Archive for August, 2009

Informed Trading

Ashby Monk

I got to thinking over the weekend about the remarkable performance of the CIC’s domestic, state-oriented investments in 2008. As I noted last week, this domestic portfolio outperformed the CIC’s commercial-oriented foreign portfolio. However, most of us believe that politicized investments will generally under-perform commercial investments. The IMF reinforced this point in its paper on DIY SWFs:

“Regardless of the governance framework, the operational management of an SWF should be conducted on an independent basis to minimize potential political influence or interference that could hinder the SWF in achieving its objectives…there should be a clear separation between the unit that executes and those involved in oversight.

Reading between the lines, investing for political (instead of commercial) benefits will lead to substandard returns and a failure to meet objectives.

However, I don’t raise the CIC case to try to cast doubt on these conventional governance theories. Rather, the CIC case simply reminded me of the benefits of “informed trading,” which is to say investments within local, familiar jurisdictions (a different animal than “insider trading”). Perhaps the CIC case may be an example of how good governance can allow SWFs to reap the benefits of informed trading? Here is what I mean:

Over the past few years, we (economic geographers and financial economists) have come to understand that ‘local’ investments have the potential to outperform investments in the broader market. According to Huberman (2001), “familiarity, apparently a non-financial attribute, affects investors’ choices” (page 675), and choices made about local investments are typically better informed, according to Coval and Moskowitz, which leads to higher returns. As I noted in a paper this year (page 872),

“While investing in those things familiar may represent a suboptimal investment strategy based on traditional portfolio theory, being knowledgeable or familiar with a certain investment undoubtedly carries advantages. Indeed, for those willing to look beyond the efficient market hypothesis, familiarity, which creates specific situated knowledge, is the source of investment opportunities unobserved by the market.”

Local investments represent clear opportunities for investment gain, so long as the SWFs do not over-invest in their back yard (i.e. allocate assets for domestic investments beyond the country’s share of global GDP) or fall victim to governance breakdowns. Indeed, extracting the benefit of familiarity necessitates strict and robust governance procedures that can thwart the influence of politics that would derail commercial objectives. A SWF investing in a local firm that it thinks is set for a global expansion is different than having a politician compel a SWF to invest in a failing firm. The former is representative of informed trading while the latter is representative of, in my opinion, a governance failure (though that does depend on the SWF’s mandate).

I’m not sure if the Central Huijin was a case of informed trading or something else entirely (luck?). But it does remind us that there are returns to be had in familiar (local) environments. Moreover, it suggests that we shouldn’t rush to “sound the alarm” just yet on domestic investing. Maybe it’s just another reason to focus on good governance.

Forthcoming SWF Research…

Ashby Monk

I have been making my way through 13 new SWF research papers that were sent out to presenters in anticipation of the forthcoming SWF conference in Singapore.   (Gordon will be representing us there and presenting this).  

There are some fascinating papers, which is a credit to the National University of Singapore and the Asian Society of International Law for putting together such a good group of academics, policymakers and practitioners.

Unfortunately, most of the papers I’ve read don’t seem to be available online (yet). Nonetheless, the list of papers and presenters is online.  So if you see a paper you’d really like to read, you should just email the author. Most will be more than happy to pass along the working paper.

Enjoy your weekend.

CIC To Invest $50 Billion In 2009?

Ashby Monk

News stories abound this morning about the CIC’s intention to invest 10 times more money in 2009 than it did in 2008. According to CIC President Gao Xiqing, CIC had 90% of its assets in cash at the end of 2008. However, he thinks the crisis has largely abated and ‘deals’ are now to be had.

A quick snoop in CIC’s annual report shows that CIC still managed to invest close to $5 billion in 2008. So, if we believe Gao’s “10 times” comment, we may see the CIC invest close to $50 billion dollars this year. This would be half of its international portfolio (according to these smart guys).

Normally I’d argue that investing this much in such a short time period is a mistake, as it would subject the CIC to considerable market timing risks. The traditional approach is to “dollar cost average” your way into the market by buying in over time.

