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There are nearly 47,000 companies listed on the world’s stock exchanges and the people of Norway own just under 1% of them. If everything goes as planned, in another 10 years they could own 2%.
It is not that Norwegians are a nation of stock market speculators. Instead, collectively they are the ultimate owners of the largest investor in public securities in the world: the Norway Pension Fund—Global. Valued at US $611 billion at the end of March, it vies for the top spot of the sovereign wealth fund tree with the Abu Dhabi Investment Authority.
However, with great power comes great responsibility: in the last 12 months the Norwegians have voted against the beleaguered Greeks being allowed a “managed default” and offered a $9.2 billion loan to the International Monetary Fund (IMF) as the organization struggles to contain the Eurozone crisis. In contrast, the United Kingdom—with a population 12 times larger—offered $15 billion.
How did this Nordic nation of barely five million people become such a power-player on the world’s economic stage?
One word: Oil.
“The fund is a redeployment of wealth from the ground to a well-diversified portfolio of assets outside Norway,” says Petter Johnsen, Chief Investment Officer (Equities) at Norges Bank Investment Management (NBIM), which is responsible for the management of the fund. “Public markets are the greatest entry point for this. This way, we can harvest the equity risk premium in the most efficient way.”
The 1% figure that Johnsen and others cite is actually just for illustration purposes; the Norwegian fund doesn’t spread its wealth about so evenly. It doesn’t invest in its home market, as it could buy the entire market cap of the Oslo Børs almost twice over, but its average holding in public markets works out to approximately 1% of every listed company on the planet.
The fund was launched in 1995 as a vessel for the new income stream the country was about to enjoy after the discovery and subsequent drilling of oil in the North Sea. Until that point, Norway had not been fiscally happy since suffering in the Second World War. In the 1980s the country was struggling with stagflation and emigration to greener grass was not uncommon for its people. After cripplingly huge investment in the infrastructure to drill the black gold out, however, Norway has barely looked back. (Ask any Swede about their nation’s decision not to go in with its neighbor on the exploration costs and they will doubtless shake their heads, sigh, and display a pained expression.)
Now, the fund contributes around 4% of its entire asset pool to support the Norwegian economy each year—in the good years, when tax revenue is high, it contributes slightly less, in the bad years it pays in slightly more. This rule was established so the country’s treasury could know what to expect on an annual basis. The figure was based on a study by Elroy Dimson, Emeritus Professor at London Business School, who estimated that 4% was the average annual long-term investment return from a public securities portfolio. Dimson is now chairman of the fund’s investment strategy board, on which he is joined by a Finn, a Swede, and a Norwegian. “That figure is largely aspirational now,” says Dimson. “Low interest rates and the financial crisis have made it pretty unlikely recently.”
Over the past 13 years, the fund has made 4% or more eight times and outperformed its benchmark on 10 occasions. Last year, it lost 2.5%—slightly worse than the benchmark—but critically, in 2008, the fund’s holdings in public markets (and naivety over its risk exposure) saw 23.3% sliced from its total value. This practically wiped out most of the gains made over the previous decade. The following year, a 25.6% return made up some of the damage, and the fund’s investment team learned a valuable lesson. In the aftermath, the fund’s directors did a lot of soul-searching, dropped a significant number of its third-party managers, and refocused on the job at hand.
“Around 95% of the assets are managed internally in Norges Bank Investment Management,” says Johnsen. “This share has been growing as we are building up the team. It takes time to build up internal competence—moving in-house is a greater responsibility, but it means we have a closer relationship with the companies in which we invest.”
Across the whole portfolio, the fund owns stocks in approximately 8,000 companies (a more realistic figure than the previously suggested 47,000). “We have a 2% ownership stake in European listed stocks and have a fiduciary responsibility to our clients (the Norwegian people) to know in detail the strategy and financial side of these companies. We end up as one of the largest shareholders in many of them,” Johnsen says.
