sovereign wealth funds and other long-term investors ... · sovereign wealth funds investments by...

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Sovereign Wealth Funds and other Long-term Investors: Natural Match for Green Investing?

Sovereign Wealth Funds and other Long-term Investors: Natural Match for Green Investing?

November 29, 2010

Imperial Hotel, Tokyo

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The Institut Louis Bachelier (ILB) and Paris Europl aceThe Institut Louis Bachelier (ILB) and Paris Europl ace

Center for Financial Innovation

SME and Innovation financing

Training and awareness on Financial Regulation

European financial information hub

Finance and social environmental innovation

Regulatory working groups

European working groups

International promotion and cooperation

Our ambition is to bring forth new research subject s in order to meet post-crisis challenges, broaden the dialogue between professionnals and practicians , improve co-ordination of actions and unite players of excellence in the field of financial res earch.

Paris financial services cluster

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The Institut Louis Bachelier Strategic Targets The Institut Louis Bachelier Strategic Targets

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Toronto

New York

Singapour

Tokyo

Moscou

Shangaï

The Louis Bachelier Institute is at the center of a n international network of research centers. We have initiated coop eration between North American and Asian partners and we ar e opening up to other potential partnerships.

� Examples of our 2010 Research Initiatives

� Other initiatives in the introduction phase

Carbon price modelling

Derivatives Clearing

The Institut Louis Bachelier: in the international sphere with its strategic financial partnersThe Institut Louis Bachelier: in the international sphere with its strategic financial partners

Exotic interest-rate derivatives

Solvency II

Sovereign Wealth Funds and Climate Change

Market Microstructure

The Institut Louis Bachelier Research Initiative on Sovereign Wealth Funds

The Institut Louis Bachelier Research Initiative on Sovereign Wealth Funds

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Pierre-Louis Lions

� Professor at the College de France

� Fields Medal

� Listed as an ISI highly cited researcher

Roger Guesnerie

� Professor at the College de France

� CNRS Silver Medal

� President of the Paris School of Economic

Patrick Bolton

� Professor at Columbia Business School

� Consulting for the IMF and the Department of Justice, Antitrust Division

Frédéric Samama

� Head of the SWF Research Initiative

� Designed and implemented the first worldwide leveraged Employee Share Purchase Program

Sponsors :

Steering Committee :

Structure :

Sovereign Wealth Funds as Long -term Investors in Sustainable DevelopmentSovereign Wealth Funds as Long -term Investors in Sustainable Development

� SWFs as long term investors in Climate Change Economics

� An ecological discount rate for SWFs and other long-term investors

� An International Green Fund (IGF)

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SWFs and Climate ChangeSWFs and Climate Change

The objective of reducing carbon emissions by 50% b y 2050 has been estimated to require a total of 45 trillion US D in investment, or a yearly average of 1,1 trillion. (IEA, 2008)

SWFs can act as catalysts for the transition to cle an technology. Investments in technologies are needed - more effici ent battery storage, electric cars, etc.

Currently R&D finance is underprovided due to its p ublic good dimension.

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Climate Change is a Systematic Risk Climate Change is a Systematic Risk -- It Deserves a Risk It Deserves a Risk Premium (1/2)Premium (1/2)

Many economists are confused about what is the appropriate discount rate

The appropriate discount rate for climate damages could be negative

The issue is not how to discount cash flows in the far distant future

Financial market practitioners know how to price uncertain future cash flows (such as emissions damages)

Cash flows in bad states of nature, where marginal utility is high, are worth more than cash flows in good states of nature

Carbon Emissions and Implications for SWF Benchmarks, 2010. Bob Litterman. SWF Research Initiative, Columbia University and the Institut Louis Bachelier.

The Market Seems to Expect Carbon Emissions Prices To Rise Slowly

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What emissions prices might look like under an optimal policy

Perhaps economic realities will overcome political realities in time

Climate Change is a Systematic Risk Climate Change is a Systematic Risk -- It Deserves a Risk It Deserves a Risk Premium (2/2)Premium (2/2)

Benchmarks should reflect the current disequilibrium in the price of emissions.

Market capitalizations weights currently reflect expectations of a very slow increase in emissions prices over time.

At some point the market will begin to reflect reality, emissions will be priced at much higher levels.Long-term investors should position themselves ahead of time.

Relative to current market capitalization weights: benchmarks should tilt toward assets that will benefit from higher emission prices and should tilt away from assets that will suffer from high emissions prices.

Carbon Emissions and Implications for SWF Benchmarks, 2010. Bob Litterman. SWF Research Initiative, Columbia University and the Institut Louis Bachelier.

