5 Government Pension Fund Norway: Further development of strategy and management
5.1 Advice from Folketrygdfondet on amendments to the management mandate
Folketrygdfondet has in a letter of 13 December 2019 to the Ministry of Finance submitted its advice on amending the management mandate for the Government Pension Fund Norway (GPFN). The background is that the GPFN’s ownership stakes in companies listed on Oslo Stock Exchange are so high that there is risk of breaching the management mandate ownership stake limit stipulated at 15 percent in Norwegian companies. Excessive ownership stakes also involve reduced scope for active management. Folketrygdfondet’s letter is available on the Ministry website.
The benchmark index for the GPFN has since 2007 comprised listed equities (60 percent) and bonds (40 percent). The benchmark has a fixed geographical distribution, with 85 percent Norwegian securities and 15 percent Nordic (Danish, Finnish and Swedish) securities.
In its advice, Folketrygdfondet refers to the large-scale equity purchases during the period of equity market downturn in 2008 and 2009, resulting from rebalancing of the GPFN equity share. This served to significantly increase the Fund’s ownership stakes in companies included in the Oslo Stock Exchange benchmark index. Ownership stakes in Norwegian companies have remained high over the period since the financial crisis, despite several subsequent rebalancing rounds involving the selling of shares, which in isolation would have reduced the GPFN ownership stakes. The main reason why ownership stakes nonetheless remain high is that the companies on Oslo Stock Exchange during the same period have paid out dividends in excess of the amount issued in initial or secondary public offerings. Folketrygdfondet reinvests such dividends, which has countered the effect from rebalancing-induced equity sales.
After the stock market slumped in March 2020, Folketrygdfondet conducted a rebalancing that included additional equity purchases. However, a swift market rebound meant that the need for equity acquisition was limited, thereby leaving the Fund’s ownership stakes in companies at Oslo Stock Exchange largely unchanged. Calculations from Folketrygdfondet show that it would not have been possible to complete a rebalancing of the GPFN equity share to 60 percent in the event of a market decline of similar magnitude to that of the financial crisis, without simultaneously breaching the ownership stake limitation set out in the mandate.
5.1.2 The purpose of the GPFN
The GPFN was originally established in 1967, under the name of Folketrygdfondet, as a savings vehicle that would contribute to the funding of future of payments under the national insurance scheme. The Fund has since 1979 been closed, with no new capital being contributed, and the return generated has been added to the fund capital on an ongoing basis. The GPFN constitutes, together with the Government Pension Fund Global (GPFG), the Government Pension Fund.
The purpose of the Government Pension Fund is, inter alia, to support the funding of pension expenditure under the national insurance scheme. The investment objective for the GPFN is to achieve the highest possible return, measured in Norwegian kroner, given an acceptable level of risk. Folketrygdfondet may deviate somewhat from the stipulated benchmark index in order to, among other things, generate excess return. The management performance record is strong. Since 2007, Folketrygdfondet has achieved an average annual gross excess return of 1.0 percentage point, corresponding to about NOK 30 billion. The strategy and performance of the GPFN are discussed in chapters 4.1 and 4.2 (in Norwegian only).
5.1.3 Folketrygdfondet’s advice
In its letter, Folketrygdfondet states that the challenge of large ownership stakes in the Norwegian equity market may be resolved in several ways. The recommendations are based on certain underlying premises. Firstly, the objective of achieving the highest possible return over time, net of costs, remains unchanged, together with the commitment to responsible investment. Furthermore, Folketrygdfondet deems a Nordic investment universe to be highly advantageous, as this contributes to better investment management quality and a higher risk-adjusted return.
Folketrygdfondet recommends a reduced proportion of the equity portfolio invested in Norway, and a corresponding increase in the proportion invested in Denmark, Finland and Sweden. Folketrygdfondet emphasises that this recommendation would entail the GPFN still retaining significant ownership stakes in the Norwegian stock market, but also sufficient room for manoeuvre to act counter-cyclically and engage in active management without the risk of breaching the ownership stake limit.
Folketrygdfondet believes investing in unlisted equities might contribute to reducing the challenges associated with the ownership stake limit, although the private equity market is unlikely to be able to absorb sufficient capital to solve the ownership stake issue within a reasonable time horizon. The GPFN may, under the current mandate, be invested in unlisted companies whose board of directors has expressed an intention to seek a listing. Folketrygdfondet has thus far made little use of this provision, as company boards rarely communicate a clear listing strategy in advance. Folketrygdfondet deems it appropriate to replace the current provision with a separate unlisted equity investment allowance, corresponding to 2–3 percent of the equity portfolio. The purpose would be to gain exposure to companies that are generally assumed to be candidates for listing at a later date. Folketrygdfondet would consider direct shareholdings in mature companies with a market value above a certain threshold to be relevant investment opportunities.
