:

“(KIC) is studying a variety of investment options, including leveraged buyouts, distressed assets purchases and venture capital…”


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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