CAIA L2 - 4.4 - Sovereign Wealth Funds

Question 1

Formula

Δ reserve account

4.4 - Sovereign Wealth Funds

Answer 1

Δ reserve account =
Δ current account + Δ capital account

Δ current account = exports - imports
Δ capital account = inflow - outflow

4.4 - Sovereign Wealth Funds

Question 2

List

A country’s currency will tend to appreciate if the country has…

4.4 - Sovereign Wealth Funds

Answer 2

• lower inflation compared to other countries,
• higher real interest rates compared to other countries,
• policies that promote capital inflows,
• slower income growth compared to other countries (results in fewer imports), and
• an absolute or comparative advantage in production of goods for export.

4.4 - Sovereign Wealth Funds

Question 3

List

2 Concerns
of a country with dependency of
commodity export

4.4 - Sovereign Wealth Funds

Answer 3

1. Revenue volatility - commodity prices = high volatily; need do diversify revenue stream (development SWF)
2. Depletion

4.4 - Sovereign Wealth Funds

Question 4

List

four types of SWFs
and main characteristics

4.4 - Sovereign Wealth Funds

Answer 4

• Stabilization Funds - smooth volatility - more cash + fixed income
• Saving Funds - benefit future generations - more equity - often have an annual spending rate (like endowments)
• Reserve Funds - meet specific future liabilities - more equity (but pension reserve = more alternative)
• Development Funds - diversify economy - more equity

4.4 - Sovereign Wealth Funds

Question 5

Define

Dutch Disease and Sterilization

4.4 - Sovereign Wealth Funds

Answer 5

Dutch Disease

inflow of foreign currency damages the long-run health of a local economy

Exports less competitive because of:
1. higher wages - workers seek into the commodity-producing sector
2. Appreciation of local currency

Sterilization process - conteracts by
* CB buy foreign currency (selling local) + sell bonds in local currency (avoiding inflation)
* Hold excess foreign currency IF exporter is state owned.

4.4 - Sovereign Wealth Funds

Question 6

Define

Reserve adequacy
(in stabilization funds)

4.4 - Sovereign Wealth Funds

Answer 6

Amount necessary
to offset
commodity price volatility and other
potential sources of shocks.

4.4 - Sovereign Wealth Funds

Question 7

List

Linaburg-Maduell Transparency Index

created by
Sovereign Wealth Fund Institute (SWFI)

4.4 - Sovereign Wealth Funds

Answer 7

Does the SWF ___

1. provide historical data on its formation, source of funds, and governmental ownership structure?
2. provide current and independent audits of its annual reports?
3. disclose ownership percentages in portfolio companies and the geographic location of its holdings?
4. provide total portfolio market value, actual returns, and management fees?
5. provide guidelines for internal ethical investing and enforce its policy?
6. disclose clear strategies and objectives?
7. clearly identify any subsidiaries and any relevant contact information?
8. clearly identify any external managers (if applicable)?
9. manage its own website?
10. provide contact information and the location of its main office?

Sovereign Wealth Fund Institute (SWFI)
recommends a score of at least
8 out of 10 for a SWF to claim
sufficient transparency

4.4 - Sovereign Wealth Funds

Question 8

List

Santiago Principles

4.4 - Sovereign Wealth Funds

Answer 8

• A well-defined investment policy
• Diligence, prudence, and skill in investment management
• A strong risk management structure
• Avoid satisfying any objective other than maximization of risk-adjusted returns
• Public disclosure of voting and board representation methods
• Not pursuing privileged information
• Explanation of the use of leverage and full disclosure of financial risk exposure
• Execution of ownership rights consistent with the SWF’s investment policy statement
• A transparent operational control and risk management process

4.4 - Sovereign Wealth Funds

Question 9

Analyze

Governance and management of:
* Norwegian Government Pension Fund Global
* China Investment Corporation (CIC)
* Temasek Holdings (Singapore)

4.4 - Sovereign Wealth Funds

Answer 9

Norwegian Government Pension Fund Global
* Funded by oil revenues
* Managed as perpetual endowment
* Recognized as model of governance

China Investment Corporation (CIC)
* Originated from manufacturing exports
* Operated as reserve investment fund
* Lack of transparency + political risk

Temasek Holdings (Singapore)
* Funded by privatization
* Operated as development fund
* Essentially equities (private + public)

4.4 - Sovereign Wealth Funds