Archive for August, 2011

The Benevolent Dictator Governance Model

Ashby Monk

Having spent more than a decade looking at the design and governance of institutional investors, I think there’s something really quite appealing about giving a single, highly skilled professional — who is also completely apolitical and highly ethical — absolute authority over a given public pension or sovereign fund. Why? We in the governance game spend a lot of time (too much) thinking about appointment procedures that balance the representative interests of the fund’s stakeholders with the demands of a modern financial institution in terms of skills and talent. And, I assure you, the level of difficulty of staffing an entire Board with sophisticated and depoliticized individuals is, to put it simply, high. (Think triple lindy levels of difficulty.) So, this ‘benevolent dictator style governance model’ has a certain appeal; it would permit real time decision-making and avoid a plethora of extra-financial interests that too often creep into board meetings and decisions. I mean think of it: a sort of Warren Buffet type character that you can trust to run the entire show. It would be awesome!

Snap out of it, Ashby! Pull your head out of your ivory tower! Seriously. As theoretically appealing as this governance model may sound, it’s a recipe for trouble. (As we know all too well, theories of finance don’t always translate into sound finance practice.) And for real world evidence, you need look no further than the New York State Common Retirement Fund.

At the CRF, the New York State Comptroller has absolute authority over the fund. And what happens when you give one man authority over 140 billion dollars? Let’s just say it hasn’t been pretty, as Columbia’s Andrew Ang details in a new case study:

“Edward Regan, who served as comptroller from 1979–1993, was investigated in 1989 by the New York Commission on Government Integrity for directing state business to investment banks and lawyers who had donated to his campaign. The commission also found that an adviser to the comptroller’s office had used office letterhead to produce a campaign agenda which apparently tied the awarding of government contracts with campaign contributions.

H. Carl McCall served as comptroller from 1993–2002. He was criticized for writing to companies in which the CRF had invested on state letterhead asking them to consider the resumes of a number of friends and family members. McCall was also accused of directing CRF business toward campaign contributors. In a class action suit led by the CRF, McCall selected two law firms which had donated approximately $100,000 to his election campaign. The selection of these firms was contested by the other plaintiffs in the case, but the district court ruled that there was inadequate proof of a “pay-to-play” scenario. The third circuit court upheld this finding.

McCall was succeeded by Alan Hevesi…In 2007, then Attorney General Andrew Cuomo launched an investigation into “systemic conflicts of interest” in the comptroller’s office during Hevesi’s tenure. Hevesi was accused, and eventually pleaded guilty, of accepting $1 million in gifts and travel from Elliot Broidy, the founder of Markstone Capital Group, in exchange for granting Markstone a $250 million investment mandate. Hevesi’s political advisor, Henry Morris, pled guilty to taking placement fees on the CRF’s alternative investment portfolio and to providing access to the fund in exchange for campaign contributions. David Loglisci, former chief investment officer of the fund, also pled guilty in connection with the scandal. In total, eight people pled guilty and $170 million was recovered on behalf of the fund.”

I think it was William Pitt who said that power is apt to corrupt the minds of those who possess it. No doubt that’s as true today as it was back in the 1700s.

The Daily Brief

Ashby Monk

  • Chinese investors, including the CADF, are looking for South African gold deals.
  • Australian Prime Minister Julia Gillard has finally weighed in on the SWF debate. She said “No”.
  • Who’s in charge at LIA?
  • Abu Dhabi’s Mubadala is considering investments in Media and Pharma industries.
  • France’s Caisse des Depots et Consignations is investing €1.2 billion in Russian ski resorts?
  • The Maple Group, which is a consortium that includes the likes of CPPIB and OTPP, is on track to acquire TMX Group, the operator of the Toronto Stock Exchange.
  • Fitch affirms IPIC’s “Stable” credit rating, which is in line with the fund’s sponsor, the Emirate of Abu Dhabi.
  • ESG factors are being taken much more seriously by institutional investors.

