Meld. St. 23 (2015–2016)

The Management of the Government Pension Fund in 2015

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1 Glossary of terms

Active management

Active management involves the asset manager composing, on the basis of analyses and assessments, a portfolio that deviates from the benchmark index established by the asset owner. In such a portfolio, some securities will be overweighted and some underweighted compared to the benchmark index. The portfolio may also contain securities which are not included in the index. The purpose of such deviations is to achieve an excess return or improve the risk-return ratio compared to the benchmark index. In the GPFN and GPFG, deviation from the benchmark index is primarily regulated by means of a limit on expected tracking error. See Excess return, Actual benchmark index, Index management, Strategic benchmark index and Tracking error.

Actual benchmark index

The actual benchmark index for the GPFG and the GPFN is based on the strategic benchmark index. The strategic benchmark index specifies the allocation across asset classes and comprises a given number of securities, determined by the criteria adopted by the index provider for inclusion in the index. However, since the various asset classes generate different returns over time, the asset allocation of the actual benchmark index will drift from the strategic weights. In order to prevent the deviation from the strategic weights from becoming excessive, the Ministry has adopted rebalancing rules for the equity portion for the actual benchmark index. See Strategic benchmark index and Rebalancing.

Within the established asset management framework, the composition of the actual portfolio may deviate from that implied by the actual benchmark index. Since the scope for deviations is limited, the risk and return of the Fund will largely be determined by the actual benchmark index. The actual benchmark index forms the basis for the measurement of excess return and risk assumed in active management. See Active management, Excess return and Actual portfolio.

Actual portfolio

The term actual portfolio designates the overall investments included in the Fund. The actual portfolio will normally deviate from the benchmark index (active management). See Active management, Actual benchmark index and Strategic benchmark index.

Arithmetic return

Arithmetic return is a measure of the average return over several time periods. It is calculated by adding up the return achieved in different time periods and dividing the sum by the number of periods. See Return and Geometric return.

Asset allocation

Asset allocation means the allocation of capital under management across different asset classes. A distinction is made between strategic asset allocation and tactical asset allocation. Strategic asset allocation expresses the asset owner’s underlying risk tolerance and return expectations, and is for the Government Pension Fund Global expressed through the composition of the benchmark index. Within the limits of the investment mandate, the asset manager may engage in tactical asset allocation. This entails actively choosing to deviate from the strategic asset allocation on the basis of assessments as to whether one asset class is over- or underpriced relative to another. See Asset classes.

Asset classes

Asset classes are different types or classes of financial assets with different risk and return properties. The benchmark index for the GPFG encompasses three asset classes: equities, bonds and real estate. The benchmark index for the GPFN includes two asset classes: equities and bonds. See Bond.


A bond is a tradable loan with a maturity of more than one year. Bonds are redeemed by the issuer (borrower) upon maturity, and the issuer pays interest (so-called coupon) to the bondholders during the period between issuance and maturity. Most bonds are based on a fixed nominal interest rate, i.e. the coupon is a specified predetermined amount. A fixed-rate bond will appreciate in value when the general interest rate level falls and correspondingly depreciate when the general interest level rises. Bonds may have different features, including a floating interest rate, a zero coupon or an ongoing redemption structure.

Capital Asset Pricing Model

The Capital Asset Pricing Model is an equilibrium model for the pricing of securities (or a portfolio of securities) with an uncertain future return. The model features a linear relationship between the expected return in excess of a risk-free rate and the sensitivity of the security (or portfolio) to market risk.

Concentration risk

If investments or loans are concentrated in an individual company, industry or market, the portfolio becomes vulnerable to incidents which affect these investments in particular. Concentration risk can be reduced through broad diversification of investments or loans. See Diversification.


Correlation refers to the degree and direction of the covariation between two variables. Perfectly positive correlation (= 1) means that the variables always move perfectly in tandem. Zero correlation means that there is no covariation whatsoever. Perfect negative correlation means that the variables always move in exact opposition to each other. The risk associated with a portfolio can be reduced by diversifying the investments across several assets, unless there is perfect positive correlation between the returns on the individual investments. See Diversification.

Counterparty risk

Counterparty risk is the risk of loss as the result of another contracting party not fulfilling its legal obligations. See Credit risk.


The interest paid to bondholders during the period between issuance and maturity. Bonds may be issued with or without a coupon.


See Correlation.

Credit risk

Credit risk is the risk of loss due to non-fulfilment of legal obligations by the issuer of a security or a counterparty to a securities trade, for example as a result of bankruptcy. See Counterparty risk.

