Norway’s sovereign wealth fund (SWF) recently awarded its first mandate to an external manager for a long-short equity hedge fund strategy and plans to award some $250m (€21.7m) to other such managers.
Norges Bank Investment Management (NBIM), which runs the NOK18.8trn (€1.6trn) Government Pension Fund Global (GPFG), says this is simply the expansion into external management of a strategy it has been following for years internally.
“Everything will continue to be managed within our mandate and within the limits we have for deviations from the index,” a spokeswoman for the central bank division says.
“We are evaluating long-short strategies in Europe and the US, where the managers will borrow stocks held in NBIM’s large index portfolio and sell them in the market,” she says, adding that this means the fund will not be net short in any company.
However, the move seems emblematic of the SWF’s shift towards active management, and use of external managers, under the leadership of chief executive officer Nicolai Tangen – himself a former hedge fund manager – and financial experts in Norway are unimpressed.
NBIM has indicated that in its search for long-short equity managers, it takes the view “smaller privately managed organisations” do better because they pay staff more.
Last year, the proportion of the SWF’s funds in external managers’ hands rose to 5.0% from 4.7% – a percentage which has been increasing at least since 2021 – with 106 firms holding GPFG mandates by the end of 2024, according to NBIM data.
NBIM says its strategy is to use external managers primarily for equity investments in emerging markets and in small and mid-cap companies, with outside firms used “in segments and markets where we believe they will enhance returns”.
In its 2024 report, NBIM says external security selection made a positive contribution to the GPFG’s relative return, whereas internal management did not.
“The real game is to invest broadly, a diversified portfolio, at the lowest cost possible”
Karin Thorburn at NHH
Karin Thorburn, professor of finance at NHH Norwegian School of Economics in Bergen, is against the organisation using more external managers and, in particular, high-cost hedge fund managers.
“They charge high fees like the private equity industry, and a large fraction of the raw, not risk-adjusted, returns are paid to the managers,” she says.
All data on stock market returns show you cannot beat the market over time, says Thorburn.
“The real game is to invest broadly, a diversified portfolio, at the lowest cost possible,” she says, adding that active managers on average generate the same returns as the market before costs, and that net of cost, most external managers underperform a low-cost index, in particular, over longer periods.
“That is why the international capital flows into passive index funds, and why the oil fund is invested as a large index fund,” Thorburn says.
Active security picking sometimes beats the markets and sometimes underperforms, she says, but that does not mean you can expect a risk-adjusted excess return net of costs in the future.
“The problem with external mandates is the higher cost,” she notes and questions the extent to which the ‘positive contribution to returns’ cited by NBIM from external security selection is risk-adjusted.
Halvor Hoddevik, independent financial consultant and chair of consultancy Rann, says academic evidence shows the risk-adjusted, after-cost performance of hedge fund strategies to be zero or negative, and there is no evidence of persistence in performance.
“Whilst these commercial investment vehicles are profitable for the managers and owners of these funds, they are less so for investors,” he says.
An SWF should focus on maximising its risk-adjusted after-cost returns, he notes, and since hedge funds would not add to that, there is no rationale for including them in the GPFG’s portfolio.
“Indeed, that the internal attempts to do this have failed should be a warning sign to not flip the dice again with external managers,” he continues.
The winning formula for managing the Norwegian SWF has been broad and systematic diversification and leveraging economies of scale in public markets, says Espen Henriksen, associate professor of financial economics at BI Norwegian Business School in Oslo.
“Through operational efficiency and a focus on all margins that may increase economies of scale – so-called “enhanced indexing” – Norges Bank has until recently been able to report positive risk-adjusted returns relative to index even after costs,” he says.
“Hedge-fund long-short strategies, with their diseconomies of scale, are a distraction from this,” he adds.
“These long-short and hedge fund strategies may prove costly in isolation. However, there is a potentially much greater risk that the indirect costs could be significantly higher because such strategies may divert attention and the focus of the management away from the fund’s core financial operations,” says Henriksen.
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