Foreign M&A Deals: Bloomberg May 23 article “China’s $941 Billion Sovereign Fund Seeks More Resilient Assets”

Bloomberg May 23 article “China’s $941 Billion Sovereign Fund Seeks More Resilient Assets”

We expect much greater scrutiny for foreign M&A deals as well as delays especially for direct investments made by Sovereign Wealth Funds, particularly China Investment Corp. We describe the ‘typical’ approval process timeline and outline key considerations in the highly opaque and secretive CFIUS review process.

4-timeline

Acquirer Considerations:

What is the host country for investor?

  • UK, Europe, Canada, Japan, Korea, raise few security or political issues
  • 7 countries investing the most in the United States, all of which are United States allies (the United Kingdom, Japan, Germany, France, Canada, Switzerland, and the Netherlands) accounted for 72.1 percent of the value added by foreign-owned affiliates in the United States and more than 80 percent of research and development expenditures by such entities
  • China raises unique issues

Does the acquirer have a good record of compliance?

  • Focus on US, foreign laws and previous CFIUS commitments
  • Focus also on acquirer’s record with respect to its own products or services or competition practices

Does the acquirer have state ownership?

  • Have the acquirer’s leaders been implicated in any law enforcement or regulatory actions?
  • Has the acquirer effectively complied with previous CFIUS commitments?
  • Will investment raise political issues in Congress?

 

Target Considerations:

  • How important are target’s assets to national security of the United States?
  • Are there government contracts?  With which agencies? Classified?
  • Is target a direct supplier to U.S. government or subcontractor?
  • Does the target have export-controlled technologies?
  • Are the target’s assets considered “critical infrastructure”?
  • Does target have outstanding litigation or competitive issues that could lead competitor to politicize CFIUS process?
  • Who are the target’s non-government customers?
  • Has the target effectively complied with previous CFIUS commitments?
  • Does target have dominant position in market for key technologies or services?

Commenting on WSJ Article May 18 2020, “Saudi Fund Snaps Up Some U.S. Stock Bargains”

WSJ article May 18, “Saudi Fund Snaps Up Some U.S. Stock Bargains”.  Saudi Arabia’s $300 billion SWF, The Public Investment Fund,  in Q1 2020 bought around $500mm equity each in Facebook, Walt Disney, Marriott, Cisco, Citigroup, Bank of America, Boeing, Carnival, Live Nation Entertainment inter-alia.

The U.S. has long been very open to receiving foreign capital in U.S. firms. Now we see a rise in protectionism,  trade barriers and inward-looking sentiment seeping into policy and regulation. The number of transactions reviewed by the Committee on Foreign Investment in the United States (CFIUS) has been growing and the fear of foreign state governments buying distressed assets increases. Opposition is no longer just vocal; a lot of activity is taking place behind the scenes in Washington. Constituency interests, too are crowding out traditional policy interests. Any involvement, other than through voting of shares, in substantive decision making of key U.S. companies is likely to be scrutinized. For mergers and acquisitions post CFIUS review, the standard process could now be longer than the typical 45-60 days if the transaction is believed to be a “threat to impair” national security.

This will be especially true for direct investments, more than for portfolio investments. How different SWFs are treated depends in large measure on how transparent they are, national security concerns as well as reciprocity.

11=Saudi PIF

Central Bank Reserve Management: How Much is Too Much?

6-how much central bank reserves

#ActiveAllocator Research: Ideas about the right level of international reserves have changed with the evolution of markets and crises. Paul Krugman in a recent interview suggested that the attitude at the moment should be “don’t worry about government deficits so much and start spending”. The U.S. Federal Reserve and other counterparts have moved aggressively with sweeping emergency rate cuts, and offers of cheap dollars, to help combat the coronavirus pandemic. Emergency policy easing by central banks in UK, Europe, Japan provide stabilization. But can countries pump indefinite  liquidity into markets to support monetary and fiscal stimulus? The coronavirus pandemic will test how much debt countries can bear.

