Norway's SWF Worried About Inflation?

aiCIO reports, Norway's SWF Seeks Real Estate, Flees Bonds:

In a move to combat rising inflation, Norway's Government Pension Fund Global, valued at $548 billion at the end of last year, is slashing its bond holdings and shifting to real estate.

The move reflects efforts by Norway's government-run oil fund, the world's second-largest sovereign-wealth fund, to increasingly invest in real estate, infrastructure and other assets that have been viewed as hedges against inflation. The decision also reflects the improvement of real estate since the financial downturn.

"We had about a 40% drop in property valuations from its peak in 2007 to the bottom of the cycle which occurred in the beginning of 2010," Mercer's Allison Yager told aiCIO. "Since then, investors have returned to the real estate market and made sizable commitments, but there's no way to know if we'll ever return to the pre-crisis peak."

While the Norwegian fund has traditionally had 60% of its assets in stocks and 40% in bonds, it now seeks a roughly 5% allocation to real estate and plans on lowering its fixed-income exposure by the same percentage. The fund's first real estate investment was announced in November 2010.

The sovereign wealth fund aims to initially concentrate its real estate portfolio on Europe. "It's quite possible that we will increase real estate as a portion of the fund when we reach the 5% target," Yngve Slyngstad, chief executive of Norges Bank Investment Management, the unit of Norway's central bank that manages the fund, told The Wall Street Journal. Furthermore, Slyngstad indicated that the fund is eyeing infrastructure.

A recent report by Prequin further illuminates the growing attractiveness of real estate among institutional investors. According to a report issued by the firm earlier this month, there has been an increase in the proportion of sovereign wealth funds investing in real estate and private equity – 51% to 56%, and 55% to 59% respectively. Separate findings by Credit Suisse reveal that bond investors should expect less robust returns in the years ahead. According to its report, bond investors can’t expect bonds to outperform forever. The authors found that bond investors should not expect returns for the next 11 years to be as strong as those of the previous 11 years, largely as a result of rising inflation.

Last week, the Norwegian fund revealed in its annual report that it returned 9.6% in 2010, fueled by gains in global stock and bond markets. Its equity holdings achieved a return of 13.3% last year, while bonds gained 4.1%. The positive returns marked the fund's fifth best performing year ever.

Drew Carter of Pension & Investments reports, Norway fund returns 9.6%, assets up 16.6% in 2010:

Government Pension Fund-Global, Oslo, returned 9.6% on investments in 2010, driven primarily by rising worldwide stock market values, the sovereign wealth fund reported on Friday.

Assets rose to 3.077 trillion Norwegian kroner ($552 billion) as of Dec. 31, up 16.6% from a year earlier.

The fund’s equity portfolio returned 13.3%, while bonds returned 4.1%.

The 2010 performance topped that of its custom benchmark by 1.1 percentage points. In 2009, the fund outperformed its benchmark by 4.1 percentage points.

Equities and bonds outperformed their respective benchmarks by 0.7 and 1.5 percentage points in 2010.

Equities and bonds made up 61.5% and 38.5% of total assets, respectively, vs. 62.4% for equities and 37.6% for bonds a year before. During 2010, 85% of cash inflows to the fund were invested in bonds to bring the mix closer to its target allocation of 60% equities, 35% to 40% bonds and up to 5% real estate. The fund’s first investment in real estate, a new asset class added in 2010, is expected to close this spring.

Inflows from the government’s sale of petroleum resources further boosted assets at the fund by 182 billion kroner, up from 169 billion kroner in inflows a year earlier.

Chris Panteli of Global Pensions added that this was the fund's fifth highest return ever:

The 264bn kroner return marks the fund's fifth best performing year ever, said Norges Bank Investment Management (NBIM), which manages the fund.

Equity holdings returned 13.3% over the year, measured in international currency, while fixed-income investments returned 4.1%. The overall return was 1.1 percentage points higher than the return on the fund's benchmark indices.

"In a year marked by the European sovereign debt crisis and fears of an economic slowdown in Europe, the fund posted its fifth-highest result ever," said NBIM chief executive officer Yngve Slyngstad.

"Globally, stocks and bonds gained last year, helped by improving company profits, low interest rates and stimulus measures from the European Central Bank, the Bank of Japan and the US Federal Reserve. The fund also benefitted from its long-term approach, as large equity purchases during the financial crisis in 2008 and in the first half of 2009 yielded solid returns. The value of our fixed-income investments also continued to recover after steep price drops two years earlier."

The fund's best-performing stock sector was basic materials, followed by the industrial and consumer goods sectors. The biggest-gaining stock investments, measured in krone returns, were food company Nestlé, Apple and oil producer Royal Dutch Shell. The weakest performers were Banco Santander of Spain, oil company BP and Banco Bilbao Vizcaya Argentaria of Spain.

The fund held shares in 8,496 companies and 8,659 bonds from 1,686 issuers at the end of 2010. Equity investments accounted for 61.5% of the fund's investments, while fixed-income investments made up 38.5%.

The fund's first real estate investment was announced in November 2010 as part of its strategy to exploit the fund's long-term investment outlook.

The market value of the fund rose 437bn kroner to 3,077bn kroner at the end of the year. Capital inflows from the government amounted to 182bn kroner in 2010.

