Trinidad and Tobago’s Trinidad and Tobago’s Heritage and Stabilisation Heritage and Stabilisation

Fund (HSF) Fund (HSF)

Ewart WilliamsEwart WilliamsFormer GovernorFormer Governor

Central Bank of Trinidad and TobagoCentral Bank of Trinidad and Tobago

February 2013February 2013

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OutlineOutlineBackground

Strategic Asset Allocation

Financial Operations

Fund Performance

Peer Perspective

Conclusion

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BackgroundBackground

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BackgroundBackground

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.

Chart I. Crude Oil and Natural Gas PricesChart I. Crude Oil and Natural Gas Prices

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WTI Crude Oil Natural Gas (Henry Hub)

Source: Bloomberg.

The FundThe 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.

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Rationale of the FundRationale 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

Rationale (cont’d)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.

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Rationale (cont’d)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.

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HSF: Governance StructureHSF: 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. Transparencyii. Accountabilityiii. Good Governanceiv. Reporting and Disclosures

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Governance (cont’d)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.

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Main Provisions of the HSF Main Provisions of the HSF ActAct

10. Savings Rule:

60 per cent of excess energy revenues (actual minus budgeted revenues) shall be credited to the Fund.

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Main Provisions of the HSF Main Provisions of the HSF ActAct

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.

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Other Provisions of the HSF ActOther 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.

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Governance StructureGovernance Structure13. 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 objectivesb) 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.

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Chart 2. HSF Governance Chart 2. HSF Governance StructureStructure

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Strategic Asset AllocationStrategic Asset Allocation

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Strategic Asset Allocation Strategic Asset Allocation (SAA)(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.

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SAA Risk and Return Trade-SAA Risk and Return Trade-offoff

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.

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Table 1. Approved Strategic Asset Table 1. Approved Strategic Asset AllocationAllocation

 Asset ClassAsset

Allocation (Per Cent)

Benchmarks

US Short Duration Fixed Income

25.0Bank of America

Merrill Lynch 1-5 Year Treasury Index

US Core Fixed Income

40.0Barclay US Bond Aggregate Index

US Core Domestic Equities

17.5Russell 3000 Index ex

Energy

Non-US Equities 17.5MSCI EAFE Index ex

Energy

Allocation Total 100.0

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Financial Operations: 2007-Financial Operations: 2007-20112011

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Fund SizeFund 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.

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Fund PerformanceFund Performance

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Market PerformanceMarket 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.

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Chart 4. Returns on Selected Market Chart 4. Returns on Selected Market IndicesIndices

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HSF Annual Rate of ReturnHSF Annual Rate of ReturnFor the Period March 2007 to July 31, 2011For 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.

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Table 5. Review of Annual Fund Table 5. Review of Annual Fund PerformancePerformance

* Returns for the period March 15, 2007 to September 30, 2007.** Returns for the period October 01, 2010 to July 31, 2011.

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 Period Portfolio Return (Per Cent)

Excess ReturnOver Benchmark

(Per Cent)

FY2007* 2.97 0.02

FY2008 3.62 0.13

FY2009 2.80 -0.38

FY2010 6.07 0.32

FY2011** 5.79 0.05

HSF ExperienceHSF ExperienceThe 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.

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Table 6. Cumulative Return (from March Table 6. Cumulative Return (from March 2007)2007)

//Per cent/Per cent/

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Asset Class Return

Money Market 7.74

US Short Duration Fixed Income 7.35

US Core Fixed Income 14.00

US Domestic Equity 32.62

Non US Core International Equity 25.20

Table 7. Annualised Returns Table 7. Annualised Returns (from March (from March 2007)2007)

/Per Cent//Per Cent/

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PortfolioPortfolio Return

Benchmark Return

Money Market 2.04 2.05

US Short Duration Fixed Income 3.70 3.65

US Core Fixed Income 7.02 7.03

US Domestic Equity 16.43 17.44

Non US Core International Equity 12.69 11.19

Chart 5. Portfolio Contribution to Total Chart 5. Portfolio Contribution to Total ReturnReturn/Per Cent//Per Cent/

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Table 8. Asset Class Contribution to Total Table 8. Asset Class Contribution to Total Return Return

For the Period October 2010 to July 2011For the Period October 2010 to July 2011

/Per Cent//Per Cent/

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Performance per Mandate

Portfolio Return

Benchmark

ReturnExcess Return

Composite Portfolio 5.79 5.74 0.05

Money Market 0.01 0.00 0.00

US Core Fixed Income 1.20 1.28 -0.08

US Core Domestic Equity 2.23 2.28 -0.05

Non US Core International Equity 1.86 1.64 0.22

US Short Duration Fixed Income 0.39 0.42 -0.04

Peer PerspectivePeer Perspective

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

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Table 9. Performance of Selected Funds by Table 9. Performance of Selected Funds by Objectives: Objectives:

Pension Reserve FundPension Reserve Fund

/Per Cent/Per Cent//

Fund FY 2011

5-YR Return

(Annualised)

Lowest FY Return

(last 5 yrs)

Strategic Asset Allocation

Australia Government Future Fund

12.4 (Jun 11) 5.2 -4.2 (Jun 09)

Bonds (15%), Equity (40%), Alt. Assets

(15%), Cash (5%), Other (25%)

Norway Government Pension Fund

9.62 (Dec 10) 3.8

-23.3 (Dec 08)

Bonds (40%), Equity (60%),

New Zealand Superannuation Fund

26.34 (Jun 11) 4.7

-22.14 (Jun 09)

Bonds/MMKT (20%), Equity (75%), Real

Estate (5%)35

Table 10. Performance of Selected Funds by Table 10. Performance of Selected Funds by Objectives: Objectives:

Stabilisation/Savings Stabilisation/Savings

/Per Cent//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 HSF

6.07 (Jun 10) 5.4*

2.8 (Sep 09)

Bonds (65%), Equity (35%)

36** Returns for 4.25 Returns for 4.25 years.years.

ConclusionConclusionThe 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.

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AppendicesAppendices

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Appendix I:Appendix I:Strategic Asset AllocationStrategic Asset Allocation

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Investment Universe available to HSF Investment Universe available to HSF and Characteristicsand Characteristics

ASSET CLASS CHARACTERISTICS

Money market and Cash equivalent

Short term, low return , low capital risks

Bonds Higher risk and return than Money market investments but lower than Equity

Equity Long term, high return and high volatility

Commodities Inflation hedge, high risk, high return

Real Estate Inflation hedge, high risk, high return

Private Equity Illiquid, higher risk than public equity, high return40

Appendix I:Appendix I:External Manager Selection External Manager Selection ProcessProcess

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Selection Process for Selection Process for ManagersManagers

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Selected External Asset Selected External Asset ManagersManagers

Investment Mandate Number of Managers Selected

US Short Duration Fixed Income

2

US Core Fixed Income 2

US Core Domestic Equity 2

Non-US Core International Equity

2

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End of PresentationEnd of Presentation

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