(April 19, 2011) — Australiashould create a sovereign wealth fund to manage the proceeds of its mining boom, Robert Mead, managing director and head of portfolio management at Pacific Investment Management Co. (PIMCO), told Dow Jones Newswires.
The Australian government may be wise to use Norway’s oil fund, Norges Bank Investment Management, as the archetype.
“The Norges bank model has obviously been a very successful model,” Mead told Dow Jones, adding that for Australia’s model, “quarantining the additional revenues raised from the resources boom should be fed into a long-term fund structure.”
In 1990, Norway set up its sovereign wealth fund to invest proceeds from the country’s petroleum reserves. Today, the fund is the world’s second-largest sovereign wealth fund, valued at around $548 billion at the end of 2010.
While helping to stabilize the economy, an Australian sovereign wealth fund that would capitalize on the country’s mining power may lead to a healthier and more robust bond market. Deutsche Bank’s fixed-interest strategist David Plank told The Australian that bank liquidity demands alone mean Australia needs a bigger bond market than was originally deemed necessary. “It is an open question as to how large it needs to be, but if it were $200 billion, the government would have to start thinking about what it does with its funds as soon as it gets back to surplus,” Plank said, noting that the financial crisis highlighted the strategic importance of the government’s bond market.
If Australia does venture down this path, the next question will be how to manage the capital — and whether to follow other leads into alternatives. In assessing the continued growth of sovereign wealth funds around the world following the economic downturn, Sam Meakin, managing editor of the 2011 Preqin Sovereign Wealth Fund Review, told aiCIO: “An increasing proportion of SWFs are also diversifying into alternative investments, meaning that they are becoming more important to the global alternatives landscape as sources of capital for managers operating in this space.”
Following the financial crisis, many sovereign wealth funds have revised their investment approaches. In November, a paper by EDHEC noted that the rapid growth of sovereign wealth funds, which currently have assets of more than $3 trillion, or more than twice the estimated size of the world’s hedge fund industry, pose a series of challenges for the international financial markets and for sovereign states. Specifically, the report recommended that the investment strategy for sovereign wealth funds should involve a performance-seeking portfolio (typically heavily invested in equities), an endowment-hedging portfolio, and a liability-hedging portfolio (heavily invested in bonds).
The paper, funded by Deutsche Bank and titled “Asset-Liability Management Decisions for Sovereign Wealth Funds,” found that sovereign wealth funds should divide their investments into returns-seeking and hedging portfolios tailored to their income from — and payouts to — their state sponsors. The paper compared this approach to the liability-driven investing paradigm developed in the pension fund industry, where it is recognized that hedging out the impact of risk factors on liability values is the first priority when designing asset allocation strategies, the paper’s lead author, Lionel Martellini, a professor of finance at EDHEC Business School and scientific director of EDHEC-Risk Institute, told aiCIO.
To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742