Last year, Norges Bank Investment Management’s dreams of adding private equity to its investment mandate once again got kicked into the long grass. This was probably the right call.
However, if Nicolai Tangen — the Norwegian sovereign wealth fund’s restless and ambitious head — is keen on a different titanic, legacy-making project, then here’s one that FTAV has been noodling on for a while: it should let other institutions and perhaps even ordinary people invest in the fund.
OK . . . we may need to backtrack a bit to explain what that would mean, how it would work, and why it’d be a big deal. It probably won’t happen, but it really should. As Espen Henriksen, a finance professor at BI Norwegian Business School, told Alphaville:
The recipe for managing the fund has been broad and systematic risk diversification and economies of scale in open public markets. Allowing other savers to participate in the fund and enjoying efficient and cost-effective risk-return exposure could enhance economies of scale and improve net returns for the Norwegian government.
This approach could generate a double win-win: supporting the broader public good while increasing the Norwegian government’s net financial returns.
To be clear, this is not actually something that is currently being discussed in Norway, even informally. It’s just a flight of fancy after reading NBIM’s latest annual report yesterday.
But after jotting down some half-baked thoughts we convinced ourselves that this is a tremendous idea, and we wanted to test out how ludicrous it is in the public arena. As Tangen is fond of saying: “Screwing up is allowed.”
Hydrocarbon heaven
First of all, here’s some background on what Norwegians usually just call “the oil fund”. If you already know all about it then feel free to skip to the next section.
The $1.82tn sovereign wealth fund is technically called the “Government Pension Fund Global”, but funding retirements is only a small part of its job. The money in the fund comes from surplus revenues generated by Norway’s oil and gas revenues, which is invested overseas by Norges Bank Investment Management — a division of the central bank — to avoid overheating the domestic economy.
The national government is only supposed to be allowed to spend roughly the annual real return of the fund across the budget. Initially this was set at 4 per cent but was subsequently lowered to 2.9 per cent. This is just a guideline, however. In times of plenty, governments have often spent much less, and in times of pain (eg after financial crisis and Covid-19) they are allowed to spend more.
By any reasonable standards, it has been a phenomenal success. The fund’s financial returns bankroll about 20 per cent of the Norwegian government’s entire budget — almost equal to its annual expenses on pensions and defence. And the model has mostly prevented the “Dutch disease” that has blighted many resource-rich countries. NBIM has become a model of transparency in an often murky world of sovereign wealth funds.
Here’s a snapshot of the first deposit cheque that seeded the fund back in 1996. From tiny acorns etc etc.
About 70 per cent of the fund is invested in equities and 30 per cent in bonds. Up to 7 per cent can be invested in real estate, and up to 2 per cent in renewable energy projects. The latter two are being gradually scaled up, but equities and fixed income are, and probably will remain, the dominant asset classes.
NBIM allocates some money to external and internal portfolio managers, but the vast majority of the money is managed passively, mimicking a benchmark handed to it by the Norwegian finance ministry (Excel snafus excepted). NBIM is allowed a tracking error of just 1.25 per cent from this index. Over the past 15 years it has only averaged 0.44 per cent.
This means that only 676 full-time people are needed to run the whole $1.8tn show, and the all-in cost of NBIM clocked in at just 0.041 per cent of assets last year. That is exceptionally low. It helps that even Tangen only takes home about $663,000 a year — roughly what a generic Wall Street MD might make.
And what of the performance? Well, NBIM has since 1998 generated annual average net returns of 6.34 per cent. Now, this may not sound enormously compelling at a time when US stocks post double-digit returns most years, but remember that only 40 per cent of the fund was initially in stocks. This was only raised to 60 per cent in 2007, and 70 per cent in 2017 (Moreover, corporate bonds weren’t added until 2002, until which it was all in lower-income, high-grade government debt).
Over the past decade it has averaged 7.3 per cent, and it has annualised about 8.9 per cent since it started scaling up in equities in 2008.
