What is the Petroleum Fund?
The Petroleum Fund of Timor-Leste was created after the
Petroleum Fund Law No.9/2005 which was passed by the
National Parliament in June 2005. By law, all petroleum and
related revenues must be paid into the fund, with balance of
the fund being invested in international financial markets for
the benefit of present and future generations of Timor-Leste
citizens. The operational management of the fund is the
responsibility of the Banking and Payments Authority, carried
out under an investment mandate agreed with the Minister of
Planning and Finance.
What is a
A bond is debt instrument (loan) where the issuer of the bond
borrower) promises to repay a sum of money at a certain interest rate and over a certain period of time to the holder of the bond
(lender). Most bonds pay a fixed rate of interest for a fixed
period of time, but there are also variable rate bonds
available in the market.
Who is the issuer of a bond?
The organization that borrows money from an investor by using
the bond market is known as the issuer of the bond. The issuer
of a bond could be a supranational agency, a national government
(for example: the United States Government), a government
agency, a municipal or a corporate
What is the coupon payment of a bond?
A bond will most often pay an interest to the
investors, also call coupon payments. The coupon is normally
paid one (annually), two (semi-annually) or four (quarterly)
times a year. The US Government Bonds for example, will pay a
coupon every six months, or semi-annually. The coupon is
normally fixed over the life of the bond (fixed coupon rate
bonds), but there are also bonds that offers variable coupon
payments (floating coupon rate bonds). The size of the coupon
payment depends on what coupon the issuer was offering when the
bond was issued (for a fixed rate coupon bonds) or the
prevailing level of interest rates (for a floating rate coupon
What is the price of a bond?
The price of a bond depends on factors in the
financial market. The current price of a bond is calculated by
discounting all the bondholders future cashflows (or payments)
to find today’s bond value (the present value) - this is the
price an investor would be willing to pay for the bond. The
factor that influences the price of a bond more than any other
is the level of prevailing interest rates in the economy. When
interest rates rise, the prices of bonds in the market fall,
thereby raising the yield of the older bonds and bringing them
into line with newer bonds being issued with higher coupons.
When interest rates fall, the prices of bonds in the market
rise, thereby lowering the yield of the older bonds and bringing
them into line with newer bonds being issued with lower coupons.
What are the risks of buying a bond?:
There are two main risk elements:
1) Market risk - the risk that the value of the bonds should fall.
2) Counterparty / Credit risk - the risk that the issuer of the bond fails to pay coupon or to repay the principal.
The bond rating system helps investors
determine a company's credit risk. The chart below illustrates
the different bond rating scales from the major rating
agencies in the U.S.: Moody's, Standard and Poor's and Fitch
Caa, Ca, C
CCC, CC, C
What is the value of the Petroleum
The value of the Petroleum Fund is
disclosed every quarter in the publicly available reports (see
own section on the BCTL web-site).
BCTL will publish a quarterly report for the fund approximately 5-6 weeks after each quarter end. The report will be published on the
What is “Net Asset Value”?
The size, or the market value, of the fund is referred to as the funds “Net Asset Value”. All the financial assets in the fund are being valued on the last day of the quarter using the last observed price of the asset. The financial liabilities are also valued using the same method. The Net Asset Value is the sum of all financial assets minus the financial liabilities.
What is Duration
Duration is a measurement of how long , in years, it takes for the price of a bond to be repaid by its internal cash flows. Bonds with
a higher durations carry more risk and have higher price volatility than bonds with lower durations.
What is Excess Return?
Excess return is a measurement of how well the performance of the portfolio is against a predefined index or benchmark. If the excess return is a positive number, than the portfolio has performed better than the benchmark.
What is Tracking Error?
Tracking error is the difference in investment returns between the portfolio and the performance of the benchmark. Tracking error can be measured ex-ante (predicted tracking error based on a certain risk model) or ex-post (realized tracking error).
What is a Benchmark?
The benchmark is measure for directing the long-term investment strategy and evaluating the investment return on a portfolio. Based on the objectives of the portfolio, the benchmark is a basket of investment assets appropriate for the risk tolerance for the portfolio. To evaluate the performance of the investment manager, the actual return of the portfolio is compared to the return on the benchmark.
What is a Basis Point?
A basis point is a unit of measure used in the financial world to describe the percentage change in the value or rate of a financial instrument. One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form.
For example, if the Federal Reserve Board raises interest rates by 25 basis points, it means that rates have risen by 0.25% percentage points. If rates were at 2.50%, and the Fed raised them by 0.25%, or 25 basis points, the new interest rate would be 2.75%.
What is the 0-5 years Merrill Lynch US Government Bond Index?:
The 0-5 years Merrill Lynch US Government
Bond Index (index ticker GVQA) is the current benchmark of the
Petroleum Fund. The GVQA is composed of US Government bonds with
less than 5 years until the bond maturity date. The index is
produced and maintained by one of the world's largest financial
management and advisory companies - Merrill Lynch, and is widely
used as a reference index for investors worldwide. Merrill Lynch
index data are available on the Merrill Lynch website.
What is the Petroleum Fund Portfolio?
The Petroleum Fund portfolio is the total of all assets held in the Petroleum Fund.
What is an investment horizon?:
The length of time the money is expected to be invested. The investment horizon of the Petroleum Fund depends on when and how much money will be needed by the owner of the fund.
The investment horizon will influence the optimal investment strategy (asset allocation). In general, the shorter the investor's horizon, the less risk he/she should be willing to accept.
What is Asset Allocation?
Asset allocation is the process of dividing an investment
portfolio among major asset categories such as bonds, stocks or
cash. The purpose of asset allocation is to reduce risk by
diversifying the portfolio.
What is Strategic Asset Allocation?
A portfolio strategy that involves periodically rebalancing of the portfolio in order to maintain a long-term goal for asset allocation.
The investment horizon is crucial input when deciding the strategic asset allocation. As a general rule the investment theory says that the fund should have more (less) risky securities and diversify into more asset classes - the longer (shorter) the investment horizon is.
What is rebalancing?
Rebalancing means to realign the weight in the portfolio with the weight of the benchmark. A rebalancing can be done within one asset class (for example bonds - to align the weights within each sub-segment), or between assets classes (for example bonds and stocks).
What is Passive Management?
Passive management (also called passive
investing) is a financial strategy in which a portfolio manager
tries to replicate the return of a certain index (the benchmark)
by taking as few portfolio decisions as possible, in order to
minimize transaction costs.
There are several market indices in the
world, and lots of index managers that are tracking many of
these market indices.
What is Active Management?
Active management (also called active
investing) refers to a portfolio management strategy where the
manager makes specific investments with the goal of
outperforming a benchmark index.
Example of historical
performance and risk numbers in the US market:
The table below shows an example of
historical annual return numbers (in the period 1928-2005) in
the US market for Stocks, Bonds and Bills:
|| Annual average return
|| Standard deviation
| US Stocks
| US Bonds
| US Bills (6 months)
The US stock market has given the highest return during this 78 year period, but the risk (defined by the standard deviation – how widely the return numbers are dispersed from the average return) has been far greater for stocks than for bonds and bills.
Another measure of risk is numbers of periods (year) with negative return. Stocks have shown negative return in 23 of 78 of the years, while bonds have 14 years with negative return. Bills have no years of negative return.