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SWFs and the Norwegian Government Pension Fund. Sovereign Wealth Focus Edinburgh, 14 June 2011 Tom A. Fearnley Asset Management Department. Agenda. Sovereign Wealth Funds Norwegian Government Pension Fund – Global (GPFG):. Sovereign Wealth Funds (SWFs).

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Swfs and the norwegian government pension fund

SWFs and the Norwegian Government Pension Fund

Sovereign Wealth Focus

Edinburgh, 14 June 2011

Tom A. Fearnley

Asset Management Department


  • Sovereign Wealth Funds

  • Norwegian Government Pension Fund – Global (GPFG):

Sovereign wealth funds swfs
Sovereign Wealth Funds (SWFs)

  • Large pools of financial assets held by and managed for the public sector.

    • More precise definition (from “Santiago Principles 2008”):

    • Special-purpose investment funds or arrangements that are owned by the general government and created for macroeconomic purposes to manage assets to achieve financial objectives, and where the investment strategies include investing in foreign financial assets.

  • Definition excludes foreign currency reserves held for balance of payments or monetary policy purposes, state-owned enterprises, and pension funds.

Three types of swfs
Three types of SWFs

  • Broadly speaking three types of SWFs:

  • 1) Natural resource funds

    • From commodity exports giving rise to fiscal surpluses.

    • Main objectives: Maintain economic stability against commodity price fluctuations, and ensure that also future generations will benefit from the exploitation of natural resources by the current generation.

    • Examples: Norway, United Arab Emirates, Russia

Three types of swfs1
Three types of SWFs

  • 2) Foreign reserve funds

    • Source of funds is balance of payment surpluses and official foreign currency operations. Funds are managed differently from normal foreign exchange reserves, with higher risk and return profile.

    • Examples: China, Singapore

  • 3) Pension reserve funds

    • A portion of national pension funds is set aside and managed separately to prepare for an aging society.

    • Examples: New Zealand, France, Ireland

  • Sovereign wealth funds assets
    Sovereign Wealth Funds: Assets

    • Aggregate assets (all SWFs): about 4 trillion USD

      • 2.3 trillion from oil&gas (60 %)

  • By region:

  • Swfs again growing
    SWFs again growing

    • Due to financial crisis, SWF assets under management fell in Q4 2008 / Q1 2009.

      • By about 10 % (SWF Institute)

      • Picking up since Q2 2009, due to continuing inflows to many funds, and positive returns.

    Swfs again growing1
    SWFs again growing

    • Also, new funds (e.g. Sovereign Fund of Brazil)

    • Hence, financial clout largely undiminished, but less visible than during recent high-profile acquisitions of Western assets.

  • 2010: “Funds today account for between one-fourth and one-third of all foreign assets held by sovereigns… SWF assets are projected to surpass the stock of foreign exchange reserves in the not-so-distant future and to top $7-$11 trillion by 2013" (John Lipsky, IMF First deputy Managing Director).

  • Typical characteristics
    Typical characteristics

    • Long investment horizons

    • Little or no leverage

    • No claims for imminient withdrawal of funds

      • Therefore:

      • Strong risk bearing capacity

      • Ability to accommodate short term volatility

      • Usually higher risk profile than foreign exchange reserves (more equity and alternative investments)

    Concerns about swfs
    Concerns about SWFs

    • In 2007 and early 2008: Mounting concerns among Western recipient countries about the growth of SWFs. Concerns about:

      • Potential for politically motivated investments

      • Potential for controlling stakes in strategic industries.

      • Lack of transparency

      • Potential for large and unpredictable capital flows

      • Shift from private to public ownership of capital.

  • In 2007 G8 and IMF called for a SWF code of conduct

    • Led to the IMF-brokered Santiago Principles on transparency, objectives and governance.

  • Concerns about swfs1
    Concerns about SWFs

    • In late 2008 and into 2009, concerns receded:

      • Focus switched from SWFs to the financial crisis.

      • SWFs more a solution (to financial crisis) than a problem ?

        • Providers of capital in times of crisis.

        • Long investment horizon could be stabilizing factor.

        • Could contribute to lower risk premia.

    • Santiago Principles on appropriate investment practices adopted in 2008.

    Santiago principles
    Santiago Principles:

    • GAPP: Generally Accepted Principles and Practices.

    • The GAPP is a voluntary framework to guide the conduct of appropriate investment practices, as well as governance and accountability arrangements, of sovereign wealth funds.