Its overall risk-adjusted returns therefore compare well with other sovereign wealth funds (at least the ones that report their results), with some allowances for the different investment strategies. NBIM has also outperformed the average US university endowment over the past 3, 10 and 25 years despite their often much racier asset mix.
NBIM’s returns have also outpaced its index by about 25 basis points a year since its inception, showing how you can still eke out some alpha even with a passive mandate. Last year it undershot its benchmark by 0.45 per cent, but over time, those small wins — from things like smarter trading, rebalancing strategies and securities lending — can really add up.
Indeed, of NBIM’s $1.8tn of assets today, only about $460bn come from oil and gas revenues. The rest has been generated by investment gains and currency movements. This is nice if you’re Norwegian, and full disclosure: the author of this post is Norwegian. [Ed: This will be shocking to readers, pls consider disclosing more often…]
This combination of good results, decent diversification, cheap costs and incredible transparency is why an open-ended, publicly available fund that replicates NBIM’s results could be a killer proposition.
After all, picking a smart selection of cheap funds that ensure a base level of diversification and performance is difficult for many people (even professional CIOs).
NBIM in practice resembles Bill Sharpe’s ultimate market portfolio. For a lot of people — both ordinary household savers and large institutional pools of money — it would therefore be a great investment choice.
A public investment utility
So how would this even work? Well, now we’re definitely entering spitball territory, but the technical difficulties don’t seem insurmountable.
NBIM would need set up some kind of separate open-ended mutual fund structure for to the public to avoid directly commingling its existing pool of public money with private money raised. This would require more lawyers and back-office staff, but on the investment side it would simply piggyback off the existing infrastructure to replicate NBIM’s returns.
This fund could probably have the same headline 4 basis point annual cost as NBIM. In fact, the more money this fund raises, the cheaper it might become over time, thanks to the economies of scale (NBIM’s current expenses are down from long-run average cost of 8 basis points).
This vehicle shouldn’t offer the same openness to constant inflows and outflows that a traditional mutual fund does. This would be an investment product designed for long-term saving, so quarterly or even annual withdrawal windows would be fine.
Sure, this would deter some people from investing. But that seems like an acceptable tradeoff to prevent haphazard and sometimes lumpy redemption requests from NBIM, which could spike in turbulent times.
At first, this public NBIM fund might just be open to other public pools of money in Norway, such as municipal pension plans. Frankly, these should already have been allowed to piggyback on the expertise built up at NBIM over the years, rather than doing it in-house.
Once the concept is proven it could be opened up to ordinary Norwegian savers, positioned as a kind of public utility for locals — a one-stop-shop for broad, cheap market exposure to encourage long-term savings, managed by one of the best custodians in the business.
Plenty of money is already invested in Norwegian asset managers, with $139bn in equity funds and another $29bn in bond funds. Most of these funds are laughably overpriced, and perform just about as well as you’d expect from primarily active funds.
Even the cheapest global equity index fund in Norway charges 15 basis points a year, triple NBIM’s costs. The all-in costs are usually much higher. There’s a reason why DNB Asset Management, the investment arm of Norway’s biggest bank, enjoyed a 63 per cent pre-tax profit margin last year.
And over time, there’s no reason why NBIM couldn’t open up this fund to investors elsewhere in Europe or even the world. As BI’s Henriksen said:
NBIM’s systematic strategy of efficient, broad diversification and economies of scale—so-called “enhanced indexing”—has, historically, delivered positive risk-adjusted returns relative to index even after costs. If the administrative fees are kept at a modest level, that could also be the case for outside savers if given access to the fund.
A natural starting point could be Norwegian public endowments, such as municipal funds created through the privatization of hydropower plants and other public utilities. These entities share the Norwegian government’s objectives and long-term savings and consumption-smoothing horizon. If successful, this model could be gradually expanded to include other savers.
Sure, we’re glossing over logistical challenges and legal issues — NBIM would need to hire a KYC team, for example — but none of them seem insurmountable. And an NBIM product would probably be very attractive to a lot of global institutional and retail money, which is often managed less well and more expensively than what NBIM can offer.
