Salar Ghahramani
Sovereign wealth funds like Norway’s grapple with significant challenges in balancing their interest in private equity investments against the transparency concerns of the public and lawmakers. The opaque nature of investments through alternative vehicles—whether in PE, venture capitals, or hedge funds—poses critical issues for democratic societies that value accountability and responsible management of public funds.
This discussion uses the experience of Norway’s $1.5 trillion SWF in private equity as a case study to explore these challenges and presents policy recommendations and solutions aimed at enhancing transparency and accountability.
In November 2023, Norway’s SWF, led by Norges Bank Governor and Chair of the fund’s Executive Board Ida Wolden Bache, CEO Nicolai Tangen, and Deputy CEO Trond Grande, highlighted the growing share of global value creation occurring in unlisted markets. They expressed confidence that such investments could yield higher returns while adhering to the fund’s standards of transparency and responsibility. Consequently, they formally requested that the country’s government allow the fund access to private equity investments.
Historically, the fund has focused on listed equities, bonds, real estate, and renewable energy infrastructure. Despite numerous requests and central bank recommendations over the years, previous governments had consistently denied the oil fund’s requests to invest in private equity, citing concerns over transparency and management costs. This time around, however, signs of government reconsideration appeared.
But, in April, the government delayed the decision further and called for an expert council to evaluate the proposal more thoroughly, with Finance Minister Trygve Slagsvold Vedum underscoring the need for careful consideration given the decision’s complexity and importance.
Arguments for and Against Private Equity Investment
The debate in Norway on private equity investment features strong arguments from both proponents and opponents:
Support for private equity investment:
- Higher returns: Proponents claim that private equity investments historically offer higher returns compared to public equities, particularly through leveraged buyouts, which have outperformed public equities by 3% to 4% annually on average.
- Diversification: Adding private equity could enhance portfolio resilience against market volatility, aligning with practices of large funds like Canada Pension Plan and Singapore’s Temasek Holdings. These funds invest significantly in private equity, including in the U.S. real estate market, where they benefit from having control over investment decisions, alongside the potential for higher returns, tax benefits, and broader diversification advantages.
- Market timing: The current slowdown in the private equity market presents an opportunity for investors to enter at favorable terms, potentially capitalizing on undervalued opportunities.
Opposition to private equity investment:
- Transparency and costs: Critics contend that private equity investments lack transparency and involve higher management costs, contrasting with Norway’s fund’s successful low-cost, transparent strategy focused on public assets.
- Risk management: Concerns about the higher volatility and risk associated with unlisted equities have led skeptics to fear potential impacts on the fund’s stability and long-term performance.
- Political resistance: There is broad consensus among Norwegian politicians against high-fee investments, complicating the justification for using government money to pay private equity fees.
Transparency is often taken for granted in discussions about democratic governance. However, the opaque nature of private equity investments poses significant concerns, limiting information availability on fund allocation and management. Such opacity can increase risks like mismanagement or corruption, which are especially problematic for funds intended to serve the public and future generations.
Global Perspective on SWFs and Private Equity
Globally, SWFs are increasingly adopting private equity as part of their investment strategies to achieve higher returns and greater diversification, reflecting shifts in market dynamics. A State Street Global Advisors report on 34 of the largest SWFs across 26 jurisdictions, holding about $8.5 trillion in assets as of 2020, underscores this trend:
- Stable asset allocation: Asset allocation among SWFs was largely stable from 2018 to 2020, with equities as the largest exposure.
- Growth in alternatives: Over half of the SWFs’ alternatives allocation focused on real estate and private equity, representing about 16% of global PE assets under management.
- Size and diversification: Larger SWFs generally show greater diversification and higher alternatives allocations, enhancing long-term performance.
These insights emphasize the global trend towards diversification and the growing interest in private equity. As SWFs move towards these less transparent and complex investments, addressing associated risks and challenges becomes crucial.
Policy Recommendations
The decision to delay the inclusion of private equity assets in Norway’s sovereign wealth fund highlights the issue’s complexity. The potential benefits of higher returns and diversification are attractive but must be balanced against transparency, cost, and risk management concerns.
Policy recommendations:
- Gradual integration: A gradual, well-managed approach should be adopted if private equity is included, allowing the fund to build expertise, monitor performance, and adjust strategies as necessary.
- Enhanced oversight: Robust oversight mechanisms are essential to ensure transparency and accountability in private equity investments, including regular reporting and independent audits.
- Balanced portfolio: It is vital to maintain a balanced portfolio that emphasizes low-cost, transparent investments in public assets, ensuring any shift towards private equity complements the existing strategy.
To attract investments from sovereign wealth funds, private equity firms must address transparency and accountability concerns also.
Solutions for private equity firms:
- Increased disclosure: Firms should provide detailed, regular reports on investment performance, fees, and risk management, including quarterly or annual reports.
- Independent audits: Third-party firms should conduct audits of private equity investments to enhance accountability and build trust.
- Clear governance structures: Private equity firms should establish clear governance structures and decision-making processes to help mitigate concerns about mismanagement.
Norway’s experience offers valuable lessons for other SWFs considering private equity investments. While the potential benefits are evident, addressing transparency and accountability issues is essential for responsible public fund management. By prioritizing these aspects, sovereign funds worldwide can navigate the complexities of private equity investments while safeguarding public interests.
Salar Ghahramani is Associate Professor of Business Law and International Law & Policy at Penn State University (Abington) and the Founder of Global Policy Advisors. He is the author of “Institutional Framework and Governance Structure of Sovereign Wealth Funds,” which was recently published in the Palgrave Handbook on Sovereign Wealth Funds.
This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS Stoxx or its affiliates.