1 Executive summary
The purpose of the Government Pension Fund is to support long-term considerations in the government’s spending of petroleum revenues, as well as saving to finance pension expenditure under the National Insurance Scheme. Sound long-term management will help to ensure that Norway’s petroleum wealth can benefit both current and future generations.
The Government Pension Fund comprises the Government Pension Fund Global (GPFG) and the Government Pension Fund Norway (GPFN). Operational management of the two funds is carried out by Norges Bank and Folketrygdfondet, respectively, within limits stipulated in designated management mandates laid down by the Ministry of Finance.
The Ministry of Finance presents in this report the performance of the two funds in 2018. The report also discusses further development of the investment strategy and addresses the responsible investment framework.
The objective for the investments in the GPFG and the GPFN is to achieve the highest possible return with an acceptable level of risk. There is broad political consensus that the Government Pension Fund should not be used as a foreign policy or climate policy instrument. The investment strategies for the two funds have been developed over time based on professional assessments, practical experience and thorough assessments. Material changes to the investment strategies have been endorsed by the Storting (Parliament) prior to implementation. Broad endorsement and a thorough understanding of the risk assumed in the management of the funds contribute to the sustainability of the chosen long-term investment strategy, also in periods of financial market turbulence.
The Ministry of Finance has defined investment strategies for the GPFG and the GPFN, which are reflected in, inter alia, the composition of the benchmark indices. The equity share of the GPFG benchmark is 70 percent, whilst the equity share stipulated for the GPFN is 60 percent. Fixed-income securities account for the remainder of the indices.
The investment strategies are based on the premise that risk can by reduced by diversifying the investments across different asset classes, countries, sectors and companies. It is also based on the premise that financial markets are largely well-functioning, thus implying that it will be difficult to systematically outperform the general market. This approach suggests that investors should diversify their investments broadly and seek to minimise asset management costs.
The GPFG and the GPFN are managed close to the benchmark indices defined by the Ministry of Finance, which in general can be closely tracked at low costs. Norges Bank and Folketrygdfondet deviate somewhat from the benchmark indices in their operational management to ensure a cost-effective adoption of the benchmarks, as well as to exploit distinctive characteristics of the funds to achieve excess return. There is some scope for unlisted real estate investment in the operational management of the GPFG.
Volatile financial markets and weak performance in 2018
2018 brought volatility to financial markets and weak stock market performance, especially towards the end of the year. Last year was characterised by uncertainty concerning future economic growth and the effects of mounting trade barriers internationally. In 2018, the GPFG generated a return of -6.1 percent measured in the currency basket of the Fund, which is the second-weakest performance in the history of the Fund. The negative return was caused by weak stock markets. In contrast, the return on the fixed-income investments was moderately positive, whilst the unlisted real estate investments performed well in 2018. The market value of the GPFG at the end of 2018 was Norwegian kroner (NOK) 8,251 billion, net of management costs. Measured in NOK, the market value declined by NOK 232 billion. Depreciation of the Norwegian krone served, when taken in isolation, to reduce the decline in the value of the Fund as measured in NOK. Net capital inflows also made a positive contribution.
The Norwegian stock market performed somewhat better than global equity markets in 2018, although last year as a whole ended with a modest decline. The return on the GPFN was -0.4 percent measured in NOK, with equity returns being significantly lower than the returns on fixed-income securities. The market value of the Fund was NOK 239 billion at the end of 2018.
Norges Bank and Folketrygdfondet seek to generate the highest possible return, net of costs, within the limits stipulated in the management mandates from the Ministry of Finance. Last year, the GPFG underperformed the benchmark index by 0.30 percentage points. The annual average return on the Fund over the last 20 years has been 0.25 percentage points higher than the return on the benchmark index. The GPFN outperformed the benchmark index by 0.76 percentage points, and the annual average excess return since 2007 has been 1.03 percentage points.
Measured as a proportion of assets under management, costs in 2018 were 0.05 percent in the GPFG and 0.06 percent in the GPFN. Management costs are low compared to other funds.
