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What price opportunity?

An overhaul of the Norwegian oil fund’s active management approach should free it from most of its current investment restrictions, according to a report co-authored by the former chief executive of the Canada Pension Plan Investment Board (CPPIB), David Denison.

Commissioned by the Norway’s ministry of finance, the report examines how the Government Pension Fund Global could approach assets currently beyond its benchmark, investing where it sees benefits rather than being bound by the government agreed restrictions – all due to the Opportunity Cost model employed by the CAD219bn (€144bn) Canadian pension plan, among others. 

The NOK5.3trn (€651.7bn) fund, which is overseen by Norges Bank Investment Management (NBIM) could be managed within a more robust framework as a result of the Finance Ministry agreeing to a reference portfolio comprising 60/40 equities and bonds, according to Denison and co-authors Andrew Ang of Columbia Business School and Michael Brandt of Duke University. 

The authors write: “The Opportunity Cost model raises the bar and accountability for active management because, since the reference portfolio can be passively implemented at close to zero cost, the difference in returns between the fund and the Reference Portfolio directly represents the value-added from active management.”

They argue that the increasing scale of the oil fund will not pose problems, and that it could “[provide] the answers to if and when a particular new alternative investment class [could] be introduced”. More important, it would do away with the need for the government to set out specific investment limits for assets such as real estate – currently capped at 5% (although only 1.2% has been committed). 

According to the paper, any direct property investment would be justifiable if NBIM believed it offered a “superior” risk/return trade-off when compared with publicly traded property in REITs – while allowing the manager to consider a raft of other property assets, including agency bond financing tied to real estate markets.

In an ideal world, NBIM would be able to justify direct private equity investments, if its mandate is amended accordingly. “In adopting the Opportunity Cost model,” the authors argue, “responsibility for making these trade-offs lies with NBIM – the party best informed to make these investment decisions.”

The oil fund would be suited for such an approach due to its long-term investment horizon, patient enough with its capital to see the “significant differences” that develop over decade-long periods when compared with the reference portfolio, the paper adds.

Such a long-term perspective is arguably already beneficial to CPPIB, which, unlike NBIM, does not act as a universal owner of assets but seeks to benefit from an upside in public markets.

Eric Wetlaufer, head of public market investments at CPPIB, recently told the RI Europe conference that the lack of a long-term approach to his area of expertise risked creating excess volatility and bubbles in markets. “This, in turn, results in management focusing on short-term performance at the expense of a steadfast focus on sustainable, long-term value creation.”

The greater freedoms proposed for Europe’s largest single investor would increase NBIM’s ability to take risks, hopefully to the benefit of Norway in the longer term. But a focus on the long term rather than market cap-weighted indices could also contribute to the stability of the financial market as a whole, given that the fund owns a significant share of global markets.

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