Norway's Oil Fund - An Infrastructure Investor of Choice

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NOTE: This is a longer version of an Oped that appeared in the Norwegian business newspaper Dagens Naeringsliv on 21 March 2014.

The revelation of the Oil Fund’s controversial investment in Formula 1 has led to Ola Mestad, Lars Hakon Sooras and Sofie Mathiasen and other Norwegian commentators to warn against allowing the Fund to invest in unlisted assets. This would be a grave mistake that would cost Norwegians dearly.

Instead, the government should bolster Fund capacity and set up a powerful independent watchdog in the form of a “Stortingets Råd for Oljefondet”.

Critics say that unlisted assets will make it harder to detect unethical investments or exercise oversight. They also warn about the lack of relevant expertise at the Fund and in the Norges Bank board that oversees it. As a reaction to the Formula 1 fiasco these concerns are understandable, but misconceived.

While unlisted investments private equity and infrastructure disclose less information publicly, they will give NBIM access to hordes of private information. It will also be in a much stronger position to demand private information and to successfully challenge questionable practices. For effective oversight, the SRO should not only enjoy privileged access to all the data NBIM holds, but also have the right to demand more information on any of its investments.

Does anyone seriously think that Formula 1, with the constant whiff of scandal and a controversial promoter repeatedly accused of corruption, would have been an appropriate investment if only it were listed? It did not pass the smell test, period.

No one with experience in finance is naïve enough to think that “listing” brings foolproof safeguards. How does one explain Lonmin, UBS, Lehman Brothers, BP, Posco, Siemens and the hundreds of other listed firms complicit in wrongdoing that Norwegians would find “dubious”? Fact is that there is no substitute for good due diligence while investing in the markets.

Investing passively in listed securities just because they are part of an index, as NBIM does now, means it can be lazy and neglect doing its homework. It is this laziness that exposes it to a greater risk of dodgy investments. Investing in unlisted assets, on the other hand, is impossible without proper due diligence, and laziness is simply not an option. Discretionary unlisted investments provide for better quality control than NBIM’s present brand of passive index investment in listed securities.

Another argument against forbidding unlisted investments is that majority of the world’s economic activity is in fact carried out by unlisted entities. It is impossible for the Oil Fund to fulfill the aim of reflecting global patterns of production by choosing only listed assets. Moreover, such restrictions significantly increase the risk and lower returns of the Fund.

Governor Olsen is right to say that the present strategy of mostly listed investments will likely deliver a return of only 3% or so. But 4% to 5% is easily possible if its investment options were broadened to include illiquid assets. An Oil Fund with 4% return will be one and a half times the size of one with 3% return in 40 years. At 5%, it will be twice at big. Restrictions against illiquid investments imposed by the Finance Ministry carry a very heavy hidden cost for future generations of Norwegians.

Most other investors in the world are “constrained” by obligations such as regular pension payouts. Not being able to liquidate a position quickly poses a real risk to them so they overwhelmingly choose liquid assets such as listed stocks and bonds. By law, the Oil Fund, a rare “unconstrained” investor would never face large sudden demands on its corpus, so locking in funds for long periods poses no risk to Norway. It is uniquely positioned to harvest a large “liquidity premium” by choosing unlisted illiquid assets that few other funds can invest it.

Of course, there is no return without risk, but the type of risk also matters a lot. If the Oil Fund invests mostly in listed liquid assets that carry little liquidity risk, it will have to take on more credit risk and expose itself to systemic risk to generate the same return. The Fund is ill-suited to take such risks. In contrast there is no other investor in the world that is better suited to take on liquidity risk. Given that it does not need liquidity, this is not a risk at all. In fact, by investing in unlisted assets the Fund can generate a much higher return for the same risk.

The Oil Fund’s present focus on listed assets in developed economies exposes it to large systemic risks. These economies have strong financial and economic inter-linkages with each other. They are also facing common problems of demographic decline and unprecedented levels of private and public debt. Investing in faster growth developing economies that are also structurally different would sharply reduce the risk faced by the Fund, while simultaneously increasing its return.

The best investment opportunities for the Fund are in unlisted assets such as infrastructure and growth equity. Realising this, Sweden is set to increase how much its $173 bn pension funds can invest in such assets. In order to fulfill its mandate, reduce risks and increase return, the Oil Fund must do the same. Setting up the “Stortingets Råd for Oljefondet” would improve governance and strengthen oversight that gives citizens the confidence that their money is being invested profitably and responsibly without taking on excessive risks.

Sony Kapoor is Director of the Think Tank Re-Define and Strategy Adviser to the Systemic Risk Centre at the London School of Economics