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Sovereign Wealth Funds - April 05, 2012

What Asset-Liability Management Strategy for Sovereign Wealth Funds?

In a call for reaction to an EDHEC-Risk Institute study entitled “Asset-Liability Management Decisions for Sovereign Wealth Funds,” which was the foundation paper of the research chair endowed by Deutsche Bank, we asked sovereign investment practitioners about their views on the use of a dynamic ALM framework for SWF management.

This report shows that practitioners appreciate the value of the approach. As far as the inclusion of liabilities is concerned, respondents agree that this is an important aspect as 92% of the practitioners in the survey think that implicit liabilities should be taken into account in an integrated framework.

Clearly, practitioners see the need to manage the implicit liabilities and 70% of the survey respondents agree that a dynamic ALM framework provides a better understanding of optimal investment policy and risk management practices.

Some respondents express concerns regarding the implementation of the techniques in practice. In particular, individual SWFs have specific objectives and the investment approach has to be tailored to meet these objectives. Additional research into the application of ALM in the context of specific SWFs and, also, further education of SWFs would increase the adoption rate of the techniques.

In fact, while the fund separation property characterises the optimal investment policy, the structure of the building blocks (especially that of the endowment and liability hedging portfolios) would reflect the objectives and the constraints of each particular SWF.

Another obstacle mentioned by some respondents is that the ALM approach is generally viewed as a country level approach while SWFs may be managed separately from the rest of the state’s asset and liabilities. This indicates there is a need to engage multiple stakeholders in the management of state assets and liabilities, as well as a need to conduct 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 the sovereign assets and liabilities can continue along the existing administrative lines, whereby an SWF is given information about the state assets and liabilities beyond its control. Such an approach only requires change to the mandate of the SWF so that the sovereign assets and liabilities outside of its control are taken into account when defining the investment policy.

In summary, the general opinion expressed by the respondents is that the dynamic ALM approach has the potential to add value to SWF investment and risk management practices, and it should be explored by investors and their solution providers.

This research was produced as part of the Deutsche Bank research chair at EDHEC-Risk Institute on "Asset-Liability Management Techniques for Sovereign Wealth Fund Management."