The 2.59 trillion Norwegian kroner ($458 billion) Government Pension Fund-Global should develop benchmarks that incorporate factors such as momentum or value/growth that “mimic active strategies,” while continuing to search for alpha by employing skilled active managers, according to a report by three finance professors.
“Bringing these factors and their exposures into the benchmark (return) of the fund allows the benchmark to reflect risk premiums recognized by both theory and practice, creates more robust portfolios and, most importantly, allows the investor to determine the appropriate amount of each factor exposure,” said the report, written by Andrew Ang, William N. Goetzmann and Stephen M. Schaefer.
The authors recommend the fund use dynamic factor tilts that would tweak exposures in the underlying benchmarks using long/short portfolios. For example, in a value/growth factor, a security considered “value” might appreciate to the point of being rebranded “neutral” or “growth.” Thus, factors would be rebalanced similar to how many pension funds rebalance within asset allocations.
If implemented, the fund could capture in its benchmark return much of the risk exposure it currently counts as coming from active management. That, in turn, raises the bar for active managers.
The amount of tracking error would be reduced under the recommendations. However, “we recommend that the scale of active management be much larger than in the present context,” the report said. The authors say factor timing, identifying new risk factors, activist investing and some fundamental value stock-picking would be ways active managers could add value.
Mr. Ang is the Ann F. Kaplan professor of business at Columbia Business School; Mr. Goetzmann is the Edwin J. Beinecke professor of finance and management studies at Yale School of Management; and Mr. Schaefer is professor of finance at London Business School.
The report, which was presented to the Norwegian Ministry of Finance, is posted on the fund's website. The ministry has not commented on the report.