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As introduced by Roger Guesnérie, ecological discou nt rates allow for discounting environmental goods which cannot be pro duced but candeteriorate rapidly.

In their model, Guesnérie and Olivier Guéant sugges t a low discount rate for environmental goods due to their risky and random d imension.

We thus have a two-good model with an environmental good and a consumption good. These two goods are imperfectly s ubstitutable.

The authors justify a precautionary principle where in when undecided between two rates we take the weaker rate.

SWFs may use this suggested rate to internalize ext ernalities such as the environment to contribute to the sustainable develo pment investment effort .

An ecological discount rate (1/3)An ecological discount rate (1/3)

Ecological Intuition versus Economic Reason, 2010. Olivier Guéant, Roger Guesnerie, Jean-Michel Lasry. SWF Research Initiative, Insitut Louis Bachelier

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The elasticity of substitution between the two goods is sigma, our key parameter. The interest rate « r » represents technology as economists represent it. Our agent is sigma and the two other parameters represent his preference for the present.

An ecological discount rate 2/3An ecological discount rate 2/3

Yield curve example (σ = 0:8, η = 1:5, r = 4%, δ = 0:1%) Yield curve example (σ = 1.2, η = 1:5, r = 4%, δ = 0:1%)

To discount consumption goods we use interest rate r. To discount environmental goods we use the ecological rate Beta that we define for the occasion: It is linked to the interest rate by Beta = r-g/sigma where “g” is growth. Where there is more growth, the ecological rate is weaker. The more the environment becomes more specific (not very substitutable to consumption goods) the smaller the rate.


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The diagrams suggest that ecological discount rates converge slowly to their asymptotic value.

Another interesting and related visual insight is t hat, when sigma is low, the rate is low, but, even when sigma is high, because the curve is increasing, the environmental rate is still low in the medium r un.

Hence, what the diagrams show is that, for a time p eriod between 1 and 2 centuries from now, the disagreement between the ra dical environmentalist and the moderate environmentalist is not huge: both have an ecological discount rate significantly below 1; 2%; the first one is between 0.45% and 0.35% and the second one is between 0.95% and 1.2%.

Their willingness to pay, for say a generation livi ng at date 150 equals the discounted value, with the ecological discount rate , respectively roughly 2=3 and 1=3, multiplied by their own marginal willingne ss to pay, which itself depends on their wealth and on their "ecological" v iews or intuition.

An ecological discount rate 3/3An ecological discount rate 3/3


Executive SummaryExecutive Summary

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A market that is not yet fluidA market that is not yet fluid

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Why a private equity section? Why a private equity section?

� Private equity funds will

� Bring long term investments and technological innovation

� Invest with the hope to generate technological breakthroughs.

� Deal with wide scope of technologies and not yet mature technologies

� Offer a fluid access to the right technologies

� Link both:

� Technology management and investment (traditionally implemented by venture capital in regions where technology is created such as Silicon Valley, Boston, Cambridge, London, Copenhagen, Munich, Paris, or Tel Aviv)

� Infrastructure and project financing (traditionally implemented by private equity or infrastructure teams in regions where energy is needed such as the GCC countries, BRICs and other developing and high growth countries)

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Additional possible featuresAdditional possible features

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Accelerate the Technological Development Through a Presence at all Investment Stages

Accelerate the Technological Development Through a Presence at all Investment Stages

International Green Fund

Technology Sourcing Fund

Project EngineeringFunds

BRIC GCCTechnology Transfer

Structure of Expertise

Renewable ESpecialists

PE/VC & Asset F. Specialists

Other

Europe/U.S.

Other

�A wide scope of complementary activities �A unique combination of sourcing technology skills and deployment/project

engineering know-how� Reducing new technology life cycle to have a quicke r and more innovative impact

on climate change� Full lifecycle investment coverage from early-stage to growth capital

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Engineering Transfer

Advisory (Govt s)

Asset Finance Projects

Rating &Labels

Researchnetwork

Financial Asset Management

SWFs, main investors & a supra-national organization monitors investmentsSWFs, main investors & a supra-national organization monitors investments

SWFs

InternationalGreen Fund

Monitoring BoardArbitrage

Countries with SWFs

Funds(Technology Sourcing Fund,

Project EngineeringFunds, Asset Finance, etc)

Seats

Investments

Advisory Firm

Private Investors

Investments

• A worldwide answer to a worldwide issue• A light and flexible structure• A “replication” of an IMF: knowledge and financing t ools• A financial institution with a political agenda

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Managing BoardOperational

Why SWFs? (1/2)Why SWFs? (1/2)

