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Special Report

ESG: The metrics jigsaw


Norway: Accumulation key

Rachel Fixsen discusses the Government Pension Fund Norway with Lars Tronsgaard, deputy chief executive at its asset manager, Folketrygdfondet

Key Data

• Manager of Norway’s Government Pension Fund Norway (GPFN), the domestic and Nordic part of the overall Government Pension Fund and smaller counterpart to the Government Pension Fund Global (GPFG)
• Assets: NOK198bn (€21.2bn) at end of 2015
• Strategic asset allocation: Equities 60%, bonds 40%
• Geographical spread: 85% in Norway and 15% in the rest of the Nordic region

Despite its name, it is not certain that the assets totalling NOK198bn (€21.4bn) invested within Norway’s Government Pension Fund Norway (GPFN) will ever be used to fund retirement benefits.

This lack of fixed liabilities puts the fund in an enviable position among institutional investors, because it is unhampered in its efforts to chase long-term returns.

“The purpose of the fund is not really defined besides being savings for future generations, and there are no liabilities,” explains Lars Tronsgaard, deputy chief executive of Folketrygdfondet, the organisation that manages GPFN’s assets.

“The use of the fund is being left open, and it will be up to politicians in the future to find the best use for it,” he says.

The GPFN, along with its larger counterpart the Government Pension Fund Global (GPFG), make up Norway’s Government Pension Fund — a huge sovereign wealth fund designed to hold and preserve revenue from oil extraction. Norway’s financial fortunes were transformed in the late 1960s when it struck oil offshore.

The government is permitted to draw down an investment return of 4% from the fund each year for budgetary use, but the capital remains invested.

Unlike a conventional pension fund or an insurance company, Folketrygdfondet does not have any liquidity or capital requirements to consider. “So we are much freer to decided on how we will perform the investments,” Tronsgaard says.

The manager creates excess return for the fund from high-quality companies, liquidity premia and by “time-varying risk premia,” Tronsgaard explains. The fund’s size relative to the Norwegian equities market means it has to have a long-term view of investments, because it is one of the three largest investors in 38 companies. “We can’t just switch the portfolio overnight or even over a month, and because we know this, it is reflected in the way we manage the portfolio,” he says.

On the other hand, the fund’s size means it has good access to the companies it invests in. “We know the companies very well, and they expect us to have views on how they are run, and we take part in talks with the management of the company. We have easy access to analysts and market participants and you see most of the flow in the market, so there are some sides that benefit from being a large investor,” he says.

Folketrygdfondet is mandated by the finance ministry to invest against a 60/40 equities/fixed income benchmark. It had submitted a proposal to add real assets to the portfolio in the form of property and infrastructure investments, but this was rejected in the parliamentary report on the Government Pension Fund released during April 2015.

The report argued that as the state was a substantial owner of Norwegian property and infrastructure, it made little sense to invest part of the GPFN in unlisted real estate and infrastructure to achieve better risk diversification.

Lars Tronsgaard

Tronsgaard says the matter is closed and Folketrygdfondet will no longer consider it. “However, listed real estate companies will still be an alternative,” he says.

For equities, the fund’s portfolio is managed actively. “We think being an active stock picker goes very well with having a high level of knowledge of the domestic market,” he says.

Folketrygdfondet tries to tilt the portfolio to give extra return both on the fixed-income side but also for equities. It aims to have a diversified credit portfolio so that no single corporate default will harm the portfolio overall, and includes paper issued by companies with both lower (high yield) and higher-quality credit profiles. “We also try to include bonds from less creditworthy companies, in order to extract credit premiums,” Tronsgaard says.

In fixed income, good credit analysis is a must to avoid taking on issuance from companies that actually will default, he says. “We also try to go into smaller companies and harvest some liquidity premiums.” 

One of the GPFN’s main advantages in its hunt for excess returns is its countercyclical approach. This is possible because it is neither an insurance company nor a pension fund with liabilities. This approach allows it to time vary credit and liquidity premiums to its own advantage, Tronsgaard explains.

“Back in 2008, following the financial crisis, risk premiums had increased to levels you had never seen before and many investors were forced to sell, including life insurance companies that had to reduce their risk levels, and funds that could invest only in certain rating categories.

“At that point, and then in 2011 and 2012 as well, there were large movements in the credit markets, and in those years we managed to take on risk when risk premiums were high.

“This has generated quite a high excess return on the fixed-income portfolio for us over the last seven to eight years,” Tronsgaard says.

While Folketrygdfondet works on its fixed-income portfolio every day, those two periods were particularly important in generating excess returns, he says. “If you have an investment philosophy of acting countercyclically, then what you would like to see in the market actually is quite high volatility.”

It is in such phases that risk premia rise, but a large element of these is the result of liquidity rather than credit risk, he says. “Being a long-term investor, we don’t need liquidity, so let’s say we are in a nice position of being able to harvest those liquidity premiums,” he says.

The ability to distinguish between credit and liquidity premiums is important, he says, as the bond buying programme adopted by the European Central Bank has made risk premia less transparent.

Again, local knowledge helps Folketrygdfondet here. “We are now in a situation to see if that is real credit risk, and there is the possibility of bankruptcies, and there are companies that will need restructuring,” Tronsgaard says.

Given the Norwegian economy’s high dependence on oil and its related industries, the current low price of crude is a crucial factor for the investment success of a domestic and Nordic investment fund.

Overall, Tronsgaard says the current investment environment is more difficult to manoeuvre than before, because of the persistently low oil price and monetary policy. “In Norway, we have some uncertainty tied to the real economy and the effects of the low oil price, which obviously affects the oil and oil-related industries, but can also spread to other industries,” he says.

Folketrygdfondet has good analysts working on oil price forecasts, he says. “I think the market does not feel that oil prices will go back to $100 [€87] plus, but even if it returns to  $60 or $70, the industry will have to change due to the fact that costs more or less got out of hand when oil prices were high. 

“This means that coming out of this crisis the E&P [exploration & production] companies will probably have another cost base,” says Trongaard.

Overcapacity in the sector means oil service companies will struggle with this change, he says.

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