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.

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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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