SWF Watch: Norway: Upping EM and Property Exposure

This post serves as a profile of Norway's Government pension fund -Global (GPF-G), the second largest sovereign fund. As such its structure and some of the content has been updated since originally posted. Last Updated: May 26 2008 when Q1 2008 results were added.

Size of Fund: The GPF-G managed just over 2 trillion Krone or $371b at year end 2007. This is a decrease from the November peak of 2.084T Krone ($384b). It fell further to reach $382b (1.945 T NOK) at the end of March 2008. Closing the year at $371 billion though implies a raw increase of over $86 billion over 2007 – or slightly more than that of 2006 ($80 billion). Of that, transfers accounted for about $55 billion – up from $47 billion in 2006 and $32 billion in 2005.

With oil staying above $90, Norway is now transfering around $6b per month (up from an average of about $4 billion a month in 2006). Norway's fund receives the entire government interest in hydrocarbons including any royalties, taxes etc. As much as 4% (roughly coinciding with the interest on the fund) can be spent each year.

Return: 2007 also saw also one of the lowest annual nominal and real returns in its 10 year history – measured in its basket of currencies and first year that the benchmark portfolio outperformed the actual portfolio. See details here in the annual report. Aftenposten notes that the fund lost about $2b on interest rate bets and $5b in equity markets. Norway of course is by no means the only fund so hit by asset market shifts of recent months. Almost all public pension funds that report returns and holdings also reported losses and any fund holding equity indices would have reported losses. In Q1, the GPF-G reported its worst ever quarter, with the fund posting a negative return of 5.6% on its portfolio as calculated in a basket of currencies in which the fund holds. Its equity portfolio reported a 12% loss in international currency. Like in Q4, excess return from the portfolio managed in house underperformed the benchmark portfolio - this time by about 1%. Similarly, the investment portfolio of Norwegian reserves reported negative returns in Q1 (and underperformed the benchmark portfolio. Despite transfers of almost $18 billion (88b NOK), the fund was worth less in March 2008, than in December 2007.

However the GPF-G is a long-term investor. Since its creation in January 1998, there has been a cumulative positive excess return of 5%, even including the last two quarters.

Dollar weakness boosted the value of its large euro and pound holdings (about 60% of the portfolio) meaning that the fund had higher nominal returns in dollars while real returns were negative in Norwegian Krone.

Asset allocation: 47.8% equity, 52.2% bonds at the end of q1 2008.

Norway has been gradually been increasing the risk profile of its fund, putting it more in line with other institutional investors. As officials have noted, its relatively conservative allocation contributed to lower returns. In 2007, the Storting (Norway's Parliament) approved an increase in the equity allocation to 60% of the portfolio from 40%. This shift is now underway - with equity now making up almost 48% of the the total actual portfolio as of the end of Q1 2008.

In spring 2008, the Norwegian parliament approved adding real estate (to be 5% of benchmark portfolio), doubling allocation to EM to 10% and adding a broader range of EM equities to the benchmark and doubling the maximum size of holdings to 10% (on average they are now 1%). Once the strategy shift is complete Norway's asset allocation will be about 60% equity, 35% bonds 5% property. We might begin to see an asset allocation shift as soon as Q2 2008.

Currency Composition: 32% US 59% EU 9% Asia at the end of 2007.

Norway's decision to up its equity share has had the net result of decreasing its exposure to the US slightly and increasing that to Asia and Emerging markets as US assets make up a higher share of the equity than the fixed income benchmark. However its recent allocation change makes up for a past limited exposure to EMs. It is now doubling its EM allocation to 10% from less than 5% and adding a range of emerging markets to its benchmark - and likely its actual portfolio.

These countries will be added to the benchmark: Argentina, Chile, China, Colombia, the Czech Republic, Egypt, Hungary, India, Indonesia, Malaysia, Morocco, Pakistan, Peru, Poland, the Philippines, Russia, Thailand and Turkey.

Previously only Brazil, Mexico, South Africa, Hong Kong, Taiwan, Korea and Singapore were included and Japan made up a significant, albeit decreasing share of its Asian exposure. Norway was recently approved as a qualified foreign investor in China and opened an Asian office in Shanghai last year. This strategy shift puts Norway more in line with other institutional investors many of which are upping their exposure to Emerging markets, especially those in Asia.

Norway's exposure to US and EU markets will likely fall somewhat in response though the new benchmark has yet to be disclosed

Strategy/Governance: Norway tends to take small stakes (average 1%) and to be a passive portfolio investor. It recently upped the maximum allowable stake held in any company to 10% from 5%. This could be a prelude to taking some larger stakes - consistent with other sovereign funds and institutional investors, most of whom are increasing their risk profile in search of high returns. Yet, all indications suggest that Norway will be unlikely to utilize its new ability to take larger stakes very much.

All of its holdings are listed in its annual report.

Norway entrusts about 20% of its assets to external managers, more so in equities. This ratio has been decreasing for the past few years. It is possible that it may turn more to external managers as it enters new asset classes and markets though. This is considerably lower than the level of outsourcing by GCC funds like ADIA or likely GIC. Recent high-profile losses by internal management could actually make it return to external management. The Fund is managed by Norges Bank Investment management (NBIM) under guidelines approved by the Storting with oversight by the finance ministry. Norwegian fund is very transparent about returns, holdings, size of assets under management. Norway takes small shares in a wide range of companies, tends to vote its stake and has clear ethical guidelines

Why pay attention to Norway’s results?