� The rationale behind the SWFs:� Transfer economic and natural wealth to the next generations� Governments bear the consequences of SWF investments (and SWFs are

possible investment tools to reduce climate change exposure)

� Some of the richest SWFs belong to oil rich countries (which must eventually transition to low-carbon economies)

� Patient investors

� Great visibility with many positive consequences:� Acceptance by their citizens (facilitate their governance)

� Acceptance by all countries (facilitate foreign investments)

� A way to:� Catch up with the much more active pension funds (e.g., ABP)

� Reduce sensitive investments (e.g., the possible political impact of oil company activities)

� Invest in a transparent manner

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Why SWFs? (2/2)Why SWFs? (2/2)

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Next Steps?Next Steps?

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ConclusionConclusion

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Source: Country reports, Deutsche Bank, and SWF Institute, 2009.

SWFs and emerging markets: A potential to reach USD 1.4 trillion over the coming decadeSWFs and emerging markets: A potential to reach USD 1.4 trillion over the coming decade

Sovereign Development Funds, 2010. Javier Santiso, The SWF Research Initiative, Columbia University and The Institut Louis Bachelier.

AppendixAppendix

Some consequences of SWF investmentSome consequences of SWF investment

� higher firm valuations and better operating performance (Fernandes 2009); data from 2002-2007 finds SWF premium in excess of 15% of firm value .

� Significantly positive abnormal stock price returns, but most investments lead to deteriorating firm performance over the following 2 years.

� Underperformance is due to inability to monitor properly "Constrained Foreign Investor Hypothesis" – Bortolotti

� Performance is worse the larger the stake, the more direct the investment (as opposed to subsidiaries), when foreign firms are involved and if the SWF is represented on board (Bortolotti)

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� Announcement of divestment results in negative returns in the short term but large, positive long-term returns –

� The large size of SWFs mean that they can shift prices.

� SWFs identify lower risk investments and the market recognizes this ability.

� SWFs overpay for their investments.

� SWFs funded by oil revenues exhibit worse long-run excess returns than non-oil funds

� The Temasek fund of Singapore, a non-commodities fund, has performed better than its rivals over the decades.

Investment behavior of SWFs vs. Mutual FundsInvestment behavior of SWFs vs. Mutual Funds26

Average Portfolio Characteristics for SWFs and Mutu al Funds

0.0

5.0

10.0

15.0

20.0

25.0

Avg Price/Earnings

Ratio

Avg Price-to-Book

Ratio

Average Dividend

Yield(%)

Avg Sales Growth (%)

Sovereign Wealth Funds Mutual Funds

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Price Momentum Beta

Sources: FactSet and Thomson Financial, 2009.

Note: A higher P/E ratio is associated with a higher price for each unit of net income, so the stock is more expensive. A higher P/B

ratio implies that investors expect more value from the asset. Although a high yield is desirable for some investors, it can also be

associated to lower future dividends. Indicators depict slight differences in the investment profile of the firms where SWFs and

mutual funds invest.


SWFs and sector allocation: a potential for new investmentsSWFs and sector allocation: a potential for new investments

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Investment perspective for SWFs:

•Freedom in asset choice

•Diversify resource allocation

•Longer-term investment horizon

•Higher return perspective

Infrastructure investment

•A “safe” investment

•Countercyclical tool for governments

Source: Factset. Thomson financial and Dealogic, 2009.

Sovereign Wealth Funds investments by sector

Estimation 1995-2008


Current SWF investment trendsCurrent SWF investment trends

� Bortolotti, 2010 finds that SWFs tend to invest in large, levered, profitable growth firms, usually hq'ed in an OECD country.

� Kotter 2009 finds that SWFs tend to invest in financially distressed cash constrained, large, mulitnational and poorly performing companies.

� Only 20% were directed towards listed companies -Bernstein 2009.

� Middle Eastern funds invest in natural resources, oil, gas, energy due to sector knowledge. Same is true for China due to interest in securing domestic energy supplies - Balding and District 2008.

� Miracky 2008 when domestic companies are involved majority stakes are almost always taken.

