August 30, 2012

Sovereign Wealth Funds Should Design Early Warning Signals to Help Predict Market Shocks, According to BNY Mellon

New Risk Approach Is Aimed at Better Managing Liquidity, Panel Says

NEW YORK and LONDON, August 30, 2012 — Sovereign wealth funds can take advantage of warning signs such as rising commodity prices to help them reduce the risk in their portfolios in advance of market shocks, according to BNY Mellon.

"It appears to be counter-intuitive, but a sovereign wealth fund that is sensitive to changes in commodity prices should begin moving into more liquid assets as commodity prices are peaking instead of waiting for them to decline," said Rumi Masih, senior investment strategist for BNY Mellon's Investment Strategy and Solutions Group (ISSG).

Masih made the comments during a roundtable discussion including BNY Mellon investment professionals and a senior advisor to sovereign institutions. The primary purpose of the roundtable was to rethink traditional investment and risk management models to help sovereign wealth funds become better stewards of their national wealth for current and future generations.

"Sovereign wealth funds, like other large institutional investors, are trying to apply the lessons of the last financial crisis," said Masih. "That way, they can be more nimble if another crisis occurs." Masih said that sovereign wealth funds could develop signals that could trigger moves to increased liquidity. He said such warnings could be customized depending on the drivers of a nation's economy.

The roundtable group focused on three challenges that became apparent during the 2008 financial crisis:

  • The need for an investment approach that takes a broader, more multi-generational view of liabilities, including the potential liabilities that could arise during market stress
  • Governance models that allow for greater tactical flexibility
  • A more transparent way to combine risk exposures across liquid and illiquid asset classes while accurately measuring value-added performance

Dr. Sung Cheng Chih, former chief risk officer for the government of Singapore Investment Corporation (GIC) and currently a consultant to several sovereign institutions, said, "The financial crisis highlighted the importance of preparing for contingencies, with some funds now seeking to create risk dashboards based on pre-agreed signals for portfolio de-risking."

The roundtable was part of a thought leadership series sponsored by BNY Mellon's Sovereign Institutions Group. "BNY Mellon understands the strategic importance of sovereign wealth funds to their countries and global economy during this time of great change," said Jai Arya, head of BNY Mellon's Sovereign Institutions Group. "That's why we are committing ourselves to helping them develop strategies for the evolving global economy."

ISSG is part of The Bank of New York Mellon, a principal banking subsidiary of BNY Mellon.

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