Norway has bucked the trend and decided against moving its sovereign wealth fund into unlisted infrastructure. Rachel Fixsen investigates why 

Norway’s decision to keep unlisted infrastructure out of its sovereign wealth fund (SWF) has raised questions about the investment case for the asset class.

At the beginning of April, the Norwegian Ministry of Finance declared that it would not permit unlisted infrastructure investments in the SWF because the potential benefits were unclear. The Government Pension Fund consists of the former oil fund, the NOK7.47trn (€802bn) Government Pension Fund Global (GPFG), and the much smaller, domestically-orientated NOK198bn Government Pension Fund Norway (GPFN).

Having considered potential changes to the way the GPFG invests and consulted the fund’s manager Norges Bank Investment Management (NBIM) and three external experts, the ministry said it was “uncertain whether unlisted infrastructure improved risk diversification or raised expected returns”.

But it did decide to raise the fund’s real estate allocation ceiling to 7% from 5%, and to benchmark real estate performance in future against a portfolio of equities and bonds rather than continuing with the current situation, where a valuation-based index for unlisted real estate values is the return objective for property.

The change to benchmarking aligns the fund with other large institutional investors, such as Canada Pension Plan Investment Board and Singapore’s sovereign wealth fund GIC.

As for the GPFN, which had been hoping to build a real assets portfolio, the ministry said it saw “little rationale for the state in investing part of the GPFN in unlisted real estate and infrastructure to improve risk diversification”.

Stijn Van Nieuwerburgh, part of the three-member expert group, thinks the government is rightly cautious about including unlisted infrastructure investment in the SWF. “Most of the investment needs for infrastructure are in the developing world, and that’s also where most of the risks are,” he says.

Stijn Van Nieuwerburgh

In addition to saying that the advantages of investing in unlisted infrastructure were difficult to quantify, the finance ministry also highlighted the fact that the asset class makes up less than 1% of the global investable market. It also noted such investments were exposed to high regulatory and political risk, and that conflicts over regulation would generally be difficult to handle and could incur reputational risk for the fund.

Are the Norwegian government’s issues with infrastructure investment perhaps unique to SWF? Some of the issues cited are indeed unique to SWFs, Van Nieuwerburgh agrees. “If an oil pipeline leaked in some other country, would Norway have to pay for the clean up?” he asks.

Independent consultant Georg Inderst says infrastructure is an inherently political investment. “There is no way around that,” he says. “But these days the pendulum is swinging back towards governments, and the onus is much more on them to come up with a consistent pipeline of projects, to have good procurement processes and to assure investors that they can provide good regulatory and policy stability.”

Political risk is a very difficult type of risk to quantify and is also very specific to the investor, with one investor finding political risk more bearable than another, Inderst says. “But there is some risk mitigation that can be done by investors, including insurance and co-investment of multilateral institutions – although this is not easy and a lot of work needs to be done by governments and the finance industry.” Inderst predicts there will be more lobbying in this area.

Peter Hobbs, managing director of private markets at bfinance, says even though there are good arguments for investing in infrastructure – it has arguably been the strongest performing asset class through the financial crisis – the market is immature. “Investors need to be aware of the risks as it matures, and one of these is the political and regulatory aspect,” he says.

Commenting on the government’s mention of the political and regulatory risk aspect of infrastructure investment for the GPFG, Hobbs points out that Norway itself made a big change in offshore gas transfer regulation when it cut tariffs for transporting natural gas on the Gassled network in 2013. The decision, aimed at boosting exploration and development for the domestic industry, brought the government into conflict with investors from other countries.

“This incident clearly illustrates the potential for infrastructure investments to be impacted by the political and regulatory environment,” Hobbs says.

Alex Moss, managing director of Consilia Capital, does not see the finance ministry’s views as necessarily reflecting the general institutional attitude towards infrastructure, citing the huge growth in capital raised for infrastructure funds over the last two years.

“My personal guess is that the decision should probably be interpreted as reflecting a number of specific execution issues,” he says. These are the fact that the GPFG’s actual real estate allocation of 3% is still well below the initial target maximum of 5% and not even half the maximum limit of 7%, which suggests that resources still need to be concentrated on the real estate allocation before new areas can practically be added, he says.

“There is probably a desire to maintain clarity over the investment characteristic of the third element – currently real estate – of the portfolio, and it is certainly true that there is a far greater history of returns, explanation of performance drivers, and understanding of implementation for real estate, the more mature asset class, relative to infrastructure, which is relatively nascent,” Moss says.

GPFGs existing asset allocation

Frédéric Blanc-Brude, director of EDHEC Infrastructure Institute, says the decision not to expand in unlisted infrastructure must be seen in tandem with the one to increase property exposure. NBIM pioneered the use of factor investing in risk management, he says, and adds that the firm has identified the need to further diversify its factor exposure by investing in illiquid assets such as real estate or infrastructure.

“As a SWF with no defined liability, they are after risk premia and they may think that real estate might deliver something similar to infrastructure in terms of illiquidity premium,” Blanc-Brude says. “Conversely, they may not be interested in the duration of infrastructure assets or the predictability of payouts since they are not a pension fund or an insurer.”

 On the benchmarking change, Karin Thorburn, research chair professor of finance at the Norwegian School of Economics, notes that the government has decided that the return on the unlisted real estate portfolio should be evaluated as part of the total tracking error. 

But she questions how this will be implemented. “The tracking error of a portfolio is typically computed based on the standard deviation of daily returns,” she says. But since unlisted real estate lacks market prices, the fund has to come up with its own estimate of the standard deviation of the real estate returns. “Estimates based on price appraisals are likely to underestimate the true return volatility, which in turn leads to an underestimation of the portfolio’s real tracking error.”

She notes that the expert group suggested using the ‘opportunity cost model’ to compute risk-adjusted returns for the real estate portfolio, but that this was rejected because the government thought it would be difficult to implement.