The Biggest Investor in the World
Inside the World’s Largest Sovereign Wealth Fund
Annie Duke is a poker champion and decision-making expert. Her 2018 book, Thinking in Bets, draws on her card-playing experience to explore how people can make smarter decisions when the facts are not all available. Recommended by leading investors such as Marc Andreessen and Howard Marks, it is widely read in the investment community, where decision-making in an environment of uncertainty is core to the job.
This week, Annie spoke at the annual Norges Bank Investment Management (NBIM) conference in Oslo (she beamed in via Zoom). As the largest single owner of the world’s stock markets, NBIM holds considerable sway, and each year it gathers experts in a range of fields to discuss a topic – this year: How to become a better investor. NBIM already has a strong track record. It has outperformed its benchmark across its 26 year history and now sits on $1.6 trillion of assets. But there is always scope to do better, hence the conference. Andreessen and Marks were both there; also Adam Grant, Michael Mauboussin and Marc Rowan.
Annie Duke presented the topic of her latest book, Quit: The Power of Knowing When to Walk Away. From an investment perspective, knowing when to quit can be a powerful skill. Annie highlighted a recent research paper that shows that closing positions too late creates a material drag on investors’ performance. “While expert investors are alpha generators when putting risk on, they give alpha back on their exit decisions,” she told attendees.1
From an organizational perspective, though, quitting can be hard. Indeed, NBIM’s very origin story is tied up in one company not quitting. That company was Phillips Petroleum and it follows a long tradition of companies in the oil industry giving it one more go…
In 1859, “Colonel” Edwin Drake was about to run out of money. He’d been drilling for over a year in Titusville, Pennsylvania and, one by one, his financial sponsors had given up hope. Finally, his last remaining backer sent him an order, instructing him to pay his bills, close up the operation and return home. Before the message arrived, Drake struck oil. The American oil industry was born.
A similar story unfolded in Persia almost half a century later. George Reynolds was chief engineer on the ground, working for Burmah Oil, whose Scotland-based executives had become unhappy about his slow progress. After seeing nothing from Reynolds in over six years, they dispatched a letter, telling him that if no oil was found at 1,600 feet at the two wells he was drilling at Masjid-i-Suleiman, he should “abandon operations, close down, and bring as much of the plant as is possible down to Mohammerah.” In May 1908, the letter in transit, first one and then the other well began to gush. Reynolds fired off a cable to head office: “The instructions you say you are sending me may be modified by the fact that oil has been struck, so on receipt of them I can hardly act on them.”
Starting in 1920, Europeans began searching for oil closer to home. The Suez crisis of 1956 gave the hunt more urgency and, in 1959, a large gas field was discovered at Groningen in the Netherlands. Realizing that the geology of the North Sea matched that of Holland, oil companies began to explore in adjacent waters. One man whose interest was piqued was the vice-chairman of Phillips Petroleum of Oklahoma, who noticed a drilling derrick near Groningen while on vacation in the Netherlands in 1962. He returned with colleagues and, in 1964, they started drilling.
After five years, they hadn’t found anything. In total, Phillips and other oil companies drilled 32 wells on the Norwegian continental shelf – they all came up dry. The process was expensive and eventually the message came from Oklahoma: “Don’t drill any more wells.” In November 1969, Phillips gave it one more go – reportedly because it had already paid for the use of a rig, the Ocean Viking, and couldn’t find anyone else to sublease it. That last drill proved a success: from 10,000 feet beneath the seabed, it drew oil.
Daniel Yergin tells the story in his definitive history of the oil industry, The Prize. He says that a few months after the find, a senior Phillips executive was asked at a technical meeting in London what methods Phillips had used to diagnose the geology of the field. “Luck,” came the reply.
