Before last week, average Americans knew (roughly) three things about Norway:
- it’s cold there
- there’s oil there
- the women are blonde
On Thursday, everyone learned a fourth “fact” about the country: it’s not a “shithole.” Or at least not yet.
But depending on how you define your “shitholes”, it might end up checking at least one box if the country’s mammoth sovereign wealth fund continues to pursue an asset allocation strategy that’s more appropriate for a twenty-something bartender investing her first $10,000 than it is for a $1 trillion rainy day cash pile earmarked for ensuring the financial well-being of future generations.
For those unfamiliar, Norway’s SWF (which invests the country’s oil wealth) is the largest on the planet with more than $1 trillion in AUM. In 2016, the country withdrew money from the fund for the first time ever in an effort to plug a budget gap amid a downturn in crude prices.
Norway has steadily sought to increase the fund’s allocation to equities in an effort to boost returns. They’re aiming to get that allocation to a whopping 70%. As of September 30, it sat at roughly 66%. To put this in perspective, Norway’s SWF owns more than 1% of global equities. As FT put it back in October, “the oil fund owns on average 1.5% of every listed company in the world”.
They take an activist approach to these investments which, when coupled with everything said above about how the assets are allocated, basically means this is just a giant, public, long-only, activist stock fund where the bond allocation is just there to hedge the equity exposure. And if you think I’m exaggerating, here’s what CEO Yngve Slyngstad said following the release of the fund’s Q3 performance numbers:
60 to 70 percent in equities — imagine it was 60 to 80 or 90 percent — the whole thing is that this fund is actually to a large extent now a public equity fund. We don’t think about this as two separate asset classes that have their distinct dynamics, the real risk of the fund is in the equity market.
Yes, “the real risk of the fund is in the equity market.” Funny how that happens when you allocate 70% to stocks.
The problem with this is painfully obvious. Assuming withdrawals become more commonplace (and you’d be forgiven for assuming that Norway opened something of a Pandora’s box in 2016 when they started tapping the fund) this has the potential to make fiscal policy beholden to the vagaries of the global equity market. Here’s what Deputy Norges Bank governor Egil Matsen said last year:
Say you have a decline in the equity market, and these returns have been partly funding the government, do you want variations in international financial markets to have a direct impact on fiscal policy?
I can answer that: “no”.
And especially not when, by virtue of the fact that you own 1% of the market, your own actions could end up making things worse if you were trying to get out during a steep correction.
Ok, so guess what Norway wants to do now? Well, I’ll tell you. Or actually no, Bloomberg will tell you. To wit, from a piece out late last week:
Norway's sovereign wealth fund wants approval to invest some of its $1 trillion of assets in unlisted companies.
So basically, they’ve grown bored with the “meager” returns they’re generating in large part thanks to their massive equity portfolio (which returned 4.3% in Q3) so now, they want to go into private equity. Here’s what the fund said in a letter to the Finance Ministry last week with regard to the proposed push into the space:
[This would] enable the fund to be invested in different types of companies to those that are available in the public equity market. Based on historical data, investing in unlisted equities can also be expected to generate a slightly higher return after costs than listed equity investments.
Right - “based on historical data” and as the old adage goes, “past performance is everywhere and always indicative of future results.”
To be clear, this is hardly uncharted territory for sovereign wealth funds. That is, it’s not unusual for SWFs to allocate to private equity. In fact, according to a study Norway had commissioned in order to justify this move, McKinsey notes that “the median public pension fund is 100 basis points below its target allocation to PE, and the median sovereign wealth fund is 420 basis points underweight.” It would appear then, that there’s a dearth of opportunities, a contention that’s supported by Bloomberg’s Mark Gilbert in the piece linked above.
Just to underscore the points Gilbert makes in his piece, why in God’s name would they bother with this? There’s no way the allocation to private equity is going to be large enough to move the needle on a portfolio that’s as large as Norway’s is, so the upside is limited while the downside is that losses could end up rubbing salt in your wounds were they to materialize during a period of broad-based weakness in global equities.
Furthermore, Norway recently decided to liquidate its oil and gas equity holdings in what, ostensibly, is a move to designed to avoid being effectively long oil with leverage (i.e. buying oil stocks with money you made from selling oil). There’s a sense in which going into private equity would amount to taking the proceeds from the sale of O&G equity holdings and funneling them into unlisted stocks. I’m not sure that counts as “derisking”.
Ultimately, this is just the same damn story that’s playing out all over the world; everyone is trying to justify a decision to move into riskier and riskier assets in an ongoing quest to juice returns.
On the bright side for Norway’s populace, if that increasingly risky SWF ever suffers a massive drawdown courtesy of a global equity rout and the concurrent fiscal crisis forces the government to figure out how to stimulate the economy without tapping a piggy bank that just took a massive haircut, disaffected citizens can always just pack up and move to America. Because as Trump made clear last week, his administration is more than happy to increase America’s allocation to Norwegians if it means paring back exposure or going outright short Haitians.