The Government Pension Fund of Norway, one of the biggest pots of public money in the world, goes by other, less formal names too: the Petroleum Fund; Norway’s Oil Fund; the Fund for Norway’s Future. The latter might be a crushing cross to bear if not for the fact that the fund is so gigantic — it had nearly 2 trillion kroner ($294 billion) in assets at the end of June, surpassing the country’s $285 billion GDP and making it the second-biggest sovereign wealth fund in the world. (Only the Abu Dhabi Investment Authority, which at the end of 2007 had $875 billion in assets, is bigger.)
The Norwegian fund, which is celebrating its 12th anniversary this year, is run with a striking layer of checks and balances that might seem at first glance to be a barrier to innovation. Its investment strategy is set by the Ministry of Finance, examined and approved by Parliament and managed by Norway’s Central Bank.
Though there is much input from many quarters, one man is doing much of the behind-the-curtains lever pulling: Forty-two-year-old Martin Skancke, the boyish-looking director general of asset management at the Ministry, is the guardian of the Ministry palace and the most influential person in the mix. It falls to him to guide the ship through waters rough and calm and to rally morale in difficult times. His job is made no less daunting by Norway’s popular commitment to socially and environmentally conscious investing. But Skancke seems to have a steady hand on the tiller, emphasizing long-term investment over trading and using the fund as a way to protect Norwegian wealth and to dispel any notion that a small country is by definition an insignificant player (Norway’s population is about 4.7 million).
“We believe, for instance, that equities — over time — give a certain premium over less risky assets,” explains Skancke, a graduate of the Norwegian School of Economics and Business Administration and the London School of Economics, who has been with the Finance Ministry since the early 1990s, working largely on monetary policy and public finance. From 2002 to 2006 he was head of the domestic policy department; he then took over asset management, where he charts global strategy.
“We also believe that less-liquid assets will give a premium over time. And we believe that diversification is the only free lunch in financial markets.”
Part of that diversification is seen in the fund’s willingness to invest in market-based hedge funds, especially long-short equity funds; it puts as much as 10 percent of assets in hedge funds. Skancke has generally steered clear of synthetic assets, especially after the Citigroup–Terra Securities scandal, in which eight Norwegian municipalities invested in high-risk hedge fund derivatives in 2001 and 2002, ultimately losing tens of millions of dollars in public money.
The Government Pension Fund has not gone unscathed by the global credit crisis. A third of its assets are in U.S. holdings, and the fund has acknowledged that its stake in the debt of Freddie Mac and Fannie Mae — worth $24 billion at the end of 2007 — has fallen steeply in value and was worth only about $18 billion at the end of June (the fund doesn’t release third-quarter numbers until the end of November). The fund has also said it had about 17.5 million shares in now-bankrupt Lehman Brothers Holdings. Overall, its returns have been positive in nine years, negative in only two and remarkably stable, with an average annual return of 6.29 percent since inception.
The fund hasn’t gone unnoticed beyond Norway. A 2007 study of 33 sovereign wealth funds by the Washington, D.C.–based Peterson Institute for International Economics scored the Norwegian fund second behind New Zealand’s for structure, governance, accountability and transparency (Norway’s fund received 23 points out of a possible 25; the Dubai fund received half a point). The report praised the fund in “buying in markets whose values are falling to rebalance its portfolios” and said it was a case study in sustainability and stability. In a similar study the International Monetary Fund said, “Norway’s experience with ethical guidelines provides further proof that commitment to the common good is not necessarily antagonistic to high returns.”
The IMF added that it will use the Norwegian fund as a model for the best-practices guidelines it is writing for sovereign wealth funds, which have come under broad fire for their typically poor transparency and tendency to mingle finance and politics.
In September the Government Fund announced it was selling its holdings in Rio Tinto, the multinational mining company, over allegations of pollution. “There are no indications that the company’s practices will be changed in the future or that measures will be taken to significantly reduce the damage to nature and the environment,” the Ministry of Finance concluded. Almost simultaneously, the fund said it would continue to be a shareholder in chemical giant Monsanto Co. because that company had reduced its use of child labor in its cottonseed production in India.
Alpha Contributing Writer Udayan Gupta met with Skancke at his Oslo office in September to discuss short-term trauma versus long-term confidence.
Alpha: Have recent events undermined your confidence in the markets or your ability to meet obligations?
Skancke: No, because our time horizon is infinite and we don’t need liquidity — we don’t have customers who withdraw their money if they become uneasy about the markets. So that is a very good and basic way of thinking, which has not been affected by events. With the formulation of a fiscal policy guideline that in effect says that we, over time, should spend only the real return on the fund, the investment horizon is — in principle — infinitely long.
Does that mark a significant evolution in your philosophy?
We began as a local fund — although there were some global components — and we were unsure about the time horizon because we thought there was a real risk that we would have to liquidate after a few years.
What changed your mind?