Currency basket

The GPFG is exclusively invested in foreign securities, and thus only in securities that are traded in currencies other than Norwegian kroner. Hence, the return on the GPFG measured in Norwegian kroner will vary with changes in the exchange rate between Norwegian kroner and the currencies in which the Fund is invested. However, the international purchasing power of the Fund is unaffected by developments in the Norwegian kroner exchange rate. The return on the Fund is therefore measured in foreign currency. This is done on the basis of the currency basket for the Fund, which weights together the currencies included in the benchmark portfolio.

Differential return

See Excess return.


The risk associated with a portfolio can normally be reduced by including more assets in the portfolio. Doing so reduces the impact on the portfolio of fluctuations in, for example, an individual share, industry or market. This is referred to as diversification, or the spreading of risk. Diversification is the main reason for spreading the benchmark index of the Fund across several asset classes and a broad range of countries, sectors and companies. Diversification can improve the ratio between expected return and risk. See Asset classes.


Duration measures how long it takes, on average, for the cash flows (coupons and principal) of a bond to be redeemed. The value of a bond is sensitive to interest rate changes, and such sensitivity increases with longer duration. See Bond.

Emerging markets

The term emerging markets denotes countries with economies that are less developed than those of traditional industrialised nations. There is no unambiguous set of criteria that defines whether a market is emerging, and country-classification practice varies. The classifications of index providers such as FTSE are commonly used for investments in listed stock markets. FTSE classifies emerging markets on the basis of, inter alia, gross domestic product per capita. Since indices provide the foundation for financial investments, account is also taken of financial market characteristics such as size, liquidity and regulatory framework.

Excess return

The contribution made by active management to the return on the invested capital is referred to as the excess return, and is measured as the difference in return between the actual portfolio and the benchmark index. It is also referred to as the differential return, or as a negative excess return when the actual portfolio produces a lower return than the benchmark index. Risk and asset management costs are also taken into account when evaluating the results of active management in this context.

Exchange rate risk

Investments may feature a different distribution across countries and currencies than the goods and services they are intended to finance. Changes in international exchange rates will therefore influence the amount of goods and services that can be purchased. This is referred to as (real) exchange rate risk. International purchasing power parity plays a key role when it comes to measuring such exchange rate risk. See International purchasing power parity.

Expected return

Expected return is a statistical measure of the mean value in a set of all possible return outcomes, and is equal to the average return on an investment if repeated numerous times. If an investment alternative has a 50 percent probability of a 20 percent appreciation, a 25 percent probability of a 10 percent appreciation and a 25 percent probability of a 10 percent depreciation, the expected return is 10 percent: (0.5 x 0.2) + (0.25 x 0.1) + (0.25 x -0.1) = 10. Expected return may be calculated using historical return series or based on forward-looking model simulations. See Return.


Externalities are production or consumption costs or benefits that are not incurred by, or accrue to, the decision maker. An example of a negative externality is environmental damage which affects society but not the company which causes it. Without regulation, the profitability of a company will not reflect the negative externalities of its production. When an externality is negative, the socioeconomic cost is higher than what is paid by the producer. The opposite applies to positive externalities. Such market failure results in inefficient resource use compared to scenarios in which the company covers the full socioeconomic cost. Regulation can promote correct pricing of externalities and thus effective use of resources for the benefit of society, for example through a tax on environmental damage.


Factors influence the return on a broad range of investments. Investors will normally require an expected return in excess of the risk-free rate to accept exposure to systematic factors, preventing the reduction of the risk associated with such factors through diversification. This is labelled a factor premium. Known systematic factors in the stock market include market risk, size, value, momentum, liquidity and volatility. Important systematic factors in the bond market are term, credit and liquidity, with corresponding factor premiums. See Diversification and Systematic risk.

Financial owner

The term financial owner is applied to investors who primarily have a financial objective when investing in securities. To spread risk, a financial owner will often prefer to be a small owner in many companies, rather than a large owner in few. See Strategic owner.

Fundamental analysis

Fundamental analysis primarily aims to analyse the factors that influence the future (expected) cash flow of an asset. A key feature of a fundamental analysis of individual stocks will be assessments relating to the income, costs and investments of the company. Fundamental analysis is used for, inter alia, the valuation of companies. Active management strategies will often involve the purchase of equities that are deemed to have a low valuation in the stock market relative to the estimated fundamental value of the company. The investor therefore expects the fundamental value of the company over time to be reflected in its share price. See Active management.

Geometric return

Geometric return (or time-weighted return) is a measure of average return over several time periods. The measure specifies the average growth rate of an investment in each period. The more pronounced the variation in the annual return, the greater the difference between the geometrically and arithmetically calculated returns. In quarterly and annual reports, return over time is most commonly reported as a geometric average. See Arithmetic return.


