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					    SWFs and the Norwegian Government Pension Fund


                Sovereign Wealth Focus
                Edinburgh, 14 June 2011

                    Tom A. Fearnley
             Asset Management Department



1
        Norwegian Ministry of Finance



    Agenda

    •   Sovereign Wealth Funds

    •   Norwegian Government Pension Fund – Global (GPFG):




2
    Norwegian Ministry of Finance




    Sovereign Wealth Funds (SWFs)

    •   Large pools of financial assets held by and
        managed for the public sector.
          More precise definition (from “Santiago
           Principles 2008”):
          Special-purpose investment funds or
           arrangements that are owned by the general
           government and created for macroeconomic
           purposes to manage assets to achieve financial
           objectives, and where the investment strategies
           include investing in foreign financial assets.

    •   Definition excludes foreign currency reserves held
        for balance of payments or monetary policy
        purposes, state-owned enterprises, and pension
        funds.


3
    Norwegian Ministry of Finance




    Three types of SWFs

    •   Broadly speaking three types of SWFs:

    •   1) Natural resource funds
             From commodity exports giving rise to fiscal
              surpluses.
             Main objectives: Maintain economic stability
              against commodity price fluctuations, and
              ensure that also future generations will
              benefit from the exploitation of natural
              resources by the current generation.
             Examples: Norway, United Arab Emirates,
              Russia




4
    Norwegian Ministry of Finance




    Three types of SWFs

    •   2) Foreign reserve funds
             Source of funds is balance of payment
              surpluses and official foreign currency
              operations. Funds are managed differently
              from normal foreign exchange reserves, with
              higher risk and return profile.
             Examples: China, Singapore

    •   3) Pension reserve funds
             A portion of national pension funds is set
              aside and managed separately to prepare for
              an aging society.
             Examples: New Zealand, France, Ireland



5
    Norwegian Ministry of Finance




    Sovereign Wealth Funds: Assets

    •   Aggregate assets (all SWFs): about 4 trillion USD
            2.3 trillion from oil&gas (60 %)

    •   By region:

                               Other
                                2%
                                          Asia
                                          35 %
                 Middle East
                    44 %
                                          Americas
                                            2%
                                       Europe
                                        17 %




6
    Norwegian Ministry of Finance



    SWFs again growing

    •   Due to financial crisis, SWF assets under
        management fell in Q4 2008 / Q1 2009.
         By about 10 % (SWF Institute)
         Picking up since Q2 2009, due to continuing
          inflows to many funds, and positive returns.
                        4200


                        4000


                        3800
         Trillion USD




                        3600


                        3400


                        3200


                        3000




7
    Norwegian Ministry of Finance




    SWFs again growing

           Also, new funds (e.g. Sovereign Fund of Brazil)

           Hence, financial clout largely undiminished, but
            less visible than during recent high-profile
            acquisitions of Western assets.

    •   2010: “Funds today account for between one-
        fourth and one-third of all foreign assets held by
        sovereigns… SWF assets are projected to surpass
        the stock of foreign exchange reserves in the not-
        so-distant future and to top $7-$11 trillion by
        2013" (John Lipsky, IMF First deputy Managing
        Director).




8
    Norwegian Ministry of Finance




    Typical characteristics

    •   Long investment horizons
    •   Little or no leverage
    •   No claims for imminient withdrawal of funds
               Therefore:
               Strong risk bearing capacity
               Ability to accommodate short term volatility
               Usually higher risk profile than foreign
                exchange reserves (more equity and
                alternative investments)




9
     Norwegian Ministry of Finance



     Concerns about SWFs

     •   In 2007 and early 2008: Mounting concerns among
         Western recipient countries about the growth of
         SWFs. Concerns about:
              Potential for politically motivated
               investments
              Potential for controlling stakes in strategic
               industries.
              Lack of transparency
              Potential for large and unpredictable capital
               flows
              Shift from private to public ownership of
               capital.

     •   In 2007 G8 and IMF called for a SWF code of
         conduct
              Led to the IMF-brokered Santiago Principles
               on transparency, objectives and governance.

