The Government Pension Fund comprises the Government Pension Fund Global (GPFG) and the Government Pension Fund Norway (GPFN). The Fund has no governing bodies or employees of its own, and is not a separate legal entity. The GPFG and the GPFN are managed by Norges Bank and Folketrygdfondet, respectively, under mandates set by the Ministry of Finance.
In this report, the Ministry of Finance presents management performance and assessments of the Government Pension Fund for 2013. Further development of the investment strategy of the Fund is discussed, and an account is given of the management framework follow-up.
The idea of a savings fund
After Norway discovered oil in the North Sea in 1969, it soon became apparent that the values involved might be significant. It was also acknowledged that the revenues from the petroleum activities are not revenues in the ordinary sense, as these are partly offset by the extraction of a non-renewable resource. It was further acknowledged that the revenues would fluctuate significantly with the oil price. It was therefore important, in order to ensure balance in the economy in the short and the long run, to manage the spending of the petroleum revenues of the State. The so-called Tempo Committee (NOU 1983: 27 green paper), chaired by Hermod Skånland, launched the idea of establishing a petroleum fund in 1983. The proposal called for the establishment of a fund that could smooth out the spending of petroleum revenues over a limited number of years. However, the Committee had limited confidence in the ability of the State to develop a savings fund – and not only a stability fund. It wrote:
“The political bodies must themselves decide whether such fund accumulation to forestall future revenue reduction is realistic. The Committee chooses, on its part, not to apply such an assumption.”
The idea of a government petroleum fund matured in the 1980s. The Willoch Government advocated the establishment of a fund in the Long-Term Programme published in the spring of 1986, cf. Report No. 39 (1985–86) to the Storting. The Act relating to the Government Petroleum Fund was enacted in 1990 on the basis of a proposition from the Syse Government.
In the beginning, the fund structure was predominantly a bookkeeping exercise. It highlighted the fact that the petroleum revenues were spent on an ongoing basis: The government petroleum revenues were allocated to the Fund, but the entire amount was returned to the fiscal budget to make up part of the non-oil deficit. In line with the improvements in the Norwegian economy during the 1990s, the first net allocation to the Fund was made in May 1996, cf. figure 1.1.
The Government Pension Fund has over time become an important financing source for government expenditure. In the fiscal budget for 2014, the transfer from the GPFG to cover the non-oil deficit is estimated at NOK 139 billion. This corresponds to 10 percent of total expenditure via government budgets. It is estimated that the importance of the Fund as a financing source for government expenditure will increase over the next few years. For 2020, the expected real return on the GPFG is estimated, on an uncertain basis, to correspond to 8¾ percent of Mainland GDP. If expenditure remains at the current level, measured as a proportion of value added in the mainland economy, the Fund may then be financing more than 15 percent of government expenditure. The said proportion will however decline again in the longer run, since the Fund will not grow in line with the gross domestic product of the mainland economy. The reduction in the financing contribution from the GPFG is concurrent in time with an estimated steep increase in government expenditure, especially on pensions, health and care.
Good results in 2013
The Government Pension Fund performed well in 2013. The return on the GPFG was 15.9 percent as measured in foreign currency and the return on the GPFN was 15.7 percent as measured in Norwegian kroner, before asset management costs. This is one of the best results over the lifetime of the Fund. Norges Bank’s active deviations from the benchmark index made a positive contribution to the return on the Fund, whilst the management at Folketrygdfondet delivered a negative excess return. At yearend, the overall value of the Government Pension Fund was about NOK 5,206 billion, reflecting an increase in value of NOK 1,245 billion over the year.
Last year, the asset management costs of the GPFG and the GPFN accounted for 0.07 percent and 0.09 percent of average fund assets, respectively. The Ministry is committed to cost-effective management of the Government Pension Fund over time. Comparisons with other funds show that the asset management costs of both the GPFG and the GPFN, measured as a portion of assets under management, are low.
