The world’s biggest sovereign wealth fund has obtained by far the biggest chunk of its excess return from emerging markets, and a major contributor to that has been its use of local asset managers for single-country mandates in countries such as China.

Norway’s famously transparent $1 trillion oil fund, Norges Bank Investment Management (NBIM), has continuously adapted its approach to external managers since its inception in 1998, as it outlined in detail in a 164-page report last week.

And Asia has become a key focus; the region accounted for a little over half of all the fund's roughly 260 external mandates in 2018 (see figure 1 below). It has invested in single-country mandates in markets such as Malaysia, the Philippines, Thailand and Vietnam, for instance.

Yngve Slyngstad

“Most of our external [active] mandates are in emerging markets, where it’s obvious you have some weaknesses in index construction, large corporate governance challenges and of course countries under constant evolution,” said Yngve Slyngstad, NBIM’s outgoing chief executive, in a presentation on the report’s launch.

These are three reasons why it can make sense to manage allocations to different emerging markets idiosyncratically and actively, he added.

NBIM started out using larger asset managers, but has gradually hired more and more smaller, boutique firms, increasingly in emerging markets.

The sovereign fund has found that privately owned asset managers – typically smaller firms with some 10 to 50 staff – are best able to generate excess return, Erik Hilde global head of external strategies, said during the presentation alongside Slyngstad.

FIG 1: NBIM'S EMERGING MARKET MANDATES
(Click for full view; Source: NBIM)

A major benefit of this that “when we meet them we meet and know most of the guys working in this organisation”, added Hilde, who selected NBIM’s first mandates alongside Slyngstad in 1998.

Erik Hilde

The approach has paid off. Between 1998 and 2018, active equity managers in emerging markets brought NBIM an annual excess return of 4.2% before fees and 3.5% after fees (see figure 2 below). That compares to an overall annual excess return from active equity managers of 2.1% before fees and 1.8% after.

Of course, as NBIM has invested more emerging and frontier markets, the issue of corporate governance became more and more important, Slyngstad said.

Indeed, it seems that picking the right manager in markets where the risk of corruption is higher, for instance, can be especially fruitful, NBIM’s research shows (see chart).

“Things like corruption influence the ability for managers to do well,” Slyngstad said. “Some seem to do better the more challenging the markets are.”

FIG 2: NBIM'S CUMULATIVE RETURNS BY STRATEGY
(Click for full view; Source: NBIM)

Hilde agreed that local managers helped the fund avoid companies with corporate governance issues and to identify those with sustainable business practices.

For instance, Shao Chingxiao, managing partner at Shanghai-based Red Gate Asset Management, which has run a China equity mandate for NBIM since 2011, explained which stocks her firm looked to avoid.  

They include those that raise equity and debt frequently; those with higher profit margins than its competitors that cannot be explained logically; those that constantly change their chief financial officers and auditors; and those that have very complex corporate structures.

Moreover, Shao said during the NBIM presentation, Red Gate wants to see “transparent and ethical” management at the company that is able to show how it can create long-term, sustainable earnings.

“So questionable companies are very difficult to access, they are not transparent with their activities, they engage in illogical business strategy, and they love M&As and expanding into areas where they are not supposed to be.”

Field trips play a very important part of investment process, she added.

This story has been updated to include the mention of NBIM's single-country Asean mandates.