3 The investment strategy of the Government Pension Fund Norway
The capital base of the Government Pension Fund Norway (GPFN) originates primarily from national insurance scheme surpluses from the introduction of the scheme in 1967 and until the late 1970s. The capital of the GPFN is deposited with Folketrygdfondet, which manages the assets in its own name and in accordance with a mandate issued by the Ministry. The return on the assets of the GPFN is not transferred to the Treasury, but is added to the fund capital on an ongoing basis. Hence, there are neither any transfers between the fiscal budget and the GPFN, nor any capital transfers between the GPFG and the GPFN.1 The market value of the GPFN was NOK 167.8 billion at yearend 2013, cf. section 4.3.
The main part of the assets of the GPFN is invested in the Norwegian stock and bond markets. The characteristics of the Fund, such as size and a long investment horizon, distinguish the GPFN from many other investors in the Norwegian capital market. Size entails certain benefits, including the ability to exploit economies of scale in asset management. At the same time, the size of the Fund relative to the Norwegian capital market somewhat restricts opportunities for major portfolio allocation changes within a short space of time. The Norwegian market is, moreover, characterised by low liquidity in several companies. This adds to the challenges associated with major portfolio adjustments.
The GPFN is a major owner and lender in the Norwegian capital market. The Norwegian equity portfolio represents about 10 percent of the market value of the main index of the Oslo Stock Exchange (adjusted for ownership stakes that are not freely tradable; so-called free float), thus making the Fund one of the principal investors on that exchange. The Norwegian fixed income portfolio represents 2.6 percent of the Norwegian bond and note market. The large long-term holdings of the GPFN in the Norwegian stock and bond markets contribute to market stability. The rebalancing rules are an important part of this, cf. the discussion in section 3.3. These imply that the Fund acquires additional holdings in the asset class whose value has declined, in order to maintain the distribution between equities and bonds stipulated in the mandate. Hence, the Fund will purchase equities during periods when others are selling, and thus contribute liquidity to the stock market during periods of volatility.
3.2 The investment strategy
The investment strategy of the GPFN is defined by a benchmark index and risk limits laid down by the Ministry. The benchmark index is divided into equities (60 percent) and bonds (40 percent). Besides, it is divided into two geographical regions; Norway (85 percent) and the rest of the Nordic region excluding Iceland (15 percent), cf. figure 3.1.
Folketrygdfondet may, within certain limits, deviate from the benchmark index. The purpose of such deviations is to conduct cost-effective asset management, as well as to generate excess return. The Ministry requires Folketrygdfondet, under the mandate for the GPFN, to organise asset management with a view to keeping the expected tracking error within 3 percentage points. The method for calculating expected tracking error shall be approved by the Ministry. In addition, a number of supplementary risk limits have been adopted, cf. Report No. 15 (2010–2011) to the Storting – The Management of the Government Pension Fund in 2010.
The mandate adopted by the Ministry for the GPFN allows for the Fund assets to be invested in unlisted companies (private equity), provided, however, that the board of directors has expressed an intention to seek a listing on a regulated market place. Hence, it does not allow the Fund assets to be invested in private equity on a general basis.
3.3.1 The background to rebalancing
The rebalancing rules form part of the investment strategy for the GPFN. Experience from the rebalancing of the GPFG was discussed in Report No. 17 (2011–2012) to the Storting – The Management of the Government Pension Fund in 2011. The Ministry emphasised that the purpose of rebalancing is to ensure that the risk of the Fund does not over time deviate materially from the risk implied by the long-term allocation adopted for the Fund between different asset classes. The Ministry notes, at the same time, that rebalancing is somewhat countercyclical in nature, inasmuch as the Fund will sell assets whose value has increased the most, in relative terms, and purchase assets whose value has declined. The Ministry concluded that rebalancing of the GPFG should continue, although revision of the detailed rules was called for. The new rebalancing rules for the GPFG were presented in the National Budget 2013, cf. Report No. 1 (2012–2013) to the Storting.
The Ministry stated, in Report No. 27 (2012–2013) to the Storting – The Management of the Government Pension Fund in 2012, that the Ministry would consider, in view of the amendments to the GPFG rebalancing rules and after taking advice from Folketrygdfondet, whether the current rebalancing rules for the GPFN are also in need of adjustment. The Ministry would inform the Storting of any such adjustments.
On 12 February 2014, the Ministry received a letter from Folketrygdfondet summarising its experience with the rules on rebalancing of the benchmark index of the GPFN. The main conclusion is that experience with the rebalancing rules is favourable. According to Folketrygdfondet, the equity portion has not deviated significantly from its strategic weight for a long period of time, and the GPFN has achieved a better ratio between risk and return than would have been achieved without rebalancing. The rebalancing costs have been moderate, and the rebalancings have probably had a stabilising effect on the Norwegian financial market.
Folketrygdfondet is nonetheless proposing certain adjustments to the rules. There may, under the current rebalancing rules, be a time lag from the occurrence of a rebalancing need until the actual commencement of rebalancing. Folketrygdfondet is of the view that asset management is restrained during that period, inasmuch as planned portfolio modifications are largely put on hold as a result of the upcoming rebalancing. Folketrygdfondet therefore proposes that rebalancing shall commence automatically on the basis of criteria defined by the Ministry, that the Ministry shall be informed immediately upon the rebalancing signal being triggered, and that Folketrygdfondet shall report retrospectively. The proposed amendments will, according to Folketrygdfondet, somewhat simplify the rebalancing rules and reduce the inconvenience for the asset management. Folketrygdfondet states that the proposed amendments will not materially change the risk exposure of the GPFN, the number of rebalancings over time, the transaction costs or the returns, when compared to the current rules.
The current rules on the rebalancing of the GPFN are confidential. The GPFN is a large investor in financial markets that are characterised by low liquidity at times. Folketrygdfondet is of the view that the need to avoid influencing the market and ensure the sound execution of asset management suggests that detailed parameters relating to the implementation of rebalancings shall be kept confidential.
3.3.2 The Ministry’s assessments
Rebalancing of the equity portion forms part of the strategy of the GPFN. The calculations of Folketrygdfondet show that rebalancing has contributed to an improvement in the ratio between risk and return of the Fund since the introduction of the rebalancing rules in 2008. The Ministry notes that Folketrygdfondet is of the view that the proposed amendments will not materially change the risk exposure of the GPFN, the number of rebalancings over time, the transaction costs or the returns, when compared to the current regime. The Ministry of Finance will consider certain amendments to the rebalancing rules for the GPFN against the background of the advice from Folketrygdfondet.