The Government Pension Fund Global

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Members of the Strategy Council, distinguished panellists, ladies and gentlemen.

It is a great pleasure to be here in Cambrigde at this important summit on the Pension Fund and Responsible Investing. Let me begin by thanking the Strategy Council for organising this summit. I would also like to extend my thanks to the Judge Business School for hosting today's event.

The purpose of this summit is a simple, but important one: To learn more.

By bringing together experts on responsible investing, we hope to deepen and improve our understanding of current knowledge and experience in this area.

The Norwegian Ministry of Finance has asked the Strategy Council of our Pension Fund to review ways to strengthen the Fund's work on responsible investment.

With this impressive gathering of highly skilled scholars and professionals, I am sure that the Council will get important input to its work.

From the ministerial side we are very grateful for your contributions.

I am also pleased to have this opportunity to present the Goverment Pension Fund and our current work on responsible investments.

The management of the Fund is a dynamic and constantly evolving process.

Over the space of a few years, responsible investment practice has become something that more and more investors wish to incorporate into their strategies. As a major player, we want to contribute to the development of best practice in this area.

Before I present our responsible investment strategy, I would like to say a few words about the Fund in more general terms.

First of all, why do we need a Pension Fund?

From small beginnings in the mid 1970s, Norway has rapidly grown to become a major oil and gas producer. We therefore established the Pension fund to manage the huge cash flows from the petroleum sector.

There are two main purposes of the Fund:

First of all, to ensure that not only this generation, but also future generations will benefit from the petroleum wealth. And secondly, to safeguard stability in the mainland economy.

As you know, rich natural resources can be a curse rather than a blessing:
Many countries have experienced that a rapid pace in the spending of resource rents has hampered their economic performance.

A clue to good management of petroleum resources is to disconnect spending from the current income from oil and gas activities. Therefore, the oil revenues are allocated directly to the Fund. It is only the expected real return on the Fund – estimated at 4 pct. of the fund capital - that is to be spent over time.

The Fund enables us to transform a volatile and temporary revenue stream into a stable and permanent income in the national budgets.

Our fiscal guidelines ensure a predictable and prudent phasing in of petroleum income into the mainland economy.

By only spending the expected real return, the Fund will never be reduced in real terms.

At the same time, the spending of the revenues contribute to stabilising production and employment. During periods of high unemployment we can spend more than 4 pct. to stimulate the economy. Correspondingly we should spend less when the economic activity is high.

The fund has grown rapidly, since the first transfer was made in 1996, and the value is currently approximately 4 450 billion NOK or just short of 600 billion EUROS.

The Fund is now among the largest sovereign wealth funds in the world, and we expect the Fund to grow also in the years ahead.

The Fund has a clear financial goal of maximizing real returns at a moderate level of risk. In line with that objective, we seek a broad geographic diversification of the investments.

The Fund is invested in about 7 000 companies, in 70 countries. Through the investments we own a small share of the world's productive capacity. On average, the Fund owns 1,3 pct. of all listed equities in the world. The strategy builds on the Fund's long time horizon and is based on assessments of expected return and risk over a long period of time.

The role of the Fund as a financial investor restricts its room for manoeuvre in other areas. The state has different roles– and the role as a large financial investor is a slightly untraditional one.

The investment strategy is set by the Ministry of Finance - and anchored in Parliament. But even though the political authorities are responsible for the overall strategy, we still act in the capacity as investor.

The purpose of the Fund is to maximise long-term real return. Other political objectives must be pursued by other means, for instance through our foreign or environmental policies. We believe that this is a more effective way of reaching important goals, such as the protection of human rights or tackling climate change. In addition, we risk loosing our credibility as a financial investor if we use the Fund as an instrument in our foreign policy. This strategy enjoys broad political support.

However, the fact that the Fund is a financial investor does not mean that we do not take ethical considerations into account. On the contrary, the role as a responsible investor is important for us.

As I mentioned earlier, the Pension Fund owns a small fraction of the world's means of production. This is often referred to as universal ownership. As a universal owner, we have a broader set of objectives than individual firms and other investors.

Water management is a good example. Water is a key input for many companies – and water scarcity is a growing problem. But it is far from clear that individual companies have an incentive to take sustainable water management into account in their short term decision making. For the Fund, on the other hand, this is a question which really matters over the medium and long term. In other words, a sustainable development is important for us, in order to safeguard the Fund's financial assets.

As a universal owner we also believe that we have a greater responsibility for contributing to a sustainable development, both in economic, social and environmental terms.

Our investment practices are based on a clear division of responsibilities and duties between three main parties: The Ministry of Finance, Norges Bank (our Central Bank) and the Council on Ethics, which is an independent council.

The Ministry, as owner of the Fund, establishes the general framework for the responsible investment practices.

It is also the Ministry that, on the recommendations of the Council on Ethics, decides whether a company should be excluded or placed under observation. The Council on Ethics is charged with monitoring the portfolio with the aim of identifying companies that ought to be excluded. Criterias for exclusion are laid down in ethical guidelines from the Ministry. The guidelines have been discussed in white papers to Parliament and have broad political support.

Norges Bank is the operational manager of the Fund, based on a mandate from the Ministry. The mandate also includes guidelines for the exercise of ownership rights.

All three parties collaborate with other bodies and contribute to research and the development of best practice within their own areas.

We have several instruments to promote our role as responsible investor. Some measures are targeted towards broad markets, some towards sectors within markets, and some towards single companies.

Exclusion has been part of our strategy since the ethical guidelines were established in 2004. This is the most visible tool – and also the tool that has attracted most attention in the public debate. Most of the companies have been excluded because of what they produce, namely certain types of weapons (such as nuclear weaponds and cluster bombs) and tobacco. But we can also exclude companies because of grossly unethical behaviour. In total 55 companies have been excluded from the Fund so far, 38 based on production, 17 on behaviour.

