Investment Objectives of Sovereign Wealth Funds—A Shifting Paradigm

WP/11/19 Investment Objectives of Sovereign Wealth Funds—A Shifting Paradigm Peter Kunzel, Yinqiu Lu, Iva Petrova, and Jukka Pihlman © 2010 International Monetary Fund WP/11/19 IMF Working Paper Monetary and Capital Markets Department Investment Objectives of Sovereign Wealth Funds—A Shifting Paradigm1 Prepared by Peter Kunzel, Yinqiu Lu, Iva Petrova and Jukka Pihlman Authorized for distribution by Udaibir S. Das January 2011 Abstract This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. While SWF investment objectives to some extent reflect inherent characteristics, notable differences in strategic asset allocation (SAA) exist even amongst SWFs of similar types. Even so, this paper shows that the global crisis may have changed SWF’s asset allocations in ways that may not be ideal or justified in all cases and that a review of investment objectives may be warranted. It also argues for regular macro-risk assessments for the sovereign, the continued importance of SWFs as a stabilizer in international capital markets, as well as the active role they could play in international regulatory reform. JEL Classification Numbers: F30, G11, G15, G18 Keywords: Sovereign Wealth Funds, Portfolio Choice, Investment and Risk Management, Government Policy and Regulation Author’s E-Mail Address: pkunzel@imf.org, ylu@imf.org, ipetrova@imf.org, jpihlman@imf.org 1 The IMF is source and copyright holder of this work. The authors thank Robert Sheehy, Udaibir S. Das, Jennifer Elliott, Alessandro Gullo, Joonkyu Park, and Han van der Hoorn for their useful suggestions. This Working Paper was published as Chapter 11 of the book “Economics of Sovereign Wealth Funds, Issues for Policymakers,” (IMF, 2010). 2 Contents Page I. Introduction .....................................................................................................................3 II. Classification of SWFs and its Implications ...................................................................3 III. Theoretical Considerations behind SWFs’ Strategic Asset Allocations .........................4 A. Investment Horizon and SAA ...............................................................................5 B. Funding Source and SAA .....................................................................................5 IV. Comparison of SWFs’ Observed Asset Allocations .......................................................6 V. Unraveling of the Crisis ..................................................................................................8 VI. Crisis Implication for Strategic Asset Allocation ..........................................................11 VII. Policy Challenges Ahead ...............................................................................................13 A. Sovereign Financing ...........................................................................................13 B. Regulatory Environment .....................................................................................13 VIII. Conclusion .....................................................................................................................14 Table 1. Sovereign Wealth Fund Classification...................................................................................4 Figures 1. SWF Asset Allocation, 2007..................................................................................................7 2. SWF Returns, 2007-2009.......................................................................................................9 3. SWF Assets under Management, December 2007-December 2009....................................10 4. SWF Asset Allocation, 2007 vs. 2009 ................................................................................12 3 I. Introduction 1. Sovereign Wealth Funds (SWFs) were severely hit by the global financial crisis. With increased public scrutiny over hefty losses incurred during the crisis, many SWFs have reviewed existing investment practices. This paper examines the ways in which different types of SWFs approach their investment objectives, describes the impact of the crisis on SWF performance, reviews the extent to which portfolios have been reallocated, and draws lessons about how and why the investment behavior of SWFs has changed. Looking forward, it also considers additional issues that may need to factor more prominently in SWF’s investment strategies, including macro-stabilization and asset-liability management considerations, as well as forthcoming