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									Sovereign wealth fund investment patterns and performance
Comments on paper by Bortolotti, Fotak, Megginson and Miracky

Dubravko Mihaljek
Bank for International Settlements

Discussion at the 15th Dubrovnik Economic Conference of the HNB

Dubrovnik, 25 June 2009

The views expressed are those of the discussant and not necessarily those of the BIS.

Overview of remarks

1. What we knew about SWFs before this paper

2. Some questions of interest to central banks

3. Questions addressed in the paper

4. Comments on the paper

What we knew about SWFs before this paper

 SWFs largely found in resource-rich, oil-exporting EMEs

 SWFs for the most part funded by real wealth

 Only China, Hong Kong SAR and Singapore operate larger
   sovereign wealth funds in non-resource-based economies.

What we knew …
               Structure of SWFs (mid-2008)
                                    USD bil.   %
   Oil and commodities                 1,752   63
   Other                               1,009   37

   Own funds                          2,365    86
   Borrowed funds                       395    14

   “Pure” SWFs                        2,297    83
   Stabilisation funds                  277    10
   Saving funds                         186     7

   Emerging markets                   2,236    81
   Other                                525    19

   Middle East                        1,061    38
   Emerging Asia                        928    34
   Advanced economies                   525    19
   Other                                246     9
What we knew …

   SWF assets growing rapidly
   Private sector estimates: $12 trillion by 2015; larger than forex
    reserves by 2011
   IMF estimate $6-10 billion by 2013
   Caveats: estimates based on tenuous assumptions about
     •  future commodity prices
     •  pace of forex reserves accumulation
     •  allocation of the increase in reserves between SWFs and
        official reserves

What we knew …

                     SWFs compared (2007)
                                            USD bil.    %
   Sovereign wealth funds                     2,800    100

   Global private investment funds           59,000     5
     – Pension funds                         21,600    13
     – Investment funds                      19,300    15
     – Insurance funds                       18,500    15

   Official foreign exchange reserves         5,700    49

   Hedge Funds                                1,500    187

   Private Equity Funds                         700    400

What we knew …

 SWFs play an important role in macroeconomic stabilisation
   in resource-based economies
 Macroeconomic rationale for the operation of SWFs in
   countries where such funds were carved out of “excess”
   forex reserves is not obvious
 The financial rationale for the operation of such SWFs not
   entirely clear, either – need to achieve high “hurdle rates”
 SWFs probably played an important role in the growth of
   capital outflows from EMEs

SWFs: some questions of interest to central banks

1. Links with fiscal policy

2. Links with monetary and exchange rate policies

3. SWFs and capital flows

Links with fiscal policy

•   Accumulation and withdrawal rules – integration of the fund
    with the state budget
    – Norway’s 4% rule
•   Spending (eg, repayment of public external debt) and/or
    lending authority (not recommended)

•   Is there sufficient control of spending and deficits on the
    regular budget?
     – Chile’s 1% structural surplus rule
 Countries with fiscal deficits and/or weak fiscal governance
  should not establish SWFs
Links with monetary and exchange rate policies

  Case 1: Government has own foreign currency revenue (eg,
  from exports of state oil or copper company)
       channel forex revenue to the SWF, invest abroad to
      avoid exchange rate, inflationary pressures / need for

  Case 2: SWF assets derive from foreign currency acquired
  through sterilised forex intervention or other borrowed funds
      – determine the level of “excess” reserves
      – determine whether the operation of the fund reduces
      the need for central bank intervention and sterilisation
       – determine “hurdle” RoR > (cost of local debt) +
      (expected appreciation of local currency)
Links with monetary and exchange rate policies (3)

•   Designing institutional setup of SWF
    Should the fund be:

    –   Integrated with central bank operations (HKMA);

    –   Operated as a standalone entity (most SWFs); or

    –   Established as a separate unit within the central bank

SWFs and capital flows
   Role of SWFs in “reverse” capital outflows from EMEs to
    advanced economies
   Role of SWFs from China, Singapore and the Middle East in
    recapitalising troubled financial institutions from Europe and
    US in late 2007 and early 2008: $80 billion,  8% of
    estimated private sector capital outflows from emerging
    market countries in 2007
   If all SWF assets from EMEs ($2.3 tril.) were invested
    abroad, they would account for 30% of the foreign assets held
    by the public and private sectors of EMEs in 2006

Questions addressed in Megginson et al paper

   What do SWFs invest in?

   How do SWFs invest?

   Performance of SWF investments

 Can help central banks and other policy makers understand
  whether they should worry about SWFs, set up their own SWF

Comments on Megginson et al paper

   Paper addressed to the academic / empirical finance
   Unique data base
   Descriptive and statistical analysis of the data on SWF
   Econometric analysis of the determinants of “abnormal”


   (Moderately) heavy on finance jargon

   Important terms (“abnormal” returns, agency costs, various
    SWF indices) not explained / not explained well until very late
    in the paper

   Imbalance between the descriptive narrative (long) and
    technical analysis (often cursory)


Statistical methodology

   Definition of “abnormal” returns: deviation from the local equity

   Is only the average return “normal”? Shouldn’t there be some
    confidence bands around the average return?


Econometric methodology
   OLS
   Dependent variable is constructed (“abnormal” return)
   13 explanatory variables
    •   6 dummy variables
    •   4 constructed variables (Truman indices of SWF
        governance )
    •   1 lagged dependent variable
    •   2 variables measuring percentage of shares acquired
        (%, % squared)


   How informative are such regressions?

   Most parameter estimates insignificant

   Have potential problems with multicollinearity (dummy variable
    trap) in panel data estimations (especially with fixed effects)
    been properly treated?


Can we take Truman indices at face value?

   No discussion of their reliability; black boxes

   Indices of governance, accountability and transparency,
    behaviour, are bound to be highly correlated

   Look at Aizenman and Glick (SFO Fed, Dec. 2008)


    How do results in the paper compare with published reports
    about SWF performance?
   Norway’s Pension Fund – Global
   Temasek: average annual return on assets 18% in local
    currency terms during the lifetime of its operations; 27% during
   GIC (at the 25th anniversary of its founding): average annual
    yield on its investments from 1981 to 2006
     •   9.5% in US dollar terms
     •   8.2% in SGD
     •   5.3% above global (G-3) inflation


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