The yawning gap at the heart of the financial system

Two particularly pernicious and inter-related challenges confront the global financial system. On the one hand, pools of trillions of dollars of savings, particularly in OECD economies, are trapped in sub-optimal investments earning poor returns. On the other, many developing countries face a serious shortage of capital, even for investments that can generate high financial and economic return. The world’s financial system fails to intermediate between the two at any scale. This leads to several perverse consequences.

Long-term investors from rich countries, such as pension funds and insurance firms, have crowded mostly into developed country bonds and stocks. Even truly unconstrained investors such as the giant Norwegian sovereign wealth fund have ninety percent or more of their portfolio invested in such assets. Total allocation to developing countries remains far below the more than 40% (and growing) share of global GDP that they now command. Allocation to unlisted assets in developing countries, which often lack the deep liquid markets that characterize OECD economies, is negligible. Perversely, large pools of savings in developing economies, particularly sovereign wealth funds and foreign exchange reserves, are also after the same listed securities in developed economies.

Norway's Oil Fund - An Infrastructure Investor of Choice

NOTE: This is a longer version of an Oped that appeared in the Norwegian business newspaper Dagens Naeringsliv on 21 March 2014.

The revelation of the Oil Fund’s controversial investment in Formula 1 has led to Ola Mestad, Lars Hakon Sooras and Sofie Mathiasen and other Norwegian commentators to warn against allowing the Fund to invest in unlisted assets. This would be a grave mistake that would cost Norwegians dearly.

Instead, the government should bolster Fund capacity and set up a powerful independent watchdog in the form of a “Stortingets Råd for Oljefondet”.

Critics say that unlisted assets will make it harder to detect unethical investments or exercise oversight. They also warn about the lack of relevant expertise at the Fund and in the Norges Bank board that oversees it. As a reaction to the Formula 1 fiasco these concerns are understandable, but misconceived.

While unlisted investments, private equity and infrastructure disclose less information publicly, they will give NBIM access to hordes of private information. It will also be in a much stronger position to demand private information and to successfully challenge questionable practices. For effective oversight, the SRO should not only enjoy privileged access to all the data NBIM holds, but also have the right to demand more information on any of its investments.

Does anyone seriously think that Formula 1, with the constant whiff of scandal and a controversial promoter repeatedly accused of corruption, would have been an appropriate investment if only it were listed? It did not pass the smell test, period.

It is time to change how Norway's Oil Wealth is managed

Norway has reached a critical point in how its oil wealth is managed. There is now an active debate not just on the investment strategy of the Oil Fund, but also on the governance mechanisms by which this oil wealth is managed.

The first debate has been driven in part by the launch of a 2013 Re-Define report that was critical of the Fund’s investment strategy. The second debate is driven by a secretive investment in Formula 1 that went wrong and has been recently exposed by Dagens Naeringsliv (DN)

Solutions to the first debate include selling out of fossil fuels, investing in the green economy, seeking out illiquid assets such as infrastructure and investing half the portfolio outside OECD economies. The solution to the second is to set up a Parliamentary Council for the Oil Fund “Stortingets Råd for Oljefondet” (SRO).

While the debates have originated independent of each other, they are intimately related. The Oil Fund is owned by Norway’s Parliament on behalf of Norwegian citizens. The Parliament defines the investment objective of the Fund as “maximising the purchasing power of the fund capital, given a moderate level of risk.” Under the present governance arrangements, this objective is translated into investment guidelines by the Ministry of Finance that are then followed by Norges Bank Investment Management, which actually invests the funds.

On why long-term investors should fund infrastructure

Investing in developing country infrastructure is a win-win strategy for long-term investors

Note: A version of this article was first published in the OECD DAC Newsletter

The world faces two major financial problems for which, luckily, there is an attractive common solution. This might be just the right time for taking the first steps towards implementing it.

The first problem is the scarcity of capital in general, and of money for infrastructure investments in particular, in large swathes of the developing world. It is widely recognised that poor infrastructure holds back development, reduces growth potential and imposes additional costs, in particular on the poor who often do not have access to energy, water, sanitation and transport.

The second problem is the current sclerotic, even negative real rate of return on listed bonds and equities in many developed economies. The concentration of the portfolios of many long-term investors in such listed securities also exposes them to high levels of systemic, and often hidden, risk.

Conversation with William (Bill) White

Note: This is an edited transcript of a wide-ranging conversation I had with Bill in April 2013 over coffee in Hong Kong 

Sony: This is Sony Kapoor of Re-Define talking to Bill White of BIS fame. He needs no further introduction. Bill, we are in this global situation where there is a huge amount debt in the system and central banks have flooded the system with money. At the same time, OECD countries are facing a structural slow-down of which the demographic time bomb is a part. They also have the highest levels of public and private debt. Simultaneously, power in global governance structures is starting to shift towards the East. Not to mention recent ructions in emerging markets.

Given that we are facing the triple challenge of the changes in governance, the structural break in growth rates, and unprecedented levels of credit and debt, particularly in OECD economies, how does the landscape look going forward? What is the best we can hope for?

Bill: To be honest, the landscape looks rather scary. Clearly, when you talk about this credit bubble we are at the end in the advanced markets, of a very long period of excessive credit creation. This has now crept over into the emerging markets as well. I think that in a certain way they have inherited it, through more or less the fixed exchange rate system, the imbalances of the advanced market economies; we have a global problem here. It is, however, most obvious in many of the advanced market economies.

So, we have a problem. Now the question is, what do we do to deal with the problem? I do not think that the quick fix, for example, the idea that you can use base money to expand government spending in a cost-less manner, or quantitative easing. I think these quick macro-fixes really are totally illusionary as a general solution. I believe that what we do have to focus on is the search for things that will actually work.

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