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"This is a way of getting more diversification"
Martin Skancke |
July 2008
News that Norway’s $395 billion Government Pension Fund (Global) will for the first time make a separate asset allocation to a global real estate mandate has the market giddy with expectation. Although there has been much discussion of sovereign wealth funds moving into or increasing their allocation to real estate, the Norwegians could be the largest among newcomers to the asset class. Founded in 1996 as the Petroleum Fund, the fund aims to manage Norway’s petroleum wealth in a sustainable manner. By stashing away large parts of its petroleum revenues the sovereign believes it will be better prepared to meet challenges related to rising pension and healthcare costs. In the beginning, the fund focused almost exclusively on fixed-income investments, adding equities to the mix in 1998. The fund also invests in money market instruments and derivatives. It is managed by Norges Bank – Norway’s central bank.
Ten years after moving into equities, the fund will start making real estate investments as a discrete asset allocation. Based on the recommendations of Norges Bank and the Strategy Council, as well as its own analyses, the finance ministry envisages that up to 5% of the capital of the fund might be invested in real estate, which would be offset by a reduced allocation to fixed-income investments. This move into real estate is the Government Pension Fund’s first step into so-called alternative assets. And in addition to its internal review and analysis, the fund consulted with many other large investors, pension funds and sovereign wealth funds to learn from their experiences.
"We’re very much a global investor and it’s natural for us to look at diversification gains in new asset classes, and real estate is a natural way to expand," says Martin Skancke, head of asset management at Norway’s finance ministry. "Also, in the longer term it can contribute to us as a hedge against inflation. Part of the long-term goal of our investment strategy is to protect the international purchasing power of the fund, so it makes sense for us to move gradually in the direction of real investments and less nominal investments."
Although the fund will reduce allocations to fixed income in favour of real assets, because the fund is growing so rapidly there will be no reduction in the size of the fixed-income portfolio. .
At the fund, strategy work is done on a long-term basis as the investment horizon of the fund is, in principle, indefinite. The fund is only 10 years old and there has been a gradual increase in both the scope of the benchmark and the investment universe including investment instruments, explains Skancke. Over the past few years, the priority was to increase risk and expected return by increasing the equity portion of the portfolio from 40% to 60%.
"Now is the time to try to optimize the portfolio by diversifying even more or trying to get an improved risk/return ratio within the same risk levels we have," says Skancke.
According to Skancke, there is a relatively wide remit within the fund to put on complex trading strategies in fixed income, for example, to generate outperformance and gain diversification that way.
"This is a way of getting more diversification," says Skancke. "Recent developments in the credit markets show that even though many instruments may give you diversification in more normal market conditions, things tend to get more correlated when times are bad. It makes sense to look at the third-largest asset class after equity and fixed income for a fund of our size and with the investment strategy it’s a great way to diversification benefits."
The first real estate investments are yet to be made and the fund is looking at all its options. "There is a continuum of real estate investment and it’s too early to say where we will be on that spectrum," says Skancke. "We need to build up the real estate practice." While Paul Golding, former head of European Property at Merrill Lynch has been hired as part of the fledgling real estate effort at the fund, requests for proposals have not gone out yet. Specific investment approaches will likely be tailored to the market the fund is entering. Skancke foresees the fund using a mix of funds, internally managed portfolios and potentially joint ventures with developers or asset managers.
"There are pros and cons of all approaches," he says. "For example, using funds you can quickly get a broad exposure but the fee structures of many funds make that not so attractive for a large fund that has the capacity to do more in house."
Looking at the fund’s experience in fixed income and equities, which tends to go for in-house management as well as outsourced specialised mandates, it is likely it will follow the same route with real estate. Here again, cost structure and diversification benefits will be crucial. Joint ventures are also a possibility but Skancke emphasizes that the operational risk issues involved in joining such partners would have to be explored fully.
When it comes to the amount of attention sovereign funds have garnered over the past six to eight months, Skancke is bemused. The funds have attracted attention because many have deep pockets and a lot of patience, giving them the capability to go into distressed assets. All that has been a good and stabilizing thing for financial markets but Skancke reckons the attention has been overdone.
"The media attention to sovereign wealth funds over the past few months has been way out of proportion," he says. "Related to the size and share they have in the markets they are really not big players if you look at the total size of the world financial markets. So the impact and influence has been overstated."