Rose: Sovereign Funds and External Asset Manager Fees – The Governance Connection


Sovereign wealth funds (SWFs) vary widely in how they use external managers, but nearly all SWFs make significant use of external managers, particularly for alternative asset classes that are difficult to access or demand labor-intensive investment strategies, such as private equity, venture capital, and hedge fund strategies. Many SWFs — and those interested in the performance of SWFs, including government officials and citizens — are now asking whether the returns, net of fees, are worth the fees charged by these external managers. However, while external asset managers — and hedge fund and private equity managers in particular — have been criticized for their high fees  (and, in 2015 in particular, high fees often coupled with poor performance), this very short paper argues that the governance and management of asset owners themselves may contribute to the problem.


Available for download here.

Rose: Public Fund Governance and Private Fund Fees


In a continuing low-interest rate environment that stifles fixed income returns, pension funds are under increasing pressure to produce strong returns from other asset classes, including alternative assets like interests in hedge funds, private equity funds, and venture capital funds. As private funds themselves struggle for returns in a hyper-competitive market, pension funds have realized, according to one official, that “the most sure-fire way to enhance returns is to reduce fees.” As a result, public pension funds have begun to press private funds to provide more transparency of their fees.

What may be most surprising to observers of this heightened focus on fees is that such requests have to be made at all. Shouldn’t pension funds already know how much they are paying in fees to private funds? In fairness to pension funds, private funds have numerous ways of concealing fees. For example, a private equity fund might hide fees through related-party transactions.

It is therefore tempting to see high and hidden private fund fees as simply a deception by private funds on unsuspecting pension funds. While not attempting to justify private funds’ actions, this article, prepared for the 2016 Private Fund Conference at UCLA School of Law, offers a different perspective: high private fund fees are, in part, a result of poor governance by state legislators and pension funds themselves.


Full paper available for download here.

Rose: Reframing Fiduciary Duties in Public Funds

Abstract: This article challenges the commonly evoked fiduciary obligation to strictly maximize fund value by asking a foundational question: who are the proper beneficiaries of public fund trustees’ fiduciary duties? The article makes a pivotal claim: public funds, including public pension funds and sovereign wealth funds, owe their duties to the government and current and future citizens collectively, and not to individual benefits claimants. This analysis is driven by the fact that in practice individual claimants function more like senior creditors than the residual claimants that are the typical recipients of fiduciary duties. This reframing of fiduciary duties in public funds has dramatic consequences for the investment policies of the funds. Most importantly, a shift in the locus of fiduciary duties to the government and current and future generations requires fund managers to more fully consider the externalities accompanying their investments, which should serve to help them fully and accurately price their investments. Private investors might ignore certain effects, such as uncompensated harms from pollution or depleted natural resources, because the government absorbs the costs of such externalities. A strict fiduciary duty to act in the interests of the fund would obligate a private investor to ignore such externalities, so long as they do not negatively affect the returns of the fund’s investments. The government that absorbs the cost of these externalities, however, should view investments differently, with a view to minimizing negative externalities, particularly those that are significantly more expensive to remediate than to prevent. As a result of this analysis, it follows that public funds should benefit from less constrained fiduciary standards that would encourage more investment in sustainable enterprises and long-term projects.

Full paper available for download here.


Rose: Sovereign Fund Selling, Market Volatility and Systemic Risk: Connections and Regulatory Possibilities

Abstract:  Sovereign wealth funds (SWF) have largely proven to be the gentle giants of the financial markets; they tend to be relatively patient, passive shareholders. In contrast to other activist hedge funds, when SWFs do engage with companies, they tend to work behind the scenes to maximize value for the long term.

And yet, because they are funds owned by a sovereign, they often receive significant scrutiny, especially in developed markets, whenever they invest. To date, most of this scrutiny has occurred on the front end of investments, as host-country politicians and regulators question the motives of SWF investment in their markets. In some cases this scrutiny proves to be strict enough to encourage SWFs to look for other opportunities in other markets. As SWFs have continued to invest responsibly and regulators have become increasingly comfortable with SWF investment, the fear-mongering associated with SWF investment has decreased.

Now, however, concerns have arisen not over how SWFs invest, but how they divest. Indeed, some reports seem to attribute depressed stock market prices and general market volatility to SWF divestment. A headline in Barron’s, for example, claimed that “Selling by sovereign wealth funds is a huge headwind for stocks,” and a headline for an article in the Financial Times declared that “Sovereign wealth funds drive turbulent trading.” Undoubtedly withdrawals from some SWFs — particularly Gulf SWFs — have had an impact on the markets, and particularly on stocks in which SWFs tend to overweight in their portfolios, such as stock in financial firms and some consumer goods companies. Perhaps the biggest impact has been felt by asset managers, which have seen their AUM deteriorate as SWFs withdraw funds.

But how significant are SWF withdrawals from markets? Put in a slightly more pointed way, do SWF withdrawals create systemic risk for the markets? And if they do, what could be done about it? This brief analysis, prepared for the Università Bocconi’s Sovereign Investment Lab 2016 Annual SWF Report, attempts to work towards an answer to those questions, and in doing so, also attempts to provide some perspective on the larger debate in the appropriate role of SWFs in global capital markets.


Full paper available for download here.