Archive for November, 2010

Deep Thoughts by Scott Kalb

Ashby Monk

Scott Kalb first went to Korea in 1978 on an academic scholarship and fell in love with the place. So, he stuck around. He learned the language. And, in the ’80s, he took a job at the Korean Ministry of Finance. However, he would eventually return to the US to do an MA at Harvard, which would propel him to Wall Street for a career in high finance. Yadda yadda yadda. He’s now the CIO of Korea’s $37 billion SWF, the Korea Investment Corporation, and is widely perceived as a creative and innovative force within the SWF community. Since taking over the CIO role in 2009, he’s revamped the SWF’s investment strategy, changed its asset allocation, and worked to improve the fund’s in-house capabilities.

In short, Scott Kalb is an interesting guy, so when he starts talking to the press, I tend to pay attention. And, notably, he’s been talking to two Bloomberg reporters this week, Tomoko Yamazaki and Komaki Ito, about the KIC’s ongoing development. In continuing the ‘deep thoughts by…’ series, here are some of the highlights:

Kalb on the fund’s ongoing cooperation and joint-investments with other SWFs:

“We are in discussions with our counterparts, sovereign wealth funds all over…We have already looked at a number of transactions together and we’re looking at some that are pending — our end goal there is to wind up having a diversified strategic portfolio in a variety of sectors and countries.”

Bloomberg reporting what Kalb said about KIC’s investment strategy:

“KIC is planning strategic investments based on a so-called barbell approach, investing in areas where there’s a ‘structural deficit’ in Korea’s economy such as natural resources, as well as industries that may have synergies in areas such as clean technology, he said.”

Kalb on the fund’s broad diversification strategy, which includes investments ranging from private equity in Africa to infrastructure in China:

“One of the lessons of 2008 is that you can’t just rely on the public markets and specifically very narrow definition of that for your portfolio because you’re not going to get enough diversification. The traditional space is going to be challenged for quite some time.”

Bloomberg reporting what Kalb said about KIC’s changing allocations:

“Sovereign funds and investors worldwide are diversifying their portfolios after the global financial crisis created high correlation across markets, Kalb said. He’s seeking to double alternative investments to about 20 percent of the portfolio from 10 percent, declining to give a specific time frame…

KIC is increasing its weighting both in public and non-traditional assets such as private equity and real estate in the developing world because of its prospects, Kalb said…

KIC has done a few infrastructure and real estate investments in China. It bought properties in other Asian markets, African private equity, and is currently looking at investments in India, Latin America, and more in China, he said…

Kalb also sees opportunities in credit, distressed debt, refinancing and restructuring across different assets ranging from private equity, real estate and infrastructure, he said. He is looking at opportunities in Japanese property because of its attractive yield, he said…

For its hedge-fund investments, macro strategy, which wagers on trends in stocks, bonds and currencies worldwide, has contributed the most to the return because of the highly correlated market environment, Kalb said, adding that he continues to favor the strategy.”

It seems to me as though Kalb is pushing the KIC in three directions: more strategic investing, more illiquid assets, and more diversification. Since all three take advantage of the SWF’s strategic advantages, I’m a fan.

Markets Lose Long-Term Capital

Ashby Monk

I’m quite sure readers of this blog already know that Ireland has decided to tap the National Pension Reserve Fund for the country’s recently announced bailout$16.6 billion in assets from the Irish SWF (roughly one half of the fund’s total AUM) will be added to the $96 billion coming from the EU and the IMF. All this money will help the government meet its financial obligations and recapitalize the country’s ailing banking sector (again). Obviously, it’s frustrating news for the country’s pensioners. But, it should be said, Ireland was darn lucky to have a SWF; without it the very autonomy of the country might have been in jeopardy.

