Risk management

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:

Concentration analysis

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.

Factor exposure

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.

Liquidity risk

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 financial instruments, markets and issuers of government bonds

The Ministry of Finance has introduced a requirement in the Management Mandate that the Executive Board of Norges Bank shall approve financial instruments, markets and issuers of government bonds. The mandate requirement calls for this approval to cover both investment risk as well as operational risk.

The bank has developed a framework to enable a systematic assessment of investment risk and operational risk for financial instruments, markets and issuers of government bonds. The information on such risks is sourced from recognized international organisations and data providers, where relevant.

The investment risk category encompasses the following considerations:

Issuing country for government bonds

  • 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.

Markets

  • Stability considers the government and institutions, the risk of war and conflict, the legal system and the rights of property.
  • Sustainability reflects the conditions of its citizens and the environment, considerations related to climate change and the preservation of natural resources.
  • Market framework and infrastructure – considers amongst others sovereign immunity, investment treaties, capital mobility, regulatory bodies and securities market regulation.
  • Functioning of the marketplace – considers Investor protection and effective monitoring and enforcement in the securities market.
  • Ownership issues - Considers minority shareholder rights and restrictions for foreign investors.

Financial instruments

  • Legal documentation – considers requirements related to instrument specific legal documentation
  • Tax – considers withholding, transfer and capital gains taxes.
  • Investment Risk – considers credit, counterparty and market risks.

The operational risk category encompasses the following categories: 

Issuing country for government bonds
Operational risk is assessed at the financial instrument (bond) level only

Markets

  • Stock exchange – considers stock exchange regulation and responsibilities.
  • Settlement and safekeeping – considers settlement risks, default protection and custody.
  • Market infrastructure and trade processing – considers settlement cycles, account structures and trade flows
  • Restrictions and disclosure – considers requirements related to licenses and investment restrictions.

Financial instruments

  • Ownership and operational factors – considers valuation aspects as well as corporate events.
  • Risk measurement – considers the measurement risks for credit and counterparty risk, market risk and performance measurement.
  • Data and systems – considers the underlying security master data and system configuration.
  • Compliance – considers the mandate, regulatory and market compliance aspects.
  • Tax - considers instrument specific operational tax issues.

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.

Key figures for the fund's risk and exposure

1 Derivatives are represented with their underlying economic exposure

2 The Ministry of Finance has decided on a transition plan for the phasing-out of bonds issued by emerging market countries and companies from the strategic benchmark index. The limit of 5 percent of the bond portfolio for these bonds may be deviated from until the completion of the transition plan.

3  Investments in listed and unlisted real estate companies are exempt from this restriction.

  Limits set by the Ministry of Finance 31.12.2020
Allocation Equity portfolio 60–80 percent of fund's market value1 72.9
  Unlisted real estate no more than 7 percent of the fund's market value 2.5
  Fixed-income portfolio 20–40 percent of fund's market value1 26.0
  Unlisted renewable energy infrastructure no more than 2 percent of the fund's market value 0.0
Market risk 1.25 percentage points expected relative volatility for the fund's investments 0.6
Credit risk Maximum 5 percent of fixed-income investments may be rated below BBB- 1.2
Emerging markets Maximum 5 percent of fixed-income investments may be in emerging markets2 5.9
Ownership Maximum 10 percent of voting shares in a listed company in the equity portfolio3 9.6
  Limits set by Norges Bank's Executive Board 31.12.2020
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- 0.4
  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 85.3
  Bond issuers minimum 60 percent 69.9
Liquidity  Minimum 7.5 percent of the fund shall be invested in treasury bonds from US, UK, Germany, France and Japan2 10.8
Leverage Maximum 5 percent of equity and fixed-income investments 1.5
Securities borrowing through borrowing programmes Maximum 5 percent of the fund 1.1
Expected shortfall Maximum 3.75 percent of the fund's investments 1.8
Securities lending Maximum 20 percent of the fund 8.3
Contract for difference gross exposure Maximum 5 percent of the fund 1.0
Issuance of options Maximum 2.5 percent of the fund 0.0
Ownership in listed real estate companies Maximum 30 percent of voting shares in a single listed real estate company 25.7
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 0.2

Risk and exposure of the fund’s unlisted real estate investments*

* Risk limits are calculated based on physical assets and excluding cash.
1 Exemption granted by the Executive Board.
  Limits set by Norges Bank's Executive Board 31.12.2020
Country allocation US: 30–70 percent of the unlisted real estate investments 46.8
  UK: 10–40 percent of the unlisted real estate investments 18.1
  Germany: 0–20 percent of the unlisted real estate investments 4.0
  France: 0–30 percent of the unlisted real estate investments 19.4
  Japan: 0–20 percent of the unlisted real estate investments 3.3
  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 57.3
  Retail space: 0–40 percent of the unlisted real estate investments 16.4
  Logistics space: 0–30 percent of the unlisted real estate investments 26.0
  Other property: 0–10 percent of the unlisted real estate investments 0.3
Real estate investments in emerging economies Maximum 10 percent of the unlisted real estate investments 0.9
Investments in real estate under development Maximum 10 percent of unlisted real estate investments  1.1
Investments in real estate that is vacant Maximum 15 percent of unlisted real estate investments 4.9
Investments in real estate in one calendar year Maximum 0.2 percent of the fund 0.0
Investments in interest-bearing securities Maximum 25 percent of the unlisted real estate investments 0.0
Debt ratio Maximum 70 percent for any one investment  69.2
  Maximum 35 percent of unlisted real estate investments 6.1
Investments with a single real estate investment partner Maximum 0.5 percent of the fund1 0.7

Last saved: 25/02/2021

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