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Abstract

Norway is one of the wealthiest countries in the world because of its oil and gas exploration and exportation. Its Government Pension Fund Global was formed in 1990 to manage the revenue resulting from these exports. The authors examine several aspects of the fund’s management, its historical returns—including its underperformance during the recent financial crisis—and the outlook for the fund going forward.

Norway’s Government Pension Fund Global (GPFG) is ranked as one of the largest investors in the world as well as the second-largest sovereign fund after Abu Dhabi’s Investment Authority. Norges Bank Investment Management, a division of Norway’s central bank, manages the assets in accordance with guidelines issued by the Ministry of Finance. The ministry, in turn, receives advice from a four-member strategy council, which includes two of the article’s authors. The council and ministry use six factors to help drive strategy: a long time horizon (because of the limited current need for income), tolerance of volatility, inability to use some sources of value added (because of the fund’s size), preference for benchmarks linked to market capitalization, a contrarian approach, and little need for inflation hedging (because of oil and gas production). The authors list the core beliefs that guide the strategy, including a commitment to diversification, a focus on earning risk premiums, a clearly articulated benchmark, careful selection and monitoring of asset managers, and a commitment to responsible investing. The anticipated rate of return for the fund is 4%, which is the expected income need.

The GPFG follows a strict adherence to the benchmark chosen by the Ministry of Finance except for a small deviation to accommodate the use of active managers. The benchmark is composed of two asset classes, with 60% in global equities and 40% in fixed income, including the recent addition of real estate. The authors highlight that the fund holds more than 1% of every listed company in the FTSE All-World Index and holds 7,945 bonds. Unlike other endowment funds that hold many different asset classes, the GPFG has remained focused on equities and fixed income for marketability and transparency. The total annual management costs range between 8 and 14 bps, which is low when compared with that of other sovereign funds. The GPFG is also committed to responsible investment screening for shareholder rights, board responsibilities, well-functioning markets, climate change, water management, and children’s rights. At the time of the authors’ study, 52 companies were excluded from the fund’s universe.

The authors note that the fund’s underperformance during the recent financial crisis elicited public criticism, especially about the active management. In response, the Ministry of Finance sought external advice; most notable among the analyses is that of Ang, Goetzmann, and Schaefer (Evaluation of Active Management of the Norwegian GPFG 2009). The advisers reported that active management adds value and, therefore, should remain part of the strategy. The advisers also found that the GPFG could assume even more risk because of its low need for current income. Since the period of underperformance, the fund has recouped all its losses, which supports the theory that continuing with a strategy in good times and bad is the correct plan of action. Because of the public criticism, however, the ministry decided to increase transparency by communicating with the public more often and maintaining a portfolio consisting largely of publicly held investments. This approach contrasts with other well-known endowment funds, which hold a variety of asset classes that do not have the same transparency or marketability. The fund will also keep the tracking error to the benchmark within 1% for equities and will simplify and reduce its bond holdings.

The Norway model for investment management has proven to be successful since inception. Seven key aspects have helped drive the fund’s success: reduction of risk through diversification, a long-term time horizon, responsible investments, cost reduction, active management, a clear governance structure and investment strategy, and a commitment to transparency and openness.

About the Author(s)

Derek W. Johnson CFA