New framework and benchmark index for the GPFG fixed-income investments
In view of the decision in 2017 to increase the equity share of the GPFG to 70 percent, the Ministry initiated a review of the fixed-income investment framework for the Fund, including the benchmark composition. The Ministry has received advice and assessments from both Norges Bank and an expert group.
The decision to increase the equity share of the GPFG to 70 percent was based on an assessment that the risk-bearing capacity of the Fund had increased. Hence, a larger equity share does not in itself, call for material changes to the composition of the fixed-income benchmark.
The Ministry is in this report proposing that corporate bonds shall continue to account for 30 percent of the benchmark index and that the maturity of the fixed-income benchmark index shall reflect market developments – as at present.
However, certain operational challenges associated with the current fixed-income benchmark, as pointed out in a letter from Norges Bank, entail that some benchmark changes are needed to facilitate lower transaction costs and increased investability. The Ministry is in this report proposing to omit emerging market government bonds and emerging market corporate bonds from the fixed-income benchmark for the GPFG. At the same time, investment in such bonds is capped at 5 percent of the fixed-income portfolio, and also subject to expanded reporting requirements. The Ministry is proposing a continuation of the current government bond weighing principle for the benchmark index, although subject to certain technical modifications.
Environmental mandates and unlisted renewable energy infrastructure investments in the GPFG
In last year’s report, the Ministry proposed an assessment of whether unlisted renewable energy infrastructure investments can be effected within the scope of the environment-related mandates, subject to the same transparency, risk and return requirements as apply to the other investments in the GPFG. It also proposed a review of the regulation of the environment-related mandates in general, including the size of the mandates. The Standing Committee on Finance and Economic Affairs requested, in its recommendation, the Ministry to revert to the Storting, no later than in the report to be submitted in the spring of 2019, with a specific mandate proposal for such investments under the environment-related mandates. The majority of the members of the Standing Committee also requested an assessment as to whether the scope of the environment-related mandates should be expanded.
Norges Bank noted, in a letter to the Ministry of Finance, that unlisted renewable energy infrastructure investments can be made within the framework for the environment-related mandates and that the Bank may have advantages relative to other investors with regard to such investments. The Bank observed, at the same time, that the upper limit of the mandates should be raised if allowing for unlisted renewable energy infrastructure investments. It is emphasised that Norges Bank will approach the investment opportunities and build expertise gradually, and would initially consider projects with relatively low market risk and operational risk in developed markets. The Bank would primarily be considering direct investments with partners.
The Ministry is of the view that it would be acceptable to allow for the GPFG to be invested in unlisted renewable energy infrastructure under a suitable framework. Unlisted renewable energy infrastructure has several similarities with unlisted real estate investments, and it is therefore proposed that the mandate provisions of such investments should be fairly similar. An unlisted investment strategy cannot be defined via a benchmark index. Any unlisted renewable energy infrastructure investments will form part of the Bank’s active management and draw on the scope for deviations from the benchmark index. Furthermore, the Ministry emphasises that any investments shall only be implemented under the environment-related mandates, and shall be subject to the same profitability and transparency requirements as the other investments of the Fund.
The Ministry is proposing that the limit on deviations from the benchmark index shall remain unchanged at 1.25 percentage points. Hence, Norges Bank will need to prioritise any unlisted renewable energy infrastructure investments against other strategies that entail deviations from the benchmark index. The normal market value range of the environment-related mandates will be expanded from the current NOK 30–60 billion to NOK 30–120 billion. The range is intended to highlight that investment opportunities and the scale of such investments may vary over time. The lower cap entails an element of dedicated allocation of investment funds and is kept unchanged at NOK 30 billion. Moreover, the Ministry is proposing the introduction of a separate upper cap on unlisted renewable energy infrastructure, at 2 percent of the Fund.