Deep Thoughts by Trond Grande

Ashby Monk

Who is Trond Grande, you ask? Well, he is perhaps the most knowledgeable individual in the world when it comes to the internal operations and strategies of Norway’s $550 billion sovereign fund. He is currently the Deputy CEO and Chief of Staff of Norges Bank Investment Management. And, previously, he was the fund’s Chief Risk Officer and Deputy COO. So if you want to learn something about the NBIM, this is the guy you need to talk to. And, lucky for us, Rupert Wright of The National did just that. So, without further ado, here are some ‘deep thoughts’ by Trond Grande:

On the rise of the Norwegian SWF: “You could say it all began for Norway when Phillips Petroleum found oil on Christmas Eve 1969; they had been drilling without success since the mid-1960s. The [border] line was drawn and much of the oil ended up on the Norwegian side. Throughout 1970s and 1980s most of the revenue was reinvested in the oil business. By the mid-1980s we realised the revenues might outweigh the investments and we might have net positive cash flow from these activities and it might even be so substantial we should try to set something aside, the idea being that these are fields that have been there for millions and millions of years and even though we are the generation that struck oil we shouldn’t be the only ones to benefit. This idea for future generations came up, but also to save the economy from the classic “Dutch disease” of overheating. In 1991 the government passed a law to create a pension fund and in 1996 the first money came into the fund, 2bn a Norwegian krone (Dh1.36bn).

On the shifting investment strategies: “The question was: where do you put this money? There wasn’t an investment strategy; they just put it in foreign government bonds and that expertise was in the central bank, which partly explains why we are here. Decision was taken to invest outside Norway and Norwegian currencies. In 1998 decision was taken to go into equities. A gradual expansion took place in small and medium-size companies, emerging markets, corporate bonds etc…We lean on the same classification as the FTSE. Not in frontier or African markets, but in developed and emerging markets, 47 different countries…In 2004 we moved to being a responsible investor – our goals are purely financial long term, but we take our investments on the premise that companies that are responsive to certain issues such as climate change and water management, we single them out as focus areas. When we invest we have a series of principles…By 2007 a decision was taken to increase equities from 40 to 60 per cent. As markets were falling, we were buying. About two thirds of equities we hold were bought during the crisis…[W]e are now allowed to invest 5 per cent in real estate. We now have 60 per cent in equities, 35 per cent in bonds and 5 per cent in real estate. It’s our first venture into non-listed or private investment space. Everything else is public in well-regulated markets and exchange traded. We follow benchmarks decided by the finance ministry.

On the benefit from transparency: “Benefit creates legitimacy of the fund for the Norwegian people. It’s a one-way street, once you say what you’re doing, it’s hard to backtrack. Are we too transparent? I don’t think so but we are getting close. We are balancing that.”

On the Financial Crisis: “2007 was a zero year. 2008 fund returned minus 23.4 per cent. That was a big loss. This caused a lot of debate. We were selling bonds to buy more equities, because that was part of our new strategy…I wouldn’t say it was calm. There was a lot of debate, culminated in March ’09, that was the bottom. March 11 annual report was released, lots of debate. There was a lot of criticism and suggestion that we sell equities and at least stop buying more. Having been through that stress test we are much stronger now. Because we are a long-term investor we can withstand short-term fluctuations. It could have been the end of the world, all the companies could have gone bust, but it wasn’t likely that would happen.”

Quite a fascinating interview. Kudos to The National (and NBIM) for making it happen.

The Daily Brief

Ashby Monk

  • Temasek and Seatown Holdings (Temasek sub) are part of the consortium buying BofA’s stake in China Construction Bank.
  • US OFAC gives LIA-backed hedge fund permission to start trading in the US again.
  • Saudi Arabia’s central bank now has more than $500 billion in reserves.
  • Coming out in defense of the Nigeria’s new NSIA: The Institute of Chartered Accountants of Nigeria.
  • Interesting take on Nigeria’s wobbly new NSIA.
  • Caisse de Dépôt du Québec is fighting off local politicians that want to direct it into (struggling) local business.
  • Japan’s largest pension fund (GPIF) is bigger than Russia’s economy (AUM v GDP).
  • Sweden’s AP2 and AP3 are moving money into emerging markets.
  • For the intrepid institutional investor: some infrastructure investments in Iran.
  • Australia seems to be the most attractive commercial property market for Asia-Pacific investors at the moment.