� Bernstein 2009 - SWFs engage in trend chasing, investing when prices are high whether at home or abroad

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Future trends for SWFsFuture trends for SWFs

� greater knowledge transfer, increased amt of joint ventures as a mechanism for knowledge transfer (recent libyan investement in a uk hedge fund)

� more renewable energy exposure focus towards Asia where greater potential for fiscal stimulus exists

� potentially larger role in domestic markets as liquidity providers

� larger developmental responsibility

� greater transparency, a more activist role and greater interest in corporate governance

Monitor Report

Sovereign Wealth Funds(SWFs)

Sovereign Wealth Funds(SWFs)

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Basic definitions of Sovereign Wealth FundsBasic definitions of Sovereign Wealth Funds

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Foreign exchange reserve funded government investment vehicles tasked with managing assets separately from official reserves (US Treasury definition)

Government created or owned special investment vehicles funded by foreign exchange (IMF Global Stability Report)

SWFs are government-owned investment vehicles funded by foreign exchange assets (OECD)

Sovereign asset pools which are neither traditional public pension funds nor traditional reserve assets supporting national currencies (State Street Global Investors)

Sovereign Wealth Funds todaySovereign Wealth Funds today

Sovereign Wealth Funds have more assets under management than hedge funds or private equity funds: 3-4 trillion USD, double that of hedge funds but half of total foreign exchange reserves and 1/8 of pension funds assets. (Mezzacapo 2009)

The growth of SWFs has been attributed to strong commodity prices, large balance of payment surpluses, increased economic power of emerging markets, and diminished confidence in the IMF.

IFSL estimates assets under management at 3.8 trillion USD in 2009 of which 66% was in commodity stock funds

Forecasted to rise to 5.5 trillion USD by 2012 and to 9.7 trillion USD by 2015 – IFSL.

Sovereign Wealth Funds CategoriesSovereign Wealth Funds Categories31

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SWF Investments: Data as of End -2008SWF Investments: Data as of End -2008

Investor Name Home country InceptionAssets

(US$ bn)Equity

(US$ bn)

Equity in Dataset (US$ bn)

No. of Equities

Source of Revenue Index Active

Abu Dhabi Investment Authority UAE 1976 460.0 -- 0.57 24 Oil No Yes

Government Pension Fund of Norway Norway 1990 371.7 176.38 100.08 2501 Oil Yes --

Saudi Arabian M onetary Agency Saudi Arabia 1952 355.1 -- 2.95 28 Oil -- No

SAFE Investment Company Limited China 1997 347.1 18.90 11.12 68 Other -- Yes

China Investment Corporation China 2007 288.8 9.24 2.70 2 Other No Yes

Government of Singapore Investment Corp. Singapore 1981 247.5 -- 17.90 239 Other No Yes

Kuwait Investment Authority Kuwait 1953 202.8 -- 11.97 155 Oil Yes No

Temasek Holdings Pte. Ltd. Singapore 1974 122.0 -- 74.75 72 Other No Yes

Public Investment Corporation South Africa 2005 79.5 29.43 24.74 90 Other -- Yes

Qatar Investment Authority Qatar 2005 65.0 -- 55.88 8 Oil -- Yes

Alaska Permanent Fund United States 1976 39.8 23.20 11.08 3041 Oil Yes --

National Pension Reserve Fund of Ireland Ireland 2001 30.9 22.87 14.44 1757 Other Yes --

Brunei Investment Agency Brunei 1983 30.0 -- 0.03 6 Oil No Yes

Khazanah Nasional Berhad Malaysia 1993 25.0 12.01 12.01 10 Other No Yes

Korea Investment Corporation Korea, Rep. of 2005 20.0 5.70 3.26 462 Other -- Yes

Mubadala Development Company UAE 2002 14.7 -- 0.40 2 Oil Yes No

New Zealand Superannuation Fund New Zealand 2003 10.2 6.08 2.16 1610 Other Yes --

Abu Dhabi Investment Company UAE 1977 -- -- 3.25 190 Oil No Yes

The Investment Allocation of Sovereign Wealth Funds, 2010. Luc Laeven and Vidhi Chhaochharia. SWF Research Initiative, Columbia University and The Institut Louis Bachelier

Where are the Sovereign Wealth Funds?Where are the Sovereign Wealth Funds?33

Sovereign Wealth Funds (SWFs) - 2009

NumberTotal assets

(USD bn)

Middle East 7 1533

Asia 9 867

OECD 10 489

Russia & Central Asia 4 177

Africa 7 109

Latin America 4 23

Pacific islands 6 1.2

Total 47 3,194

Source: OECD Development Centre, estimation based on Dealogic,

Deutsche Bank , and SWF Institute.


Cultural and geographical influences on global asse t allocationCultural and geographical influences on global asse t allocation

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•Asia and EU remain preferred targets

for SWF investments.

•An interest to diversify from

dominating currencies (EUR, JPY)

•Asian investment reflects long-term

growth potential

•Latin America lags behind other

emerging regions

Note: Covers public transactions for the period 1995-2009

Source: Dealogic.

SWF investments by region

SWFs by regional investment allocationSWFs by regional investment allocation


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