The country's economy has been insulated from the worst of the downturn but stability and long-term security remains central to pension fund investment strategy, borne out by a preference for income and an emphasis on alignment, as Gail Moss reports

One of Norway's most famous pieces of music - Morning, from Edvard Grieg's Peer Gynt suite - might well have been written to describe the country's pension fund investors waking up again to new investing potential, as the financial climate stabilises.

"Norwegian pension funds have moved into a more active mode," says Caspar Holter, partner, Pensjon & Finans. "After the fatigue of the crisis over the past two years, they are doing much more than they were at this time last year - reshuffling asset allocation and reviewing managers."

This new-found enthusiasm also includes property investing.

"The current allocation across the board is about 6%, but there's room to increase it substantially," says Holter. "We've seen a growing interest in real estate, especially with the launch of a couple of new funds - Storebrand Eiendom AS and Aberdeen Norge Eiendomsfond Norge III ANS. Furthermore, although prices haven't increased very much in the domestic commercial property market, there seems to be a growing interest - there have been deals in the pipeline this year, and we expect the last month of the year to be good."

Direct investing on the whole tends to be more for the four or five biggest pension funds, although many own a single building, often their own headquarters. Det Norske Veritas, for instance, owns an office block making up 7% of its total assets as a long-term hold.

Norway's largest fund, the Government Pension Fund, is now legally entitled to invest up to 5% in real estate. Norges Bank Investment Management has now made its first real estate investment on behalf of the fund with a 25% stake in the Crown Estate's Regent Street Portfolio.

But Holter says that while the small and medium-sized pension funds have not been active in the property sector, they have now started to invest.

However, the Norwegians are still placing a high priority on safety, according to Mark Meiklejon, investment director, Standard Life Investments.

"The key thing in the last 12 months is that investors are focusing on the core end of the market in terms of risk appetite," says Meiklejon. "People are looking mainly for income-producing assets."

One of the main factors behind this is the scarcity of income from traditional sources, says Meiklejon.

"Scandinavian domestic interest rate and Euribor products are still not generating much return," he says. "Corporate bonds are looking relatively expensive, while gilts are also relatively expensive and low-yielding in Scandinavia." 

The need for income is heightened by the fact that Norwegian pension funds are required to show an annual return of over 3%. 

However, pension fund investors are no longer primarily seeking capital appreciation from properties, says Meiklejon: "Although in the past two years, some of the bigger investors have seen opportunities to buy good-quality assets cheaply." 

Oslo Pensjonsforsikring (OPF), the local authority pension fund, invests primarily in Norway, but has some direct investments in Finland and holdings in funds in Europe.
In terms of risk, it looks for core and core-plus products, and it is currently getting 7% unleveraged returns from its real estate portfolio.

"We find that there is an element of duration in real estate with long leases, and this makes sense as a good hedge to our long-term pension liabilities," says Kjetil Haug, chief investment officer of OPF. "Moreover, real estate offers an attractive risk premium, and supports a steady cash flow that matches our annual return guarantees well. Finally, we find real estate a reasonably good diversifier during ‘normal' market cycles."

Frode Asenden, managing director of Storebrand Eiendom AS, says: "In terms of direct investments, the main focus at the moment is properties with long leases - say 10 or 20 years." Storebrand Eiendom AS has completed some large deals in the past few months, including four logistics properties, with average leases of around 18 years, totalling NOK1.45bn (€0.17bn).

"The specific industry sector is not as important as the length of the lease," he says.
Norway, of course, has not had as bad a recession as most other European countries, and while GDP fell by 1.5% in 2009, the OECD is predicting growth of 1.2% for 2010 and 2% for 2011, with unemployment peaking at under 4%.

Unsurprisingly, therefore, office properties are enjoying relatively low vacancy rates.
"Oslo, the largest market in Norway, is seeing vacancy rates of 6-7%, and a large part of that is in buildings which are not suitable as offices and will probably be refurbished or redeveloped," says Asenden. "The yield for investing direct is around 6-6.5% for the most interesting investment properties."

Traditionally, Norwegian pension funds have started with a core direct allocation in the domestic market, and possibly other Nordic countries, then diversified farther afield via comingled funds.

Albert Yang, director of institutional business, property, Henderson Global Investors, says: "They are continuing to look for core returns from Europe but there has been a recent uptick in interest in our US products. They are looking at the US for value returns, and then Asia if they want extra growth. In the second half of this year, there has definitely been some window shopping internationally."

However, one trend the financial crisis has provoked is that Norwegian pension funds are tightening their selection criteria for managers, as are those in other Nordic countries.

"We spend a lot more time than before doing due diligence," says Yang. "The number of corporate governance questions has increased and there is an increase in interest in sustainability."

He says that alignment is a key part of the requirements for fund managers and that many investors are now contracting for performance fees to be paid on realised gains, rather than valuations.

"Generally, smaller managers were more leveraged than the bigger ones in the last downturn, so pension funds have been more reluctant to establish new relationships with them," says Meiklejon. "Instead, they are strengthening their existing relationships with core managers. But it is very difficult generally at this point in the cycle to establish new relationships." 

And seeding is also an important issue. 

"A year ago, investors were looking for blind funds looking to buy up distressed properties," says Meiklejon. "Now they prefer fully seeded funds, established funds with an established income stream. The bulk of pension schemes have been bruised from their allocations to high-risk holdings." 

A further potential brake on investing has been the EU's Alternative Investments Fund Management directive, with some pension funds waiting for the definitive version to arrive before committing to more spending.

But in spite of the more cautious attitude of pension fund investors, Holter expects the current renewal in activity to continue.

"Pension funds will continue to invest as long as there are problems in the bond market," he says. "More investors are showing up, and prices will rise during the next year or so because of demand."