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Trinidad and Tobago’s Heritage and Stabilisation Fund (HSF) Ewart Williams Former Governor Central Bank of Trinidad and Tobago February 2013 Trinidad and.

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Presentation on theme: "Trinidad and Tobago’s Heritage and Stabilisation Fund (HSF) Ewart Williams Former Governor Central Bank of Trinidad and Tobago February 2013 Trinidad and."— Presentation transcript:

1 Trinidad and Tobago’s Heritage and Stabilisation Fund (HSF) Ewart Williams Former Governor Central Bank of Trinidad and Tobago February 2013 Trinidad and Tobago’s Heritage and Stabilisation Fund (HSF) Ewart Williams Former Governor Central Bank of Trinidad and Tobago February 2013 1

2 Outline Outline Background Strategic Asset Allocation Financial Operations Fund Performance Peer Perspective Conclusion 2

3 Background 3

4 Background 1. As mentioned earlier, the Trinidad and Tobago economy benefitted tremendously from two oil booms during the 1970’s, but government spending went unchecked. The non-energy fiscal deficit climbed from less than 10 per cent of non-energy GDP to over 40 per cent in the early 1980’s. 2. The collapse of oil prices in the 1980’s met the country unprepared for fiscal adjustment, for which the economy suffered for almost a decade.

5 Chart I. Crude Oil and Natural Gas Prices 5  WTI Crude OilNatural Gas (Henry Hub) Source: Bloomberg.

6 The Fund 3. As oil prices began to recover in the late 1990’s, the Government introduced an Interim Revenue Stabilisation Fund (IRSF) in 2000. 4. The Fund was formalized in March 2007 with the passage by Parliament of the Heritage and Stabilisation Fund (HSF) Act. 6

7 Rationale of the Fund 5. The HSF is both a stabilisation and a savings fund. The rationale behind this dual purpose Fund is to:-  Insulate fiscal policy and the economy from adverse swings in international oil and gas prices (the stabilisation objective).  Accumulate savings from the country’s exhaustible assets of oil and gas for future generations (the heritage element). 7

8 Rationale (cont’d) 6. There are two arguments underpinning the heritage objective. - Firstly, there is the ethical argument that natural resources are exhaustible sovereign assets, the benefits of which should be spread over successive generations. - The second argument is that savings funds transform natural resources into a diversified portfolio of financial assets. Thus, a well managed savings fund can reduce the volatility inherent in an oil and gas economy. 8

9 Rationale (cont’d) 7. The idea is to build up a large savings fund and to manage it actively such that the Fund and the investment income would be available to finance government expenditure when oil/gas prices experience major slumps or when oil and gas reserves are depleted. 9

10 HSF: Governance Structure 8. An underlying tenet of Sovereign Wealth Funds is that since they represent the patrimony of the people, that is entrusted to the government to manage, they must be subject to the highest standards of: i.Transparency ii.Accountability iii.Good Governance iv.Reporting and Disclosures 10

11 Governance (cont’d) 9. Consistent with these principles the HSF Act provides for, inter alia, the following:  a savings Rule;  a withdrawal Rule;  a clearly defined governance and disclosure or reporting regime. 11

12 Main Provisions of the HSF Act 10. Savings Rule:  60 per cent of excess energy revenues (actual minus budgeted revenues) shall be credited to the Fund. 12

13 Main Provisions of the HSF Act 11. Withdrawal Rule:  Draw-downs are permitted if actual energy revenues in a given fiscal year are at least 10 percent below budgeted revenues.  Withdrawals could be up to 60 per cent of the shortfall, but not exceeding 25 per cent of the Fund.  There is a capital floor (of US$1 billion) for the Fund, beyond which draw-downs are not permitted. 13

14 Other Provisions of the HSF Act 12. Other provisions of the Act include: I. The Fund cannot be used to directly finance capital expenditure or as collateral for government borrowing. II. The Fund should be invested in assets not directly related to oil and gas. III. The Fund is to be invested with a medium- long-term horizon. 14