10
     Norwegian Ministry of Finance




     Concerns about SWFs

     •   In late 2008 and into 2009, concerns receded:

            Focus switched from SWFs to the financial crisis.

            SWFs more a solution (to financial crisis) than a
             problem ?
                   Providers of capital in times of crisis.

                   Long investment horizon could be
                    stabilizing factor.
                   Could contribute to lower risk premia.



            Santiago Principles on appropriate investment
             practices adopted in 2008.


11
     Norwegian Ministry of Finance




     Santiago Principles:

     •   GAPP: Generally Accepted Principles and Practices.

     •   The GAPP is a voluntary framework to guide the
         conduct of appropriate investment practices, as
         well as governance and accountability
         arrangements, of sovereign wealth funds.

     •   Negotiated and endorsed in October 2008, by 26
         sovereign wealth funds, with IMF as facilitator.




12
     Norwegian Ministry of Finance




     Santiago Principles:

     •   Key principles:
          i) Sound objectives and legal framework to
           facilitate the formulation of appropriate
           investment strategy.

            ii) Sound institutional and governance
             framework that separates the functions of the
             owner, governing body, and management to
             facilitate accountability and operational
             independence.

            iii) Clear investment and risk management
             framework to promote a disciplined investment
             process and sound investment operations.


13
     Norwegian Ministry of Finance




     OECD guidance for recipient countries

     •   At the same time, OECD guidance on recipient
         country policies towards SWFs was adopted by
         OECD members on 8 October 2008.

     •   These principles reflect long-standing OECD
         commitments that promote an open global
         investment environment.

     •   The principles are:




14
     Norwegian Ministry of Finance



     OECD guidance for recipient countries
     •   Recipient countries should not erect protectionist
         barriers to foreign investment.

     •   Recipient countries should not discriminate among
         investors in like circumstances. Any additional
         investment restrictions in recipient countries should
         only be considered when policies of general
         application to both foreign and domestic investors
         are inadequate to address legitimate national
         security concerns.

     •   Where such national security concerns do arise,
         investment safeguards by recipient countries
         should be:
            transparent and predictable; - proportional to
            clearly-identified national security risks; - and
            subject to accountability in their application.


15
     Norwegian Ministry of Finance


     SWFs:
     Part of the Problem or the Solution ?
     •   SWFs now hold a significant share of sovereign
         foreign assets, and should therefore work towards
         well functioning capital markets and responsible
         investing.
               Should act as ”Universal owners”, with
                strong interests in the ”global commons”.

     •   Norway’s SWF (Government Pension Fund - Global)
         is now 12 times bigger than its foreign exchange
         reserves.

     •   Norway’s GPFG ownership share of the world’s
         listed companies has now reached 1 per cent (1.8
         per cent in Europe).

     •   Similar stakes for the other top SWFs.
16
     Norwegian Ministry of Finance




     SWFs and Financial Stability

     •   Extensive research is being conducted on this
         issue.
     •   Existing research on SWFs suggest that they can
         be a stabilizing force in global financial markets.
     •   Event studies do not find a destabilizing impact
         from SWF investments and divestments in equity
         markets, while simulations of SWF asset allocations
         imply only modest economic effects.
     •   With SWFs improving their transparency and
         disclosure over time, the availability of historical
         SWF transactions will provide researchers with the
         necessary data to examine further their
         implications for financial stability.
     •   See overview article by IMF economists Tao Sun
         and Heiko Hesse, March 2009.

17
     Norwegian Ministry of Finance



     SWFs and Transparency
     •   In line with the Santiago principles, some SWFs are
         becoming more transparent.
     •   Thus following in Norway’s steps.
            Norway’s GPFG is the most transparent by far.

     •   Abu Dhabi Investment Authority, until recently one of
         the most secretive SWFs, made a significant step in
         March 2010 by publishing its first annual report.

