In summer 2007, the decision was taken to increase the fund’s allocation to equities
from 40 to 60 per cent. In the second quarter this year, this allocation was achieved
following equity purchases totalling more than NOK 1 000 billion. During the same
period, the fund’s ownership interests in global equity markets doubled.
In June 2007, the Norwegian parliament approved an increase in the strategic allocation to equities from 40 to 60 per cent. The share of assets allocated to equities is one of the most important choices influencing the fund’s future return. The decision to increase the equities share was based on expected long-term returns, relative to the risks associated with the fluctuations in value. On the advice of Norges Bank, among others, the Government decided in summer 2007 to increase the allocation to equities in the fund to 60 per cent.
NOK 1 000 billion of equities
Since the transition began in the second quarter of 2007, the fund has purchased equities for a total of NOK 1 010 billion. Of this figure, NOK 641 billion has come from inflows of new capital, while NOK 369 billion has been transferred from the bond portfolio to the equity portfolio over the past two years. Without the transfer from bonds to equities, the allocation to equities would have been 44 per cent at the end of the second quarter this year (see Chart 6–1). Almost half of the transfer of capital from the bond portfolio took place during the first few months of 2009 when equity markets fell and inflows into the fund were low.
Implementation
In theory, the increase in the allocation to equities should have been implemented immediately, as the new asset allocation is expected to result in a superior risk-adjusted return. However, a change of this kind involves a number of trade-offs.Implementation over a short time span with large equity volumes relative to liquidity in the market would normally push up prices in the short term. At the same time, the fund’s transactions would become more transparent and predictable. This could give other market participants an informational advantage, for example when pricing large individual transactions. A concentrated transition process could also lead to the fund buying securities at historically high prices or selling at historically low prices. A stable transition process over an extended period, where the capital is distributed relatively evenly, reduces the risk of an unfavourable market impact and the significance of market timing.
Re-allocating 20 per cent of the fund’s assets to equities also involved such a large capital requirement that the transition process had to be carried out over a lengthy period. An immediate increase in the allocation to equities at the end of the second quarter of 2007 would have required equity purchases of NOK 860 billion, assuming no changes in the value of the bond portfolio.
Due to the downturn in equity markets from the third quarter of 2008, the transition fell into two phases (see Chart 6–2). From the second quarter of 2007 until the fourth quarter of 2008, the fund used all inflows of new capital to increase the allocation to equities. Income from redeemed bonds and coupons was also re-invested in equities rather than bonds.
By the end of 2008, the allocation to equities was still only 49 per cent. In addition, inflows into the fund fell back in the first two quarters of 2009 due to lower oil prices. Inflows in these two quarters were NOK 44 and 40 billion, respectively, compared with NOK 128 and 77 billion in the last two quarters of 2008.
It was therefore decided to make greater use of capital from the bond portfolio in order to achieve the desired exposure to equities. Around NOK 177 billion was transferred from the bond portfolio to the equity portfolio during the first half of 2009. This involved substantial sales of fixed income securities at what were, historically, relatively high price levels.
The fund has purchased equities continuously over the past two years, both when the market was rising through to the end of 2007 and during the subsequent downturn (see Chart 6–3). The average purchase price for equities over the period as a whole was 22 per cent lower than at the beginning of the transition period. Similarly, the release of capital from the bond portfolio was performed at prices averaging 11 per cent higher than at the end of the second quarter of 2007.
The transition costs are estimated at NOK 8.7 billion, or 0.85 per cent of the capital invested. During the course of the transition period, the fund doubled its ownership interests in more than 7 000 companies in 46 countries from 0.4 to 1.0 per cent. These companies account for about 98 per cent of the world’s investable equity market. Combined with relatively stable inflows of capital, falling equity markets have contributed to a substantial increase the fund’s ownership stake.
