So, What Are Sovereign Wealth Funds Targeting?: Assessing Benchmarks

In the midst of the frenzy about the motivations of sovereign wealth funds, there has been surprisingly little attention to what these funds are actually targeting.

Both sovereign funds and those receiving their funding have focused instead on whether they have a stabilizing role, whether they are active passive investors, the fact that they have a long-term investment horizon, on average. But there is little focus on their disclosed benchmarks. In part this is a result of the opacity of many funds , that is the lack of information most disclose on their targets, investment strategy and holdings. In part, it reflects the increase in high profile direct acquisitions which at present remain a relatively small share of total holdings of most sovereign wealth funds. though that could change, if one extrapolates from recent investments of some funds. On the other hand, recent purchases could also be a one-off opportunity. In particular funds might be starting to think they are overexposed to the financial sector.

In an effort to move beyond the debate on whether SWFs are stabilizing or not, this note surveys the disclosed benchmarks and return targets of sovereign wealth funds. to skip to the nitty gritty details check below the fold. These targets give some indication of what markets SWFs are invested in, their investment approach and how they compare to public and private sector counterparts.

– The funds of Norway, Kuwait, Singapore, Saudi Arabia, Korea and Kazakhstan all disclose some of the benchmarks they target in their active and passive mandates though the amount they disclose varies. With the exception perhaps of ADIA which uses its own internal and undisclosed benchmark, funds that have a higher reliance on portfolio investment and use of external managers tend to release more benchmarking data. In part this may reflect the primacy such data has in monitoring asset managers.

– Some (Alberta, Alaska and Norway) disclose detailed benchmarks relevant to different parts of the portfolio, the deviation between their strategic asset allocation and actual current holdings and the excess returns achieved over their benchmarks. Others disclose merely the overall benchmarks for equities and fixed income.

– More activist funds focused on acquiring concentrated public and private equity stakes tend to disclose even less – only an overall return target, more consistent with their potentially more volatile returns. However, it may be safe to assume that these funds use internal targets comparable to private equity firms and perhaps those of the more transparent funds that are exposed to private equity.

– The benchmarks reveal differences between the funds. Those that have a more stabilization purpose in mind or who are at early stages of diversification process tend to be most exposed to the g-10. However, the fact that many funds disclose only benchmarks used and not the share of the portfolio to which they are allocated does mean that we should not read too much into benchmarks.

China’s Investment Corporation is a key case to watch. The CIC included the benchmarks and targets that it expects external managers to outperform in its recent call for proposals to manage equity and fixed income mandates. The release of such details not only reveals the benchmarks of choice, MSCI All Country, EM, EAFE and related bond indices but also their regions of interest and projected returns. Netting out fees, the CIC expects returns 150-200bps above the selected equity and fixed income benchmarks (see below for details). In some cases (AXJ equities) the CIC, or the mandate-seeker must propose a suitable weighted benchmark.

China has not disclosed the size of these mandates nor the size of funds allocated to portfolio investment. but In its quest to get up and running to start making returns, the CIC may entrust a significant share of the $40-50 billion as yet unallocated resources to external managers. This would be consistent with the pattern of other SWFs – Norway, ADIA, Kuwait, Korea, GIC and others entrust a large share of assets to external managers though on average this is decreasing overtime as funds seek to manage more funds internally. For example in 2000, practically all of Norway’s equity holdings were managed externally, in 2006, less than 40% were. However, this round of investment closely tied to indexed funds, many only be one step in China’s investment deployment.

The CIC is – reportedly – already under considerable pressure to make high returns, because of its financing structure. The CIC was funded by means of a swap between the ministry of finance and central bank with MoF issued bonds offsetting foreign assets received from . These bonds (in RMB), issued by the finance ministry were either sold to the central bank through an intermediary (the Agricultural Bank of China) or directly to the public (about 15%). for details see a previous post. The Chinese CIC will need high returns in dollars to make sufficient returns to meet its interest payments especially as the RMB is likely to keep rising over the dollar. Li Liming warns that CIC may have trouble finding the returns from dividends to meet its first interest payment of 12.9 billion RMB at the end of February, suggesting that so far only the shares in China’s recapitalized banks are profitable. Furthermore, Li suggests, Central Huijin (now CIC) may lose on the the fx swaps between the government and the banks.

Apparently such concerns are weighing on Chinese policy makers and influencing decisions – perhaps accounting for the high returns they seek. As Rozanov noted, a sovereign funds’ financing structure and long-term liabilities do and should inform its strategy and risk-return assessment. As with all reserve-funded SWFs, a base goal is to make higher returns than the cost of domestic sterilization bills, which traditional reserve assets tend not to.