 

For much of the post-war period, the rule of thumb was that international reserves should cover three-to-four months of imports. The Guidotti rule that reserves should exceed short term debt is now generally accepted as benchmark for assessing the adequacy of reserves – governments should be able to stay out of market for new financing for up to a year if needed. With the growth of capital markets, views of reserve adequacy have changed. Countries are now expected to have more reserves to protect against potentially large and disruptive capital flows, even if the exchange rate regime is floating

Factors include the exchange rate regime, the size and currency composition of the debt, trade flows, monetary aggregates and an assessment of risks and structural aspects of the market. Taking all these into account often raises the estimate of required reserves

 

SWFs Need to Re-examine Their Charter During 2020

The SWF legal status is key since it impacts the fund’s form, governance, links between actors and applicable law. With many effects of the coronacrisis still to unfold,  previous provisions may no longer be relevant.  A revision in legal status should consider Santiago Principles to promote improved governance, foster accountability, ensure transparency and instill prudent investment practices.

2-swf legal status

SWFs Need Re-examine Established Investment Process and Permitted Investment list in 2020

ActiveAllocator Research: After the market debacle and expected pronounced volatility, existing investment processes need an overhaul. This includes reflecting changes (downgrades) in country ratings and lists of permitted investment.

1swf-investment process

SWFs Need Re-examine Established Investment Guidelines in 2020

Sovereign Wealth Funds (SWFs) have lost hundreds of billions of $ ever since the Coronacrisis gathered speed. Revising Fund’s investment guidelines is vital to repairing the damage done. A wait and hold approach is hardly prudent. Such guidelines are going to be a key decision for it both flows from as well as impacts the fund’s form, governance, links between actors and the applicable law. I believe that investment guidelines should follow from the basic principles and core values of the Fund, as well as its general entrusted mission.

revise investment guidelines

 

SWFs Need Re-examine Historic Institutional Framework in 2020

Sovereign Wealth Funds (SWFs) have in March 2020 alone, cumulatively lost hundreds of billions of $ in citizens accumulated wealth. Attributing this to adverse market movements is hardly an excuse. I observe that most SWFs have been on ‘auto pilot’, driven by inertia after they were formed. Meanwhile much has changed in their external and internal country environments. This naturally has ramifications on the legal framework within which such vehicles now operate, as well as their initial objectives and macroeconomic linkages with national economies. This in turn influences their investment policies and risk management frameworks.  In my view the Coronacrisis should catalyze fundamental rethink of a Fund’s institutional framework and governance structure.

I believe that this is a good time for soul searching. For whether a SWF is placed under the supervision of the Ministry of Finance, or the Central Bank, or is run as an independent entity has enormous importance going forward. Something that I highlight here, as well as will build upon in subsequent postings.

institutional framework

 

SWFs Need to Radically Revamp Risk Management Process Now

Sovereign Wealth Funds (SWFs) have lost hundreds of billions of $ ever since the Coronacrisis gathered momentum, beginning March. I believe it the largest destruction of accumulated citizens wealth in history. Having advised multiple SWFs I am acutely cognizant that each has its own specificity, governance, asset allocations, risk levels and special objectives. A Fund’s institutional framework too has great influence over managers, both internal and external, and therefore has an impact on its management and returns. A SWF’s legal status also is a key decision point,  since it impacts the fund’s form, governance, links between actors and the applicable law.

I am of the view that recent market events highlight the importance of managing risk holistically even more so.  I draw attention to five issues in this visual.

Sovereign Wealth Funds - risk process

SWFs Need to Revisit Objectives During Coronacrisis

SWFs Need to Revisit Objectives During Coronacrisis

I hold the view that nations that have already set up a Sovereign Wealth Fund (SWF) now ought to revisit every aspect – the mandate, mission statement: the very objectives of the Fund, the institutional and legal framework, the way it should manage and monitor the investment process going forward, investment guidelines that may no longer serve well, risk management/ benchmarks, the governance framework, the optimal mix between internal and external managers as well as myriad of issues including evaluation and performance assessment. Recent huge losses suffered may itself generate a public debate on topics of investment of “excess” reserves, the level of future risk and more important spill-over implication for macro-economic policies.