The good performance in 2013 reflects the positive developments in global stock markets. Stock prices appreciated over the year as the result of, inter alia, the US Federal Reserve continuing to provide liquidity to the economy. Developed stock markets experienced a general upturn. The return on the equity portfolio of the GPFG was 26.3 percent. The high return was fuelled by the developed market investments. The return on the fixed income investments of the Fund was about nil in 2013.
From January 1998 to December 2013, the average annual return was 5.7 percent for the GPFG and 7.1 percent for the GPFN, before asset management costs. Returns have fluctuated significantly over this 15-year period.
The average real return on the GPFG from January 1997 to December 2013 was just below 3.9 percent, net of inflation and asset management costs, compared to just over 3.2 percent measured at yearend 2012. This is slightly below the 4-percent real rate of return expected in the long run. The return is nonetheless close to long-term expectations, given normal fluctuations in average returns over periods of 15 years.
The return on the Fund varies signficantly from year to year, although the recurring income from equities, bonds and real estate in the form of dividends, coupons and rent is more stable. At present, the recurring income of the GPFG amounts to around NOK 130 billion per year, or about 3 percent of the fund capital. The recurring income of the GPFN amounts to just over NOK 6 billion, or about 4 percent of its capital.
Accrued returns account for NOK 1,799 billion of the overall value of NOK 5,038 billion of the GPFG as at yearend 2013. Consequently, more than a third of the value of the Fund is attributable to return on the investments, as measured in international currency. Close to 70 percent of the achieved return is due to return on the equity investments, whilst about 30 percent is generated by the fixed income investments.
The return on the Government Pension Fund has in both 2012 and 2013 been very favourable, relative to the expected rate of return over time. The Ministry notes that one needs to be prepared for significant fluctuations in the value of the Fund in coming years. Returns have fluctuated considerably over the lifetime of the Fund. Over the period 1998–2013, the annual return on the GPFG has varied between -23 percent and 26 percent. Corresponding fluctuations would, at current Fund values, represent a decline in the Fund value of about NOK 1,200 billion or an increase in value of NOK 1,300 billion.
Established principles for the management of the Government Pension Fund
The Sundvolden platform states that “the Government will continue to build on the framework established for the management of the GPFG”.
The overarching objective for the investments is to achieve the maximum possible return, given a moderate level of risk. This enables more welfare to be financed over time via the return on the Fund.
Asset management shall be premised on transparency and ethical awareness. A system for responsible investment practices has been established, with companies that violate certain ethical criteria being excluded from the investment universe of the Fund, including serious human rights violations, gross corruption and severe environmental damage. Norges Bank integrates considerations of environmental and social issues in the asset management, and has divested from companies whose business model it has considered to be unsustainable in the long run. Such divestment takes place within the limit for permitted deviations from the benchmark index. The exercise of ownership rights is based on internationally recognised principles and standards laid down by, inter alia, the UN and the OECD. Responsible investment is discussed in section 4.5.
The investment strategy of the GPFG has been developed gradually over time on the basis of comprehensive professional assessments. Such assessments also underpin the broad support for the strategy of the Fund in the Storting. The long-term investment strategy stipulates a fixed equity portion of 60 percent. The equity portion largely determines the risk level of the Fund. Since the Fund has a good ability to absorb risk, the strategy is not predicated on minimising the volatility of returns. Such a strategy would generate a significantly lower expected return over time. The role of government bonds in the Fund is primarily to reduce the volatility of Fund returns. Their expected return is not high. The equity investments, which give us ownership stakes in companies worldwide, are expected to generate the main contribution to return over time. The investments, in equities, bonds and real estate, provide recurring income in the form of dividends, interest payments and rent.