The Ekofisk oil field Phillips had discovered turned out to be huge, originally estimated to contain more than 3 billion barrels of recoverable oil. Production started in 1971 but it wasn’t until oil prices rose dramatically during the 1973 oil crisis that its true value became apparent. By then, other fields had also been discovered and the Norwegian government was keen to retain some of the value. As well as participating directly, in 1975, it introduced a special tax on top of already high corporate tax rates to capture 78% of producer profits.
Initially, those tax receipts were funneled into the government budget. But a commission set up in 1983 warned that variations from changes in oil prices should not be allowed to impact directly on government expenditure. The commission proposed a “buffer fund” to absorb revenue fluctuations and uncouple production activity from spending decisions. The idea was ready to go when an oil price collapse in 1986 made it moot. Saudi Arabia abandoned its policy of cutting production in response to increasing output elsewhere and prices fell, shattering Norwegian government hopes to accumulate financial reserves.
When the idea was reprised in 1990, there wasn’t any wealth to invest but, as a tool to make the country’s use of oil revenue more transparent, a fund was nevertheless established. For five years it sat there – an “exercise in accounting” – as the country’s non-oil deficit (exacerbated by a banking crisis, no less) continued to exceed annual net oil and gas revenue.
Finally, in May 1996, the finance minister was able to make his first transfer to the fund, of close to 2 billion kroner ($300 million). Later that year, another 45 billion kroner was added ($7 billion).
The fund is now worth 17,395 billion kroner, equivalent to $1.6 trillion, or 3x Norway’s GDP. Money has been added along the way, but less has been taken out, and investment performance has contributed to the fund’s growth. The government maintains a strict spending rule that allows it to withdraw only the equivalent of the real return on the fund – estimated to be around 3% per year – but 3% of a big number is a big number and such withdrawals are sufficient to fund 20% of the state budget. Meanwhile, the fund compounds. Net flows account for less than half the current value of the fund; most is due to investment performance.2
This week’s investment conference highlighted some of the challenges the fund now faces. Is it too big? Is its mandate to invest principally in public securities appropriate? As a government-owned entity, can it compete with private players? Annie Duke delivered her presentation in the section about behavioral characteristics of the best investors, not the one on building successful investment organizations, but the question of whether the fund should quit its current strategy is worth asking.
To join me behind the scenes inside the world’s biggest investor, read on.
NBIM has a bold goal: To be the leading large investment fund in the world.
As a government-run entity in a market of private sector players, it faces an immediate handicap. The fund – officially the ‘Government Pension Fund Global’ – falls under the responsibility of the Ministry of Finance, which delegates management to Norges Bank, the central bank. Norges Bank’s involvement goes back to the original idea of the fund which contemplated oil revenues being deposited in a kroner account and invested in foreign securities similar to the way the bank manages foreign exchange reserves. But the structure also allowed the fund to borrow the central bank’s cloak of independence, protecting it from political interference. Once it became clear assets would balloon, NBIM was set up as a separate department within Norges Bank in 1998.
Government control comes with heavy constraints. The fund’s use of external managers, staff remuneration and asset allocation are all tightly regulated. Remuneration limits are set by the central bank’s executive board at rates that are “competitive but generally not market-leading.”3 Rather than being a disadvantage in the market for talent, though, the firm uses its government mandate as an advantage. “We manage the fund on behalf of the Norwegian people,” it says – a purpose that is deemed very attractive by employees. Even non-Norwegian employees value the mission:
“I worked other places before, making a few really, really wealthy persons even more stinking rich,” said one. “Our mission statement ‘for future generations’ – I like that. To me, it gives my work meaning.”
To compete with higher pay elsewhere, the firm also puts a lot of emphasis on culture. CEO Nicolai Tangen has hired experts in sports psychology and mental training to work with staff. Last year, he invited an anthropologist to embed herself in the organization for a year, joining staff at “seminars, workshops, and all kinds of happenings – from Town Halls and lectures to birthdays celebrations, Thirsty Thursdays, and Christmas parties.” As well as helping boost performance, the CEO is keen to promote fun. “To succeed in a challenging, fast-paced working environment, we also believe it is important to have fun at work,” he writes in the firm’s strategy document.