     •   Also GIC and Temasek of Singapore now produce
         annual reports (since 2008).
           Done to ”assure the investment community and the
            countries in which we invest that our activities have
            only one purpose – financial return” (Tony Tan,
            Deputy Chairman)


18
     Norwegian Ministry of Finance




     SWFs and Transparency…

     •   Few disclose total size and returns, however.
          Fear that detailed disclosure may jeopardize
           investment strategies.
          ”Complete transparency would raise more
           questions than answers”, Bader al-Sa’ad,
           Managing Director, Kuwait Investment
           Authority.




19
     Norwegian Ministry of Finance




     SWFs as providers of capital

     •   As already noted, SWF can be
               Providers of capital in times of crisis.
               Investors with long horizons, possibly
                making them longer term owners.
     •   SWFs now being actively encouraged to buy
         government debt:
               Reports that European government debt
                managers now engage in “sales tours” to
                SWFs (Financial Times, 25 March 2010).
               Their hope is that SWFs will be able and
                willing to absorb a significant share of the
                huge government bond issuance expected
                for the coming years.



20
     Norwegian Ministry of Finance




     SWFs as providers of capital…

     •   As for Norway’s GPFG, the fund was one of the
         largest buyers in the world’s stock markets in
         2008, at the depth of the financial crisis:
               Bought shares worth 55 bn USD throughout
                the year.
               To move towards 60 % allocation to equities
                (in a falling equity market)




21
     Norwegian Ministry of Finance




     SWFs as providers of capital…

     •   Finally, some recent news (Washington Post, 18
         April 2010):
     •   ”World Bank gets help from SWFs to invest in
         developing nations”
           State-owned investment vehicles from South
            Korea, Azerbaijan, Netherlands and Saudi Arabia
            have agreed to invest USD 600 million in a
            bank-sponsored equity fund for less-developed
            countries.
           While not large, it could open up a pool of
            capital that World Bank president Robert B.
            Zoellic said could prove to be important in
            creating a new ”architecture” for the post-crisis
            global economy.


22
         Norwegian Ministry of Finance



     Agenda

     •   Sovereign Wealth Funds

                                                   (GPFG):
     •• Norwegian Government Pension Fund – Global (GPFG):




23
     Norwegian Ministry of Finance




     2nd largest Sovereign Wealth Fund
     (Source: SWF Institute, March 2011)

                         UAE (ADIA)

                       Norway (GPF)

                Saudia Arabia (SAMA)

                       China (SAFE)

                         China (CIC)

                Hong Kong (HKMAIP)

                     Singapore (GIC)

                         Kuwait KIA)

                       China (NSSF)

                Singapore (Temasek)

                       Russia (NWF)

                                       0   100   200   300      400   500   600   700


                                                       USD bn




24
         Norwegian Ministry of Finance




                           Government Pension Fund
                               Formally established 1 January 2006
                               Managed by the Ministry of Finance

     Government Pension Fund Global               Government Pension Fund Norway
     (former Government Petroleum Fund)           (former National Insurance Scheme Fund)

     •   Invested abroad                          • Invested in Norway (85%) / Scandinavia
     •   Operational management: Norwegian        • Operational management:
         Central Bank (Norges Bank)                 “Folketrygdfondet”
     •   NOK 3 102 billion (USD 562 bn) end       • 135 billion NOK (USD 23 bn)
         of Q1 2011                                 at 31 Dec 2010




25
     Norwegian Ministry of Finance




     Origin of Government Pension Fund

     •   Strong public finances…
     •   Due to oil and gas production in North Sea.
     •   Production peaked in 2004, but still large.
     •   5th largest net oil exporter in 2008.
     •   40 per cent of reserves have been extracted.
                           300

                           250
         Mill. S.m3 o.e.




                           200

                           150
                                                Realized

                           100                  Expected


                           50

                            0




26
     Norwegian Ministry of Finance




     Origin of Government Pension Fund

     •   Government oil and gas revenues are invested in
         the Fund…
                                    500
                                    450
                Bn NOK (2011 NOK)




                                    400
                                    350
                                    300
                                    250
                                               Realized
                                    200
                                               Expected
                                    150
                                    100
                                     50
                                     0




     •   …except what is spent to cover a structural (non-
         oil) budget deficit, determined by a ”spending
         rule”.
27
       Norwegian Ministry of Finance