BUT! These aren’t normal times and the CIC isn’t a normal investor. It was recently freed of all its liabilities, so it can now take some bigger risks than it might have been able to. Also, the market timing risk may be worth taking. Given that we are coming out of a crisis, most equity markets are still trading at large discounts vis-a-vis 2007.

So after playing it safe in a year when playing it safe was brilliant, the CIC may end up investing a huge amount of assets in a year when investing huge amounts of assets is brilliant. Only time will tell.

Temasek Charts New Course

Ashby Monk

According to P.R. Venkat and Costas Paris in this morning’s WSJ, Temasek does not consider itself to be a SWF:

“Despite the government being its sole shareholder, Temasek doesn’t consider itself to be a sovereign-wealth fund. Temasek officials insist its goals are primarily financial rather than to support Singapore government policy, although Singaporean companies make up a substantial portion of its portfolio.”

I’m intrigued by this development, since Temasek played an important role in the International Working Group of Sovereign Wealth Funds. If it’s not a SWF, what was it doing in the IWG? Is it going to pull out of the new Forum?

Clearly, Temasek is charting a new course, which has now resulted in the amendment of its Charter:

“We have refined our Charter to more clearly articulate our focus as a value-oriented investor, and also as a shareholder focused on achieving sustainable returns by engaging with the boards and management of our portfolio companies.”

I’d say Temasek is working hard to ensure its international legitimacy before a global expansion. The loss of Charles Goodyear as CEO—the American that was to pave the way for such an expansion—was a blow. It is probably also trying to bolster its domestic legitimacy after an awful year (the NYT reports the fund lost $27 billion during the financial crisis). So changing its Charter is probably a good move. It reinforces its commercial principles and distances itself from the government, which will likely provide international and domestic constituencies a bit more confidence in the SWF’s operations and motivations.

DIY SWF

Ashby Monk

As seen on the Government Shopping Network:

…You’ve heard about the SWF craze. Countries around the world are rushing to get SWFs to manage all sorts of tough macroeconomic spots and stains that just won’t come out with store-bought policies. Maybe you’ve thought to yourself, I’d like a SWF too. Now here’s your chance! With this easy to use roadmap you too could be the proud owner of a SWF…brought to you by the IMF…

In all seriousness, this new paper (Setting up a Sovereign Wealth Fund: Some Policy and Operational Considerations) is quite interesting. Its objective is to offer policymakers interested in setting up a SWF a roadmap of topics that should be considered before, during and after the SWF is set up. It takes the reader through definitions, sovereign characteristics, timing, objectives, rules (funding, draw-down), structure, governance and investment policy. In short, Das et al. have set out what they see to be the basics of DIY SWF. It’s a welcome intervention.

SWF Performance in the ‘Great Recession’

Ashby Monk

Foreign Policy has just published a short article by Veljko Fotak and Bill Megginson in which the authors describe and explain the severity of the losses suffered by SWFs. As they note:

“…sovereign wealth funds lost a staggering $66.88 billion on their publicly disclosed investments and experienced a total return of negative 53.23 percent from the date the investments were made through March 27, 2009.”

The authors see more than just poor investment decisions at work:

“It’s not simply the managers’ fault. These are, after all, state-owned investment funds. As our data suggest, poor stock picking could have been the result of pressures that forced managers to invest in distressed industries and firms for political reasons.”

Referring to their data (in the recent Monitor report they contributed to), I also saw evidence for political influence over SWFs. If true, this would surely exaggerate the losses made by these SWFs.

I think it’s an interesting story…but I was actually surprised to see it in Foreign Policy, which is a magazine (and website) I read regularly. I think of FP as a provocateur, publishing articles that force the reader to reconsider firmly held beliefs and challenge conventional points of view. While this SWF article is interesting, it confirms what many in the west already hold to be a truth: SWFs are inherently political and this politicization creates inefficiencies (e.g. losses).

This got me thinking as to how I might write a short article on politicized SWF investment that was challenging and provocative. After a solid 30 seconds of reflection, I decided I would have written an article about how political influence can lead to SWF investment outperformance. And I think I’d have some evidence to back it up.

