Here Is A Portfolio Model That Works

Includes: FB, IBM, JNJ, KO, PDLI, YHOO
by: Antonio Carradinha

Long-term individual investors can learn an enormous amount by following the right examples when it comes to investing. Though institutions seem to have very different goals and capabilities with respect to building a portfolio, things may be different in a case of absolute excellence in terms of asset management.

The Norwegian Government Pension Fund Global (GPFG) is the largest sovereign wealth fund in the world and individuals could learn a great deal from it.

After discovering its first oilfield in 1969, Norway has created this Fund that received its first sum of money of about $300m in 1996. Now (May 13, 2013), it has a value of more than $750b (NOK 4,313b). The strategy and the philosophy underlying the asset allocation could be used by any individual investor with a portfolio of merely $50,000.

With this investment vehicle, Norway avoided the so-called "Dutch disease." In fact, instead of introducing money from the oil extraction into the economy, it created the Petroleum Fund to manage Norway's resource wealth in a long-term and sustainable manner. Thus, the fund helped to create conditions to ward off the danger of rising inflation and to increase the value of its currency, which would imply a decline in the manufacturing sector. All Norwegians, the current and future generations, will benefit from this huge natural wealth.

But back to the point in question: can the oil fund serve as a model to other investors?

Because of the long-term nature, GPFG has been felt to be more suited to active management. By doing so while investing almost entirely in publicly traded securities, this Fund goes against the principles of the "Yale School." In addition, the Fund does not invest in venture capital, private equities and commodities.

It is interesting to analyze that the fund currently has a very traditional asset allocation of 60 percent in equities, 35 percent in bonds and a target to achieve 5 percent in real estate.

As asset values are continuously changing, it calls on active management with a strategy exempt from subjective decisions. In fact, as equities should make a fixed 60% share of the Fund, if they fell sharply, the Fund had to buy more to keep that target of asset allocation. And it would buy as much as considered necessary with no emotion involved as part of a disciplined strategy. Conversely, if a portion of the portfolio had risen and then exceeded the set limit, the subsequent sale would be mandatory though well safeguarded in terms of management.

It is important to note that this is the right way to buy always low and sell high the required portion of the portfolio.

Another aspect worth considering is the share of 60% allocated to equities. At first glance, it would seem somewhat risky to have such a large stake in equities. On the contrary, well-chosen value and growth companies with large market capitalizations are an excellent long-term investment when we think on a risk/reward basis.

The following characteristics are in summary what we can learn from this "Norway Model," which not only can be applied by any investor, it can make all the difference in the long run:

  • Very long-term investments subject to an active management
  • Equities as the driving force for the increase in value of the Portfolio
  • Diversification of investments
  • Right decision making: to keep the defined target level of assets, it is mandatory to make further purchases when prices are low and additional sales when prices are high.
  • Investing in companies that have solid value and growth potential
  • Getting an increasingly favorable ratio of risk / reward
  • Low management fees

Investment must not only be driven by the right strategy, but there must be a commitment to stick to that strategy even during bad times. There is little evidence that high-beta or high-volatility stocks earn larger returns than their peers: some studies even report the contrary. The most prominent source of systematic return is the value premium. In the future, the fund has endorsed a tendency to raise risks consistent with "risk parity" investing and to avoid a heavy reliance on the equity premium.

Alpha is the excess return of a fund relative to the risk-adjusted return of the benchmark index. Everyone strives for positive alpha, but it is mainly the goal of any portfolio manager. The portfolio itself depends on beta returns (systematic risk or volatility) because a positive correlation between each asset and the benchmark with adequate volatility is what can be manageable. In this case, high beta returns will ultimately lead to superior alpha returns.

In the normal management of the Fund, as it would happen in the portfolio of an individual investor, it is essential to avoid excessively pro-cyclical investing. Rebalancing back to a constant asset mix involves staying on the strategy initially defined in order to resist pursuing asset class winners in recent years. On the other hand, continued emphasis on fundamental research is crucial. In the long run, investors should seek to control fees and cost inefficiency in their portfolios.

As a quick example of such an investment, I would buy Coca-Cola (NYSE:KO), IBM, Johnson & Johnson (NYSE:JNJ), Yahoo (NASDAQ:YHOO), Facebook (NASDAQ:FB) and BioPharma (NASDAQ:PDLI). Bonds, sovereign or not, should have good rating, and a yield far from lows.


This Oil Fund follows a management style that has no complexity and is often universal. The fund emphasizes reducing risk through diversification, and includes almost exclusively publicly traded securities. Being oriented toward the very long-term provides the necessary patience to wait for results, and the ability sometimes to take a contrary investor stance. Such moderate active management is decisive for the choice of assets. Another crucial aspect for the development of the fund is well-defined governance that allows a clear strategy as its guiding principles are met without changes. With the awareness that moral hazard and agency problems must be minimized, short-term thinking is discarded. This approach seems easily replicable by most investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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