Norway’s GPFG argues the case for private equity – again

Norges Bank Investment Management, investment manager of Norway’s $1.5 trillion wealth fund, Government Pension Fund Global, has once again petitioned policy makers in the Ministry of Finance to let it invest in private equity. NBIM is requesting a 3-5 per cent allocation with large and mid-sized managers that will extend into a co-investment program overtime.

Some four previous appeals, most recently in 2018, have fallen on deaf ears leaving GPFG excluded from the $7.8 trillion market that has grown 20 per cent every year since 2017 in marked contrast to over sovereign funds. A decision is likely to come in the first half of next year.

“Investment in private equity could give higher returns after costs than listed equities over the long term,” wrote Ida Wolden Bache, chair of the executive board and Nicolai Tangen, chief executive of NBIM in a letter sent to the Ministry of Finance.

“The unlisted equity market has grown rapidly in recent years and accounts for an ever-larger share of the global market portfolio. A broader investment universe will provide more investment opportunities and help the fund benefit from a larger share of global value creation.”

Wolden Bache and Tangen stressed the diversification benefits of investing in private equity, arguing that moving into the asset class now fits with GPFG’s gradual diversification over time. Back in 1996 the fund only invested in government bonds; listed equity was added in 1998 and more countries and market have come online over the years. Unlisted real estate was added in 2010 and unlisted infrastructure in 2019.

The strategy could also tap into NBIM’s decade of experience investing in unlisted markets. “Norges Bank will be able to draw on experience from its existing unlisted investments. This will be relevant in areas such as designing partnership agreements, structuring ownership, accounting, risk management, tax matters, regulatory compliance and reporting.”

All private equity investment would be via managers. And although GPFG will be able to draw on its deep expertise of manager selection in listed markets, a new allocation to private equity will require new hires. “We anticipate around 10-15 employees working on unlisted equity investments in the early phase, and around 20-30 in the longer term.”

Wolden Bache and Tangen rule out investing directly in unlisted companies. “Direct investments would demand considerable and different expertise to that required to invest in or with private equity funds, which primarily requires competence in manager selection. Norges Bank has built up considerable expertise in evaluating external managers in listed markets since 1998 and has good experience with this.”

NBIM would cap investment at 5 per cent in any one fund. To manage country risk, it would invest primarily with private equity funds in developed markets in Europe and North America which mainly invest in companies in the same regions. “In order to avoid too many partners and ensure cost-efficiency, we will therefore invest with mid-sized and large partners,” they add.

GPFG would be able to make much of its advantages, they continue. “Large investors in private equity often have better access to both the best managers and co-investments, and obtain lower management fees,” continuing. “An unlisted equity portfolio of 3-5 percent of the fund will enable us to take advantage of the benefits of the fund’s size and facilitate adequate diversification across managers and vintages.”

Cap on fees?

The letter recognises the resistance to private equity’s high external manager fees – even when these investments bring the fund an excess return after costs. NBIM’s agreements with external managers currently include a cap on fees and the authors acknowledge it is unlikely that a private equity fund will accept a limit on fees, flagging “this requirement will need to be adjusted if the fund invests in private equity funds.”

NBIM will therefore build expertise in its ability to co-invest alongside private equity funds in a bid to reduce fees. “Investors do not normally pay fees on co-investments, and investments of this kind are effective in reducing total fees in relation to invested capital,” they write. “Fees as a share of invested capital will fall proportionally with the share of co-investment.”

Co-investment will involve deciding whether or not to participate in co-investments offered by the private equity fund with the opportunity to opt out. “Investors are typically given ten working days to consider whether to participate in a co-investment.”

“We will build a portfolio of co-investments gradually to ensure diversification across companies, sectors, geographies, and managers. We will acquire non-controlling interests in the companies. The GPFG’s total interest in any one company will not normally exceed 15 percent,” they write.

Transparency

The submission also addressed the MofF fears around transparency given the lack of publicly available information in the asset class and lack of daily pricing. “Norges Bank will set strict requirements for selecting partners, responsible investment and transparency, as well as restricting investments geographically.”

“For unlisted equity investments, reported results will likely be negative in the early years. It will, on average, take longer to sell unlisted equity investments than investments in listed companies, and there is a risk that we will not be able to sell before the lifetime of private equity fund naturally ends.” The board also reassured that the strategy would not increase the equity market risk in the fund relative to the benchmark index.

The latest push by NBIM has raised questions from investment commentators on linked-in, voicing concerns around building an investment program from scratch with annual allocations running into billions. Rob Baur, Professor of Finance, Institutional Investors chair at Maastricht, an expert on the fund,  writes.

“I just wonder how the executive board of Norges Bank dealt with these pro and con arguments in an (academic) evidence-based way. Has this process been spelled out in a formal document? If so, where can I find it?”

Oxford University’s Ludovic Phallipou, a critic of the private equity industry, argued the GPFG is being drawn into the industry by PE fund managers and “sales guys.”