MONEY BEGETS MONEY

At a time of low oil prices the State Oil Fund of the Azerbaijani Republic (SOFAZ) can compensate for its falling revenues by increasing the effectiveness of its asset management.

Up till now its fund management has been based on a conservative approach where the main factor is stability and a necessary safeguard of assets even at the cost of low yield. But it is common knowledge that the markets of the developing countries provide more revenue which can easily be combined with reasonable limits of risk. That is why the Azerbaijani government has changed its policy of SOFAZ's asset management, shifting the stress from a conservative to a relatively more risky but profit-making investment portfolio. However, the risk was justified because investments in foreign assets have been restricted by a BBB- ratings level of securities. This is a perfectly justified move by the government which could appreciably increase yield from SOFAZ's fund management. That said, the situation is by no means so ominous to cast prudence to the winds in search of a quick profit by conducting operations in speculative securities that could have a "junk" rating.

The figures state that in the second quarter of this year SOFAZ even managed to increase its assets by 853m dollars compared with the first quarter, bringing their level up to 35.8bn dollars, although overall, as of 1 July 2015, SOFAZ's assets were reduced by 3.56 per cent compared with the beginning of the year. However, it is very significant that with an average price-fixing of over 60 dollars a barrel for Azerbaijani BTC FOB Ceyhan oil there has been clear evidence of an increase in SOFAZ's assets. Naturally, the increase in SOFAZ's assets was registered much more vigorously in the years when the prices for "black gold" exceeded 100 dollars a barrel. And this is understandable because the vast majority of the fund's assets are made up of proceeds from the sale of oil and gas.

The low yield from Azerbaijan's investments is linked with the fact that the Azerbaijani government, at the recommendation of international financial institutions (IFI), has continued to float SOFAZ's investment portfolio in securities with a high investment rating. This was attributed to the very low level of risk loss of the fund's assets. But in pointing out this factor, the government made it clear that the sharp increase in the yield of SOFAZ's investment portfolio had been prepared as an alternative course of action.

The point was that the Azerbaijani government, before the slump in oil prices, stored the bulk of its assets not just in securities with a maximum reliability rating of AAA, but mainly with a period of distribution of no more than one year. So, the difference in the yield of investments for one year or 3-5 years in AAA higher rating securities is very insignificant. And the annual period of distribution of assets allows for a more prompt reaction to changes in the market situation. The low yield was, first and foremost, linked with the low rates of the US Federal Reserve System in recent years. Accordingly, if the Azerbaijani government had distributed its investments in securities with a five-year term when oil prices were high, then today it would not have had the opportunity to redeploy them from an AAA to a BBB level.

However, compared with the first half of last year, the proportion of maximum reliability securities with an AAA rating in SOFAZ's investment portfolio this year has been reduced, because the proportion of securities with an A and BBB rating has, on the contrary, increased. (see Table 1)

The proportion of investments with a term up to one year has also been significantly reduced, leading to an increase in investments for 3-5 and over 5-year terms. One is also struck by the increase in the growth of the proportion of shares, gold and real estate in the time period under review. (Table 2)

The geography of the distribution of SOFAZ's investment portfolio has also begun to change over the year. It has been a question of shifting the fund's Azerbaijani investments from the word's developed countries to the developing countries. Specifically, whereas a year ago 76.6 per cent of the investment fund went to the developed countries, 6.8 per cent to international financial institutions and 16.6 per cent to the developing countries, one year later the proportion of the developing countries increased to 23.6 per cent, and accordingly the proportion of IFI was reduced to 2.9 per cent and the developed countries to 73.5 per cent. A striking example of the changes in the geography of Azerbaijan's investments was the emergence of the Australia/New Zealand region, which accounted for 13.53 per cent of SOFAZ's investment portfolio.

It should be noted that BBB rating securities should in no way frighten the pessimists by the inevitability of losses. Why shouldn't SOFAZ invest in assets with this rating if the funds of the USA and Europe are happy to acquire SOCAR Eurobonds with an investment rating of BBB-?

The decision of the SOFAZ management to invest in the shares of companies with a BBB rating will enable the level of yield of the investment portfolio to be increased 2-3 times. In other words, it is quite possible that the yield from asset management will increase from the current 1.5 to 4 per cent annually. And in terms of the volumes of the fund this means additional revenues of 1 billion manats from the management.

So the justified risk could enable SOFAZ to obtain by no means small revenues. Bearing in mind the natural depletion of fields and the fall in extraction volumes, it is precisely the management of the fund's assets that should become the main source of revenue.