Archive for April, 2011

Airplane Reading

Ashby Monk

Alas, more international travel is in my near future. I’ll be catching the SanFran-to-London-express tomorrow, as I’m heading back to the UK for a week to catch up with some colleagues at Oxford and attend Institutional Investor’s Global Sovereign Funds Roundtable. Once again, the Roundtable looks to be quite a remarkable event. It should be a lot of fun. If you’re attending, don’t hesitate to introduce yourself.

I generally put a few academic papers on my Kindle for long flights just in case a motivated mood should strike. And, for this flight, I’ve decided on the following two:

Both look quite interesting. Anyway, I’ll (try to) continue updating the blog from the road.

Top Ten Tweets

Ashby Monk

Here they are: Your top news items from the past week’s @sovereignfund Twitter feed:

  1. China’s ExIm Bank to launch new ‘sovereign fund‘ for LatAm infrastructure.
  2. CIC, Temasek, KIC and others are cornerstones of Glencore float.
  3. IMF joins calls for Australia to set up new SWF for mining revenue.
  4. CIC to offer $4 billion in loans for investors in Indonesian infrastructure.
  5. Putin is out raising money for Russia’s new domestic sovereign fund.
  6. Guinea has plans for a new ‘Local Development Fund‘ funded out of mining levy.
  7. If true, this would have to be the oddest SWF investment I’ve come across: Stud farms.
  8. Brazil’s SWF getting pummeled by lack of diversification: Over half of fund’s holdings are in Petrobas.
  9. The IFSWF has released an agenda for the upcoming meeting in Beijing.
  10. Oman Investment Fund (OIF) may buy close to 5% in Universal Commodity Exchange.

Reducing Western Anxiety over the CIC

Ashby Monk

With foreign reserves crossing $3 trillion and recent announcements of new and revitalized SWFs, it’s perhaps fitting that I should come across a paper by Jean-Marc Blanchard (in the Chinese Journal of International Politics) that investigates the role of China’s SWFs in the country’s ‘Grand Strategy’. But before you get too worked up, I should say that the paper’s primary focus appears to be about extinguishing Western anxieties over China’s SWFs and in particular the CIC. Here is some summary blurbage:

“This article examines how China is using its SWF and RMB policies as part of its aforementioned grand strategy to realize such security interests as national independence, regime preservation, prestige, and economic modernization. It also demonstrates that worries about the political ramifications of China’s SWF and RMB are overblown.”

“Contrary to what many perceive…China has not been aggressively using the CIC to advance its grand strategy. Instances where it has been used in this vein have been largely in support of preserving China’s domestic economic modernization/regime…there are constraints on the ability of Chinese elites to wield the CIC as a grand strategy device, and that using it that way might hinder China’s use of it in others. Besides these considerations, the CIC’s poor first-year investment performance, as earlier mentioned, makes problematic the idea of the CIC as a monolith moving according to a master plan wherein many domestic constituencies have their own ideas on how the CIC should use its funds, and others demand that the CIC deliver good investment returns.”

I think this last point is compelling: The CIC faced considerable domestic ire over poor investment returns in its initial year. So, if the domestic constituencies won’t tolerate poor returns, the CIC really doesn’t have much room for playing around with non-financial objectives. That’s not to say that strategic objectives don’t fit into the investment calculus somewhere, but it seems that good returns are necessary for the CIC’s domestic legitimacy. That should, in theory, alleviate at least some Western concerns about the CIC. (Even if other, less transparent, entities are perhaps another matter altogether.) Get the paper here.

When (Not) to Set Up a Heritage Fund

Ashby Monk

Sudden increases in commodity revenues tend to strengthen a nation’s currency, resulting in exports becoming more costly for foreigner buyers, which, in turn, renders the domestic manufacturing base less competitive. This, friends, is the Dutch Disease. And, with oil prices now above $120 a barrel, it has once again become a major area of concern for resource rich countries in the developing world.

And, as you are no doubt aware, one of the main catalysts in the rise of SWF popularity has been the ability to use these funds to manage resource revenues in the hopes of preventing the Dutch Disease. Indeed, from Africa and Latin America to the USA and Asia-Pacific, commodity funds are popping up at an increasing rate. Many developing countries now see SWFs as potentially vital components of their economic development strategy.

But should they? New(ish) research by some of my colleagues on the other side of town (OxCarre) on how and when Dutch Disease occurs offers a new perspective. The authors are circumspect about the utility of offshoring assets for long-term time horizons in helping to avoid Dutch Disease in developing countries. As such, while they agree that stabilization funds are crucial for managing resource volatility, the OxCarre researchers are less enthusiastic about long-term savings funds. Clearly, this could have important implications for the types of sovereign funds that developing countries are setting up. So it is interesting. Seriously.