For comparison, the average asset-weighted cost of equity-focused active US mutual funds stood at 0.65 per cent in 2023, according to the Investment Company Institute. Even if you include passive index funds in the mix the average cost still only falls to 0.42 per cent. In the less competitive European market — where many people blithely plough their money into any fund recommended by the smooth salesman at their local bank — the average equity fund costs 1.18 per cent.
Institutional investors usually pay a lot less than retail investors, but an NBIM fund would probably be an extremely competitive product. Hell, even Vanguard funds cost an average at 0.08 per cent at the end of 2023 — almost twice as high as NBIM. 😱
Obviously, the asset management industry would despise it, much like how commercial publishers hate competing with taxpayer-funded public broadcasters who give away their content for free. Hardly anyone would have an interest in selling it. Distribution might therefore be a problem. It’s hard to envisage NBIM going on an advertising blitz or offering sales commissions either, so it would have to rely on word of mouth and media attention to gather customers.
But that’s pretty much how Vanguard operates, and it’s worked out pretty well for them. We’re pretty sure that broadly-available version of NBIM would get decent traction regardless.
Yes but . . .
We’ve flicked casually at some logistical issues — back office stuff etc — and dismissed them as completely manageable, but there are probably tons of small fiddly things that we’re oblivious about, forgetting or downplaying. And there are some broader issues that are worth highlighting.
For example, NBIM has ethical guardrails set by Norway’s parliament to ensure broad popular support in a country known for social-democratic politics.
A host of companies are completely excluded because of blanket prohibitions on investing in anything involved in the production of nuclear weapons, coal and tobacco, or any company that “contribute to violations of fundamental ethical norms”, mostly relating to human rights and environmental degradation.
These are assessed by an independent “Council on Ethics”, which can recommend putting individual companies under observation, recommend NBIM exclude them, and review previous exclusions.
This council has at times been controversial — for example, the optics of banning tobacco investments while tobacco remains legal in Norway are a bit iffy — and as the size of the fund has swelled and times have changed, the controversies have grown in magnitude.
For example, Israeli investments have become a major flashpoint lately. Some groups want to prohibit hydrocarbon investments entirely (despite the awkward fact that oil riches created the fund). The ban on investments in companies with any involvement in nuclear weapon production mean that European giants like Airbus and BAE are uninvestable, but NBIM still owns shares in more controversial US guns and ammo makers like Sturm Ruger and Vista Outdoor. That looks out of sync with the current zeitgeist.
Here’s a snapshot of some of the exclusions. You can find the full list here.
More generally, the kind of “responsible stewardship” and active ownership long advocated by NBIM has become less trendy these days.
It already became a minor scandal in Norway when Elon Musk clashed with Tangen after NBIM voted against his mammoth Tesla pay package. As the fund keeps growing, these conflicts will probably become larger and more frequent. For some investors, NBIM’s approach might be exactly what they want; others might prefer a more passive ownership approach to go with the passive investment strategy.
Moreover, if NBIM-Public were successful, it would transform an already huge fund into a behemoth, and dramatically increase NBIM’s already sizeable boardroom influence.
To some Norwegians this might be part of the attraction — leveraging already-existing investment infrastructure to subtly increase the country’s soft power projection — but as a rule of thumb it’s probably healthier for the financial system to have a diversity of distinct pools of capital with differing investment and governance styles, rather than a narrowing club of titanic ones.
For NBIM itself, adding a broader range of clients could also be a distraction from its core job. Tangen, a former hedge fund manager, has often joked about how nice it is to just have one client to care about (the Norwegian finance ministry). Adding a listed fund of some kind would add all sorts of diversions.
Moreover, the Norwegian parliament — which would need to bless the decision — is not prone to make big ambitious moves, and has a lot of other more pressing things to deal with. So it will probably never happen.
Still, Alphaville has now wrung more than 2,000 words out of this flight of fancy, so that’s something at least. And who knows what the future holds? A listed NBIM fund arguably makes more sense than venturing into private equity.