One of the paradoxes of institutional investment in Norway is that although all investors have an appetite for risk, most do not have the risk capital to satisfy it. In this respect they are in marked contrast to Swedish institutional investors, who have little appetite for risk but - thanks to the strictures of the financial supervisory authority - have built up healthy capital reserves or buffers in their funds.

The reason for the dearth of risk capital available to Norwegian institutional investors is a combination of a minimum guarantee that insurers must pay on their pension products and the low interest rates.

The minimum guarantee has been lowered from 4%, when interest rates were far higher, to 3.5% when they are much lower. This has created an uncomfortable capital squeeze for many pension funds.

As a result, pension funds can be categorised as ‘haves' and ‘have nots' The corporate schemes tend to be capital-rich while the publicly owned pension funds and life insurers are capital-poor.

"There is a huge difference in strategy and thinking between a municipality owned pension fund with a small budget and a pension fund owned by a large international player in the oil industry here with an unlimited amount of capital available," says Oddgeir Matre, the director of institutional clients responsible for pension funds at DnB NOR Asset Management.

"Some of the large pension funds with a single sponsor can choose to increase their exposure to equities to maximise return. They are not worried about risk capital. The life companies by their nature will have limited capital available and they will not have the same freedom."

What asset managers can do for Norwegian pension funds and insurers therefore depends largely on the amount of capital they have available, he says.

Attempts to level the Nordic playing field, so that Norwegian pension funds and insurers are governed by the same solvency rules and regulations as the rest of Scandinavia, have so far failed. Although the Sweden and Denmark have both introduced ‘traffic light' systems to ensure that institutions have sufficient risk capacity, Norway seems unlikely to follow.

Earlier this year the Kredittilsynet, the Norwegian financial supervisory authority, proposed the introduction of capital solvency tests along the lines of the traffic light system in Sweden and Denmark. However, this was rejected by the Ministry of Finance,

The proposal was also opposed by the Norwegian Association of Pension Funds (Norske Pensjonskassers Forening/ NPF), who said that it would exacerbate the problem of the shortage of long-dated bonds in Norway , and create even greater problems than those faced by pension funds in Denmark and Sweden.

The problem is that the Norwegian government, which is running a big surplus because of the oil revenues, does not need to borrow, and the debt office, far from issuing long-dated bonds to help the pension funds, is issuing short duration

Asset managers have tried to persuade the government to issue more long-dated bonds. Hans Aasnaes, chief executive officer of Storebrand Investments, the asset management arm of the insurer Storebrand says "We have tried lobbying the central bank and the government to issue more long dated bonds, which we think should be in the interest both of the central bank and the Ministry of Finance because it would take some liquidity out of the markets. But there seems little willingness to help the life insurance companies that way."

What could help increase the amount of risk capital available to Norwegian institutions is Solvency II, a new EU/EEA solvency framework in insurance which comes into force in 2008.

So where are pension funds allocating the risk capital they have? The story for the past two years has been real estate, says Jorgens Hjemdal, director of institutional business at DnB NOR Asset Management. "Real estate is a very hot topic in Norway, especially for the small or medium sized pension funds. The insurers and the large pension funds have been in real estate for a long time but there is now a large demand for real estate from the smaller pension funds."

The benchmark allocation to real estate has been set by the large insurance companies. This has typically been plus or minus 10% and is now closer to 15% . Yet there are signs that the market may be reaching its peak, says Hjemdal "Everybody wants to get in at the same time, so there is a danger that the market could be over-heating.

"The early movers have seen great returns of 17 to 20% over the past two years. We still think there are reasonable returns to be had from real estate in the future as well. Some of the players in this market are still expecting double digit returns over the next couple of years," he says.

At the moment is real estate investment almost exclusively domestic. "It's its very difficult to get any real exposure abroad," says Hjemdal. "Going forward, I think international diversification will be important in real estate."

Investors are holding back from further hedge fund investment, says Hjemdahl. "Many investors are reluctant to invest more into funds of hedge funds, at least in this environment. They want to see the returns picking up first. But we expect demand to grow going forward." Meanwhile Norway's new mandatory pension system is providing a stream of new business to life insurers and their asset manangment arms

From 1 January all companies with at least two employees are required by law to offer a mandatory pension scheme. This has prompted a major shift by companies into defined contribution (DC) schemes.

Storebrand has acquired some 20% of the new DC market . Within this market, Storebrand Investments has seen a growth of interest in balanced indexed products.

Aasnaes admits he was surprised by the demand. " A year ago we thought the DC market would mean more active management and more high margin products. Instead all the growth has been in the demand for been for balanced portfolios of indexed products."