On Thursday October 18th, 2018 the Stabroek News published an article entitled `Merrill Lynch interested in sovereign wealth fund’. The investment world has taken notice of the potential wealth that lays offshore in Guyana. The government should study the history of those who seek to bestow advice on how to manage Guyana’s potential windfall. The flawed oil contract is giving up more than an investment bank is likely to generate in future returns.
There are generally three items that determine the size of your portfolio at the end of an investment period:
1. The skill of the money manager
2. The length of time the money stays invested
3. The amount you invest
Let’s look at history to see if Merrill Lynch has demonstrated it is a skilled money manager. There are few who possess the skills to manage money to beat an index fund such as the S&P 500. Investing in the stock market is a zero-sum game, so you have to be highly skilled and experienced to gain an advantage against other players. This is the reason why the greatest investor that ever lived, Warren Buffett, has told folks to invest their money in index funds.
Merrill Lynch lost more than US$40 billion during the financial crisis that started in 2007. It eventually lost the confidence of its trading partners and its survival came into question. Thus, Merrill Lynch sold itself to Bank of America in 2008. In 2011, Bank of America ran into trouble and needed US$5 billion of capital from Warren Buffett to calm worried shareholders. For being their saviour, Buffett got the right to buy Bank of America shares at US$7. Now, those shares are worth about US$28. That is quadrupling his money in about 7 years. It would seem logical that the government should seek to have Warren Buffett to invest its money before it gives any money to the Merrill Lynch or its parent, Bank of America.
As for the length of time the money has to compound. Guyana is a few years away from receiving funds that it can place in a sovereign fund. Buffett is only promising his shareholders 6% annual returns. After inflation and management fees from an investment bank, the expected returns may be a paltry 3% for a sovereign fund. That doesn’t leave much room to use the money without depleting the principal. The money compounding at a low rate of return will not do much to increase the size of the fund irrespective of the time it is held in the fund.
That brings us to the last point, the amount of money you have to invest. At the moment, Guyana stands to reap much less, percentage-wise, than what other nations have received from their oil contracts. This is shown in the ‘3b. Progressivity’ chart from the IMF report, a summary was published on December 24th, 2017 in Stabroek News. To have a big sovereign wealth fund that can serve the needs of the nation for generations, Guyana needs to start with a large amount.
Extreme poverty is defined as living on less than US$1.90 a day. About 19% of Guyanese live on this amount. That is less than a Wall Street banker pays for coffee. Instead of receiving crumbs from the contract, it would be more prudent to renegotiate for a larger share of the oil revenues. It is better to start with a larger share of the pie than pin your hopes on future returns.
Yours faithfully,
Darshanand Khusial, M.Eng
October 22nd, 2018
