It Is A Great Idea For Norway’s $1 Trillion King Kong SWF To Have A 70% Stock Allocation, So Stop Pretending Like It Isn’t

So the story remains the same for equity demand: buybacks and the active-to-passive shift or, put differently, the indiscriminate, price-insensitive funneling of cash into overvalued shares.

That’s from a post we did on Saturday, bemoaning the fact that the lion’s share of U.S. equity demand emanates from the sources that are almost by definition not concerned with valuation. Here’s the chart from Goldman for those that might have missed it:

There’s no price discovery here. It’s just corporate management teams leveraging the balance sheet and investors blindly chasing the rally via ETFs.

Passive flows and the corporate bid are part of what we’ve called “the wave paradox.” It’s no longer possible for anyone to discern whether they’re riding the wave or creating the wave they’re riding. There’s no semblance of analysis in these flows.

“And what should we think about the willingness of investors to turn over their capital to a process in which neither individual holdings nor portfolio construction is the subject of thoughtful analysis and decision-making, and in which buying takes place regardless of price?,” Howard Marks asked earlier this year, in what was a hotly-debated missive that included a characterization of today’s markets as something akin to the perpetual motion machine that drove the dot-com euphoria.

But passive flows and buybacks aren’t the only contributors to this dynamic. Don’t forget about the largely price insensitive bid from sovereign wealth funds. Let’s bring in some excerpts from our original “wave paradox” post:

The entire market is subject to this phenomenon. And everyone from the whales to the minnows are unwittingly participating in it.

For instance, Norway’s $950 billion-ish sovereign wealth fund (the largest on the planet) seems to have lost track of whether they’re riding the wave or creating the wave they’re riding.

“We don’t have any views on whether the market is priced high or low, whether bonds and stocks are expensive or cheap,” Trond Grande, the fund’s deputy chief executive said recently.

Well Trond, that’s interesting considering the fact Norway is getting ready to up the fund’s equity allocation to 70%, a level that’s probably more appropriate for a twenty-something bartender looking to invest his first $10,000 than it is for the world’s largest piggy bank. The one that is supposed to safeguard Norway’s oil wealth for future generations.

If you look at what’s behind the allocation decision it’s clear what Norway is doing: they started making withdrawals from the fund last year to plug budget gaps created by the downturn in crude prices and with returns suppressed by low rates on the fixed income side, they’re simply trying to juice profits by buying more stocks. Then they’re arming ol’ Trond with a bunch of amorphous aphorisms that sound like they walked out of a market-themed Barnes & Noble calendar, and trotting him out to reassure the world that Norway isn’t getting reckless.

Bottom line: clearly Norway “has a view” on where stocks are going and while it’s probably true that they think equities have room to appreciate further based on how expensive bonds are, if you’re managing nearly $1 trillion and your equity allocation is 70%, it would be easy to mistake the impact of your own investment decisions for evidence that those decisions were good ones.

Well guess what? Norway’s SWF just returned 3.2% in Q3 thanks to the giant equity holdings which gained 4.3% over the period. Look at the size of this fucker:

It’s worth $1 trillion. And as you can see, the equity allocation is enormous. It’s at 66% now, and as noted, it’s on its way to 70%:

Here’s a chart which illustrates the point made above about how Norway started making withdrawals to plug budget gaps for the first time last year:

 

And here’s a look at the fund’s largest equity holdings:

Just to drive the point home: this fund now owns something like 1% of global stocks all by itself.

Now you might be asking this: at what point does this turn into a public stock fund where the bond allocation is just there to hedge the equity exposure? Well, the answer would apparently be: “right now”. Here’s CEO Yngve Slyngstad:

60 to 70 percent in equities — imagine it was 60 to 80 or 90 percent — the whole thing is that this fund is actually to a large extent now a public equity fund. We don’t think about this as two separate asset classes that have their distinct dynamics, the real risk of the fund is in the equity market.

And he says that like it’s somehow a good thing.

Not only that, they’re also starting to bully companies around, which I guess is fine if they’re pushing for shareholder-friendly initiatives, but Christ almighty, they own on average 1.5% of every listed company on the planet. Here’s FT:

The world’s biggest sovereign wealth fund is declaring victory in its attempt to become a more active and influential investor on corporate governance.

Norway’s $1tn oil fund unveiled a groundbreaking plan two years ago to publicly disclose how it would vote ahead of companies’ annual meetings and expected to do so initially 20 times a year and more after that.

Instead, this year it has just published its intentions early three times – over the Linde-Praxair merger, pay policy at Royal Bank of Scotland, and shareholder proposals at Monster Beverage.

Yngve Slyngstad, chief executive of Norges Bank Investment Management, which manages the fund, told the Financial Times: “It has been more effective than we thought.” 

Yes, “it’s been more effective than we thought” – imagine that! Here’s a bit more:

The oil fund has voted against some of its biggest shareholdings at annual meetings this year including Apple, Facebook, Amazon, Alphabet, Novartis and HSBC. It is also pushing companies on executive pay. Mr Slyngstad said the fund wanted to keep the ability to pre-announce its voting intentions even if it had used it “way less” than expected.

“It is a sharp tool, not a blunt tool. So we are trying to use it carefully,” he said, adding that the fund wanted to use it above all in cases where it highlighted a principle, not just something it disagreed with.

So this is just a massive activist hedge fund. Only it’s not. It’s supposed to safeguard the wealth of an entire country and instead its raising its allocation to equities to 70% at a time when it already owns 1% of global stocks and at a time when those same global stocks are in a bubble.

But it gets worse. Remember what we said about this back in August:

Ok so the problem with all of this should be glaringly obvious: if that fund is being used to plug budget gaps and the fund’s managers are under pressure to increase its exposure to stocks in order to generate higher returns, then fiscal policy is by definition becoming increasingly beholden to the vicissitudes of global equity markets.

Here’s what Deputy central bank governor Egil Matsen said last year:

Say you have a decline in the equity market, and these returns have been partly funding the government, do you want variations in international financial markets to have a direct impact on fiscal policy?

Allow us to answer that: “no, you do not.” Because that would be a fucking disaster of truly epic proportions.

And see they know this, but they’re going to go ahead and keep pushing the envelope anyway. Here’s what the above-mentioned Yngve Slyngstad says in the letter that accompanies the latest quarterly report:

We must be prepared for volatile stock markets, and can not expect such a return every quarter.

Right, and it would be fine to say that if you were an actual hedge fund that wasn’t being tapped to fund government spending. The future of the country of Norway literally depends on this $1 trillion monstrosity and they’re dumping 70% of it into global equities at all-time highs.

Nothing further.