The investments are diversified across a large number of individual equities and bonds, as well as, more recently, a number of properties. By diversifying the investments in a portfolio, the overall risk will be lower than the sum of the risk of each individual investment. The Ministry has adopted a benchmark index for the GPFG, which implies that the composition of investments in equities and corporate bonds adheres to the principle of market weights, whilst the composition of investments in government bonds is based on the sizes of countries’ economies, as measured by gross domestic product (GDP weights). The benchmark and the global mandate for real estate investments contribute to investments being diversified across countries and regions.
Over time, most of the risk of the Fund originates from developments in general stock and bond markets, as reflected in the benchmark index. Norges Bank may nonetheless, in its operational asset management implementation, deviate somewhat from the benchmarks, within certain risk limits defined in the mandate from the Ministry. The contribution to the risk of the Fund from Norges Bank’s deviations from the benchmark index has been moderate over time.
Section 2.1 of this report outlines the main features of the investment strategy of the GPFG. The investment strategy of the GPFN is discussed in section 3.1. The governance structure of the two parts of the Government Pension Fund is discussed in chapter 5.
Further development of the investment strategy
Good long-term management of the Government Pension Fund is premised on widespread support for, and confidence in, the way in which the Fund is managed. The Ministry is therefore committed to assessing, on a regular basis, how the management of the Fund can be developed further. This will be guided by the principle that any changes made to the investment strategy shall be based on comprehensive professional assessments and analyses. Any material changes to the management of the Fund are submitted to the Storting.
This year’s report discusses several themes, including a comprehensive review of Norges Bank’s management of the GPFG, in line with the periodical reviews previously notified to the Storting. The provisions governing the rebalancing of the equity portions of both the GPFG and the GPFN are discussed. Furthermore, there is a discussion about the investments of the GPFG in oil and gas stocks. Previous analyses are updated and expanded in this report. Moreover, the report discusses the advice from the Strategy Council for the Government Pension Fund Global regarding responsible investments. A number of specific measures are also presented in following up on the Sundvolden declaration on investments in emerging markets and poor countries, as well as investments in renewable energy. Finally, there is a discussion on addressing climate issues in the management of the GPFG.
The investment strategy of the Government Pension Fund is premised on the purpose of the Fund, assumptions regarding the functioning of the financial markets, as well as the special characteristics and comparative advantages of the Fund. The investment strategy is characterised by seeking to exploit the long horizon of the Fund and profiting from investments that offer risk premiums over time. Other key elements are broad diversification of the investments, responsible investment practice, cost-effectiveness, moderate limits for deviations from the benchmark index and a clear governance structure.
When the Storting deliberated Report No. 10 (2009–2010) to the Storting – The Management of the Government Pension Fund in 2009, it was proposed that Norges Bank’s management of the GPFG be examined on a regular basis. The background to this is the need for widespread support, also for the operational implementation of the management of the GPFG. The Ministry emphasises that the risk assumed by Norges Bank in its asset management needs to be managed and communicated well.
The Ministry has, in line with this, commissioned a review of the asset management performance of the Bank. The Ministry has also addressed how further delegation of asset management tasks to Norges Bank may improve the ratio between expected return and risk. Both Norges Bank and a group comprising three internationally recognised experts were therefore requested to present such analyses.
Section 2.2 discusses various types of asset management activities that may improve the ratio between return and risk compared to that of the benchmark index established by the Ministry. A limit for deviations from the benchmark index offers scope for improved diversification of the risk in the Fund, and an expected improvement in the ratio between risk and return. However, the contributions will vary over time, and deviations from the benchmark may also deliver negative contributions to the performance of the Fund. Thus far, the management performance of the Bank has been good. Gross excess return currently stands at about NOK 90 billion on top of the return on the benchmark index. The deviations from the benchmark have over time had a moderate impact on absolute risk. The Ministry does not at present propose any changes to the limit on deviations from the benchmark index, measured by so-called tracking error, but will revert to this issue in the report in the spring of 2015.
