The Norwegian Government Pension Fund suffered its worst year in 2008, losing NKr633bn (£69bn, $111bn, €77bn) or close to a quarter of its value. Critics likened it to gambling.
About NKr80bn of the losses were directly related to active management, which has prompted calls for a more passive investment strategy. In April, Norway’s finance ministry started a broad review on whether to continue active management of the NKr2,500bn fund, the world’s second largest sovereign wealth fund.
A new academic report – commissioned by the government in connection with the review – says the fund has been taking “appropriate” risks. But it recommended one notable change: incorporating systematic risk factors, such as volatility and liquidity, into the fund’s benchmark.
“Seventy per cent of Norway’s active management is explained by these additional risk premiums,” says Andrew Ang, a professor at Columbia Business School in New York and one of the report’s three co-authors. “It should be better understood and brought into the benchmark explicitly.”
This will be the backdrop for when about 150 invited experts gather in Oslo on Wednesday to give their views on how the fund should proceed.
The report, completed last month by experts at Columbia, Yale School of Management, and the London Business School, said “the fund is actually not an actively managed portfolio”. This is based on the observation that active returns – the difference between the fund’s actual returns and its benchmark – only constituted a small fraction of both the mean and the volatility of the total return.
“Overall . . . the returns on the fund are similar to those that could have been earned on a fund holding the benchmarks with additional, essentially passive exposure to these (systemic) factors,” the report said.
“The incremental contribution of active management has been slightly positive overall, with notable negative returns during 2008 and the early part of 2009.”
The report also found the fund’s pattern of risk exposures is appropriate for a long-term investor, and said active management could enhance the fund’s other aims, such as socially responsible investing.
Still, it recommends the fund change its benchmark, currently defined by geography and asset class, to include other factors such as volatility, liquidity, and credit risk. A factor benchmark approach would make it easier to monitor new asset classes, such as real estate, which was added to the fund in 2008.
The report could lead to changes via a White Paper in April whereby the additional risk premium is incorporated into the benchmark. That would mean lower performance fees for external managers, because it would raise the performance bar. It would also shift the responsibility from Norges Bank Investment Management, the manager of the fund, to the finance ministry, as asset owner, on how much systematic risk the fund takes.
This would all be ground-breaking, according to Mr Ang. None of the other large pension funds or SWFs incorporate systematic risk factors into their benchmark.
“This report is almost revolutionary,” says Lars Søraas, a Norwegian venture capital analyst and economist promoting passive management. “But you’ll have a problem explaining to the Norwegian people you’re going to have a volatility risk.”
NBIM has declined to comment on a possible “factor benchmark” ahead of this week’s seminar. Not surprisingly, it remains an advocate of active management. In a letter to the finance ministry last month, NBIM defended the strategy on the basis that investment opportunities vary over time and the benchmark portfolio would therefore never represent the “correct” portfolio at any time.
“A passive, uninformed approach to operational decisions is an alternative without a sound theoretical or practical justification,” said Svein Gjedrem, Norway’s central bank governor, and Yngve Slyngstad, NBIM chief executive, in a joint letter. Costs would be lower but they would not be able to achieve the benchmark return, they said.
Progress, Norway’s largest opposition party, is one of the fund’s critics on this subject. It lambasted the fund’s active management strategy following the heavy losses in 2008.
“Several experts have concluded that in the long run, you will not be able to beat the market,” said Christian Tybring-Gjedde, a Progress party finance committee member.
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