Government-commissioned reports do not always get much of an airing. While their launch is often celebrated – and while they allow leaders to demonstrate their reform drive without having to make tough decisions – the findings are regularly ignored, either because they’re not in line with the rulers’ views or because they no longer fit the political agenda.
Yet sometimes such reports have the potential to shake the ground. Last year, when the Norwegian government ordered an updated review of the active management of its $860 billion oil fund, the scope of the exercise and calibre of the personalities involved suggested it was not looking for bland vindication of the institution’s strategy (David Denison, one of the authors, is a former president and chief executive of the Canada Pension Plan Investment Board). The resulting report, published earlier this year, did not disappoint.
Founded in 1990 to grow the country’s oil and gas wealth, Norway’s Government Pension Fund Global (GPFG) has since inception been confined to investing in stocks and bonds abroad, recently adding properties to its potential remit. But the review advised that, instead of tracking a ready-made index, the institution should adopt a so-called “opportunity risk model”, whereby fund managers can invest in illiquid assets as long as they beat a simple benchmark, usually made up of a mix of public equities and bonds. They also recommended that the fund raises its “tracking error” limit – the amount by which it can deviate from its benchmark on an annual basis – from 1.0 percent to 1.75 percent.
Such changes may look like technicalities. But industry specialists we spoke with reckoned that, if adopted, they would be a very promising prelude to GPFG’s comprehensive engagement with illiquid assets – other than property. As Max Castelli, head of strategy for global sovereign markets at UBS, told us this week: “What the proposed model implies is that the fund could soon go and invest heavily into private equity and infrastructure”. The opportunity risk model, indeed, is already used by the likes of Canada Pension Plan Investment Board (CPPIB) and Singapore’s GIC, which rank among the largest direct institutional investors in real assets.
There is good reason to hope such changes could eventually materialise. The review’s recommendations were recently endorsed by Yngve Slyngstad, chief executive of Norges Bank Investment Management, who came close to advocating a new management model at a seminar last week (Norges Bank invests the fund on behalf of the Norwegian government). The review’s implications were also implicitly agreed with by the Labour Party, Norway’s leading opposition party and the largest in Parliament, which plans to propose a motion early next year to broaden the institution’s remit to include infrastructure, starting with renewable energy.
It is not yet clear whether Norway’s ruling Conservatives and Progress Party will back the move (the government rejected similar proposals in 2011). Some say conservative voices may balk at the relative immaturity of the asset class, which still lacks adequate indicators and benchmarks.
But the institution’s eventual move to infrastructure looks bound to happen. By some accounts, sovereign funds that invest primarily in listed assets, like GPFG, posted nominal returns of close to 5.4 percent over the last 15 years. Sovereigns with a 10 to 20 percent allocation to alternatives, such as Singapore’s GIC, posted returns of about 7.4 percent; endowment-type sovereigns, with 40 to 60 percent allocated to such assets, generated returns of nearly 11.8 percent. Insiders say this gap in performance is providing a lasting rationale for a rethink of GPFG’s risk appetite.
It will help, economists reckon, that an imminent rise in US interest rates will force significant losses on large holders of fixed-income assets, inducing them to diversify into high-yielding, riskier assets. Governments, on the other hand, look increasingly eager to harness fresh capital to finance projects they can no longer support with their balance sheets. This is all the more evident in developing countries, where sovereign wealth funds – perhaps because they are based in similar markets or enjoy the greater freedom that comes with having no future defined liabilities – seem less fearful to tread than other institutional investors.
The fund’s sheer size means setting the GPFG supertanker on its new course will probably take a few years. But as other public giants of the prudent kind, such as Japan’s $1.1 trillion Government Pension Investment Fund, start dipping their toes into infrastructure, it is unlikely Norway’s sovereign wealth fund will long remain an exception.