Portfolio & Risk Management for Central Banks and Sovereign Wealth Funds

My Chapter on “Portfolio & Risk Management for Central Banks and Sovereign Wealth Funds” published by Palgrave Macmillan ——

Attached my piece published by Palgrave Macmillan in a book as part of proceedings of the World Bank, Bank for International Settlements, European Central Bank Public Investors Conference.

This will be of interest to those seeking original readings on Reserves Management for central banks and sovereign wealth funds. It aims to outline best practice in respect of strategic asset allocation, facilitating knowledge-sharing across organizations and encouraging collaboration and dialogue between reserves and asset management specialists.

Sovereign Wealth Funds – ESG Activity Lagging

These, as a cohort are lagging other institutional investors such as pension funds. Some exclusion criteria is used; and in a few  cases some environment related investments have been made. They can do a lot more.

As long-term investors: They can reap long-term returns of environmental, social risk adjusted portfolios and ESG engagement. They can provide a source of stability in the capital markets.

As passive investors: Not always a good thing as this could dilute shareholders power and create a governance gap

As active investors: Engagement with the companies in which they hold some stakes.  Make clear that the influence is purely economic based for any other type of  influence could be a risk for other investors and the companies in which they  hold stakes.

Strategic Asset Allocation Improvement and Superior Implementation

#ActiveAllocator Research Case Study – We successfully demonstrated to the world’s perhaps most sophisticated Government Investment Fund that our proposed changes to their strategic portfolio could increase annual returns by over 60 bps, while holding risk constant. That’s a non-trivial returns enhancement when you are speaking about hundreds of billions of dollars. Never underestimate the power of Strategic Asset Allocation done correctly.  We further demonstrated concrete steps to enhance their portfolio by approximately 40 bps as described here. Here is a snapshot of one such portfolio sleeve by way of illustration (NDA prohibits us from disclosing specifics).

4-SAA Case Study continued

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