What do SWF practitioners think?
Following the publication of its foundation paper by Martellini and Milhau in 2010, EDHEC-Risk Institute issued a call for practitioners’ reactions to the application of ALM in sovereign wealth funds. Reactions show that most practitioners find applying an ALM framework to SWFs allows for a better understanding of optimal-investment policy and risk-management practices. However, there is concern that the three building blocks suggested above could be too simple to match the strategic objectives of the SWF.
A large majority of the sovereigninvestment practitioners surveyed manage short-term constraints and implicit liabilities, and they believe that the ALM framework provides a better understanding of optimal-investment policy and riskmanagement practices. The majority of respondents recognise the need to hedge endowment fluctuations and endorse the approach put forward by EDHEC Risk Institute. Sovereign investment practitioners lament a lack of dedicated ALM and risk management solutions.
Engage stakeholders across state assets
It is a common misconception that SWFs do not have explicit liabilities and, as a result, an ALM framework might not be appropriate for SWFs’ investment and risk management. Respondents to this survey confirm that applying a dynamic ALM framework offers important insights into SWFs’ optimal investment and risk management. For a summary of the results, see the box above.
While the majority of respondents find the fund-separation approach appropriate for SWFs, some express concerns that using the three main building blocks for decision-making would oversimplify the investment decisions. However, the framework is fully customisable and, in reality, the structure of the building blocks, as well as the dynamic allocation between them, reflect the objectives and the constraints of each particular SWF. The expressed concerns indicate that more applied research and education are needed to illustrate how the approach can be tailored to a particular fund.
Another obstacle mentioned by some respondents is that ALM is generally viewed as a country-level approach, while SWFs may be managed separately from the rest of the state’s assets and liabilities. While the follow-up publication to the foundation paper (Scherer, 2011) showed how to extend the framework to account for the sovereign sponsor’s economic balance sheet in optimal policy, doing so is usually not expected of SWF managers.
This indicates the need to engage multiple stakeholders managing state assets and liabilities, and for further research into solutions tailored to particular models of corporate governance.
In fact, integrated ALM does not require giving a single entity control of all assets and liabilities. Management of sovereign assets and liabilities can continue along the existing administrative lines provided the SWF is given information about the state assets and liabilities beyond its control, and its mandate is updated so that these assets and liabilities can be taken into account when defining investment policy.
Frédéric Ducoulombier is director of EDHEC Risk Institute–Asia in Singapore.
