World's Biggest Wealth Fund Faces Tighter Reins at $1 Trillion

  • Fund’s proposal to shift out bond index is being questioned
  • Government looking at proposal for new board at wealth fund

Norway's central bank headquarters in Oslo.

Photographer: Kristian Helgesen/Bloomberg

After hitting the $1 trillion milestone this month, the Norwegian wealth fund can expect even more scrutiny going forward.

The government is currently looking at a proposal from a committee led by a former central bank governor to separate out the fund from Norges Bank. This idea is now being seized on as a means to tighten oversight, with more people arguing that the fund has grown too large and complex to handle for the central bank, which is stocked with economists but lacks expertise in overseeing investments.

“With a separate board you’ll be able to appoint professional people who really understand asset management, and who can have the necessary critical attitude toward the fund’s management,” said Knut Anton Mork, a professor at the Norwegian University of Science and Technology.

The issue got added attention this month when the fund proposed a plan to dump the bond index it follows. Top economists and academics in Norway say the move raises concerns the managers of the fund are asking for too much free rein in how to oversee the wealth of future generations of Norwegians.

The fund proposed a plan to change the index for its $330 billion bond portfolio, reducing its 23 currencies to three -- dollars, euros and pounds -- and dumping corporate bonds. It said it doesn’t make sense to take currency risk amid converging global bond yields and only wants the most liquid bonds. Corporate debt is unnecessary risk, it argues, after getting permission to raise its stock holdings to 70 percent of its portfolio.

Read more on the fund’s plans here

But the fund at the same time said that it should be allowed to invest in the same bond universe as now. This raises questions about its motives, according to key observers. It could potentially mean that it will be easier for the fund to beat the index, and impress its owners, by placing bets in bonds that are outside the benchmark.

“The managers of the fund seem to want to replace the strategic benchmark index with a reference portfolio where the managers themselves will have broad flexibility in how to implement it,” said Espen Henriksen, an associate professor at the Norwegian Business School who was a senior economist at the fund from 2010 to 2012. “This would be a clear break with a key tenet of the highly successful Norwegian asset management model.”

Mork said the letter laying out the plan to the ministry “could be interpreted as a way to take on more risk, and maybe to do so without being noticed by politicians.”

Tight Rules

The fund is managed by Norges Bank Investment Management, which is a unit of the central bank. It’s tightly regulated by the Finance Ministry, which has set ethical guidelines and prohibited direct investments in infrastructure and private equity. The government also decided on the indexes it must follow. While it largely sticks to the indexes, the fund has leeway to make active bets. Its return can only deviate by more 1.25 percentage points from the index it follows in one of every three years.

The Finance Ministry is now considering the fund’s bond proposal, which could have broad-ranging effects on the world’s fixed-income markets. The letter was sent after a request from the Finance Ministry, and the fund will now follow the normal process, said Thomas Sevang, the fund’s spokesman. The fund declined to comment further.

Mork and Henriksen’s words carry weight. They both served on a government-appointed committee that last year advised that the fund be allowed to boost its equity share to 70 percent from 60 percent. Mork, who was chairman, dissented from his own group and argued that the stock portfolio shouldn’t be increased. The government gave the go-ahead for the changes earlier this year amid a bid to boost returns.

The Universe

Henriksen said that NBIM “deserves praise” for raising the question for the need to own corporate bonds because of their close relation to stocks. But if its analysis shows that the debt is redundant it should have been consistent and advised the Finance Ministry “to remove corporate bonds from the investment universe,” he said. “We shouldn’t separate the strategic benchmark index, which reflects the request from the owners, and the portfolio that managers at NBIM are actually investing in on behalf of the owners.”

Read more on the debate over fund oversight here

Mork questioned the fund’s stated need for added liquidity. It has cash flowing back in from interest, dividend and real estate of about 200 billion kroner a year, far exceeding government withdrawals to cover budget needs.

“What sticks is that this is one in a string of proposals to the ministry from the fund and the central bank’s board where they each time argue how it will improve performance,” said Mork. “But for us on the outside it’s natural to ask what the real motive behind this is.”

Mork said it’s “clear” there’s a principal and agent situation, with an agent that has all the incentive in the world to show they are smart managers.

“To have the liberty to take their own bets will always be appealing to them,” Mork said. “They have a mandate, now they’re trying to push this even further.”

— With assistance by Mikael Holter

    Before it's here, it's on the Bloomberg Terminal.