I believe that the more transparent and the more professional they are, the more open will be capital markets and their own citizens to their activities. We present a visual by way of catalyzing conversation.

revisit objectives during coronacrisis

Global Central Bankers Survey – February 2020

I had polled global central bankers in January/February – around 47 OECD and non-OECD banks participated with multiple respondents each to the survey.  While the names of the banks are known (albeit concealed as I don’t have permission to reveal)  the respondent profile was anonymized to ensure better disclosure. At that time I did not sense the severity of the impending Coronacrisis, so questions related to it were not asked – a mistake I feel, in retrospect.

Attached is an excerpt.

Central Bank Survey1

Sovereign Wealth Funds Need to Reinvent in 2020

The cost of holding high levels of foreign exchange reserves can be estimated as the difference between the interest rate paid by the central bank on domestic securities and the interest earned on foreign exchange reserves, adjusted for any exchange rate change.

Guan Seng Khoo, PhD and me are of the view that during the coronacrisis this spread is likely to change very fast. We hold the position that the close relationship between SWFs and country central banks will come under pressure, especially for the petrodollar SWFs as oil prices have tanked to less than $30. Of course not all SWFs are created equal: they lie along a spectrum of risk appetite. Those that in the past demonstrated a strong willingness to lever up and make strategic purchases, serve dual objectives of wealth creation and support of their country’s policies will now need to rethink their mandates. In order to do that, we recommend that they need to think in terms of the larger eco-system and not silo mandate, as we showcase in this visual.

swf1

Central Banks Need to Choose a Correct Benchmark in 2020

A recent #ActiveAllocator survey shows that central banks rate “avoiding default” as their most important objective. That hope for serendipity is now likely over. Central banks now face heightened concern from the economic slowdown, rising deficits, currency debasing and assorted other risks.

Guan Seng Khoo, PhD and me recommend that they should further increase reserves in conjunction with greater currency and instrument diversification, and invest in new asset classes. Guan Seng has spoken extensively on the merits of indexation towards an ALM centric model, the need to arrest funding shortfalls, to monitor high levels of Surplus at Risk (SaR) as well as create a central bank liability index, interalia. His approach represents a paradigm shift away from asset, sector or horizon-driven selection and allocation. We draw attention to developing a new benchmark, by encouraging thinking through first principles in a visual here.

correct benchmark1

Central Banks Risk Management Need to Change in 2020

The need to be able to properly quantify risks, particularly those “fat tail” risks that present a special challenge to policymakers has never been more important, than in 2020. Guan Seng Khoo, PhD and me in our long careers have come to understand that transparency on risk/return and data availability allows better bench-marking and control. We feel that moving away from recognized benchmarks can help central banks achieve a better match of assets and liabilities. Internally created benchmarks can be effective in meeting safety and liquidity requirements, measuring performance and increasing accountability. All of this needs to be explicitly tied to the risk management function.

Central Bank Risk Management1

Central Banks Should Broaden Range of Assets Held in 2020

In 2020 central banks ought to consider a more active reserve management strategy; one that incorporates modern innovations in asset management which bring intensified focus on returns. While counter intuitive perhaps to conservative central banking mindset, Guan Seng Khoo, PhD and me recommend a gradual expansion of the range of credit and duration of instruments held. We also suggest hedges to key risks, including commodity risks as well as consideration towards agency paper and investment tranches of collateralize mortgage securities supported with more active currency positioning and securities lending. Their FX policies should be geared towards paying greater attention to boosting market confidence in the context of float/managed float. We further feel moving away from recognized benchmarks can achieve a better match of assets and liabilities. Internally created benchmarks can be effective in meeting safety and liquidity requirements, measuring performance and increasing accountability.