Market fluctuations will result in the equity portion of the Fund deviating from the strategic weight of 60 percent. A higher (or lower) equity portion will change the return and risk characteristics of the Fund. Rebalancing is intended to restore the strategic weight, thus ensuring that the risk of the Fund does not over time deviate materially from that implied by the long-term allocation across asset classes adopted for the Fund. Rebalancing may, at the same time, exhibit certain countercyclical properties, inasmuch as the Fund sells assets that have appreciated in value, in relative terms, and purchases assets that have declined in value. The rebalancing provisions are discussed in section 2.3. It is proposed that tracking error upon rebalancing be excluded from the limit for premitted deviations from the benchmark.
Section 2.4 discusses return and risk in oil and gas equities. The main policy measure for reducing the oil and gas price risk of the State is the reallocation of wealth from oil and gas on the continental shelf to financial investments in the GPFG. The Ministry has analysed whether there is reason to expect that the oil price risk can be further reduced by changing the composition of the investments in the GPFG. No changes to the benchmark index are proposed on the basis of these analyses.
The Ministry is committed to that the Government Pension Fund shall be managed in a responsible manner. Considerable experience has been gained in this area in the last decade, and the responsible investment strategy has been developed over time. The ethical guidelines were introduced in 2004. The guidelines were evaluated in 2009. 2010 saw the establishment of a new responsible investment mandate for Norges Bank and new guidelines on the observation and exclusion of companies in which the Fund may invest.
It is the ambition of the Ministry that all aspects of the management of the Government Pension Fund shall be in line with best practice internationally. In January 2013, the Ministry therefore requested the Strategy Council for the GPFG to assess how the collective resources and competencies of the Ministry of Finance, the Council on Ethics and Norges Bank can best be utilised to further strengthen responsible investment in the GPFG.
The report of the Strategy Council was submitted in November 2013 and has been circulated for public consultation. Section 2.5 discusses the recommendations of the Strategy Council, the consultative comments received and the follow-up of the Ministry. In this White Paper the Ministry announces a number of changes that will, in the view of the Ministry, strengthen responsible investment. Among the proposed measures are the integration of all the responsible investment tools in Norges Bank.
Section 2.6 of this report discusses the follow-up of the statements in the Sundvolden platform, in which it is declared that:
“The Government will establish an investment programme within the GPFG, with management requirements of the same scope as for the other investments made under the GPFG, but with the aim of investing in sustainable enterprises and projects in less affluent countries and emerging markets. Furthermore, the Government will consider drawing up a separate mandate in the field of renewable energy, with management requirements of the same scope as for other investments made by the GPFG. ”
In the report, the Ministry proposes, inter alia, that the mandate given to Norges Bank be amended such as to expand the investments in renewable energy.
Previous assessments have concluded that the active ownership and advocacy vis-à-vis coal and petroleum companies will be a more effective strategy for addressing climate issues and effecting changes than to exclude companies from the Fund. The report outlines the follow-up of the request from the Storting for the appointment of an expert group to examine whether these conclusions remain viable, as well as shed light on the implications of climate change for the GPFG in general.
Transparent management and a strategy with widespread support
Widespread support for the main principles underpinning the management of the Government Pension Fund makes an important contribution to enabling us to adhere to the long-term strategy, even during times of market volatility. Good long-term management is necessary to ensure that the revenues from the petroleum resources will benefit both future and current generations.
The Ministry emphasises that the risk in the management of the Fund must be managed, controlled and communicated in a clear and effective manner. Nonetheless, experience shows that it is challenging to uncover all types of risk in advance. Section 4.4 addresses verifications of return data and independent assessments of frameworks and processes for the management and control of risk.
Transparency is a prerequisite for securing widespread confidence in the management of the Government Pension Fund. The Ministry seeks to facilitate a broad-based debate on important aspects of the investment strategy of the Fund. Material changes to the strategy are submitted to the Storting. A thorough decision-making process is one of the strengths of the investment strategy.
Alongside the ongoing reporting of Norges Bank and Folketrygdfondet, this report is intended to contribute to transparency and broad-based debate concerning the management of the Fund.