Politicians Call for Norwegian SWF Split

September 13, 2013 by Loch Adamson

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ON THE EVENING of September 9, Prime Minister Jens Stoltenberg, leader of the Labor Party, conceded defeat in the Norwegian general election, paving the way for Erna Solberg, leader of the Conservative Party, to form a new government. Although expected, Stoltenberg’s departure ushers in an era of change and uncertainty for Norway’s giant sovereign wealth fund, the Government Pension Fund Global (GPFG).

Throughout the hard-fought election campaign, Solberg, who will head a right-wing coalition government beginning on October 14 after Stoltenberg presents the budget, vowed to consider alternative structures for managing GPFG’s 4.5 trillion-kroner ($750 billion) asset pool, which is overseen by Norges Bank Investment Management (NBIM), an arm of Norway’s central bank. At an August 5 press conference in Oslo, she told reporters that GPFG’s assets "might be too big to be handled by just one fund" and that her party would explore the idea of splitting them by manager or objective to boost returns, which have not met the government’s expectations. Currently, NBIM invests the entire fund in equities (63.4 percent), bonds (35.7 percent) and real estate (0.9 percent). Solberg’s concerns were echoed by the ultra-right-wing Progress Party, which wants to go further and break off three smaller funds to focus on renewable energy, foreign aid and domestic infrastructure. These arguments resonated with voters. Forced to respond, the government announced less than a week before the polls opened that it would consider creating a dedicated real estate fund using 10 percent of GPFG’s assets.

It wasn’t the first time that Norway’s sovereign wealth fund, the world’s largest, had become embroiled in electoral politicking. In the run-up to the 2005 national contest — a contentious campaign that brought Stoltenberg to power — voters expressed dissatisfaction with GPFG’s management and demanded that more of Norway’s oil revenue go toward financing tax cuts and improving schools and hospitals.

To polish the fund’s image, the then-incumbent government, led by Christian Democrat Kjell Magne Bondevik, agreed to impose a set of ethical guidelines on GPFG’s portfolio of investments. Soon after those rules took effect, the fund made two high-profile exclusions: Bentonville, Arkansas–based discount retail giant Wal-Mart Stores and Phoenix, Arizona–based mining company Freeport-McMoRan Copper & Gold.

In another move to curry favor with the electorate, before the 2005 election the government passed legislation to rebrand the fund, changing its name from the Norwegian Government Petroleum Fund to Government Pension Fund Global to highlight its importance in underwriting Norwegian public pensions and to foster a greater sense of public ownership.

Although dividing GPFG would be the biggest shake-up in the fund’s 17-year history, such a move is necessary if the government wants to see above-market returns. GPFG’s equity portfolio, which includes more than 7,400 companies worldwide, gives it the equivalent of a 1.25 percent stake in every publicly traded stock. With such a huge portfolio, GPFG’s managers struggle to beat the market, making the fund little more than a giant index tracker.

As a result, the fund’s returns lag those of its peers. GPFG has posted an inflation-adjusted annual return of just 3.26 percent in the past 15 years, according to international financial think tank Re-Define. That showing falls well short of the Norwegian government’s long-term 4 percent target and the performance of its peers. The Abu Dhabi Investment Authority has achieved an annualized return of 7.6 percent over 20 years. GIC (formerly Government of Singapore Investment Corp.) gained an annualized 6.5 percent during the same period; its ten-year annualized return is 8.8 percent.

The comparison may not be completely fair given that the Abu Dhabi and Singapore funds each have more than three decades of investment experience. But GPFG’s annual returns also lag those of newer funds such as the New Zealand Superannuation Fund, which was founded in 2003 and has gained 8.8 percent annualized since its launch.

As GPFG’s manager, NBIM appears to have recognized this underperformance and sought to rectify it. In 2008, NBIM began pushing for the fund to be allowed to diversify its portfolio into real estate and infrastructure. It argued that as a long-term investor, GPFG is ideally positioned to take advantage of the illiquidity premiums afforded by such holdings.

The Storting, Norway’s Parliament, gave the fund permission to make a 5 percent allocation to real estate in 2008; three years later GPFG completed its first such investment, buying a 25 percent stake of all commercial properties on London’s Regent Street owned by the U.K.’s sovereign property investor, the Crown Estate, and forming the Regent Street Partnership. But NBIM has yet to persuade the Storting to allow GPFG to invest in infrastructure.

In 2009, NBIM instituted another initiative to drive retuns. The value investing program seeks to imitate private equity by allowing NBIM’s capital strategies team to take stakes of as much as 10 percent in large publicly listed companies and in firms planning IPOs that it considers to have the potential for good long-term returns.

In addition to adjusting its asset allocation, NBIM has started to intervene in its portfolio companies in an effort to increase GPFG’s returns. In April, GPFG opted to take seats on the director nomination committee of Gothenburg, Sweden–based automaker Volvo, in which it owns a 4.5 percent stake, and in August the fund appointed a corporate governance advisory board to help it take a more active role in bigger portfolio companies.

Despite these activities, a Solberg-led coalition government will want to change the fund’s structure. But that change is more likely to be a slow-burning wrangle than an overnight revolution. Norwegian politics tend to be more consensus-oriented than those of other European countries. The Conservative Party’s finance spokesman, Jan Tore Sanner, has said that he’s keen to obtain cross-party agreement for reforming GPFG.

Restructuring the fund probably won’t be a top political priority — for now, anyway. The Conservatives’ election campaign largely focused on improving hospitals, schools and roads. Although the Progress Party called for increasing spending by GPFG on domestic health care, education and infrastructure, as part of the new ruling coalition it’s already started to tone down its rhetoric.

Recent macroeconomic indicators have helped quash talk of using the fund for infrastructure upgrades: In August, Norway’s underlying inflation rate rose to 2.5 percent, its highest level since July 2009, while the krone has strengthened sharply against the U.S. dollar and the euro in recent months. Both of these developments raise concerns that Norway’s economy will struggle to stay competitive and will embark on an overheating cycle that risks driving up wages and rendering the country’s exports too expensive — exactly the problems that GPFG was established to prevent.

Consequently, Solberg has said that annual government withdrawals from GPFG will stay at about 3 percent of the fund’s yearly return rather than climb to the 4 percent limit. Such an increase would be the equivalent of a fiscal stimulus of more than 2 percent of Norway’s mainland gross domestic product, according to Tina Mortensen, London-based economist at Citigroup Global Markets.

Change is surely coming to GPFG, but it won’t be immediate. Still, asset managers in infrastructure, private equity and real estate should be prepared for a shift in Norway’s sovereign wealth fund investment policy. When the fund starts allocating to new asset classes and increasing the scope of its real estate holdings, the result could be a torrent of money.

This cash will probably come with strings attached: The fund continues be an activist investor and is seeking more bang for its billions, demanding stellar performance and lower fees. After all, the Norwegian public will be watching.

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