Speech by Minister of Finance, Mr Sigbjørn Johnsen

To be checked against delivery

Ladies and gentlemen,

It gives me great pleasure to welcome you to this seminar on active management. In April last year we said that we would undertake an evaluation of the experiences with active management in the Pension Fund. This seminar is an important part of that effort. We will present our conclusions to the Storting in the spring.

I would like to start my introduction by reminding you of the background and purpose of the Fund.

The Government’s ambition is to pursue a policy based on sound, long-term management of Norway’s petroleum wealth. This reflects a fundamental social perspective and is an overarching priority for the Government. Our job is to ensure that this wealth can benefit all generations. At the same time, we must contribute to stability in output and employment.

The purpose of the Fund is to support government savings to finance pension expenditures. It should also promote long-term considerations in the spending of government petroleum revenues.

There is broad political support surrounding the management of Norway’s petroleum wealth, including the fiscal policy rule. The policy rule says that the structural non-oil budget deficit over time should correspond to the expected real return of the Pension Fund.

The Fund was established by law in 1990, but the first transfer to the Fund was actually made six years later. I happened to be the Minister of Finance in 1996, when the first deposit, 2 bn. NOK, was made. This was one of the last things I did as a Minister. Since then, the Fund has grown rapidly to about 2 600 bn. NOK – or approximately 460 bn. USD – much more than expected. 

The Ministry of Finance has chosen an investment strategy based on a clear financial goal of maximising real returns at a moderate level of risk. The strategy is expressed in terms of a benchmark to the manager.

Our current strategy is based on 60 pct. invested in equities and 40 pct. in bonds. Over time, 5 pct. of the Fund will be invested in Real Estate, reducing the bond portfolio to 35 pct.

There has been a gradual evolvement in the investment strategy for the Fund since inception. The Ministry is constantly looking for ways to improve the trade-off between return and risk. We do this by further spreading the investments and better exploiting the Fund’s characteristics. That will also be our guideline going forward.

Besides choosing an appropriate investment strategy, the Ministry of Finance is responsible for the overall guidelines for the management of the Fund. This includes setting a risk limit for deviations from the Fund’s benchmark, so called active management. The investment mandate for active management is given to the Central Bank, which has established a separate entity for asset management called Norges Bank Investment Management (NBIM).

The main topic to be discussed today is the issue of active management in the Pension Fund. Asset management is a risky and complicated business, requiring specialised knowledge. Based on a goal of achieving the highest possible return given a moderate level of risk, my primary concern with all investment decisions is as follows:

1. What is the basis for expecting a reward for taking risk due to active management?
2. What is the expected impact on the fund’s overall risk and return?

To my knowledge these questions have been discussed by academics for more than three decades. By inviting distinguished speakers to the discussion today, we hope to shed new light on this topic. We should all bear in mind, however, that there is no “right” or “wrong” answers in this debate. As with every aspect of investing, we have to use our best judgement in an uncertain world.

2008 was a challenging year for the Fund, loosing almost a quarter of its value and very poor results in active management. In 2009 we experienced the opposite outcome, with very strong performance and reversal of the losses in 2008. Since the Fund has a long investment horizon, we should be willing to accept large changes in the Fund’s value in the short term when a financial crisis hits. Remember, the Fund had strong risk bearing capacity and in my view we are well positioned to live with the type of risks we have been facing. This risk is the basis for harvesting returns over the longer term.

Openness about all aspects of the management of the Fund is a precondition. Without transparency, I cannot imagine that the strategy for the Fund would be sufficiently robust and have the necessary legitimacy.

For example: Despite very poor investment returns last year, there is still broad political support for the Fund’s long-term investment strategy. I think this reflects all the time and effort that has been spent consulting with the Storting and the broader public on the investment strategy of the Fund. This makes all the stakeholders feel a sense of ownership to the strategy.

Transparency – in the form of a seminar like this – is a disciplinary mechanism. It allows interested professionals to get engaged in the management of the Fund, and provide public feedback on the chosen investment strategy.

Transparency is also important because it builds trust. It is an important ingredient in securing the broad public support that is necessary to carry out a wise and long-term strategy for managing the petroleum wealth. Otherwise, a period of market turmoil could easily result in the Fund’s long-term investment strategy becoming embroiled in short-term populism. That could lead to major changes that would not be in the long-term interests of the Fund or its stakeholders. A robust investment framework, as well as a strong support from the owners, makes us better equipped to stick to the right strategy through changing circumstances.

There is thus little risk of negative returns alone leading to the Fund having to sell its assets. This situation is very different to that of many other institutional investors, who have had to sell risky assets at low prices because of the financial crises and capital adequacy requirements.

The area where we had the most criticism in 2008 concerns active management, an area which is far less important in terms of the Fund’s total risk. In addition to the important lessons the manager has learnt about risk management, one could also say that the strategy for active management proved to be not sufficiently well anchored with the broader public. Stakeholders have not felt a strong sense of ownership to the strategy of active management.

In order to address this, we promised a thorough assessment of whether and to what extent active management should be continued. Before Christmas we published four reports on active management of the Fund. By releasing the reports, we invite other parties with interest in this issue to engage in the debate about active management in the Fund. We have invited another four professionals to comment on the report from the finance professors later on. As time permits, we will invite you all to ask questions or comment on the issues being discussed in each of the three sessions.

The reports and today’s seminar will provide important parts of the basis for a robust assessment of active management that can stand the test of time.

In a way, our Fund is in itself a risk management tool. It has been established to handle the risk stemming from revenues from natural resources. By transforming petroleum reserves into a portfolio of financial assets, the Fund contributes to spreading risk. By providing sustainable financing to the state budget, the Fund also contributes to economic stability.

There are many similarities between managing public money and private money. One such similarity is the need to enlist the owners’ support for the investment strategy. This is the only way to ensure the necessary robustness through a business cycle. Building support and trust from owners and stakeholders is a continuous process. It is often a long time lag between input and result.

But for a sovereign fund there is often a higher degree of public scrutiny than for a private fund. There is therefore a greater need to participate in the public debate.

It can be demanding to invite political representatives to have an informed debate about key investment strategy issues. But for us it is at the same time a precondition if we are to achieve a good and sustainable outcome. So transparency is a key element in our risk management strategy at the national level.

Thank you all for taking the time to participate at this seminar. I know that many of you are familiar with the workings of our Fund and the debate on active management. We should all look forward to interesting presentations and an enlightening debate.

Thank you.