The Deutsche Bank "Asset-Liability Management Techniques for Sovereign Wealth Fund Management" Research Chair
EDHEC-Risk Institute has created a research chair in "Asset-Liability Management Techniques for Sovereign Wealth Fund Management", in partnership with Deutsche Bank, under the scientific responsibility of Lionel Martellini, Scientific Director of EDHEC-Risk Institute.
It is now widely recognized that sovereign funds represent a dominant force on international financial markets. By some estimates, the total size of sovereign wealth funds currently stands at $2.9 trillion, which amounts to approximately 60% of the world's foreign exchange reserves and exceeds the estimated size of the world's hedge fund industry (around $1.5-$2.0 trillion). The growth of sovereign wealth funds is in fact likely to continue, and is expected to reach around USD28 trillion by 2022, which is more than double the amount of FX reserves ($13 trillion), with their share in global financial asset holdings expected to grow from 2.5% in 2007 to 9.2% in 2022 (Morgan Stanley (2007)).
This rapid growth of sovereign wealth funds and its implications pose a series of challenges for the international financial markets, but also for sovereign states. The purpose of this research chair is to focus on improving our understanding of optimal investment policy risk management practices for SWFs. In particular, we ambition to analyse the optimal investment policy of a SWF in a dynamic ALM framework that will allow us to formalize the impact on the optimal allocation policy induced by the presence of risk factors affecting i) the state surplus dynamics and ii) the (implicit or explicit) liabilities the fund is facing.
Once the long-term strategic allocation has been defined, a number of implementation issues remain, in particular those related to reconciling a top-down asset allocation perspective and a bottom-up long-term security selection strategy. In fact, it is very legitimate for SWFs to seek long-term alpha opportunities, and/or consider reaching strategic stakes in selected target companies, an effort for which they are better equipped than hedge funds, which have a shorter time-horizon, or pension funds, which have lower risk budgets/margins for error and are subject to a number of short-term regulatory constraints.
This research programme will include the following developments:
- Introducing a formal dynamic asset allocation model that will incorporate the most salient factors in SWF management
- Proposing an empirical analysis of the risk factors impacting the inflows and outflows of cash for various sovereign funds, with a specific example in each of the two main categories (foreign reserve fund and natural resource fund)
- Discussing how investment banks and asset managers could design dedicated solutions for SWFs based on the financial engineering of customised building blocks aimed at facilitating the implementation of the intertemporal hedging demands related to the presence of a variety of risk factors impacting sovereign surpluses (where the money is coming from) and liabilities (what the money will be used for).
Research output:
- Macroeconomic Risk Management for Oil Stabilization Funds in GCC Countries
The existence of oil stabilization funds as the largest category of sovereign wealth funds relies on oil prices as a main source of macroeconomic risk for oil exporting countries. Given the often contingent spending policies of oil stabilization funds (accumulating wealth when oil prices are rising and spending wealth to support the local economy when GDP is shrinking) it is important to understand the magnitude and relative importance of oil price shocks relative to other sources of macroeconomic risk.
Using the Bernanke/Sims approach, this paper establishes oil price innovations as the most important short- and long-term economic drivers of local GDP for GCC (Gulf Cooperation Council) countries. Investment guidelines for oil stabilization funds should therefore stress the necessity to invest in assets with negative correlation to oil price movements to protect the total wealth of an oil-exporting economy. Using a Bayesian VAR, the paper projects the impact of different oil price scenarios on local GDP and hence the likely growth of oil stabilization funds.
Related articles:
- "EDHEC points the way for SWFs," Lionel Martellini, December 2008, FTfm