     The spending rule

     Return on investments                                  Revenues

                                       Petroleum
                                       revenues


                                       Transfer to          State
            Fund
                                       finance non-oil     Budget
                                       budget deficit



                                                         Expenditures
                 Fiscal policy guideline                 • consumption
           (over time spend real return of the fund,     • investment
                      approximately 4%)                  (infrastructure,
                                                         human capital)

28
     Norwegian Ministry of Finance




     Public Sector Net Assets and Government
     Pension Fund (percent of GDP)
     •   Public sector is in large positive net asset position,
         mainly due to the Fund.

             180 %

             160 %

             140 %

             120 %

             100 %                                                                                                                          Net assets
              80 %
                                                                                                                                            GPF
              60 %

              40 %

              20 %

               0%
                     1995
                            1996
                                   1997
                                          1998
                                                 1999
                                                        2000
                                                               2001
                                                                      2002
                                                                             2003
                                                                                    2004
                                                                                           2005
                                                                                                  2006
                                                                                                         2007
                                                                                                                2008
                                                                                                                       2009
                                                                                                                              2010
                                                                                                                                     2011




29
     Norwegian Ministry of Finance




     Gross public sector debt

     •   Mainly bonds and bills issued to maintain a liquid
         secondary government bond market.

     •   Borrowed funds mainly used to service the debt,
         which is kept relatively stable as share of GDP.

     •   The large positive net asset position of the
         government means that the gross debt is not
         considered one of the Fund’s liabilities.




30
     Norwegian Ministry of Finance



     Investment strategy: Our circumstances

     •   No clearly defined liabilities.

     •   Indefinite investment horizon.

     •   Therefore, strong risk bearing capacity
              Year to year volatility of less concern.

     •   However, “target” real return around 4 % in average
         over the long run (the spending rule).

     •   Could be seen as the Fund’s liability.
          Although, stated objective is to “maximize
           international purchasing power given moderate risk”.
          Reflects fact that fund will ultimately be used to
           finance imports.
31
     Norwegian Ministry of Finance




     Fund governance




32
     Norwegian Ministry of Finance



     Division of responsibilities between:

           Owner (Ministry of Finance)
                Decides investment strategy (strategic
                  benchmark, rebalancing scheme, scope
                  of active management, investment
                  universe).
                Monitors operational manager.
                Develops ethical guidelines.
                Reports to Parliament.


           Operational manager (Norges Bank, the Central
            Bank
                 Implements investment strategy.
                 Invests monthly inflows.
                 Runs active management program.
                 Exercises fund’s ownership rights.
                 Reports to Ministry of Finance


33
     Norwegian Ministry of Finance


      Strategic Asset Allocation for the Fund

                Strategic benchmark                          Investments in real estate
                                                             started in 2011




          Equities 60%               Fixed Income 35%              Real Estate 5%

      Equity index:                 Fixed-income index:         Real estate mandate:
      FTSE Global All-Cap           BarCap Global Agg. +        Directly investible
                                    Global Infl.-Linked         index cannot be
      Fixed regional weights
                                                                constructed
                                    Fixed regional weights
      > 7 000 equities
                                                                Index established to
                                    > 10 000 bonds of
                                                                state return objective
                                    investment grade
                                                                Special set of risk
                                                                limits, separate from
        Active risk limits:                                     equities and fixed inc.
        Overall portfolio level active risk budget:
        1% tracking error (as of 1 Jan. 2011)
        Supplementary limits (minimum overlap etc.)


