Alison Swersky speaks to Norway's finance minister Sigbjørn Johnsen about the Ministry of Finance's decision to limit active risk within the Government Pension Fund Global
Alison Swersky: What are the biggest changes you’ve recommended to parliament for the Government Pension Fund Global?
The Norwegian pension reform seems to be well in line with international recommendations
Sigbjørn Johnsen: This is the fourth annual report to Parliament on the management of the Government Pension Fund. This is a report where we invite Parliament to discuss the fund’s performance and to engage in planned changes in the management of the fund. In this year’s report, the discussion of the fund’s organisation and the evaluation of active management is the most important for the fund going forward.
Alison Swersky: What was the motivation behind these proposals?
Sigbjørn Johnsen: With respect to active management, we promised in the report published a year ago that we would come back to this. And Parliament asked us to come back to the question about the organisation of the management of the fund.
Alison Swersky: There had been fears that the Ministry would ban active management within the fund, but ultimately you didn’t. Why did you decide to limit the risk used within active management, instead of imposing an outright ban?
Sigbjørn Johnsen: The Ministry recommends that there should still be a certain limit to deviate from the fund’s benchmark portfolio.
A pure passive management strategy would be expected to add unnecessary costs and the fund’s special characteristics nevertheless points to a potential for positive excess returns that to some extent should be exploited.
Beyond this, a certain degree of active management will have positive spill-over effects with other parts of the management.
The report proposes several changes to better regulate the risk in active management. A key change is that the scope for active management measured in terms of expected tracking error is reduced from the current upper limit of 1.5 percentage points to a limit of 1.0 percentage points – but with room for deviations in exceptional circumstances.
Moreover, alternative measures to limit risk are enhanced, such as limits to leverage and requirements on concentration risk and absolute overlap between the actual and the benchmark portfolio.
Alison Swersky: You’ve recently announced rules allowing the Global Fund to invest in real estate? Why did you include real estate as part of the portfolio?
Sigbjørn Johnsen: It has previously been decided to invest up to 5% of the GPFG’s assets in real estate. This is the third largest asset class in the world after equities and bonds. Many large international funds invest in real estate. The decision to include real estate as a separate asset class can be regarded as a natural continuation of the strategy to exploit the characteristics of the fund and as a means of spreading the investments more widely.
This report presents the guidelines for investments in real estate, which came into force on March 1 this year.
Alison Swersky: Are there other asset classes you’re considering adding?
Sigbjørn Johnsen: Many important choices have been made with respect to the investment strategy of the GPFG in recent years. In the opinion of the Ministry, the current benchmark portfolio reflects an acceptable level of risk for the fund.
The sources from which the return and risk associated with the fund have originated thus far are primarily linked to the fact that a market return has been achieved through a benchmark portfolio consisting of relatively liquid equity and bond markets. The benchmark portfolio has been expanded gradually and the diversification of risk has increased.
Future work on the investment strategy will focus in particular on evolving the strategy so as to exploit the special characteristics of the Government Pension Fund in the best possible manner. Further development will seek to diversify the risk further and increase the weight of investments that benefit from the fund’s size, long-term perspective and ability to hold less liquid assets. The decision to invest up to 5% of fund in real estate is an example of such a change.
Alison Swersky: Aside from the losses in 2008, has the Pension Fund been meeting its objectives?
Sigbjørn Johnsen: The Government has high ambitions for the management of the Government Pension Fund Global. We are continuing to develop the management of the fund in order to meet our long term objectives, and there are important lessons to be learned from the financial crisis.
The financial crisis had a significant impact on the Government Pension Fund. However, the losses from 2008 were to a large extent recovered in 2009, faster than many had expected. We have seen how volatile financial markets can be, but this is volatility we can live with, because the fund does not have specific liabilities requiring it to sell assets when prices are low. An alternative investment strategy aiming to minimise return variability would imply significantly lower expected returns.
The last years’ market developments underline that sticking to the long-term investment strategy over time is a prerequisite for harvesting risk premia. Another lesson learnt is the importance of continuously developing the methods used to identify, manage and communicate the relevant risk factors for the fund.
Alison Swersky: When will Norway once again go back to adhering to its oil spending rule, which limits the government to spend only 4% of the value of its wealth fund during a “normal year”?
Sigbjørn Johnsen: According to our fiscal guideline, the structural, non-oil budget deficit shall over time correspond to the expected real return on the Government Pension Fund Global.
This return is estimated at 4% per year. In the short term, however, the guidelines stipulate that one should spend more or less than 4% in order to counter fluctuations in economic activity.
The active use of fiscal policy to counter fluctuations in economic activity in 2009 and 2010, is, thus in accordance with the fiscal guidelines.
The government has stated that, as economic prospects improve, we will have to return to this sustainable path for spending of petroleum revenues. If the economic development continues to pick up as we have seen in the last couple of months, we should start to move closer to the 4% path from the next budget. In light of this, it is not natural for me to name a specific date for when we will be back on the 4% path.
Alison Swersky: Has spending over the limit in 2010 and in 2009 had any impact on the country’s pension liabilities?
Sigbjørn Johnsen: The spending in 2009 and 2010 has not by itself had any impact on the country’s pension liabilities. However, even though Norway doesn’t have to worry about increasing deficits and public sector debt like several countries are struggling with these days, also we must take into account long term fiscal challenges from an ageing population. This includes the pension liabilities. This underscores the need for returning to the 4% rule as the economy recovers.
Alison Swersky: Are there any other country’s pension systems that have aspects that you think could fit well in Norway?
Sigbjørn Johnsen: The Norwegian pension reform seems to be well in line with international recommendations, for instance from OECD. Norway will introduce a new pension system based on lifetime income, a flexible retirement age from 62 years based on actuarial neutrality in order to improve efficiency, and longevity adjustment of pensions to improve sustainability. Diversification of pension income has been improved by the introduction of mandatory supplementary pensions.
The Norwegian pension reform is inspired by the reform in Sweden. The Norwegian reform does however not include an autonomous public pension system, and the pension system in Norway is still an integrated part of the general public finances.
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