Norway’s SWF About To Get Aggressive?

Ashby Monk

I’ve given Norway’s SWF a bit of a hard time over the past few years for not taking more advantage of its long-term time horizon. My view is that the largest SWF in world (which claims to have an “infinite” time horizon) should be able to make very solid returns in the world of illiquid assets. However, to date, the fund has been (overly) conservative, preferring traditional asset mixes and ignoring illiquid assets, such as private equity and infrastructure.

Well hold onto your hat, people; that’s all about to change!

Bloomberg is reporting that former central bank governor Svein Gjedrem will replace Tore Eriksen as chief advisor to the MoF on the oil fund’s investment rules. Why is that a big deal, you ask? Because Eriksen was hyper conservative about investment policy. He was, a least to a certain extent, the man behind the fund’s conservative investment approach. Here’s a recent quote from Eriksen:

“…with a big fund there are a lot of management challenges and the more complicated we make the fund the more complicated the management will be…It’s much more complicated to invest in properties, in infrastructure than in equity and bonds, which you can buy every day on every market.”

Ugh. OK. Yes, Mr. Eriksen, what you say is technically true; investing in infrastructure is more complicated than buying a stock on the exchange. Buuuuut, with over $570 billion in assets under management, I’m pretty sure you could find the resources to deal with these new complexities. Think of it as an investment in the organization that will pay dividends in the long run. Parking half a trillion dollars in short-term, volatile, liquid securities is not always preferable to investing in real assets. Trust me.

Anyway, Gjedrem is a totally different type of player. In fact, while he was running Norges Bank, he was pushing Eriksen to let NBIM expand into more illiquid assets. So now that Gjedrem has Eriksen’s job, things are most assuredly going to change. How can I be so sure? Read this blurb taken from a letter Gjedrem wrote to the MoF while at the central bank:

“We [have] recommended that the fund’s investment universe should be expanded to include less liquid investments in private equity and infrastructure, as well as real estate…Investments in real estate and infrastructure confer direct ownership of real assets and an expected return in the form of stable, inflation-adjusted cash flows. This inflation adjustment comes from the periodic income from these investments often being linked to movements in inflation. An increase in this type of real asset in the portfolio should be aimed at, because this can help reduce uncertainty about developments in the fund’s international purchasing power…The fund is well-suited to bearing the risk and harvesting potential gains from investments in less liquid assets, as the fund does not have short-term liquidity needs. Nor is the fund subject to rules that could require adjustments to the portfolio at inopportune times…Investments in traditional infrastructure projects would, in portfolio terms, be expected to contribute stable, inflation-adjusted cash flows and so help safeguard the fund’s long-term international purchasing power. Any investments in infrastructure would consequently be part of the asset class of other real assets.”

That’s music to my ears. Here’s hoping Norway’s fund gets a bit more aggressive in the coming years.

7 Responses to “Norway’s SWF About To Get Aggressive?”


  1. 1 Cor June 16, 2011 at 1:27 pm

    That sounds hopeful indeed! Of course an answer would be highly speculative but what could be the geographical regions of interest for infrastructure investments at such a gigantic fund? Are emerging markets on the cards? Would NBIM manage these illiquid investments internally? Or else what type of intermediaries would stand to gain?

  2. 2 GH June 16, 2011 at 8:39 pm

    Taking a liquidity premium always seems like a ‘no lose’ option for an investor with limited need of liquidity. However, there are considerable complexities. The value of the premium is very cycle-dependent. Building a large investment infrastructure for private market investments also seems like a no brainer – but the best people in these markets are unlikely to come cheap, so outsourcing is often the only option, leaving several % points per annum on the table. You are right that it makes investment sense, but just being big does not make it easier or more justifiable – you need to invest huge amounts relative to the market in order to make a material difference to overall returns. With that size in investment comes operational complexity and significant governance issues. For example, owning a developing country’s infrstructure looks financially very attractive but provides exposure to higher risk factors (e.g. geo-political) that may not be easily quantifiable and could be outside of the comfort zone of the trustees/Board. All to say, I agree with the premise, but we should not brush aside the practical implications just because the fund is ‘rich’.

  3. 3 SL June 17, 2011 at 12:52 am

    He was also the man invoking oil exposure hedging, if I remember well. Next years reports are definitely going to be worth-reading stuff…

  4. 4 Ina August 11, 2011 at 11:39 am

    It might be that the author is right in his conclusion and that Norges should invest in private equity and infrastructure, but I can’t find one — 1 — single coherent argument here for why Norges actually should have a comparative advantage in entering into these asset classes.

    More specifically: Why should a public fund, for which transparency and legitimacy is so important, enter opaque and unregulated markets? Why should they risk the entire Fund construction and the Government’s Spending Rule and, in best case, be compensated with a few basis points higher returns? Why should a fund with a large risk-bearing capacity invest in assets with “stable, inflation-adjusted cash flows”?

    A few questions from Asset Pricing 101 beg to be asked: What are equities and corporate bonds if not claims on real cash flows? Why are equity and bond prices volatile when the underlying real cash flows actually are stable?

    Instead of presenting depressing, uneducated rambling, the author should start reading basic financial economics. My suggestion would be to start with a basic graduate-level asset pricing book.

