Archive for September, 2010

Lucky To Have A Sovereign Wealth Fund

Ashby Monk

The big news today is the announcement in Ireland that the total cost for the banking industry rescue may reach €50 billion. And you thought Ireland was getting its act together? Actually, it was…kinda. This is a lovely explanation by The Economist:

“Ireland looks like an abstemious jogger that has suffered a heart attack…Ireland has tried hard to fix its problems. Public-sector wages have been slashed and new taxes raised. The economy is already flexible.”

The Economist is right, Ireland has taken extraordinary measures (and behaved quite abstemiously) to shore up its economic woes. In fact, the government has done something that, back in 2001, it vowed it would never do: it has used its National Pension Reserve Fund to help shore up the domestic banking industry.

When the NPRF was established in April 2001, the idea was that it would not be touched (…for any reason…) until 2025. Here is the blurb from the NPRF website:

“No money can be drawn down before 2025 and, from then on, drawdowns will continue until at least 2055 under rules to be made by the Minister for Finance.”

Granted, the NPRF has not technically been tapped by the government. Rather, the government has used its new authority (thanks to The Investment of the National Pensions Reserve Fund and Miscellaneous Provisions Act 2009) to direct the NPRF to invest in some struggling ‘listed credit institutions’.

In my view, however, the result is the same; the NPRF is acting outside of its original mandate. Call it what you want — and the NPRF calls these “directed investments” — this is an extraordinary request. In fact, the website goes on to say that, “the Fund’s statutory investment policy is not applied to these investments.” In other words, the Fund doesn’t consider whether these “investments” are sound; it just does what it’s told.

And so, this pension reserve fund has become a key component in the government’s bank recapitalization plan. And what began with a €7 billion bank program in February 2009 will apparently continue today with billions more from the NPRF.

I still have some misgivings about the NPRF being used in this manner. Yes, I get how grave the situation is and that desperate times necessitate desperate measures. But the country has cracked into its pension piggy bank 15 years too early. And it pains me to see the long-term, intergenerational issues, once again, taking a back seat to the “needs of the day”. How…seriously…how can governments ascribe to these long-term problems (such as pensions or climate change) the same sort of urgency as a banking crisis? Because these long-term problems require long-term solutions…

Public Funds Moving Assets In-House

Ashby Monk

There is an increasingly common trend among government-sponsored funds to take a greater role in (and responsibility for) asset management. We’ve seen this in Alaska. We’ve seen this in China. We’ve even seen this in Libya. And it seems to me that this trend is caused at least in part by a growing impatience with the fees charged by external asset managers, which has led certain funds to develop internal asset management capabilities to realize “alpha” for themselves.

But the latest fund to go this route is not a high-flying SWF. It’s a public pension fund from the state of South Carolina. Peter Lattman of the NYT is all over this story:

“…frustrated by what it sees as expensive fees and lack of transparency at private equity firms, one state has decided on a do-it-yourself approach. South Carolina’s pension fund is creating an independent firm to oversee the fund’s private equity holdings — doing what it would have paid a private equity firm to do. The effort is similar to the direct investment funds created by two of Canada’s biggest pension plans — Ontario Teachers’ Pension Plan and the Canada Pension Plan Investment Board — but is believed to the first of its kind in the United States.”

The rationale here is obviously to lower the costs associated with what is quite an expensive asset class. Indeed fees can be astronomical in the private equity industry. And I know this all too well: when I tell people I used to work at a successful PE shop in New York but left to pursue a career in academia, I get suspicious and curious looks that imply I must have been deranged to walk away from this kind of payday. Fair enough. But (!) these astronomical fees (while good for the PE insiders) often erode returns for clients. In fact, Booz & Company reportedly did an internal study that found that the SC pension could save $2 billion in fees and other costs over the coming decade by reducing its reliance on outside managers and investing directly. That’s huge. Now, that’s only one side of the equation (the other side is the returns generated for the fees paid), but it’s still a pretty compelling piece of data.

Even so, while funds might be intrigued by this strategy, it’s no panacea. In fact, it just creates a new set of problems for institutional investors. For example, if you are taking responsibility for the investment decisions, you better have the design, governance and competency to make this a successful endeavor. In other words, you need to operate according to best-practice standards of investment management. And this can be very hard in the context of a public fund, where it can be difficult to pay private sector salaries. Here’s the NYTs again:

“Although its reduced fees will save South Carolina money, the firm’s lower revenue will make it difficult to pay compensation on par with Wall Street firms.”

But if the fund can’t hire the talent, then this decision will inevitably fall into the “penny wise, pound foolish” category. That being said, when you see that a Russian monkey outperformed 94% of professional asset managers in 2009, you gotta feel pretty good about their chances. Good luck, South Carolina!

Egypt Is Finalizing A New SWF

Ashby Monk

Reuters is reporting this morning that Egypt is finalizing a draft law for a new “asset management agency” that would operate like an SWF. According to Mahmoud Mohieldin, the outgoing investment minister, the new agency would bring “stability and efficiency to state owned-assets”. This is potentially a big deal for Egypt, as the new SWF (let’s just call it that) may be given purview over 147 (!) state owned firms and would ultimately be responsible for future privatizations and, ostensibly, managing the financial assets derived. Mohieldin also said that the inspiration for this new entity was Malaysia’s Khazanah.

