COMPETENT APPROACH

The global financial system has been greatly shaken in the last decade, and not all countries can survive the difficult times without carrying a heavy debt burden. A classic example of a debtor is the leadership of Greece, which fell into a difficult financial situation after the 2004 Summer Olympics. Over the last decade, the Greek people have borne a heavy debt burden while the Greek government keeps changing as in a kaleidoscope, finding no way out of the financial impasse.

One of the measures to prevent the impact of the global crisis is the availability of reserves concentrated in separate state funds.

In essence, the creation of a sovereign fund by the country's leadership can be attributed to a competent approach to the use of revenues. We should not forget that the category you will be attributed to in the future - creditors or debtors - depends on how efficiently funds are spent regardless of whether it is at the household or state level.

And the trend of creating sovereign funds has intensified since the beginning of the 21st century. Although the first sovereign fund was allegedly founded in Kuwait in 1953, 65 per cent of existing funds have been organized since 2000.

Contrary to the popular cliche, not all funds have been created only by oil and gas producing countries. At present, there are approximately 70 sovereign funds that operate accumulated financial resources worth 7 trillion dollars, and of them, funds worth 4.1 trillion dollars are formed by revenues from oil and gas. In other cases, a source for the formation of sovereign funds is the pension funds as well as funds received from privatization in Singapore.

Funds by geographic location are concentrated mainly in Asia (41.8 per cent of total resources), the Middle East (36.5 per cent) and Europe (17.3 per cent) and the rest are in North and South America, as well as Africa.

Among the leading sovereign funds we can note the Government Pension Fund of Norway - 882bn dollars, the Abu Dhabi Investment Authority (UAE) - 773bn dollars and the China Investment Corporation - 747bn dollars.

According to their mission, the sovereign funds include three main issues: macroeconomic stability, savings and pension reserves.

In accordance with the resolution of tasks, sovereign funds tend to place their funds in higher-yielding assets with a significant term of placement to less profitable assets with immediate liquidity with short-term placement.

At the same time, the larger the sovereign fund, the greater risks its leadership can take to obtain the highest dividends from the placement of the investment portfolio, which can be traced in the structure of investments by the Norwegian sovereign fund. Its assets are invested in shares - 61 per cent, securities with stable income - 27 per cent and property - 2 per cent.

Of course, the fall in oil prices on the world market has a very negative impact on the sovereign funds, the main revenues of which come from the export of oil and natural gas. For example, the National Welfare Fund (NWF) of the Russian Federation, which was formed on 1 February 2008 with 32bn dollars, reached its maximum size in May 2011 - 94.34bn dollars.

At the same time, the NWF reached the stage of the fall in oil prices in July 2014 with reserves of 85bn dollars. However, the period of the active fall in oil prices had a negative impact on the reserves of the fund - by 1 November 2015, the NWF reserves totalled 73.45bn dollars.

Azerbaijan managed to avoid a sharp decline in the assets of its own sovereign fund. The funds of the State Oil Fund of Azerbaijan (SOFAR) reached its peak in 2014 - 37.1bn dollars, and at the end of the first three quarters of this year, they fell to 34.738bn dollars.

It is clear that the Central Bank received the main blow after the February devaluation, and its reserves have decreased by 6.924bn dollars since the beginning of the year and amounted to 6.834bn by 1 November 2015.

But SOFAR continues to perform successfully the main task of ensuring macroeconomic stability. It is thanks to transfers from SOFAR to the state budget that the implementation of major infrastructure projects has been ensured in recent years. The volume of transfers has totalled 61.4bn manats since 2003.

However, given the deteriorating situation on commodity markets - in particular the decline in oil prices, the government revised the policy of using SOFAR assets. In 2016, the volume of transfers to the state budget is provided in the amount of 6bn manats, which is 40 per cent less than in 2015. As a result, SOFAR is expected to maintain the amount of funds at the current level at the end of 2016. And that, coupled with the possibility of improving the investment portfolio, is a major challenge in the current environment.

Until 2011, SOFAR assets were placed in dollars, euros and pounds sterling. At the end of 2010, SOFAR investment portfolio to-talled 22.677bn dollars, of which 53.41 per cent were placed in dollars, 41.43 per cent - in euros and 5.16 per cent - in pounds sterling.

Already in 2011, the SOFAR investment strategy was changed - the fund got the opportunity to expand both the currency portfolio and the geography of investments and invest in stocks, real estate and gold, and not only in securities with a stable income, although in this case, in accordance with the investment policy, there are restrictions on the currency of countries with a rating of at least "A".

Thus, currently 47.8 per cent of SOFAR assets are US dollars, 35.9 per cent - euros, 5 per cent - pounds sterling, 0.5 per cent - Australian dollars, 1 per cent - Turkish liras, 1.4 per cent - Russian roubles, 1.2 per cent - Korean wons, 1.4 per cent - Chinese yuans, 1.5 per cent - Japanese yens, 1.1 per cent - other currencies and 3.2 per cent - gold.

The geography of SOFAR investments has also increased markedly: 57.54 per cent - in Europe, 22.65 per cent - in North America, 3.71 per cent - in Australia, 11.12 per cent - in Asia and the Pacific, 0.85 per cent - in the Middle East, 0.99 per cent - in South America, 3.13 per cent - in international financial institutions and 0.01 per cent - in Africa.

By the structure of assets and the type of investment, most of the assets are securities with stable income (81.6 per cent), but investments in stocks, gold and real estate have expanded significantly (See Figure 1).

It is not difficult to note that SOFAR is forced to keep a significant part of its investment portfolio in government bonds with very low yield, but with high liquidity.

By the way, 30.8 per cent of the SOFAR investment portfolio was placed for a period of up to one year, 28.3 per cent - from one to three years, 15 per cent - from three to five years, 9.2 per cent - more than five years, and 16.7 per cent of the funds have been invested in real estate, stocks and gold.

It is precisely the placement of almost a third of funds in short-term assets (up to 1 year) that preserves ample opportunities for responding to the deteriorating situation on foreign markets and taking preventive measures.

That is to say if there is a sharp drop in oil prices, SOFAR may withdraw assets worth more than 10bn dollars.

However, oil prices in 2016 may exceed the indicator of 50 dollars per barrel forecast in the country's budget, and SOFAR assets will increase accordingly.

The most promising investments in SOFAR can be investments in real estate, as in addition to the rent, it is quite possible that the price of the acquired property will grow. Another promising trend is the acquisition of private shares.

The SOFAR management can take these steps in the long-term if financial reserves increase and the macroeconomic situation in the world improves. It can become an impetus for the Azerbaijani government to make further changes to the current structure of the investment portfolio with the predominance of riskier financial instruments - real estate and private shares - to increase dividends from the assets that have been placed.

Competent management of the sovereign fund will not only protect the national economy from financial upheavals, but also ensure prosperity for future generations.