34
       Norwegian Ministry of Finance


     The investment universe gives significant degree
     of freedom for Norges Bank’s active management


                              Investment universe


                • All emerging markets        Benchmark:
                  for equities and bonds
                • Commodity derivatives
                                              Listed equities
                                              Investment grade bonds
                                              Real estate




      Market risk budget:
      100 bp tracking error on total portfolio
35
           Norwegian Ministry of Finance



        Major changes in the investment strategy

                   Some
                                                              60%        -Real estate
       40%       emerging            More EM, new
                                                             equities,   -All EM equity
      equities    markets               ethical
                                                             small-cap   markets
                   (EM)               guidelines




      1998        2000       2002        2004       2006      2007       2008         2010




     Few limitations           Non-           -High yield bonds                    Evaluation of
     on derivatives/        government        -Commodity derivatives                  active
     short positions           bonds          -new requirements in                 management
                                               risk management




36
      Norwegian Ministry of Finance



     Ethical guidelines and corporate governance
     Two main ethical obligations:
      1)   The obligation to ensure sound financial returns so that
           future generations will benefit from the petroleum wealth.

               Exercise ownership rights – corporate governance.
                Priority areas: Investor rights, board responsibility,
                well-functioning markets.


      2)   The obligation to respect the environment and the
           fundamental rights of those who are affected by the
           companies in which the Fund invests.

               Exercise ownership rights – integrated ESG approach.
                •   Priority areas: Climate change, water
                    management and the rights of children.
               Guidelines for the observation and exclusion of
                companies that fail to satisfy a minimum ethical
                standard.

37
     Norwegian Ministry of Finance


     Volatile and uncertain economic outlook

     •   The economic outlook remains foggy and difficult.
         Several reasons:
           Highly leveraged developed economies
           Private and public sector deleveraging,
            combined with exit from monetary stimuli
           High commodity prices
           Regulatory environment in transformation

     •   Deflation or inflation?

     •   However, funds with very long investment horizon
         and high risk bearing capacity should be able to
         absorb the market shocks without forced or
         unwarranted changes to investment strategy.




38
     Norwegian Ministry of Finance




     Stormy times highlight need for:


           Moderate real return expectations, also long
            term.

           Diversification across asset classes and regions
                 Although diversification did not serve its
                    purpose in 2008.

           Better risk measurement and control (both
            passive and active risk), including better
            understanding of tail events and their
            probabilities.




39
           Norwegian Ministry of Finance


     The fund has experienced very volatile equity
     markets
     Real return on a portfolio close to fund’s equity benchmark

                                                                                            2010
                23                                                                          2006
                22                                                                          2004
     Number     21                                                                          1991       2005
                20                                                                          1984       1998
     of years   19                                                                 2007     1982       1996
                18                                                                 1992     1980       1995
                17                                                                 1979     1978       1993
                16                                                                 1976     1971       1989
                15                                                                 1969     1961       1988
                14                                                       1994      1965     1960       1968
                13                                                       1987      1964     1956       1967
                12                                                       1981      1963     1953       1955       2009
                11                                                       1977      1944     1950       1952       2003
                10                                           2001        1966      1941     1943       1951       1999
                  9                                          2000        1962      1939     1942       1949       1997
                  8                                          1970        1957      1934     1938       1936       1986
                  7                                          1947        1948      1919     1925       1935       1983
                  6                                          1946        1945      1912     1923       1932       1972
                  5                                          1937        1940      1911     1915       1926       1958
                  4                                          1930        1918      1910     1909       1924       1933
                  3                              1990        1929        1916      1903     1906       1921       1928       1985
                  2     2008        2002         1973        1917        1914      1902     1905       1908       1927       1975
                  1     1974        1920         1931        1907        1913      1901     1900       1904       1922       1959       1954

                      Below -32   -32 to -24   -24 to -16   -16 to -8   -8 to -0   0 to 8   8 to 16   16 to 24   24 to 32   32 to 40   Above 40

                                                                        Return in percent

40
     Norwegian Ministry of Finance




     Few places to hide in 2008…

     •   Almost all asset classes saw large drops in value in
         2008
             Stock markets (worst since 1900 !)
             Bond markets (credit spreads)
             Real estate
             Commodities
             Diversification failed when most needed.