An index comprises a set of securities defined on the basis of the selection criteria applied by the index provider, and specifies an average return for the securities included in the index. Indices are prepared by securities exchanges, consultancy firms, newspapers and investment banks. They may, for example, be based on countries, regions, markets or sectors. If it is possible to invest in a portfolio in line with the index composition, the index is said to be investable. This will typically be the case with highly liquid securities, like listed equities. An index of unlisted real estate developments, on the other hand, will not be investable. When an index is used as a return measure for a specific securities portfolio, it is referred to as a benchmark index. See Index management, Actual benchmark index and Strategic benchmark index.

Index management

Index management (passive management) entails organising asset management to ensure that the actual portfolio reflects the composition of the benchmark index. If the composition of the actual portfolio is identical to the composition of the benchmark index, the return on the actual portfolio will be equal to the return on the benchmark index, ignoring transaction costs, taxes and asset management costs. If the benchmark index includes most of the securities traded in the market, index management will achieve a return that reflects the return on the market as a whole. The costs associated with index management are normally low. See Index, Actual benchmark index and Strategic benchmark index.


Inflation is an increase in the general price level.

Inflation risk

Inflation risk is the risk of a loss of purchasing power as the result of unexpectedly high inflation. See Inflation.

Institutional investor

Institutional investors are organisations set up for the purpose of engaging in investment activities, typically on behalf of clients. Institutional investors normally manage large portfolios covering several asset classes and geographical markets. Examples of institutional investors are pension funds, insurance companies, securities funds and sovereign wealth funds. Banks and hedge funds may also be classified as institutional investors.

International purchasing power parity

This term describes a theory which states that over time exchange rates are determined by the amount of goods and services which can be purchased using each currency. Exchange rates will be drawn to a level at which the prices of goods and services converge when measured in a common currency. No account is taken of transportation costs, trade barriers or the fact that not all goods can be traded internationally. There is a broad consensus among researchers that international purchasing power parity applies in the long run. Purchasing power parity plays a key role in the measurement of exchange rate risk. See Exchange rate risk.


By investability is meant the extent to which an investment idea or rule can be implemented in operational asset management. Investability may differ for small and large funds.

Liquidity premium

A liquid security can be traded relatively quickly and at a relatively predictable price. A liquidity premium is an expected compensation for investing in illiquid securities. In practice, liquidity premiums are difficult to define and measure. See Risk premiums.

Market efficiency

Market efficiency implies that the price of a financial asset, such as an equity or a bond, at all times reflects all available information about the fundamental value of the asset. If this hypothesis is correct, it will be impossible for a manager consistently to achieve an excess return through fundamental analysis. See Active management and Fundamental analysis.

Market risk

Market risk is the risk that the value of a securities portfolio will change as the result of broad movements in the market prices of equities, currencies, commodities and interest rates. It is normally assumed that higher market risk is accompanied by a higher expected return over time. See Expected return.

Market value weights

A portfolio or index is market-value weighted when the investments in each individual security or asset are included with a weight corresponding to the security’s or asset’s proportion of total market value. See Index.

Nominal return

Achieved return measured in nominal prices, i.e. without inflation adjustment. See Return, Inflation and Real rate of return.

Operational risk

Operational risk is the risk of economic loss or reputational loss as the result of deficiencies in internal processes, human error, systems error or other loss caused by circumstances that are not a consequence of the market risk in the portfolio. Operational risk does not generate a risk premium. However, in managing operational risk, the gain to be made by keeping the probability of such losses low must be balanced against the costs incurred as a result of increased control, monitoring, etc.

Passive management

See Index management.


A collection of different securities and asset classes held by an investor. See Diversification.

Principal-agent problem

Principal-agent problems describe situations in which there is not a complete alignment of interests between the person issuing an assignment (the principal) and the person performing it (the agent). In cases where the principal and the agent have access to different information, the agent may make choices that are not necessarily in the interest of the principal. In the capital markets, such situations may generally arise both between an asset owner and an asset manager and between an asset manager and the senior executives of the companies in which investments are made.

Probability distribution

A probability distribution describes the relative frequency of various values that an uncertain (stochastic) variable may assume. The best known probability distribution is the normal distribution, which is symmetric around the mean value (expected value). Asymmetrical distributions are often referred to as skewed. Distributions in which extreme outcomes (large or small) carry a higher probability than under the normal distribution are referred to as distributions with “fat“ or “heavy“ tails.

Real rate of return

Real rate of return is the achieved nominal return adjusted for inflation. It may also be referred to as return measured in constant prices or in terms of purchasing power. See Inflation and Nominal return.