2-central banks to broaden assets held

 

 

 

Evolution of Sovereign Wealth and Government Investment Funds

 

SWF1

 

This essay draws attention to four areas:

  1. Investment & Protectionism: Managing Public Opinion and Political Resistance
  2. Mutual Responsibilities of Providers and Receivers of Funds
  3. Institutional Design of Investment Funds: Managing Governance, Accountability and Performance
  4. Investment Objectives & Asset Diversification: Balancing Risk & Returns

Investment and Protectionism: Managing Public Opinion and Political Resistance

An increase in assets placed by Government Investment Funds (GIFs) occurs at a time of increasing protectionist sentiment in developed economies. This development, perhaps more than other salient issues specific to the operation of GIFs, makes the investment climate for such entities more challenging.

For 30 years, beginning with the launching of economic reforms by Deng Xiao Ping in China, Margaret Thatcher in the United Kingdom, Ronald Reagan in the United States, Manmohan Singh in India as well as reforms in many other countries veered global trend towards freer markets. Growing acceptance of foreign investment became part of the global dynamic. The “Washington consensus” led the IMF and World Bank to carry a liberalization agenda to emerging markets. Economic transitions launched in the early 1990s in the countries of the former Soviet Union and Eastern Europe provided second impetus towards a more open investment climate. And privatization expanded the pool of assets potentially open for foreign investment. Cross-border investment in portfolio equity, portfolio debt, and foreign direct investment expanded while banking flows fluctuated without a clear trend. Recently, there has been a change in public sentiment within the G-7 countries – Canada, France, Germany, Italy, Japan, United Kingdom and the United States. As per a Wikipedia entry, as of 2018, these seven countries represent 58% of the global net wealth ($317 trillion) and more than 46% of the global gross domestic product (GDP) based on nominal values, and more than 32% of the global GDP based on purchasing power parity.

Surveys and anecdotal evidence and media reports suggest declining numbers of people within G-7 agreeing that “free trade is good,” that “free markets are good” and “the impact of foreign companies is good.” Majorities still do support free trade and free markets, but acceptance of foreign companies slipped to a minority view within the G-7 in 2019. In contrast, support for globalization has been growing in emerging regions over the past two decades, for global markets are a natural destination for emerging market exports. Foreign firms, operating within the domestic economy, are seen much more positively in the emerging markets than in the older industrial countries. One may logically extrapolate that foreign investors, more generally, are viewed in this way too.

The more protectionist opinions in the G-7 may simply be the inevitable reaction to a long-lasting trend, which eventually runs out of momentum. It also clearly reflects the disappointing economic progress of large parts of the population in the post-industrial countries. The more pro-foreign investment views in most emerging markets suggest that the latter factor is important – improving standards of living have come along with increased foreign investment. The change in climate is also reflected in voices raised in advocacy of government- directed industrial policy and in economic security. This is now also creating pressure to protect sectors that are viewed as strategic in a mindset that sees economic activity in zero-sum terms.

In addition, rapid increases in cross-border investment bring reactions from unfamiliar investors. In part, this has been felt when investors have come from countries with less deep and long-established economic and financial ties, and in part it has been felt by government-affiliated investors – especially in the United States where the Federal government is not a significant holder of economic assets, outside its own debt. These sensitivities have been experienced by GIFs exporting capital to the United States. But, the negative reaction to unfamiliar investors has been broader as shown by political attacks on private equity funds and hedge funds in Europe and Japan. And in general, on forces of free market capitalism. Certainly, mistrust can exacerbate political reactions to investment, but the general climate reinforces such tendencies and creates political problems on a wider front.

Growing anxiety about national security with a new focus on homeland security has also affected the acceptance of foreign investment, especially in the United States. While focus has been on control investments, the public debate has often blurred the distinction between portfolio investment and operation control.

Those who work in global finance are affected by anti-globalization sentiment, and have an interest in countering, by promoting better public understanding of the economic gains from increasing cross-border trade and investment. Lack of public understanding of who foreign investors are, as well as their objectives and their track records are evident in the United States and in other countries today – Jeff Bezos of Amazon received a very lukewarm reception in India, in his visit to India, January 2020. Political leaders often show no greater awareness of the record of foreign investors – evinced by comments of India’s trade minister, Piyush Goyal to Amazon CEO’s visit. Incumbents who stand to benefit, have an interest in promoting policies that build political support for open markets – for example, improving education to prepare people for greater success in globalized markets. But while this climate may persist, it is also necessary to consider ways to minimize the impact of negative sentiment on investment opportunities.

