Introduction
In just a few years, the Government Pension Fund Global has grown into one of the world’s largest funds. In line with this growth NBIM has, as the fund’s manager, built an organisation with about 300 employees at offices in Europe, the US and Asia. The fund’s investment universe has expanded considerably since NBIM’s start in 1998, increasing the demands on infrastructure and control processes in every part of the organisation. NBIM has chosen to outsource some support functions to streamline its operations and focus on its core investment management role.
The expansion of the organisation, strong growth in assets under management and changes in the mandate have increased costs substantially. Even so, we are now seeing signs of economies of scale as costs grow at a lower rate than assets under management.
A focus on costs alone will not give a full picture of NBIM’s management. Higher costs may result in higher revenue or better quality in the work carried out. The fund’s performance is readily measurable and increased use of resources can lead to substantial additional revenue in the form of a higher return on the fund. One important aim in the fund’s management is to maximise the long-term return after costs.
Operating costs for the management of the fund totalled 2,959 million kroner or 0.105 percent of average assets under management in 2010, including performance- based fees to external managers of 986 million kroner for excess return generated. Excluding these fees, costs came to 0.07 percent of average assets under management.(1)
NBIM uses external managers for parts of the fund’s investments. Common to most of these managers is that they must aim to beat the markets they operate in and deliver an excess return for the fund. The fees paid to these managers are largely determined by the excess return they generate, which means that a high fee reflects an even higher amount of revenue for the fund. As this type of cost is very distinct from NBIM’s other operating costs, we have chosen to exclude these fees in the rest of this cost review.
The chart below shows developments in costs and assets under management over time. Over the entire period from 1998 to 2010, operating costs totalled 16.1 billion kroner, including performance-related fees to external managers of 4.4 billion kroner.
Chart 16-1 Development of market value and management costs, 1998-2010.
The chart below shows developments in costs relative to assets under management, measured in basis points. The lower line shows costs excluding performance-based fees to external managers. From 2003 to 2010, these costs fell to 7.0 from 9.1 basis points of assets under management.
Chart 16-2 Management costs compared with assets under 1998-2010. Basis points
Factors that affect cost levels
To obtain a complete picture of the cost development over time, it is necessary to take account of the major changes in the investment universe and other aspects of the mandate since 1998, some of which have had a substantial impact on cost levels. There have been several such changes since capital was first transferred to the fund in 1996.
In 1998, a 40 percent allocation to equities was introduced. In 2007, it was decided to increase this allocation to 60 percent and small and medium-sized companies were included in the fund’s equity benchmark. A year later, a number of emerging markets were added to the equity benchmark. In 2002, bonds from private issuers were included in the fixed-income benchmark, which previously contained only bonds issued by governments and supranational organisations. In 2010, real estate was added as a new asset class.
Asset mix
NBIM estimates that internal equity management has cost around twice as much as internal fixed-income management over time. Settlement and custody costs are higher for equities than for bonds, and a more complex infrastructure is needed to trade in equity markets and to follow up specific corporate events and tax matters and to exercise ownership rights. All things being equal, the increase in the allocation to equities from 40 percent to 60 percent is estimated to have raised unit costs by 1 basis point, or just under 300 million kroner.
Expansion of the investment universe
The expansion of the investment universe since 1998 has led to considerable growth in the number of securities included in the fund’s benchmark indices. More complex benchmark indices and a larger investment universe require more resources in every part of the organisation and result in higher costs.
The inclusion of small and medium-sized companies in the equity benchmark index has increased the number of companies in the index to 7,200 from around 2,400. The inclusion of private bonds in the fixed-income benchmark index also led to a substantial increase in the number of instruments: 11,200 were included in the fixed- income benchmark in 2010, compared with fewer than 1,000 in 1998.
Exchange rates
About 75 percent of NBIM’s operating costs are billed and paid in foreign currency. As the accounts are kept in Norwegian kroner, movements in exchange rates can have a substantial accounting impact even if the actual cost in foreign currency is unchanged.
Operating costs in 2010
Note 2 in the financial accounts gives an overview of operating costs charged to the fund in 2009 and 2010. The main components are personnel-related costs, IT costs, fees to external managers, settlement and custody costs and other external services.
The chart below shows movements in these cost categories from 1998 to 2010. The data available for 1998 to 2002 is slightly less detailed and fewer components are shown in the early years.
Chart 16-3 Development of individual cost components since 1998. Costs (millions of kroner, left-hand axis) and market value (billions of kroner, right-hand axis)
NBIM had employees at five offices at the end of 2010. Salaries, employer’s contributions and other personnelrelated costs have increased over time in line with the increase in staff numbers. Performance-based pay, which depends partly on the excess return generated by each portfolio manager, forms part of the salary figure. This cost component can therefore vary considerably from year to year due to variations in performance-based pay. From the end of 2003 to the end of 2010, the number of permanent employees at NBIM climbed from 118 to about 300, an increase of 156 percent. During the same period, assets under management grew by 255 percent. More assets under management per employee mean that NBIM is realising economies of scale in terms of staffing.
