Structuring Israel's Sovereign Wealth Fund
May 5, 2011
Beverly Hills, CA
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| Eugene Kandel, head of the National Economic Council, discusses Israel's long-term strategic goal to use revenue from the recent gas discoveries to benefit both current and future generations. |
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| Karnit Flug, deputy governor of the Bank of Israel, explains the potential impact of the growing foreign exchange reserves on the Israeli economy. Also pictured is Sir Ronald Cohen of Bridges Ventures and The Portland Trust. |
Israel is anticipating a dramatic surge in income from foreign exchange reserves from high-tech exports and the massive natural gas fields that were recently discovered. This capital flow could quickly increase foreign exchange reserves and strengthen the shekel, creating undesirable economic side effects.
The billions of dollars in potential revenue could lead to drastic currency appreciation that would threaten the competitiveness of the country's export sector while building inflationary pressures domestically.
Many resource-rich countries - from Norway to Singapore and South Korea - have created national sovereign wealth funds (state-owned sovereign investment funds) to invest revenues globally as a way of moderating inflation risks and creating an effective investment mechanism for national economic development. In fact, the total assets under management of sovereign wealth funds exceed $4 trillion, far more than private equity and hedge funds in the global financial markets.
Sovereign wealth funds are not a homogeneous group with a shared goal. They are driven by different objectives that include fiscal stability, internal development, future savings and increasing returns on foreign exchange reserves. Based on its objective, each fund holds a different position in the spectrum of risk tolerance and uses different investment strategies.
The Milken Institute, at the request of Israel's National Economic Council, conducted a Financial Innovations Lab to discuss and map potential designs for an Israeli fund, including its legal structure, governance framework and investment strategy. The session brought together a diverse group of policymakers, scholars, investment fund executives, financial industry and sovereign wealth fund advisors, and representatives from NGOs for practical advice on how to structure the fund and address pot ential challenges.
Experience shows that in some countries these funds have been compromised by political pressures and require more effective corporate governance. Participants examined various best practices to ensure adequate governance and asset management with the goal of carving out new channels of capital for savings and investment in Israel's dynamic economy while avoiding inflationary pressures. Additionally, Lab participants examined trade-offs between investment vs. sovereign debt retirement or restructuring. The Lab reviewed methods for allocating gas revenues toward investment or debt retirement.
After presentations on Israel's macroeconomic condition, participants debated the purpose of an Israeli fund and examined its potential to further enhance and secure national retirement insurance. The group suggested that Israel establish as soon as possible a small fund that can be expanded later. A benchmark rate of return was also discussed, and participants agreed that revenue could be spent domestically on improving human capital and security once return thresholds were achieved.
Results from the Lab, including recommended next steps for implementation, are available here. For more information, contact Caitlin MacLean, manager of Financial Innovations Labs, at cmaclean@milkeninstitute.org.
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