Norway ponders moving into alts

Sovereign wealth fund giant reviews $64 billion in externally managed assets

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Indexing: Martin Skancke says most of the fund’s assets are in enhanced strategies.

How the giant 2.522 trillion Norwegian kroner ($423.7 billion) Government Pension Fund-Global, Oslo, can get the best bang for its buck is turning into a $64 billion question for its external money managers.

A review started early this month by the Norwegian government will examine, among other things, how the fund can best improve returns using its huge size and the fact that it's free from fixed liabilities. The lack of specific liabilities effectively extends the fund's investment horizon and gives it more tolerance for illiquid assets.

The upshot: The government might allow the fund — which is invested 60% in stocks and 40% in bonds — to move into alternative investments while at the same time decreasing its active risk by shedding some or even all of its external active stock and bond managers, which ran $64.5 billion in assets as of June 30, according to a recent report from Norges Bank Investment Management, which oversees investment of the fund.

None of the fund's assets are completely passive; rather, most are managed in enhanced indexing strategies, said Martin Skancke, director general of asset management at Norway's Ministry of Finance, which oversees the fund that is fed by sales of Norway's oil reserves. All of the externally managed portfolios are active, said NBIM spokeswoman Siv Meisingseth.

Mr. Skancke said early talks have begun to consider allowing the fund to invest in private equity and infrastructure, especially as part of plans the Ministry of Finance announced in April to invest 20 billion kroner over five years in a new environmental portfolio.

“It is an indication of the early stages of something that will turn into a trend,” said Roger Urwin, global head of investment content at Watson Wyatt Worldwide, Reigate, England. Sustainable investing should be attractive to the “most sophisticated and most long-term” investors, such as sovereign wealth funds. “I think it's a fit for many of the sovereigns' agendas.”

Parliament has approved a 5% real estate allocation for the fund, to be funded by reducing bonds, but no investments have been made. The fund reportedly might increase its exposure to emerging markets equities, in which it has invested since 2000.

The fund had 34 external equity managers and six external fixed-income managers. Equity firms included Aberdeen Asset Management PLC, Lazard Asset Management LLC, Pyramis Global Advisors, Schroder Investment Management Ltd. and T. Rowe Price Associates (TROW) Inc. (TROW) as of March 31, the report said. Hedge fund manager GLG Partners LP and real estate firm AEW Capital Management LP were included in the list of equity shops. Barclays Global Investors and BlackRock (BLK) Inc. (BLK), which are soon to be merged, figured on both lists.

No one at NBIM was available to comment for this story, according to Ms. Meisingseth. In August, NBIM boosted its leadership team with a number of appointments, including promoting Bengt O. Enge to chief investment officer. The appointments completed a management reorganization that began with the appointment of CEO Yngve Slyngstad in 2008.

3-part review

Begun earlier this month, the fund review will take three parts. The Ministry of Finance hired three academics to review the fund's performance and help chart a strategic investment plan; it tasked Mercer with reporting on peer funds' views on active management and what impact active investment management has on active ownership; and it charged NBIM with reviewing itself and to consider adding a strategic plan, risk and leverage limits and “more extensive public reporting requirements.”

The review will be carried out by Andrew Ang, professor of finance at Columbia Business School, New York; Stephen M. Schaefer, professor of finance at London Business School; and William N. Goetzmann, the Edwin J. Beinecke Professor of Finance and Management Studies at Yale School of Management, New Haven, Conn.

Part of their task will be to review literature on the efficient markets hypothesis and “discuss to what extent the relevance of the (hypothesis) varies across different markets and assets,” according to a description of the project on the Ministry of Finance's website. The efficient markets theory says that market players use widely available information to swiftly and correctly price securities, and that investors are rewarded exactly for the risks they've taken, such that it is difficult to beat the market over time. However, statistical deviations from the theory have been seen historically.

“The question is whether there are deviations from efficient markets that are exploitable,” Mr. Skancke said. “Some (possible opportunities) come into the picture because size affects cost.”

“We think it is an extremely interesting and important task, with implications not only to the Norwegian people and government but to active management in general — for the whole industry,” Columbia's Mr. Ang said in an interview.

The review also will look at active management risk. The goal is to thoroughly educate the public and government so leaders can make informed choices in deciding how much risk they're willing to take, Mr. Skancke said. A similar process was followed before parliament gave a green light to increasing the equity portion of the fund's assets to 60% from 40% in 2007, a move NBIM completed in the quarter ended June 30. The move, paired with the stock rallies worldwide in the first half of the year, helped the fund gain 14.9% on investments in the six months ended June 30.

Mr. Skancke agreed to the suggestion that the review represents the fund's still-early development and its rapid rise in assets (the fund's assets were worth less than $28 billion as of Dec. 31, 1999). To some extent, size is driving the review, he said. Fund officials need to decide how much active risk they're willing to take.

“One question is whether our risk appetite grows with the size of the fund,” Mr. Skancke said.

The fund is also encountering size-related problems that other huge funds have worked through, such as capacity constraints, especially with external managers.

On the other hand, the Norwegian government wants to look at ways it can use its size to maximize returns. Free from the liabilities handcuffing other pension funds, the fund isn't burdened by liquidity concerns. (While the purpose of the fund is to boost government savings to meet public pension payments of the future, the fund is not a pension fund with specified benefit payments.)

“We can afford to be more patient than other investors,” Mr. Skancke said.

Key factor

Active ownership is a key part of the investment strategy at the fund. The 2008 annual report fund described active ownership as being how the fund “exercises (its) shareholder rights and how (it) discharge(s) (its) obligations ... (to) promot(e) good corporate governance and encourag(e) high ethical, social and environmental standards at investee companies.” The fund has six focus areas in active ownership: equal treatment of shareholders; shareholder influence and board accountability; well functioning financial markets; climate change; water management; and children's rights.

However, the fund is taking a more restrained approach than some other investors, remaining committed to its 10% cap on ownership of any company. “We don't have any plans to increase that,” Mr. Skancke said. “We are a purely financial investor in these companies.”

He said taking significant active ownership positions would gobble up to too much attention and would “need a different skill set than being an investor.”

Results from the three-pronged review will be made public in December. Norway will solicit further expert opinions in January and will deliver a report to the Storting, the Norwegian parliament, in the spring.

“Many of the large (institutional) investors are going through a similar process of self-examination, and they are all probably approaching it in slightly different ways,” said Divyesh Hindocha, global director of consulting at Mercer in London. Mr. Hindocha is leading the team looking at the Norway fund's peers. He said that in the current review, Norway is following its “tradition to stop, look and listen,” and “robustly” examine an issue.

Mercer will interview about 15 of Norway's peer funds in depth and report in two major areas. First, Mercer will look at whether other funds have made changes to active management, for any reason, but including in reaction to the global economic crisis.

Second, Mercer will assess whether active investment management affects an investor's ability to carry out effective active ownership. For example, do public companies respond better to investors they know are in it for the long haul, or to those they know might sell their shares if they feel like the company isn't listening?