There has been a lot written on this topic (for more details on the NPRF and the Irish bailout, go see this good stuff), so I’d like to talk about a tangentially related topic: the shrinking time horizon of governments. Why? Because Ireland is not alone in using its here-to-fore long-term pension assets for short-term spending needs. For example, there is news out this morning that France is ‘seizing €36 billion in pension assets‘ from the Fonds de Réserve pour les Retraites (FRR). As they say, misery loves company.

To give you a bit of background, the FRR was set up in 2001 to prefund public pensions (much the same way the NPRF was in Ireland):

In fact, the FRR likens itself to the NPRF:

“Many aging developed nations have set up reserve funds, including social democracies in Northern Europe (Sweden, Norway), traditionally liberal States (Ireland, New Zealand), Southern European countries (Spain, Portugal) and Japan. Certain emerging countries undergoing rapid demographic change – such as Korea or China – have followed in their footsteps. These funds have a shared mission: to help PAYGO systems meet the aging challenge more rapidly and smoothly.” (emphasis added)

Anyway, according to George Coates in Financial News, France’s parliament passed a law last week that will allow the country to use the reserve fund’s long-term assets to pay off the country’s short-term welfare debts.  (Though, it should be noted, the original decision to tap the FRR was included in the pension reform package earlier in the year). As Coates points out, this is a similar move to that of Ireland’s (and others).

So, why is the French government doing this? Here’s the FRR’s explanation for what’s going on:

“The French government decided on the 16th of June to propose to parliament the mobilisation of the assets and resources of the FRR in order that they contribute towards the financing of the deficits of the general pension scheme during the ramp up of the pension reform. This will be achieved by the transfer from 2011 onwards of the income received by the FRR to the Caisse d’Amortissement de la Dette Sociale (CADES) and the Fonds de Solidarité Vieillesse (FSV). Furthermore, following the declarations by the government before the parliamentary committees, each year until 2024 the FRR will pay a sum, the amount of which will be established by the next law concerning social security financing, to the CADES

I can’t really fault France for spending pension assets on…well…pensions. Still, there are some serious implications.

In short, this will require a “radical restructuring” of the FRR’s investments. For example, the allocation to equities (currently pegged at 40%) will be scaled back dramatically in favor of cash and short-term government bonds, which will provide the liquidity the FRR needs to pay short-term liabilities. Only one-third of existing assets will remain “long-term”. The elimination of these long-term assets will have knock-on effects in France and beyond. Let’s turn back to George Coates:

“…the FRR had been an innovative force in the relatively conservative French asset management world. It had pioneered a shift in the style of managing money in France, from balanced mandates, where a single fund manager invested its client’s money in many different asset classes, to specialist mandates, involving many fund managers focusing on particular areas of expertise…The FRR promoted socially responsible investment, increased the use of investment consultants and encouraged objectivity in assessing performance.”

In effect, the FRR was promoting, by example, good investment governance and sophisticated asset management in a country that has typically been too conservative. Indeed, the FRR had adopted a new strategic asset allocation policy as of June 2009 that resembled (albeit slightly) a factor based approach (see chart below). That’s pretty amazing.

Let me sum up before this post gets ridiculously long: In both the Irish and the French cases, the asset management industry and financial markets more generally will lose tens of billions of dollars of supply of sophisticated, long-term capital. In my view, that’s a real shame! This long-term capital tends to generate higher returns and, to be a bit simplistic, do cooler stuff (such as build infrastructure, finance new technologies or encourage good corporate governance). The same cannot be said for short-term capital.


Long Weekend Reading

Ashby Monk

Here in the United States, it’s my favorite holiday today: Thanksgiving! Why is Thanksgiving my favorite holiday, you ask? I guess it’s because everyone in America participates (it’s a secular holiday). It’s about celebrating the stuff we have, rather than thinking about the stuff we want to have (cf Christmas). And, it’s about eating amazing food with the people we love, which, if you think about it, is the penultimate answer to the long list of life’s “why” questions. (Why do you work? I want to make money. Why do you need money? I want to be able buy stuff. Why do you want to buy stuff? I want to eat well and drink heartily with the people I love! Why do you want to do that? To be happy. Final answer.) Oh, and Thanksgiving is always on a Thursday, so it comes with two days off of work, which is very nice.

