Ethics Case Study of the Week: Managing a Sovereign Development Fund

By Gary Sarkissian posted 02-22-2021 08:00


CFA Institute’s Code of Ethics and Standards of Professional Conduct codify the ethical guidelines for the investment profession that are critical to maintaining the integrity of capital markets and investor trust.  Members, candidates, and even firms make a commitment to uphold these standards as they help elevate ethical decision-making universally around the globe.  

As investment professionals, we are certain to face important ethical decisions in our day-to-day activities.  Some scenarios we encounter will be straightforward, while others may be more complex.  No matter what circumstances we face, continuous learning remains imperative in an investment industry that continues to evolve with products undergoing innovation and a regulatory environment continuing to adapt. 

For that reason, each week we will feature a sample case from CFA Institute’s Ethics in Practice Casebook.  Each case is built upon a real-life example that may involve a regulatory matter or even a CFA Institute Professional Conduct investigation.  At the end of the case is a multiple-choice question that addresses the ethical nature of the actions taken in that case.  

This week’s case involves several elements of the CFA Institute Code and Standards. 

Managing a Sovereign Development Fund
After many years working for a large private equity (PE) firm in the United Kingdom, Adebayo, a CFA® charterholder, returns to his home country to take a position as CFO/CIO of his country’s Sovereign Development Fund (SDF or the Fund). The Fund’s goal is to benefit the local economy by financing local development projects that will generate high investment return to attract global investors as partners with the government through investment in the Fund. In that way, the capital deployed locally will have a leveraged impact on the economy and society. The Fund has a limited budget for professional staff, so Adebayo hires two junior analysts who have excellent professional credentials but who have not worked in the country.

Soon after taking the position, one of the country’s regional governors (who is also the leader of the country’s dominant opposition political party) strenuously advocates for the Fund to invest in a large mining project in an underpopulated and remote area of the country. The project will bring economic benefits to the governor’s region. At the same time, the country’s minister of finance, who hired Adebayo, is pushing for the Fund to invest in a large infrastructure project in an urban area that will create thousands of jobs for supporters of the political party currently in power.

In addition, former colleagues at the PE firm contact Adebayo and express interest in making a significant investment in the Fund. They ask to meet with Adebayo to get detailed information about the Fund’s current and future investment. The PE firm seeks assurances that the Fund will continue to follow an aggressive strategy to maintain high returns. After the PE firm makes a large investment in the fund, they ask Adebayo to give them regular updates on the Fund’s investment performance and financial health, on future government funding, and on the status of the Fund’s projects.

Choose one of Adebayo’s actions from the below choices and describe how it implicates the ethical principles and requirements of the CFA Institute Code of Ethics and Standards of Professional Conduct.

A. Making hiring decisions for the Fund’s investment team.
B. Investing Fund assets in the mining project as requested by the regional governor.
C. Investing Fund assets in the infrastructure project as requested by the finance minister.
D. Providing detailed information to former colleagues about the fund’s current and future investments.
E. Providing assurances to the private equity firm that the Fund will continue to maintain high investment returns through an aggressive growth strategy.
F. Providing regular updates on the condition of the Fund to a large private investor.

Click the “Analysis” button below to see the analysis for this case, and feel free to discuss in the comments below.  The completion of this case qualifies for 0.25 hour of Standards, Ethics, and Regulation (SER) credit

This case touches on several elements of the CFA Institute Code of Ethics and Standards of Professional Conduct (Code and Standards).

Hiring Decisions. The Code and Standards requires members to act with integrity and competence. Adebayo, himself an experienced CFA charterholder, seemingly meets this standard by hiring two junior analysts with excellent professional credentials to help manage the Fund. To be successful, the SDF personnel should have skills and expertise with global credibility consistent with building and maintaining investment partnerships so that co-investors are comfortable with the quality of the investment team running the SDF. It is crucial that the individuals be investment managers of the highest standing, and ideally, that they have a track record to back it up. A successful SDF should also have strong expertise in the local market to be able to source, assess, and structure investments in a credible way to provide confidence to co-investment partners that a return objective will be met. Ideally, the Fund would be staffed by qualified personnel with relevant education who have professional experience working in the locality. Adebayo, who has worked for years outside the country, might have considered seeking local expertise to enhance the competence of his team.

Investment Decisions. The Code and Standards require members to exercise diligence, independence, and thoroughness as well as to have a reasonable and adequate basis to support investment action. Adebayo has at least two different investment opportunities to choose from, each with its own benefits. The mining operations are likely to increase his country’s wealth and boost the economy; at that same time, they have the potential for robust return on investment. The infrastructure project will similarly boost the economy by providing long-term employment for thousands of workers. Either investment may be justified on its merits and achieve the goal of the Fund to have a positive socioeconomic impact. Clearly, however, the government champions of each project are placing political pressure on Adebayo. Adebayo must be resolute in maintaining his independence and objectivity to act in the best interests of the Fund and its investors and not be swayed by conflicts of interest resulting from outside influences or pressures. A successful SDF should have a robust and rigorous governance framework for making investment decisions that can stand up to global due diligence. Development orientation is not an excuse for a lack of rigor in investments. If the Fund is going to originate deals locally and attract co‑investors, it needs to be able to prove that it will act in the investor’s best interest.

Transparency and Fairness. Two fundamental ethical principles embodied in the Code and Standards are transparency and fairness to investors. Adebayo can develop trust in the Fund on the part of potential investors through regular transparency and accountability to the co-investment community. It would be appropriate and reasonable for Adebayo to provide detailed information to potential investors, such as his former employer, so that they can conduct due diligence on the Fund. But Adebayo must be careful that he does not improperly disclose confidential information or material nonpublic information to potential investors. Furthermore, he must treat all investors fairly. It may be acceptable in some circumstances to regularly communicate directly with a particular investor, but all investors of the fund should be treated fairly and receive the same disclosures about the financial prospects and other information about the Fund, not just those with whom Adebayo has a close relationship.

Investment Mandate. The Code and Standards require CFA Institute members responsible for managing assets to a specific mandate, strategy, or style to take only investment actions that are consistent with the stated objectives. In the case of the Fund, Adebayo has a dual mandate to invest in projects that have beneficial socioeconomic impact as well as have a positive investment return. This mandate is different from traditional investment funds that focus only on return on investments regardless of outside impact. A successful SDF will have a clear, commercial mandate that will guide the management team’s decision making and help other investors understand and relate to its mission. Investors in the Fund must understand that investment return is not the single determinative factor that will guide Adebayo’s decision. Any assurances or action by Adebayo to private co-investors in the Fund promising a set rate of return or promising to prioritize maximizing return would be contrary to the mission of the SDF.

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