One advantage of the firm’s structure is that it has a single client, so it doesn’t need to employ salespeople, nor manage conflicts between fund performance and firm growth. A 2017 proposal to establish a separate entity to manage the fund was rejected by the Ministry of Finance and the Parliament, both of which concluded that such a structure could present principal-agent problems if the entity’s goals and priorities are no longer fully aligned with those of the asset owner.
A single client also means lower costs. Last year, the fund expensed 6.6 billion kroner of costs (of which personnel made up 2.0 billion kroner), equivalent to 0.045% of assets under management. Since 2012, this rate has been 11-19 basis points lower than peer expense rates, according to data provided by CEM Benchmarking Inc. The firm employs external managers (paying them 1.2 billion kroner in base fees last year and 1.3 billion kroner in performance fees) but most assets are managed internally. Of 261 individual portfolios, 150 are managed internally and 111 are assigned to external equity managers.
The firm’s overall asset allocation is strictly governed by a mandate issued by the Ministry of Finance. From the beginning, the plan was always to invest abroad. Policymakers had watched as the Netherlands suffered adverse economic consequences following the discovery of gas at Groningen years earlier. Newfound wealth led to a rapid appreciation of the Dutch guilder, making exports of non-oil products less competitive. Unemployment rose and capital investment dropped – a phenomenon that became known as ‘Dutch Disease’. Foreign investment could help mitigate the risk, and it would also prevent the fund being used as a source of cheap financing for populist initiatives at home.
Initially, an asset split of 40% equities and 60% fixed income was proposed but, in 2007, this was flipped to allow 60% of the fund to be invested in equities. Today, the target is 70%. In 2010, the fund added unlisted real estate to the portfolio and, in 2021, it began making investments in renewable infrastructure.
Within these asset allocation guidelines, the fund targets a benchmark index, specified by the Ministry of Finance. Over the years, the composition of the index has changed as a result of implicit choices made by index providers, for example around country inclusion, as well as explicit choices made by the Ministry of Finance itself, for example on ethical grounds, where a Council of Ethics makes frequent recommendations. (Currently 169 companies are excluded from the investment universe, with 23 under observation – full list here).
But rather than being used as the sole driver of the fund, the index is used as a guide. Risk associated with designing the benchmark sits with the Ministry of Finance, while Norges Bank takes risk in deviating from it. Initially, a tracking error limit of 150 basis points was allowed; this was cut to 100 basis following the financial crisis in 2011, before being raised again to 125 basis points in 2017 (albeit with real estate stripped out, which broadly offset the widening).
Over the years, the firm has delivered enhanced returns by trading around its index. Since the beginning of 1998, its relative return has annualized at 0.28%. An independent performance evaluation published in 2022 concluded that active management of the equity portfolio in particular creates value and that in the period January 1998 through to September 2021, overall active management added 228 billion kroner of value before costs and 170 billion kroner after costs.
Given its size, though, capturing value from active management is hard. The firm owns stock in 8,859 companies around the world, holding an average 1.5% stake in each of them (2.7% in European companies). In 2022, the fund down 14.1% (albeit with a positive relative return of 0.87%), CEO Tangen admitted that “being invested in pretty much the entire world, we have nowhere to hide.” One way the firm adds value is through negative selection – it did not have a position in Wirecard for example. In the past ten years, it has earned an annualized 0.17% from security selection (split roughly half internally-sourced and half external) with the rest of the relative return coming from market exposure (0.14%) and securities lending (0.05%). (Real estate has detracted 0.06% from relative return.)
