May 23 (Bloomberg) -- The Norwegian sovereign wealth fund, the world's second largest, suffered the worst quarter since it was established in 1998 as a global debt squeeze battered financial markets.

The Government Pension Fund - Global's investments dropped 5.6 percent in the first three months of the year, erasing its 4.3 percent return last year, the central bank said in a statement from Oslo today.

Financial markets have been roiled worldwide by the fallout from the U.S. housing recession and subsequent global credit crunch. The MSCI World Index of stocks slumped 9.5 percent in the first quarter. Norway's 2.02 trillion kroner ($403 billion) pension fund, which invests the country's oil wealth abroad to avoid stoking inflation, performed even worse, with its equity investments falling 12.7 percent.

``This is the worst quarter we have had,'' the head of the fund, Yngve Slyngstad, told a press conference in Oslo today. ``March was the month when the turmoil peaked. These are not normal markets.''

The government pumped an additional 88 billion kroner ($17.5 billion) into the fund in the first quarter as the price of crude rose to a record. DnB NOR AS, the country's biggest lender, has forecast the savings fund will rise to 5.7 trillion kroner by 2015. Norway is the world's fifth-largest oil exporter.

Hedge Funds

The pension plan, which held 429,700 kroner for every Norwegian at the end of April, is not the only investment fund that has seen its value dwindle in the face of what Norges Bank Governor Svein Gjedrem has termed the worst financial crisis since World War II.

Hedge fund managers James Simons and Stephen Mandel are showing the biggest losses of their careers as frozen credit markets, depreciating homes and a U.S. economy exhibiting all the signs of a recession are wreaking havoc on even the savviest investors.

``It's hardly a surprise that any asset manager has lost money recently,'' said Paer Magnusson, a senior fixed income strategist at Danske Bank A/S. ``I mean, who hasn't?''

Simons's $18 billion Renaissance Institutional Equities Fund has declined 12 percent since its value peaked last May, investors with direct knowledge of the situation have said. Mandel's Lone Cedar Fund dropped about 10.6 percent from its high in December, according to people familiar with the fund.

Money Managers

By the end of 2007, Norges Bank Investment Management had hired 47 external money managers to help invest the oil fund. Twenty-five external equity managers, including Aberdeen Asset Management and Legg Mason Capital Management Inc., have mandates worth a total of 217 billion kroner, while 22 fixed income managers, including Barclays Global Investors N.A. and Lehmann Brothers Asset Management LLC, have 128 billion kroner.

Sovereign wealth funds control an estimated $2.5 trillion worldwide, more than all the hedge funds combined. Morgan Stanley estimates government-run investment funds may reach $12 trillion within a decade.

Slyngstad, holder of two degrees in law and economics and two masters degrees in economics and political science, succeeded Knut Kjaer as head of the Norwegian fund at the start of this year. This is the first quarterly report he has presented.

The fund's performance is measured by a weighted basket of currencies, according to which its value fell by 115 billion kroner in the first quarter.

The situation is already improving. The fund's assets rose to 2.02 trillion kroner in April from 1.95 trillion kroner in March, according to a May 16 statement by the central bank, which manages the fund for the government.

Portfolio Shift

The fund has said it is moving toward having 60 percent in equities and 40 percent in bonds. On March 31, it had 47.8 percent of its assets in stocks and 52.2 percent in bonds. Its fixed- income investments rose 0.9 percent in the first quarter.

The soaring price of oil means the fund will grow to 2.32 trillion kroner by the end of 2008, the Finance Ministry forecast in its revised 2008 budget.

The relative opaqueness of many sovereign wealth funds has led to calls for tighter regulation, or limits to what they can invest in. Norway's savings vehicle has been lauded for its transparency.

The fund is currently limited to a maximum company ownership stake of 5 percent. The government has proposed lifting that limit to 10 percent, to increase the share of money invested in emerging markets to 10 percent from 5 percent and to add real estate to the fund's investment portfolio.

The fund also has ethical guidelines, which ban it from investing in companies that are involved in nuclear weapons, cluster munitions, and firms that it says are guilty of human rights or environmental abuses.

An ethics council investigates companies alleged to be breaking the investment guidelines and the fund has so far banned 27 companies, including Wal-Mart Stores Inc., BAE Systems Plc, Lockheed Martin Corp. and Vedanta Resources Plc.

To contact the reporter on this story: Robin Wigglesworth in Oslo at wigglesworth@bloomberg.net

Last Updated: May 23, 2008 11:38 EDT