SOFAZ in One Sentence or Less

Ashby Monk

The State Oil Fund of the Republic of Azerbaijan has released its 2010 Annual Report, and it is one of the more creative disclosures I’ve read in a while; it intermingles Azeri culture and heritage…

…with the the Oil Fund’s annual accounts.

The Daily Brief

Ashby Monk

  • Wikileaks strikes again: In 2008, US Embassy staff in Singapore attempted to explain the GIC and Temasek. It seems to me the cable raises more questions than it answers.
  • The debate over a new Australian SWF for mining revenues is all over the Oz papers this. There are those for it and those against it.
  • The Qatar Investment Authority seems to be playing the role of white knight for Greece’s banking industry.
  • South Carolina Attorney General Alan Wilson is investigating fraud at the SC Retirement System. It’s not clear why, but an investigation has begun nonetheless.
  • The Iran Foreign Investment Corp (IFIC) is looking at some rather big investments in Southern Iraq.
  • Kazakhstan’s SWF expected to reach $72.5 billion by 2015.
  • The Palestine Investment Fund is launching a new investment program to help small enterprises in refugee camps.
  • Former Deputy Chairman of the GIC Tony Tan was elected as Singapore’s next President.

Weekend Reading

Ashby Monk

With Hurricaine Irene bearing down on the United States (and on five of my close family members), I wanted to make sure everyone is stocked up on obscure academic research. You know, just in case. Actually, in all seriousness, I’d like to send good vibes to those readers on the East Coast this weekend. Stay safe.

Here’s your weekend reading:

First, Benjamin A. Templin has a new paper entitled “Social Security Reform: Sovereign Wealth Funds as a Model for Increasing Trust Fund Returns.” It’s an interesting paper. Here’s a blurb:

“The last ten years has seen a significant shift in the way countries manage public pension and social insurance reserve funds. Rather than invest solely in government bonds, funds now employee modern portfolio techniques to diversify assets and earns a higher rate of return. Even after considering the losses incurred during the 2007-2009 financial crisis, funds that have managed to remain apolitical have competitive returns and sometimes outperform the market…Curiously, the U.S. has not followed suit even though the long-term benefits of a diversified portfolio are well-known. The reason for this economically irrational behavior is likely rooted in the beliefs underlying the country’s neoliberal political economy on the role of government as an owner of private enterprise. Institutional studies suggest that the rules constraining government investment are not likely to change rapidly given the constraints of path dependence theory. However, the U.S. has seen incremental change in terms of attitudes towards government ownership. Many states run venture capital funds and government employee pension funds have been successful as apolitical state investment entities. Moreover, attitudes towards foreign SWFs have shifted from fear and anxiety over politically motivated investments to a greater acceptance of the sovereign investors as a wealth-maximizing entity. Crisis also drives change. The Social Security Trust Fund is now expected to be depleted by 2036. Diversifying the Trust Fund could eliminate as much as 30 percent of Social Security’s funding deficit and do so without raising taxes or reducing benefits…Foreign sovereign wealth funds that were created for the purpose of funding national pension systems provide a model for the U.S. to form an independent entity that is apolitical yet able to be held accountable for its actions. As politicians grasp for solutions to Social Security’s funding problems that minimize tax increases and benefit cuts, they should consider adopting the successful models of Canada, New Zealand and Australia.

I like this topic. In fact, I like it so much I recently did an entire research project on it (see here for our initial results).

Second, Di Wang and Quan Li have a new paper entitled “When Clashes Spur Rules: Domestic Politics of Sovereign Wealth Funds Institutionalization.” Here’s an abstract:

“Truman’s score shows a remarkable variation in whether Sovereign Wealth Funds (SWFs) institutionalize their investment. Some have explicit policies on fiscal treatment and investment behavior; others remain obscure. What explains these variations? This article argues that SWF host countries with multiple veto players are more institutionalized, i.e., have specified more “rules of game” for the SWFs because there are more conflicts of interests, and information asymmetries are more acute. This veto player approach to explaining variation in institutionalization of SWF investment is tested using Truman’s scoreboard data. The statistical analysis shows a strong correlation between the number of veto players and the institutionalization of SWF investment.”

Stay dry, East Coasters!


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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