The Management Mandate for the Government Pension Fund Global (GPFG) requires Norges Bank to establish investment mandates that are environment-related. The market value of these investments should normally be in the range of 30-60 billion kroner. In its letter of 22 June 2018, the Ministry has asked for a review of the regulation and management of these mandates. The Bank’s review is presented in this letter and builds on information published in letters of 18 September 2009, 3 February 2010, 12 March 2014, 21 November 2014 and 15 December 2017.
In connection with the Storting’s consideration of the Revised National Budget in 1999, it was decided to create a separate environmental portfolio within the fund (the Environmental Fund). The Environmental Fund was set up in 2001 and wound down in 2004 on account of weak performance and the introduction of ethical guidelines for the GPFG. Following a wide-ranging public review of the ethical guidelines in 2008, the Ministry recommended creating a special investment programme focusing on eco-friendly activities or technologies expected to have clear environmental benefits, cf. Report to the Storting No. 20 (2008-2009). At that time, the Ministry was considering defining a separate investment universe for environmental investments that also included unlisted equities and infrastructure.
In the National Budget for 2010, it was decided, following the Bank’s advice, that the Bank should establish separate environment-related mandates within the existing investment universe for the fund’s investments. The environment-related investment mandates have since been managed within the same investment universe and constraints as the rest of the fund1. In the National Budget for 2010, the Ministry stated its intent for these environment-related investments to eventually amount to 20 billion kroner2. In 2012, the Ministry decided to specify a range for these investments in the Management Mandate. The range was initially set at between 20 and 30 billion kroner and has subsequently been increased twice.
Through the mandate requirement, the Ministry compels the Bank’s investment management to be active, and the composition of the portfolio to deviate from the benchmark index. From the outset, it has been assumed that environment-related investments are to be based on the same required rate of return as for the fund’s other investments. The Bank, the Ministry and Ang et. al (2014) have emphasised that the requirement for environment-related mandates places a restriction on the Bank’s management that potentially limits its opportunities to generate excess return3.
The Management Mandate does not specify what constitutes an environment-related investment. In its letter of June 22, the Ministry asks the Bank to elaborate on the principles used in the specification of an environment-related company. It is not clear what constitutes an environment-related company. The potential universe for such investments comprises both large conglomerates with only a small share of environment-related activities and pure environmental companies in various sectors. The specification is therefore, to some extent, a matter of judgement.
In Report to the Storting No. 20 (2008-2009), the Ministry wrote: “The investments must be aimed at eco-friendly assets or technology that is expected to yield indisputable environmental benefits, such as climate-friendly energy, improving energy efficiency, carbon capture and storage, water technology, and the management of waste and pollution.” In keeping with this, our environment-related equity investments have concentrated on companies in low-emission energy and alternative fuels, clean energy and energy efficiency technology, and technology and services for the management of natural resources. In the mandates we issue to managers, we require the companies included in the environment-related equity mandates to have at least 20 percent of their business in these areas. It has also been decided that the environment-related mandates may not be invested in oil and gas producers, coal companies or mining companies4.
From the outset, the environment-related mandates were managed both internally and externally. External management is more expensive than internal management5. To reduce management costs, the Bank decided earlier this year to discontinue the externally managed environment-related mandates. The environment-related mandates are now managed entirely in-house.
The environment-related mandates are currently invested in listed equities and green bonds6. At the end of the second quarter of 2018, the market value of these mandates was 54 billion kroner, broken down into 45 billion kroner in equities and 9 billion kroner in green bonds7. Even without the requirement for the Bank to establish environment-related mandates, a substantial share of the fund would still be invested in environment-related companies and green bonds. This is a result of the broad benchmark indices set by the Ministry. At the end of July, around 6 percent of the companies in the fund’s benchmark index for equities were classified as environment-related8, and bonds in the Bloomberg Barclays MSCI Green Bond Index made up 0.3 percent of the fund’s benchmark index for bonds. At the fund’s current value, this corresponds to around 340 billion kroner.
The risk and return characteristics of the Bank’s investments in green bonds do not differ significantly from the Bank’s other bond investments with comparable credit and interest rate risk. The environment-related equity mandates, on the other hand, have underperformed the fund’s equity benchmark, returning 5.9 percent since inception in December 2009 as opposed to 9.7 percent for the benchmark. Over the past five years, however, the return on the environment-related equity mandates has been slightly higher than that on the fund’s equity benchmark. The return on the environment-related equity mandates has been more volatile than the return on the equity benchmark. This is only to be expected, as the environment-related mandates are invested in far fewer stocks than the fund’s broad equity portfolio. Because the environment-related investment mandates make up only a small part of the fund, the requirement for the Bank to make these investments has had little impact on the fund’s overall return or risk.
The environment-related equity mandates are managed according to the same key principles as the fund’s other investment mandates for equities. The management objective is an excess return over the relevant benchmark. In the enclosure, we show risk and return for the environment-related mandates and relevant return metrics. The excess return from securities selection has varied over time and with different return metrics.
When the Ministry presented its proposals for an environmental programme in Report to the Storting No. 20 (2008-2009), the intention was for this to form part of a wider strategy to enhance the fund’s responsible investment profile. The fund’s strategy for responsible investment is much more extensive now than it was in 2009 and is integrated into investment management. Both the Ministry and the Bank aim for the Bank’s work on responsible investment to be in line with leading international practice9. We report on the Bank’s responsible investment activities in our annual Responsible Investment Report.
Since the environment-related mandates were introduced, there have been changes in international standards, disclosure requirements and general corporate practices in the environmental field. The EU’s Guidelines on Non-financial Reporting and the recommendations of the Task Force on Climate-related Financial Disclosures are two examples10. The Bank will continue its work on integrating environmental issues into the management of the fund. In the same way as today, we will make adjustments where we believe that this supports the management objective.
Øystein Olsen Yngve Slyngstad
1There has been little discussion of the investment universe for the environment-related mandates since 2009. Report to the Storting No. 21 (2014-2015) looked at whether the mandates should be focused on renewable energy. On the Bank’s advice, the Ministry decided against this.
2At this time, the Ministry was also considering establishing a programme of investments in sustainable growth in emerging markets. The intended allocation of 20 billion kroner was originally to cover both programmes.
3For further information, see Report to the Storting No. 19 (2013-2014), Norges Bank’s letter of 21 November 2014 and Ang, Brandt and Denison (2014) “Review of the Active Management of the Norwegian Government Pension Fund – Global”.
4The following ICB sectors are excluded from the environment-related investment universe: 0530 (Oil & Gas Producers), 1750 (Industrial Metals & Mining) and 1770 (Mining). Companies with more than 20 percent of their business in upstream oil and gas production, coal and coal-related operations, and nuclear power are also excluded from the investment universe.
5Management costs for the environment-related mandates were discussed in the Bank’s letter of 21 November 2014.
6Green bonds are bonds where the capital raised is earmarked for climate-friendly projects. To ensure that the capital raised is used for this purpose, investors often require independent assurance.
7The Bank has four internal environment-related equity mandates and one internal mandate for green bonds. The investment mandate for green bonds was established in 2016.
8Based on the companies included in FTSE’s broad environmental index (FTSE EO).
9See Report to the Storting No. 13 (2017-2018) and Norges Bank Investment Management’s strategy for 2017-2019.
10For further information on the Task Force on Climate-related Financial Disclosures (TCFD), see the Bank’s letter of 21 February 2018.