Investing for the long run

Ladies and gentlemen,

It gives me great pleasure to welcome you to this high-quality investment seminar, where we are focusing on issues relevant to the Government Pension Fund.

2008 was a turbulent year for the fund. By choosing the title “Investing for the long run” for the seminar, we hope to turn the discussion slightly away from the day-to-day headlines in the financial press. Instead, we would like to focus on the longer-term aspects, which after all characterize this fund. I therefore look forward to panel discussions on investment strategies for long-term investors and lessons from the financial crisis.

As the fund’s owner, I have had to spend a lot of time and effort this past year explaining to the public that our fund is managed in a sound and prudent manner. Since the fund has a long investment horizon, and is big and slow moving like a super tanker, we have to be willing to accept large changes in the fund’s value in the short term when a financial crisis hits.

I admit I am sometimes tempted by the thought of having a little less transparency in the management of the fund. It would perhaps have made my working days a little easier. But such temptations are quickly outweighed by all the benefits of transparency. In fact, openness about all aspects of the management of the fund is a precondition. Without transparency, I cannot imagine that the strategy for the fund would be sufficiently robust and have the necessary legitimacy.

Transparency – in the form of a seminar like this – is a disciplinary mechanism. It allows interested professionals to get engaged in the management of the fund, and provide public feedback on the appropriate investment strategy.

Transparency is also important because it builds trust. It is an important ingredient in securing the broad public support that is necessary to carry out a wise and long-term strategy for managing the petroleum wealth. Otherwise, a period of market turmoil could result in the fund’s long-term investment strategy becoming embroiled in short-term populism. That could lead to major changes that would not be in the long-term interests of the fund or its stakeholders. A robust investment framework, as well as a strong support from the owners, makes us better equipped to stick to the right strategy through changing circumstances.

For example: The fund had very poor investment returns last year. But there is still broad political support for the fund’s long-term investment strategy. I think this reflects all the time and effort that has been spent anchoring with Parliament and the broader public the investment strategy of the fund. This makes all the stakeholders feel a sense of ownership to the strategy.

The area where we have had the most public criticism instead concerns active management, an area which is far less important in terms of the fund’s total investment risk. In addition to the important lessons the active manager has learnt about risk management, one could also say that the strategy for active management was not sufficiently well anchored with the broader public. Stakeholders have not felt a strong sense of ownership to the strategy of active management.

In order to address this, we will in the coming year have a thorough assessment of whether and what kind of active management we want to have. This assessment, followed by public consultation, will provide the basis for a robust strategy that can stand the test of time.

So from my perspective, an important lesson for investors from the financial crisis is to have a good and robust investment strategy that has the strong support of its owners. To achieve this, we need a sound governance system that can deal with risk.

The first thought that normally springs to mind when you mention the word “risk”, is the management of financial and operational risk. This is indeed a challenging area that deserves attention and resources. Recent history has shown weaknesses in the use of quantitative risk models. Perhaps more importantly, we have seen weaknesses in the qualitative understanding of risk in many organizations.

But this is also an area that many organizations, as well as an army of consultancy firms, now have on their radar screens. In addition to risk management within the investment operations, I would like to add that there is also a need to focus on risk management at the national level.

Risk management is all about identifying your risks and controlling them. In that process one needs to be both creative and rigorous. We cannot allow ourselves to be too vulnerable.

In a way, our fund is in itself a risk management tool. It has been established to address the risk stemming from incomes from natural resources. By transforming petroleum reserves into a diversified portfolio of financial assets, the fund contributes to spreading risk. By providing sustainable financing to the state budget, the fund contributes to economic stability.

If we look at the developments in recent years, the importance of dealing with uncertainty and risk has indeed been highlighted. Many oil funds saw a sharp drop in net inflows as export revenues shrank and domestic expenditures rose. In addition, there were very weak returns on most assets, as well as operational challenges arising from a financial system in distress. Together, it became clear that many funds would get a serious test of the robustness of their governance arrangements.

There are many similarities between managing public money and private money. One such similarity is the need to enlist the owners’ support for the investment strategy, in order to ensure the necessary robustness through a cycle. Building support and trust from owners and stakeholders is a continuous process. It is often a long time lag between input and result.

But for a sovereign fund there is often a higher degree of public scrutiny than for a private fund. There is therefore a greater need to participate in the public debate.

It can be demanding to invite political representatives to have an informed debate about key investment strategy issues. But for us it is at the same time a precondition, if we are to achieve a good and sustainable outcome. So transparency is an important part of our risk management strategy at the national level.

Another important risk factor for us all, be it as citizens of the world or part-owners in a fund with a very long investment horizon, is climate change. Climate change can have wide-ranging consequences for the world economy and financial markets.

This government takes climate change seriously – also in the management of the Government Pension Fund. As a broadly diversified and long-term investor, the fund has an interest in avoiding negative economic and financial repercussions of climate change.

On the 3rd of April we presented our annual report to the Storting on the management of the fund. In this year’s report we detailed plans to establish a new environmental investment programme, and to initiate a broad study of the possible effects of climate change on global capital markets. We also want to strengthen the focus on issues related to climate change in Norges Bank’s work on engaging with companies. Together, it is my hope that these measures will position the fund among the leading funds internationally in this area, and that we will inspire other investors to address the issue of climate change.

Given the strength of the scientific evidence linking human activity with climate change, and the associated economic, social and political risks, I believe it is prudent for fiduciaries of financial institutions to consider the implications of climate change for strategic asset allocation decisions.

I can now make public that we, together with the consulting firm Mercer, are taking a leading role in launching a comprehensive research project in this area. The project is aimed at assessing the impact of climate change on financial markets, as well as implications for strategic asset allocation. More specifically, the project aims to develop a methodology for conducting scenario analyses, and to identify risks to long-term financial investments, across asset classes and geographical locations.

Traditional strategic asset allocation modelling approaches have not taken climate risks, or opportunities, sufficiently into account. This project seeks to address that gap. This is an ambitious and complex task, which is more efficiently undertaken in collaboration with others. I will therefore encourage large institutional investors and industry thought leaders worldwide to join forces in this project. Together we need to develop the tools and critical thinking that is required to understand the financial implications of climate change. 

We may hear more on this issue of climate change at today’s session on implementing responsible investment strategies. But before that, I am looking forward to hearing distinguished academics and practitioners share with us their views on “Investment strategies for large long-term investors”, “Lessons for investors from the financial crisis”, and “Strategic Currency Allocation for Resource Funds”.

I would also like to remind you that this seminar is meant to be an occasion for meeting, mingling and informal discussions. In addition to coffee breaks, we have a fair bit of time over lunch as well as dinner. At that time our central bank governor, Mr Svein Gjedrem, will take the opportunity to share with you his views on some select issues.

I know that many of you are familiar with the workings of our fund, and I look forward to interesting presentations and insightful comments.

Thank you.