    • 5 Ashby Monk August 11, 2011 at 2:30 pm

      Uneducated ramblings, eh! Wow!
      1) Thanks for commenting. I know you’re not a fan, but it keeps me honest. Good on you (though hiding behind anonymity…much less impressive.)
      2) Let’s disagree to agree on the illiquidity premia that a long-term investor can collect in private markets. My view, (which I’d call mainstream) is that it’s worthwhile to maximize financial returns for stakeholders. But you disagree with that. Fine.
      3) Sorry to disappoint you, but I have actually read all the asset pricing text books. And here’s my question for you: how are all your models doing right now?
      4) The reason I ask is because there’s plenty of research coming out to show that CAPM, APT, Black Scholes Merton, etc. all break down when the market, you know, stops doing what we want it to do. is that useful?
      5) Read these papers:
      Don Mackenzie’s “Opening the Black Box”: http://www.tandfonline.com/doi/abs/10.1080/09692290500240222
      Mackenzie and Millon on Financial Derivatives: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=279029
      6) I also really like this paper. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1840734. It’s a fun read about why the “gods” of asset pricing weren’t pricing real assets…they were pricing assets in a laboratory. Big difference.
      7) “Hokey religions and ancient weapons are no match for a good blaster at your side, kid.”
      ;)

      • 6 Ina August 21, 2011 at 7:19 pm

        I hope we agree that the objective for the management of a SWF — like any other fund managers — should be to maximize present and future welfare for the stakeholders. As you probably know better than almost anybody else, we shouldn’t consider financial investment strategies in isolation from the wider policy framework of which financial-wealth management is only one part. Future welfare will be determined both by the returns on the financial wealth and by the productivity of the rest of the economy. The latter is, however, not independent of the policy framework for managing natural-resource wealth.

        Investments in illiquid assets are inherently less transparent and accountable and associated with much more severe principal-agent problems than investments in highly liquid equity and bonds markets. A fundamental question is whether you believe that there are investment opportunities out there which entail a risk of undermining the legitimacy of the entire policy framework of which the SWF is only one small part, but that the Norwegians nonetheless should pursue?

        To be clear. I believe that the starting point for a discussion about portfolio theory should be what academic researchers consider consensus. To paraphrase John Huntsman, “I [also] believe in evolution and trust scientists on global warming. Call me crazy.” ;)

        Financial theory has moved a very long way since the CAPM, APT and Black-Scholes models of the 1970s. One of the many challenges to those theories were the equity volatility puzzle (see eg Shiller 1981, AER). What Shiller essentially documented was that prices are much more volatile than dividends, ie. it turns out that cash flows from real assets, like traded equities, are very stable (in real terms), but nonetheless, that the prices are highly volatile.

        During the last 30 or so years, researchers have documented that the main source of price volatility of traded assets are due to changes in the market price of risk and not volatility of the real cash flows that the asset owners have claims on. The experiences for the last weeks and years are vivid illustrations of this. These academic insights have profound implications for how to analyze and think about assets which aren’t traded.

        The quote you assign to Gjedrem, seems totally and utterly confused. There is hardly any analytical structure or logical consistency. Why should a long-term investor who “does not have short-term liquidity needs”, “nor is [] subject to rules that could require adjustments to the portfolio at inopportune times” care about short-term fluctuations in inflation? If there’s any investor who shouldn’t care less about either the volatility of the cash flows or short-term inflation fluctuations it must be an investor with exactly those characteristics.

        Instead, a fund like Norges should think much deeper about what their own characteristics are and what “liquidity” really is. Most likely they are well suited for in a systematical, well-founded and fully transparent and accountable manner provide liquidity when liquidity premiums are high. What’s your take?

  5. 7 Ashby Monk August 22, 2011 at 12:16 pm

    Thanks again for the comment. Very insightful. Honestly, I think we agree on many things but have nuanced interpretations of their relevance at the level of fund operations.

    For example, you say…“Future welfare will be determined both by the returns on the financial wealth and by the productivity of the rest of the economy.” I think I agree with that…but I still don’t think it’s an over-arching “mission statement” that can guide the operations of a fund. In my view, you can’t run a sovereign fund or a pension fund with a view to maximizing returns for the the economy “in general” if you have to maximize returns to the fund; that’s the “clarity of focus” that allows for success (not to mention being in line with the Santiago Principles, for which NBIM is a signatory).

    Also, you said: “Investments in illiquid assets are inherently less transparent and accountable and associated with much more severe principal-agent problems than investments in highly liquid equity and bonds markets.” Totally agree. Please read this paper; I’d apprecate any feedback you have on it. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1837813.

    I’m not sure I agree with your interpretation of this statement. You ask:

    “A fundamental question is whether you believe that there are investment opportunities out there which entail a risk of undermining the legitimacy of the entire policy framework of which the SWF is only one small part, but that the Norwegians nonetheless should pursue?”

    Your point here…and I don’t want to put words in your mouth…is to say that investing in lower transparency assets with illiquidity could threaten domestic legitimacy. And that’s possible. But recall that when equity markets tumbled in 2008 the government launched a deep investigation into the fund’s operations and even threatened to shut NBIM down. (If only implicitly.) The reason? The public couldn’t handle the volatility of the equity markets even if the fund managers could.

    My view, in the increasingly volatile markets, having some “stability of returns” in illiquid assets may in fact spare the NBIM the ire of Norwegian politicians and public that “demand good returns” each and every year.

    It may allow the funds to actually take a long-term view, rather than facing the public’s probing eyes each and every quarter…


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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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