By Ashby Monk
This blog is a source of open discussion and engagement on the topic of SWFs. As such, we welcome and indeed seek out all views and opinions on the subject. Today, we offer the third instalment of what is becoming a routine segment: “Q&A with a SWF expert, stakeholder or policymaker”. We are pleased to welcome Professor Gordon L. Clark of the University of Oxford. While Prof. Clark’s views are his own, his perspective helps to further debate and facilitate understanding.
NOTE: Q&A will be taking the rest of the month off. Our next Q&A is slated for September 5th, 2008.
Ashby Monk: Prof. Clark, what is your interest in SWFs? How do they fit into your research agenda?
Gordon Clark: I am very interested in the governance of financial institutions whether they be sovereign wealth funds, pension funds, or for that matter rate-setting organisations such as the Bank of England and the European Central Bank. In this respect, sovereign wealth funds are extremely important albeit new players in the global financial world. They may play a pivotal role in galvanizing resources for future investment at a time when the developed economies’ financial resources are constrained as they seek to recover from the current crisis. Sovereign wealth funds are simultaneously a reflection of global economic integration and an instrument for further global economic development should they be tamed and focused upon long-term rates of return. Equally, sovereign wealth funds have the potential to be significant players in global political intrigue and hostilities.
Ashby Monk: You’ve done a remarkable amount of research on the governance of pension funds. Can you briefly tell us what your research tells you about how SWFs might be governed?
Gordon L. Clark: My interest in the governance of pension funds is both a theoretical question and intensely practical issue. Understanding the design and structure of such institutions and how those elements affect performance are the crucial issues involving myself but also others such as Roger Urwin from Watson Wyatt. With Roger, we have developed principles of best practice governance (see the recent paper published in the Journal of Asset Management). We are concerned with enhancing investment performance, considering how the organization of a pension fund including the allocation of roles and responsibilities may affect the rate of return as well as the long-term variance in returns. We believe a well-governed pension fund like a well-governed sovereign fund can affect the long-term performance of institutions such that nominated beneficiaries have their welfare enhanced and protected.
Ashby Monk: That raises an interesting point: we’ve seen a lot of different definitions for SWFs in varying literatures. How would you define a SWF, and how is it different from a public pension fund?
Gordon L. Clark: In defining a sovereign wealth fund and comparing it to pension funds lets begin with what a pension fund is and then let’s work back to what a sovereign fund is and is not. In general, a pension fund is a beneficial institution, with an intended beneficiary who often claims a property right to a promised benefit or expected benefit. Furthermore, the pension fund is often underwritten by a sponsor such that the institution guarantees the payment of benefit should the pension fund fail to deliver. Pension funds are governed by boards that combine representation with expertise with an underlying fiduciary duty to the intended beneficiary. Granted, this sounds idealistic. Nonetheless, these principles are accepted as determining the intended purpose of pension funds as we know them.
By contrast, we can say what sovereign wealth funds are not. That is, they are not beneficial institutions with an intended recipient: no one, whether beneficiary or citizen, has a property right to an expected benefit, and more often than not the government sponsor does not underwrite its performance except where the sovereign wealth fund writes a private contract with other investors wherein its promised performance is in some way or other underwritten by the government as a commercial entity. This means that sovereign wealth funds are quite different institutions than pension funds (as we know them).
I think we can identify a number of common characteristics among sovereign funds notwithstanding the many differences. For example, sovereign wealth funds are typically an operational arm of government, held within the boundaries of the sponsoring government in some form or another. Sovereign wealth funds are often subject to government policy whether in terms of the intended purpose of specific investments or an overarching strategy as regards to the deployment of assets locally and globally. Sovereign wealth funds are often managed internally, albeit with contracts with external investment providers. Sovereign wealth funds often seek investment opportunities in the rest of the world; perhaps paradoxically, because of the transparency, security of investment, and promised rate of return of developed financial markets and economies. Sovereign wealth funds are often long term investors, operating far beyond the ups and downs of markets, market cycles, and intermediate financial crises. Nonetheless, it is difficult to determine the time horizons of sovereign wealth funds. It might be said that one reference point might be endowment funds or charities and public institutions. This issue is very important in understanding the motives and operation of sovereign wealth funds.
Ashby Monk: Take us out 10 years – what is the status of SWFs?
Gordon L. Clark: It seems inevitable that sovereign wealth funds will be much larger in terms of the volume of assets held by those institutions. Granted, their growth in assets will depend, in part, upon the price of commodities. Likewise, the growth of assets may well depend upon the global rate of economic growth and the continuing demand from the developed economies’ for developing economies products and services. That a number of sovereign wealth funds have been reliant upon trade and commerce for the accumulation of foreign currency reserves suggests that there is an intimate relationship between trade, exchange, and the accumulation of sovereign wealth fund assets.
That these institutions will have more assets need not translate into being effective in the global economy. Here I can see two issues that will need to be resolved. First, their influence will depend on how well they are governed and whether their governance is effective and professional as regards the rate of return or whether their governance is a product of political opportunism. If it is the latter, if political opportunism is the driving force, then I can see the rest-of-the-world putting-up barriers against sovereign wealth funds and effectively neutering their impact upon developed economies. There is a second issue that is related. Will sovereign wealth funds be incorporated into global capital markets? Here, the answer may well rest with the degree to which those institutions are able to attract and retain skilled investment professionals. If they are unable to recruit talented financial professionals, at least against the terms and conditions that drive global financial markets, sovereign wealth funds may be forced to retreat from playing an active and continuing role in the flux and flow of global finance. They will be forced into economic and political leverage which may or may not be reap the benefits intended by their government sponsors.
Ashby Monk: Thanks, Professor Clark, for taking time out of your busy schedule to chat with us today.
We continue to seek out guest bloggers and question & answer participants. Please contact Brett Keller for details on doing either.