15 Governance Structure 13. The Fund has a clearly defined governance structure (Chart 2) as follows:  Parliament approves the legislation.  There is the Board of Directors, appointed by instrument from the President of the Republic,whose job is to decide on the: a) Investment objectives b) The Strategic Asset Allocation (SAA)  The Central Bank is appointed as Fund Manager, but outsources the function to external fund managers.  There is quarterly reporting by the Board to the Minister of Finance, who in turn provides an annual report to the Parliament.  There is an annual audit of the Fund done by the Auditor General’s Office. 15

16 Chart 2. HSF Governance Structure The Parliament Minister of Finance The HSF Board Central Bank Sub- Investment Manager Custodian External Auditor 16

17 Strategic Asset Allocation Strategic Asset Allocation 17

18 Strategic Asset Allocation (SAA) 14. Consistent with the Government’s return objective, risk tolerance and investment constraints. the HSF Board with technical assistance from the World Bank agreed on a SAA that called for 25 per cent of the portfolio to be invested in fixed income securities with a maturity of 1-5 years, 40 per cent in longer-term fixed income securities and 35 per cent in equities, equally divided between US and non-US equities. 18

19 SAA Risk and Return Trade-off 15. The SAA embodies universally accepted principles, for example, the higher the expected return the greater the risk. 16. Thus, while equity investments have proven to yield higher returns over the long term, these investments also carry a higher degree of volatility. 17. In these circumstances, the goal of the SAA is to meet a long term real rate of return (of about 2 per cent) while recognising that there will be short term fluctuations in the market. 19

20 Table 1. Approved Strategic Asset Allocation Asset Class Asset Allocation (Per Cent) Benchmarks US Short Duration Fixed Income 25.0 Bank of America Merrill Lynch 1-5 Year Treasury Index US Core Fixed Income40.0 Barclay US Bond Aggregate Index US Core Domestic Equities 17.5 Russell 3000 Index ex Energy Non-US Equities17.5 MSCI EAFE Index ex Energy Allocation Total 100.0 20

21 Financial Operations: 2007-2011 21

22 Fund Size  The Fund was established with an initial balance of US$1,402.2 million on March 15, 2007 – a transfer from the IRSF.  As at August 31, 2011 the Net Asset Value of the Fund was US$3,882.7 million.  Total contributions to the Fund since March 2007 amounted to US$2,133.11 million.  Interest on the Fund amounted to US$570 million.  No withdrawal requests were made. 22

23 Fund Performance Fund Performance 23

24 Market Performance 23. The five-year period of operation of the HSF, spanning March 2007 to present, saw unique conditions characterized by:-  The international financial crisis followed by a global recession.  Very low interest rates in developed markets.  Dislocation of credit markets.  Unprecedented intervention by governments and Central Banks.  Extreme volatility in financial markets. 24

25 Chart 4. Returns on Selected Market Indices 25

26 HSF Annual Rate of Return For the Period March 2007 to July 31, 2011  The Fund has averaged an annual return of 5.27 per cent. This compares to a benchmark return 5.24 per cent per annum. 26

27 Table 5. Review of Annual Fund Performance Table 5. Review of Annual Fund Performance * Returns for the period March 15, 2007 to September 30, 2007. ** Returns for the period October 01, 2010 to July 31, 2011. 27 Period Portfolio Return (Per Cent) Excess Return Over Benchmark (Per Cent) FY2007*2.970.02 FY20083.620.13 FY20092.80-0.38 FY20106.070.32 FY2011**5.790.05

28 HSF Experience  The Fund performed relatively well despite a low interest rate environment and volatile international financial markets.  In the earlier years, much of the Fund was invested in fixed deposits with highly rated commercial banks and US treasury bills. While this meant relatively low returns, it avoided major losses during the financial crisis of 2008/2009.  In 2009, the Fund began investing in equities which since have been the main driver of returns up to July 2011. In fact, the accumulated return on the equity portfolio is approximately 28.91 per cent from 2009. 28

29 Table 6. Cumulative Return (from March 2007) /Per cent/ 29 Asset ClassReturn Money Market7.74 US Short Duration Fixed Income7.35 US Core Fixed Income14.00 US Domestic Equity32.62 Non US Core International Equity25.20

