The $1.3tn contrarian wealth fund

Norway’s $1.3tn sovereign wealth fund has unveiled a new strategy. Given its measurement — it famously owns a median 1.5 per cent of each listed firm on the earth — it’s value a better look.

A number of the headline changes had been trailed by chief government Nicolai Tangen at an FT convention on Wednesday, a day earlier than the formal technique plan was launched:

The world’s largest sovereign wealth fund will grow to be a extra vocal shareholder and plans to vote towards firms that fail to set a internet zero emissions goal, overpay their high leaders, or wouldn’t have sufficiently numerous boards.

Some background: Norges Bank Investment Management is formally housed contained in the central financial institution, its cash comes from Norway’s oil and fuel revenues, its funding mandate is formulated by the finance ministry and authorized by parliament.

Additionally some disclosure: the creator of this put up is Norwegian [but you never mention it — Ed], lives in Oslo, and has given speeches to the fund actually speaking his book (one free, and one the place the charge was instantly donated to UNICEF by NBIM).

The governance stuff is of course what’s going to generate essentially the most warmth. ESG is struggling a little bit of a backlash in the intervening time (FTAV is a bit sceptical as nicely), however given Norwegian politics the sovereign wealth fund can not assist however be seen to be on the vanguard of the problem. NBIM was excluding firms on moral grounds lengthy earlier than ESG was even a glimmer within the eyes of asset-management advertising administrators.

However most attention-grabbing (to us) titbit hinted at by Tangen on Wednesday was that NBIM may take higher benefit of its long-term funding perspective and restricted liquidity must “be more contrarian”. (Lately it’s getting tougher to search out anybody who received’t describe themselves as a contrarian.)

However how? In spite of everything, its mandate doesn’t go away a lot room for flexibility.

About 70 per cent of NBIM’s cash is in equities, and roughly 30 per cent in fastened earnings. It’s step by step increase an actual property portfolio that may in time account for 3–7 per cent of the fund’s belongings (in 2020 NBIM was additionally allowed to speculate as much as 2 per cent in renewable infrastructure tasks). The overwhelming majority of the sovereign wealth fund’s cash is just about passive.

However Tangen is a former hedge fund manager, and it is sensible that he desires to be extra than simply the world’s largest beta monkey. And NBIM apparently now thinks that it may be smarter and extra tactical throughout the straitjacket of its funding mandate.

Right here’s the highest stage little bit of the strategy report fleshing out a bit what Tangen was hinting at:

Central to the administration mandate is the benchmark index consisting of 70 % equities and 30 % fastened earnings. We handle the fund near this index. Nonetheless, we imagine some funding alternatives diversify the fund past the reference index, notably unlisted belongings. All our funding processes have energetic parts. This improves our capability to realize the best attainable return and to be a accountable proprietor.

We benefit from the fund’s lengthy horizon and restricted short-term liquidity wants after we make investments. We are able to face up to giant fluctuations within the fund’s worth and make investments whose underlying worth could take a very long time to grasp. Our lengthy horizon permits us to behave in a different way from different buyers in tough and illiquid markets. We imagine that essentially the most worthwhile funding alternatives come up in risky markets…

…On this technique interval we are going to strengthen our long-term mindset, be affected person, and differ energetic threat as market circumstances change. This permits us to benefit from the perfect alternatives after they come up. Variations in asset costs will be associated to behavioural components or leverage inflicting procyclicality. Lengthy-term buyers are well-positioned to benefit from such variations. We are going to search to purchase when others wish to promote and promote when others wish to purchase.

A few of this kinda is sensible. The Norwegian authorities is meant to solely spend roughly the three per cent long-term actual return of the fund yearly (initially 4 per cent), so NBIM can take a really totally different perspective from even different supposedly long-term buyers like pension plans.

Efforts to minimise the prices and maximising the benefits of scale are due to this fact pure. For instance, in equities NBIM says it desires to speculate extra in automation, increase collaboration between merchants and portfolio managers to enhance execution, and be extra opportunistic and aggressive in share lending and conditions like IPOs and rights points.

Our measurement makes us a gorgeous accomplice in capital market occasions. Traders who’re passive in such occasions could threat much less allocation than desired. To scale back the probability of this, we work actively with facilitators and firms contemplating such transactions. A big, secure capital base and the perfect credit score standing additionally make us a gorgeous accomplice for securities lending. The fund’s traits allow us to realize larger earnings on securities lending than the common investor.

Wonderful wonderful wonderful. That is an apparent space the place NBIM can most likely sweat a number of extra foundation factors of efficiency out of its portfolio. And even a number of foundation factors provides up in absolute nominal greenback phrases whenever you handle a whopping $1.3tn.

