Biggest Wealth Fund Warns Outflows Are Affecting Risk Strategy

Norway's Sovereign Wealth Fund Hampered by Outflows
  • Says ‘big chunk’ will be invested in negative yielding bonds
  • Says most important issue is setting new equity share

Norway’s $890 billion sovereign wealth fund is acknowledging that rising withdrawals by the government could hamper its quest to manage more risk and generate greater returns as it takes on more and more negative yielding securities.

The net outflows are “relevant for how we think about the risk-bearing capacity of the fund,” Egil Matsen, the deputy governor at Norway’s central bank who’s in charge of oversight of the fund, said in an interview Friday while attending a central banking conference in Jackson Hole, Wyoming. 

“Say you have a decline in the equity market, and these returns have been partly funding the government,” he said. “Do you want variations in international financial markets to have a direct impact on fiscal policy?”

The fund, set up to safeguard Norway’s oil wealth, has long acted as a backstop for global equity markets because it could measure risk in terms of decades. It has so far shrugged off the withdrawals, which started this year and reached 45 billion kroner ($5.4 billion) in the first half, saying income from bonds, real estate and stock dividends more than covers the outflows.

Matsen’s comments come as the government meets this week to set the parameters for next year’s budget. Prime Minister Erna Solberg has come under fire from the opposition, economists and even support parties for her rising use of oil money, estimated to reach 205.6 billion kroner this year.

That is still well within a self-imposed 4 percent limit of the fund’s value. But that fiscal rule is being questioned as the fund faces years of diminished returns and has warned it will be difficult to live up to the target of a 4 percent return after inflation and costs.

“As the older bonds come to maturity and are reinvested, a big chunk of that will be reinvested in bonds with very low or even negative yields,” said Matsen. “That’s just a matter of fact that will affect the return of the fund going forward.”

A lack of inflows means the fund can’t as easily shift into new assets without selling off part of its portfolio. For now, it has been reducing its bond holdings but it is also looking at a new model which could include trimming its stock portfolio.

This is part of a review of whether to add more so-called real assets. A group of experts, including two former finance ministers, is reviewing if the fund should be allowed to raise its stock holdings beyond the current 60 percent target. The fund is also looking into how to increase its real estate portfolio to 7 percent from 5 percent and potentially add infrastructure.

The “most important” issue now is the fund’s equity share, Matsen said.

“We’re doing a lot of internal analytical work now to assess how the economic landscape has changed since the last review of this in 2007,” he said. “It’s a different world. It’s way too early for me to give any preview of our advice, but that’s certainly a big and important decision.”

The fund is also looking at whether the “correlation structure” between equities and bonds has changed since 2007, Matsen said. “There may be data that suggests there’s a different pattern there than in 2007.”

It’s also working on how to gauge performance of its real estate investments, which will be measured against a reference index of stocks and bonds, he said.

“This will have substantial implications for the management of the fund going forward,” Matsen said.

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