Visit the website of Norway’s oil fund and an extraordinary sight awaits. Several times a second, the value of the world’s largest sovereign wealth fund is updated. One moment this week, the fund gained $134-million U.S. in less than one minute, only to lose nearly all of it over the next minute.
This transparency is only one of the notable aspects of the fund, which has grown at a frantic pace since receiving its first sum of money – about $300-million – in 1996. It now has a value of more than $600-billion and owns 1 per cent of all global equities and, on average, 2.25 per cent of every listed European company.
The fund was created as part of Oslo’s effort, after discovering its first oilfield in 1969, to avoid “Dutch disease”: the curse that has blighted many of the world’s biggest oil producers with problems such as inflation and weak manufacturing.
It was also designed to manage its energy earnings over the long term, something that has caused some to talk of a “Norway model” in investment to rival the dominant method for big, public investors patented by Yale University. Yale’s model focused on investing in illiquid markets such as private equity and hedge funds, whereas Norway went for a simpler route: investing in thousands of different bonds and shares.
But with the fund’s rapid growth comes added scrutiny and challenges. Norway’s fund is expected to double again in the next decade to more than $1-trillion. Norway, the fifth-biggest oil exporter, experienced intense soul-searching after the 2007-08 financial crisis when the fund had a negative return of 23 per cent in just one year.
The Government Pension Fund Global, as it is officially known since it invests only outside the country, is currently grappling with just how active and aggressive an investor it should be given that its ultimate owners are the Norwegian people. That in turn places it in the centre of one of the investment industry’s biggest debates, leading some outsiders to ask: Can the oil fund really serve as a model to other investors?
The fund has grown faster and been more successful than anyone envisaged. Originally expected to last 30 years or so, the fund – now in its 22nd year – is expected by politicians to last for a century or more.
The Norwegian government has embarked on a program of cautious change. The fund receives booming petroleum revenues – with the government committed to spending no more than 4 per cent of the fund’s return annually – and started out investing only in government bonds.
Over time, it has been allowed to buy shares but never more than 10 per cent of one company, avoiding the big bets that many public funds take. It also has a large ethical dimension with the finance ministry forbidding it from owning certain sectors such as tobacco groups or companies such as Walmart, excluded six years ago because of labour practices.
Its current asset allocation is a highly traditional mix of 60 per cent in shares, about 40 per cent in bonds and a tiny percentage in property.
“It is important to have an investment strategy that has broad support,” says Pal Haugerud, head of the ministry of finance’s asset management division. “Over time we have developed the strategy from only European bonds to include equities, emerging markets and recently real estate. By doing this, gradually we think we have allowed broad support to be secured for the strategy.”
There are occasional calls from some politicians for the government to take more money from it. The central bank would prefer the government to take only 3 per cent.
Still, the role of the finance ministry and parliament in the fund’s strategy means there is a strong consensus behind its mission of saving wealth for future generations.
But by investing almost entirely in publicly traded securities, the oil fund acts in stark contrast with the much-followed approach of Yale University. Known as the Swensen model after its founder David Swensen, it has long been a favourite for long-term investors and seeks to invest in more illiquid assets.
That puts Norway at the heart of a heated debate on whether active or passive management makes the most sense. Passive investing merely seeks to mimic the returns of a market, often through an index-tracking fund. Active investors try to pick winners and losers, buying more or less of certain companies or assets.
Academics are divided on the merits of each approach. Because of their long-term nature, sovereign wealth funds and managers of endowments have been felt to be more suited to active management where they can try to boost returns by taking risks normal funds often cannot.
The oil fund, also known as Norges Bank Investment Management as it sits inside Norway’s central bank, bristles at suggestions it is anything other than an active investor. “We clearly think it’s not possible to call it passive investing,” says Yngve Slyngstad, chief executive of the fund, which has 320 employees.
Combined with the straightforward 60-40 split between equities and bonds, this more simplistic approach than Yale’s has supporters. David Chambers, Elroy Dimson and Antti Ilmanen – two academics and a fund manager all with close links to the oil fund – argue that the Norway model “might be a more suitable template for many other investors than Swensen’s Yale model” in a recent paper for the Journal of Portfolio Management. They contend the oil fund’s costs and managerial complexity are significantly lower and that its reliance on public markets makes it easier to forecast future performance compared with the unpredictability of illiquid assets.
