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When Sovereign Funds Don’t Work

 This blog is movingNot to worry: same blogger; same content; same price (free).

I’ve been saying this for years now: when it comes to resource rich countries using sovereign wealth funds to successfully manage resource revenues and overcome the resource curse, strong institutions and good governance are indispensable. In short, governments should not be setting up a sovereign fund if they do not already have the necessary institutional ingredients to actually make it work. As evidence of this, I’d like to direct your attention to a neat new paper by Antony Goldman entitled “Poverty and Poor Governance in the Land of Plenty: Assessing an Oil Dividend in Equatorial Guinea”.

The Goldman paper is well worth reading, as it depicts a dire governance situation in Equatorial Guinea and, in so doing, offers a useful case study of a failed (or, at least, failing) sovereign fund. Here’s a bit of background: the country is rich in natural resources — GDP per capita is above $11,000 — but these riches are enjoyed by only a small proportion of the country. Indeed, three quarters of the population apparently live in poverty. Here’s an interesting blurb to describe why this is the case:

“Equatorial Guinea’s management of natural resource revenue has earned it international notoriety.  Allegations of a local elite with an apparent taste for multimillion dollar mansions abroad and wasteful spending at home have dominated reporting of the country since the oil boom began…Money is managed by a tight-knit group of family and ethnic group members, but governance is filled with intrigue and unexplained changes…The government has developed a recent track record for savings, but there are no safeguards on those funds or mechanisms to ensure that they last…There is little evidence of what goes into the Malabo government’s plans for managing oil and gas revenues.  Neither the President nor the ruling party make substantive public disclosures about the budgeting process.”

That’s pretty bad. But none of the this stopped the country from (or the international community from pushing the country towards) setting up a sovereign fund:

“Equatorial Guinea has a Fund for Future Generations (FFG), but there is little transparency about its management.  At its creation, the government pledged to deposit 0.5 percent of annual oil revenues into a special account at the regional central bank, the Banques des Etats de l’Afrique Centrale (BEAC).  In 2008, the World Bank confirmed that the government had been following through on its promise (Toto Same 2008), but now the government’s statistics on money held at the BEAC appear to present global figures rather than a breakdown, suggesting that the money could be spent without safeguards – and that the rhetoric behind the initiative is designed to satisfy an external constituency while the substance of policy and practice on the ground effectively remains little changed.”

This was the same problem we saw in Chad — the international community pushed the idea of a sovereign fund to ensure inter-generational savings, but the institutional and governance frameworks required at the local level to make such a policy effective simply did not exist. As we now know, some resource rich countries are so corrupt that setting up a commodity fund for managing resource rents is pointless. So here’s my takeaway from all of this: An SWF isn’t a mechanism to bypass weak institutions and poor governance at the local level. Rather, it should be the manifestation of these effective institutions and good governance.

Anyway, for some more details, here’s blurb from a paper I wrote on this topic:

“One would hope that a SWF could be set up such that it is insulated from instability just as one would hope that the fund could help underwrite political and economic stability. But it is important to reinforce that establishing a SWF and sustaining its capacity over the long term confronts the same problems already constraining economic growth and development.  The prevailing institutional and political reality cannot be ignored. For example, political elites and interest groups may try to use the fund for their own gain or clientelistic activities. For resource-rich African countries, the scope of challenges in this regard is wide. Such prevailing conditions may even constrain the establishment of a SWF not to mention the employment of the fund for development goals. For example, the ruling elite may find it useful to establish a SWF, but only as a means of maintaining its power or financing pet projects.”

The Daily Brief

This blog is movingNot to worry: same blogger; same content; same price (free).

Some news of note for your Friday:

  • China’s National Social Security Fund is looking to invest in foreign private equity funds.
  • I was very interested to read (in French) that Qatar has launched a €50mil investment fund for low income neighborhoods in Paris. Cool stuff.
  • Malaysia’s Khazanah and Singapore’s Temasek continue to work well together.
  • Saudi’s Public Investment Fund may set up a joint investment vehicle with India to focus on Indian infrastructure.
  • Chile will be transferring another $1.7 billion to its sovereign funds. Total AUM will be in the range of $20 billion.

A Syrian Sovereign Fund?

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Syria’s President Bashar al-Assad announced yesterday that he will establish a new sovereign wealth fund called the “National Investment Fund”. The objective of the new fund will, apparently, be to support and stabilize the Syrian financial markets through a “long-term investment policy”. The fund will initially have around $40 million and operate under the supervision of the Ministry of Economy and Trade. Minister Nidal al-Shaar apparently said that ‘the Law will positively interfere in the financial market performance through establishing an investment sovereign fund to activate the act of the Securities’ Market.’ Where’s the money coming from for this new SWF? Good question, as the decision by Arab states to turn against Syria is likely having significant economic consequences for the country. Indeed, the same Nidar al-Shaar said late last year that the economy was in a state of emergency. Nonetheless, Syria received an offer of $5 billion in aid from Iran and Iraq back in July. Perhaps that’s the source of funds?