In 1998 we increased the equity portion of the portfolio from zero to 40 percent. Then we lived through the dot-com bubble and lost a lot of money in 2002. There were no serious challenges to our investment strategy after that, so gradually we found the confidence to suggest we take more risk. We have taken a very gradualist approach, and that’s because we are asking the Norwegian people for their trust in investing 20 percent of the GDP each year — so we have to be very serious about reputational risk. That means that going out immediately into high-risk market investments is probably not a very good idea. We want to make sure not only that we understand what we are doing but that the general public understands what we are doing every step of the way.
There’s been a major backlash here in Norway against hedge funds, owing to the municipal losses associated with Citigroup–Terra Securities. Does that make hedge funds a hard sell?
We have nothing against hedge funds because what is a hedge fund? Some of the strategies used in active management at banks are long-short strategies. So are the funds that are doing that equity funds or hedge funds? It’s just a matter of definition. Even though we don’t do private equity funds, what we are looking at is doing more in the pre-IPO, venture capital space of private equity. We’re also seriously looking at the leveraged-buyout type of funds.
How do you decide where to put money?
We feel that our job is to provide the politicians — they are the ultimate owners — with the data to establish the goals. Yes, the politicians come and go, but there has been fairly broad consensus on the investment strategy of the fund. Our job as civil servants is to provide them with a menu of risk and expected returns and to illustrate it. For instance, when we made the decision to increase the equity portion from 40 percent to 60 percent [in 2007], we did the analysis, and it showed that there was a 75 percent chance that we would make more money with 60 percent equity and a 25 percent chance that it was a bad decision. So we said, Here are the options: Increase the equity portion, 75 percent chance we’ll make money; 25 percent chance we’ll lose money.
But I think it’s always difficult for us to find a good way to illustrate the consequences in a way that makes sense, and the only way we can do this is by gradually increasing the risk and seeing how it stands up through periods of turbulence before trying more change. Creating a sustainable investment strategy for a fund as big as ours takes time. We are not as nimble as a Yale or Harvard. Our decision-making process is longer, and our size makes it hard to rapidly build up significant allocations in less-liquid markets. So we have to turn our deliberateness into an advantage and trade in long-term horizons.
Assuming you wanted to, how would you change the direction of such a big ship?
All major shifts in strategies have to be submitted to the Ministry. It also helps to have a consensus. We don’t just write a report. We sit down with the finance committee, which involves all the parties of the coalition, we give them the arguments, show them the slides and the numbers. It is a long process for us. So when we suggested an increase in the equity portion to 60 percent, the No. 1 priority was to demonstrate that the analysis we did pointed to a higher equity portion for the fund. That is the single most important decision in terms of the strategy of the fund. For us the natural process was to do the analysis of the equity portion and try to build a consensus on increasing it and to make people understand that we are making a conscious decision to increase risk and expected return. And the next logical step was real estate, so we made the decision to give priority to that. It’s just natural prioritizing.
Is there a ceiling on how much you can control in a company or a fund?
It’s 10 percent of any one company or fund. Our average ownership share is about 1 percent. But even with a 1 percent share, you can be among the top ten shareholders in most companies.
So you see yourself as activist investors?
We are not active in the sense that we are strategic owners and care about corporate governance. And we are not passive in the sense that we’ll sit back and accept anything from management.
But you’ve divested your holdings in more than two dozen companies.
There are two categories. We screen companies based on what they produce, and the only products we exclude are some weapons — like nuclear weapons, cluster bombs, land mines and biological weapons. Of the 27 from which we’ve divested, 20 are in that category. The second category is based not on what they produce but on how they produce — for instance, those that cause environmental damage, rely on child labor or commit human-rights abuses.
Why invest in such companies in the first place?
These guidelines were set up after we began investing. In principle, when we go into new markets, we expand the benchmark for emerging markets, for small-cap companies. And then we try to screen these markets before we go in.
What kind of thought goes into a decision like that?
We have a council on ethics. They are independent from us. Their membership includes two law professors and one philosophy professor. If they come to us with a company they believe there are problems with — and if these problems are so severe that there’s a reason for exclusion — we will then go to the Central Bank and ask if they have a strategy that could help influence the company to change. Sometimes the Central Bank will say: “To be honest, this company won’t even pick up the phone. They don’t have a tradition of listening to their shareholders. It’s very difficult to track what they are doing. It also isn’t in a sector where we have focus. It is also difficult to get other investors involved.”
So the possibility that we will change something in the company is pretty low, in which case we will probably say, “Divest.” If, on the other hand, the Central Bank says, “Well, yes, we believe that we can influence this company, and we can get other investors on board. It’s a sector where we have focus, where we have resources, and this is what we intend to do over the next months,” we will probably try that approach. I think it is important to see exclusion as a last resort, as the last in a chain of activities. The first step is always to stay and try to change the behavior. But where we have tried and failed, we will divest.