Folketrygdfondet further acknowledges that annual withdrawals from the GPFN would serve to reduce the growth of the Fund and limit its ownership stakes in Norwegian companies, and is not opposed to such an arrangement from a professional investment management perspective. Folketrygdfondet does, however, caution against a lumpsum withdrawal from the GPFN, as an alternative investment of the capital would, according to Folketrygdfondet, generate a lower risk-adjusted return than if the capital were to remain in the Fund.
Other options, such as reducing the equity share, tracking the benchmark more closely, increasing the ownership stake limit or use of external mandates, are not, in the view of Folketrygdfondet, appropriate solutions. Folketrygdfondet believes such solutions would either result in lower expected return or challenge the financial objective of the Fund.
Certain technical modifications to the equity benchmark, including transitioning from fixed to floating regional weights with assigned country factors are also proposed.1 In addition, amendments to the fixed-income benchmark are recommended.
5.1.4 The Ministry’s assessments
The Ministry acknowledges that the challenge of excessive ownership stakes in companies on Oslo Stock Exchange may be addressed in several ways. One option might be to increase the ownership stake limit, thereby permitting Folketrygdfondet to become a larger owner on Oslo Stock Exchange. Other solutions might include increasing the share of investments in the Nordic region, expanding the scope for unlisted equity investments or to withdraw capital from the Fund.
Folketrygdfondet is one of the largest financial investors on Oslo Stock Exchange. There are, in the view of the Ministry, no substantial arguments in favour of the State being a large owner on Oslo Stock Exchange, as this is considered a well-functioning market with no special need for government intervention. There are primarily historical reasons why the GPFN is invested in the Norwegian securities market.
Folketrygdfondet is a financial investor. This implies that the State does not have any strategic objective for its ownership or any requirement for involvement in strategic decision-making processes. Ownership stakes are capped at 15 percent to support this notion. The Ministry of Finance agrees with Folketrygdfondet’s position that increased ownership stakes in Norwegian companies might induce uncertainty as to Folketrygdfondet’s role as a financial investor. Against this background, the Ministry is of the view that the 15-percent ownership stake limit for Norwegian companies should remain unchanged.
An overarching consideration behind the investment strategy for the State’s financial wealth in the Government Pension Fund is broad diversification of risk. This is primarily achieved through the investments in the GPFG, since the GPFN accounts only for about 2 percent of the State’s total assets in the Government Pension Fund. Since the GPFG also invests in the Nordic region, a potential expansion of the GPFN’s Nordic share would provide limited additional risk diversification for the State. The Ministry of Finance assumes that there are economies of scale in closely tracking a benchmark index as is the case for both the GPFN and the GPFG. Having two separate funds operating in the same market would therefore, as a general rule, be inefficient, and might if considered in isolation result in higher costs. Folketrygdfondet is referring to positive investment management effects from being able to invest in the Nordic region, but such effects are not quantified. It is uncertain to what extent a higher share invested in the Nordic region would have any significant impact on risk and return in the Fund. The Ministry is proposing to keep the Nordic share of the benchmark index for the GPFN unchanged at 15 percent.
Folketrygdfondet is of the view that investments in unlisted equities may reduce the challenges associated with the magnitude of GPFG’s listed equity investments in Norway, but comments that this market is characterised by weak liquidity and is unlikely to be able to absorb enough capital to solve this issue within a reasonable time horizon. Folketrygdfondet considers nonetheless that an amendment to the mandate provision governing the scope for investing in unlisted companies could be beneficial. The Ministry shares this view.
The GPFN may within the current mandate be invested in unlisted companies whose board of directors has expressed an intention to seek listing on a regulated marketplace in Norway or elsewhere in the Nordic region (except Iceland). Since this provision has been little used thus far, the Ministry will look into whether the current wording is appropriate, and whether the provision may be expanded somewhat. It will for this purpose be necessary to obtain additional information on, inter alia, which other criteria than an expressed intention to list may potentially be used to identify companies assumed to be candidates for listing at a later date.
Based on an overall assessment, the Ministry concludes that the challenges of large ownership stakes in listed Norwegian companies on Oslo Stock Exchange should be resolved, in full or in part, through withdrawals from the GPFN. Withdrawals may take different forms, including lumpsum withdrawal and/or annual withdrawals. Withdrawals from the GPFN will require further analysis of, among other things, authorisations and other consequences. The analysis should include an assessment of operational implications on the part of Folketrygdfondet. The Ministry of Finance will be examining the specific scope and framework for such withdrawals. It is intended for additionally proposed amendments to the mandate to be reviewed concurrently.
The country factor for Norway is recommended set in the interval between 10 and 18. The recommended adjustment factor for the rest of the Nordic region is set at 1. This would imply a Norwegian stock market allocation ranging from 62 to 75 percent.