Commodity Savings Funds: Asset allocation and spending rules. Washington DC March 10-11, 2008

Transcription

1 Commodity Savings Funds: Asset allocation and spending rules Arjan Berkelaar Principal Investment Officer Asset Allocation & Quant Strategies Jennifer Johnson-Calari Director Sovereign Investment Partnerships Washington DC March 10-11, 2008 Road Map Challenges of managing commodity revenues Advantages of stabilization & savings funds Important design questions Spending mechanism Asset allocation Fund management 2

2 Challenges of managing commodity revenues Presence of substantial amounts of oil and gas reserves is potentially a mixed blessing Commodity revenues are volatile and finite Fiscal policy and boom-bust cycles in spending Economic distortions Relative decline of manufacturing sector Import-driven consumption boom Inflationary pressures Rent-seeking behaviors Ensure intergenerational equity 3 Natural resources: blessing or curse? 8 Economic Growth and Natural Resource Abundance Annual GDP per capita growth Natural Resource Capital as % of Domestic Wealth Source: World Bank 4

3 Cyclical or secular oil price change? Source: BP Statistical Review of World Energy. ( US average, Arabian Light posted at Ras Tanura, onwards Brent spot). 5 How to avoid the resource curse? A number of countries have adopted the use of oil or commodity funds a portion of government revenues from oil (and gas) or other commodities is saved Fund rules separate oil revenues from budgetary spending (stabilizes impact of commodity revenues) Allows for conversion of non-renewable resources into earning financial assets Typically funds have one of 2 (or both) purposes: Stabilize or dampen effect of oil revenues on fiscal budget Savings for current & future generations to ensure intergenerational equity Oil and gas will be depleted in 20 to 50 years Saving for future generations and intergenerational equity 6

4 Examples of savings & stabilization funds Country AUM (US$ bn) Inception Year Source Purpose Abu Dhabi 875 N/A Oil Saving Norway Oil Saving Kuwait Oil Saving Russia Oil Both Qatar Oil and gas Saving Alaska Oil Saving Kazakhstan Oil, gas, metals Both Alberta Oil Saving Chile Copper Both Botswana Diamonds Saving Timor-Leste Oil Saving Azerbaijan Oil Saving Trinidad & Tobago Oil & Gas Both Source: Morgan Stanley, Wikipedia, and others 7 Do commodity funds work? Two important questions: fiscal self-insurance (smooth fiscal expenditure) and macroeconomic stability Davis et al. (2001) find weak evidence that countries with an oil fund tend to have more cautious fiscal policies Key to the success of a commodity fund is prudent expenditure policies by the government. Recent study by IMF tested whether commodity funds (oil funds) help reduce macroeconomic volatility based on the experience of 15 countries. Oil funds are associated with reduced volatility of broad money and prices Oil funds are associated with lower inflation Only weak statistical relationship between presence of oil funds and real exchange rate volatility

5 Important considerations in designing commodity funds Design of spending and savings rules Integrate fund in budget/fiscal policy Ideally all revenues flow into the fund and government withdraws a portion annually to support budget Spending rule can be designed to ensures stable income to the government Asset allocation Convert depleting asset into diversified portfolio to create financial wealth Design an asset allocation that generates sufficient returns over the long-run Keep bulk of the fund outside the domestic economy Management of the fund Central Bank, separate investment unit or separate agency Internal management or external management Sterilizing foreign currency inflows Investment Income Income Commodity revenues FUND Liquidity Investments Finance Budget: domestic investments Revenue flow directly into fund would improve transparency and simplify sterilization operations

