Mark Gilbert is a Bloomberg Gadfly columnist covering asset management. He previously was a Bloomberg View columnist, and prior to that the London bureau chief for Bloomberg News. He is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”

The world's biggest sovereign wealth fund is finding that size is both an asset and a liability. As Norway's fund approaches $1 trillion in assets, the question arises as to whether it's become too big for comfort as it wrestles with maintaining returns.

One of the side effects of the massive quantitative easing programs implemented by the world's central banks has been the elimination of bond-market volatility. Concurrent with that is an increase in the tendency of government bond prices to track each other more closely.

The Japanese and German economies are very different. Japanese inflation is running at an annual pace of 0.4 percent, compared with 1.8 percent in Germany. The former has debts worth more than 230 percent of its gross domestic product; the latter has a debt-to-GDP ratio of less than 70 percent.

And yet you'd struggle to slip a cigarette paper between the 10-year bond values of both countries.

Almost in Lockstep
The correlation between Japanese and German government bond futures contracts is close to perfect over a 10-year period, and pretty close over shorter timespans
Source: Bloomberg's Historical Regression Analysis, weekly calculation of R2 on value

As a result of the increase in correlation, Norway's sovereign wealth fund is asking its finance ministry for permission to restrict the index against which it measures its $333 billion bond portfolio to just the three most liquid currency classes, down from 23 currencies currently:

In the long term, the gains from broad international diversification are considerable for equities but moderate for bonds. For an investor with 70 percent of his investments in an internationally diversified equity portfolio, there is little reduction in risk to be obtained by also diversifying his bond investments across a large number of currencies.

Limiting the index to dollars, euros and pounds wouldn't outlaw investments in other currencies. "We assume that the fund will continue to be invested in some of the currencies and segments that we recommend removing," the fund said in a letter to the finance ministry dated Sept. 1. As a result, "deviation between the benchmark index and the portfolio will increase."

But the fund will want to limit those deviations as much as possible. That means less room for the more than $21 billion of Japanese government bonds the fund held at the end of the second quarter, accounting for more than 6 percent of the portfolio. With the Japanese central bank committed to purchasing 80 trillion yen ($726 billion) of bonds annually, the market there is "large but far less liquid" than for the three main currencies, the fund said. The risk is that it owns JGBs with no diversification benefit, but would struggle to sell them in the event of a market downturn

It also presages a reduction in the 3.1 percent invested in Canadian dollar bonds, and the 12.3 percent spread across various emerging market currencies. U.K. and euro zone debt, though, could benefit from the proposal that the new benchmark be 54 percent in dollars, 38 percent in euros and 8 percent in sterling. Euro-denominated securities currently have about a 26 percent share of the fund's investments, while sterling accounts for just 4 percent.

The Norwegian asset manager is struggling as the size of its portfolio near the $1 trillion mark. Chief Executive Officer Yngve Slyngstad told Bloomberg News last week that expanding the range of assets the fund invests in, such as increasing real estate or infrastructure investments, takes too long to build stakes significant enough to move the needle on returns.

So maybe it's time to reopen the debate about whether the nation needs two or three or more funds. Each could follow a different investment path, adding an extra dimension of diversity to the nation's pursuit of returns. A smaller fund, for example, may decide that illiquidity is a market feature to be exploited, rather than a drawback to be avoided. 

Some of the world's most successful hedge fund managers are those with the discipline to resist the urge to keep growing by taking in more investor cash. Maybe Norway needs to add rigor by splitting up its behemoth. 

--Gadfly's Elaine He contributed charts.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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Mark Gilbert in London at

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Jennifer Ryan at