But others disagree, arguing that the fund spread its interests so widely that it ends up with returns and a risk appetite in keeping with a passive rather than active investor. A striking report, commissioned by the Norwegian government after the financial crisis, concluded the fund was little more than a passive investor. It found that, statistically, active management had “an almost trivially small impact on the overall risk of the fund” and stated that “to a first approximation, the fund is actually not an actively managed portfolio.”
Similarly, Ashby Monk, a sovereign wealth fund expert who is a research director at Stanford University in the U.S., says: “In a way, it resembles a giant index fund.”
He adds that it may be a cost-effective way of managing money but that additional opportunities are being missed, largely because of the bureaucracy involved in running the fund.
Recently, the Norwegian finance ministry allowed the fund to invest in property. But the government has resisted the fund’s own pleas to invest in alternative assets such as infrastructure and private equity.
Mr. Monk says: “I expect that most people at NBIM recognize that, as a long-term, inter-generational investor, they should be allocating some portion of their capital base to infrastructure assets. But they’re currently not doing so. And as best I can tell that’s really just a function of the decision-making process and structure within the ministry sitting overtop NBIM. It’s slower than turning a supertanker.”
Mr. Slyngstad is somewhat weary of this debate. “The question of indexing or not indexing poses the wrong question,” he says in an interview.
Changes are under way. First, the allocation to equities was increased in 2007 from 40 per cent to 60 per cent. In 2008, the fund was permitted to buy shares in companies in emerging markets.
Property investments were also allowed, the first private market the fund could invest in. But despite prominent purchases such as in London’s Regent Street, it has been hard to boost the relative size of property in its portfolio as the fund has been growing by more than $50-billion a year.
Mr. Slyngstad adds that a similar argument limits its ability to invest in private equity and hedge funds where stakes are often quite small. “We are too large to make a significant allocation to alternative assets,” he says.
Instead, the fund is reconsidering technical but influential matters: chiefly benchmarks. Rather than relying on external indexes, it has been constructing its own. “You could either call it active management or thinking much more closely about what index you follow given the unique characteristics of this fund. What we have been doing the last three years is to spend a lot of time thinking about the benchmark construction,” says Mr. Slyngstad.
So one change has been to move its bonds benchmark away from being weighted according to the size of debt, as is traditional, to one set according to gross domestic product. That automatically increases its exposure to emerging markets and away from Europe. The finance ministry has also cut the regional allocation of all investments to Europe from 60 to 40 per cent.
Officials are cautious not to reveal too much, but one consequence of changing the benchmarks could be to increase the fund’s risk. “A natural question regarding the future development of the fund’s strategy is whether the special characteristics of the fund can be exploited to achieve a better ratio between expected return and risk,” Mr. Haugerud says. That could involve the fund providing liquidity at times of market stress and investing in smaller companies.
Mr. Slyngstad says the fund could move more in the direction of many hedge funds, which prefer to measure their performance on an absolute return basis rather than whether they did better than the market. “I think the most important thing here in the discussion on indexing is taking another look at relative to market [versus] absolute returns. We are just scratching the surface,” he says.
Still, friction remains between its long-term nature and its need to inform the Norwegian public in the short term on its performance. Every loss, such as in the second quarter because of difficult stock markets, is greeted by intense scrutiny from the Norwegian press.
But the criticism of its weak performance in 2008 has subsided after it more than recouped its losses in subsequent years.
And, for all the debate over how the fund is run, there remains a deep fascination in it abroad. Martin Skancke, Mr. Haugerud’s predecessor at the finance ministry, is now a consultant to sovereign wealth funds and has recently advised Libya and a country in sub-Saharan Africa.
With a mixture of disdain and admiration, another adviser to large public investors highlights the way the fund has shunned big investments, instead owning shares in 8,000 companies and about 4,000 bonds. While this undoubtedly shows the fund has awesome scale, it also calls into question whether it can act effectively as an active investor over such a range.
“What the Norwegian fund has become is this giant financial theory behemoth that is 60 per cent in equities, 35 per cent in fixed income and a desire to have 5 per cent in real estate. It spreads the money as thinly as it can across the world.”