Norway Pension Fund Balances ESG with Returns

As a major oil-producing country whose economic future depends on how it invests revenues from its most valuable natural resource, Norway has managed to strike a balance between meeting high standards of environmental, social, and governance (ESG) objectives and a steady investment return.

Norway’s $1.011 trillion Government Pension Fund Global has reported strong returns from oil and gas and basic materials stocks in its latest quarterly report, but also was recently named one of the top 25 responsible asset allocators in the Bretton Woods II Leaders List.

Although it wasn’t until 1969 that the country first struck oil in its vast offshore reserves, experts say there are only about 50 years of oil production left in Norway’s North Sea oilfields, which is why the country has essentially transferred its economic future from its rigs to a sovereign wealth fund. The Norwegian Oil Fund was established by law in 1990 to support the government’s long-term management of petroleum revenues. The fund is owned by the Norwegian people, and is managed by Norges Bank, the country’s central bank on behalf of the ministry of finance.

“We seek to promote the long-term economic performance of our investments and reduce financial risks associated with the environmental and social practices of companies that we are invested in,” Thomas Sevang, head of communications and external relations for Norges Bank Investment Management, told CIO. “We need to be reliable and transparent to earn trust and legitimacy. We build trust through being as open and transparent as possible, and work continuously on increasing knowledge of the management of the fund.”

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The fund also keeps track of how its ethical investment decisions have affected its investment returns. In a March report released by the fund analyzing the impact that excluding companies for ethical reasons has had on the fund’s return, it was found that the product-based exclusions have reduced the return on the equity index by close to 1.9 percentage points.

“Both the exclusion of tobacco companies and certain weapons manufacturers have reduced returns,” said the report. “This effect has to some extent been mitigated by the positive contribution of the conduct-based exclusions, primarily the environmentally based exclusions of mining companies.”

The report said that the other exclusion criteria have had only a minor effect on the return on the benchmark index, adding that over the past 11 years, the equity benchmark index has returned 1.1 percentage points less than an index unadjusted at constituent level.

As part of its aim for transparency, the fund also publishes a comprehensive annual activity report related to the “three pillars” that underpin its responsible investment efforts: standard setting, ownership, and risk management.

“We aim to contribute to the development of standards and practices that will serve the long-term interests of the fund,” said Sevang. “Our principles, expectations, and positions build on internationally recognized standards. We make submissions and prioritize corporate governance and sustainability topics in defined initiatives to contribute to improved disclosure, standards, and practice development.”

He added that research increases the understanding of factors that can affect future investment risk and return. “We promote research to inform market standards and practices, data development, and our own responsible investment priorities.”

Sevang said the fund is an active owner and uses its voting rights to safeguard its investments, which includes voting to promote sustainable development, and good corporate governance.

“We aim to vote at every shareholder meeting,” he said. “Information from our portfolio managers is integrated into our voting decisions. As a large, long-term investor, we engage directly with companies’ board and management.”

In 2016, the fund voted at 11,294 shareholder meetings, and representatives of the fund had 3,790 meetings with company management.

The fund has developed criteria for what it does and does not want to invest in. There may be companies in specific sectors and countries that it chooses not to invest in as a result of challenges related to the long-term profitability of business models, or the external impacts of companies’ activities. At the same time, there may also be situations where the fund decides to divest completely from companies following an assessment of environmental and social risks.

“We monitor and analyze risks from environmental, social, and governance issues as part of our overall risk management,” said Sevang, which he added could result in divestments from companies where the fund sees elevated long-term risks. “Our divestments follow from the application of our integrated risk model. Through our environmental investments, we dedicate capital to environmental technologies.”

The divestments differ from the ethically motivated exclusions under the guidelines for observation and exclusion from the Government Pension Fund Global, which are decided on by the fund’s executive board following a recommendation from the council on ethics or, in the case of the coal criterion, Norges Bank Investment Management.

Sevang said the fund performs general assessments of topics and sectors on an ongoing basis, before going into specific issues in greater depth. It emphasizes development of high-quality data and corporate disclosure, and continues to enhance its databases of non-financial data. Risk assessments may lead to adjustments to the portfolio and divestments.

Norway first issued guidelines for the observation and exclusion of companies from the Government Pension Fund Global in November 2004. The Ministry of Finance appointed a council on ethics to research and evaluate companies, and to make recommendations on exclusions based on the criteria set out in the guidelines.

The guidelines include two types of criteria, one that was related to specific product types and excluded companies that produced tobacco, sold or produced weapons, or military materials to certain countries, or produced weapons that violated fundamental humanitarian principles. A separate set of criteria excluded companies where there was an unacceptable risk of grossly unethical corporate conduct that contribute to serious or systematic human rights violations, serious violations of the rights of individuals in situations of war or conflict, severe environmental damage, gross corruption, or other serious violations of fundamental ethical norms.

