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Letter from Dr. Eliot Kalter, co-head of SWFI and president of EM Strategies

Dear Readers,

kalterIn our February edition of the Sovereign Wealth Fund Bulletin, we covered political risk issues as SWFs diversify by asset allocation and geographic reach.  It is thereby quite relevant that in this March issue of the Bulletin, we turn our attention to issues facing new SWFs. There has been a rapid growth of SWFs in recent years, with a large proportion of funds in emerging and frontier markets. In the last ten years more SWFs have been launched than in the previous fifty years (beginning with Kuwait, the first, in 1956).  It is therefore not surprising that many of these new sovereign investors are at an early stage in their learning curve in applying best practices to asset allocation and risk management, as well as to the governance, transparency and accountability issues they will face in managing the mandates and operations of these funds.

SWFs certainly are not a homogeneous group, with mandates ranging from stabilization and reserve management to saving for long-term pension and development needs. But as a whole, their prominence on the global financial stage in likely to continue to increase both in size and in their appetite and ability to play an important role in providing long-term financing both in the emerging and advanced economy markets. It is thereby highly important to give new SWFs access to quality advice and best practices that will help them maintain their course in meeting domestic mandates, while being a force for global stability in the face of the challenges that markets are likely to continue to face in the years to come.

We welcome you then to our March Bulletin, which leads off with an interview that Sovereign Wealth Fund Initiative co-heads Pat Schena and I conducted with Dr. Edwin Truman, Senior Fellow, Peterson Institute for International Economics on March 12. Dr. Truman is a highly respected economist and a leading authority on SWF structure, governance, transparency, and accountability. During our interview, we discussed a variety of issues, including the proliferation of new sovereign wealth funds, current trends in investment decisions, and the future role of the IMF’s International Forum of Sovereign Wealth Funds. Two issues in particular were of special note:  1) the transformation process as SWFs adapt to new and changing circumstances and 2) the process of adopting best practices in global governance.  Here we note with interest that few new funds have come close to meeting the standards of the Santiago Principals as no new member funds have adopted the Principals since their inception 3 ½ years ago.

Our first article in this Bulletin is by John St. Claret Ezeani, who practices Public International Law and International Economic Law and holds the LL.M. (International Law) Degree from the Fletcher School of Law and Diplomacy. In “An Overview of the Nigerian Sovereign Investment Authority,” he describes the evolution of the legal framework for this new SWF. He notes that the Fund was set up to bridge the gap between two competing viewpoints related to the utilization of surplus revenue accruing to Nigeria from perennial price surges in the international crude oil market. While some have argued that it is wiser to save such extra-budgetary revenues for future use as a budget stabilization mechanism in the event oil prices fall below budgetary projections, others contend that such a policy foolhardy and to the detriment of national development. He concludes that the Act intends for the Funds to address the concerns of both camps, but leaves unanswered many questions related to the ultimate operations of the Funds.

A contribution by Shuvam Dutta, CEME Research Assistant, entitled “Drivers of Strategic Asset Allocation Decisions for Sovereign Wealth Funds” reviews the allocation decisions of SWFs and discusses the theoretical underpinnings that have guided the investment philosophy of sovereign wealth.  In this context, he compares how fund mandates have informed actual asset allocation decisions. He closes with commentary on some of the special circumstances posed by funds established in the last ten years.

We also include in this Bulletin an analysis by Dr. Schena that looks retrospectively at a SWF that is well established, but in the process of responding to changing circumstances and operating requirements: the China Investment Corporation.  He examines the formation, including the original capitalization, of the CIC and resulting governance and control issues to better understand the operating challenges that confront the CIC and the efficacy of its responses.  The note provides a brief review of the CIC’s institutional foundation and capital structure, then analyses selected control and governance issues in light of teh CIC’s relationship with China’s State Administration for Foreign Exchange.  It concludes by posing several key challenges which impact the optimization of the management of China’s foreign reserves.

As I close, I would like to call your attention to an addition to this month’s Bulletin, though not related to new SWF’s, that instead contributes to themes raised in our two prior Bulletins.  Affiliate authors Asim Ali and Shatha Al-Aswad, follow their February article with “SWFs and Egypt: A Fresh Look at Infrastructure Funding and Investments”.  The paper argues in favour of Gulf area SWF investment in the economies of Arab Spring countries, particularly Egypt, to establish a foundation for sustainable development and socio-political stability.  To this end, the authors posit that the GCC and Egypt can mutually benefit by collaborating together. In the case of Egypt, they encourage the political leadership to look to the local economy for solutions and, with the help of GCC investment support, to enhance core competencies in the areas of infrastructure development, tourism, and Islamic finance.

We hope these selections will stimulate your creative thinking on the critical issues that shape sovereign wealth investment.  As always, we welcome your thoughts and feedback.

With best regards,

Eliot Kalter, PhD
Senior Fellow, Center for Emerging Market Enterprises