I’m thinking of a large SWF. This SWF has two distinct sides to its operations. On the one hand, it has its global investment activities, which represent its commercial investment operations. On the other hand, it has its domestic operations, which represent its investments in domestic and state-owned firms. In order to dampen western anxieties about political investing, this SWF keeps a strict “firewall” between the two sides of the fund. I’m of course referring to the China Investment Corporation:

“CIC maintains a strict operational firewall between its global investment activities and those of Central Huijin, which represents the State’s interest in domestic, state-owned financial institutions.”

In short, Central Huijin, a wholly owned CIC subsidiary, was set up to invest exclusively in domestic state-owned financial institutions on behalf of the state to enhance the value of state-owned financial assets and improve the governance of SOEs. While the objective over the long-term may be to make money, there are clear and obvious political undercurrents.

According to the conventional logic (highlighted in the FP article), the ‘commercial’ side of the CIC should have outperformed the ‘political’ side. So what happened? According to the CIC’s first annual report, the CIC’s global portfolio returned -2.1%. This is actually pretty darn good considering the massive declines in global stock markets (S&P 500 was down roughly 40% for the year). However, as Lou Jiwei notes in the report:

“Combined with Central Huijin’s excellent performance, CIC provided its shareholder with an overall return on registered capital of 6.8%.”

In other words, Central Huijin had an amazing year. Indeed, looking back to page 47 of the annual report, we see that the CIC is no longer a “$200 billion SWF,” it is a “$298 billion SWF.” This sudden growth is due to the domestic, politicized portfolio managed by Central Huijin.

If the FP wants provocation, here it is: The arm of the CIC representing the State’s interests outperformed the commercial arm in 2008. The very idea goes against conventional theories of governance and financial performance. Now I’m sure there are numerous points that are debatable about the above. We could also spend another 1000 words speculating as to why Huijin did so well. But that’s beside the point; this post was simply an attempt to get you thinking about these issues in a new way.

Transparency A Threat to Legitimacy?

Ashby Monk

About a year ago I had a long discussion with a former employee of an OECD SWF. This individual made a fascinating observation: their transparency and accountability came with a financial cost. In order to secure the acceptance of domestic constituencies, this specific SWF had been less aggressive in its early years than it might have been. In other words, it took time to secure the acceptance of the domestic stakeholders (i.e. achieve legitimacy***) before it could foray into investing in more risky assets.

So it is interesting to note that as formerly secretive SWFs become more transparent, they too are coming to see how hard it can be to secure the acceptance of domestic constituencies. Recent losses have made this process more difficult. Moreover, according to some analysts, losing domestic support may actually prevent SWFs from investing for the long-term and focus more on the short-term, which would remove a SWF comparative advantage over other institutional investors. In other words, as with my interviewee above, these funds are beginning to understand the cost of transparency.

But here is my question: what is the alternative? Hiding away behind a veil of secrecy to avoid public scrutiny is not, in my view, appealing. To be sure, Alaska’s recent experience with its reorganization may have been difficult, but I’m sure Alaskans are comforted that their representatives are holding the SWF accountable for its decisions. And while being more transparent may be difficult for funds such as the GIC, I wonder if it would be having an easier time in the present crisis if it had a more transparent past. The financial crisis perhaps reminds us that securing the consent of domestic constituencies can actually offer some cover in down times.

So I don’t view the increasing levels of transparency as a threat to legitimacy. I take the opposite view; transparency may solidify the legitimacy of SWFs over the long term, albeit it with some short- and medium-term costs (that are worth paying).

***Dowling and Pfeffer (1975) described legitimacy as the acceptance of an organization by its environment. As Massey (2001, 157) notes, “An illegitimate status demands that the organization respond, or else organizational failure could result.” In this sense, legitimacy is a constraint. Specifically, being legitimate means that the organizational procedures, structures and principles align with the values, norms and expectations of the society in the environment in which the organization seeks legitimacy. In situations where the organization is highly transparent, there is considerable pressure to get this right.


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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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