    • Negotiated and endorsed in October 2008, by 26 sovereign wealth funds, with IMF as facilitator.

    Santiago principles1
    Santiago Principles:

    • Key principles:

      • i) Sound objectives and legal framework to facilitate the formulation of appropriate investment strategy.

      • ii) Sound institutional and governance framework that separates the functions of the owner, governing body, and management to facilitate accountability and operational independence.

      • iii) Clear investment and risk management framework to promote a disciplined investment process and sound investment operations.

    Oecd guidance for recipient countries
    OECD guidance for recipient countries

    • At the same time, OECD guidance on recipient country policies towards SWFs was adopted by OECD members on 8 October 2008.

    • These principles reflect long-standing OECD commitments that promote an open global investment environment.

    • The principles are:

    Oecd guidance for recipient countries1
    OECD guidance for recipient countries

    • Recipient countries should not erect protectionist barriers to foreign investment.

    • Recipient countries should not discriminate among investors in like circumstances. Any additional investment restrictions in recipient countries should only be considered when policies of general application to both foreign and domestic investors are inadequate to address legitimate national security concerns.

    • Where such national security concerns do arise, investment safeguards by recipient countries should be:

      transparent and predictable; - proportional to clearly-identified national security risks; - and subject to accountability in their application.

    Swfs part of the problem or the solution
    SWFs: Part of the Problem or the Solution ?

    • SWFs now hold a significant share of sovereign foreign assets, and should therefore work towards well functioning capital markets and responsible investing.

      • Should act as ”Universal owners”, with strong interests in the ”global commons”.

  • Norway’s SWF (Government Pension Fund - Global) is now 12 times bigger than its foreign exchange reserves.

  • Norway’s GPFG ownership share of the world’s listed companies has now reached 1 per cent (1.8 per cent in Europe).

  • Similar stakes for the other top SWFs.

  • Swfs and financial stability
    SWFs and Financial Stability

    • Extensive research is being conducted on this issue.

    • Existing research on SWFs suggest that they can be a stabilizing force in global financial markets.

    • Event studies do not find a destabilizing impact from SWF investments and divestments in equity markets, while simulations of SWF asset allocations imply only modest economic effects.

    • With SWFs improving their transparency and disclosure over time, the availability of historical SWF transactions will provide researchers with the necessary data to examine further their implications for financial stability.

    • See overview article by IMF economists Tao Sun and Heiko Hesse, March 2009.

    Swfs and transparency
    SWFs and Transparency

    • In line with the Santiago principles, some SWFs are becoming more transparent.

    • Thus following in Norway’s steps.

      • Norway’s GPFG is the most transparent by far.

    • Abu Dhabi Investment Authority, until recently one of the most secretive SWFs, made a significant step in March 2010 by publishing its first annual report.

    • Also GIC and Temasek of Singapore now produce annual reports (since 2008).

      • Done to ”assure the investment community and the countries in which we invest that our activities have only one purpose – financial return” (Tony Tan, Deputy Chairman)

    Swfs and transparency1
    SWFs and Transparency…

    • Few disclose total size and returns, however.

      • Fear that detailed disclosure may jeopardize investment strategies.

      • ”Complete transparency would raise more questions than answers”, Bader al-Sa’ad, Managing Director, Kuwait Investment Authority.

    Swfs as providers of capital
    SWFs as providers of capital

    • As already noted, SWF can be

      • Providers of capital in times of crisis.

      • Investors with long horizons, possibly making them longer term owners.

  • SWFs now being actively encouraged to buy government debt:

    • Reports that European government debt managers now engage in “sales tours” to SWFs (Financial Times, 25 March 2010).

    • Their hope is that SWFs will be able and willing to absorb a significant share of the huge government bond issuance expected for the coming years.

  • Swfs as providers of capital1
    SWFs as providers of capital…

    • As for Norway’s GPFG, the fund was one of the largest buyers in the world’s stock markets in 2008, at the depth of the financial crisis:

      • Bought shares worth 55 bn USD throughout the year.

      • To move towards 60 % allocation to equities (in a falling equity market)

    Swfs as providers of capital2
    SWFs as providers of capital…

    • Finally, some recent news (Washington Post, 18 April 2010):

    • ”World Bank gets help from SWFs to invest in developing nations”

      • State-owned investment vehicles from South Korea, Azerbaijan, Netherlands and Saudi Arabia have agreed to invest USD 600 million in a bank-sponsored equity fund for less-developed countries.