What is needed is, nuanced, more and better discussion of experiences in managing political resistance and to exchange ideas on how this might be done more effectively. Participants in such conversations may wish to address the following:

  • Is the difference in attitudes between post-industrial developed countries and emerging markets reflective of experiences making investment in different countries over time?
  • What are the differences in the political climate for investment across the G-7, in the developing countries and in key emerging markets? Do these differences call for different approaches?
  •  Are there particular conditions that heighten the risk of a political response to an investment?
  • Are there ways of pre-testing the political climate before an investment is announced?
  •  What can be done by investors and by countries to keep sensitivities regarding economic security from damaging the climate for investment?
  •  Is it better to be pro-active or reactive in pursuing a public affairs strategy? Should a public affairs strategy focus first on the political community or directly target opinion leaders and the public? Does this differ from country to country?
  •  Does working with local investor partners reduce or exacerbate political risk?

Mutual Responsibilities of Providers and Receivers of Funds

As assets managed by GIFs continue to grow and as their risk appetite increases, the responsibilities of both providers and receivers of funds have become intense subjects of discussion. Concerns about rising protectionism, potential reactionary and/or reciprocal treatment, and maintaining the free flow of capital more generally form aspects of the debate. Policymakers, academics, members of the global business community, as well as fund managers have suggested ways to best confront the variety of issues raised by the increasing instances of cross-border investments by foreign government-controlled funds. The IMF and OECD have already produced a draft set of best practices for recipient countries.

Yet, multiple questions remain unresolved:

  • Is the development of “best practices” likely to be adequate to keep the critics of foreign investment at bay? And from the investing countries, do the OECD/ IMF and self-adopted best practices provide adequate assurances about rules of the game?
  • What means of enforcement of best practices are appropriate, if any? Who decides?
  • What institutions should be covered by a “best practices” framework for investment funds? What level of government ownership is “influential,” and how far is “arm’s length” management?
  • Some have argued that the absence of an adoption of voluntary guidelines for investment funds could lead to a backlash. Others note that if the funds are needed to support industries in need of capital (such as financial services), the doors will remain open. Which of these realities is likely to prevail?

Institutional Design of Investment Funds: Choices in Governance, Accountability and Performance

It is estimated that over 50 governments now have national investment funds. Institutional designs vary greatly, and many countries in the early stage of developing fund structures are looking to investment funds that have long track records (like ADIA, Norges, Temasek, GIC, and KIA etc.), ostensibly to understand structural and organizational choices. While each government has its own consideration in making organizational decisions, consistent objectives include governance, accountability and performance.

A fundamental governance question is the desirable degree of independence from the government. Some governments, Malaysia – in the news now for the wrong reasons – have prioritized home- country investment and economic development, resulting in an institutional framework that fits within the ministry of finance. Others have created investment corporations, specifically designed to provide some independence from government political intervention, and to emphasize both a commercial and a performance orientation.

A common issue for many governments in the early stages of forming an investment fund is accountability and oversight of the fund; which entity or government officials should have oversight responsibilities?

A common choice is the Central Bank. Close to half of GIFs have some tie or organizational subordination to their Central Bank. Often Central Banks are immediately at the table in these discussions because they are the source of the initial or ongoing funding and often provide the initial staffing needs for new funds. However, even when the source of funding comes from a commodities windfall, or from privatization proceeds, many countries consider the strong governance benefits of the Central Bank to be significant; financial prudence and the political independence of the Central Bank are often seen as characteristics critical to the success of a GIF. There is also a dissonant view, however, that this may impact fund performance as Central Bank professionals bring a conservative reserve management mindset and experience base that is different from that traditionally required to manage an inter-generational, more diversified and complex investment portfolio.

