Denial – Norway’s Oil Fund and the facts

Recent publication of a report by three leading international academics has caused a stir concerning the world’s second largest sovereign wealth fund. The purpose of the report was to examine whether the fund had received any benefit from its use of ‘active’ management. The conclusions for those of us who believe in the efficacy of passive investment strategies was hardly a shock. The professors concluded that the fund had only benefited to the extent that the use of active management had given it exposure to certain systematic risk factors in the market. These are risks that if properly managed would appear to be worth taking such as a higher exposure to small and value companies than one gets through traditional commercial indices. Further the professors concluded that the fund did not to use active managers to access these risk factors. I would agree entirely. These index tilts towards small and value have been accessible for a number of years through funds with extremely broad universes of stocks to choose from. These funds are completely agnostic about which stocks they own as long as the stocks have the desired characteristics and as such are passive compared to traditional actively managed funds which still believe in stock selection.
Sadly the head of the Oil Fund seems to have taken these conclusions as an attack on the way in which he and his team are managing the fund. Given that they are responsible for only 1% of the active management this is probably not fair – they are only executing the misguided and unrefined guidelines of the Finance Department’s advisory panel to the fund. He however compounds his error by maintaining that active management should continue to be used to reduce risk!!!! A better approach in my opinion would have been to be more open minded to the academics’ suggestions. The fund is large enough and staffed by enough competent people to be able to execute properly on exploiting systematic risks without resorting to traditional active management. It would seem that yet again highly educated professionals refuse to make changes even when confronted by overwhelming evidence that attacks ideas which have become so deeply ingrained that they are now beliefs.
The report raises the issue as to whether the guidelines laid out by the Norwegian Finance Department, which sets the management guidelines for the Oil Fund, are actually subtracting from the return that could be earned for the fund’s potential beneficiaries, the Norwegian people. Proper fiduciary responsibility should dictate that they seek to eliminate the unnecessary costs of active management whilst at the same time refining the way in which the fund is managed to properly exploit those risk factors which may produce extra return.
Hopefully we will see the management of the fund refining its investment mandate in a direction which is more responsible and appropriate in terms of protecting the interests of its external stakeholders.