However we get a bit extra nervous after we see the extra concrete ways in which Tangen desires the sovereign wealth fund to be extra “contrarian”:

  • “We are going to take sector threat when risk-reward is especially engaging and use our specialist data to establish traits that make us count on larger long-term returns in some sectors than others.”

  • “We are going to develop our forensic accounting and behavioural evaluation to scale back publicity to firms we count on to underperform.”

  • “We are going to establish high quality firms and take barely bigger stakes when we have now motive to imagine they may outperform.”

  • “We are going to use exterior managers in segments and markets the place we imagine they may improve returns. In some markets, we additionally imagine exterior managers will cut back the danger of our investments by avoiding sure firms with problematic enterprise fashions and weak company governance.”

  • “We are going to pursue the chance to put money into firms earlier than they record (pre-IPO). This might give us entry to firms earlier within the firm life cycle and doubtlessly improve returns.”

In related vein, in fastened earnings NBIM plans to “put money into chosen segments exterior the benchmark to diversify the portfolio and harvest threat premia”, whereas the property division plans to us its capability to put money into each listed and personal belongings to “exploit durations of disruptions in actual property markets”. (CC: BREIT).

To encourage this shift NBIM plans to “promote psychological security in order that our portfolio managers dare to be contrarian and keep away from herd behaviour”, and extra actively tweak broader and sectoral allocation positions and risk-taking “as market circumstances change”. Mkay.

We’re not going to go as far as to say that this can be a former hedge fund supervisor hedge fundifying NBIM, despite the fact that it’s tempting.

The fund is simply too massive and the mandate too restrictive. These are simply tweaks across the edges. And admittedly a number of them make intuitive sense. Measurement and a virtually limitless funding horizon are large benefits if harnessed nicely.

For instance, one of many points with exploiting many funding components/threat premia is (if one believes of their existence within the first place) is that it’s VERY onerous to hold on when there are periodically lengthy and/or deep stretches of underperformance.

This isn’t only a foible of unusual yokel buyers. In observe, pension plans typically additionally wrestle to keep faith. Even true believers can ultimately throw in the towel — typically simply earlier than issues flip round. And as Tangen advised my colleague Richard Milne, NBIM has already made some canny strikes:

Final yr, we overweighted built-in power firms. When a number of buyers jumped up and down and advised everyone how proud they had been they’d no power publicity, that’s after we scooped a number of these positions. They don’t come about on a regular basis however generally varied sectors or firms are oversold or overbought.

We had the identical within the bond portfolio, the place a giant half had been buying and selling with unfavorable charges. The chance-return was actually skewed: you knew there have been limits for a way unfavorable the charges may go however there was no restrict for a way a lot it may go up. You generally have these actually skewed conditions. Traditionally we haven’t been ok at profiting from them.

Nonetheless, the tough actuality is that makes an attempt to time markets — whether or not it’s in cute tactical asset allocation shifts or sectoral tilts — is a fraught enterprise. Simply because it makes intuitive sense it doesn’t imply it is sensible in concept or in observe.

The educational proof means that market timing is hard. Even most practitioners agree that it should be avoided. In case you keep away from the worst of a sell-off you’ll be able to nonetheless lose out general by lacking the rebound, for instance. As Elroy Dimson, a finance professor on the London Enterprise College who led a earlier strategic assessment for NBIM a decade in the past, has bluntly put it:

…oftentimes, when individuals make a prediction, they get it incorrect. And the price, for instance, of attempting to keep away from the worst occasions or seize the perfect is that you just may get it fully incorrect. That merely will increase the danger, over the lengthy haul, of your funding portfolio.

Perhaps NBIM’s in-house “specialist data” will permit it to choose sectors and “high quality” firms higher than the broader market? Maybe its four-person group of forensic accountants will be capable to spot frauds faster than any auditor, brief vendor, monetary watchdog or journalist? Conceivably it may decide pre-IPO investments higher than all the opposite massive fund complexes that flooded this zone lately (and at the moment are ruing it)?

It appears a stretch although. Oftentimes, contrarian investing appears to be a flowery manner of claiming: “Will blame lengthy durations of underperformance on central banks and declare private credit score each time they take pleasure in six good months of returns”.

Tangen appears conscious that with these modifications he’s making a rod for his personal again although. As he advised Richard:

Dwelling in a world the place you put money into a contrarian manner, that’s a life with none buddies. It’s sort of the place I dwell. I’ve lived there my complete life.

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