The active management review of the Norwegian Government Pension Fund Global is coming to its end. Last spring, the ministry of finance launched an extensive evaluation to scrutinise the performance of the active management of the fund’s manager, Norges Bank Investment Management.

The key focus has been to find out whether there are reasons to expect reasonable risk-adjusted returns net of fees from active management. Critics of active management usually argue that trying to beat a benchmark is too difficult, too costly and involves too much risk. Six months after the evaluation process began, the ministry of finance hosted a seminar in Oslo at the end of January to present and discuss the results.

“We have been looking forward to a good debate on the management of this fund for many years. It’s unfortunate that it took a lousy performance on our part in 2008 to trigger this debate,” commented Yngve Slyngstad, chief executive officer of NBIM.

Sticking to its long-term strategy of increasing the equity allocation to 60 per cent of assets in the middle of the financial turmoil was certainly not a profitable move for NBIM and the fund. Unsurprisingly, the 2008 results were the weakest in the fund’s history and NBIM came under fire as the fund lost almost a quarter of its assets in 2008. Furthermore, the fund’s returns were 3.4 per cent lower than that of the benchmark portfolio. Primarily, the active losses were concentrated in fixed income, in both internal and external management.

Martin Skancke, director-general of the ministry of finance’s asset management department, recognises that while the overall strategy of the fund has remained solid during the financial crisis, there are areas within the investment framework that need further elaboration.

“There are certainly lessons to be learnt from the financial crisis and important lessons to be drawn for the management of the fund. But you should be careful not to draw too many conclusions from the crisis,” says Mr Skancke.

However, he says it has highlighted the need for a broad and solid anchoring of strategy and discipline in execution, primarily with active management.

“The losses of 19.9 per cent of our benchmark portfolio caused less concern among our politicians than the underperformance of 3.4 per cent by the active management compared with the benchmark. That shows that the main parts of the strategy were well understood, but other parts less so,” says Mr Skancke.

“Active management had not been presented to parliament and explained in the same rigorous way as other parts of our investment strategy. Some risk factors in active management had not been identified and communicated as well as they should have been. This created a need to put active management on a more solid footing by giving parliament a broad presentation of active management strategies. The review was undertaken to facilitate this.”

The results of the active management review will be presented this spring in the ministry of finance’s annual report, followed by a discussion in parliament. As a part of the process, the ministry has received advice from two external evaluators and from NBIM.

An international expert group, consisting of Andrew Ang at Columbia Business School, Stephen Schaefer at London Business School and William Goetzmann at Yale School of Management, reviewed NBIM’s performance and made recommendations for changes. The ministry of finance also appointed Mercer to assess other institutional investors’ experience of active management and how it relates to active ownership.

The expert trio first reviewed NBIM’s historical track-record and came to the conclusion that the amount of active risk taken by the fund is very small but, in general, has added value. However, it noted that active management has played a small part in the overall performance of the fund. The report further concluded: “The small amount of active management has very large exposure to systematic factors and that over two-thirds of the active returns are attributable to systematic factors. These systematic factors, especially liquidity, volatility, and credit, fared very poorly during 2008 and early 2009 and are responsible for most of the active losses.”

The experts recommended that the use of benchmarks should be reviewed and that it should move towards a factor benchmark approach. As the fund’s performance is “largely determined by its exposure to a number of systematic factors, the fund should move to a more top-down, intentional approach to choosing factor exposure”, according to the report. The ministry of finance “should decide how much risk is appropriate by bringing these factors into the fund’s benchmark”.

NBIM has argued for the importance of at least keeping the current level of active management. Not only because the fund is moving into new areas where the opportunities for alpha are even bigger, for example emerging markets, but also because of the intertwined relationship between active management and corporate governance. According to NBIM, the knowledge from active management is a prerequisite to exercise active ownership rights and the potential for results from active ownership increases with the quality and competence of its active management.

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