The Government Pension Fund Global aims to get the highest return possible on its investments without taking too much risk. To do this, the fund must identify, measure and manage the risks it faces, using various models and analyses.
The fund’s market risk is primarily determined by the composition of its benchmark portfolio. The most important market risk factors are the fund’s share of equities, movements in stock prices, exchange rates and interest rates, as well as credit risk changes in fixed-income investments.
Expected tracking error
The Ministry of Finance has set limits for how much risk Norges Bank Investment Management may take in its active management of the fund. The most important limit is expressed as expected relative volatility (tracking error) 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 125 basis points, or 1.25 percentage point. This means that the difference between the fund’s return and the benchmark portfolio’s return is expected to exceed 1.25 percentage point in only one out of every three years.
Expected tracking error uses historical prices to predict future market volatility. The extremely volatile markets of 2008 showed that it is important to view risk from several angles, not only relying on traditional mathematical models based on historical pricing relationships. These mathematical models underestimated expected relative risk in 2008 by assuming normal markets and a reasonable continuity of relationships between risk factors. Norges Bank Investment Management uses the following risk measurement methods as a supplement to traditional statistical risk models based on historical pricing:
One of the simplest measures of risk in the equity portfolio is the degree of overlap with the benchmark index. A 100 percent overlap means the equity portfolio is exactly the same as the benchmark index and has the same risk as the benchmark. The actual overlap at the end of 2009 was about 85 percent. This means that about 85 percent of the fund’s equity portfolio corresponded to the benchmark index, while the remainder deviated from the benchmark as a result of the active management of the fund.
To assess the risk associated with investments that deviate from the benchmark index, Norges Bank Investment Management looks at a number of factors. These include the concentration of the portfolio, meaning to what degree the portfolio consists of a few large or many small investments. A portfolio with a few large investments will be more concentrated than a portfolio with many small investments. Norges Bank Investment Management measures the concentration of investments in individual companies, sectors and regions. The level of risk will often be higher in a concentrated portfolio than in a diversified portfolio. Even so, a manager may prefer to concentrate investments in a portfolio if the possibility of solid returns over time is higher than in a more diversified portfolio. Norges Bank Investment Management seeks to balance concentration and diversification of investments.
Exposure to systematic factors such as small-cap companies, value companies and emerging markets normally entails higher returns, but also higher risk. It is therefore important to continuously measure the fund’s exposure to such factors. It is important to gain a static and dynamic overview to manage systematic exposure to one or more risk factors.
The ability to change the composition of the fund’s investments depends on its liquidity exposure. The size of the fund’s investments relative to overall market turnover decides how quickly such changes can be made. It is relatively straightforward to calculate the liquidity risk of the fund’s stock market investments. It is more challenging when it comes to fixed-income positions, where a high proportion of trading is over the counter.
Approval of government bonds
The Ministry of Finance has introduced a requirement in the Management Mandate that the Executive Board of Norges Bank shall approve issuers of government bonds. The mandate requirement calls for the approval framework of government bonds to cover both investment risk as well as operational risk.
The bank has developed a framework to enable a systematic assessment of investment risk as well as operational risk for government bonds issued by different issuers. The information on such risks is sourced from recognized international organisations and data providers. The investment risk category encompasses considerations related to Stability, Sustainability and Serviceability.
- Stability considers the government and institutions, the risk of war and conflict, the legal system and the rights of property owners.
- Sustainability reflects the conditions of its citizens and the environment, considerations related to climate change and the preservation of natural resources.
- Serviceability is the country’s ability to service and pay back its debt, consideration of its future financial situation and its ability to withstand financial shocks.
The operational risk category considers five main categories:
- Valuations of the financial instrument
- The transaction flow for the purchase and sale of government bonds
- Asset servicing and the standardisation of cash flow
- Tax considerations
- Custodial relationships
Information is sourced from internal as well as external sources with knowledge from the specific marketplace. When considering operational risk we consider risk mitigations such as; controls, procedures and development work we have started which may reduce the operational risk level.
Based on investment risk and operational risk data for the respective issuers, issuers are allocated to a risk category by theme of “very low”, “low”, “medium” or “high”. Issuers of government bonds assessed to have a “high” risk within the subset of investment risk or operational risk will normally not be approved for investments.
