chief economist, dubai international financial center...
TRANSCRIPT
A Brave New World for SWFsDr. Nasser Saidi
1
Chief Economist, Dubai International Financial Center AuthorityExecutive Director , Hawkamah - Institute for Corporate Governance
Agenda: A Brave New World for SWFsAgenda: A Brave New World for SWFs
Introduction and Stylized Facts
Objectives of SWFs
Investor Activism & Corporate Governance
Role of SWFs in the New Economic Environment
Risk Management
Conclusions
2
Transforming Wealth Transferring WealthTransforming Wealth, Transferring Wealth• The PV of income from oil and gas in the GCC are estimated at
hl $40 illi ( DIFC E i N # 4 dif )roughly $40 trillion (see DIFC Economic Note # 4 on www.difc.ae)
• Resources from GCC region are no longer amassed in foreignbank accounts, but actively managed through a variety ofbank accounts, but actively managed through a variety ofinvestment vehicles improperly dubbed SWFs, while a more aptdescription would be Future Wealth Funds
• Contrary to common belief, SWFs from various countries arenot a homogeneous group: they differ in objectives, investmentstyle openness accountability and strategystyle, openness, accountability and strategy
• Though SWFs have been in existence for decades) they havespurred concerns & investment protectionism in conjunctionwith a shift of global economic centre of gravity towards East.
3
Stylized Facts: Top SWFs RankingStylized Facts: Top SWFs RankingLinaburg‐Maduell Transparency
Country Fund Name Assets $Bn Inception OriginTransparency Index
UAE – Abu Dhabi Abu Dhabi Investment Authority $627 1976 Oil 3
Norway Government Pension Fund – Global $512 1990 Oil 10
Chi SAFE I t t C $347 1** 1997 N C dit 2China SAFE Investment Company $347.1** 1997 Non-Commodity 2
China China Investment Corporation $332.4 2007 Non-Commodity 6
Singapore Government of Singapore Investment Corporation $247.5 1981 Non-Commodity 6
China – Hong Kong
Hong Kong Monetary Authority Investment Portfolio $227.6 1993 Non-Commodity 8
Kuwait Kuwait Investment Authority $202.8 1953 Oil 6
China National Social Security Fund $146.5 2000 Non-commodity 5
Russia National Welfare Fund $142.5* 2008 Oil 5
Singapore Temasek Holdings $133 1974 Non-Commodity 10
Qatar Qatar Investment Authority $85 2005 Oil 5
Libya Libyan Investment Authority $70 2006 Oil 2
Source: SWF Institute
Australia Australian Future Fund $59.1 2006 Non-Commodity 9
Stylized Facts: Growing assetsStylized Facts: Growing assets•The value of combined global assets held by SWFs ‐‐ led by strong expansion byThe value of combined global assets held by SWFs led by strong expansion by commodity‐backed SWFs is estimated to have breached the US$4 trillion mark in September 2010, retaining the level they stood in Dec 2008. In Sept 2007 the total was US$3.2 tn and US$3.75 tn in Sept 2009.
The balance of investing power has shifted from the Middle East to Asia, according to the latest research by the SWF Institute, as the Middle Eastern SWF account for 40% of total assets
The US$1.6 tn attributed to the largest MENA funds (but excluding CB international reserves) is just over half the foreign official assets of Chinainternational reserves) is just over half the foreign official assets of China (US$2.8 trillion).
Stylized Facts: SWF match oil revenuesStylized Facts: SWF match oil revenuesIncome Diversification: the revenues from financial investments of the SWF in some countries have become asinvestments of the SWF in some countries have become as important as commodity energy revenues and act as a major buffer against oil & gas price shocks
With time the growth of financial income of SWFs has major implications for: N f B l f P fl Nature of Balance of Payment flowsNecessity to build wealth & asset management capacity Country Credit worthiness & rankings Risk management should now encompass banking & financial market risksInternational financial connectedness of the SWF countries
=Objectives: a mix of purposes=
Sovereign Wealth Funds encompass a variety of investment vehicles
Objectives: a mix of purposes
7Source: Afshin Mehrpouya, Chaoni Huang, Timothy BarnettIRRC Institute SWF Report October 2009
Objectives: fears of political interference are unjustifiedObjectives: fears of political interference are unjustified
SWFs have explicit national economic objectivesNo SWF has disclosed a set of extra‐national economic objectives as part of its mandate. Temasek, mentions macroeconomic goals such as “growing the middle class” and “transforming economies” applied in a broad sense to its i d h ldinvestments around the world.Political objectives?None of the SWFs targets explicitly political/strategic objectives or has d t t d b h i ti t liti ll ti t d i t tdemonstrated behaviour amounting to politically motivated investments.SWFs have played a stabilising roleBy contrast there is substantial evidence that SWFs have been an important t bili i f d i th fi i l i i ( it i t t i di t dstabilizing force during the financial crisis (equity investments in distressed banks & financial institutions) and its aftermath (substantial investment in Western Government securities and financial sector).