There are a few good OxCarre papers you could read, but I’ll first refer you to Rick Van der Ploeg’ paper entitled “Fiscal Policy and Dutch Disease.” Here’s a useful blurb:

“The main insight we derive from this model is that if the natural resource windfall is substantial but not large enough for the country to become a rentier, capital goods must be produced at home and adjustment to natural resource windfall takes time. The result is an appreciation of the real exchange as factors are shifted from the non-traded sectors to manufacturing. This sluggish adjustment process is a result of the absorption constraints in the non-traded sector which imply that it takes time to build this home-grown capital. A much more detailed analysis of this can be found in van der Ploeg and Venables (2010). Specific factors are also crucial to explain the dynamic responses of capital intensities and wages in response to a natural resource windfall, which do not occur in the Dutch disease model without specific factors (e.g., Sachs and Warner, 1997). The reason is that with perfect international capital mobility and no specific factors of production, the wage, the relative price of non-traded goods and the capital intensities in the traded and non-traded sectors are pinned down by the world interest rate. If a country is small and the windfall is large, it will be able to import capital and migrant labour in which case the Dutch disease can be avoided.”

In other words, the Dutch Disease is quite real, but it can be and has been avoided in certain circumstances. The key is to draw in investments and imports as the resource boom accelerates. And the ability to draw these in is (in part) a function of the domestic economy’s infrastructure stock and available skills. What are the implications?

“It may then be optimal to temporarily park some of the windfall in a sovereign wealth fund until the non- traded sector has produced enough home-grown capital (infrastructure, teachers, nurses, etc.) to alleviate absorption bottlenecks and allow a gradual rise in consumption…The economy experiences temporary appreciation of the real exchange rate and other Dutch disease symptoms. However, these are reversed as home – grown capital is accumulated.”

In other words, a sort of “parking fund”  may be appropriate, but a long-term savings fund would not be.

Anyway, all this is to say that developing countries facing resource booms should weigh a variety of options when trying to come up with strategies for overcoming the resource curse. According to van der Ploeg, Venables, et al., that may mean giving up on the heritage or future generations funds and prioritizing capacity-increasing, domestic investments in the current generation. Interestingly, these authors seem to be arguing that one type of SWF (heritage fund) should simply be replaced by another type of SWF (holding or development fund).

One final thought: the resource curse and the paradox of plenty, which holds that resource-rich countries often underperform resource-poor countries on economic and social indicators, may logically drive some countries to set up long-term SWFs (heritage funds) in a bid to move offshore all the windfall revenues. After all, if resource-poor countries perform better, perhaps it’s best to simply act as if the resources don’t exist? That may be a path around the resource curse, but it does not capitalize on countries’ natural endowment to accelerate growth. And this, it seems to me, is the point of OxCarre: Squirreling away resource revenues is inappropriate when they can be fruitfully invested in domestic infrastructure, ports, and skills without engendering the Dutch Disease.

Anyway, I find this discussion and research really interesting. It’s a bit dense, at times, but the implications are significant. So it’s well worth plodding through it:

The IFSWF Agenda

Ashby Monk

The International Forum of Sovereign Wealth Funds, which ostensibly exists to facilitate understanding of SWF activities, is finally starting to open up. After breaking its 11-month silence last week, it has, once again, released some information publicly. At this point, the fact that it’s issuing anything is newsworthy. However, the IFSWF has actually issued something of interest: the agenda for its upcoming annual meeting in Beijing. As such, it has hopefully put an end to its ‘We’re going to meet / We met’ PR strategy that resulted in two press releases in 2009 and 2010 (that’s total press releases for the entire organization).

Anyway, the agenda looks solid. For the most part, it reads like an interesting investment conference, touching on the global investment climate, risk management, governance, financial stability, and more. Still, there are some topics that will be of interest to the broader policy community. Perhaps the most interesting session in this regard will be the first session of day one: “Use and Application of the Santiago Principles.” Apparently, the IFSWF will present the findings from an internal survey of the IFSWF membership that highlights their use and application of GAPP. In short, the IFSWF will be giving report cards on the implementation of the Santiago Principles.  Will these report cards ever see the light of day? Probably not. But it’s still interesting to see that they’re talking about the issue. (And, either way, you can always get some details here.)

For me personally, session two on day two looks the most compelling, as it focuses on how the crisis has changed the way SWFs consider long-term investment strategy. With no liabilities (by definition), SWFs are perfectly suited to long-term investment strategies, in particular those that include illiquid assets such as infrastructure. However, many SWFs fail to implement investment strategies that take advantage of this inter-generational focus. And this myopia means that many government funds are underutilizing their greatest competitive (and comparative) advantage: time. So it would be quite cool to be a fly on the wall in this session.

Anyway, the communiqué comes out May 12th; it’ll be an interesting read.

Mo’ Reserves, Mo’ Problems

Ashby Monk

What do you do with three trillion dollars? China has been wrangling with this problem for over a year now. It seems that every time we (the news consumers) think that they (the policymakers) have finally set their long-term reserve investment strategy, nothing happens for months. But, dear reader, you’re in luck, as this is apparently one of those times that precede the months of nothingness. In other words, I have news to report.

Last week Central Bank Governor Zhou Xiaochuan said reserves had surpassed “reasonable levels” and that China needed new ways to manage and diversify its holdings. More significantly, Zhou suggested that one option on the table was to…

“…consider some new types of investment agencies which focus on new investment areas…It’s inappropriate for me to detail the next stage of the plan, but the direction is clear.”

