Asset Allocation

Sovereign Wealth Funds look to risk

The International Forum of Sovereign Wealth Funds held its second annual meeting in Sydney last week. reports on the meeting’s outtakes – including asset allocation and risk management implications.

Improving risk management and the continued free-flow of investment capital were topics of intensive discussion at the second meeting of the International Forum of Sovereign Wealth Funds in Sydney last week, hosted by its chair, David Murray, chair of the Australian Future Fund, with deputy chair, Jin Liqun, chairman of the board of supervisors of China Investment Corporation also in attendance.

Following the meeting of 22 member countries, Murray said risk management, and a better understanding of portfolio risk, would improve the dialogue between sovereign wealth funds and their owners.

“A risk approach that brings out new characteristics in portfolios can give great insights into the dialogue SWFs needs to have with their owner and the owner with the community” he said. “The normal process can cause, or pressure through reputation a change direction in of investments.”

He said it was common for large investors to construct investment beliefs, and by exploring risk aspects taken into the portfolio, and having further insights into risk it can cause that debate to be reopened.

While governance was not discussed widely at this forum, he said it was an important issue for SWFs because of the discussion around regulations, and the perceived relationship of SWFs with their owners, and would be discussed a lot more at further meetings.

“Governance is important to us because of whether people believe we can make a difference, through the value of portfolios, or as blood brothers of government.”

Murray said the forum now had in place programs to develop its work further, gathering and sharing information and experiences among members, summaries of which would be published.

“We now have quite a body of work to complete before we meet again,” he said.

One such project will be surveying the forum members to provide their experiences of dealing with the Santiago Principles, some of the results of which will be published.

The Principles were agreed to and drafted by the IWSWF, in 2008, largely as a result of the bad press some sovereign funds were receiving around the world as to whether or not their investment decisions were being politically manipulated.

They agreed to aim for greater transparency as well as to cultivate an environment which avoided any hindrance of cross-border investments.

Murray emphasised that IFSWF members sought commercial returns from their investments, rather than political or strategic outcomes, and the importance of free flows of capital between investment markets.

He said the group was particularly keen to make this case to “recipient countries” of SWF investment and major international financial organisations such as the US Treasury, European Commission and the OECD in the next 12 months.

This would be part of an IFSWF report on the investment activities of its members and how they were aligned with the Santiago Principles. Murray said the IFSWF would engage the international organisations to learn if SWFs were routinely “treated differently” to other large investors.

“There are some curious treatments of investors that we’d like to open up, particularly where it’s related to expectations of us.”

‘We intend to publish a summary of our progress to add some colour and provide some certainty around the Santiago Principles and what SWFs do.”

Murray expressed doubts of the validity of indices designed to gauge the transparency of SWFs, such as the Linaberg-Maudell index, created by the SWF Institute.

“Sometimes [people] construct [indices] without regard to what the Santiago principles actually say and the country differences fundamental to these principles – and sometimes without regard to the truth.”

He indicated this was another motivation for publishing the report on IFSWF actions.

Despite recent co-investment memorandums of understanding signed by SWFs, such as those formed last year by the Korea Investment Corporation with Malaysia’s Khazanah Nasional and the United Arab Emirates government, Murray said co-investment policies or opportunities were not discussed openly in the forum.

“Co-investment tends to happen on a bi-lateral basis…Some funds take comfort in the expertise of other funds in certain areas.”

Given the recent tendencies of major institutional investors – including SWFs – to raise their exposures to emerging markets, the IFSWF discussed whether current risk management tools could adequately map the risks of these markets.

“Models used to develop portfolio structures are necessarily drawn from historical data. In the case of emerging markets, the view put to us is the global economy for a while will be a multiple-speed economy. If you rely on historical data to provide the data on asset allocations, they will not service you well with these different speeds of growth,” Murray said.

The forum heard from a number of academic and private sector specialists, and CIC’s Jin Liqun said the forum would continue to invite expertise in particular areas.

At this meeting, he said a presentation by Columbia University’s Professor Andrew Ang discussing revised theories around the efficient market hypothesis, was a very interesting exercise for the sovereign wealth funds.

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