Example: ADIA asset allocation strategy a p e asse a oca o s a egyADIA offers a prominent example of global asset management, as described in an interview with Handelsblatt HH Sheikh Ahmed Bin Zayed Al Nahyan (http://www.adia.ae/En/pr/Handelsblatt_Interview_110110.pdf)
“Historically, our allocation to global equities has averaged between 40% ‐60%, with a further 15% ‐ 30% in fixed income and the remainder divided between other asset classes including real estate, private equity, alternative investments and infrastructure.
It is correct that around 60% of ADIA’s assets are invested in index‐replicating strategies In equities we use S&P indices in the U S and MSCI indices for thestrategies. In equities, we use S&P indices in the U.S. and MSCI indices for the rest of the world. In fixed income we use our own customised form of various indices such as the Barclays Corporate Bond index and the JP Morgan Government Bond Index as well as the Barclays Inflation Linked Bond index ”Government Bond Index, as well as the Barclays Inflation Linked Bond index.
Source: Handelsblatt 11 January 2010
The Policy Impasse of Conflicting Objectives?The Policy Impasse of Conflicting Objectives?
SWFs might pursue three types of objectives:St bili ti f d ti iStabilization of domestic economies
Long term savings maximization
Economic development
• Achieving all three of them simultaneously would be challenging, if not g y g g,impossible: e.g. at times of stress domestic stabilization conflicts with long term return maximization. Likewise stabilization and economic development require different strategies
• The temptation however is difficult to resist in times of crisis: the SWFs of countries such as Kuwait, Qatar, Russia, China, Kazakhstan have been asked
d b k d h k kto support domestic banks and sometimes the stock markets
10
SWFs tend to have a hands off approachSWFs tend to have a hands off approachEven the larger SWFs maintain a distance from management
Source: Afshin Mehrpouya, Chaoni Huang, Timothy Barnett IRRC Institute SWF Report October 2009
A New Tendency: Institutional Investors’ ActivismA New Tendency: Institutional Investors Activism
One of the repercussions of the crisis is the tendency to engage in more active investment management: it is still in embryonic state, butmore active investment management: it is still in embryonic state, but it is consistent with greater size of institutional investment funds and the recommendations from regulators and corporate governance professionals
From purely passive investors the SWF are likely to become more active taking an interest in the companies where they acquire a stake. In other words it is likely that the SWFs will display more shareholder activism in the future to protect their interests.
Management should be accountable to owners and sound Management should be accountable to owners and sound principles of corporate governance need to be solidified in board rooms of SWFs to ensure good risk management and sound investment performance
12Source: IMF WEO, April 2010
investment performance.
Corporate Governance and the financial crisisCorporate Governance and the financial crisis Financial crisis: the underlying problem, internationally and regionally, was one of governance.regionally, was one of governance.
Many parties have been blamed for the financial crisis – boards, senior management, regulators – for failing in their duties, but investors g g gas owners cannot walk away from responsibility. Investors have a duty to act as share owners not just share holders.
Emerging international best practices: in the epicentres of the financial crisis, the US and the UK, the governments are giving more rights and duties to the investment community.
Stewardship Code, a corporate governance code for investors, was issued in the UK in July 2010, setting a clear benchmark of behavior expected of all investors
13Source: IMF WEO, April 2010
expected of all investors.
SWFs and corporate governanceSWFs and corporate governance Tools include integration of governance factors in the investment process, dialogue and engagement, contact with regulators, proxy voting, shareholder g g g g p y gproposals and legal action. To counter any accusations of inappropriate interference, SWFs should (1) develop guidelines based on international accepted corporate governance principles and (2) address accountability and transparency within their ownprinciples and (2) address accountability and transparency within their own institutions (OECD SOE CG principles, Santiago Principles + Kuwait Declaration):• Structure of the fund, including its objectives, fiscal treatment, and whether it is separate from the country’s international reserves• Governance of the fund, including the roles of the government and the managers, and whether the fund follows guidelines for corporateresponsibility and ethical investment behaviorresponsibility and ethical investment behavior• Accountability and transparency of the fund in its investment strategy,investment activities, reporting, and audits• Behavior of the fund in managing its portfolio and in the use of leverage
d d i ti
14Source: IMF WEO, April 2010
and derivatives.
SWF Risk ManagementSWF Risk ManagementThe counter part to more activism is better risk management
“We believe in managing risk, not avoiding it. Our strategy always begins by identifying an acceptable level of risk and then looking for ways within those parameters to maximise returns over the long term. This approach has served us well But it is crucial to admit mistakes where they exist ”us well. But it is crucial to admit mistakes where they exist …
interview by HH Sheikh Ahmed Bin Zayed Al Nahyan to Handelsblatt
Financial crisis has demonstrated that this function needs to acquire central importance in SWF management, with a focus on overall exposure and the risk factors that would impact it
Risk Management as a Chess GameRisk Management as a Chess Game As in a chess game the uncertain new landscape requires, first, putting up a strong defense in the form of prudent cash, liquidity, counterparty, prudent collateral management and good corporate governance.
