GPFG Highlights: Norges Bank Governor Øystein Olsen Annual Address in Oslo

Øystein Olsen

Øystein Olsen

We are highlighting a section of Norges Bank Governor Øystein Olsen’s annual address in Oslo. The address was given to the Supervisory Council of Norges Bank and invited guests on February 16, 2012. To view the whole address, click here.

“Norway invests a large proportion of its petroleum revenues in international equity, bond and real estate markets via the Government Pension Fund Global. Norway’s welfare must continue to build on the value created within its own borders. The investments via the Fund provide us with a share of the value created outside our borders.

The Fund should be invested with a view to maximising future purchasing power. At the same time, investments must be diversified in order to reduce the risk of losses also during periods when markets are shrouded in fear and uncertainty.

As investor, Norway is different from most others. The Fund does not need to borrow in order to invest. There are no short-term liquidity requirements or regulation that can force it to make unfavourable investment choices. These distinguishing features allow the Fund to apply a long-term horizon – to sit tight in periods of heightened uncertainty. Hence, equities make up the largest share of the Fund’s investment portfolio as equities are expected to provide a higher return than bonds over time.

As a long-term investor, the Fund is well poised to take advantage of large swings. For us it can be profitable to buy equities following a price decline, if expected returns are high. During the financial crisis, the Fund’s ownership share in global production doubled. Such a counter-cyclical investment strategy – also known as rebalancing – can be implemented more effectively if Norges Bank is given wider responsibility for balancing the Fund’s overall risk and return. A simplified, publicly available regulation for rebalancing the Fund would be an advantage.

The value of the Fund – in krone terms – is continuously updated on our website and is now close to NOK 3.5 trillion. This is almost twice as high as mainland annual GDP. The size of the Fund allows us to take advantage of investment opportunities worldwide. The Fund has recently started investing in real assets. In the first round 5 percent will be allocated to real estate.

The world’s economic geography is changing. While growth in advanced economies has been weak and slowing, growth is robust in Latin America and Asia. Several countries in Africa are now catching up.

In line with the guidelines, the Fund has considerable ownership interests in Europe. Its holding in an average European company is around three times as high as in the Americas and Asia. The chosen regional distribution is related to Norway’s import pattern and can be viewed as a form of currency hedging. But the result has been that a large proportion of the Fund is invested in a region that has experienced weak growth over the past decade.

A more even distribution of the Fund’s ownership will provide us with the opportunity to take part in the value creation in regions with strong growth. This implies a reduction in the allocation to European equities and an increase in the allocation to the Americas and emerging economies. High economic growth in Asia can provide sound returns on investments in that region even though today’s equity prices already reflect expectations of higher growth in eastern than in western regions. A more even distribution will nonetheless improve the trade-off between risk and expected rewards.

The currency composition of the bond portfolio should also be adjusted. According to the guidelines, the distribution in the bond portfolio should be based on the volume of sovereign debt issued by each country. This has resulted in rising loans to countries that have issued new debt. The risk linked to that strategy came into evidence in the wake of the financial crisis. A distribution of government bonds that is based on GDP will reduce this risk. Moreover, it has been proposed that government debt issued by emerging countries also be included in the portfolio. The consequence of this is the same as for the equity portfolio, that is to say a reduction in the Fund’s European holdings.

The financial crisis showed that many securities move in tandem. The number of bonds in the portfolio has been more than halved over the past few years. We can likely achieve the same risk distribution with substantially fewer securities. This will also reduce operational risk and bring down management costs in the long run.”

Read more: Norges Bank

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