Re-Define has launched a major new report on the Norwegian Sovereign Wealth Fund, the largest in the world. The report can be found here and the press release here
I still remember that feeling of surprise when I first looked at Norway’s Sovereign Wealth Fund (GPF), now the world’s largest, in 2007. Having worked both in the financial industry and in public policy, I was struck by three observations in particular. They still make me uneasy.
The first was how the portfolio, in 2007, was comprised almost entirely of investments in liquid securities in the developed world. These still constitute more than 90% of the GPF. The second was how some of the largest investments of the GPF were in oil companies. Even today, three of the ten largest equity holdings of the GPF today are in oil majors and as much as 10%-15% of the overall portfolio is heavily exposed to oil, gas or coal. The third was the laid-back approach the GPF took to engaging on matters of governance, policy and ethical guidelines, which has not changed.
These observations led me, in mid-2008, to write a note to the then Finance Minister Kristin Halvorsen with three suggestions. First, that the GPF, as a long-term investor should expand its investments in fast-growth developing economies. This would deliver higher returns, diversify some of the risks away and engender development. Second, that the GPF, which derived its new revenues from oil & gas, should sell off all stakes in the sector and seek out investments in green technologies in order to reduce its overexposure to carbon and benefit from the growth of the green economy. Third, that the GPF should be more active in improving the functioning of the financial system, particularly through tackling opacity in financial flows and structures.
Not much has happened since though the on-going discussion in the run up to elections makes me hopeful that the time for a mature and informed debate on improving the GPF has finally, if belatedly arrived.
In its 15 years of operation, the GPF has generated an annual return of only 3.17%, falling well short of its 4% target. It is increasingly unlikely, perhaps even impossible, that the GPF will ever meet it. The sclerotic returns are the direct result of the Ministry of Finance’s decision to invest more than 90% of the portfolio in slow-growing mature economies. Meanwhile, more than half of the countries in the world, including some of the fastest growing developing economies, remain off-limits to the GPF. So do instruments such as infrastructure and growth (private) equity that the GPF, as a large long-term investor, is uniquely placed to take advantage of.
The GPF sharply underperforms many of its peers – other SWF’s such as Temasek and GIC of Singapore, large pension funds such as Calpers and the Harvard and Yale university endowments. All of these have large investments in developing economies and invest in illiquid asset classes such as infrastructure and private equity. Even institutions such as Norfund and the IFC – the private sector arm of the World Bank, which have a dual profitability and development mandate, do better than the GPF.
The GPF’s approach, which can be explained by an understandable conservatism to stick with the familiar and avoid negative headlines at all costs, has now become a bet on the future of OECD economies being bright. This locks in low returns and exposes the GPF to concentrated risks of ageing populations and over-indebtedness faced by many mature economies. The GPF has inadvertently taken on a lot of risk, for very little return.
NBIM justifies its portfolio decision by saying that liquid public equity and debt markets in emerging economies don’t fully capture opportunities arising from growth. This is a reason to invest in nascent firms through private (growth) equity and in much needed infrastructure, not to stay on the sidelines. In a report commissioned by Kirkens Nodhjelp that is published today, we show how investing up to $200bn by 2020 in such investments through a GPF-growth fund would improve the profitability of the GPF and reduce the long-term risks it faces.
Not only will this be good for Norway, it will also enable faster growth in poorer economies and create millions of much-needed jobs.
Climate change related risks also loom large over the GPF. Fast forward to 2025 and the GPF is expected to be worth double of the $760bn it is worth today with most of the new money coming from the sale of the oil & gas Norway drills. Like it or not, the policy action to tackle climate change that Norway rightly supports, will have a negative impact on the future value of the GPF.
As much as half of the future expected value of the GPF in 2025 is negatively exposed to policy measures, such as an increase in the price of carbon emissions or an agreement to limit their quantity, that are necessary to tackle the impending threat of climate change. Despite this, the GPF has invested as much as 10%-15% of its portfolio in oil, gas and coal related assets, which will also lose value in the face of such policy action.
The only way to prudently manage this risk is for the GPF not only to divest all such assets but also in addition to invest heavily in low carbon technology and other green investments. These will gain in value when policymakers act on tackling climate change at the same time as new revenue for the GPF would fall, thus reducing the overall risk.
In managing its risks prudently, the GPF can also contribute to tackling climate change.
Beyond this, the GPF must take on the responsibility that comes with its size. It has a vested interest in a transparent and well-functioning financial system, a prerequisite for sustainable profits in the long run. It should actively engage both with the companies it owns as well as policy makers to advocate for measures that address financial instability as well as those that reduce the reputational and legal risks from the aggressive use of tax havens by the firms it partly owns.
The G-20 has, belatedly taken on this agenda and the GPF would be pushing at an open door.
Taking the three measures we have laid out is the only way the GPF can deliver on its fiduciary duty towards Norwegian citizens of maximizing returns for moderate risk in a manner that is both sustainable and responsible. It’s time to turn words in action.
Sony Kapoor is Director of the International Think Tank Re-Define, a Senior Visiting Fellow at the London School of Economics and author of ‘Investing for the Future’ a new report on the Norwegian Sovereign Wealth Fund