Transfers of new capital to the Government Pension Fund – Global are determined
largely by the amount of revenue from oil and gas production accruing to the
Norwegian State. The accumulation of the fund can therefore be seen as a way of
converting non-renewable natural resources into savings in global financial markets.
The fund is currently in a phase where the allocation to equities is being increased in
order to improve the long-term trade-off between risk and return. This is happening
at a time when the relative value of petroleum resources and equity investments is
more favourable for an oil producer than previously in the fund’s history.
Over the life of the fund, and especially in recent years, oil prices have been climbing (see Chart 6–1). This has paved the way for increased transfers to the fund. In the third quarter of 2008, NOK 128 billion was transferred to the fund, the largest amount yet in a single quarter (see Chart 6–2).
It was decided in June 2007 to increase the fund’s allocation to equities from 40 to 60 per cent. This decision was intended to improve the long-term trade-off between risk and return in the fund, and reflects the owner’s long strategic investment horizon and immense capacity to bear risk. For a fund as big as the Government Pension Fund – Global, such a strategic change needs to be phased in gradually.
Since the fund began investing in equity markets in 1998, returns in these markets have fluctuated considerably. A peak was reached during the IT bubble in 2000 and again before the financial crisis bit in 2007 (see Chart 6–3).
The allocation to equities is now being increased in a period when transfers to the fund are large but uncertain, due to high and volatile commodity prices. Volatility has been increasing this year in both the oil market and the equity market, but volatility has been significantly higher in the oil market than in the equity market over time (see Chart 6–4).
It is important that the change is made in such a way as to safeguard the fund’s potential long-term returns. Uncertainty about future returns in financial markets is such that, for a fund that is building up ownership in equity markets over time, it will rarely be appropriate to try to time new investments.
However, the issue of timing investments can be viewed from another angle. Given that the increase in equity investments is being based on revenue generated in the petroleum sector, it is particularly interesting to observe how the relative value of oil and equity investments has changed over time.
Oil’s purchasing power has increased substantially in recent years. This can be illustrated by looking at the value of the world’s total annual oil production relative to the market value of the world’s equity markets. One year’s oil production in the late 1990s amounted to just 2 to 3 per cent of the market value of companies included in the FTSE World Index, whereas the equivalent figure in 2008 is more than 10 per cent (see Chart 6–5), even allowing for the increase in oil production during the period.
Chart 6–6 shows developments in the purchasing power of a barrel of oil relative to the market value of the global equity market. It can be seen that a barrel of oil has been able to buy more than three times as large a share of the equity market in 2008 as when the fund began to invest in equities in 1998. However, because the valuation of equity markets has fallen relative to underlying earnings at listed companies, the picture is even clearer if it is based on the level of exposure to actual earnings in which ownership of the equity market results. Selling a barrel of oil and buying global equity markets in 2008 has given exposure to actual earnings more than 10 times that in 1998.
The result of the developments outlined above is that the Government Pension Fund – Global’s stake in global equity markets is rapidly rising (see Chart 6–7). This is due both to the phasing-in of a higher allocation to equities in the portfolio, and to the relative value of petroleum resources and equity investments being substantially more favourable than previously in the fund’s history.
