The Norwegian Government Pension Fund Global (GPFG) has announced that it will diversify its investments into alternative assets, but has rejected private equity in favour of real estate due to supposedly poor returns. 

The fund's recent annual report revealed its total market value increased by NKr437bn (€55.4bn) to NKr3077bn. The increase was due to transfers of NKr185bn and returns on investments of NKr264bn. The strength of the Norwegian krone reduced the value of the fund's investments by NKr8bn.

According to the report, the GPFG's size, strong liquidity and long investment horizon calls for an evaluation of investments in less liquid asset classes such as private equity and infrastructure.

Private equity investments have been labelled by the fund as more risky than investments in listed equities and because of that should warrant higher expected returns.

However, historical data has shown this has not been the case and high management fees are cited as an important reason for this. The statement continues that the fund's ability to achieve satisfactory risk-adjusted returns after costs is therefore uncertain, even though the GPFG's characteristics should make it possible to achieve higher returns and cost advantages relative to other investors.

“The basis for the strategy work remains to seek to achieve maximum international purchasing power within moderate risk limits. The Fund is managed on behalf of the Norwegian people. A set of common ethical values means that the fund must be managed responsibly,” said Minister of Finance Sigbjørn Johnsen.

The Ministry of Finance and Norges Bank are now starting to build up in the real estate market. The Ministry believes it is best practice to gain experience in real estate first before including other unlisted asset classes in the fund's investment sphere.

“In the report there is a discussion about whether the GPFG should be invested in private equity and infrastructure. The perspectives this report provides constitute a good basis for the Storting [Norwegian Parliament] to discuss the development of the fund’s investment strategy in a broader context,” the finance minister added.

The report is supported by numerous research documents and letters to aid the Storting in its discussions concerning the fund's future. One report in particular is written by Ludovic Phallippou and evaluates the potential for the GPFG to achieve above-average returns from investments in private equity.

His report compares the GPFG to Calpers as they are of a similar size and observes that their returns from private equity are close to returns from public equity. The report recognises that “the future may be different from the past... Historically, when little capital is allocated to a private equity segment (e.g. venture capital) expected returns are high, probably because there is always a steady flow of future Googles and Starbucks out there awaiting venture capitalists. Thus, while knowledge of past returns is apposite, these past returns should not be too naively extrapolated into the future.”

The final section of the report details the fees charged by private equity funds. “Three points are worth noting. First, fees are not a function of public equity returns. This means that high fees can be charged for high returns even though these returns are inferior to those of public equity. Second, the fixed component of the fees is large. It means that an investor can be charged three per cent per year even though the fund has negative returns, a situation that can also be encountered with certain mutual funds or hedge funds. Third, a large portion of the fees in eight buyout funds comes from portfolio company fees, which are the consulting and advisory fees that the fund might charge to the portfolio company. These fees are not directly visible for investors, are mainly at the discretion of the fund and can be quite substantial.”