The tribulations of a democratic SWF
Government indicates that unlisted infrastructure brings on board new risks that the Norwegian public will not like ‘Discretionary bets’ and ‘operational mistakes’ seen as big risks that the oil fund should avoid
How many institutional investors give serious consideration to the risk that they themselves will cease to exist?
It is this concern that has persuaded the strategy setters behind Norway’s NOK7.9trn (€842bn) Government Pension Fund Global (GFPG) to once again to block the fund’s access to unlisted infrastructure projects.
Norges Bank Investment Management (NBIM), which manages the fund, had recommended adding an explicit allocation to infrastructure. Instead, it got an equity increase up to 70%, from 62.5% currently – subject to parliamentary approval.
Espen Henriksen, associate professor of financial economics at BI Norwegian Business School, sat on the committee tasked with advising the government on the fund’s strategic portfolio composition.
“This recommendation to increase systematic risk-taking was conditional on the extent of discretionary bets being kept at the current low level,” Henriksen says.
In practice, this means that the recommendation to increase the equity share was conditional not allocating more to private markets, he says, such as unlisted real estate or infrastructure.
This was based both on fundamental financial factors faced by all asset owners, and on considerations specific to a democratically-owned fund such as the GPFG, Henriksen says.
Not only is the GPFG the world’s largest sovereign wealth fund (SWF), but also it occupies a unique position compared to its peers because it belongs to a country with a very open democratic government.
As the vehicle that holds most of Norway’s post-1996 proceeds from oil and gas extraction in the form of international equities and bonds, the management of its assets is a highly political topic.
The GPFG commits to rules on what proportion of the fund’s revenue can be spent, when the government can withdraw from the fund, and how the fund can be invested.
“Risks and expected returns associated with systematic strategies may be communicated to the public – which is in stark contrast to operational risks or idiosyncratic risks associated with speculative bets, which are not possible to quantify and communicate ex ante,” Henriksen says.
“Experience, gained among other things from the financial crisis, has shown that the public has much less acceptance for losses due to discretionary bets or operational mistakes than losses due to systematic market movements.”
Henriksen adds that Norway’s entire savings mechanism and the GPFG’s existence are vital parts of society.
“By far the biggest risk for the country and for the welfare of future generations is that we together are not able to uphold a savings mechanism,” he says.
“The value of the savings mechanism is many magnitudes larger than any potential excess returns from discretionary bets.”
It is important to remember that the GPFG is already highly exposed
to both real estate and infrastructure through its listed investments, he adds, so the addition of these sector exposures as unlisted investments cannot be justified on the grounds of a huge diversification gain.
As the oil fund makes financial gains for Norway, the broader picture is that maintaining the saving mechanism that the fund provides is actually the biggest financial gain for the country.
As a result, Henriksen concludes, the fund can carry “the kind of risk that can be communicated to the public”. The risk of operational mistakes is something it can less afford.