The Norway Model: Lessons for Private Wealth Management
What can wealthy private investors and their financial advisers learn from a largely unknown but gigantic Norwegian sovereign wealth fund? Quite a lot, it turns out. According to “Yale Versus Norway,” a white paper published in September by Greycourt, an independent investment adviser serving wealthy families and select institutions, there are characteristics of the Government Pension Fund Global, as the Norwegian fund is officially known, that make it “simpatico” with family investors. While the paper ostensibly compares the management styles of the famed Yale endowment with Norway’s sovereign wealth fund, a good chunk of the paper is devoted to how high-net-worth families can adapt many of the investing principles of the “Norway model.”
But first, some background. Norway’s giant fund is the largest sovereign wealth fund in the world, with $580 billion in assets as of the middle of 2011. Gregory Curtis, chairman of Greycourt and author of the paper, points out that, despite the name, the fund has no pension liabilities and isn’t funded by corporate or public pension contributions. Instead, it is funded by oil profits, and withdrawals from the fund are paid into the state treasury. The fund is, to quote another recent paper by a trio of researchers, “highly rated for its professional, low-cost, transparent, and socially responsible approach to asset management.” As a result, the authors added: “Investment professionals increasingly refer to Norway as a model for managing financial assets.”
Norway’s sovereign wealth fund is overseen by Yngve Slyngstad, chief executive of Norges Bank Investment Management, and its investment track record is “quite good,” Curtis says, adding: “It’s only a modest exaggeration to say that the NGPF [Norway Government Pension Fund] is the ‘anti-Yale’ in its investment approach.” (David Swensen, head of Yale University’s endowment fund, which managed $19.4 billion as of September 2011, needs little introduction.)
Greycourt’s Curtis, who served for many years as president of a family office for the Mellons and served as president of the Laurel Foundation, lists several ways in which the Norway model differs from the Yale model. For example, the fund follows “a team approach in which the staff operates by consensus and the investments are closely supervised by an Advisory Council, a Strategy Council, and even a Council of Ethics,” Curtis writes. The real take-away for financial advisers is how all of this applies to wealthy family investors. Curtis acknowledges that not everything about the fund’s approach is applicable, but he argues that “the implications are nonetheless significant.” His main points are as follows:
- Core beliefs. The Norway fund believes that (a) markets are largely efficient, (b) diversification is an important risk control, (c) the equity risk premium will be the main source of returns, (d) the fund should be managed to a specific benchmark, (e) external managers are important, and (f) the fund should be managed with reference to socially responsible criteria. Except perhaps for the last of these core beliefs, most families would agree with the NGPF, Curtis asserts.
- Size matters (or maybe not). Investors are usually divided into institutional players and retail investors. Wealthy families fall between these two extremes. As a result, some of the advantages of size also accrue to wealthy families, assuming the family is experienced enough and well-organized enough to take advantage of its size. For example, assuming a reasonable level of spending, many wealthy families are deploying vastly more capital than will ever be needed by living generations, and hence have very long investment time horizons, much like the NGPF.
- Is it possible to sustain a long-term view? Many investors — colleges and universities, for example — have investment lifetimes that are, for all practical purposes, infinite. The problem, as the NGPF has discovered, is that a long-term outlook can become awkwardly short term when the markets crash. Families, of course, face the same problem, writes Curtis.
- Diversification. This is a core value at NGPF, but it’s a value that has been slow in coming and still has a ways to go. The lessons for families: first, it’s better to build a diversified portfolio from the beginning, says Curtis, and second, if you are going to make major portfolio changes either make them slowly over time or make them in a counter-cyclical way.
- Avoiding inadvertent indexation. When you are investing almost $600 billion, one of the great dangers is that you will end up owning everything in the market. The NGPF, for example, owns about 1% of every listed company in the world. For them, indexing is an intentional, probably unavoidable strategy. While families aren’t nearly so large, many family portfolios are so overly diversified and include so many managers that, when you really drill down, what you find is a big and expensive index fund. If a family investor really has so little conviction in its active managers that it’s unwilling to concentrate among a few of them, it would be a lot cheaper just to buy a real index fund.
- Costs matter. The NGPF is intensely focused on keeping costs down. This is every bit as important for family investors.
- But costs aren’t everything. Possibly in its zeal to keep costs down, the NGPF has largely ignored a potential source of excess return: active management. Wealthy families — at least those with a sophisticated in-house investment staff or those employing outside advisers — are in a position to exploit the benefits of active management, especially in less efficient sectors of the market.
- Risk premia. The NGPF has assumed as part of its core beliefs that the equity risk premium will represent the major source of return for the fund. But this focus ignores other forms of risk premia that might be available to the NGPF. For example, the fund should be able to exploit the value and liquidity premia, and possibly the size premium. Unlike the NGPF, with its focused-premium approach, family investors should be able to take advantage of multiple risk premia, Curtis says.
- Transparency. The Norwegian Ministry of Finance states, in a report to parliament, that “transparency is a prerequisite for securing widespread confidence in the management of the Government Pension Fund. The risk which is assumed in management activities must be presented properly.” Family constituencies differ from those of the NGPF but need to be recognized and addressed.
- Socially responsible investing. Environmental, social, and governance (ESG) factors are very important to the NGPF. Evidence about the effectiveness or ineffectiveness of these factors in investment portfolios is contradictory, Curtis writes, but if a substantial portion of a family wants ESG factors to be considered for use in its portfolio, while other family members want them excluded, there is clearly a problem that needs to be addressed.
- Goals-based investing. Maybe the most important aspect of the NGPF is how rigorously it has been designed for the goals it was established to meet. Its mandate is to maximize purchasing power (on an international basis) subject to risk levels that are acceptable to the fund’s managers and, most important of all, to the people of Norway. NGPF’s performance has been excellent in pursuit of the goals it set out to meet. This is often a difficult lesson for families to learn, Curtis contends, but it is a crucially important one.
Prior to the global financial crisis, emulating Yale had become a fashionable family wealth strategy. Yet families and their financial advisers would do well to look elsewhere for inspiration. As Curtis concludes in the Greycourt paper, “the Norway Model seems to speak much more directly to families and, equally important, seems to be implementable by all but the smallest family investors.”
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