Sovereign Wealth Funds and other Long-term Investors: Natural Match for Green Investing? November 29, 2010 Imperial Hotel, Tokyo

Transcription

1 1 Sovereign Wealth Funds and other Long-term Investors: Natural Match for Green Investing? November 29, 2010 Imperial Hotel, Tokyo

2 The Institut Louis Bachelier (ILB) and Paris Europlace 2 Regulatory working groups European working groups International promotion and cooperation Paris financial services cluster Center for Financial Innovation SME and Innovation financing Training and awareness on Financial Regulation European financial information hub Finance and social environmental innovation Our ambition is to bring forth new research subjects 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 research.

3 The Institut Louis Bachelier Strategic Targets 3

4 The Institut Louis Bachelier: in the international sphere with its strategic financial partners 4 The Louis Bachelier Institute is at the center of an international network of research centers. We have initiated cooperation between North American and Asian partners and we are opening up to other potential partnerships. Examples of our 2010 Research Initiatives Exotic interest-rate derivatives Solvency II Toronto Moscou Sovereign Wealth Funds and Climate Change Market Microstructure New York Shangaï Tokyo Other initiatives in the introduction phase Carbon price modelling Singapour Derivatives Clearing

5 The Institut Louis Bachelier Research Initiative on Sovereign Wealth Funds 5 Structure : Sponsors : Steering Committee : Roger Guesnerie Pierre-Louis Lions Patrick Bolton Frédéric Samama Professor at the College de France Professor at the College de France Professor at Columbia Business School Head of the SWF Research Initiative CNRS Silver Medal President of the Paris School of Economic Fields Medal Listed as an ISI highly cited researcher Consulting for the IMF and the Department of Justice, Antitrust Division Designed and implemented the first worldwide leveraged Employee Share Purchase Program

6 6 Sovereign 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)

7 7 SWFs and Climate Change The objective of reducing carbon emissions by 50% by 2050 has been estimated to require a total of 45 trillion USD in investment, or a yearly average of 1,1 trillion. (IEA, 2008) SWFs can act as catalysts for the transition to clean technology. Investments in technologies are needed - more efficient battery storage, electric cars, etc. Currently R&D finance is underprovided due to its public good dimension.

8 8 Climate Change is a Systematic Risk - It Deserves a Risk Premium (1/2) Many economists are confused about what is the appropriate discount rate The Market Seems to Expect Carbon Emissions Prices To Rise Slowly 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, Bob Litterman. SWF Research Initiative, Columbia University and the Institut Louis Bachelier.

9 Climate Change is a Systematic Risk - It Deserves a Risk Premium (2/2) 9 Benchmarks should reflect the current disequilibrium in the price of emissions. What emissions prices might look like under an optimal policy 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. Perhaps economic realities will overcome political realities in time Carbon Emissions and Implications for SWF Benchmarks, Bob Litterman. SWF Research Initiative, Columbia University and the Institut Louis Bachelier.

10 An ecological discount rate (1/3) 10 As introduced by Roger Guesnérie, ecological discount rates allow for discounting environmental goods which cannot be produced but can deteriorate rapidly. In their model, Guesnérie and Olivier Guéant suggest a low discount rate for environmental goods due to their risky and random dimension. We thus have a two-good model with an environmental good and a consumption good. These two goods are imperfectly substitutable. The authors justify a precautionary principle wherein when undecided between two rates we take the weaker rate. SWFs may use this suggested rate to internalize externalities such as the environment to contribute to the sustainable development investment effort. Ecological Intuition versus Economic Reason, Olivier Guéant, Roger Guesnerie, Jean-Michel Lasry. SWF Research Initiative, Insitut Louis Bachelier

11 An ecological discount rate 2/3 11 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. 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. Ecological Intuition versus Economic Reason, Olivier Guéant, Roger Guesnerie, Jean-Michel Lasry. SWF Research Initiative, Insitut Louis Bachelier

12 An ecological discount rate 3/3 12 The diagrams suggest that ecological discount rates converge slowly to their asymptotic value. Another interesting and related visual insight is that, 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 run. Hence, what the diagrams show is that, for a time period between 1 and 2 centuries from now, the disagreement between the radical 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 living at date 150 equals the discounted value, with the ecological discount rate, respectively roughly 2=3 and 1=3, multiplied by their own marginal willingness to pay, which itself depends on their wealth and on their "ecological" views or intuition. Ecological Intuition versus Economic Reason, Olivier Guéant, Roger Guesnerie, Jean-Michel Lasry. SWF Research Initiative, Insitut Louis Bachelier

13 Executive Summary 13

14 A market that is not yet fluid 14

15 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) 15

16 Additional possible features 16

17 Accelerate the Technological Development Through a Presence at all Investment Stages Structure of Expertise Technology Sourcing Fund Europe/ U.S. Engineering Transfer Renewable E Specialists Other Technology Transfer PE/VC & Asset F. Specialists International Green Fund Project Engineering Funds BRIC Advisory (Govt s ) GCC Rating & Labels Other Research network Asset Finance Projects Financial Asset Management 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 quicker and more innovative impact on climate change Full lifecycle investment coverage from early-stage to growth capital 17