Product-based exclusions are rather simple. Either a company produces tobacco – or it does not. The Conduct-based exclusions are more complicated. The conclusions in these cases will necessarily be a matter of discretionary assessments.

A challenging issue is what it takes to conclude that a company contributes to unethical conduct – especially if the company is not directly responsible for the conduct in question.

The Council on Ethics therefore conducts thorough investigations – both to identify and assess companies.

The final decision about whether or not to exclude a company is made by the Ministry, based on the Council on Ethics' recommendation. We make public, not only our decision, but also the full recommendation document from the Council. We know that many stakeholders follow our exclusion decisions closely. This means that the entire material on which we make our decision has to be accurate and the result of a thorough research process.

Exclusion rarely solves the underlying problem directly. When we exclude a company we also loose the ability to exert influence through the exercise of ownership rights. Therefore, exclusion should always be a measure of last resort, once the company's will and ability to improve its practices have been assessed.

In situations where there may be doubt as to whether the conditions for exclusion have been fulfilled or how the company's behaviour will develop in the future, we may choose to place it under formal observation. Observation is a relatively new mechanism – and a tool we hope will enable us to stimulate to more change in the companies' behaviour.

Active ownership is not as visible as exclusion, but this is an important tool that is used on all the companies in the portfolio. The active ownership activities are based on internationally recognized global standards established by the UN and the OECD. As a shareholder in companies, Norges Bank can exercise its voting rights and in other ways express its views on corporate governance and overall strategy. The Bank also collaborates with other investors, it has dialogue with authorities and participates in international networks.

Active ownership is demanding and depends on expertise, resources and patience. With ownership in 7 000 companies across the world, it is important to have clear priorities and goals in order to have an impact.

Therefore the Bank has defined a number of focus areas within environmental and social issues, as well as good corporate governance. On these areas the Bank has formulated specific expectations to the companies. The Bank has chosen areas that should be relevant for investors in general and the Fund's portfolio in particular.

In addition to exclusion and the use of ownership rights, we have established a programme on environment-related investments. These are investments in renewable energy, technology for increased energy efficiency, water technology and the treatment of waste and pollution. Through the programme, we aim to learn more about green investments and industries that might become more important in the future.

Through international collaboration, we can help develop a clearer common understanding of what constitutes best practice for responsible investment. The UN Principles for Responsible Investment (PRI) are an example. Both the Bank and the Ministry have signed these principles.

Climate change is an important issue in our international cooperation. For instance, the Fund participates in several investor initiatives to increase reporting and transparency on areas like greenhouse gases and sustainable forestry (Forest Footprint and CDP)

Finally, as a big investor, we believe we have a responsibility to contribute to research and investigation. Improving knowledge is important in order to achieve better management and promote best practice internationally.

A couple of years ago, the Ministry of Finance initiated a research project on how climate change and different policy responses may affect funds like ours over the next 20 years. 14 large Funds worldwide participated in this study, resulting in the Mercer-report.

It is now almost ten years since the ethical guidelines were introduced. Considerable experience has been gained over the last decade, and the responsible investment strategy has been developed over time. The guidelines were evaluated in 2009. The evaluation indicated that more emphasis should be given to the potential for contributing to positive change in the conduct of companies. In addition the interaction between exercise of ownership rights and exclusion of companies should be strengthened. In 2010 we therefore established a new mandate for responsible investment to Norges Bank and new guidelines on observation and exclusion.

Now we wish to refine the responsible investment strategy further. Our ambition is to be in line with, and even contribute to the development of best practice. There is no better starting point for such a process than turning to some of the best experts in this field for advice. And that is why we have asked the Strategy Council to examine how the responsible investment strategy can be further improved.

The Council has currently five members:

First of all, there is Elroy Dimson from London Business School and Cambridge Judge Business School. He is the eminent chair of the Strategy Council and has extensive experience from the Council. The other members are Idar Kreutzer, Chief Executive Officer of Finance Norway, Rob Lake, former Head of Responsible Investment at PRI, Hege Sjo, Hermes Investment Management, and last but not least Laura Starks, Professor of Finance at the University of Texas.

Together you provide a wide range of expertise and knowledge, both on our Fund and on broader international developments, operational as well as theoretical.

The Strategy Council's mandate is to evaluate how any gaps between the Fund strategy and international best practice for responsible investment can be closed

We have also asked the Council to examine how the collective resources and expertise in the Ministry of Finance, the Council on Ethics and Norges Bank can best be utilized to strengthen the work on responsible investments still further

The Council may propose changes to strengthen the work on responsible investments, including operational and institutional changes. The report will be submitted in October 2013. We eagerly await it!

To sum up:

The work on responsible investments is an important – but also challenging – part of the management of the Pension Fund. We are satisfied with the results so far, but we have not yet finished this work.

Many important and complex questions lie ahead of us – and the sessions today will no doubt provide further insights into some of these, whilst at the same time probably posing some new ones.

The Ministry of Finance has for many years used academics and other external experts to assist in developing the management of the Fund.

Independent advice is an important part of our efforts to improve the management. In addition, such advice contributes to transparency and open debate about our decisions. The Strategy Council has played an important role in this respect. So once again, I would like to thank the Council for your invaluable input that you provide.

Ladies and gentlemen, Cambridge has been a seat of learning and enquiry for many hundreds of years. In the best tradition of scholarship, we hope that we can share and improve our knowledge. And – even more importantly - move further down the path to better and even more responsible investing.

I look forward to all your presentations - and to some fruitful and productive discussions.

Thank you for your attention.