Costs for IT, information and decision-support systems consist of the purchase and replacement of hardware and software, as well as costs for lines and communication equipment. This item also includes a number of information and decision-support systems used in many of NBIM’s departments. Within this category, costs for information systems have grown fastest, due partly to the increase in staff numbers, but also to NBIM investing in new asset classes, instruments and markets. This cost component has grown at roughly the same rate as assets under management, even though changes in the investment universe and mandate would indicate a higher rate of growth. In particular, NBIM realises economies of scale over costs of hardware, software, lines and communication equipment.
Since 2007, NBIM has entered into various agreements for the outsourcing of IT services. These relate primarily to the operation, maintenance and development of IT infrastructure with global 24-hour support. Agreements have also been entered for the operation and development of IT applications. The costs associated with these agreements relate to the globalisation of NBIM’s operations and buying these services externally is more costeffective than building up internal capabilities. Most of the work on outsourcing IT was performed in 2007– 2009, and costs grew rapidly during this period before levelling off. At the same time, the use of internal IT staff was scaled back sharply, which substantially reduced this cost component. The decision to outsource many IT services has paved the way for economies of scale in the years ahead.
The fee structure agreed with external managers normally includes a fixed component which is paid out whether the manager generates an excess return or not. These base fees have grown much more slowly than the amount of externally managed capital.
Services related to the settlement of transactions and custody of securities are provided by international banks and financial institutions. The costs associated with these services depend partly on the number of transactions performed and partly on the size of the holdings kept in custody. Our agreements with these suppliers set prices for settlement and custody in each market. Prices vary from market to market, so a change in the market mix will impact overall costs. Settlement and custody costs are generally much lower in developed markets than in emerging markets. Consequently, the inclusion of a number of emerging markets and of small and mediumsized companies in the investment universe has led to higher costs in this area.
NBIM has entered into agreements regarding settlement and custody which bring lower unit costs as the number of transactions and the size of the fund increase. A typical agreement will give a percentage discount once the value of assets in custody passes a certain level. There are also agreements where the price per transaction falls once the number of transactions passes a certain volume. We have therefore made substantial savings as a result of the growth in assets under management. All in all, settlement and custody costs have grown slightly faster than assets under management in recent years. This is due to the changes in the investment universe. Allowing for this, we have realised economies of scale in this area too.
NBIM is charged for some of the costs of control and support functions performed by other parts of Norges Bank. These include costs for internal and external auditing, administrative functions and pensions.
Other costs include the operation of NBIM’s offices outside Norway. NBIM has opened two offices in Asia, in 2007 and 2010, and has expanded its offices in London and New York. This has contributed to an increase in costs in this category.
Comparison with other funds
CEM Benchmarking Inc. (CEM) produces a detailed report for the Ministry of Finance each year comparing the fund’s management costs with other large funds. Differences in the funds’ cost levels may be due to differences in cost effectiveness, but may also be related to differences in size, asset mix and investment style.
Norges Bank’s total management costs for the Government Pension Fund Global amounted to 0.14 percentage points (or about 14 basis points) of average assets under management in 2009. Direct comparison of these costs with costs at other large funds does not, however, tell the full story of whether Norges Bank’s management is cost effective. CEM has therefore developed a cost benchmark based on the fund’s asset mix which indicates the costs the peer group would have had with the same asset mix as the fund.
The peer group consists of the largest funds in the CEM survey (seven US, three Canadian, two European and one Asian pension fund). The fund’s average market value in 2009 was substantially higher than in the peer group.
CEM’s analysis shows that the fund’s actual management costs were 0.015 percentage point lower than the cost benchmark in 2009, equivalent to almost 310 million kroner. These lower costs are due primarily to Norges Bank making less use of external managers than the peer group. The cost of internal management is substantially lower than the cost of external management. In addition, the analysis shows that Norges Bank’s internal management has cost less than at comparable funds. Table 1 shows that the fund’s management costs have been lower than in the peer group every year since 2003.
Table 16-1 Cost development for the Government Pension Fund Global and comparison peer group in the period 2003–2009. Basis points
| |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
| Government Pension Fund Globa |
10.3 |
10.5 |
10.6 |
9.8 |
9.4 |
10.6 |
14.1 |
| Comparison peer group (median) |
13.1 |
12.0 |
13.4 |
10.8 |
11.3 |
13.6 |
15.5 |
(1) In addition to the Government Pension Fund Global, NBIM manages Norges Bank’s long-term foreign exchange reserves and, until the end of 2010, managed the Government Petroleum Insurance Fund on behalf of the Ministry of Petroleum and Energy. Fees to external managers and to settlement and custodian institutions are invoiced and paid separately for each fund. Other operating costs are allocated between the funds using a distribution key based largely on market values and asset allocations.
