Deep Thoughts by John Nugee

Ashby Monk

Long time friend of the show John Nugee has published a boringly titled article — “Current Issues in Official Sector Asset Management” — that is anything but boring. In fact, it’s fascinating. Not that I find that surprising, as John is widely respected in our small community of wonks.

For those that don’t know John, he has a long history in the government funds space: He was ED in charge of reserves management at the Hong Kong Monetary Authority, Chief Manager of reserves management at the Bank of England, and Director of the European Investment Bank and European Investment Fund. And all this was before he took up his job at SSGA where he is now the Senior Managing Director in charge of Official Institutions (i.e. central banks and sovereign funds).

Anyway, all this is to say that John is a smart dude with his finger on the pulse of this space. So it was a lot of fun to read his reflections on the events of the past three years. He flags the changing perceptions of governance, risk management, and diversification (among other things) for SWFs. It’s worth reading in its entirely, but here are some of the more interesting “deep thoughts” broken down according to issue:

  • Time Horizon: “…the crisis posed the question of whether sovereign asset owners were correct to assume that simply because their funds were held long term, they were optimally invested with long-term investment horizons…most pure store-of-wealth funds, where the objective is unequivocally investment return and long term capital growth, found that even the dramatic losses of 2008-09 were not enough to cause them to abandon their adherence to a long-term investment style.”
  • Clarity of Focus: “Over the last 10 years or so, a significant number of central banks, particularly but not only in Asia, have accumulated reserves that are now without doubt beyond the minimum level needed for policy purposes, and as a consequence, one of the features of central bank reserves management in this period has been the addition of investment or store-of-wealth objectives alongside the more traditional reserves management objectives. This has resulted in a number of reserves portfolios where the central bank is in effect aiming to achieve two purposes within the same fund – on the one hand, the classic monetary policy role of the funds, and on the other, an investment portfolio for which return is the main objective. Recent turbulent markets have reignited the debate on how comfortably these two objectives sit together in the same overall portfolio, and a number of central banks are considering making the separation between their policy reserves and investment reserves more transparent, or going the further step of establishing a wholly separate structure for the investment part of the reserves. If this debate continues to bear fruit, it may herald in time a greater clarity between the respective roles of central banks and sovereign wealth funds, and a greater distinction between the funds the two types of institutions manage.”
  • Active Management: Nugee quotes a Middle Eastern SWF executive as follows, “…whereas in the past we used to assume that assets should be managed actively unless it was clear that a certain asset class or market did not offer opportunities for active managers or reward active management, now we tend to see it the other way round. We conclude that assets should, as the default, be managed passively unless there is clear evidence that a given asset class has sufficient imperfections that active management is likely to be consistently rewarded”
  • Diversification: “The last few years have shaken many previously firmly held convictions and beliefs, about markets, about investment theory and about the correct way to manage asset portfolios. Sovereign funds have been hit by the turmoil in markets alongside everyone else…One of the lessons from the crisis for funds so affected is that existing asset allocation and external mandate decision processes were not always well suited to the more dynamic markets environment they have faced over the last three years. As we move into slightly less turbulent times, but with the possibility that market volatility may return, this is an area that a number of funds are addressing.”
  • Future Outlook: “Overall, the signs are that most sovereign funds have used the experience of the last few years to re-examine their core beliefs, to reassess their general approach to their asset management task, and in many cases, to confirm that their fundamental approach is still valid. But within that, they have also taken the opportunity to refine some of their activities, to address any weaknesses in process and to prepare themselves for future challenges. In a world where many are still damaged by the financial turbulence of the last few years, sovereign asset owners look well placed to continue to develop and prosper.”

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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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