30 Table 7. Annualised Returns (from March 2007) /Per Cent/ 30 PortfolioPortfolio Return Benchmark Return Money Market2.042.05 US Short Duration Fixed Income3.703.65 US Core Fixed Income7.027.03 US Domestic Equity16.4317.44 Non US Core International Equity12.6911.19

31 Chart 5. Portfolio Contribution to Total Return /Per Cent/ 31

32 Table 8. Asset Class Contribution to Total Return For the Period October 2010 to July 2011 /Per Cent/ 32 Performance per Mandate Portfolio Return Benchmark Return Excess Return Composite Portfolio5.795.740.05 Money Market0.010.00 US Core Fixed Income1.201.28-0.08 US Core Domestic Equity2.232.28-0.05 Non US Core International Equity1.861.640.22 US Short Duration Fixed Income0.390.42-0.04

33 Peer Perspective 33

34 Chart 6. Value of Selected Funds (June 2011) 34

35 Table 9. Performance of Selected Funds by Objectives: Pension Reserve Fund /Per Cent / Fund FY 2011 5-YR Return (Annualised) Lowest FY Return (last 5 yrs) Strategic Asset Allocation Australia Government Future Fund12.4 (Jun 11)5.2-4.2 (Jun 09) Bonds (15%), Equity (40%), Alt. Assets (15%), Cash (5%), Other (25%) Norway Government Pension Fund9.62 (Dec 10)3.8-23.3 (Dec 08)Bonds (40%), Equity (60%), New Zealand Superannuation Fund26.34 (Jun 11)4.7-22.14 (Jun 09) Bonds/MMKT (20%), Equity (75%), Real Estate (5%) 35

36 Table 10. Performance of Selected Funds by Objectives: Stabilisation/Savings /Per Cent/ Fund FY 2011 5-YR Return ( Annualised ) Lowest FY Return (last 5 yrs) Strategic Asset Allocation Alaska Permanent Fund 20.6 (Jun 11) 4.5 -18.0 (Jun 09) Bonds (21%), Equity (59%),Alt. Assets (18%), Cash (2%) Alberta's Heritage Fund 10.4 (Mar 11) 3.5 -18.1 (Mar 09) Bonds (20%), Equity (50%), Alt. Assets (30%) Korean Investment Corporation 8.46 (Dec 10) 4.2 -13.7 (Dec 08) Bonds (49%), Equity (44%), Alt. Assets (6%), Cash (1%) Trinidad an Tobago’s HSF6.07 (Jun 10)5.4* 2.8 (Sep 09)Bonds (65%), Equity (35%) 36 * Returns for 4.25 years.

37 Conclusion  The HSF grew from US$1.4 billion to $3.9 billion over the last 4.5 years.  Investment in Fixed Income securities and Equities have benefitted the portfolio’s performance in the more recent years.  While the Fund’s performance has been creditable in both absolute and relative terms, it is important to review both the legislation and the operation of the Fund to determine whether amendments are required to meet the changing environment. 37

38 Appendices 38

39 Appendix I: Strategic Asset Allocation 39

40 Investment Universe available to HSF and Characteristics ASSET CLASS CHARACTERISTICS Money market and Cash equivalent Short term, low return, low capital risks BondsHigher risk and return than Money market investments but lower than Equity EquityLong term, high return and high volatility CommoditiesInflation hedge, high risk, high return Real EstateInflation hedge, high risk, high return Private EquityIlliquid, higher risk than public equity, high return 40

41 Appendix I: External Manager Selection Process 41

42 Selection Process for Managers 20 firms responded to RFPs Shortlisted 17 firms Due diligence visits to short listed firms – Aug’08 179 firms responded RFPs sent to24 firms – Apr’08 PSN database (>500 firms considered) RFIs sent to219 firms – Feb’08 42

43 Selected External Asset Managers Investment MandateNumber of Managers Selected US Short Duration Fixed Income2 US Core Fixed Income2 US Core Domestic Equity2 Non-US Core International Equity2 43

44 End of Presentation 44

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