In other words, Zhou hinted at the idea of PBOC and SAFE creating some new sovereign funds to rival the CIC. And, today, the papers are filled with reports from ‘sources close to the PBOC’ (…picturing guy on street corner next to PBOC…) that have details on these new Chinese SWFs. For example, according to Caixing Online, the new funds will have a variety of roles: one will be for intervening in FX markets, while another will invest strategically in energy and precious metals.

It’s interesting to hear all of this coming out on the same day that the FT is reporting that the CIC will receive another $100-200 billion in capital. (And, as if to pre-empt my incredulity at reading another article predicting a cash injection into the CIC, the FT made a point of saying it had three separate sources confirming this cash injection. Dear FT: I’m quite sure you do. But, at this point, I’ll have to see it to believe it. Signed, Ashby.)

Anyway, it seems clear to me from these two separate stories that much of the rhetoric in the public domain stems from ongoing turf wars within the Chinese government for who gets the reserves. So I wouldn’t give any of these pronouncements too much weight until someone actually says something officially.

Also, if you’ll permit me one more gripe on this Monday morning: Is anyone else getting tired of countries invoking the Norwegian-model in descriptions of the new fund they are considering? For example, here’s the WSJ article from this morning,

“The source said the funds would be loosely modeled on the Norwegian sovereign wealth fund commonly referred to as the Petroleum Fund.”

Groan.

OK. Yes. I get it. The GPF-G / NBIM is a remarkable fund. It really is; its social and ethical foundation has been instrumental in facilitating the legitimacy of the SWF with the domestic populace. And its sophistication and performance, as well as its integration into the budget process, are definitely praise worthy.

But (!) I’m fairly certain that any fund whose strategic investment strategy focuses on “energy and precious minerals” or that intervenes directly in currency markets could not be described as “Norway-style SWF management.” The NBIM is a portfolio investor. It’s only now pushing into real estate. So if the information about these funds from the PBOC source is correct, then these new funds will be nothing like the Norwegian SWF.

Anyway, I’m not saying the Norwegians can’t offer countries quite a bit of insight on how to set up SWFs – they can and they have – I’m simply saying that not every fund in the world has to be based on Norway’s model. It seems to me that countries cite the Norwegian fund when they want to assuage the West about their intentions, noting (correctly) that many Westerners don’t seem to be concerned about the behavior of the NBIM. But, lean in so you can hear me better, the secret ingredient for why nobody thinks of the Norwegian fund as threatening is…because it’s Norwegian. That’s a tough ingredient to find in China.

Weekend Reading

Ashby Monk

It’s technically a day off today. But for the highly motivated SWF reader, I thought I’d quickly share two papers on SWF portfolios I read this morning.

First, Christopher Balding has a paper entitled “Portfolio Allocation for Sovereign Wealth Funds in the Shadow of Commodity Based National Wealth.” Here’s a blurb:

 “Sovereign wealth fund states find themselves in an enviable, albeit difficult position. Focusing solely on the financial asset returns of the sovereign wealth fund in the absence of the larger national wealth framework omits key factors in the long term net asset value growth, public finances, and economic development. Oil based sovereign wealth fund states are inextricably linked to the price of oil and their national wealth will grow in line with oil prices. Within the framework of maximizing national wealth returns, rather than focusing on risk adjusted returns for the financial asset portfolio of sovereign wealth funds, oil dependent states should consider the national wealth portfolio and oil as the anchor. Maximizing the risk adjusted returns of the national wealth portfolio over the long term will outperform a narrower focus on financial asset returns.”

The paper then goes on to offer a theoretical model of how SWFs should structure their portfolios in order to invest in the broad interest of the state. I won’t spoil the fun. Read it here.

Second, Filipa Sá and Francesca Viani of the Bank of England have a new working paper entitled “Shifts in portfolio preferences of international investors: an application to sovereign wealth funds.” Here’s a blurb:

“Reversals in capital inflows can have severe economic consequences.  This paper develops a dynamic general equilibrium model to analyse the effect on interest rates, asset prices, investment, consumption, output, the exchange rate and the current account of a shift in portfolio preferences of foreign investors…To illustrate the mechanics of the model, we calibrate it to analyse the consequences of an increase in the importance of sovereign wealth funds (SWFs). Specifically, we ask what would happen if ‘excess’ reserves held by emerging markets were transferred from central banks to SWFs.”

And what do they find?

“We look separately at two diversification paths: one in which SWFs keep the same allocation across bonds and equities as central banks, but move away from dollar assets (path 1); and another in which they choose the same currency composition as central banks, but shift from US bonds to US equities (path 2). In path 1, the dollar depreciates and US net debt falls on impact and increases in the long run. In path 2, the dollar depreciates and US net debt increases in the long run. In both cases, there is a reduction in the ‘exorbitant privilege’, ie, the excess return the United States receives on its assets over what it pays on its liabilities.”

Enjoy your long weekend.


About

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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