Anyway, I’m taking today and tomorrow off (yes, I wrote this post yesterday). But, given that most of this blog’s readership is outside the US, I thought I’d do a “weekend reading” post for non-American readers. Here you go:

  1. Bernardo Bortolotti, Veljko Fotak, William L. Megginson, and William F. Miracky have a new paper entitled “Quiet Leviathans: Sovereign Wealth Fund Investment, Passivity, and the Value of the Firm.”
  2. Matt Krzepkowski and Jack Mintz have a new paper entitled “Canada’s Foreign Direct Investment Challenge: Reducing Barriers and Ensuring a Level Playing Field in Face of Sovereign Wealth Funds and State-Owned Enterprises.”
  3. Matthias Lücke has a new paper entitled “Stabilization and Savings Funds to Manage Natural Resource Revenues: Kazakhstan and Azerbaijan vs. Norway.”

Enjoy your long weekend!

South Africa Wants ‘Africa Development Fund’

Ashby Monk

South Africa’s Economic Development Ministry has finally released the much-anticipated ‘New Growth Path’ report. As the title suggests, it offers up a ‘new path’ for facilitating economic development and creating millions of new jobs in South Africa:

“The shift to a new growth path will require the creative and collective efforts of all sections of South African society. It will require leadership and strong governance. It takes account of the new opportunities that are available to us, the strengths we have and the constraints we face. We will have to develop a collective national will and embark on joint action to change the character of the South African economy and ensure that the benefits are shared more equitably by all our people, particularly the poor.”

Some lofty ambitions there! So, what’s on this ‘path’ exactly? It turns out that the new proposal combines a variety of micro- and macroeconomic interventions. And, since you are reading about this report on this blog, you’ve no doubt already guessed that one of the key recommendations is to establish a new SWF:

The “Government will launch an appropriately structured Africa Development Fund to assist in financing…infrastructure, and at the same time play the role of a sovereign wealth fund in helping to achieve a more competitive rand.”

According to the Economic Development Minister Ebrahim Patel:

This “…document recognizes the challenges of an uncompetitive currency and sets out clear steps for government to address the impact of the rand on the economy and jobs…This includes a somewhat looser monetary policy with lower interest rates, greater building of foreign reserves and a sovereign wealth fund to manage foreign reserves more actively.”

That’s all well and good, but it sounds to me like the Africa Development Fund may have a multitude of objectives and constraints (e.g. domestic infrastructure investments and investing of foreign reserves on global financial markets), which means it will be quite challenging to get the design and governance ‘right’ so this fund can be successful in this complex environment. But it’s early days yet, so I’ll chill out on the governance jibber jabber and just say: Welcome to the SWF club, South Africa!

Understanding Financial Interconnectedness

Ashby Monk

Here’s the thing with globalization: It’s got baggage. Don’t get me wrong, I love to start my days with an Ethiopian coffee and a French croissant while I watch my Japanese TV and surf my American computer (made in China), all while waiting for my Finnish phone to ring so I can explain to my Dutch and Australian colleagues (who work at Oxford) my plans for an upcoming conference in Tunisia (which is being run by an American company through offices in London) and a research trip to Abu Dhabi. Come on, how could you not love globalization? Could you live without curry, burritos, sushi, or Chinese takeout? Maybe, but I’m not sure I’d want to.

But…and there is always a but…globalization definitely has its detractions. Beyond the clear shortcomings of the ‘rising tide lifts all boats‘ analogy, globalization causes real problems for macroeconomic risk management. For example, when country A opens its markets up to country B (and vice versa), they create mutual dependencies through trade and specialization. Accordingly, each country implicitly accepts a certain level of vulnerability to the other country’s internal problems. And, when these problems are contagious, it follows that contagion can result.