Whatever the source(s), objectives or motivations, the creation of a new sovereign fund in Syria is fascinating. Now I’m not a Syria expert, but I am aware that this country is facing a significant domestic uprising with an increasing likelihood that President Assad will, eventually, fall. So this new SWF is, in all probability, one of the Assad regime’s last ditch efforts to stave off the inevitable. And we shouldn’t be too surprised by this, as there is a growing body of research that shows SWFs to be “autonomy-maximizing institutions”. So let’s revisit some of the SWF basics to try to shed some additional light on Syria’s decision, shall we?

The basics: most SWFs arise out of growing international cooperation and greater integration of nation-states into the global economy. As countries open themselves up to these global forces, policymakers increasingly recognize this opening as a potential threat to their sovereignty and autonomy. The SWF, then, is a part of the give and take between states and markets, sitting at the intersection between the two and acting as a sort of buffer. In this way, you can think of SWFs as a form of self-insurance, a coping mechanism for dealing with the external uncertainties that come with joining global markets. SWFs offer policymakers a chance to make reliable and consistent plans in an environment that is increasingly subject to volatility and market-based short-termism.

How does all this fit in with Assad and Syria? Well, interestingly, it really doesn’t. In fact, it appears (to me) that Assad is setting up his new National Investment Fund for almost the opposite reasons — as the country grows more isolated, the burden of propping up its industry has fallen on the Syrian government. The new fund seems to be a way for Syria to fill the vacuum left by foreign partners leaving. So, then, the question is whether this new fund will achieve its objectives of stabilizing Syria.

Maybe. Here’s an insightful quote from a solid piece of research by Kyle J. Hatton and Katharina Pistor of Columbia University:

 “…the internal governance structures of the SWFs themselves ensure that SWF management is directly accountable to the ruling elite in each sponsor country. Consequently, it is unsurprising that SWFs can be, and are, wielded to advance the interests of those elites. First and foremost among these interests is the maintenance of their privileged position…The task of maximizing autonomy is, however, complex. The privileged position of ruling elites in non-democratic countries is dependent on domestic stability, security of the state against foreign rivals, and the maintenance of substantial autonomy relative to superpowers to which they might otherwise be vulnerable. Without domestic stability, elite status is fragile and will last only until the next coup or mass uprising; a foreign invasion would topple existing elites or at least subsume them into a hierarchy with foreigners at the top. Finally, as autonomy relative to superpowers decreases, the ability to direct state action toward benefiting the elite is restricted and domestic legitimacy may be threatened.”

I have to say, I find that a disconcerting conclusion – namely that SWFs are there to keep the ruling elites…well…ruling and elite. But I myself believe that SWFs exist “to preserve local autonomy and state sovereignty.”

In a way, a sovereign fund exists at the most basic level to stabilize and buffer. That’s really it. A SWF can help protect against a commodity price collapse, a mortality improvement, a diminishing tax base, or even a currency crisis (among many other things). In short, SWFs exist to preserve, bolster and sustain existing institutions, orders and regimes. In many countries, especially in democracies, this stability is perceived to be a very good thing because it extends the time-horizon of policymaking and minimizes the impact of short-term economic volatility. However, as it just so happens, that same stability in the case of non-democratic regimes may mean extending the reign of a dictator. And that’s not really a good thing. I’ll be very interested to see what happens in Syria.

The Daily Brief

This blog is movingNot to worry: same blogger; same content; same price (free).

And now, the news:

  • China will, apparently, be doubling its overseas investments in the coming five years.
  • Here’s another reason why sovereign fund’s are trying to make direct investments in private equity.
  • What’s China doing in Alberta? A lot actually.
  • CalPERS former Board member Villobos may have his estate liquidated in bankruptcy. He had sixteen houses, which he accumulated thanks to fraudulent dealings.
  • Malaysia’s KWAP — which is a fund you’ll be hearing more of in 2012 and beyond — bought a big building in Australia.

Liquidity as a ‘Style’ of Investing

 This blog is movingNot to worry: same blogger; same content; same price (free).

Back in November, Norway’s Government Pension Fund – Global hosted an ‘Investment Strategy Summit’ that brought together a group of finance luminaries from academia and industry to ponder and opine on the future of long-term investing (h/t Joe Light). The motivation for this Summit is clear (at least to me): the GPF-G is ostensibly the world’s largest long-term investor, but its current investment strategy seems to ignore this fact. The sovereign wealth fund is almost exclusively invested in public equities and fixed income, which are assets the WEF lists as short to medium term assets (though the SWF does have plans to add some minor positions in real estate). Anyway, here’s what Mrs. Hilde Singsaas, State Secretary of the Ministry of Finance, had to say about the Summit:

“The purpose of this summit is to discuss the further development of the investment strategy for the Government Pension Fund – Global…Today, we would like to turn the discussion slightly away from the day-to-day headlines in the financial press. Instead, we would like to focus on the longer-term aspects, which after all characterize this Fund.”

