Editor’s comment: The Norway oil fund report that challenges ethical institutional investment

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The report issued today by the Strategy Council to the Norwegian government on the future of responsible investment at the Norwegian Government Pension Fund – Global (GPFG), could, RI believes, be hugely important. It behoves everyone involved in responsible investment to read it. If adopted, it could herald the end of ethical investment at the core of the fund’s strategy (incarnated by the fund’s Council on Ethics) and a significant shift towards investment materiality tests for ESG issues followed by highly focused engagement and exclusion as a weapon of last resort. The document is well written. At its heart is a valuable re-iteration of the enlightened self-interest in responsible investment that long-term asset owners should apply: duration investment in a world of damaging short-termism does not compute. But as it notes, some funds have an onus to be more responsible than others, and particularly in Norway where, as it points out, responsible investment practices and transparency are prerequisites for support from the socially orientated Norwegians. However, the report also provides a reality check on whether ESG information is or isn’t material to investors. It says: “It is not clear from an academic perspective how (or whether) these ancillary issues actually affect asset prices and portfolio returns. The efficient market view suggests that when an issue emerges as being important for firm value, it will be impounded into share or debt prices. Moreover, if the issue is considered to have the potential to influence a firm’s future performance, the probability of such an effect will already be priced into the firm’s securities.” Some in the RI world will debate the premise, which is dependent on investment timeframe and research quality. But it broadly fits with the circular mainstream argument about whether active investment management outperforms. Indeed, the report points out that the GPFG is – with expected assets of $1trn by the end of2019 – a giant beta investor; hence its vital self-interest in the sustainability and integrity of markets and economic growth over time. Where the report marks a serious philosophical departure for GPFG is in its recommended shift from ethical oversight to a combination of intensive ESG materiality analysis followed by dedicated, detailed corporate lobbying using the fund’s asset power. As it points out: “The GPFG has significant holdings in many companies and is often among the firm’s largest owners. At the end of 2012, the Fund had stakes of more than 2 percent in 891 companies and exceeded 5 percent ownership in 34 companies.”
Page 21 neatly demonstrates the recommended chain of influence from ESG materiality evaluation, to prioritizing issues, to focused engagement, to exclusion as a last resort, and within one body, Norges Bank Investment Management (NBIM), manager of the fund’s assets, thus doing away with the Council on Ethics, which the report says has led to a significant overlap of resources. As a means of balancing the need for transparency against what it calls “the necessary discretion” of engagement, the report says NBIM could publish aggregated, but informative, summary reports on its corporate lobbying. What about ESG issues that may not be directly material to investment but socially important?
The report says asset management should not be regarded as an alternative to the government’s addressing of political dilemmas. RI, last week, pointed up the most flagrant example, whereby Norway has had a 30-year, multi-billion dollar relationship with US defence contractor Lockheed Martin, a firm which is excluded by GPFG for its links to weapons that may violate humanitarian principles. Can a country both apply and not apply international norms at the same time? Another realpolitik angle is that the fund’s ethical stance has in the past led to diplomatic stand-offs; a position that the new
right-of-centre Norwegian government is likely to want to avoid. Indeed, the report suggests that Norwegian companies have been at the receiving end of tit-for-tat reprisals because of GPFG’s ethics. At the other end of the spectrum, the report says the Norwegian Ministry of Finance is increasingly challenged by NGOs for slow adoption of exclusions proposed by the Council on Ethics. In short, the report suggests the fund’s ethical position is a political football, which could become more problematic if further exclusions (around 60 companies are excluded at present) begin to strain the idea of efficient portfolio management. It concludes: “Given these considerations, a general need for clarity in the fund’s investment mandate becomes critical.” As opposed to being seen as the great excluder, the report suggests GPFG should act as a bulwark on ESG research at the portfolio and societal level. This would give the fund a dual role as a blueprint for responsible investment and the instigator of global policy discussions on sustainable finance. The report could be said to take a leaf from Teddy Roosevelt’s “speak softly but carry a big stick” aphorism, which so often has it’s long-termist ending “and you will go far” truncated.
On a practical level though, the report provokes questions, not least the mechanism by which this new focused integration strategy will actually feed into asset manager contracts.The report notes: “If the owner pursues a strategy that seeks to outperform through active portfolio management, it is potentially useful to integrate ancillary issues (e.g., relevant ESG considerations) into investment decisions at the security level. On the other hand, if the owner believes that the Fund will achieve its best performance through index replication, then market-wide initiatives are likely to be particularly important. Examples of the latter include improving corporate transparency, ensuring fair business practices, pricing externalities, and improving capital market quality and efficiency.” That’s a statement that needs some meat putting on the bones. Another question is what happens to the fund’s current exclusions? If the report is right, couldn’t the excluded companies be better approached through a renewed, re-focused engagement programme, or will they stay blacklisted? The bigger question though will be whether Norway’s politicians and people decide to choose responsible investment pragmatism over more visceral ethical exclusions that capture the public imagination. Whatever Norway decides, the ramifications will be felt globally given the sheer size of GPFG, making it not just a question for Norway but for us all.
Link to Strategy Council report

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