In Depth

Norway’s Sovereign Wealth Fund Bullish On Small Money Managers

Apr 1 2011 | 7:13pm ET

As Norway’s Government Pension Fund Global has grown, so have the in-house management capabilities of its manager, Norges Bank Investment Management, which administers the fund on behalf of the Norwegian Finance Ministry.

“When it comes to external management,” Dag Dyrdal, NBIM’s chief strategic relations officer, told FINalternatives, “there’s…been an evolving and maturing process on the equities side. So, it started off as [a] very high percentage, more or less all of it, managed externally,” but by the end of 2010, “less than 10% of the fund was managed externally.”

In an ordinary fund, a 10% allocation might not pique the interest of too many investment managers, but Norway’s Government Pension Fund Global is not ordinary—with total assets somewhere just north of US$500 billion, it is the second largest sovereign wealth fund in the world, smaller only than the Abu Dhabi Investment Authority (US$627 billion). As for the value of that 10% allocation, well, you do the math.

Dyrdal says that while the nominal amount managed by external managers may increase as the fund grows, the percentage entrusted to those outside the fund is likely to remain the same or even decline over time.

“When it started in ’96 it was entirely fixed income,” says Dyrdal of the fund, “government bonds initially.”

In 1998, the fund received its first mandate to invest in equities (40%) and in 2007 this was increased to 60%. Last year, its investment universe was expanded again to include real estate and the fund was authorized to allocate up to 5% to this asset class, putting the new breakdown at 60% equities, 35% fixed income, 5% real estate.

Initially, Dyrdal says, the fund looked to external managers for both fixed income and equity investments, but, as NBIM’s 2010 Annual Report acknowledges, this strategy proved more effective in the equities space:

“Experience with external fixed-income mandates has been much less positive than on the equity side and the fund’s external fixed-income management has now been largely phased out…The fund scaled back its externally managed fixed-income mandates from 128 billion kroner (US$23 billion) in 2007 to 25 billion kroner (US$4.5 billion) in 2010. The remaining fixed-income mandates were retained and contributed a return of 5.8 billion kroner (US$1 billion) 2010.”

On the equities side, as of 2010, says Dyrdal, the fund “had around 60 mandates in equities which are mostly highly specialized mandates falling into two categories:…emerging markets, where we mostly allocate single-market mandates and particular sectors, industries.”

“In both cases these are typically areas where we don’t see that we currently are in a position to build up sufficient closeness to the market or skills internally to cover them. It’s also typically in areas where we see good opportunity for alpha return, so all our external mandates are targeted with an alpha return.”

Healthcare, Technology, Renewable Energy  

In terms of emerging markets, the Norwegian Government Pension Fund Global has invested in Poland, Russia, Turkey, China, India, Indonesia, Malaysia, Thailand, Brazil and South Africa. As for sectors and industries, the 2010 Annual Report cites healthcare as the most important:

“Here,” says the report, “managers look for companies at the cutting edge of developments and many of the investments are in small companies in biotechnology or technical equipment. Our external healthcare managers are currently heavily invested in companies developing new medicines for cancer, which requires considerable expertise in medical research.”

The fund is also interested in technology for renewable energy and water management, which also represents an opportunity for external managers:

“Although we are building internal expertise in this area, we also need the skills of external managers,” states the report. “We need to know what we are investing in and we need insight and expertise to find the right companies.”

Winning A Mandate: Size Doesn’t Matter

So what does it take to win one of these mandates from the world’s second-largest sovereign wealth fund?

Says Dyrdal, “For the emerging market mandates, it’s a requirement for [managers] to have local expertise, presence on the ground. We currently only have five offices outside of Oslo—we’re located in London, New York, Singapore and Shanghai—and [we’re invested in], I think it’s more than 60 countries, so clearly there are areas, particularly in the emerging markets, where we rely on local managers for the active equity positions.”

Surprisingly, perhaps, size is not a factor. Dyrdal says many of their external managers are “quite small.”

“[They] can be boutique managers as well,” he says, “Probably more of the new managers who’ve come on board over the last couple of years are in that category rather than the big, general asset managers, because of the requirement for specialization.”

Historical performance does not necessarily carry a huge amount of weight. Dyrdal says NBIM is more concerned with meeting managers on their own turf to “get a good feel for the people in the organization, for the competencies, for the culture.” And as they are looking for specialists, he says, it’s important the firms have “strategies in place similar to what we’re looking for.”

NBIM does not invest in funds, per se, so managers must be able to provide and support segregated accounts. Drydal says this setup also helps them achieve another of their goals—transparency. “They are trading in our name and that basically gives us a different level of control,” he says. “Transparency is protected through the segregated accounts which give us ongoing, real-time access to the positions.”

In addition, NBIM considers a potential manager’s business practices. “That’s definitely important for us,” says Dyrdal, “we do emphasize the governance structure of the firms.” It’s for that reason, he says, that they “travel a lot and meet with these candidates at their offices in order to get a good understanding and assurance that they have good routines and procedures in place.”

According to the 2010 Annual Report, the process Dyrdal described can take from six to eight months from NBIM’s initial meeting with a manager to the decision to award a mandate.

Market Clout

Institutional investors are seen as the future for hedge funds, but negotiating fees with a $500 billion entity like the Norwegian Government Pension Fund Global is not for the faint of heart. The fund acknowledges its own clout in its 2010 annual report, where it states:

“Management agreements are entered into with the aim of keeping total fees as low as possible, given the objective of an excess return. How far NBIM is willing to stretch when negotiating fees depends on an assessment of the manager’s ability to generate excess return over time. As a large, recognized long-term investor, NBIM normally has a strong hand when negotiating with external managers.”

That said, however, NBIM then goes on to acknowledge that “Competition for many managers’ capacity is fierce…and not all managers are willing to accept NBIM’s terms.”

The fund manager acknowledges having paid “substantial” fees to external managers in past years, including 2009, when it paid its two highest annual fees ever, 530 million kroner (US$94 million) and 170 million kroner (US$30 million). Following these payments, the fund introduced a ceiling for annual fees in all external management agreements. According to the 2010 annual report, “Any fee accrued above this ceiling may be paid out at a later date, but only if the mandate retains a positive excess return since inception.”

The Future

Asked if he could imagine NBIM venturing into additional asset classes, Dyrdal said he felt private equity and infrastructure represented opportunities waiting to be tapped.

“As an advisor to the Ministry we did suggest including those asset classes in 2006,” he said, “…which was the same time we advised on going into real estate and you know, it’s still on the agenda, it’s still being discussed, it’s not like it’s a definite no…but I don’t think it’s going to happen short term.”

The sheer size of the fund, according to Dyrdal, means the lead time for major changes in strategy is “a couple of years.”

“In real estate, the advice was given in 2006, the decision in principle was taken in 2007, and we had a mandate to start investing in 2010. But the challenge is, of course, that the bigger the fund gets the bigger the threshold is to enter [an] asset class where you do not have prior experience, in terms of building up the internal competencies and skills... But certainly, as the manager of the fund, we have been positive [about] adding further asset classes.”


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