That’s why I think this Summit is so interesting: it offers some useful insights on where the GPF-G (and other long-term investors) may be positioned in ten years time. Anyway,  all of the presentations are now online, and, interestingly, one of the big themes was illiquidity. So I’d like to specifically draw your attention to two presentations; one by Roger Ibbotson and another by Andrew Ang.

  • Ibbotson demonstrates that less liquid stocks trade at a discount to more liquid stocks, which means that buying the former instead of the latter allows investors to secure cash flows more cheaply. Accordingly, he finds that less liquid stocks have higher and more stable long-run returns.
  • Ang shows how an investor, such as the NBIM, can harvest illiquidity premia:
    • “By setting a static allocation to illiquid asset classes [real estate] at the aggregate level
    • By engaging in dynamic strategies at the aggregate level, by purchasing risky assets [equities] when others want to sell
    • By being a market maker, which supplies immediate liquidity by acting as an intermediary
    • By choosing securities within an asset class that are more illiquid, that is by engaging in liquidity security selection.”

Given the outperformance of illiquid assets shown below, that sounds like a sensible plan to me. However, recall that the Endowment Model basically blew up in 2008-09 because many of the funds (e.g., Harvard) simply didn’t understand what a portfolio of illiquid assets would mean for the fund in a crisis. In short, for any of the premia above to be realized, you really have to know what you’re doing. And Summits like the one the GPF-G put on is a good first step in this direction.

The Daily Brief

This blog is movingNot to worry: same blogger; same content; same price (free).

Here now, the news:

  • MassPRIM is divesting from all its portfolio companies with dealings in or ties to Iran’s energy industry.
  • If you’re in agriculture, you’ll want to pay attention to what’s happening in Qatar. Seriously.
  • The Washington State Investment Board continues to expand its PE portfolio. Did you know the WSIB has almost 35% of its assets in alternatives?
  • I was interested to learn that CalSTRS has a new ‘innovation group’ and has been dabbling in such things as micro-finance. Cool.
  • Central Huijin will apparently leave the CIC and find its new home within the MoF.
  • Here’s a nice post on Sokoni — the digital infrastructure platform for Africa.
  • Pension funds are doing more in US infrastructure.
  • And in sporting news: Paris Saint Germaine has spent more than $100 million on players since the Qataris took over.

What’s Temasek Doing? It’s Innovating Wisely

This blog is movingNot to worry: same blogger; same content; same price (free).

For a holding company that started life with significant positions in a bird park, a shoemaker and a steel mill, Temasek has come a long, long way. Today, the Singaporean sovereign wealth fund is one of the more creative and pro-active governmental investor in the world. As an illustration of this innovative spirit, I’d like to direct your attention to its new, wholly-owned asset manager called Pavilion Capital.

Pavilion will target investments in small and medium sized companies in North Asia (and especially China). It will be run by Temasek’s former CIO, Tow Heng Tan, and have roughly $1.9 billion to make direct investments in the region. Here’s how Temasek described the new venture:

“This new platform will focus on funds and direct investments in North Asia, particularly to expand our current reach and coverage of the opportunities with privately owned enterprises and small and medium enterprises in China.”

A SWF setting up a wholly owned, de novo asset manager is always an interesting development (even though it seems to be increasingly common), and a couple of questions jump out at me in this case:

  1. Why does Temasek – which has 77 percent (!) of its assets already invested in Asia – need to ‘expand its reach and coverage’ in Asia?
  2. Why does Temasek – a government-owned asset manager – need to set up a separate government-owned asset manager to achieve its objectives?

I have a few thoughts on this.

On the first question, Temasek may (once again) be setting up a vehicle that can attract third party funds. As we know from its Seatown Holdings venture, the SWF is already thinking in these terms. So, with Pavilion, it may be hoping to attract third party investors into a strategy that is undoubtedly one of the fund’s core competitive advantages: the Asian marketplace. Since Temasek has, arguably, unparalleled expertise in North Asia, then why shouldn’t it consider leveraging this expertise to make money through asset management fees? After all, this is the same type of strategy we’re seeing at OMERS these days with its infrastructure and real estate companies (see Borealis and Oxford Properties). I’d argue that OMERS is a pretty good model for Temasek to be following.

On the second question, I think Temasek recognizes that innovation and creativity are probably best achieved beyond the confines of the existing organizational structure of the fund. Traditionally, creativity is a real challenge within large, public investors (or any bureaucratic organizations for that matter). The hiring and firing rules can be quite cumbersome, and the decision-making can be slow and blunt. So by setting up a separate vehicle, the organizational and path dependent constraints can be overcome. For example, the new vehicle can pay market rates for talent. It can avoid legacy costs. And it can take on a bit more risk knowing that investment decisions will be dynamic and responsive to market developments (rather than calendarized appointments). In short, it can be more profitable.

So Temasek is being innovative and creative in a wise way. We’ll have to see what happens, but this really is an interesting start.


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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