Finally, LingLing Wei of the WSJ reports, Norway's Sovereign Fund Moves to Cut Bond Position:

Norway's government-run oil fund, the world's second-largest sovereign-wealth fund, is cutting its bond holdings and shifting its investments to real estate to protect itself against rising inflation.

The Government Pension Fund Global, valued at nearly 3.1 trillion Norwegian kroner ($548 billion) at the end of last year, historically has invested 60% of its assets in stocks and 40% in bonds. It now aims to gradually invest as much as 5% of its assets in real estate while reducing its fixed-income investments by the same percentage.

Yngve Slyngstad, chief executive of Norges Bank Investment Management, the unit of Norway's central bank that manages the fund, said it will take time to build up the fund's real-estate portfolio, which initially will focus on Europe. "It's quite possible that we will increase real estate as a portion of the fund when we reach the 5% target," Mr. Slyngstad said in an interview.

He also said the fund is looking at infrastructure as well, which typically includes toll roads, airports and other assets that produce a steady stream of income over long periods of time.

The fund's move comes as a growing number of sovereign-wealth funds and state-run pension plans are rejiggering their portfolios to protect against inflation, analysts say. These megafunds, among the world's largest investors, increasingly are looking to invest in real estate, infrastructure and other assets that traditionally have been viewed as hedges against inflation.

According to a study by data tracker Preqin of 59 active sovereign funds, the number of these funds investing in property has increased to 56% at the beginning of this year from 51% last year, and the number of them investing in infrastructure has jumped to 61% from 47%.

Real estate and infrastructure have historically performed better than bonds in extended periods of rising prices. That is because inflation usually leads to rising interest rates, which cut the value of bonds because interest payments are fixed. Rents tend to rise in times of inflation. Infrastructure contracts also often include provisions for inflation adjustments.

Inflation concerns stem from growing budget deficits and loose monetary policies in developed countries and rising demand in developing markets. On Friday, China, which is fighting inflation, raised banks' reserve requirements for the third time this year.

"Investors globally are concerned about inflationary pressures arising out of significant monetary injections by central banks," said Zubaid Ahmad, global head of sovereign-wealth funds at Citigroup Inc.

Funds eyeing property investments also include South Korea's National Pension Service, with more than $250 billion in assets, and China's $300 billion state-run fund, China Investment Corp.

In recent years, countries from the oil-rich United Arab Emirates and Norway to big exporters like China have been funneling oil revenues or trade surpluses into wealth funds rather than government securities in a bid to seek higher returns. Assets managed by these state-run funds now total about $4 trillion, led by the $630 billion Abu Dhabi Investment Authority, the world's largest fund, according to Preqin.

The Norwegian fund draws its capital primarily from the country's oil sales. It returned 9.6% in 2010, driven by gains in global stock and bond markets, according to the fund's annual report released on Friday. Its equity holdings scored a return of 13.3% last year, while bonds gained 4.1%.

The fund is expected to close its first property deal by the end of this month—a £452 million ($745 million) investment in some 113 office and retail properties on London's Regent Street, one of the city's busiest shopping areas.

As the fund invests globally, it has extensive investments in foreign currencies including euros, pounds, dollars and yen. A slightly stronger kroner reduced the fund's market value by 8 billion kroner last year.

Mr. Slyngstad said the fund also is reshaping its "currency composition and duration of bond holdings" as part of its efforts to protect against inflation.

You can read more on the fund's 2010 performance on NBIM's website. The big question is whether the Norwegian fund and other large global mega funds are right to be worried about inflation, getting out of bonds and investing billions into real estate, infrastructure and other alternative asset classes including commodities. I'm not so sure. There is inflation in emerging markets stoked by the Fed's QE policy and now seems like the perfect time for funds like CPPIB to buy up US real estate. But the idea that we're headed towards some major stagflationary episode just doesn't sit well with me.

When I was in Albany, NY this weekend, I had a drink at the hotel bar and asked the bartender what he thinks of the US economy. The chef overheard our conversation and joined in. The television was showing images of the US military planes bombarding Libya. The bartender looked at me and said: "I wish we stopped worrying so much about what's going on outside our country and started worrying a lot more about what's going on here. There is a lot of unemployment, people are hurting and all Democrats and Republicans are doing is squabbling among each other." The chef nodded in agreement as if to say it's not getting better.

As I was leaving the hotel room, PBS was playing a special with financial expert Suzie Orman, The Money Class. I'm not a big fan of these so-called financial experts but she's pretty decent at offering good advice (but she's also dispensed some bad advice too!). Anyways, I listened to some pretty sad stories but one in particular got to me. Some middle-aged man called Larry, lost his job, went back to school to complete his Masters and now owes more than $120,000 in student loans. This poor man is earning a little more than $20,000 a year. He's never going to get out of debt!

And there are millions of people like Larry out there, indebted up to their eyeballs, living paycheck to paycheck. I guess you can say inflation will help banks and the government inflate away their debt, but for regular hard working folks, after they're done paying the rent, buying groceries, gas and clothes, they won't be saving much to pay off their debts. All this to say that while inflation remains a concern as the Fed keeps printing and emerging markets overheat, I'm not willing to proclaim the end of the bond bull market. Not by a long shot.