As an asset owner, the firm takes its responsibilities seriously. It votes at all its companies’ annual general meetings – around 120,000 proposals a year – announcing its voting intentions five days ahead of time for transparency purposes (and making it arguably the third largest proxy advisory firm, after ISS and Glass Lewis, given its influence). In 2011, when the EU proposed a deal to refinance Greek debt, NBIM voted against it – without consulting the Ministry of Finance. In a more recent example, it is leading a class action suit against Silicon Valley Bank – a stock it didn’t manage to negatively select.
The Ministry of Finance values transparency, hence its preference for listed securities. A full list of holdings is available on the fund’s website. But listed securities don’t necessarily offer the best allocation for a long-term oriented fund, one whose mission is “safeguarding and building financial wealth for future generations” – and NBIM knows it. For years, its management has badgered the Ministry of Finance to allow it to invest in private equity. In a letter to the Ministry last November, CEO Tangen and the governor of Norges Bank noted that unlisted equity investments represent a natural evolution of the fund’s investment strategy as the listed market becomes narrower:
“A small proportion of listed companies are accounting for an ever larger share of the listed equity market. The number of listed companies worldwide has levelled off. Since 2010, the listed equity market has not grown beyond what can be explained by movements in share prices. There are fewer IPOs in developed markets, and the companies coming to market are larger than before. This suggests that the GPFG is missing out on part of companies’ growth by not investing until after they have been floated and eventually enter the fund’s equity benchmark. These trends are not new but have become more pronounced over time.”
At NBIM’s recent investment conference, Marc Rowan, CEO of Apollo Global Management, added his thoughts: “Why does an institution with a 20 or 40 year time horizon concern itself with liquidity?” he asked.
“I don’t think the strategies that we have employed over the past 40 years are going to work going forward,” he told the conference. “We’re all going to have to overcome biases that we have about public and private.” He argued that while in the past, private investments were higher risk (and higher return), increasingly their value is in diversification they offer from indexation and concentration.
Other long-term funds are already there. CEM Benchmarking shows that the ten largest state-owned investment funds and pension funds allocate around 13% of their assets to private equity. Stanford Management Company, whose CEO Robert Wallace presented at the conference, has a policy target weight of 38%.
Unfortunately for Rowan, as a trafficker in unlisted assets, the Ministry of Finance said no. In a white paper released earlier this month, the minister asked for more time to reflect on NBIM’s proposal. Having created an elegant structure for capturing both a rise in oil prices and a rise in equity prices, the Ministry needs to consider whether it extrapolates historic trends, or tries something new.
Annie Duke may yet be called back to Oslo for advice.
Further Reading
The paper analyzes roughly 10,000 episodes (i.e., full cycles of a given position from first entry to last exit) across 43 active equity portfolios over 14 years. It concludes that manager decision-making at the position level tends to accumulate in the early phase of an investment and decay over time. On average, positions are held too long, leading to a peak-to-exit negative portfolio impact of 7 basis points per position.
The question often comes up why the UK didn’t try something similar with its North Sea oil windfall. One issue is that it never captured as much value. Unlike in Norway, the UK government didn’t retain a direct financial interest in oil production, and corporate taxes were lower. The UK also produced more of its oil and gas in years when prices were low than Norway did: Production peaked in Norway in 2004; the UK’s twin peaks occurred in the late 80s and late 90s. Between 1970 and 2014, government revenues from oil and gas production amounted to $470 billion in the UK in real (2014) terms, and $1.2 trillion in Norway. But also, the UK government (under prime minister Margaret Thatcher) allowed UK individuals to create their own wealth with North Sea Oil revenues if they so wished, via lower taxes. The problem here is that the policy didn’t directly benefit future generations, a factor which is core to the NBIM mission; nor was it shared democratically.
Last year, the average salary across the firm’s 738 employees (a number which includes turnover; headcount at year-end was 654) was $142,000. Those 30% of employees eligible for a bonus received $126,000 on top (the maximum is generally 100% of fixed salary). The co-chief investment officers of equities took home $1.5 million each.
Fascinating. I’m curious if the US has ever considered something like this?