Defeating All Comers?

From aiCIO Magazine's June Issue: Norway’s sovereign fund is pioneering a new investment model based on transparency and ethics. Worthy, but is it working? ­Elizabeth Pfeuti reports.

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There are nearly 47,000 companies listed on the world’s stock exchanges and the people of Norway own just under 1% of them. If everything goes as planned, in another 10 years they could own 2%.

It is not that Norwegians are a nation of stock market speculators. Instead, collectively they are the ultimate owners of the largest investor in public securities in the world: the Norway Pension Fund—Global. Valued at US $611 billion at the end of March, it vies for the top spot of the sovereign wealth fund tree with the Abu Dhabi Investment Authority.

However, with great power comes great responsibility: in the last 12 months the Norwegians have voted against the beleaguered Greeks being allowed a “managed default” and offered a $9.2 billion loan to the International Monetary Fund (IMF) as the organization struggles to contain the Eurozone crisis. In contrast, the United Kingdom—with a population 12 times larger—offered $15 billion.

How did this Nordic nation of barely five million people become such a power-player on the world’s economic stage?

One word: Oil.

“The fund is a redeployment of wealth from the ground to a well-diversified portfolio of assets outside Norway,” says Petter Johnsen, Chief Investment Officer (Equities) at Norges Bank Investment Management (NBIM), which is responsible for the management of the fund. “Public markets are the greatest entry point for this. This way, we can harvest the equity risk premium in the most efficient way.”

The 1% figure that Johnsen and others cite is actually just for illustration purposes; the Norwegian fund doesn’t spread its wealth about so evenly. It doesn’t invest in its home market, as it could buy the entire market cap of the Oslo Børs almost twice over, but its average holding in public markets works out to approximately 1% of every listed company on the planet.

The fund was launched in 1995 as a vessel for the new income stream the country was about to enjoy after the discovery and subsequent drilling of oil in the North Sea. Until that point, Norway had not been fiscally happy since suffering in the Second World War. In the 1980s the country was struggling with stagflation and emigration to greener grass was not uncommon for its people. After cripplingly huge investment in the infrastructure to drill the black gold out, however, Norway has barely looked back. (Ask any Swede about their nation’s decision not to go in with its neighbor on the exploration costs and they will doubtless shake their heads, sigh, and display a pained expression.)

Now, the fund contributes around 4% of its entire asset pool to support the Norwegian economy each year—in the good years, when tax revenue is high, it contributes slightly less, in the bad years it pays in slightly more. This rule was established so the country’s treasury could know what to expect on an annual basis. The figure was based on a study by Elroy Dimson, Emeritus Professor at London Business School, who estimated that 4% was the average annual long-term investment return from a public securities portfolio. Dimson is now chairman of the fund’s investment strategy board, on which he is joined by a Finn, a Swede, and a Norwegian. “That figure is largely aspirational now,” says Dimson. “Low interest rates and the financial crisis have made it pretty unlikely recently.”

Over the past 13 years, the fund has made 4% or more eight times and outperformed its benchmark on 10 occasions. Last year, it lost 2.5%—slightly worse than the benchmark—but critically, in 2008, the fund’s holdings in public markets (and naivety over its risk exposure) saw 23.3% sliced from its total value. This practically wiped out most of the gains made over the previous decade. The following year, a 25.6% return made up some of the damage, and the fund’s investment team learned a valuable lesson. In the aftermath, the fund’s directors did a lot of soul-searching, dropped a significant number of its third-party managers, and refocused on the job at hand.