A robust investment strategy with good results

“The returns on the Government Pension Fund Global (GPFG) in 2010 were good. The overall results of the last years show that the large losses during the financial crisis has been more than compensated by the gains made in the subsequent market upswing. One important reason is that we held on firmly to the long-term investment strategy,” says Minister of Finance Sigbjørn Johnsen.

The government today presented the annual report on the management of the Fund to the Storting (Norwegian Parliament).

“A broad parliamentary basis for important elements of the management of our mutual savings is a pre-requisite for safe management in the long-run. It is important that one succeeds in maintaining a long-term strategy, especially when the markets are uncertain,” says finance minister Johnsen.

The total market value of the GPFG increased by NOK 437 billion in 2010, to NOK 3 077 billion (USD 525 billion). The increase was due to transfers to the fund of NOK 185 billion and return on the Fund’s investments of NOK 264 billion.  A strengthening of the NOK reduced the NOK value of the Fund’s investments by NOK 8 billion, but this has no impact on the Fund’s international purchasing power. The management costs totalled NOK 3 billion in 2010.

In percentage terms, the Fund had a return of 9.6 percent in 2010, 1.1 percentage points above the return of the benchmark. Norges Bank Investment Management achieved good results in both the equity and bond management. The Ministry’s long-run expectation is that the bank shall deliver an excess return of around ¼ percentage points annually over time.

“The financial crisis in 2008 resulted in historically large losses, but the subsequent market recovery has also been unusually strong and rapid. If one views the entire period of 2008-2010, the Fund has returned more than NOK 240 billion. Had we reduced the Fund’s risk in either 2008 or 2009, the recovery during the market upswing following the crisis would have been dampened accordingly. There is still much uncertainty about the further performance of the financial markets, and we must be prepared for new periods of volatility," says the Minister of Finance.

The report offers different perspectives on the development of the GPFG’s strategy over the coming years.
“The basis for the strategy work remains to seek to achieve maximum international purchasing power within moderate risk limits. The Fund is managed on behalf of the Norwegian people. A set of common ethical values means that the fund must be managed responsibly,” says finance minister Johnsen.

Current projections show that the GPFG might double by 2020. The investment strategy will also be gradually changing through this period. A portfolio of property investments is in the process of being established. The Fund’s strong growth and large size in itself establish an important backdrop for the future development of the strategy.
“In the report there is a discussion about whether the GPFG should be invested in private equity and infrastructure. There is also a broad review of the Fund’s regional allocations and bond investments. The perspectives this report provides constitute a good basis for the Storting to discuss the development of the Fund’s investment strategy in a broader context,” says the finance minister.

The GPFG’s size, strong liquidity and long investment horizon make it natural to evaluate investments in less liquid asset classes such as private equity and infrastructure. The Ministry considers investments in private equity to be more risky than investments in listed equities and the former should therefore warrant higher expected returns. Historical returns imply that this has not been the case. High management fees are an important reason for this. The Fund’s ability to achieve satisfactory risk-adjusted return after costs is therefore uncertain, even though the GPFG’s characteristics should make it possible to obtain higher return and cost advantages relative to many other investors. There exists limited data on historical returns for infrastructure. Investments in infrastructure have mainly been done through similar fund structures as those of private equity and have many of the same characteristics, such as high leverage and high management fees. The Ministry and Norges Bank are now starting to build up competencies from investments in the largest and most mature unlisted market, real estate. The Ministry’s view is that it is prudent first to gain experience from this market, before including other unlisted asset classes in the Fund’s investment universe. Hence the Ministry is not planning to open up for investments in private equity or infrastructure now.

Geographically, the GPFG’s investments are divided by fixed allocations to three regions: Europe, America/Africa and Asia/Oceania. More than half the Fund’s capital is invested in Europe. Since Europe is the region Norway has traditionally imported the most goods and services from, it has thus far seemed reasonable to think of the emphasis on European markets as a protection of the Fund’s international purchasing power against currency fluctuations.

The review in the report implies that the GPFG’s currency risk is relatively limited, and smaller than previously assumed. Hence the current concentration on European investments seems less warranted. The global production capacity and financial markets are increasingly located in other parts of the world, also in emerging markets. Over time, the relative allocation to Europe should therefore be reduced, and allocations to the rest of the world similarly increased.  This change in the regional allocation will be implemented gradually. Abrupt changes in the Fund’s allocations are not an option. The expected transfers of petreoleum revenues to the GPFG in the years to come should make it possible to achieve the bulk of any changes to the allocations through the addition of new investments, in other words, without selling existing European holdings.

The report also discusses the long-term strategy for the composition of the Fund’s fixed income portfolio. The Ministry has received advice on the topic in the form of a report from two external experts, Professor Stephen Schaefer and Dr Jorg Behrens, and a letter from Norges Bank. Both documents are presented in the report. The documents amongst others concern the potential for bonds to contribute both to traditional risk diversification and to the collection of specific, long-term, risk premia. The analyses show that these risk premia are complex to define, isolate and measure. They are also likely to be time-varying.

“We do not now propose any changes to the overall fixed income strategy, but we will continue to assess whether this strategy should be altered to better achieve the full potential of the assets class’ diversification properties and ability to collect specific risk premia. We will also consider whether the bond portfolio should be split into one core portfolio and one or more side portfolios, so called satellites. The Ministry will consider adjustments to the fixed income management mandate and benchmark, but will not make substantial changes without further parliamentary deliberations,” says finance minister Johnsen.

Read more:

• Report No. 15 to the Storting - Management of the Government Pension Fund in 2010 
  (Full version - updated 7 June 2011)  
• Reports and letters