Article | Last updated: 18/10/2016
Press release from the Mork-Commission, on Official Norwegian Report NOU 2016:20
The Commission appointed to assess the equity share of the Government Pension Fund Global is today submitting its report to the Minister of Finance, Siv Jensen.
– The choice of equity share is a trade-off between expected return and risk. The trade-off needs to reflect the risk of loss of wealth, the level of overall risk in the nation’s total wealth and the fiscal policy role of the Fund. A lower interest rate level should not have any impact on the equity share, says the Chairperson of the Commission, Knut Anton Mork.
The majority of the Commission’s members recommend that the equity share be increased from 60 percent to 70 percent. A minority comprising the Chairperson of the Commission, Knut Anton Mork, recommends that the equity share be reduced to 50 percent.
The terms of reference and composition of the Commission
The Commission was appointed by the Solberg Government on 8 January 2016. It has comprised Knut Anton Mork (Chairperson), Harald Magnus Andreassen, Hilde C. Bjørnland, Harald Espedal, Kristin Halvorsen, Espen Henriksen, Sigbjørn Johnsen, Kari Olrud Moen and Karin Thorburn.
The Commission was requested to analyse expected return and risk in the Fund for different equity shares. Equities currently represent 60 percent of the strategic benchmark index for the Fund. In assessing the equity share, the Commission was requested, inter alia, to consider the objective, time horizon and size of, as well as expected outflows from, the Fund. The Commission was also requested to assess whether any change to the equity share should have any implications for other key investment strategy choices.
Lower interest rate level
Long-term, near risk-free real interest rates have declined since the previous assessment of the equity share of the Government Pension Fund Global a decade ago. The Commission bases its recommendation on the premise that the expected excess return from investing in equities, the equity premium, is largely unchanged from the last time the equity share was considered. Against this background, the Commission believes that the expected real rate of return on the Government Pension Fund Global is now considerably less than 4 percent. With the current equity share, the Commission is assuming an expected, annual real rate of return on the Fund of 2.3 percent over the next 30 years.
The majority of the Commission’s members recommend that the equity share be increased from 60 percent to 70 percent:
- A higher share of equities increases the expected return, and the contribution to the fiscal budget, but also entails more volatility in the value of the Fund and a higher risk of a decline in its long-run value. The majority is of the view that the this risk is acceptable, provided that there is political will and ability to adapt economic policy to the accompanying increase in risk, in both the short and long run.
The majority also underlines the following:
- The equity share of the Fund has been increased gradually, and one has gained more experience with, and political understanding of, the management of the Fund. The ability to adhere to the chosen investment strategy has thus far been good, even during periods of financial market turbulence.
- Since the previous examination of the equity share, the petroleum wealth has become better diversified, following the conversion of oil and gas in the ground into financial wealth abroad.
- The strategy for the Fund is predominantly based on open knowledge and exposure to systematic risk premiums, thus implying that operational risk is low. This makes it easier to communicate and gain acceptance for risk.
The majority makes the following additional observations:
- The Fund has become large relative to Norway’s economy and public finances. Practising fiscal policy will become more challenging in coming years, irrespective of the equity share. The fiscal rule should continue to be practised flexibly in order to handle such instability. One potential approach, which the Commission illustrates in its report, may be to increase spending somewhat slower when the value of the Fund has increased, whilst reducing spending somewhat faster when the Fund value has declined.
- If the withdrawals from the Fund exceed its real return over time, the financial wealth will be depleted, irrespective of the equity share. One potential margin of safety may be introduced by basing withdrawals on a cautious estimate of the expected real return.
A minority of the Commission’s members (comprising the Chairperson of the Commission, Knut Anton Mork) recommends that the equity share be reduced to 50 percent:
- Fiscal policy needs sufficiently secure access to a stable and predictable flow of transfers from the Fund in normal times, as well as funds to cover automatic stabilisers and discretional fiscal policy measures during recessions. It would appear that this argument was practically absent from the debate behind the decision to increase the equity share from 40 percent to 60 percent in 2007, probably because the transfers from the Fund represented a much smaller fraction of the fiscal budget at that point in time.
- The minority recognises that the reduction in the oil and gas remaining in the ground over the last decade is an argument in favour of a higher equity share, but considers this less important than the predictability of budget contributions from the Fund.
- A lower equity share will naturally translate into lower expected return for the Fund as a whole. Fiscal policy needs to adapt to this fact. The need for a margin of safety is reduced by a lower equity share, but not eliminated.
- The strategy for the Fund of predominantly relying on open knowledge and exposure to systematic risk premiums cannot, in the minority’s view, be given weight as a change that provides for increased risk taking.
Other key choices
Issues the Commission believes merit further attention in the event of a change to the equity share are the composition of the fixed-income benchmark index, various deviations from market weights, rebalancing, as well as financial risk from climate change and the risk of a permanent decline in oil and gas revenues. At the same time, the Commission emphasises the importance of retaining the Fund’s role as a long-term financial investor.
- Knut Anton Mork, mobile: +47 907 75 756
- Hilde C. Bjørnland, mobile: +47 464 10 767