The Norwegian Wealth Fund Confident Enough to Take on More Risk

on Aug 20, 2012
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The largest sovereign wealth fund in the world has declared its plans to take on more risk in its strategic investments, a move possibly establishing a new trend for the more conservative publicly-owned investment funds.

The Government Pension Fund – Global, often referred as The Oil Fund, was set up in 1990 as a fiscal policy to support long-term management of Norway’s petroleum revenue. Despite being called a pension fund, it derives its financial backing from oil profits, not pension contributions. The fund has a value of $600bn (£382bn), owns 1 per cent of all global equities and on average has stakes of 2.25 per cent in every European company listed on a stock exchange. Norges Bank Investment Management (NBIM), part of the Norwegian Central Bank, manages the fund with the purpose of safeguarding the long-term interests of Norway.

!m[](/uploads/story/272/thumbs/pic1_inline.png)Because it is ultimately owned by the Norwegian people, the fund struggles to determine its level of aggression in its investment strategy. Its current asset allocation is highly traditional and consists of 60 per cent shares, 40 per cent bonds and a fraction invested in property. A debate has been long held over the question of whether The Oil Fund needs to adopt active or passive management.

When investing passively, a fund would merely mimic the returns of a market, which is often achieved through index tracking. Active investing has the goal of picking the winners and the losers and the freedom of buying more or less of certain assets. According to the fund’s management, their strategy is more of an active one but given the fact that the fund owns shares in 8,000 companies and has 4,000 different bonds in its portfolio, it is hard to claim it has the capacity to be truly active over such a huge range.

With their new plans to take on more risk, NBIM believes the fund can be more opportunistic in times when markets dry up. This comes as a retrospective judgement after The Oil Fund achieved a negative 23 per cent return during the 2008 financial crisis and to heavy criticism. An academic report commissioned by the government has concluded that despite popular believes of too-aggressive management, the fund in fact has been extremely passive. As a recommendation, the report proposes to the fund to look beyond the equity risk premium and try to gain from other risk factors by exploiting its special characteristics of being long-term, huge and state-owned.

The fund can exploit [its nature as a long-term investor] by being a provider of liquidity in periods when there is a lack of liquidity,” said Pål Haugerud, head of asset management in Norway’s finance ministry.
Recently, the Norge fund, driven by the deteriorating market conditions in Europe, has decided to further reduce its exposure to countries in the Eurozone and instead turned to Japanese, US and emerging market bonds. In the second quarter, the fund reduced its holdings of bonds issued in euro to 48.1 per cent down from 51 per cent. The fund had already gotten rid of Portuguese, Irish and Greek government bonds in the first quarter.
“The changes were in line with a strategy to gradually reduce the share of bonds in currencies of developed European nations,” the fund said in a statement.
Numerous rebalancing rules are established, including buying equities and selling bonds when share prices have fallen and bond prices have risen.
“We can maybe look at ways to develop the current, rule-based rebalancing further,” Mr Haugerud said. One possible project for the future is to look at the “time-varying risk premia”, which is based on the strategy of buying cheap and selling expensive.

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