Institutional Investment - October 27, 2010

Matching sovereign surplus timings with anticipated future liabilities will be a key issue - an interview with Boon-Chye Loh

In this month's interview, Boon-Chye Loh, Head of the Corporate and Investment Bank, Asia Pacific, at Deutsche Bank, discusses the specific challenges involved in catering to Sovereign Wealth Funds, Deutsche Bank's business strategy in this regard, and the output of the Deutsche Bank research chair on Asset-Liability Management Techniques for Sovereign Wealth Fund Management at EDHEC-Risk Institute, notably the first-year publication from the chair entitled "Asset-Liability Management Decisions for Sovereign Wealth Funds."

Boon-Chye Loh

How does Deutsche Bank approach sovereign wealth funds (SWFs) as a clientele?

Boon-Chye Loh: SWFs require a carefully orchestrated coverage model that interacts with the various touch points of the organisation including the executive office, the chief investment officer, risk and portfolio managers, but also executives in wholly-owned or associate companies, to cite just a few.

Of the nearly forty SWFs in existence today, only ten were in existence pre 1993. Nations with surplus capital, which have been pioneers of forming sovereign investment funds, are well-structured and actively thinking about how to manage their capital to provide for the future. Investment banks need to remain nimble and evolve their coverage strategies as these funds continue to grow in sophistication and number.

How do you address the specific characteristics of this clientele?

Boon-Chye Loh: SWFs have some similarities to insurance companies and pension funds, given their tremendous size and long-term investment strategies (versus the shorter-term investment horizons of hedge funds, for example). There are other characteristics, however, that make them unique. This includes underlying social aspects or goals related to the home market of the fund, additional layers of influence, and multiple layers of stakeholders.

With such large pools of capital, sometimes larger than many of the markets that they invest in, it is a daunting task to determine how to deploy the portfolio to achieve returns while remaining sufficiently diversified.

What led Deutsche Bank to endow a research chair on Asset-Liability Management for Sovereign Wealth Funds?

Boon-Chye Loh: Given the many dynamic factors a SWF is exposed to relative to traditional investors, a standard portfolio model is not applicable.

In 2008, Deutsche Bank began discussing with EDHEC-Risk Institute the theme of asset-liability management techniques for SWFs, with the goal of engaging leading independent minds to conduct research on what is essentially green-field subject matter. A research chair was set up in January 2009 to run for three years, with the design of a dynamic asset allocation model for sovereign wealth fund management being the first work stream for the chair to focus on.

Given our strong presence in Singapore, we are pleased that EDHEC has established a local research centre to conduct research for global dissemination.

What do you think are the implications of this chair’s output so far?

Boon-Chye Loh: The first output of the research chair is an asset allocation framework that can be used to guide the investment and risk management processes of sovereign wealth funds. It shows that the optimal strategy of a particular fund depends on the dynamics of its endowment process, assets, and liabilities, and that it is state-dependent. Being dynamic, the strategy recognises the ability of long-term investors to take advantage of distressed markets for bargain hunting, which the events of the last three years has underlined. More interestingly, the optimal strategy involves allocating to three building blocks: a performance-seeking portfolio, an endowment-hedging portfolio, and a liability-hedging portfolio.

While the performance portfolio should be built in the same way for all investors, i.e. to maximise reward per unit of risk, the endowment- and liability-hedging components need to be customised to meet the needs of each fund. Investment banks have thus an important role to play in custom-designing portfolios to facilitate the adoption of this superior risk and investment management framework by sovereign wealth funds.

What do you think are the key challenges SWFs will be facing in the foreseeable future?

Boon-Chye Loh:

  • Matching sovereign surplus timings with anticipated future liabilities will be a key issue. In 1950, 75% of US pension assets were in bonds and 15% in stocks. By 2002, bonds are down to around 20% and stocks have increased from 15% to 55% as the pension system has rebalanced to deal with a shortfall of assets in the face of ballooning liabilities created by an ageing population. 16% of the population is currently over 60 in the US, but this will rise to 27% by 2050, placing further strain on the system’s ability to catch up to its future liabilities. In Asia, the trend is very similar although the region is starting from a lower base due to a more recent demographic transition and less-developed healthcare systems. With a boom of middle-aged citizens and improved healthcare the impact will be more dramatic. Philippines has a 6% old age dependency rate, which will quadruple to 23% by 2050, while Singapore’s will increase more than five-fold from 11% in 2000 to 60%.

  • Another issue will remain to manage pools of capital that are larger than public markets. SWFs have a similar issue that managers of very large funds have – in order to generate returns they need to invest significant chunks of capital. This makes it difficult to pick investments that will outperform the market benchmark when the size of the investment can itself move the market.

  • Finally, balancing the search for high risk-adjusted returns with strategic investments, for example investments aimed at guaranteeing the supply of key resources, will continue to be high on the agenda.

About Boon-Chye Loh

Mr Loh is Head of the Corporate and Investment Bank (CIB), Asia Pacific, at Deutsche Bank. He assumed the role on July 27 2010, when he was also appointed to the 15-member global executive committee that sets and executes business strategy for CIB.

Mr Loh’s appointment followed the amalgamation of Deutsche Bank’s Global Transaction Banking, Corporate Finance and Global Markets businesses to form CIB on July 1 2010. The combined businesses accounted for more than 80 per cent of Deutsche Bank’s group revenue in 2009 and employ about 5,400 people in Asia Pacific (as of June 1 2010).

Mr Loh was promoted to the new role from his previous position as Head of Global Markets, Asia ex-Japan, which he had held since 2002. Mr Loh had joined Deutsche Bank’s Emerging Markets Division in 1995 and later assumed responsibility for all local Asian fixed income markets and OTC derivatives business, before becoming CEO of Global Markets in Singapore in 2001.

He began his career as an Investment Officer with the Monetary Authority of Singapore in 1989 and joined the Singapore branch of the Morgan Guaranty Trust Co of New York in 1992, managing their South-East Asia fixed Income and derivatives business.

Mr Loh graduated in 1989 from the National University of Singapore with a Bachelor of Mechanical Engineering.

He currently chairs the Singapore Foreign Exchange Market Committee and has been a director of the Singapore Exchange Ltd since October 2003.

He has also served as the Chairman of the Capital Markets Working Group (1998), the Deputy President of ACI Singapore (1999) and as Chairman of the Debt Capital Markets Committee of the Singapore Investment Banking Association (2000).

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