It is a cautious allocation, just 5%, but the Norwegian Government Pension Fund - Global has the cash to buy properties that are closed to most investors, as Shayla Walmsley reports

No one from the Norwegian Government Pension Fund-Global is talking about its shiny new NOK140bn (€16.6bn) real estate allocation. Not least because the fund is in the process of recruiting a new property manager, with the old one, Paul Golding, ex-head of Merrill Lynch's real estate investment banking for Europe and the Middle East, understood to be in the running.

The NOK2.6trn fund's advisers have been equally cagey. But sources familiar with the fund seem to have a fairly good idea of how it plans to invest in real estate.

Some of the plan is already on record. The fund, which has partially diverted its bond allocation to real estate, will take its time. In March, it claimed it would take several years to reach its 5% target because of both the size of the portfolio and the risk presented by volatility in the real estate sector.

"The people managing the fund will gradually invest to avoid too much market movement. They've been quite cautious when increasing their market share in stocks," says Morten Kampli, a partner in Norwegian fund manager Realkapital.

As with its equity portfolio, the fund will not invest in its domestic real estate market for fear of destabilising it. Yet in other markets the injection of significant capital would do more good than harm, says Alessandro Bronda, head of investment strategy at Aberdeen Property Investors. "At the moment, the investment market is more debt and equity. It would support pricing, and that would be good news," he says.

From the fund's perspective, too, there is something to be said for global diversification. Claude Angéloz, co-head of private real estate at Partners Group, points out that real estate is the asset class where investors benefit most from diversification. "If you invest in a multinational, it's irrelevant whether its headquarters are in Stockholm or Switzerland," he says. "In property, it isn't just the city that's important but the street and even which side of the street. Micro-considerations make all the difference."

Some observers doubt that the Norwegian fund will remain within traditional, mature-market, non-listed constraints for long. "Because of its size, the fund has little choice but to have direct holdings. I expect there will be a process of learning, hiring top-class professionals, and then becoming increasingly global," says Elroy Dimson, professor emeritus at London Business School, who advised on the fund's real estate strategy.

Given the constraints of the allocation - indexed, geographically diversified, in non-listed funds invested in mature markets and traditional sectors - the cautious approach promised by the Norwegian central bank, which manages the fund, is hardly surprising. What is perhaps more surprising is its reported scouting of UK assets, given what Angéloz might consider a questionable entry point.

"Property is a long-term asset class and it's crucial to get the entry point right because you'll be invested in it for five, maybe seven, years," he says.

"When we see prime London office or a retail mall in Manchester trading at a 5% cap rate, based on our more bearish view of the UK economy, we see prices based on investors having capital to deploy. If we can buy a German residential portfolio that's 85% leased at an 8.4% cap rate, that's a much more attractive proposition."

Given the overwhelming institutional appetite for prime, secure assets with stable cash flows, and the fact that these make up only 10-15% of the market, targeting core assets in mature markets will present the fund with significant competition from other investors.

But it also presents the fund with a significant opportunity because it has the capacity to buy very large assets. "If it is buying an asset worth €60-70m, there will be an extra discount on pricing because few others will be in a position to buy it," says Bronda. "In that case, the competition will come from sovereign wealth funds in Asia and the Middle East. Other than these, investors would need finance from banks to buy anything big."

Kampli believes the fund will not invest in property like a sovereign wealth fund - in other words, it will not invest in trophy assets, and it will not necessarily seek majority stakes.
In other asset classes, Kampli points out, the Norwegian fund has invested very differently than a Middle East sovereign wealth fund, which acquires whole companies on the equities side and trophy buildings in real estate.

"That isn't the style of the Norwegian government pension fund," he says. "In equities, it takes small stakes in companies. In real estate it will look at high-quality assets but it will be less focused on trophy buildings."

But the fund will not invest like a pension fund, says Dimson - because it is not one. If a pension fund is like an insurance company, with pressures to alter its asset allocations to match its liabilities, the Norwegian fund is not matching specific liabilities. It is more like the savings of a wealthy individual, he says, with liabilities determined by how much it has by way of assets.

However, those assets must offer not only a long-term return but also short-term credibility for the population of a highly transparent society. "The fund belongs to a consensually driven, transparent society. Norwegians value openness enormously, and the fund publishes in extraordinary detail what it invests in, what strategies it follows, and how it has performed," he says.

"It's more transparent, partly because of how Norway treats government money," agrees Kampli. "When you look at how it has given out mandates and how it has invested, it's very different from other sovereign wealth funds, which tend to be less transparent with their information."