Changes to the benchmark portfolio of the Government Pension Fund - Global
10 February 2006
Norges Bank's letter of 10 February 2006 to the Ministry of Finance
In a letter dated 22 August 2005, Norges Bank recommended that the percentage of equities in the benchmark portfolio of the Government Petroleum Fund should be re-evaluated when the framework pertaining to the new Government Pension Fund had been established. As from 1 January 2006, the Petroleum Fund forms part of the Government Pension Fund, as its sub-portfolio Global. Under reference to the Advisory Agreement with Norges Bank, the Ministry of Finance has announced that the equity portion in the said portfolio shall be evaluated in 2006. As per the beginning of 2006, the Government Pension Fund – Global (the "GPFG") represents more than 85 percent of the Government Pension Fund, which percentage will increase over time.
The Storting has laid down a fiscal rule for the Government Pension Fund, to the effect that the spending of capital from the Fund shall normally correspond to the expected real return thereof. The Fund shall make its investments in foreign currency. If it is desirable for the real return to be subject to the minimum possible uncertainty, the investments of the Fund should be made in government inflation-linked bonds or in short-term fixed-income securities. However, one has chosen to assume somewhat more risk in order to increase the expected return. This has been achieved by, inter alia, investing in longer-term fixed-income securities, in bonds with credit risk, and in equities.
The percentage invested in equities is the main parameter in determining the risk assumed by the Fund. The equity portion should reflect the owner’s trade-off between expected return and risk. Given that the Fund operates with a long investment horizon, it is the risk relating to the accumulated return over a longer period of time which is relevant.
The 40-percent allocation to equities was established in 1997 (National Budget 1998), and then re-evaluated in 2001 (National Budget 2002). The underlying issue is how much risk the owner of the Fund wishes to assume in order to achieve a higher expected return. The experience garnered in 2002 may be of use when performing such evaluation. In 2002, the return on the Petroleum Fund was distinctly negative, when measured in both international currency and Norwegian kroner. Nevertheless, the fund construction was not seriously questioned, and its long-term investment strategy was not re-examined. The Fund benefited from this by way of good returns on equities in subsequent years. Such experience provides a good foundation for accepting somewhat more risk of suffering weak return performance in individual years, whilst attaching more weight to the long-term purpose of the Fund.