The proposed regulation will enable Norges Bank to exploit any economies of scale, including cost-effective implementation of the investments, whilst at the same time facilitating a gradual approach to a sub-segment which is small relative to other markets in which the Fund is invested. The regulation is not intended as an instruction to Norges Bank, under which the Fund shall be invested in unlisted renewable energy infrastructure.
The Ministry will prepare a proposal for specific mandate provisions after the Storting’s deliberation of the report, and present these to Norges Bank. It is intended for the mandate provisions to enter into effect no later than 1 January 2020.
New provisions on rebalancing of the equity share of the GPFG
The management mandate to Norges Bank defines a fixed strategic allocation between equities and fixed-income securities. It has been decided to increase the equity share of the strategic allocation to 70 percent. Diverging developments in stock and bond markets mean that the equity share of the actual benchmark index may vary. In order to prevent the equity share of the benchmark index deviating materially from the strategic weight over time, provisions have been introduced on when and how rebalancing shall be effected. It has, since the adoption of the current provisions in 2012, become more challenging to carry out rebalancing at low cost. The Ministry is therefore proposing certain modifications to the provisions. The adjustments imply that rebalancing shall be triggered when the equity share deviates by more than 2 percentage points from the strategic weight. Rebalancing shall also be carried out more gradually than before.
Review of Folketrygdfondet’s management of the GPFN
Folketrygdfondet may deviate somewhat from the Fund benchmark in its management of the GPFN, within limits stipulated by the Ministry of Finance. The purpose is to ensure a cost-effective adoption of the benchmark index and to achieve excess return over time. The Ministry reviews Folketrygdfondet’s management of the GPFN on a regular basis, as is the case for Norges Bank’s management of the GPFG; see last year’s report1. A key issue in these periodical reviews is whether the limit on deviations from the benchmark index should be changed.
The Ministry of Finance is of the view that the performance achieved by Folketrygdfondet in its management of the GPFN over time is favourable. The Ministry is not proposing a change to the current limit on deviations from the Fund benchmark, nor has Folketrygdfondet given any advice to such effect.
The GPFG and the GPFN both have a clear financial objective. The Funds shall be managed responsibly within the scope of their overarching financial objective. The mandates laid down by the Ministry of Finance for the GPFG and the GPFN refer to responsible management standards and principles, and Norges Bank and Folketrygdfondet apply such standards and principles in their responsible management activities.
Norges Bank and Folketrygdfondet make investment decisions and exercise the ownership rights of the funds independently of the Ministry, in line with established mandates and guidelines. Important responsible management tools are standard-based advocacy of principles and expectations, company dialogue on relevant topics and issues, as well as the submission of proposals and the casting of votes in general meetings of the companies in which the funds are invested. Norges Bank and Folketrygdfondet also participate in the ongoing development of standards. Risk management is also an important aspect of the responsible management of fund assets.
The Ministry of Finance has adopted ethically motivated guidelines for the observation and exclusion of companies from the GPFG. Certain criteria in the guidelines are based on specific products, such as tobacco, weapons and coal. Other criteria are conduct-based, such as serious human rights violations and severe environmental damage.
The Council on Ethics provides recommendations to Norges Bank on the exclusion and observation of companies. The decision-making authority on such matters rests with the Executive Board of Norges Bank. The Bank may opt for a different tool than that recommended by the Council on Ethics. The overarching objective is to apply the most appropriate tool for each individual case. For the coal criterion, Norges Bank may make decisions without any recommendation from the Council on Ethics.
The coal criterion
The Storting adopted, in connection with the deliberation of last year’s fund report, a petition resolution calling for an assessment of whether the current criteria for exclusion of coal companies are adequate for purposes of excluding companies with considerable coal-related operations. Norges Bank was requested, as part of the basis for the Ministry’s assessment, to provide an account of its operationalisation of the coal criterion, as well as to estimate the extent of coal-related operations to which the Fund is still exposed.
