From the view of a country with hardly any natural resources, countries that have huge oil and gas reserves can seem very fortunate indeed. However, Svein Gjedrem, Governor of Norges Bank, Norway's central bank, challenged that notion during a recent talk at Singapore Management University. Organised by the Sim Kee Boon Institute for Financial Economics, Gjedrem said that what seems as a blessing, can also be a curse.
Historical experience has not always been kind to countries that have a lot of resources, said Gjedrem. Taking reference from a European neighbour, he told the story of what is termed as 'Dutch Disease'; of how the 1960s discovery of natural gas deposits in the North Sea had, at first, bolstered the Dutch economy, but subsequently, led to an unhealthy dependence on oil.
The country struggled to wean itself off easy money, he said. While revenues were gushing in from the wells on the one hand, other sectors of the economy suffered from a lack of attention. The oil money may have lifted the Dutch guilder, but it made other sustainable businesses like those in export and manufacturing less competitive. The transition got increasingly painful as wealth from the fields slowed.
The Dutch were not alone. Economic history is littered with examples of such over-reliance on natural resources: 16th century Spain, whose infamous conquistadors brought back treasure chests of gold from America to Spain; the collection of guano, or sea-bird manure, which was used as a gunpowder ingredient in 19th century Peru; and of course, in recent decades, oil and gas are seen to be the culprits behind the economic difficulties of oil-producing countries, from Azerbaijan to Venezuela.
Saving for future generations
To avoid the primrose path, Norway saw a need to take a sustained long-term strategy. In 1990, the government established the Petroleum Fund to manage and invest national revenue from the industry. Norges Bank Investment Management, or NBIM, is the manager of this fund, which, in 2006, was renamed the Government Pension Fund Global.
Oil and gas are huge in Norway presently, contributing 26% of the GDP; 34% of the government's revenue, 23% of total investment and half of the country's exports. Norway is now the world's sixth largest oil exporter and the second largest gas seller. However, Gjedrem expects production, which peaked in the middle of the last decade at more than 250 million cubic metres per year, to decline to some 150 million cubic metres by 2030. This is why it is necessary to build up a financial fund to meet the challenges for the economy, he explained.
What Norway has been doing, is to channel direct revenue as well as tax collections from oil and gas companies into the fund. The money is then invested abroad and not spent internally, so as not to over-heat the domestic economy. There is also a strict fiscal rule, where the government is not to spend more than the returns generated from the fund. In the short term, this will avoid depleting the fund and over the long-term, it ensures that future generations of Norwegians will be able to benefit from the nation's wealth.
Keeping in mind that natural resources are finite, the country is also seeking to transform its wealth composition in favour of financial services. Petrol is an important part of our national wealth now. But a big part of a nation's wealth is also its human capital, said the governor.
Allocating to Asia
From US$300 million, the fund has grown to its current size of some US$440 billion, making it the second largest of the so-called sovereign wealth funds (SWF). Other large SWFs include that run by the Abu Dhabi Investment Authority, another oil-rich state. Countries like Saudi Arabia, Kuwait, Russia, China and Singapore also run their own versions of SWFs.
Currently, the NBIM allocates 60% of its assets to equities and 40% to fixed income. There is also geographical diversification. Half the equity is parked in Europe, 35% in America and Africa, whereas Asia, seen by many investors as a region offering relatively higher growth potential, is allocated only 15%. In fixed income, this proportion is even lower, at 5%, with Europe accounting for 60%, and the remainder in Americas and Africa.
However, the current allocation is set to change, not just in terms of geographical representation, but also in terms of new asset classes. Earlier this year, the fund made known its mandate to invest 5% of its assets in real estate - a new area of investment for NBIM. Just do not expect the fund to swoop in and buy entire city blocks or townships for its real estate portfolio. Rather, it would be a very gradual process that will start with countries close to us where we have the possibility to learn more about how the real estate market functions, said Gjederm.
NBIM is also likely to increase its presence here. We are overweight in Europe and underweight in Asia. But Asian companies are doing very well. With the strong growth in Asia, our (fund) distribution may be in for a change, he said.
To better manage its Asian assets, NBIM on June 30 officially opened its Singapore office - its second in Asia after Shanghai (which was opened three years ago). For NBIM, the advantage of having its new representative office located in this part of the world is the proximity to suppliers, he added.
In response to a query from the audience about possible future cooperation between the NBIM and Singapore's SWF, Gjedrem noted that the fund's managers have benefited from contact with the Government of Singapore Investment Corporation (GIC) and Temasek Holdings. Of the two, GIC is more similar in nature to NBIM, although it has been around for a longer time and has more experience compared to NBIM. He added, The flow of information and judgement over the years has benefited us a lot. We hope that in future, we can discuss development and strategies with GIC and other funds in this region for mutual benefit.
The fund is currently earning a return of 2.9%, an improvement from roughly half that rate during the recent downturn, but still short of its long term target of 4%. However, Gjedrem is relatively unconcerned about the short term fluctuations in the market. His optimism is perhaps guided by some commonsensical investment strategies that not all investors necessarily follow.
Simply put, NBIM will buy while the market is down and cheap, in particular, during major downturns - such as the tech bubble burst of 2000, and early last year, when the global financial markets were at their nadir. The proportion of the fund's holdings in equities has gone up too. From 40% in 1998, the fund was 60% equities by 2007.
The size of assets under the care of NBIM is forecasted to rise to a whopping US$900 billion in 2020. An estimate by the International Monetary Fund puts the size of the 38 SWFs that it is tracking, to US$4.3 trillion as of 2009. With new funds being created and coupled with growth of existing funds like Norway's, this pool of SWFs is expected to grow to US$7 trillion over the next three years.
With such growing financial muscle that answers ultimately to governments and not necessarily free-market capitalists, there have been growing interest - and some say concerns - over the transparency of such SWFs. The nagging fear among respondents to a May 2010 survey conducted by public relations agency Hill & Knowlton and market research firm Penn Schoen Berland (PSB), was that such a growing presence will spill from the financial markets into international politics. NBIM, for one, is probably among the largest shareholders of various large non-Norwegian European companies.
Benign image, apolitical fund
Nevertheless, the fund has been the most successful in cultivating a benign image. According to Hill & Knowlton and PSB, this fund is considered the least likely (43%) to be motivated by political objectives compared to 87% for the least trusted SWF of them all - Russia. Singapore's rating is in second place, at 50%.
This global role model of transparency and governance divides the administration responsibilities of the fund between two mechanisms - the NBIM under the Norges Bank is in charge of ownership strategies and corporate governance, while the Ministry of Finance has the final say on exclusions from the fund's investment universe through the advice of a Council of Ethics based on ethical guidelines issued in 2004.
According to Gjedrem, there are two basic premises to the guidelines: One, a portion of Norway's petrol wealth should be retained to benefit future generations. Two, the fund should not hold investments that constitute an unacceptable risk that the fund may contribute to unethical acts.
For example, the fund will not put its money into tobacco companies. And where potential investee companies have been found to be engaged in unethical acts, which Gjedrem said was based on United Nations accepted international anchored values, the NBIM would conduct dialogues with the companies to seek resolution.
So, twenty years after its inception, how does Gjedrem rate the success of NBIM? Some boxes have been checked, some, not quite. Productivity, for one, has remained strong over the last two decades, with Norwegian companies performing well in sectors like banking, telecommunications and manufacturing. Yet, the Norwegian krone has appreciated.
Consumer prices are also up. Norway is home to the world's most expensive Big Macs, at US$7.20, compared to US$3.73 in America. [So] while we have avoided part of the (Dutch) Disease, we have to be very careful, he concluded.