Traditionally home-biased Norwegian pension funds are proceeding cautiously. The debate over the prudent man principle is a case in point. Lynn Strongin Dodds reports

Although Norway's new investment regulations have not yet been finalised, local institutions have already started to analyse opportunities on the global real estate scene. In many ways they have no choice. The domestic market has not only become too pricey but opportunities are also limited. While few expect to see a flood of money pouring over the borders, there could be a gradual stream.

The argument for investing overseas has been well documented and is the same for most pension funds - diversification and an enhanced risk and return profile. It is easy to see, though, why Norwegian institutions have been reluctant to look outside. Their domestic market was offering bountiful rewards. According to figures from Investment Property Databank, total returns reached a record 17.6% in 2006 while Oslo's commercial market surged on the back of a strong economy fuelled by oil prices and consumer spending. Data from Norwegian commercial property company Akershus Eiendom reveals that rental growth in the prime office segment of Oslo in the first half of 2007 was the strongest in Europe at 50%. Yields in prime office space in the country remained low at 4% to 5%. 

However, the growth has meant that new prospects were thin on the ground as the prime locations were already snapped up. Newcomers have found it difficult to get their foot on the property ladder while existing investors are having trouble finding prime property at reasonable prices. Moreover, the supply is expected to remain tight as the development of new office buildings is predicted to be only 100,000m2 a year for 2007 and 2008, and no more than 150,000m2 in 2009, according to Akershus.

Peter Hobbs, head of global real estate and infrastructure research at RREEF, explains, "Historically, Norway pension funds have been domestically focused but I think the trend to invest internationally is gaining momentum. This is because their home market is too small to provide the core plus returns that they are looking for over the long term. They will proceed quite cautiously and build their exposures over time instead of simply chasing higher returns. The Norwegians operate in a similar systematic way to the Swedes in that they will use their asset liability modelling to determine their allocations. Then they will likely use a combination of quantitative and qualitative analysis to choose the most attractive markets and the best fund managers."

Espen Klevmark, managing director of Norway and head of fund development for Aberdeen Property Investors internationally, adds, "Institutions are risk-averse and conservative investors, but fund size is clearly an issue, particularly for a small country.

The 100+ small and medium-sized Norwegian pension funds have still less than 5% property exposure on average, mostly indirect, and international diversification is less important and hardly achievable. The 8-10 larger institutions have on average a fair 10-12% exposure, but the majority of portfolios are still direct investments in Norway and if institutions do invest internationally it typically means Sweden or Denmark. However, property is growing in popularity and I think we will see more funds taking global exposure indirectly."

Vital, a NOK229bn (€30bn) Norwegian pension insurance company, is a case in point.  The bulk of the portfolio, which accounts for almost 12% of total assets under management, is still invested in Norway's commercial offices, hotels and shopping centres. About 20% is in neighbouring Sweden, while 10% is dubbed "outside" investments. At the beginning of 2006, the group made a foray into Europe via a €40m injection into an international property fund.

For now, all eyes are on the actions of the Government Pension Fund, formerly known as the State Petroleum Fund. Although the scenario has not changed dramatically from last year in terms of committed investments, things have progressed with the appointment this past May of Paul Golding, a former real estate investment banker from Merrill Lynch, to head its real estate projects. There was talk that he was making the rounds in the City of London exploring the opportunities in the UK and Europe. Overall, rumours have been circulating that the behemoth fund with €243bn assets under management could spend as much as €30bn on global commercial property. So far, the Government Pension Fund, which is managed by Norges Bank Investment Management, will not reveal its hand. A company spokesperson has confirmed that the fund is preparing to invest in real estate, but he noted that it was too early to put a figure on the size of the investment. It is still waiting for the Norwegian Parliament to make a decision on pending regulation and while some had hoped this would be at the end of 2007, others believe it is now more likely to happen in the first half of 2008.

Last year, the Kredittilsynet, the country's financial supervisory authority, proposed the introduction of the so-called prudent person principle. This means that the upper limit of 35% for all assets in equity investments would be abolished and that funds could venture into alternatives such as hedge funds. There has been a great deal of debate and discussion as to whether the prudent principle is the right course of action to take.

Separately, the country's ministry of finance published a White Paper proposing that the Government Fund be allowed to increase its equity allocation to 60% from 40% as well as move into the alternative space including real estate and private equity. Harry Humble, investment director, property product specialist for Standard Life, points out, "I think it is good that the Government Pension Fund is taking its time considering the options. In general, Norwegian pension funds are somewhat different to other institutions in their independent approach. In other markets major pension funds have tended to dominate the decision to pursue this asset class. To date, Norwegian institutions seem to pursue a less consensual approach. Once the government does make a commitment, though, it will be in a meaningful way. Over the long term, the fund has the scale to become one of the largest players in the real estate market."

Also, many industry participants believe that other Norwegian pension funds will follow suit in time. Matthew Ryall, fund manager of the European Property Fund of Funds at BlackRock, points out, "The Norwegians are not alone in having a home bias. Many other countries in Europe and the UK have been the same. However, the market is small and I think that Norwegian institutions should be looking at allocating a minimum of 25% of the property portfolio to international property in order to diversify the risk and ensure the best returns. Over the long term, this should be increased to 75% but it will take time. At the moment, international exposure is in the low single-digit numbers."