The rest of this note summarizes what is known about benchmarks and targets of key sovereign wealth funds. Overall, most funds use the MSCI All country Index as their primary (equity) target, with a range of indices being used as a global bond target (JP Morgan, Lehman brothers etc)


China is reviewing proposals for actively managed mandates in equities and fixed income. Eligible firms manage at least $5 billion in assets, have six year track records and have not been guilty of securities violations.

These mandates are to be based on the following return targets

Equities; Return net- of-fees 300 bps above MSCI All Country Index for global equities 200 bps above EAFE 300 bps above MSCI EM Asia ex – Japan, benchmark to be suggested by manager seeking the mandate Fixed income: 150 bps above a GDP-weighted bond index EM: 200 bps above the JP Morgan EMBI Global

Although mandate size and share of the portfolio is not disclosed, these benchmarks imply a high exposure to Emerging markets, especially in Asia – and potentially relatively small exposure to the US. This is consistent with a general and ongoing diversification trend among sovereign funds and as a result of nations entrusting more assets to sovereign funds which tend to invest in riskier assets. Many sovereign funds are planning to further increase their exposure to Asia and EMs – but will th
ere be enough things to buy? An earlier FT piece on GCC investment in Asia seemed to indicate that several GCC public and private investors were struggling to find good deals especially in China.

The new mandates may be an attempt to balance out China’s existing US exposure through CIC’s stakes in two US financial institutions (Blackstone and Morgan Stanley) as well as SAFE’s reserves (dollar share is likely 70%). Alternatively, the CIC might prefer to manage some US exposure in-house or prefer investment in alternatives – not equities and fixed income. It may prefer co-investment alongside the likes of Blackstone to an indexed mandate.

It will be worth watching to see how these mandates are bestowed and if there are further direct investment purchases. Not only does the disclosure of this information give some indication of the CIC’s strategy, it could be a clue about the degree of transparency China will pursue.

Kuwait discloses key benchmarks on its website though it does not state the share of portfolio to which they belong.

Overall, the fund for future generations, whose equity allocation is about 60%, aims to outperform the MSCI global index. Since a restructuring beginning in 2004, which took Yale’s endowment as a model, the fund has upped alternatives and EM exposure to about 15% and aims its equity allocation on shares of global GDP – though its large Daimler stake makes it overweight Europe.

Its regional equity mandates are compared to relevant indices such as the S&P500 for US large cap stocks and the S&P/TSX Composite for Canadian large Cap stocks. Comparable benchmarks are selected if undisclosed for its Small, Medium and Large cap stocks in Europe, Japanese, Asian and EM equity and North American European, Asia and EM fixed income mandates.

UPDATE: KIA announced plans to up its allocation in GCC equity funds. It also disclosed guidelines for these funds and the managers here. This increase will join holdings already in the reserve fund. In part previous funds invested in Kuwait were intended to help develop asset management industry (following in Singapore’s lead perhaps).

Kuwait is one of the few funds (see Alberta and Alaska below) that discloses alternative investment benchmarks.

Private Equity: 500bps return greater than the rolling 10-year average of S&P 1200 Global Index Hedge Fund: 100bps return above HFRI Fund of Funds

Real Estate: 125 bps return above UBS Global real estate index

Norway: Norway’s strategic benchmark is based on FTSE large and mid-cap equity indices for the 27 countries in which Norway invests. Lehman Brothers Global bond Aggregate and Global fixed income indices in 21 currencies.

Norway’s actual benchmark tends not to deviate greatly from is strategic portfolio. Norway also reports the excess return it receives from. At the end of Q3 2007, Equities made up about 42% of the portfolio – it is in the process of upping the Equity share to 60% which will also increase its exposure to Asia and decrease US exposure. At present and in its strategic portfolio, Norway has rather little exposure to EMs. (Norges Bank)

Saudi Arabia

An old report (perhaps circa 2002-3) suggested that SAMA used the following benchmarks in its portfolio. It seems reasonable that this is still the case. Equities: S&P 500 (US) , MSCI (Europe and Global), TSE (Japan) Fixed Income/cash: JPM Global Bond Index, 3-month Libor (cash/deposits).

SAMA is thought to have a certain share of equities among its non-reserve foreign assets (around $250 billion in November 2007). They also include small holdings of corporate bonds ranked AA or higher by S&P. SAMA also manages almost $60 billion in foreign assets on behalf of other government institutions – likely Saudi pension funds. These likely also contain a split of equity and fixed income holdings abroad. Equity is outsourced to professional asset managers.

SAMA’s vice governor recently suggested that Saudi Arabia was planning a new sovereign fundwhich would invest in foreign equities. The fund, to be spearheaded by the Public investment fund within the finance ministry, might – he suggested – begin with $6 billion. This is considerably lower than estimates cited in the FT or Saudi foreign assets.

Any new fund could well use similar targets to SAMA, particularly if funds are entrusted to external fund managers. Although the fund is starting with a small amount, it might quickly grow either if it received some of Saudi Arabia’s existing foreign assets or a greater share of new assets.