     •   And liquidity dried up in several markets




41
     Norwegian Ministry of Finance


     Except: Government bonds (real return)
                  49                                                                2009
                  48                                                                2007
                  47                                                                2005
                  46                                                                2004
                  45                                                                2003
                  44                                                                2001
                  43                                                                1996
                  42                                                                1992
                  41                                                                1990
                  40                                                                1989
                  39                                                                1988
                  38                                                                1987
                  37                                                                1983
                  36                                                                1977
                  35                                                                1976
                  34                                                                1975
                  33                                                                1972
                  32                                                                1971
                  31                                                                1970
                  30                                                                1966
                  29                                                                1962
                  28                                                                1961
                  27                                                                1960
                  26                                                     2006       1959
                  25                                                     1999       1958
                  24                                                     1981       1955
                  23                                                     1980       1953
                  22                                                     1979       1952
                  21                                                     1978       1949
                  20                                                     1969       1940
                  19                                                     1968       1938
                  18                                                     1967       1936
                  17                                                     1965       1933
                  16                                                     1964       1931
                  15                                                     1963       1929
                  14                                                     1957       1928     2008
                  13                                                     1956       1926     2002
                  12                                                     1950       1924     2000
                  11                                                     1942       1923     1998
                  10                                          1994       1941       1913     1997
                   9                                          1974       1939       1910     1991
                   8                                          1973       1937       1909     1986
                   7                                          1951       1935       1908     1985
                   6                              1948        1945       1925       1905     1984
                   5                              1947        1944       1914       1904     1954
                   4                              1946        1943       1912       1903     1934       1995
                   3                              1920        1919       1911       1902     1930       1993
                   2                              1918        1916       1907       1901     1927       1982
                   1                              1917        1915       1906       1900     1922       1921       1932

                       Below -32   -32 to -24   -24 to -16   -16 to -8   -8 to -0   0 to 8   8 to 16   16 to 24   24 to 32   32 to 40   Above 40

                                                             Return in percent
42
     Norwegian Ministry of Finance




     Our long term real return expectations

     •   Long term, assuming markets in equilibrium
         (rational pricing, no bubbles):
                        Global       Global        Global
                        government   real estate   stocks
                        bonds


         Expected
         real               2.5 %       3.5 %         5.0 %
         return,
         geometric


         Expected            6%          12 %         16 %
         volatility




43
     Norwegian Ministry of Finance




     Our long term correlation expectations

     •   Long term, assuming markets in equilibrium
                          Global       Global        Global
                          government   real estate   stocks
                          bonds

         Global
         government              1          0.3          0.4
         bonds



         Global                              1           0.6
         real estate


         Global                                           1
         stocks


44
     Norwegian Ministry of Finance




     Expected real return on fund

     •   Expected real return: 4.25 %
     •   Expected volatility: 9.8 %

     •   Realized net real return since 1 Jan. 1998: 3.05 %




45
         Norwegian Ministry of Finance


     Europe’s largest single owned asset pool, high
     expected growth from inflows and financial returns:

     The Government Pension Fund’s market value (real) 2010-2030:
     Expected growth, with 68 % and 95 % confidence levels

                          16,000


                          14,000




          Billion NOK
                          12,000


                          10,000


                           8,000


                           6,000


                           4,000


                           2,000


                              0
                               2010   2014   2018    2022    2026    2030




      Source: Ministry of Finance, Report to Parliament April 2011

46
     Norwegian Ministry of Finance

     Summary:
     Main characateristics of Fund
     •   Very large and growing SWF
           Owns roughly 1 % of world’s stock market

     •   Purely financial investor
           Max ownership share in listed markets: 10 %

     •   Very long investment horizon
           In practice unlimited

     •   No clearly defined liabilities
           But is funding a structural non-oil budget deficit

     •   Highly transparent

     •   Emphasis on integrated ESG approach to investing
47
       Norwegian Ministry of Finance




       Contact details                  Links
     Norwegian Ministry of Finance     Ministry of Finance
     Asset Management Department       •  www.regjeringen.no/en/dep/fin
     P.O.Box 8008 Dep
     NO-0030 Oslo, Norway              Government Pension Fund
                                       • www.government.no/gpf
     Visiting Address: Akersg. 40
     Telephone: +47 22 24 45 10        Norges Bank Investment Management
     Fax: +47 22 24 95 91              •  www.nbim.no
     E-mail: postmottak@fin.dep.no




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