Norges Bank’s account indicates that processes have been established which ensure a sound, structured and satisfactory operationalisation of the coal criterion. The Bank notes, at the same time, that the wording of the criterion, with an emphasis on thresholds and forward-looking assessments, involves resource-intensive efforts. If the relative thresholds (30 percent of revenues or operations) under the criterion are lowered, the information gathering and transaction cost challenges will increase owing to a larger number of companies in need of assessment for potential exclusion from or inclusion in the Fund. It is estimated that about 75 percent of overall coal operations have thus far been excluded or placed under observation. The majority of remaining coal operations are confined to a small number of companies that can be said to have extensive coal-related operations in absolute terms. The Ministry is of the view that the relative 30-percent thresholds under the criterion should not be changed, but should be supplemented by absolute thresholds for coal mining and coal power capacity. The Ministry is proposing to put the said thresholds at 20 million tonnes and 10,000 MW, respectively, which will result in the criterion also capturing companies with considerable coal-related operations in absolute terms. The Ministry will be monitoring the implementation of the absolute thresholds and assess potential threshold reductions in view thereof.
The conduct-based climate criterion
The conduct-based climate criterion was incorporated into the ethically motivated guidelines for the GPFG in 2016. Norges Bank has in a letter of 7 November 2018 requested more detailed clarification from the Ministry as to the application of the criterion. The Council on Ethics has submitted a number of recommendations to Norges Bank. The Executive Board of the Bank has thus far not reached any decision on these cases.
The Ministry is of the view that application of the criterion should be based on the following general premises:
The established high exclusion threshold.
The intention of applying a chain of measures.
The climate criterion shall be dynamic over time.
The criterion as a conduct-based criterion.
The premise last-mentioned implies that the criterion does not define the production of specific products as grossly unethical in itself. Instead, the emission intensity of individual companies is considered a consequence of their conduct (actions or omissions). Factors influencing emission intensity may, for example, involve the choice of production method, including inputs and technology.
Furthermore, the assessment of companies against the criterion should be based on an integrated approach informed by the following considerations:
Emissions, emission intensity and basis for comparison: In order to be assessed under the criterion, a company needs to have large emissions in absolute terms, both in aggregate and based on the type of industry under assessment. The company must also have significantly higher emission intensity than companies with which it is appropriate to draw such comparisons.
Forward-looking assessments: A key issue is whether there are specific and credible plans for how emission intensity shall be reduced to an acceptable level within a reasonable period of time. The assessment shall be in line with the premise of a high exclusion threshold. It may for purposes of such assessment be relevant to consider, inter alia, the company’s own plans, expected developments in the peer group, as well as anticipated developments in relevant technologies, standards and practices.
Climate Scheme: As discussed in the fund report submitted in the spring of 20152, it is appropriate for an overall assessment to pay heed to whether companies’ greenhouse gas emissions are subject to taxes, emission allowances or other regulation mechanisms. In the absence of international guidelines or standards, it would be appropriate to consider the EU emission trading system (EU ETS), which may be classified as a strict climate scheme on the basis of its rules, compliance mechanisms, linear reduction factor and emission allowance prices, as a norm or basis for comparison when assessing the framework faced by companies.
Basis for assessment and other factors: Companies’ emission intensity and forward-looking plans may constitute the primary basis for assessment. However, when companies act in conformity with applicable statutes and regulations and are subject to strict climate regulation such as the EU ETS, their emissions cannot in themselves be said to imply unacceptable conduct. Hence, additional factors would need to come into play in order for the conduct of such companies to be considered unacceptable. It will also for other companies be relevant to consider any other factors as part of an overall assessment, although emission intensity and forward-looking plans may constitute a sufficient basis for assessment. Other factors of potential relevance to an overall assessment of companies are relocation of high emission intensity production from countries with a strict climate scheme to countries with no such framework, opposition to or circumvention of climate schemes, positive conduct under a climate scheme, how climate considerations are integrated in corporate governance, or inadequate reporting of, or on, greenhouse gas emissions.
