From The Economist
SELDOM has a school of thought fallen from grace as fast as that of “efficient markets”, the concept that asset prices already reflect all available information. Yet despite the crisis, the ideas of the Chicago School are still at the centre of a row over the management of the world’s second-largest sovereign-wealth fund.
The Norwegian Government Pension Fund Global, which is more commonly known as Norway’s petroleum fund, looks after some 2.6 trillion Norwegian krone ($444 billion) in savings from royalties on the country’s oil and gas reserves in the North Sea. The fund, which Norway is saving for a rainy day, is already about the size of the national economy and will probably double within about a decade.
For most of the past ten years it has hummed along happily. As Europe’s largest shareholder it has taken its ownership responsibility to heart with typical Nordic earnestness. It regularly writes letters to companies urging them to improve their corporate governance. It also blacklists firms that it thinks are not well-behaved. Among them are tobacco companies and arms producers.
In the years before the crisis, making the world a nicer place was not at odds with making money. The fund comfortably beat the investment benchmarks set for it by Norway’s government. But that all came to a crashing halt in 2008, when the fund’s value slumped by almost a quarter; its equity holdings dropped by around 40%. The absolute fall was no worse than those of many other large investors, yet it prompted soul-searching in Norway. This was partly because losses were far larger than expected for what was thought to be a low-risk investment strategy, and partly because the fund had made some ill-timed bets on banks, including Lehman Brothers.
Shocked, the government asked for a review of the fund’s active-management approach by Mercer, a consultancy, and for a report by three business-school academics—Andrew Ang, William Goetzmann and Stephen Schaefer from Columbia, Yale and London respectively. The three professors found that for all their stock-picking and do-gooding, the fund’s managers could just as well have thrown darts at a board. Taking the crash into account, the oil fund’s performance was essentially indistinguishable from that of a passively managed index fund. “The evidence points to the fact that over time, managers do not provide extra profits,” says Espen Sirnes of the University of Tromso.
How then did the fund manage to beat its benchmarks before the crisis? The professors argue that this was not because of clever share selection but because it took on extra risk by, for instance, investing in securities that are not easily traded or buying bonds of companies that might go bankrupt. They argue that instead of trying to beat the markets, the government should simply have the fund track an index tweaked to take on a bit more risk because of its very long investment horizon.
The fund’s managers have fired back with a 96-page rebuttal of passive investing. Among other things, they say that only fools would buy corporate bonds based on nothing more than their credit ratings. The fund bounced back sharply in 2009, posting a 22% gain in the first nine months of the year. That should help their cause when the Norwegian parliament debates the issue in the spring.