-As the second largest pension fund (after Japan’s GPIF) and second largest sovereign wealth fund, its significant assets under management mean it can influence markets. Its tendency to take only small stakes (mostly under 1%) mean that it is unlikely to have significant sharp strategy shifts though. -It provides a baseline for other less transparent funds – giving an estimate of transfers and returns. While Norway tends to save more (actually all of the government interest in hydrocarbon business) than other SWF sponsoring countries, it also likely has lower returns – though the lack of consistent disclosure by other funds makes it harder to judge.

-Norway’s pattern of disclosure itself provides a model for other funds- the EU and US have repeatedly pointed to Norway as a model. Even should other funds not follow Norway in disclosing everything from the returns made on lending out its securities to every equity owned, it does provide a model – and one that the US and EU are increasingly pointing to.

-Several countries have explicitly adopted Norway’s model of integrating the fund into the budget process, with all proceeds being deposited and with a share being spent as needed. Norway restricts spending to 4% of the fund’s value (the assumed return) – others allow a higher share.

Norway’s results provide a taste of how sovereign investors are faring amidst the market turmoil and most importantly how they might react to market turmoil. Sovereign investors emphasize their long-term focus and suggest they can stabilize markets - With more revenues coming in – they may be able to buy up cheaper assets. And with no immediate need to sell, they are less vulnerable to deleveraging. But sustained low returns are a different story. We’re not there yet of course, one or two quarters does not a record make or break. Norway tends to balance its portfolio.

Norway is not alone in reporting negative investment returns in Q4. The funds of Alaska, Alberta reported losses. In part, like Norway, Alberta's returns reflect its reporting currency. A strong Canadian dollar depressed the value of foreign currency (especially U.S.) holdings.

The funds of New Zealand and Australia took multi-billion dollar hits and the Canada pension plan, French pension reserve fund and Irish reserve fund also reported slowing returns. These returns are consistent with those reported by many other institutional investors especially in Europe. Calpers, the largest US pension funds noted that it began repositioning its portfolio a year ago to be more defensive – this likely explains its launch of new investments in commodities, timberland and inflation-linked bonds. Though with their long-term focus these funds should be able to ride out short-term volatility. Yet with their transparency, sustained losses might raise concerns from the public whose funds they are.

With high oil revenues, oil funds in particular have more funds to place. Norway’s transfers ($55b) are an indication. So are the savings of the Saudi Monetary Authority – which received around $76 billion in 2007 and an amazing $65 billion from September to January (both adjusted for valuation changes). GCC funds probably added $100 billion dollars. And despite lower investment returns Alaska suggests it will release a larger dividend than in previous years.

But in the short-term at least some funds might be rethinking some investment choices. Russia indicated that it sustained losses on its holdings of US agency bonds (especially of Fannie and Freddie) – perhaps a reason President Putin suggested improving reserves management. For the year as a whole Russia’s stabilization fund reported returns of 11% in dollar terms largely on exchange rate gains from its Euro and pound holdings. Yet with a long-term focus quarterly concerns might seem short-sighted. Information where it is available is could provide clues on how these funds manage their assets and effect global markets and given asset classes.

We will have to wait for clues of how other less transparent funds have done. Some of the high profile investments have lost value – in particular the financial sector. GIC’s managers noted that their decision to reduce holdings of mortgage securities provided the cash that facilitated the capital injection to UBS. Timing is a tricky thing.

Several factors make it hard to compare Norway to other funds

Its asset allocations are different than other funds and its risk tolerance has been lower. Norway’s fund has had relatively modest returns over time. – averaging nominal 6.5% returns for the decade from 1997-2007 and real returns of 4.3% (all in its basket of currencies). In part this is the result of its tendency to rebalance its portfolio – meaning that it consistently directed inflows towards less well-performing assets. In this way it was likely more of a stabilizing actor for financial markets, though its returns were lower.

Norway has significant European holdings – mostly Eurozone, UK and Scandinavia, whose equity markets have had high returns. Norway may have amongst the highest exposure to European equities and bonds, likely higher than funds in the gulf and Asia. As such its portfolio may more resemble a European pension fund. Yet my work in progress indicates that Europe has received more direct investment from GCC sovereign investors than the US has.

Another difference, Norway has very low exposure to emerging markets. Its benchmark equity portfolio includes under 5% in countries like Brazil, Mexico, South Africa, Hong Kong, Taiwan and Singapore. It is possible that Norway’s exposure to EMs could rise though. after all it just opened its third overseas office in Shanghai (after London and New York). It also has no exposure to the Middle East. UPDATE: As expected, by me at least, Norway is to begin investing in China - It was just approved as a qualified foreign investor.

Finally another difference – voting! In 2007 Norway voted at 38 000 shareholder meetings of 4200 equities (it holds shares in about 7000). NBIM released total voting records for 2007. Norway is one of the few funds that exercises its voting rights – or is explicit about it. Many other sovereign funds, if not investment companies have abdicated their voting or management rights. As such Norway resembles other pension funds and institutional investors rather than sovereign wealth funds. We will likely hear more about these issues and more tomorrow at a House financial services subcommittee hearing. To my knowledge it’s the first to have actual sovereign investors giving testimony. Representatives from the Norwegian fund, Temasek and the Canada Pension Plan will appear.