Gambling companies in the GPFG
The Standing Committee on Finance and Economic Affairs referred, in connection with the deliberation of last year’s fund report, to the Storting’s petition resolution of 7 May 2018, which called for an examination of the basis for excluding gambling companies from the GPFG. The Ministry of Finance notes that there shall be a high threshold for ethically motivated exclusions from the Fund. The Fund shall not be a policy instrument for attaining other political objectives. Gaming operations are, within defined limits, lawful in many countries, including Norway. Exclusion of non-Norwegian gambling companies on the grounds that such companies undermine Norwegian legislation and the monopoly model under Norwegian gaming policy, would be in conflict with both the objective for the Fund and the premise that the exclusion of companies shall be based on ethical criteria reflecting broad national values and international norms. Ethical criteria for the observation and exclusion of gambling companies from the GPFG are, against this background, not being established.
Separate council on ethics function for the GPFN
The Standing Committee on Finance and Economic Affairs requested, in connection with the Storting’s deliberation of the fund report submitted in the spring of 2018, an assessment from the Government as to whether it is appropriate to establish an ethics council for the GPFN based on the GPFG model. A key consideration in the Ministry of Finance’s assessment is the major difference between the GPFG and the GPFN, both with regard to the number of companies in which the funds are invested and the size of the ownership stakes held therein. The Ministry accords particular weight to Folketrygdfondet’s close monitoring of the companies in which the Fund is invested, and its active corporate dialogue with a large portion of its portfolio companies. This means that Folketrygdfondet is well placed for actively engaging in responsible investment practices. Folketrygdfondet exercises considerable influence by communicating its environmental, social and governance expectations. Furthermore, the Ministry finds that a separate council on ethics function for the GPFN would entail a risk of diverging interpretations of the ethically motivated guidelines, as noted by both the Council on Ethics and Folketrygdfondet.
Observation and exclusion are based on clear risk assessments and prioritisations, and a high exclusion threshold. Nordic companies that are excluded from the GPFG are also excluded from the GPFN. The Ministry is of the view that it would be inappropriate to establish comprehensive mechanisms and devote resources to analysing Norwegian companies, which are headquartered in a transparent and well-regulated market and are subject to strict legislation. The Ministry finds, against this background, that the proposal for the establishment of a separate council on ethics function for the GPFN should not be adopted. This assessment is in accordance with recommendations in letters from both the Council on Ethics and Folketrygdfondet.
Other relevant topics
The Ministry of Finance has initiated a review of the equity framework and benchmark for the GPFG, including the geographical distribution of the equity benchmark. The Ministry of Finance has in a letter to Norges Bank requested advice and assessments as to the composition of the equity benchmark for the Fund. The Bank has, inter alia, been asked to provide an account of special characteristics of emerging markets, along with risk and return properties of such markets, as well as experience from investing the Fund therein. The Ministry has also commissioned a report from the consultancy firm and index provider MSCI as part of this review. The Ministry aims to present assessments of the equity framework and benchmark in the fund report to be submitted in the spring of 2020.
In November 2017, Norges Bank proposed to omit the energy sector from the benchmark index for the GPFG, in order to reduce the oil price risk associated with the state’s wealth. The Ministry appointed, in February 2018, an expert group to assess whether the Fund should continue to be invested in energy stocks. The group recommended, based on an overall assessment, that the GPFG should remain invested in such companies. The Ministry submitted a separate report on the matter on 8 March this year; see Meld. St. 14 (2018–2019); Energy Stocks in the Government Pension Fund Global. An executive summary of the aforementioned report is available in English on the Ministry website.
The Central Bank Act Commission submitted its report on a new Central Bank Act and the organisation of Norges Bank and the management of the GPFG to the Ministry of Finance on 23 June 2017. The Government presented its assessments in a separate report to the Storting in October 2018.3 The Storting’s deliberation of the report demonstrated that there is broad support for the management of the GPFG to remain in Norges Bank, and that a designated monetary policy and financial stability committee should be appointed. The Government will revert to the Storting in the spring of 2019 with a proposition on a new Central Bank Act.