Tags: ESG, Government Pension Fund Global, Norway, Pension, Sovereign Wealth Fund

Current perceptions of the hedge fund industry and the preferred strategies within the space were among the themes discussed by asset owners gathered at Agecroft’s Hedge Fund Investor Leadership Summit held in New York on November 3. These investors also shared traits they seek and signals they monitor when potentially terminating manager relationships. Participants included:

Ben Chang, senior associate at the $62 billion Alaska Permanent Fund Corp. (APFC)
Katherine Molnar, senior investment officer at the $7 billion Fairfax County Retirement Systems
Matthew Sherwood, senior manager at the $2.5 billion Ministers and Missionaries Benefit Board
Jason Josephiac, senior investment analyst at the $27 billion United Technologies Corp.

On the Role of Hedge Funds in the Portfolio

Chang: We recently revamped our hedge fund strategy such that we redeemed about $3 billion from fund-of-funds and put that to direct investments.

At previous board meetings, I had to defend exactly why APFC should continue to invest in hedge funds when hedge funds as a whole have returned lower than the S&P 500. The APFC uses hedge funds as an absolute return mandate. We’re hoping to achieve CPI +5%, regardless of the broader market atmosphere. We’ve been mostly invested in equity market neutral, macro, relative value [strategies], but most of the managers we’ve selected have relatively low correlations to the S&P, HFRI, Barclays Aggregate to anything that we can think of.

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Molnar: [Under the three defined benefit plans the fund manages, hedge fund allocations range between 25-35%. Global macro and relative value are the primary hedge fund strategies within the portfolio.]

All things being equal, we’re looking for higher volatility versus lower volatility, which has been pretty hard to come by these past few years. If we can convince ourselves that a manager is diversified not only to the rest of our hedge funds but to the broader portfolio, then we prefer to have more volatility and the high requisite returns that comes along with that

Sherwood: We have [various] hedge fund buckets, [and] each have different mandates. We have long/short equity, global tactical allocations; it really depends on where we’re going to benchmark that strategy. We’re going to look for alpha, and because we have specified benchmarks that we use as hurdles, we’re looking for managers that can crush those.

Josephaic: We use [ hedge funds] in a portable alpha construct. We don’t invest in hedge funds; we invest in hedged funds. Most of our managers are going to be beta or market neutral.

Current Preferred Strats

Josephaic: I’m never hot or heavy on any type of strategy. Diversification is the only free lunch.

Sherwood: A great complement to [our] portfolio assets would be some trading strategies across asset classes: arbitrage strategies, with the interest rate hike cycle, maybe merger and risk arbitrage. Those are a few things on my radar.

Molnar: If [equity and/or interest] volatility increases, that should be good for certain hedge fund strategies, including macro, fixed-income relative value, equity relative value, long/short equity…I’ve been hearing and saying that for four years, so I don’t really know.

Chang: My favorite, personally, are sector specialist equity market neutral managers, [where] they lever up their fund 2-2.5 times such that they’re increasing returns on specific bets. So, if you have a skilled manager, you can still return 10-15% per year—that demonstrates skill. Being equity market-neutral and being able to demonstrate the same amount of alpha, that’s what really makes sense to me.

Signals Regarding Manager Selection/De-Selection

Josephaic: It’s relatively easy to evaluate track record. I want people that are in the business that are passionate about what they do, that aren’t necessarily loud about what they do. You want to be able to get through those tough environments when a manager has a drawdown and that they can come to you and explain what is going on, and you can have an honest conversation, as opposed to someone who doesn’t.

Sherwood: Personality does matter. If you’re going through an eight-month stretch of underperformance or negative returns and you’re not the most likeable person, it’s going to be easier to pull the trigger on you. If you make your money in market mispricing or credit optionality, and you continue to do that and you’ve had some bad breaks, but you’re going to stay the course, that’s what I like.

Even if they’re managing money and their assets grow from $1 billion to $10 billion in the course of a couple of years and they’re not taking the risks that they would, and instead of a trader [become] an asset gatherer, that can be problematic.

Molnar: I fired a manager a few years ago, not because they were in a drawdown, but once I became convinced they never were going to be able to get out of that drawdown because of their psyche. Something snapped. It became clear that because he was in a drawdown, he didn’t feel comfortable putting risk on when the environment dictated that.

Tags: Agecroft Partners, Hedge Fund Investor Leadership Summit, Hedge Funds

Agecroft: Asset Owners Share Hedge Fund Perspectives