6 Spending rules used by commodity savings & stabilization funds Common spending rules Bird-in-hand rule: spending is equal to the expected real rate of return* times the market value of the fund Implemented in e.g. Norway and Alaska Total wealth rule: spending is equal to the expected real rate of return times the total wealth (= market value of the fund + oil in the ground) Implemented in East-Timor, Mauritania, Sao Tome Hybrid rule: in between bird-in-hand and total wealth rule Mixed rule: in between bird-in-hand (or total wealth) and constant real spending Used by university endowment funds * Expected real rate of return assumptions vary between 3% to 5% 11 Other rules used by commodity savings & stabilization funds Price-based savings rules save revenues in excess of budgeted revenues based on reference price for oil & gas Implemented in e.g. Russia and Oman Save revenues in excess of budgeted revenues (based on reference price) and can withdraw when falling short of budgeted revenues Implemented in Trinidad & Tobago and Chile Macro-economic rules Target non-oil primary deficit to GDP (with or without debt reduction) Implemented in Norway 12

7 Creating permanent wealth by transferring commodity wealth into financial wealth Several oil-exporting countries are on a declining production path They may only have one chance to get it right The values are expressed in real terms (i.e dollars) Example for country with oil expected to last from 2007 to 2022 Long-term investment results 30.00% % 14.0 Annual Real Return 10.00% 0.00% % % Cumulative Real Return % Real Return on 3-mo T-Bills Real Return on 50% Stocks/50% Bonds Cumulative Real Return on 3-mo T-Bills Cumulative Real Return on 50% Stocks/50% Bonds

8 The path from oil to equities Investing in a financial portfolio of stocks and bonds can reduce the risk of oil significantly while improve total income Data from 1983 to 2007 Graph is based on a speech by Knut Kjaer (Norges Bank Investment Management) from oil to equities 15 Bonds and stocks do well when oil and gas prices are falling 14.0% 12.0% 10.0% Real Returns on Financial Assets when Natural Resource Prices Fall by more than 5% Oil Natural Gas 8.0% 6.0% 4.0% 2.0% 0.0% TIPS Govt. Bonds Corp. Bonds Stocks Real Estate 16

9 Asset allocations for commodity savings funds Asset Allocations of Savings and Endowment Funds Norway Alaska Alberta Yale Harvard Equities 60.0% 58.0% 49.0% 45.0% 45.0% Domestic Equities 27% 15% 11% 12% International Equities 60% 27% 30% 15% 22% Private Equity 4% 4% 19% 11% Fixed Income 40.0% 26.0% 30.0% 4.0% 9.0% Domestic Fixed Income 23% 30% 4% 6% International Fixed Income 40% 3% 3% Real Return Strategies 0.0% 12.0% 16.0% 28.0% 33.0% Inflation Indexed Bonds 7% Real Estate 10% 10% 9% Infrastructure 2% 4% Timberland 2% Commodities 17% Hedge Funds 0% 4% 5% 23% 18% Cash -5% 17 Institutional solutions for fund management Managed by Central Bank alongside reserves Separate investment unit in central bank (e.g. Norges Bank) Managed by Ministry of Finance (e.g. previous setup of Alberta Investment Management) Separate investment agency with professional board (e.g. New Zealand Superannuation Fund) Fully outsourced Who owns the risk?

10 Successful funds have depoliticized the management of the funds Establishment of specialized institutional arrangements for managing the funds with varying degrees of independence from government to reduce the following risks: Direct raiding: Funds are used for purposes other than originally intended or ex-ante contributions are not paid Indirect raiding: unsustainable fiscal behavior e.g. excessive debt accumulation backed by Fund s resources Inefficient management of the Funds: constraints on investments that are inconsistent with the investment horizon of the Fund because of reputational risk constraints Outsourcing asset management Private Sector Existing experience in asset classes unfamiliar to official institutions Significantly greater resources than official institutions could hope to have Innovative, flexibility to adapt quickly What to Outsource Investment management of unfamiliar assets / strategies Risk management technology DO NOT outsource ownership of risk

11 Internal v. external management Three alternative structures In-house management Develop asset allocation and investment guidelines internally Internal management of the assets Outsourcing (Fund-of-Funds) Develop asset allocation and investment guidelines internally Outsource manager selection (hiring and firing) of external asset managers to a fund of funds ( manager of managers ) Full discretion of investments with manager (subject to investment guidelines) External asset managers (Hybrid) Develop asset allocation and investment guidelines internally Selection of asset managers done internally Outsource investment management responsibilities (subject to investment guidelines) 21