18 SWFs, main investors & a supra-national organization monitors investments Monitoring Board Arbitrage Countries with SWFs Seats Managing Board Operational International Green Fund Advisory Firm SWFs Investments Funds (Technology Sourcing Fund, Project Engineering Funds, Asset Finance, etc) Investments Private Investors A worldwide answer to a worldwide issue A light and flexible structure A replication of an IMF: knowledge and financing tools A financial institution with a political agenda 18

19 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 19

20 Why SWFs? (2/2) 20

21 Next Steps? 21

22 Conclusion 22

23 SWFs and emerging markets: A potential to reach USD 1.4 trillion over the coming decade 23 Source: Country reports, Deutsche Bank, and SWF Institute, Sovereign Development Funds, Javier Santiso, The SWF Research Initiative, Columbia University and The Institut Louis Bachelier.

24 Appendix

25 Some consequences of SWF investment 25 higher firm valuations and better operating performance (Fernandes 2009); data from 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) Announcement of divestment results in negative returns in the short term but large, positive longterm 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 longrun excess returns than non-oil funds The Temasek fund of Singapore, a noncommodities fund, has performed better than its rivals over the decades.

26 Investment behavior of SWFs vs. Mutual Funds 26 Average Portfolio Characteristics for SWFs and Mutual Funds Sovereign Wealth Funds Mutual Funds Avg Price/Earnings Ratio Avg Price-to-Book Ratio Average Dividend Yield(%) Avg Sales Growth (%) 0.0 Price Momentum Beta 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. Sources: FactSet and Thomson Financial, Sovereign Development Funds, Javier Santiso, The SWF Research Initiative, Columbia University and The Institut Louis Bachelier.

27 SWFs and sector allocation: a potential for new investments 27 Investment perspective for SWFs: Freedom in asset choice Diversify resource allocation Longer-term investment horizon Higher return perspective Sovereign Wealth Funds investments by sector Estimation Infrastructure investment A safe investment Countercyclical tool for governments Source: Factset. Thomson financial and Dealogic, Sovereign Development Funds, Javier Santiso, The SWF Research Initiative, Columbia University and The Institut Louis Bachelier.

28 28 Current 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 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 Future 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 Miracky 2008 when domestic companies are involved majority stakes are almost always taken. Bernstein SWFs engage in trend chasing, investing when prices are high whether at home or abroad

29 29 Sovereign Wealth Funds (SWFs)

30 30 Basic definitions of Sovereign Wealth Funds Sovereign Wealth Funds today 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) 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. 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) 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.

31 Sovereign Wealth Funds Categories 31

32 32 SWF Investments: Data as of End-2008 Investor Name Home country Inception Assets (US$ bn) Equity (US$ bn) Equity in Dataset (US$ bn) No. of Equities Source of Revenue Index Active Abu Dhabi Investment Authority UAE Oil No Yes Government Pension Fund of Norway Norway Oil Yes -- Saudi Arabian M onetary Agency Saudi Arabia Oil -- No SAFE Investment Company Limited China Other -- Yes China Investment Corporation China Other No Yes Government of Singapore Investment Corp. Singapore Other No Yes Kuwait Investment Authority Kuwait Oil Yes No Temasek Holdings Pte. Ltd. Singapore Other No Yes Public Investment Corporation South Africa Other -- Yes Qatar Investment Authority Qatar Oil -- Yes Alaska Permanent Fund United States Oil Yes -- National Pension Reserve Fund of Ireland Ireland Other Yes -- Brunei Investment Agency Brunei Oil No Yes Khazanah Nasional Berhad M alaysia Other No Yes Korea Investment Corporation Korea, Rep. of Other -- Yes M ubadala Development Company UAE Oil Yes No New Zealand Superannuation Fund New Zealand Other Yes -- Abu Dhabi Investment Company UAE Oil No Yes The Investment Allocation of Sovereign Wealth Funds, Luc Laeven and Vidhi Chhaochharia. SWF Research Initiative, Columbia University and The Institut Louis Bachelier

33 Where are the Sovereign Wealth Funds? 33 Sovereign Wealth Funds (SWFs) Number Total assets (USD bn) Middle East Asia OECD Russia & Central Asia Africa Latin America 4 23 Pacific islands Total 47 3,194 Source: OECD Development Centre, estimation based on Dealogic, Deutsche Bank, and SWF Institute. Sovereign Development Funds, Javier Santiso, The SWF Research Initiative, Columbia University and The Institut Louis Bachelier.

34 Cultural and geographical influences on global asset allocation 34

35 SWFs by regional investment allocation 35 SWF investments by region 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 Source: Dealogic. Sovereign Development Funds, Javier Santiso, The SWF Research Initiative, Columbia University and The Institut Louis Bachelier.