Public Fund Investment Policies: 2015 Annual Review

LAW, FINANCE AND GOVERNANCE http://moritzlaw.osu.edu/law-finance-governance/ INTRODUCTION _____________________________________________________________________________ 3 INTERNAL/EXTERNAL ASSET MANAGEMENT ________________________________________________________ 5 QUANTITATIVE ASSET ALLOCATION _______________________________________________________________ 6 ESG AND PROHIBITED INVESTMENTS _____________________________________________________________ 7 MANDATE TO INVEST IN PARTICULAR INVESTMENTS___________________________________________________ 8 INVESTMENT MANAGEMENT STANDARD ___________________________________________________________ 9 PROXY VOTING ____________________________________________________________________________ 10 EXPRESSED CORPORATE GOVERNANCE POLICIES AND PREFERENCES ___________________________________ 11 INTERNAL ETHICS POLICY ____________________________________________________________________ 12 ACKNOWLEDGEMENTS _______________________________________________________________________ 13 CONTACT INFORMATION ______________________________________________________________________ 14 The Public Funds Investment Policies Survey is an annual publication, now in its second year,1 which surveys the current investment policy disclosures of the 25 largest (by AUM) SWFs in the world, as listed by the Sovereign Wealth Fund Institute, and the 26 largest (by AUM) SPFs, as listed in the Pension & Investments/Towers Watson 300 Ranking (2012). The policies reviewed in this survey were obtained directly from the funds when possible, using data available as of summer 2015. Because a minority of funds (primarily SWFs) does not disclose investment policies, caution should be used in interpreting these results. Many funds may have extensive internal policies but choose not to disclose these policies, and the lack of disclosure should not be taken as evidence that such policies do not exist. When possible, reference was made to other sources of data to corroborate or augment disclosed data. Investment policies serve a number of different purposes. They provide discipline and guidance for investment managers by setting appropriate risk tolerances and time horizons, they limit risk by prescribing certain types of investments and proscribing others, and they can even reflect the social, environmental and economic priorities and concerns of the fund’s public beneficiaries. Covering these and other areas, this survey considers eight critical investment policy questions: 1. Does the fund manage assets internally? 2. Is the fund subject to binding quantitative asset allocation standards? 3. Is the fund prohibited from investing in certain kinds of assets (other than investments prohibited under Sharia law)? 4. Is the fund required to invest in particular investments (such as domestic investments or “green” investments)? 5. Are fund managers held to a prudent investor standard? 6. Does the fund actively vote its equity shares? 7. Does the fund have expressed corporate governance policies and preferences? 8. Does the fund have an ethics policy? This survey report shows the percentages of SWFs and SPF that provided disclosure on these critical issues. 1 The methodology and discussion on the selection of appropriate disclosure metrics, as well as the initial survey of publicly available disclosures, appeared in A Disclosure Framework for Public Fund Investment Policies, presented at the Fifth Joint BIS/World Bank Public Investors Conference (2014). The survey can be downloaded at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2489080. To maintain a consistent analytical and descriptive framework for year-to-year comparison, some descriptions and examples borrow from the 2014 report.      Funds are reporting a shift towards increasing internal asset management, although many funds continue to primarily use external management. More funds are disclosing asset allocation targets and restrictions. An increasing number of funds disclose that they follow a “prudent investor” standard of care in making and managing their investments. Many funds restrict investments based on ethical, social or governance considerations, although the majority of funds do not funds do not provide disclosure on how or whether ESG issues affect their investments. SPFs tend to provide better disclosure of their policies than SWFs. Funds vary significantly in their use of external asset managers. The majority of funds disclosing their management style state that they primarily manage assets internally. Some funds, notably those managed by the Abu Dhabi Investment Authority and the Kuwait Investment Authority, report a shift to increased in-house asset management. This is an important shift, as SWFs tend to rely on external managers more than pension funds, likely in part because they tend to have been created more recently, and are still building internal management capacity. However, the number of funds disclosing that they primarily use internal asset management has not increased since 2014. Primarily internal Primarily external About 50% managed internally, 50% managed externally Not disclosed Percentage of SPFs Percentage of SWFs Total Primarily internal Primarily external Primarily internal 50% Internal, 50% External Not disclosed Not disclosed Primarily external As noted in the prior survey, almost all funds disclose that they operate under explicit allocation targets or ranges that limit the type and amount of investments they are able to make. In many cases these limits are set by statute, and in a smaller number of cases the funds are restricted through internal policies. While one can calculate asset allocation averages across all SPFs and SWFs, it is not possible to determine an average asset allocation regulatory scheme. Sovereigns regulate their funds