      • While not large, it could open up a pool of capital that World Bank president Robert B. Zoellic said could prove to be important in creating a new ”architecture” for the post-crisis global economy.


    • Sovereign Wealth Funds

    • Norwegian Government Pension Fund – Global (GPFG):

    • Norwegian Government Pension Fund – Global (GPFG):

    2 nd largest sovereign wealth fund source swf institute march 2011
    2nd largest Sovereign Wealth Fund(Source: SWF Institute, March 2011)

    Government pension fund
    Government Pension Fund

    Formally established 1 January 2006Managed by the Ministry of Finance

    • Government Pension Fund Global

    • (former Government Petroleum Fund)

    • Invested abroad

    • Operational management: Norwegian Central Bank (Norges Bank)

    • NOK 3 102 billion (USD 562 bn) end of Q1 2011

    • Government Pension Fund Norway

    • (former National Insurance Scheme Fund)

    • Invested in Norway (85%) / Scandinavia

    • Operational management:

    • “Folketrygdfondet”

    • 135 billion NOK (USD 23 bn)

    • at 31 Dec 2010

    Origin of government pension fund
    Origin of Government Pension Fund

    • Strong public finances…

    • Due to oil and gas production in North Sea.

    • Production peaked in 2004, but still large.

    • 5th largest net oil exporter in 2008.

    • 40 per cent of reserves have been extracted.

    Origin of government pension fund1
    Origin of Government Pension Fund

    • Government oil and gas revenues are invested in the Fund…

    • …except what is spent to cover a structural (non-oil) budget deficit, determined by a ”spending rule”.

    The spending rule
    The spending rule


    Return on investments

    Petroleum revenues


    State Budget

    Transfer to finance non-oil budget deficit

    Fiscal policy guideline(over time spend real return of the fund,


    Expenditures• consumption • investment (infrastructure, human capital)

    Public sector net assets and government pension fund percent of gdp
    Public Sector Net Assets and Government Pension Fund (percent of GDP)

    • Public sector is in large positive net asset position, mainly due to the Fund.

    Gross public sector debt
    Gross public sector debt (percent of GDP)

    • Mainly bonds and bills issued to maintain a liquid secondary government bond market.

    • Borrowed funds mainly used to service the debt, which is kept relatively stable as share of GDP.

    • The large positive net asset position of the government means that the gross debt is not considered one of the Fund’s liabilities.

    Investment strategy our circumstances
    Investment strategy: Our circumstances (percent of GDP)

    • No clearly defined liabilities.

    • Indefinite investment horizon.

    • Therefore, strong risk bearing capacity

      • Year to year volatility of less concern.

  • However, “target” real return around 4 % in average over the long run (the spending rule).

  • Could be seen as the Fund’s liability.

    • Although, stated objective is to “maximize international purchasing power given moderate risk”.

    • Reflects fact that fund will ultimately be used to finance imports.

  • Fund governance
    Fund governance (percent of GDP)

    Division of responsibilities between
    Division of responsibilities between: (percent of GDP)

    • Owner (Ministry of Finance)

      • Decides investment strategy (strategic benchmark, rebalancing scheme, scope of active management, investment universe).

      • Monitors operational manager.

      • Develops ethical guidelines.

      • Reports to Parliament.

  • Operational manager (Norges Bank, the Central Bank

    • Implements investment strategy.

    • Invests monthly inflows.

    • Runs active management program.

    • Exercises fund’s ownership rights.

    • Reports to Ministry of Finance

  • Strategic asset allocation for the fund
    Strategic Asset Allocation for the Fund (percent of GDP)

    Strategic benchmark

    Investments in real estatestarted in 2011

    • Equities 60%

    • Fixed Income 35%

    • Real Estate 5%

    Equity index:

    FTSE Global All-Cap

    Fixed regional weights

    > 7 000 equities

    Fixed-income index:

    BarCap Global Agg. + Global Infl.-Linked

    Fixed regional weights

    > 10 000 bonds of investment grade

    Real estate mandate:

    Directly investible index cannot be constructed

    Index established to state return objective

    Special set of risk limits, separate from equities and fixed inc.

    Active risk limits:

    Overall portfolio level active risk budget: 1% tracking error (as of 1 Jan. 2011)

    Supplementary limits (minimum overlap etc.)