Of course, decisions on governance and oversight can impact transparency issues. For example, the monetary policy decision-making process has often been closely held and guarded. This tendency has, in some cases, carried over in the creation and management of many GIFs. In addition, in some countries, GIFs are considered part of the strategic national wealth and can be viewed in the context of political and national security considerations, as opposed to financial market disclosure standards. In these situations, accountability and oversight may ultimately move to the absolute highest levels of government.

The governance and accountability debate links directly to decisions around the role of a GIF board of directors (including how and by whom board appointments are made), the role of the asset manager, and the source of the original and ongoing funding.

Governance must also necessarily involve accountability for performance against a specific mandate. The clarity of the mandate is an essential early step in the design of any GIF, and can or may include strategic and economic objectives, as well as wealth maximization and performance against specific investment objectives. Important is, there are performance opportunities that relate to the overall management of the fund. For example, many GIFs are exploring innovative solutions and efficiencies in operations and technology, including middle and back office functions such as payments and operating liquidity optimization.

In addition, an issue driving overall performance is the ability to attract and retain high quality professionals. GIFs, with the odd exception, akin to Central Banks and government pension funds have limitations in their ability to properly incentivize performance. While many investment funds have been able to implement innovative compensation schemes, others have had to rely more heavily on well compensated external asset managers, where these entities otherwise, would have preferred to have built in-house competencies.

The following are possible questions worthy of discussion:

  • If sovereign entities with substantial experience in managing organizational and governance issues took out a blank piece of paper to help the newer funds design their organizational model, would there be any consensus on where a GIF should sit, to whom it should report and the degree of political independence necessary to perform? Is there a best practice?
  • Do transparency issues about fund disclosure come at the expense of performance? If there is a competitive disadvantage or performance downside, is the importance of disclosure of the decision-making process, general investment objectives, size, risk and investment parameters such that it should be done anyway?
  • Are compensation and incentive structure limitations of government materially impacting ability to attract and retain appropriate professionals? What has worked most successfully in addressing the need to attract high performance professionals? If appropriate incentive structures are difficult to implement, is outsourcing an appropriate response?
  • Should investment in domestic economic development be subordinated to, or allowed to run in parallel to, the risk adjusted return objectives of a GIF? Should there be multiple portfolios with different objectives within the same institution?
  • The degree of assets managed internally versus externally varies dramatically across the GIFs. Is there any consensus on the optimal mix? Is the ultimate objective to be able to in-house manage a large portion of the fund’s assets?
  • Considering the growing trend among private sector asset managers toward outsourcing middle and back office functionality, should GIFs too move in this direction, while maintaining control of the front end?
  • Where more than one GIF exists within a nation, should they compete, as would private sector entities, or should they have clearly differentiated mandates and investment objective delineation? Is there a framework for making this decision?

Investment Objectives and Asset Diversification: Balancing Risk and Returns

There are a variety of portfolio strategy and design principles, funding and allocation decisions and strategic investment objectives that guide the GIF investment process. This note highlights some key issues that currently confront decision-makers, without going into a detailed analysis of each.

One often hears GIFs referred to as ‘the new Global Wealth Managers’ as the size of current and future assets under management makes them comparable to large private asset managers. As the GIF community grows both in number and in assets, the need for methodical approaches to asset allocation has increased. For GIFs, the strategic asset allocation methodology used by many large endowments, may be one useful model, given the often-similar conservative risk-return perspective and the long-term investment horizons.

Of course, not all GIFs are created equal. While many have long-term and even multi-generational time horizons, others have potential short-term liabilities due to a stabilization mandate related to budgetary smoothing objectives. For the latter, an entirely long-term portfolio is not appropriate. The distribution of potential calls on funds has broad ramifications for risk and return objectives, asset mix, and the appropriate liquidity level of investments.