When the defense is solid SWFs can more confidently take advantage of h i l i h i f l k f li idi b di i l ithe gap in valuations that arise from lack of liquidity by traditional investors engaged in deleveraging. In other words, one can pursue strategies targeting a closing of the valuation gap between technical and fundamental factors.
But, this requires spatial outreach, adaptability and institutional agility by the SWF: akin to using the Queen to spearhead the attack on the chessboard
Communication is increasingly recognized as vital. The global crisis has highlighted the importance of establishing the proper context for politicians and others to evaluate what is taking place in the portfolios of SWFs. g p pPolitical risk management is an integral part of risk management.
Risk Management has become RiskierRisk Management has become Riskier
The crisis has shattered the traditional risk management approach based V R d h i li i d d i d lon VaR and other simplistic data driven models.
The new environment requires holistic risk‐management frameworks encompassing several scenarios: specifically they must supplementencompassing several scenarios: specifically they must supplement conventional asset‐class diversification with targeted and cost‐effective management of tail risks which are likely to become more frequent
Governing bodies of sovereign wealth funds will have to reinforce the risk management function, maintain it in house and assign responsibilities to managers and staff armed with a suite of forward‐looking analyticsg g y
Such functions which affect key investment decisions cannot be built overnight. They require significant and sustained efforts devoted to build up the process and must be dynamically adapted to new circumstances
Central Banks vs SWF ObjectivesCentral Banks vs SWF Objectives A central bank manages its foreign asset holdings in order to meet t i ll h t t b l f t d ti l l itypically short‐term balance of payments needs, particularly in reducing the probability of sudden stops in foreign capital inflows, therefore it will hold safer and liquid foreign assets issued by countries ith i i t ti lwith a primary international currency
In contrast, a SWF, acting on behalf of future generations will opt f l ti l t h ldi f t ith hi h t d lfor relatively greater holding of assets with a higher expected long term return, even in peripheral countries.
18
'Strategic’ vs ‘Portfolio’ InvestmentStrategic vs Portfolio InvestmentThe SWF unlike other investment vehicles, have another dimension to
id i h h f l i i i i iconsider, i.e. whether to focus on exploiting current opportunities in financial markets or to create new ones
Financing long gestation projects Financing long gestation projects
Support technological innovation
Address security issues e.g. in food and commodities
At the most fundamental level, institutions will need clear overall guidance gfrom their governing bodies, so managers of SWFs can allocate their assets in a forward‐looking long‐term manner anchored by solid cash, liquidity, counterparty, and collateral management.
Long Term StrategiesLong Term Strategies
Rather than pursuing often volatile short‐term positions,a long‐term investment strategy should aim to track the longterm fundamentals, i.e.
• Demographics• Technological innovation
With particular emphasis on the quality of key drivers of competitiveness
• Human capital (i.e. education)• Physical capital (i.e. infrastructure)•Institutional capital (governance legal & regulatory)•Institutional capital (governance, legal & regulatory)
Coordination among StakeholdersCoordination among Stakeholders The activity of an SWF has a series of macroeconomic consequences in terms of capital flows currency movements fiscal stability interest ratesterms of capital flows, currency movements, fiscal stability, interest rates differentials and new types of risk exposure
Moody’s : As well as preserving the wealth of GCC countries for futureMoody s : As well as preserving the wealth of GCC countries for future generations, SWFs underpin GCC governments' creditworthiness in a number of ways. They serve as a buffer against fiscal shocks and help to generate revenues that are not dependent on oil or gas prices.
So the activity of the SWF should not be seen in isolation but needs to be put into the broader perspective of economic & financial policy making
21Source: IMF WEO Apr 2010, UAE/ Qatar Article IV, REO October2009
Main Issues as the Global Financial Crisis RecedesMain Issues as the Global Financial Crisis Recedes1. Persistent divergence & secular realignment between mature
economies and emerging markets => opportunities in EMEs
2. Slimming of the financial sector as a proportion of GDP in Anglo‐Saxon countries => hub and spoke model giving way to cobweb network of inter‐connected Regional Financial Centresnetwork of inter connected Regional Financial Centres
3. Re‐pricing of risk and curtailment on leverage => financial innovation will be move away from exotics and towards the basics
l h h l d l f d4. Persistently high unemployment in industrial countries => profound workers’ skill dislocation, higher natural rate of unemployment, fragile safety nets;
5. Greater government involvement in economies and pervasive regulation => risks of investment & trade protectionism and currency wars intensifying: set‐up an investment protectionism y y g p pobservatory
Conclusions: A Brave New World for SWFsConclusions: A Brave New World for SWFs The world is undergoing a secular shift in the epicentre ofeconomic geography which the Great Recession has acceleratedeconomic geography, which the Great Recession has acceleratedrequiring a change in strategy for SWFs Sophisticated Risk Management functions need to be developedand nurtured.More capacity to absorb risk should favor long term focus SWFs objectives should be stated and communicated to avoidjrisks of increasing investment protectionismSWFs should set‐up an “Investment Protectionism Observatory” Governance Openness and accountability are tools that improve Governance, Openness and accountability are tools that improvedecision making Macroeconomic implications of SWF activities need to be
23
internalized into national policy making
