The Norway v. Yale Models: Who Wins?
(February 14, 2012) — As investment professionals increasingly refer to Norway as a model for managing financial assets, a new paper contrasts the Norway Model — an approach highly rated for its professional, low-cost, transparent, and socially responsible approach to asset management — with the highly acclaimed Yale Model to draw lessons for asset management.
The Norway model – or its underlying philosophy – might be a more suitable template than Swensen’s Yale model for many investors, according to the paper published in October 2011 by David Chambers, Elroy Dimson and Antti Ilmanen. “There are three major reasons. First, while there is little long-term evidence of persistent alpha returns, there is ample historical support for beta returns from multiple factors. This can make the Norway Model attractive to many investors since they can also evaluate the potential future performance statistically, rather than relying on an ill-defined and unmeasured ‘illiquid asset premium.’ Second, the costs and managerial complexity of the Norway Model are significantly lower. Third, there is much less opportunity for agency problems when portfolio holdings are marked to market, centrally custodied, and observable. The Norway Model has been the subject of much recent discussion. It is likely to be an important contributor to investment thinking over the years to come.”
The Norwegian Government Pension Fund Global (GPFG) stands in stark contrast to the Swensen model — which has helped endowments in the United States beat market indexes by relying on assets such as commodities, real estate and private equity. According to the paper, Norway has relied almost exclusively on publicly traded securities, it is constrained to a low tracking error, and it has a rigorous asset allocation that allows little deviation from the policy portfolio. The paper continues: “More generally, it depends on beta returns, not alpha returns. This contrasts with the Swensen model, which aims for investment managers to bridge their deficit in systematic risk exposure by exploiting market misplacing.”
With that in mind, the authors ask: How can Norway’s model be profitably imitated, and what is suitable for Norway but inappropriate for other investors?
The authors explain that Norway’s Ministry of Finance has outlined the fund’s investment strategy, underpinned by several core beliefs: a belief that markets are largely efficient; a commitment to diversification; a focus on earning risk premia; a clearly articulated benchmark; careful selection and monitoring of asset managers, especially for less liquid assets; and a commitment to responsible investing. Meanwhile, certain requirements must be met: effective control of operational risk; exploitation of the Fund’s size and long horizon; and adherence to good governance principles.
The paper concludes: “The GPFG is managed along lines that differentiate the Fund from other pools of investment assets. The Fund follows a management style that is sometimes universal, and therefore suitable for adoption by most investors, and sometimes specific to Norway…the Fund emphasizes reducing risk through diversification, limiting itself almost exclusively to publicly traded securities. This approach is easily replicable. Even today, there are still many endowment and other funds that are seriously overexposed to founder-stock and to home-biased assets.”
In addition, the paper notes that while Norway’s fund claims to be highly diversified, the Swensen approach was developed as an “extended diversification” model and GPFG has so far eschewed private equity and has only recently embraced real estate. “It is not clear whether the Fund’s responsible investment strategy adds or subtracts from performance,” the paper continues. “There are two components, social responsibility and active governance; the former reflects national preferences, and there is as yet little evidence on the efficacy of the latter.”