As boards of GIFs debate investment objectives and risk-return hurdles, one of the many macro questions being asked is the degree to which a GIF should take into consideration the underlying risk-return issues and challenges facing the country. This debate is important. But the implications may be interpreted to run counter to mutual responsibility discussions, particularly as it relates to the desirability of pure commercial investment strategies in a narrow sense. In a broader sense, however, it is sound commercial logic to consider return correlations with assets of the same beneficiaries that are outside the fund. The most obvious example of this would be a country that is benefiting from high commodity prices as an oil exporter and makes an investment decision to under-weight energy within its GIF portfolio. The opposite side of that coin, of course, is a non- energy-exporting country over-weighting allocation to the energy sector as a hedge against the country’s resource vulnerability – such decisions, long the preserve of static investment policy statements, ought to be made very dynamic.

One of the central debates within the early-stage GIFs is around the merits of investing directly or indirectly in so-called “alternative” assets. While the growth and importance of alternatives is a given, the pros and cons of investing directly into real estate, infrastructure or corporate transactions, versus investing into funds with those objectives merits serious discussion. Much of the issue centers around experience and comfort levels; some think that there is a logical learning curve that starts with the indirect approach, graduates to co- invest positions and only later moves to hiring professionals and the in-house management of direct investment decisions

Turning to the risk side of the investment debate, periodic market turmoil results in a global re- assessment and re-pricing of risk. Risk measurement best practices are under review as skew, liquidity and correlation assumptions in extreme market conditions are re-evaluated. During market turmoil risk organizations in financial institutions (insurance, banks and asset managers alike) are shaken and revamped on a regional and increasingly a global scale. But where there is turmoil and volatility, there is often also opportunity. One of the more important decisions to be made in times of market dislocation is the degree of flexibility – given to a GIF in tactical asset allocation decisions and the skill required for a GIF to execute successfully in this area. This relates directly to the ability to take advantage of a long investment horizon to make market timing decisions and to significantly overweight a given asset class, sector, region or market segment. Away from the strategic asset allocation investment policy, the tactical asset allocation policy is an important internal decision within the control of any GIF.

An example, during the 2008 financial crisis, large-scale investments in the banking sector represented opportunistic market timing calls in tactical asset allocation. While there has been political attention drawn to the scale and significance of these investments, it has been recognized that the consequences would have been even more severe if these investments had not been made and if the banks not been recapitalized, allowing them to continue to provide global liquidity. But did GIFs know how this would pan out or did they go by gut-feel?

In thinking about the above themes, important questions come to mind:

  • What lessons in the area of investment policy can be learned by the GIFs from the relatively evolved asset management industry? What about large endowments that share common long-term investment horizons and limited short-term liabilities? To what extent should the relatively successful asset allocation mix of endowments be replicated by GIFs?
  • What are the best practices in the area of evaluation and management of risk within GIFs? How have risk management positions been most successfully staffed? Are the framework, technology and investment mandates clear in order to effectively manage risk?
  • How has past turmoil in global financial and credit markets changed perspectives on risk management and measures? Have views of left tail risks, illiquidity risk and correlation and contagion risk been meaningfully altered considering past events?
  • How much flexibility should GIFs incorporate in tactical asset allocation policies? Do market dislocations represent an opportunity to make skill-based market timing, over-under weighting decisions that will have a material long-term impact on investment returns? What are some of the largest opportunities?
  • How can a government best take account of its economic and financial position (such as trade flows, current account balances and natural resource positioning), as it determines the investment objectives of its GIF(s)?
  • Should short-term stabilization funds be broken out and managed differently from the inter- generational funds? Should asset allocation be based on risk-based budgeting at all?
  • What responsibility should GIFs have for global financial market stability and functionality? If GIFs were required to make investment decisions as a purely commercial entity, as say would a hedge fund, is there potential for systemic risk?
  • When considering accounting and values of holdings, does ‘marking to market’ make sense in very long-lived funds? If not, what is the alternative?

Central Bank Reserve Management: Developments 2020

ActiveAllocator is grateful to the Bank of International Settlements and the European Central Bank for their generous support. Here is our first piece (of hopefully many) on “Central Bank Reserve Management: Developments 2020” – where we surveyed 47 Central Banks to derive real world insights for you .

email me for pdf