This contagion can be in the form of a health related pandemic, such as SARS or [insert animal name here] flu. Alternatively, it can be in the form of an economic malaise, which is the case this morning. Indeed, global markets are off today due to fears that Ireland’s economic woes will spread to its economic partners around with world. In case you’re in a cave somewhere (…probably catching the Marburg virus before hopping a direct flight to my hometown…), Ireland may need an 85 billion euro rescue package (50 billion to finance the government and 35 billion to save Irish banks from collapse). And, as you might expect, there are plenty of reports out today about contagion fears — and these fears are already affecting currency and asset markets.

Anyway, all this interconnectivity and interdependence has inspired me to unleash some serious economic geography on you today. In particular, I think a brief discussion of a recent IMF Staff Paper, entitled “Understanding Financial Interconnectedness”, seems particularly apropos. Here’s a blurb:

“Countries are financially interconnected through the asset and liability management (ALM) strategies of their sovereigns, financial institutions, and corporations. This financial globalization has brought benefits as well as vulnerabilities. In particular, the speed with which illiquidity and losses in some markets can translate into global asset re-composition points to the risks of interconnectedness…

“This paper takes initial steps toward understanding financial interconnectedness by first outlining the architecture of cross-border finance and then exploring two related fault lines—funding models and ratings—that played a pivotal role in the global financial crisis….The paper uses available data on cross- border banking from the Bank for International Settlements (BIS) in the run up to and during the crisis, as well as a novel dataset on the global funds industry (money market, mutual, hedge, exchange-traded, and pension funds), to illustrate global financial interconnections and risk concentrations in the run up to the crisis. To be very clear, the paper does not construct a global risk map, nor does it attempt to point out where systemic risks are currently building up or might arise in the future. There are significant data gaps that preclude the completion of a comprehensive risk map—gaps that can only be bridged with buy-in from the membership on the value of such an exercise. The role of this paper is to suggest how such analyses might be undertaken and to offer some new perspectives on augmenting financial surveillance at the multilateral and bilateral levels.”

Gotcha. But these humble authors do offer up some cool insights that are worth flagging. For example, this figure shows the extent to which cross-border financial interconnectedness has increased over the past 25 years:

Next, the paper offers a cool graphic highlighting the “principal nodes” for cross-border funds in the global economy. What’s particularly relevant here is Ireland’s prominent role therein:

Finally, the paper illustrates the extent to which Ireland has become a major hub for assets under management. The country apparently has 3% of the world’s assets:

All this is to say that it’s in all our interests that Ireland get its act together. The global economy is highly dependent on this small European country, which makes a sovereign default or banking collapse potentially calamitous.

To bring this back to SWFs, this interconnectedness is, in large part, what inspired so many countries to begin hoarding reserves: self-insurance against other countries’ problems. You know what they say…

Ireland Learns ‘Directed Investment’ Lesson the Hard Way

Ashby Monk

Ireland’s Sunday Independent had one doozy of a story yesterday:

As an SWF wonk, I have to say that I feel particularly bad for the Irish NPRF (and Ireland’s pensioners). Recall that, because of the government’s directed investments policy, the NPRF is now a huge shareholder in Ireland’s banking system. By the looks of things, this is not an enviable position to be in.

But fear not, concerned friends, when one SWF falls down…others are waiting in the wings to save the day!

“The Chinese and other Asian sovereign wealth funds are believed to be prepared to shell out to effectively fund any bailout by buying bonds issued by the EU bailout fund. They are also likely to be targeted as potential buyers for Irish banks by the NTMA, dependent on negotiations with the IMF and EU officials.” (emphasis added)

Are you kidding me? Are we really talking about SWFs saving Western financial institutions again?! Apparently so. And people still actually think that SWFs can fill the function of ‘investor of last resort‘? Again, apparently they do.

