investments
Active management and excess return
The Government Pension Fund Global aims to get the highest possible return on its investments within set risk parameters. As an extension to this goal, the fund seeks to outperform its benchmark portfolio through active management.
Active management means a fund manager makes specific investment decisions to maximise returns and outperform a benchmark index or portfolio. It is the opposite of passive management, when a fund manager seeks to replicate the composition of a benchmark index to match its returns.
NBIM uses different types of active management, ranging from so-called enhanced indexing to specialised sector management. The goal is to identify investment opportunities that a passive approach would miss, helping the fund beat its benchmark.
Added value target
NBIM seeks an average annual net added value of 25 basis points, or 0.25 percentage point, through active management of the fund. Net added value is the difference between the fund’s actual results and the results that could have been achieved with passive index management. The fund’s estimated added value has historically been about the same size as its actual gross excess return. Gross excess return is widely used by international funds as a measure of performance, showing the difference between a fund’s return and benchmark index’s return.
The Ministry of Finance has set limits for how much risk NBIM may take in its active management of the fund. The most important limit is expressed as expected tracking error (relative volatility) and puts a ceiling on how much the return on the fund may be expected to deviate from the return on the benchmark portfolio. The expected tracking error limit is 150 basis points, or 1.5 percentage points. This means that the difference between the fund’s return and the benchmark portfolio’s return is expected to exceed 1.5 percentage points in one out of every three years.
