Governor Gjedrem Reflects On Norway’s SWF

Ashby Monk

I’m off to an infrastructure investment conference at Stanford today, but I thought I’d leave you with my thoughts on this fascinating speech by Governor Svein Gjedrem, which examines the rise of Norway’s Government Pension Fund Global. As you may know, Gjedrem is a unique source on the GPF-G and NBIM, as he has served as Norway’s Central Bank Governor since 1999! (Though he is set to hand over his responsibilities to Øystein Olsen in January.) As you might expect, then, his speech, which is entitled “Perspectives on managing the Government Pension Fund Global”, provides wonderful context and interesting background on the Norwegian SWF. I’ll turn it over to Governor Gjedrem:

On the GPF-G’s origins:

“After Norway discovered oil in the North Sea in 1969, it became clear early on that this would be a source of substantial wealth. The revenue would transform Norwegian society. In 1983, the Committee on the Future of Petroleum Activity – chaired by Hermod Skånland who was appointed central bank governor in 1985 – launched the idea of an oil fund…The notion of a sovereign oil fund matured through the 1980s. The government, under the premiership of Kåre Willoch, called for the establishment of such a fund in the Long-Term Programme presented in spring 1986, and the Act on the Government Petroleum Fund was passed in 1990.”

On the design characteristics required for success:

First: The totality of government petroleum revenues is transferred to the Fund.

Second: The Fund is integrated into central government budgets and accounts. The non-oil deficit is covered by an annual transfer from the Fund. The government cannot borrow to finance current expenditure as long as there is capital in the Fund.

Third: The capital in the Fund can only be used for domestic spending via general budget transfers, and not for earmarked transfers.

Fourth: The Fund’s capital must be invested abroad.”

On the SWF’s “fiscal rule”:

“The fiscal rule for petroleum revenue spending, which was adopted in 2001, states that the government may spend – as an average over the business cycle – the expected normal real return on the capital in the Fund over the central government budget. This return is estimated at 4 per cent. The rule ensures that the capital in the Fund is not drawn on unless the real return on the Fund is lower than 4 per cent. In this way, future generations will also benefit from the oil wealth.”

On the main considerations associated with setting up a SWF within the central bank:

“Three challenges were considered in particular:

First: Norges Bank could risk impairing its reputation by accepting this assignment.

Second: Would it be possible for a central bank to assume the role of a professional investment manager?

Third: How could this activity be organised within the central bank?

Norges Bank’s Executive Board, under the chair of former central bank governor Kjell Storvik, chose to take on this task. The Bank solved the two other challenges by delegating management to a separate unit for investment management – Norges Bank Investment Management or NBIM. A key aim was to establish NBIM as a business unit with clear financial objectives. Eventually, Chinese walls were erected between NBIM and the rest of the Bank. NBIM does not participate in monetary policy deliberations and does not have access to the Bank’s work concerning other matters.”

On the domestic difficulties associated with the financial crisis:

“In the hearing before the Storting (Norwegian parliament) in 2009, directly after the reporting of substantial losses in 2008, I indicated that unless the economic outlook went from bad to considerably worse, active management would deliver substantial excess returns in the coming years. Even though there was probably an underlying fear of a collapse in the financial system, it was fairly clear that the main factor behind the decline was limited market liquidity. Since the second quarter of last year, book values have increased even faster than we dared to hope. Returns have also been good as a result of a restructuring of the portfolio. The Fund continued to pursue active management through the crisis. It has proven important that active management could be pursued.”

On active management:

“Active management has on the whole delivered good results, contributing an average 0.3 percentage point to the overall annual return. All in all, active management has increased the value of the Fund by several tens of billions of Norwegian kroner.”

Some interesting perspectives on a remarkable fund during an amazing time period!

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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