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Figure 2.6.3.2.4: BU Condensate Price vs. World Oil Prices
Source: PF Administration Unit
Production forecast
The ESI was originally estimated based on the P90 forecasts low forecast of both
petroleum prices and petroleum production, consistent with a 90 probability that actual
will exceed the forecast. In 2011, the methodology for forecasting petroleum oil prices was
changed to using the average of the low and the base P50 forecasts as the low forecast
was deemed to too conservative to be consistent with good judgment prudent.The
methodology for forecasting petroleum production is unchanged. The MoF will further
analyse the production forecast methodology and report in next year’s report.
2.6.3.3 Managing the PF
The PF Model
The PF Law is designed to contribute to a wise management of Timor‐Leste’s petroleum
resources for the benefit of both current and future generations. The PF is a tool that
facilitates sound fiscal policy, where appropriate consideration and weight are given to the
long ‐term interest of Timor‐Leste’s citizens. The PF helps policy makers to make well‐
informed budget decisions in an environment of fluctuating petroleum incomes that are
temporarily at a high level. The decision on how much to spend and how much to save i.e.
spend later is done in the State Budget where all the Government’s priorities are weighed
against each other.
The PF mechanism implies that petroleum revenues are transferred in their entirety to the
fund and invested abroad in financial assets. The investment policy of the Fund aims at
maximizing the risk‐adjusted return. The fund’s only outflow is transfers to the central
government budget, pursuant to parliamentary approval. The amount that may be
transferred to the budget is guided by ESI, which is defined as 3 of the petroleum wealth.
20 40
60 80
100 120
140
2004 2005
2006 2007
2008 2009
2010 2011
2012 2013
2014
US pe
r bar
re l
BU Condensate
Brent WTI
JCC
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The implied investment objective of the Fund is accordingly set at 3 real return, as a
necessary condition to enable sustainability on the spending side in terms of maintaining
the purchasing power of the petroleum wealth when spending is constrained by the ESI.
Governing the PF
Based on the “Santiago principles
15
”, the PF governance model is one of high degree of
transparency and disclosure of information. This helps build public support for wise
management of petroleum revenues and reduces the risk of bad governance. Transparency
ensures that information can be used to measure the authorities performance and also
guards against any possible misuse of powers. One of the fundamental elements of the
fund’s governance structure is that no one person or institution is responsible for making
and implementing investment decisions because each party is formally accountable to
another for their role in the decision‐making process. This degree of transparency serves to
encourage consensus and enable accountability, which means authorities and whoever
handles public money can be held responsible for their actions.
As the Executive, the Government through the MoF is responsible for the overall
management of the PF, on behalf of the people of Timor‐Leste. The PF Law makes the
Government accountable to Parliament through various reporting requirements. The
operational management is carried out by the Central Bank, which invests the fund’s capital
according to guidelines established by the MoF and mandates developed by the Investment
Advisory Board IAB. The MoF is required to seek advice from the IAB before making
decisions on any matter relating to the investment strategy or management of the PF.
PF Investment Policy
The PF was established in 2005 with a simple investment strategy that mainly constrained
investments to US Dollar denominated high rated bonds issued or guaranteed by
Governments. This was deemed necessary to avoid exposure to risk and volatility while
building capacity. It was also considered important to take time to build public support and
to avoid turbulence in terms of market losses before the management had received a
certain degree of integrity, credibility and reputation for professionalism.
The PF Law amendments in 2011, which followed a long and thorough process involving all
stakeholders, allowed for up to 50 allocation to public equities, not less than 50 in fixed
income, and not more than 5 in alternative instruments. The rationale for these changes
was two‐fold:
15
International Working Group’s “Sovereign Wealth Funds: Generally Accepted Principles and Practices”,
otherwise known as the Santiago Principles. The Principles identify a framework of generally accepted
principles and practices that properly reflect appropriate governance and accountability arrangements as well
as the conduct of investment practices by Sovereign Wealth Funds SWFs on a prudent and sound basis.
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Diversification;
this is the process of exposing the portfolio to a number of different asset classes
for example bonds and equities rather than being concentrated in any one of these alone.
The key to the diversification process is that different asset classes usually do not move
together. Combining assets with returns that are less than perfectly correlated can therefore
mitigate overall volatility.
Enable sustainable spending; the Government believes that a target allocation to equities
of 40 over time will enable the Fund to generate 3 real return with reasonable
probability. This would be a necessary condition to ensure the sustainability of public
spending, which is guided by the ESI, set at 3 of petroleum wealth. The Government notes
at the same time that the higher allocation to the traditionally more volatile asset class of
public equities will involve more short‐term fluctuations in the fund´s investment returns.
Having a long‐term investment horizon, the Government is ready to accept this increased
short ‐term risk to pursue its belief that equities will perform better than bonds in the long‐
term. In
pursuing its investment belief, the Government´s first order priority has been to gradually increase
the equity allocation from 5 at the end of 2011 to 40 by June 2014 aiming, among
other things, to buttress any adverse effects that bad market timing would incur. As of
end of 2
nd
quarter 2014, the fund´s allocation to 40 equities was completed. The Government
also has reduced the concentration to US Treasuries by allocating 10 of the fund
to non‐US developed market investment grade sovereign bonds. The
evolving investment allocation of the PF involves a sound and responsible process of introducing
new investment mandates and external managers. Table 2.6.3.3.1 shows the PF portfolio
and manager structure as of June 2014. The Government is conscious that increasing
the number of asset classes and sub asset classes requires a more sophisticated monitoring
framework to ensure that each manager is performing well and in accordance with
their guidelines. In general, a gradual development of the governance structure and capabilities
are a prerequisite for a successful development of the investment strategy.
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Table 2.6.3.3.1: PF Portfolio and Managers Structure
Number Managers
and Mandates, as of June 2014 Weight
Market Values,
millions Return
since inception
Total PF Portfolio
100.0 16,634
4.6 International