adjustments to the global regulatory environment. II. Classification of SWFs and its Implications 2. SWFs are typically categorized as stabilization funds, savings funds, pension reserve funds, or reserve investment corporations (Table 1).2 The majority of established SWFs are either savings funds for future generations or fiscal stabilization funds. There are only a handful of pension reserve funds (Australia’s Future Fund, Chile’s Pension Reserve Fund (Chile-PRF), Ireland’s National Pensions Reserve Fund, New Zealand’s Superannuation Fund, and the Russia Federation’s National Wealth Fund (Russia-NWF)) operating today, and even fewer reserve investment corporations (China Investment Corporation (CIC), Korea Investment Corporation (KIC), and Government Investment Corporation of Singapore (GIC)). Some SWFs have multiple objectives (e.g., State Oil Fund of Azerbaijan, Kuwait Investment Authority, and Norway’s Government Pension Fund-Global), and a number of countries also have more than one SWF with different objectives, including Chile, the Russian Federation, and Singapore. 3. The different types of SWFs have important differences in their investment objectives and behavior. A reserve investment corporation, for example, will need to consider the possible repercussions of balance of payments risks, and will want to hold a portion of its portfolio in liquid assets. The SWF’s type and its objectives will also influence its investment horizon. For instance, savings SWFs are expected to have longer investment horizons than stabilization SWFs, whereas pension reserve funds can derive their investment horizons from the timing of the future anticipated liabilities falling due, which can be decades in the future. 4. SWFs’ investment objectives may also be influenced by the source of their funds and may take into consideration other assets and liabilities on the wider government balance sheet. 2 See, for example, IMF (2007, 2008); and Hammer, Kunzel, and Petrova (2008). 4 Table 1. Sovereign Wealth Fund Classification Source Year established Country Macro stabilization Policy Purpose Saving Pension reserve Reserve investment 1953 Kuwait 1976 Canada 1976 United Arab Emirates 1976 United States 1980 Oman 1983 Brunei Darussalam Kuwait Investment Authority, General Reserve Fund Kuwait Investment Authority, Future Generations Fund Alberta Heritage Savings Trust Fund Abu Dhabi Investment Authority Alaska Permanent Fund State General Reserve Fund Brunei Investment Agency 1996 Norway Government Pension Fund-Global Government Pension Fund-Global Government Pension Fund-Global 1999 Azerbaijan 2000 Iran, Islamic Republic of State Oil Fund State Oil Fund Oil Stabilization Fund Oil and 2000 Mexico Natural Gas 2000 Qatar Oil Revenues Stabilization Fund Qatar Investment Authority 2000 Trinidad and Tobago 2001 Kazakhstan 2002 Equatorial Guinea 2004 São Tomé and Príncipe 2005 Timor-Leste Heritage and Stabilization Fund National Fund Petroleum Fund Heritage and Stabilization Fund Fund for Future Generations of Equatorial Guinea National Oil Account PetroleumFund 2006 Bahrain 2006 Libya The Future Generations Reserve The Future Generations Reserve Fund Fund Libyan Investment Authority 2008 1956 Other 1996 Commodity 2006 2007 1974 1981 1993 Fiscal 2000 Surpluses 2001 2004 2005 1981 Russian Federation Kiribati Botswana Chile Chile Singapore Singapore Malaysia Ireland New Zealand Australia Korea, Republic of Singapore Reserve Fund Economic and Social Stabilization Fund (ESSF) Kiribati, Revenue Equalization Fund Botswana, Pula Fund Singapore, Temasek Khazanah Nasional BHD National Wealth Fund Pension Reserve Fund Ireland, National Pensions Reserve Fund New Zealand Superannuation Fund Australia, Future Fund Government of Singapore Investment Corporation Korea Investment Corporation Government of Singapore Investment Corporation FX Reserves 2005 2007 Korea, Republic of China Korea Investment Corporation China Investment Corporation Source: Authors` compilation. III. Theoretical Considerations behind SWFs’ Strategic Asset Allocations 5. The type of SWF, its investment horizon and funding source, and other balance sheet characteristics should all affect its strategic asset allocation (SAA). 3 This section discusses some stylized theoretical underpinnings for SWFs’ SAAs.The section that follows compares the actual asset allocations of several SWFs with these underpinnings and discusses other factors that may be driving asset allocations. 3 See also, for example, Das, Lu, Mulder, and Sy (2009) for more information. ... - tailieumienphi.vn