But, remarkably, there is at least a recognition this time that SWFs are not interested in throwing good money after bad:

“However, any sale of Irish banks would be dependent on some form of guarantee to protect the buyer from future losses.”

No doubt. However, the Irish SWF also received plenty of assurances when it was directed to invest in failing Irish banks too:

These investments were in perpetual preference shares with an annual non-cumulative fixed dividend of 8% payable in cash or, in the case of non-payment by either bank of the cash dividend, ordinary shares in lieu. The preference shares could be repurchased at par up to the fifth anniversary of the issue and at 125% of face value thereafter. Warrants issued with, but detachable from, the preference shares gave an option to purchase up to 25% of the enlarged ordinary share capital of each bank (following exercise of the warrants). The warrants were exercisable at any time from the fifth to tenth anniversary of issue of the preference shares or immediately prior to any takeover or merger of the bank concerned, whichever is earlier. The number of ordinary shares which may be acquired pursuant to the exercise of the warrants was subject to anti-dilution protection in line with market norms for warrants. Accordingly, the warrants will be proportionately adjusted for any increase or decrease in the number of ordinary shares in issue resulting from a subdivision or consolidation of units of ordinary shares. The warrants will also be proportionately adjusted for any capital distributions by the bank and for certain bonus issues or rights issues by the bank.

And even with all those provisions, how many of you think the NPRF will make a profit — or even get its money back — on its 7 billion euros?

And herein lies the tragic story in all this. If the Irish banks had been headed for failure anyway, wouldn’t it have been nice to keep the NPRF’s money, say, for what it was legitimately intended? (i.e. pensions.) (Not to worry, I won’t rehash all my old arguments on this topic…just see here, here, here, here and here.)

Interestingly, the real ‘investor of last resort’ in this case was actually an SWF: the NPRF. It invested in the Irish banking system…not because it thought there was an opportunity for profit, but because it was told to by the government to do so. In this respect, we should call directed investments what they really are: bailouts. Whether a state treasurer is directing his pension fund to invest in a struggling firearms manufacturer during an election, or a national pension reserve fund is directed to invest in a struggling banking industry, these funds go where no others will…because, ultimately, the investments make no economic sense. And you don’t need to be a futurologist to know what tends to happen in these cases: heavy financial losses.

And, with that, I’m forced back to the topic of investment governance. It’s for similar reasons that many public funds have spent so much time thinking about governance mechanisms that will ensure independence from political (and external) influence. Now, I have to give the Irish credit; I understand why they dipped into the NPRF. But, nonetheless, it still pains me to see pension money wasted in this manner.

Field Work In Mauritius, Please

Ashby Monk

The big news out this morning is that Mauritius plans to set up a new SWF. According to Finance Minister Pravind Jugnauth, the new fund will be worth about $500 million and draw its assets from currency reserves:

“To ensure greater stability in the forex market, the government is creating a sovereign wealth fund that will be invested in a range of asset classes abroad.”

This announcement has been expected for some time. Back in March, I noted that wild currency fluctuations had put the idea of a new SWF on Mauritian radar:

“Over the past two years, the Mauritian rupee has experienced a great deal of volatility vis-à-vis the dollar; down over 11 percent in 2008 and then up nearly 5 percent in 2009. This has made long-term budget planning very difficult. As such, the new SWF is meant to help smooth exchange rates (ostensibly by facilitating central bank operations and sterilization) so the government can be more certain about the country’s long-term economic plans.”

That seems eminently wise. And so, with the official announcement, I’d like to personally welcome Mauritius to the SWF club. And when I say, “personally”, I mean I’d like to come to Mauritius, in person, for some sort of SWF launch event or conference or whatever. We can call it ‘field work’ or ‘close dialogue’ or whatever passes enough muster to get me a week “working” in this remarkably beautiful country. Have you seen this place? Amazing.


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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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