At around $611 billion, the Norwegian fund is more than two and a half times larger than the Californian Public Employees’ Retirement System, the largest pension fund in the United States. It employs 50 external managers to invest 5%, or $30 billion, of the fund across specialist mandates, such as emerging markets and small cap companies. The internal direct investment team numbers little over a hundred and each manager has a distinct portfolio. In 2000 the fund set up sector strategies—portfolio managers are responsible for specific industries and each has a tailor-made model portfolio that contains about 30-50 companies. “They can invest outside these names,” Johnsen says, “but we want a core focus. It is a single ownership structure—the portfolios are all managed separately—but together they are a combination of specialized mandates. Combined, they follow and invest in some of the largest 1,000 global companies—mainly in the developed markets.”
A study at the end of the last decade by Mercer questioned the efficacy of active management. It was not seen very favorably, or at least paying third-party managers for the privilege wasn’t. “We focus on cost efficiency, which is one reason why we manage so much internally,” Johnsen says. “We can also attract people to work for us. Around half of the sector strategies group is employed in our international office in London. We also have offices in New York, Shanghai and Singapore, which allows us to have access to the companies in which we invest and to industry experts. We do more than 2000 meetings a year.”
The returns on the equity portfolio have not been world-beating for all this effort, however. Despite only failing to beat its benchmark on three occasions since 1999, this portfolio has just inched above it for the rest of the time. The active management of equity in NBIM has produced an excess return of 50 basis points and an IR of 0.6% since inception, according to Johnsen.
“They are so huge they have to be realistic about how much alpha they can actually capture,” says Nicholas Motson, Lecturer in Finance at Cass Business School in London.
So, the problem, and it is a high-quality one, is the size of its assets.
Johnsen notes that the fund will not buy into a standardized product offered by an asset manager, but demands a separate mandate managed by a specific person, investing on a segregated account on its behalf. “It’s a question of capacity and scalability,” he says. “Many fund managers have a cap on the level of assets they manage—the relationship has to be meaningful to both parties and often it isn’t.”
Scalability is also a challenge for the internal teams. “Due to the size of the fund—we really have to concentrate our strategies. We are not after short-term outperformance, like a hedge fund, for example, but are focused on our investment strategy and creating alpha in the long term,” Johnsen says.
However, some have questioned this approach, for it lies so far outside the mainstream when compared to its peers. It is certainly one of the few enormous investors to stick almost entirely to publically listed (and mainly liquid) securities. The fund made a foray into real estate in 2010 and has since allocated a target 5% of the total portfolio to the asset class. The 5% stake reduced its fixed-income holdings to 35% and retained a 60% exposure to equities.
“What is the model?” asks Motson at Cass. “There doesn’t seem to be one. Just park the money in liquid assets, don’t move things about, and ride out the lumps and bumps? It’s what endowments used to do 25 years ago. It’s almost the exact opposite of Yale, as Yale holds mainly very liquid investments. It has a huge equity and bond allocation, which is surprising for a long-term investor. Yale harvests illiquidity.”
The Norway model sits in direct opposition to that of most long-term investors with distant liabilities. Illiquid assets are usually the bill of fare for many of the giant funds, but so far they have not been an option for Norway.
“It is not an investor in private equity,” notes the London Business School’s Dimson. “Still, there’s no reason, in principle, why they cannot harvest an illiquidity premium from public equity (buy a stock when illiquid and sell on when it’s more liquid).”
What about infrastructure? It is the toast of the town for Europe’s other largest investors—but Norway isn’t quite onboard yet. “After moving 5% into real estate, the fund will have established the skill to look at and invest in illiquid assets—infrastructure could conceivably be the next step. However, there are so many people investing in it now, prices are very high,” said Dimson.
Johnsen echoes these sentiments: “Looking at our ambition of a 4% real annual return, infrastructure could make sense. Real estate was our first step into private market investments—infrastructure has attractive characteristics but we are not at that stage yet.”