For me, however, the most interesting bit comes at the very end of the Reuters article. Apparently, the new agency will be overseen by a committee of…wait for it…30 (!) members. I’m sorry to have to be the one to say this, but a 30 person committee is roughly 23 too many. I understand wanting to provide important stakeholders with representation on this decision-making body, but large and unwieldy committees are recipe for gridlock and decision-making failure. I’ve personally witnessed the fractured and heated debates that take place within public pension fund committees of 12 people, so I can only imagine what a 30-member committee will look like. Anyway, the law has not yet received parliamentary approval, so there is still time to limit the size of this committee to something more reasonable.

Joint India-Venezuela SWF Rejected

Ashby Monk

Back in May, I reported that Venezuela wanted to partner with India in a $100 billion SWF to jointly acquire energy assets in Latin America. It was an audacious idea on the part of the Chavez, which, oddly enough, India actually took pretty seriously:

“‘India has asked for a draft of the proposal. It will be discussed with concerned ministries and companies dealing in energy sector,’ said an external affairs ministry official, requesting anonymity.”

Unfortunately for those hoping to see the world’s first overtly strategic bi-lateral SWF, there’s news out this morning that India has formally rejected Venezuela’s offer. It was fun while it lasted.

Why did India take a pass on this opportunity? Not for the reasons you are probably thinking. Here’s the same “external affairs ministry official” from before:

“Given the political risks in Venezuela, it will be advisable to take a consortium financing and energy assets development with China and Russian firms to spread political risks…”

So, if I’m reading this correctly, India has decided to press ahead with strategic energy investing in Latin America, but it just views Russia and China as more reliable business partners than Venezuela. I’ll let you noodle on that one for a while…

Events Worth Attending

Ashby Monk

Much to my wife’s chagrin, I’ll be on the road quite a bit over the next few months attending conferences, giving seminars and doing field work in some far flung places. (For those out there that don’t speak academic, “field work” is just a snazzy way of saying “interviewing smarter people than me”.) So you’ll have to be a bit patient for posts, as there may be a few days where I simply don’t get to it. Anyway, it struck me that two of the conferences may be of interest to readers of this blog:

1) Sovereign Wealth Funds and Other Long Term Investors: A New Form of Capitalism? — This is hosted by the Committee on Global Thought at Columbia University.  As you’ll see from the list of speakers, this should be a remarkable event. Gordon will be presenting our paper on ‘form and function’, which means I’ll be enjoying this event from the bleachers (which suits me just fine). For those interested, there is a video explaining the motivation for this event; Stiglitz seems a bit distracted, but the next two interviewees are solid.

2) Asia & Middle East Government Funds Roundtable — This event will be hosted by Institutional Investor in Kuala Lumpur, Malaysia at the Mandarin Oriental. Again, this event should be very interesting. There’s a seminar for the government funds on November 1st (that I’ll be leading / moderating), which will be followed by two full days of panels and discussions that look very timely and relevant. And the list of speakers is fantastic.

Anyway, if you have plans to be at either if these, let me know. I’m always interested to meet someone who actually reads this stuff.

Comparative Advantage in Reserve Management

Ashby Monk

Joshua Aizenman and Reuven Glick have a new paper out entitled, “Asset Class Diversification and Delegation of Responsibilities between Central Banks and Sovereign Wealth Funds”. The paper is a bit of a bear for the non-quants out there (and here), but if you can manage to tear yourself away from the pages of equations long enough to read the introduction and the conclusion, then I think you’ll find that they’ve done some very interesting work.

The first part of the paper offers up a model that compares the “optimal” investment diversification strategies for central banks and SWFs, focusing on the tradeoffs between safe foreign reserve assets and the higher yielding, riskier assets one might expect a SWF to hold. For me, this part of the paper falls into the “formalizing-what-we-already-intuitively-know” category. But, still, it’s a worthwhile exercise.

The second part on governance and behavior is altogether something different, and I found it quite intriguing:

“…we find that the assignment of the financial stability objective to the central bank tends to increase the gap between the optimal diversification patterns of the bank and the SWF, with the central bank specializing even more in holding safe assets so as to minimize the downside risk of sudden stop crises, while the SWF specializes more in holding foreign equity assets in its portfolio.”

In other words, the better the central bank is (or is allowed to be) at doing its job, the better the SWF can be at doing its job. Apparently, the law of comparative advantage seems to hold true even in the domain of reserve management.

Weekend Reading

Ashby Monk

I’m on the road today, but I wanted to leave you with this interesting article before the weekend: “Foreign State Immunity and Foreign Government Controlled Investors” by David Gaukrodger of the OECD.  I was downright captivated by some of the case studies Gaukrodger used to illustrate the evolution of ‘foreign state immunity’ and how it has been applied in different jurisdictions. I hadn’t realized that certain SWFs (e.g. Kuwait Investment Authority and the National Fund of Kazakhstan) have already had to test the limits of their sovereign immunity in various courts. Anyway, thought-provoking stuff. Enjoy your weekend.


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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