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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. Outline. Background Strategic Asset Allocation Financial Operations Fund Performance Peer Perspective Conclusion. Background. Background.
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Trinidad and Tobago’s Heritage and Stabilisation Fund (HSF) Ewart WilliamsFormer GovernorCentral Bank of Trinidad and TobagoFebruary 2013
Outline • Background • Strategic Asset Allocation • Financial Operations • Fund Performance • Peer Perspective • Conclusion
Background • 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. • 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.
Chart I. Crude Oil and Natural Gas Prices • WTI Crude Oil Natural Gas (Henry Hub) Source: Bloomberg.
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.
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).
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.
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.
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: • Transparency • Accountability • Good Governance • Reporting and Disclosures
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.
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.
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.
Other Provisions of the HSF Act 12. Other provisions of the Act include: • The Fund cannot be used to directly finance capital expenditure or as collateral for government borrowing. • The Fund should be invested in assets not directly related to oil and gas. • The Fund is to be invested with a medium-long-term horizon.
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.
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.
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.
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.
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.
HSF Annual Rate of ReturnFor 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.
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.
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.
Table 8. Asset Class Contribution to Total Return For the Period October 2010 to July 2011/Per Cent/
Table 9. Performance of Selected Funds by Objectives: Pension Reserve Fund/Per Cent/
Table 10. Performance of Selected Funds by Objectives: Stabilisation/Savings /Per Cent/ * Returns for 4.25 years.
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.