    The investment universe gives significant degree of freedom for norges bank s active management
    The investment universe gives significant degree of freedom for Norges Bank’s active management

    Investment universe


    Listed equities

    Investment grade bonds

    Real estate

    • All emerging markets

    • for equities and bonds

    • Commodity derivatives

    Market risk budget: 100 bp tracking error on total portfolio

    Major changes in the investment strategy
    Major changes in the investment strategy for Norges Bank’s active management

    Some emerging markets (EM)

    • Real estate

    • All EM equity markets




    More EM, new ethical guidelines

    40% equities









    Non-government bonds

    Evaluation of active management

    • -High yield bonds

    • Commodity derivatives

    • new requirements in

    • risk management

    Few limitations on derivatives/

    short positions

    Ethical guidelines and corporate governance
    Ethical guidelines and corporate governance for Norges Bank’s active management

    • The obligation to ensure sound financial returns so that future generations will benefit from the petroleum wealth.

      • Exercise ownership rights – corporate governance. Priority areas: Investor rights, board responsibility, well-functioning markets.

    • The obligation to respect the environment and the fundamental rights of those who are affected by the companies in which the Fund invests.

      • Exercise ownership rights – integrated ESG approach.

        • Priority areas: Climate change, water management and the rights of children.

      • Guidelines for the observation and exclusion of companies that fail to satisfy a minimum ethical standard.

    Two main ethical obligations:

    Volatile and uncertain economic outlook
    Volatile and uncertain economic outlook for Norges Bank’s active management

    • The economic outlook remains foggy and difficult. Several reasons:

      • Highly leveraged developed economies

      • Private and public sector deleveraging, combined with exit from monetary stimuli

      • High commodity prices

      • Regulatory environment in transformation

    • Deflation or inflation?

    • However, funds with very long investment horizon and high risk bearing capacity should be able to absorb the market shocks without forced or unwarranted changes to investment strategy.

    Stormy times highlight need for
    Stormy times highlight need for: for Norges Bank’s active management

    • Moderate real return expectations, also long term.

    • Diversification across asset classes and regions

      • Although diversification did not serve its purpose in 2008.

  • Better risk measurement and control (both passive and active risk), including better understanding of tail events and their probabilities.

  • Swfs and the norwegian government pension fund

    The fund has experienced very volatile equity markets for Norges Bank’s active management

    Real return on a portfolio close to fund’s equity benchmark


    of years

    Return in percent

    Few places to hide in 2008
    Few places to hide in 2008… for Norges Bank’s active management

    • Almost all asset classes saw large drops in value in 2008

      • Stock markets (worst since 1900 !)

      • Bond markets (credit spreads)

      • Real estate

      • Commodities

      • Diversification failed when most needed.

  • And liquidity dried up in several markets

  • Except government bonds real return
    Except: Government bonds (real return) for Norges Bank’s active management

    Return in percent

    Our long term real return expectations
    Our long term real return expectations for Norges Bank’s active management

    • Long term, assuming markets in equilibrium (rational pricing, no bubbles):

    Our long term correlation expectations
    Our long term correlation expectations for Norges Bank’s active management

    • Long term, assuming markets in equilibrium

    Expected real return on fund
    Expected real return on fund for Norges Bank’s active management

    • Expected real return: 4.25 %

    • Expected volatility: 9.8 %

    • Realized net real return since 1 Jan. 1998: 3.05 %

    Swfs and the norwegian government pension fund

    Europe’s largest single owned asset pool, high expected growth from inflows and financial returns:The Government Pension Fund’s market value (real) 2010-2030:Expected growth, with 68 % and 95 % confidence levels

    Billion NOK

    Source: Ministry of Finance, Report to Parliament April 2011

    Summary main characateristics of fund
    Summary: growth from inflows and financial returns:Main characateristics of Fund

    • Very large and growing SWF

      • Owns roughly 1 % of world’s stock market

    • Purely financial investor

      • Max ownership share in listed markets: 10 %

    • Very long investment horizon

      • In practice unlimited

    • No clearly defined liabilities

      • But is funding a structural non-oil budget deficit

    • Highly transparent

    • Emphasis on integrated ESG approach to investing

    Links growth from inflows and financial returns:

    Contact details

    Norwegian Ministry of Finance

    Asset Management Department

    P.O.Box 8008 Dep

    NO-0030 Oslo, Norway

    Visiting Address: Akersg. 40

    Telephone: +47 22 24 45 10

    Fax: +47 22 24 95 91

    E-mail: postmottak@fin.dep.no

    Ministry of Finance

    • www.regjeringen.no/en/dep/fin

      Government Pension Fund

    • www.government.no/gpf

      Norges Bank Investment Management

    • www.nbim.no