There’s another stumbling block for these illiquid assets, and that is the illiquidity itself. Complete transparency is a given for this investor. The Norwegian people have to be able to know the value of their assets at any given time. If an asset is illiquid, by its very nature, it is difficult to price. “Infrastructure is attractive and inflation-linked, but the problem for the moment is that they don’t know if they are under or overpaying for the assets,” says Dimson. “The fund is completely transparent. Norwegians believe in avoiding any kind of opacity—this is why it took a long time to get into real estate as it is hard to put a definite value on it and the ultimate owners of the fund don’t want to feel like they have overpaid for something. This level of transparency can give rise to challenges though, as questions to the investment manager and the manager’s answers are in the public eye.”
Transparency really is the word in Norway. All taxpayers in the country have their annual income posted on a website for the rest of the world to see what they earn. This is seen as the norm. “We publish a complete holdings list at year-end, but we will generally not make comments or announcements about single investments,” says Johnsen. “We have active large positions; if we are completely transparent about what we are doing it would become a real challenge to our investment possibilities. There is a cost to being too open.”
One thing they are open about, however, is their ethical policy. The fund has become synonymous with responsible investment. A high-profile attempt to alert retailer Wal-Mart to some of its suppliers’ labor practices led to the company being dropped from the Norwegian portfolio. There are around 50 companies on a black-list. However, this is the last resort and “engagement” is favoured over “exclusion.”
“When you are a fund of this size, there are some large-cap stocks you can’t avoid buying,” says Dimson. “Instead, it can be appropriate to engage with companies. But through the ethical screening process, some companies are ruled out altogether, even though that may give rise to a loss of diversification. The fund has established an ethics commission, which is relatively separate from the investment function.”
The Advisory Council on Ethics was created in 2004 and was so concerned with the sustainable and socially responsible basis of the fund, that even its name was changed. Originally called the “The Government Petroleum Fund,” it was rebranded “Pension” in January 2006. This was partly due to calls from environmental groups that the country was profiting from a product that was potentially ecologically unsound. The new title is a misnomer, however. It may eventually end up paying Norway’s pension bill, but there are no guarantees. The fund has no liabilities—at least, no established ones—and is not likely to be giving much more than 4% to the Treasury for a couple of generations.
This is not just down to luck; it has been mapped out from the beginning. The Norwegians learned lessons from other countries that suddenly became vastly wealthy through such a windfall as an oil strike. In a paper published this year, Dimson explains how the fund worked to avoid the infamous economic plague knows as Dutch Disease. This phenomenon sees citizens becoming lazy and unmotivated as society has more money than it really know what to do with. Prices rise, people spend too much, and they stop working for what they have. And then the inevitable crash occurs when this money runs out. (The Economist coined the term to describe the decline of manufacturing in the Netherlands after the country found natural gas in 1959).
It is unlikely that there will be a “Norwegian Disease” of this nature any time soon, especially as the oil has not yet run out—nor does it look like oil prices are going to crash. So what does the future hold for the 100 or so investment professionals running (most of) the money?
“There will be a change of emphasis in our investment ideas to take more advantage of being a large investor,” Johnsen says. “Our capital strategies team will be taking advantage of our long-term view by taking long-term positions in single companies. This will concentrate our focus on research and investment efforts. We might move into more private investments—currently we can only do ‘pre-IPO’ deals, but we could further expand into the non-public space and take long-term, more illiquid positions.”
And Europe? The fund dropped much of its peripheral Eurozone debt holding this year over fears of default. It also voted against Greece being allowed a pass for one of its coupon payments. “The equity team has to be market neutral on Europe—through our delegated mandate approach the portfolio managers have full responsibility so we won’t take a structural view,” says Johnsen. “According to new strategic benchmarks from the Ministry of Finance, there will be some re-weighting in terms of exposure, but still an overweight in Europe. Most of the reweighting will be done through inflows to the fund, which will probably be large in the coming years. At the same time, this kind of situation throws up opportunities for us as a long-term investor.” And there are few like it. At more than $600 billion, all eyes will continue to be on Norway’s mega-fund and its novel model of investing. Liquidity, ethics, and transparency all buck various trends in the institutional investing space—and buck them with such force that many will be looking for it to fail. As with nearly all long-term investors and investments, however, this relatively young experiment is just waiting to play out. Critics—and opponents—will be watching for a while to come.