Korea: The Korean Investment Corporation (~$20b) targets the Lehman global bond index and MSCI world equity in line with its 70% bonds, 30% equity target.

Until recently its whole portfolio was in very liquid assets, most sovereign bonds. It will now begin to invest in equities and corporate bonds and to increase the share managed internally from the current almost zero level to 25% by 2008.

Technically the KIC’s holdings remain part of Korea’s reserves held by the central bank and ministry of finance.

Singapore: GIC’s main target is to beat G3 inflation which it claims to have done since 1981 – with an average of 9.5% returns in USD terms over the 25 year period until 2006.

Benchmarks include the MSCI World equity and enhanced Lehman global bond indices. GIC’s portfolio is thought to be about 50% equity, 20% bonds and as much as 30% alternatives (private equity, property, commodities).

In 2001, GIC noted that its in-house managers achieved similar returns to those external managers.

GIC outsources a significant share of its assets, in part a process to develop Singapore’s asset management industry by entrusting a share of reserves.

Temasek, Singapore’s direct investment arm discloses no benchmarks of which I am aware.

Kazakhstan: As much as 25% of Kazakhstan’s $22 billion National Fund may be in equities with the remainder in deposits and fixed income.

Benchmarks: The National Fund targets the Merrill Lynch 6-month T-bill index, Salomon World Government Bond Index and MSCI World Equity excluding energy.

According to Spring 2007 remarks, the fund’s equity benchmark is 45% S&P 500, 30 % DJ Euro
STOXX 50, 10 % Nikkei 10% FTSE, and 5% S&P ASX.

It has no holdings denominated in EM currencies – holdings are in USD, EUR, GBP, JPY and AUD.

Alaska: Alaska’s permanent fund uses a series of benchmarks applicable to its holdings. It discloses the benchmark associated with each mandate entrusted to an professional asset manager on its website. It uses these benchmarks also to measure funds managed internally, especially bonds.

Key benchmarks include: Equities: S&P 500, Russell 1000, Russell 2000 (US) MSCI EAFE, EM

Bonds: Lehman Aggregate Lehman U.S. High Yield 2% Cap and Salomon non-US World Gov Bond(50% hedged) (non-US bonds)

Alternatives: Libor+ 4% (absolute return strategies), 5.5% return above inflation (Infrastructure)

Real Estate: Morgan Stanley REIT, NCREIF Classic (Real Estate)

for Private equity, It uses a custom benchmark that assumes 13-15% absolute long-term real return net of fees (an assumed 25 – 50% premium to public equity markets.

Alberta: Alberta’s Heritage fund ($17b) discloses the benchmarks that underpin its strategic benchmark portfolio and notes how the share of actual holdings deviate from this strategic benchmark. Key benchmarks include

fixed income: Scotia Capital Universe Bond Index

Equities: Standard & Poor’s / TSX Composite Index (Canada), Standard & Poor’s 1500 Index (US) MSCI EAFE (non-north America)

Property: Investment Property Databank Large Absolute Return strategies: HFRX Global Investable Index (hedged in C$)

Private Equity (8% above inflation – CPI). It outsources most of its private equity and a significant share of equities.

The remaining funds do not – as far as I am aware – disclose benchmark information.

Abu Dhabi: The Abu Dhabi Investment Authority which manages around $650 billion (RGEestimate) does not disclose any benchmark. A 2006 Euromoney interview described an internally set benchmark, with derived targets for internal and external managers to meet in their various mandates.

Other GCC funds: Given their focus on concentrated bets in private and public equity, most of the smaller more activist GCC funds (QIA, DIC, Isthithmar, Mubadala) don’t disclose an equity benchmark. They do however target returns of approximately 15%, goals in line with with state d high exposure to private equity, property and concentrated stakes in public equity, scaled up with leverage. Qatar aims for a 15% annual return. DIC similarly targets returns in the mid-teens.

Russia: Russia’s new wealth fund officially created February 1 (see more here (Nyt) here (Morgan Stanley) and here (RIA)) has not disclosed any benchmarks and will not do so until consensus surrounding its investment strategy is reached. A debate on Russia’s investment horizon that is when Russia will be allowed to tap the fund for pension and other payments – is delaying the shift to higher risk assets. For the foreseeable future, at least till September, its assets will remain in conservative government bonds similar Russia’s reserve fund (the new stabilization fund). Finance ministry officials have stated that it may turn to professional fund managers to manage the wealth fund once it branches out to corporate bonds and equity. At such a point it may use comparable benchmarks to other funds.

At present it has no exposure to emerging markets, with approved countries with a currency split of 45 USD 45 EUR and 10% GBP. Both the reserve and wealth funds now invest in government and agency bonds of a wider variety of countries in the EU15, US and US. UPDATE: I may have jumped the gun in assuming that Russia had already added Japan and some other countries to the list of those approved.