How Changes to Norway's $995 Billion Fund Could Hit Debt MarketsBy
Proposals include cutting 20 currencies including yen
U.S. assets, gilts may benefit if portfolio re-weighted
Investors may pile into Treasuries and gilts at the expense of Japanese and Chinese debt if a proposal by the world’s biggest wealth fund is implemented.
Norway’s $995 billion sovereign fund is looking at keeping bonds in its benchmark index in just three currencies -- the dollar, the euro and the pound -- at the expense of 20 others. The changes, which will need approval from the next government after Monday’s election, would likely create ripples across bond and currency markets if Norges Bank Investment Management reallocates purchases.
Here is a roundup of various markets that might be most affected under the proposals:
Japan would be the biggest loser with demand for its currency being sapped by as much as $19 billion of yen selling, according to Nomura International. Currently the currency makes up around 6 percent of the fund’s $333 billion bond holdings -- the removal of which may mean that the Bank of Japan’s debt purchases crowd out foreign investors from the market.
“Should the advice be implemented, over time it is not unreasonable to expect that the number of countries where we own government debt will be somewhat reduced,” Norges Bank Investment Management spokeswoman Marthe Skaar said in an email.
That would be positive for dollar-yen, euro-yen and pound-yen, Nomura strategists Yujiro Goto and Sam Bonney wrote in a note.
In contrast to Japan, U.S. assets could be the biggest beneficiaries. The proposals also underlined how U.S. Treasuries remain vital to the fund’s performance given they are the “primary source of liquidity in the management of the fund.”
Currently the dollar comprises around 43 percent of the fund’s portfolio but that could rise to nearly 60 percent under the changes, and it could need to add around $50 billion of Treasuries, according to Jason Simpson, a fixed-income strategist at Societe Generale SA in London.
Keeping pound-denominated assets at the expense of the Japanese yen would also boost demand for U.K. securities including gilts, Simpson said. He estimates that the share of sterling in the fund would rise to around 5.4 percent from 4 percent now, equating to roughly $4.8 billion dollars of gilt holdings.
While that would only account to “a couple of auctions,” there could also be some secondary effects due to the fund’s size in a low-yield and low-inflation environment where liquidity is sparse, Simpson said. It is also a sign of trust in the U.K., which finds itself currently mired in Brexit negotiations with the European Union.
“They say they are very long-term investors and so clearly taking the view that there will be no disasters,” Simpson said.
Chinese bonds received no mention in the proposed changes to the wealth fund, but given the three currencies it is looking at, it won’t be compelled to buy securities from the world’s third-largest bond market. That could come as a disappointment for the country, which is seeking to break down barriers to investing in its onshore market.
The fund had invested $2.9 billion in debt from Chinese issuers as of last year, according to its website, which doesn’t specify the currency of the securities. The yuan doesn’t feature in the 23 currencies that form part of the fund’s current fixed-income benchmark, which is compiled by Bloomberg LP, the parent of Bloomberg News.
Skaar declined to comment on China specifically and said the fund might still invest in currencies removed from the index if that dampens fund volatility, provides liquidity or “exposure to risk premia unique for the fixed-income market.”
It may take some time for the fund to offload its Polish bonds, according to Arkadiusz Urbanski, a fixed-income strategist at Poland’s second-largest lender Bank Pekao SA, adding that low yields could be about to reverse as global monetary policy tightens.
“Depending on the nominal scale of their engagement, potential selloff may take the Norwegians some time -- more than a day or a week,” he said. “What the Norwegians are doing should rather be read as sending a signal, like Greenspan did once or Warren Buffett -- a signal that ultra-dovish monetary policy around the world is slowly coming to an end.”
Polish debt has had a good run, giving investors a 23 percent return in dollar terms this year -- trailing only Mexico among emerging markets.
Over $5 billion of the country’s fixed-income assets are held by the fund. Even so, investors should not fret yet as the money manager would be all too aware of the damage it could wreak if it exited all at once, according to Jussi Hiljanen, European head of fixed-income research at SEB AB in Stockholm.
“If they would liquidate a substantial share of their Swedish holdings it would be a massive amount for the market to digest,” he said in emailed comments. It seems more likely that it will take place at a measured pace so “it is uncertain how much selling pressure it will generate and when.”
— With assistance by Adrian Krajewski, Love Liman, Chris Anstey, and Jonas O Bergman