Norwegian oil fund raises real estate limit but rejects infrastructure

Norway’s sovereign wealth fund has decided against investing in unlisted infrastructure and is raising its real estate allocation from 5% to 7%.

The Norwegian Ministry of Finance today announced that it was “not prepared to permit” unlisted infrastructure investments, as the potential benefits were still unclear.

The government decided against making any changes to the smaller Government Pension Fund Norway (GPFN), which had hoped to establish a real asset portfolio.

With respect to the Government Pension Fund Global (GPFG), however, Ministry said it was “uncertain whether unlisted infrastructure improved risk diversification or raised expected returns”.

The Norwegian government is giving the go-ahead to move away from a real estate benchmark and instead measure the performance of its real estate investments against a portfolio of equities and bonds.

The Ministry has been assessing potential changes to the way the GPFG invests in the private market, including the creation of an infrastructure allocation.

It has been consulting Norges Bank Investment Management, which manages the fund’s investments, and external experts, including Stijn Van Nieuwerburgh of New York University, Richard Stanton of the University of California and Leo de Bever, former chief executive at the Alberta Investment Management Corporation.

“Both the expert group and Norges Bank consider that the range of investment opportunities can be expanded by permitting investment in unlisted infrastructure,” the Ministry said.

“The fund’s distinctive characteristics and potential management advantages can make it profitable to exploit such opportunities. However, such advantages are difficult to quantify.”

The government points to the unlisted infrastructure market relatively small size, citing estimates of its comprising less than 1% of the global investable market.

Finance minister Siv Jensen said: “A number of important factors indicate that investments in unlisted infrastructure should not be permitted.

“Such investments are exposed to high regulatory or political risk. Conflicts with the authorities of other countries regarding the regulation of transport, energy supply and other important public goods will generally be difficult to handle and entail reputational risk for the fund.”

She added: “The government considers that a transparent, politically endorsed state fund like the GPFG is less suited to bear this type of risk than other investors. Following an overall assessment, the Ministry is not prepared to permit the GPFG to invest in unlisted infrastructure at this stage.

“It would be useful to gain more experience from unlisted real estate before any expansion to additional types of unlisted investment.”

But the Ministry is enabling the GPFG to increase its real estate allocation from 5% to 7%.

At the end of 2015, the sovereign wealth fund had 3% of its assets in real estate.

The decision comes more than a year after the government commissioned a review, led by London Business School’s Elroy Dimson, on the current 5% cap on real estate.

Real estate performance will also be benchmarked against a reference portfolio of equities and bonds.

This would move the GPFG in line with some other large institutional investors that use a similar ‘opportunity cost model’, including the Canada Pension Plan Investment Board.

“The investments will be evaluated against a broadly composed index that can, in principle, be followed closely at low cost,” the Ministry said.

The new approach should give Norges Bank more flexibility when it comes to deciding on new real estate investments.

But the organisation will need to ensure real estate investments stay below the 7% limit to avoid any forced selling should the GPFG’s listed investments suffer significant falls in their value.

Based on the fund’s market value of nearly NOK7.5trn (€796bn) at the end of last year, it could increase its unlisted real estate holdings by NOK343bn before breaching the new 7% cap.

Real estate was the fund’s highest-returning asset class last year and had grown to account for 3.1% of assets, an increase of 0.9 percentage points year on year. 

While down compared with results for 2013 and 2014, property for the third consecutive year outperformed fixed income, and, for the third time since 2011, it achieved a better performance than the sovereign fund’s equities.

The fund’s property holdings are currently split between listed and unlisted real estate – with the latter accounting for NOK180bn in 2015, and returning 10.8%, compared with a 7.8% return from listed real estate companies including Great Portland Estates, Gecina and Deutsche Wohnen.

“Under the new regulatory framework,” Jensen said, “the scope and composition of the fund’s unlisted real estate investments will be decided by Norges Bank.

“This solution gives a clear division of labour between the Ministry of Finance and the Bank, as well as an overall limit of the fund’s risk.”