The Ministry has adopted strategic benchmark indices for the GPFG and the GPFN which incorporate a fixed equity portion and, for the GPFN, also a fixed regional allocation. Since returns develop differently in respect of each asset class and region, the equity portion in the actual benchmark index will over time move away from the strategic allocation. The Fund’s actual benchmark index is therefore permitted to deviate somewhat from the strategic composition. Further, rules have been issued on the rebalancing of the index. When deviations exceed predetermined limits, the necessary assets are purchased and sold to bring the actual benchmark index into conformity with the strategic benchmark index. Rebalancing returns the risk in the Fund to the level implied by the strategic benchmark index. It also gives the investment strategy something of a counter-cyclical flavour, since over time the Fund will buy the asset class which has fallen substantially in value in relative terms and sell the asset class which has experienced high relative value growth. See Actual benchmark index and Strategic benchmark index.

Relative return

See Excess return.


Historical return is calculated as the change in market value from one specific date to another. Cash outflows during the period, such as equity income and coupons, are included when calculating the return. See Arithmetic return, Geometric return, Excess return and Expected return.


Risk is a measure that provides some indication as to the probability of an event occurring and the consequences thereof, for example in the form of losses or gains. There are various aspects to risk. One important aspect is the distinction between risk that can be quantified and risk that is difficult to quantify. An example of the former is the market risk associated with investments in the securities market. An example of the latter is the operational risk inherent in a portfolio. Standard deviation is one common way of quantifying risk. See Market risk, Operational risk, Credit risk, Systematic risk and Standard deviation.

Risk premium

Investors will normally demand an expected return beyond the risk-free rate for accepting risk which cannot be eliminated by diversification, i.e. for exposure to systematic risk factors. This excess return is referred to as the risk premium. See Diversification and Factors.

Standard deviation

Standard deviation is often used to measure portfolio risk. It indicates how much the value of a variable (in this case the portfolio return) is expected to fluctuate around its mean. The standard deviation of a constant value will be 0. The higher the standard deviation, the larger the expected fluctuations (volatility) or risk relative to the average return. Linking the standard deviation to a probability distribution sheds light on the probability of a portfolio decreasing in value by more than x percent or increasing in value by more than y percent during a given period.

If normally distributed, a return will deviate from the average return by less than one standard deviation in approximately two out of three instances. In 95 percent of the cases, the return will deviate by less than two standard deviations. Empirical studies of returns in the securities markets indicate that very low and very high returns occur more frequently than implied by a normal distribution. This phenomenon is called “fat tails” or “tail risk”. See Probability distribution and Risk.

Strategic benchmark index

The overarching investment strategy for the Government Pension Fund is expressed through strategic benchmark indices for the GPFN and the GPFG, respectively. The strategic benchmark indices specify a fixed allocation of capital across different asset classes and, in the GPFN’s case, also a fixed regional allocation. The strategic benchmark indices provide a detailed description of the asset allocation, and are set by the Ministry of Finance in the respective fund mandates. See Asset allocation, Asset classes and Actual benchmark index.

Strategic owner

The term strategic owner is used to describe investors who, unlike financial owners, actively seek to exploit their ownership status for non-financial purposes, for example to secure a desired change in conduct. For a strategic owner, it is important to exercise influence over the company, preferably through a large ownership share and a seat on the company’s board of directors. Such owners are also referred to as industrial owners. See Financial owner.

Systematic risk

Systematic risk refers to the proportion of risk associated with a security or portfolio that cannot be diversified away by holding more securities. Investors cannot diversify away from recessions, lack of access to credit or liquidity, market collapse, etc. Systematic risk thus reflects the inherent uncertainty of the economy. According to financial theory, higher systematic risk will be compensated for in the form of higher expected returns over time. See Diversification and Risk factors.

Tracking error

The asset owner will normally define limits as to how much risk the asset manager may take. A common method is to define a benchmark index, together with limits specifying how much the actual portfolio may deviate from the benchmark index. In the mandates of Norges Bank and Folketrygdfondet, the Ministry of Finance has defined a limit in the form of a target for expected tracking error, i.e. the expected standard deviation of the difference in the returns on the actual portfolio and the benchmark index. This means that over time, if certain statistical assumptions apply and the entire limit is utilised, the actual return will deviate from the return on the actual benchmark index by less than the defined limit as expressed in percentage points in two out of three years. See Active management, Excess return, Actual portfolio, Actual benchmark index and Standard deviation.

Unlisted investments

Unlisted investments are investments in assets which are not traded in open and regulated markets.


Return variations. Measured by standard deviation. See Standard deviation.

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