in various ways that make comparisons difficult. For example, some funds operate within ranges rather than set upper or lower limits, and while one fund may have a cap (but no floor) on certain asset investments, another fund may employ a floor (but no cap) on other types of assets. Additionally, some funds, such as the Alaska Permanent Fund, do not use traditional asset allocation categories such as “Equity,” “Fixed Income,” “Cash or Equivalents,” and “Alternative Investments” such as private equity, hedge funds or infrastructure. The APF instead classifies investments as “Cash and Interest Rates,” “Company Exposure,” “Real Assets,” and “Special Opportunities.” Legal environments vary as well, so that a fund may be provided an allocation target but is not legally required to hit the target—it serves as guidance, but not a binding restriction. In other cases, however, a target may serve as a binding restriction. Altogether, 27 of the 51 funds surveyed (compared to 25 of 51 funds surveyed in 2014) provide some kind of disclosure of the regulations governing their asset allocation strategies. Restricts domestic investments Percentage of SPFs Percentage of SWFs Total Restricts foreign investments Restricts equity Restricts Ownership percentages of equity Restricts fixed income Restricts according to currency risk Restricts non-publicly traded investments Environmental, social and governance (ESG) factors are an increasingly important issue for many sovereign wealth funds and large public pension funds. Funds are also subject to restrictions that prohibit the find from investing in asset classes that violate Sharia law, or are deemed to be imprudent or otherwise inappropriate for the fund, such as alternative investments, commodities, derivative instruments and, in one case, even equities. Despite the increased discussion of ESG issues among investors, disclosed policies on ESG investing and asset restrictions did not change significantly from 2014 to 2015. ESG Restrictions ESG Considerations ESG Mandate Asset Class Restrictions Percentage of SPFs Percentage of SWFs Total The most common restriction is asset class restrictions, with a number of funds, including all of Sweden’s AP Fonden funds, restricting derivatives investments. Many other funds screen for social issues, including human rights violations (AP Fonden 7), tobacco companies (Australia Future Fund, Norway Government Pension Fund – Global), or certain weapons manufacturers (Ireland National Pensions Reserve Fund, France Fonds de Réserve pour les Retraites). While ESG restrictions and considerations and asset class prohibitions are not found in a majority of disclosed investment policies of the world’s largest public funds, specific mandates to invest in certain asset classes or according to ESG principles are even rarer. The disclosures show no significant changes from 2014 to 2015. Domestic Investment Foreign Investment Specific Sector Investment Percentage of SPFs Percentage of SWFs Total A number of SPFs have explicit mandates to invest some or all of their funds in domestic securities such as domestic bonds (Japan’s Government Pension Investment Fund and Belgium’s Zilverfond) or domestic equities (Norway’s Government Pension Fund). South Korea’s National Pension Service is required to use some of its assets for public service projects. None of the surveyed SWFs have disclosed specific domestic investment mandates (Gelb et. al, (2013) however, do find general domestic mandates with some funds). Several SWFs have explicit foreign investment mandates, however, including Norway’s Government Pension Fund-Global, China Investment Corporation, and the Russia Reserve Fund. In each case, the sovereigns imposing explicit external mandates also have funds that include domestic investment components (Norway’s Government Pension Fund, Central Huijin (a subsidiary of CIC), and Russia’s National Wealth Fund). Two funds, the SWF Abu Dhabi International Petroleum Company (not to be confused with Abu Dhabi’s larger SWF, ADIA) and the Ireland SPF, NRPF, have disclosed sector-specific investments. The fund with the sole ESG madate, France’s Fonds de Réserve pour les Retraites, has integrated low carbon leaders indices into equity management to promote carbon footprint reduction. Many funds disclose the standard of care to which fund officials must adhere in their investment decisions and asset management. Many funds, particularly those with Common Law traditions, use some version of a “prudent investor” standard of care, which generally requires that a fiduciary discharge his or her duties with the care, skill and diligence that a prudent person acting in a similar capacity would use in the management of a similar enterprise. Of the funds surveyed, the SPFs and SWFs from Canada, Ireland, New Zealand, Hong Kong, Singapore, and Alaska follow some form of the prudent investor rule, and even some funds from non-common law countries, including the China Investment Corporation, the China National Social Security Fund, Sweden’s AP Fonden 3, and the Korea Investment Corporation, also follow a form of the rule. Other funds disclose different standards that are not explicitly a form of the “prudent investor” rule, but nonetheless require loyalty or accountability of fund officials. Compared to 2014, more funds are now disclosing that they follow a “prudent investor” rule. Prudent Investor Standard Percentage of SPFs Percentage of SWFs Total Other Fiduciary or Loyalty Standard Consistent with the behavior of most other large institutional investors, most SWFs and SPFs do not publish their proxy voting policies, though Norway’s GPFG is a notable exception to this rule for SWFs. Likewise, as with proxy voting policies, only GPFG discloses actual proxy votes. This lack of transparency makes it difficult to ascertain whether SWFs and SPFs behave