Government bond issuers are monitored. If the risk assessment for an already approved issuer is changed from “medium” to “high” this will require a new approval by the Executive Board for the fund to continue to be invested. If the Executive Board does not approve the issuer, the fund can no longer be invested in bonds from this issuer.
Return and risk 2017
This publication gives an overview of the fund’s return and risk with a focus on equities and fixed income.
Go to the publication
Historical returns and risk
The historical performance measurement report is a broad analysis of different measurements and focuses particularly on the historic returns and risk. The report looks at the period from inception and up to 31 March 2015.
Key figures for the fund's risk and exposure
|Limits set by the Ministry of Finance||31.03.2018|
|1 Derivatives are represented with their underlying economic exposure.
2 Equity investments in listed and unlisted real estate companies are exempt from this restriction.
|Allocation||Equity portfolio 50 - 80 percent of fund's market value1||66.1|
|Unlisted real estate no more than 7 percent of fund's market value||2.7|
|Fixed-income portfolio 20 - 50 percent of fund's market value1||32.0|
|Market risk||1.25 percentage points expected relative volatility for the fund's investments||0.3|
|Credit risk||Maximum 5 percent of fixed-income investments may be rated below BBB-||2.9|
|Ownership||Maximum 10 percent of voting shares in a listed company in the equity portfolio2||9.6|
|Limits set by Norges Bank's Executive Board||31.03.2018|
|Credit risk||Maximum 2 percent of the net asset value of the fixed-income investments may be invested in a single issuer government bond rated below BBB-||1.1|
|Maximum 0.5 percent of the net asset value of the fixed-income investments may be invested in other single issuer rated below BBB-||0.1|
|Overlap between actual holdings and benchmark indices||Equities minimum 60 percent||83.8|
|Bond issuers minimum 60 percent||73.5|
|Liquidity||Minimum 7.5 percent of the fund shall be invested in treasury bonds from US, UK, Germany, France and Japan||10.7|
|Leverage||Maximum 5 percent of equity and fixed-income investments||0.8|
|Securities borrowing through borrowing programmes||Maximum 5 percent of the fund||2.0|
|Expected shortfall||Maximum 3.75 percent of the fund's investments||1.4|
|Securities lending||Maximum 20 percent of the fund||14.0|
|Contract for difference gross exposure||Maximum 5 percent of the fund||0.8|
|Issuance of options||Maximum 2.5 percent of the fund||-|
|Investment in any one company||Maximum 1.5 percent of the fund||0.8|
|Ownership in listed real estate companies||Maximum 30 percent of voting shares in a single listed real estate company||21.0|
|Assets managed by any one external manager||Maximum 0.5 percent of the fund||0.2|
|Counterparty risk||Maximum 0.75 percent for any one counterparty||0.3|
Risk and exposure of the fund’s unlisted real estate investments*
|Limits set by Norges Bank's Executive Board||31.03.2018|
|* Risk limits are calculated based on physical assets and excluding cash
1 Exemption granted by the Executive Board
|Country allocation||US: 30-70 percent of the unlisted real estate investments||45.2|
|UK: 10-40 percent of the unlisted real estate investments||24.1|
|Germany: 0-20 percent of the unlisted real estate investments||4.0|
|France: 0-20 percent of the unlisted real estate investments||16.7|
|Japan: 0-20 percent of the unlisted real estate investments||1.7|
|Other countries: 0-10 percent of the unlisted real estate investments||3.9|
|Sector allocation||Office space: 40-80 percent of the unlisted real estate investments||58.3|
|Retail space: 0-40 percent of the unlisted real estate investments||19.9|
|Logistics space: 0-30 percent of the unlisted real estate investments||21.4|
|Other property: 0-10 percent of the unlisted real estate investments||0.4|
|Real estate investments in emerging economies||Maximum 10 percent of the unlisted real estate investments||1.8|
|Investments in real estate under development||Maximum 10 percent of unlisted real estate investments||1.3|
|Investments in real estate that is vacant||Maximum 15 percent of unlisted real estate investments||6.0|
|Investments in real estate in one calendar year||Maximum 1 percent of the fund||0.0|
|Investments in interest-bearing securities||Maximum 25 percent of the unlisted real estate investments||-|
|Debt ratio||Maximum 70 percent for any one investment||49.1|
|Maximum 35 percent of unlisted real estate investments||7.0|
|Investments with a single real estate investment partner||Maximum 0.5 percent of the fund1||0.6|