similarly to other types of funds, such as pension funds, endowment funds, or mutual funds. Some funds state that they are primarily passive in shareholder voting, but one, the Abu Dhabi Investment Authority, notes that it will vote its shares defensively in order to protect its financial interests. Presumably, many funds make use of proxy voting services, but only one fund discloses its use of proxy advisors. As of 2015, 28 of 51 funds provided some disclosure of their proxy voting policies (or at least the existence of such policies), with SPFs tending to provide such disclosures significantly more often than SWFs. The surveyed public funds, as a group, tend to actively vote their shares. However, only about half of the SWFs state that they actively vote their proxies, while the other funds state that they are predominantly passive or do not vote their shares. Actively Votes Shares Percentage of reporting SPFs Percentage of reporting SWFs Total Primarily Passive / Does Not Vote Uses a Proxy Advisor to Vote A minority of funds have articulated specific corporate governance preferences for the public and private firms in which they invest. Typically, such disclosures describe in basic terms what corporate governance measures a fund is likely to support. Only a few funds describe the governance issues that are important to them, and even fewer provide disclosure on how they engage with companies in which they invest. Among SWFs, the Australia Future Fund and Norway’s Government Pension Fund – Global are leaders on corporate governance issues and disclosure of governance policies. The Future Fund, for example, makes significant policy disclosures on a range of governance issues, including executive compensation. In a small number of cases, funds relying extensively on external managers also provide basic guidelines for how the managers should vote shares held on behalf of the fund. The Alaska Permanent Fund, for example, states that it is the governing board’s responsibility to “encourage but not require managers to consider the following principles when voting proxies,” including “proxy matters dealing with a corporate governance process have the potential to improve board-shareholder dynamics for an extended period,” “board independence,” and certain “proposals have the potential to impact corporate governance and improve board shareholder dynamics.” A significant number of funds—primarily SPFs—are also signatories to the United Nation-sponsored Principles for Responsible Investment.2 Every fund that is a UNPRI signatory also provides significant disclosures on corporate governance preferences. Governance Preferences or Governance Guidelines UNPRI Signatory Percentage of reporting SPFs Percentage of reporting SWFs Total 2 UNPRI signatories commit to six principles, including: (1) incorporating ESG issues into investment analysis and decision-making processes; (2) being active owners and incorporating ESG issues into ownership policies and practices; (3) seeking appropriate disclosure on ESG issues by the entities in which the signatories invest; (4) promoting acceptance and implementation of the UNPRI within the investment industry; (5) working together to enhance effectiveness in implementing the UNPRI; and (6) reporting on activities and progress towards implementing the UNPRI. A code of ethics helps to ensure that investments are made in accordance with the fund’s investment policies and any other relevant regulations. In general, the survey finds that SPFs tend to provide better disclosure of their policies than SWFs. In the case of ethical codes, however, more SWFs than SPFs disclose that they have a code of ethics in place. Internal Ethics Policy Percentage of SPFs Percentage of SWFs Total Most funds disclose only the existence of an internal code of ethics. Singapore’s Government Investment Corporation, for example, states that “[w]e expect the highest standards of honesty from everyone in GIC, both in our work and in our personal lives. This includes abiding by the laws of the countries we invest in, and observing our code of ethics in letter and in spirit.” A few funds disclose the entire code of ethics. Mubadala’s disclosure is exemplary in this respect; the fund discloses its full, 73-page code of ethics. The code covers a wide variety of ethical issues, including “preventing improper payments in cash or in kind,” “preventing money laundering,” “protecting intellectual property and confidential information,” and “serving in our communities,” among many other topics. Brittany Pace (Moritz College of Law, Class of 2013), Joseph Perruzzi (Moritz College of Law, Class of 2014) and Chadwick Schmitt (Moritz College of Law, Class of 2014) contributed diligent research assistance for this survey. Gabrielle Stevens provided excellent editing and technical support. Paul Rose, Frank E. and Virginia H. Bazler Designated Professor in Business Law; Executive Director, Law, Finance & Governance @ Ohio State 208 Drinko Hall 55 W. 12th Avenue Columbus, Ohio 43210 Tel: (614) 688-5818 Email: rose.933@osu.edu Law, Finance and Governance @ Ohio State Daphne Meimarides, Director 458 Drinko Hall 55 W. 12th Avenue Columbus, Ohio 43210 Tel: (614) 688-4283 Email: meimaridis.3@osu.edu Law, Finance and Governance is a non-partisan program of The Ohio State University Moritz College of Law that links the legal and business knowledge of scholars, industry professionals, and policymakers to stimulate new ideas, encourage knowledgesharing, support research and foster networks. The focus of the program extends from capital markets to other forms of business activity outside the public markets, such as insurance, infrastructure, banking and public finance, all of which are important, especially to Moritz’s home communities of Columbus and Ohio. 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