the norwegian government pension fund

Santiago October 2007 1KNK NBIM

Norges Bank Investment Management

The Norwegian Government Pension Fund & NBIM

Presentation to Central Bank of Chile,Santiago, 3 October 2007

Knut N. KjaerNorges Bank Investment Management

Santiago October 2007 2NBIM KNK


Agenda• Introduction, background• From oil to equities • Fund management model• Strategic asset allocation • Experiences 1998 – 2007 (testing the strategy in practice)• NBIM tasks and organization• Achieving excess return by active management• Performance 1998 – 2007:2• NBIM critical success factors• Ethical investments• Discussion points



Historical Context • ”One may disregard the

possibility of discovering coal, oil or sulphur on the Norwegian Continental Shelf”(Letter from the Geological Survey of Norway to the Ministry of Foreign Affairs, 1958)

• 1962: Phillips Petroleum applies for exclusive exploration and production rights (Not granted)

• 1969: First petroleum discovery (Ekofisk Field)(Production started in 1971)



Historical Context 1990 The Norwegian Government Petroleum Fund

established by law1996 Initial capital transfer (May)1998 Equities added to the investment universe2002 Non-government bonds added to the investment

universe2004 Ethical investment guidelines issued2006 The Government Pension Fund established

• Part of a broad-based national pension reform• Continuation of the Petroleum Fund and the National

Insurance Scheme Fund – no change in organisational set-up or activities – two separate funds

• The Government Pension Fund – Global continues to be managed by Norges Bank



Source: Facts – The Norwegian Petroleum Sector 2007, Ministry of Petroleum and Energy

The Ranking of Oil Producers 2006(mill b/d)

Production

2.77

2.84

3.03

3.21

3.68

3.70

4.27

7.32

9.65

10.23

0 2 4 6 8 10 12

Norway

Venezuela

UAE

Canada

China

Mexico

Iran

USA

Russia

Saudi Arabia

Net export

0 2 4 6 8 10

Libya

Mexico

Kuwait

Venezuela

Nigeria

Norway

UAE

Iran

Russia

Saudi Arabia



Macroeconomic indicators for the petroleum sector




The net government cash flow from petroleum activities




Transfers to the Pension Fund The Governments Net Cash Flow from Petroleum

0.0

10.0

20.0

30.0

40.0

50.0

60.0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

USD

bn

Transfers to the Petroleum Fund

Financing the budget deficits



The National Challenges

0

5

10

15

20

25

1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050

Petroleum revenuesPensions

% of GDP

• Ensure a fair distribution of oil wealth across generations– as oil wealth is transformed to financial wealth do not spend the principal, only the

expected real return

• Avoid pronounced cyclical fluctuations in the mainland economy due to variations in oil revenues

– invest in financial assets abroad only



An international Perspective on Our Business

Source: Funds’ web pages, Investments&Pensions, the Economist / Latest available information

Bn .

USD

0

50

100

150

200

250

300

350

NBIM, Norway ABP, Netherlands CalPERS, USA AP-fondene, Sweden PGGM, Netherlands

Bn. USD

Pension Fund Global Other Funds



Sovereign Wealth Funds – Largest Funds Ranked by AssetsFund name Country Assets (USD)Adia UAE 875GIC Singapore 330Funds of various types Saudi Arabia 300Government Pension Fund - Global Norway 300State FX Investment Corp and Hueijing Co. China 300Temasek Holdings Singapore 100Kuwait Investment Authority Kuwait 70Australian Future Fund Australia 40Permanent Reserve Fund Alaska, USA 35Stabilisation Fund Russland 32Brunei Investment Authority Brunei 30Korea Investment Corporation Sør Korea 20Khazanah Nasional BHD Malaysia 18National Stabilisation Fund Taiwan 15Alberta Heritage TF Canada 13Oil Stabilisation Fund Iran 11Source: Morgan Stanley estimates



Projected Growth of the Government Pension Fund - Global

Source: Revised National Budget 2007, May 2007

0

50

100

150

200

250

300

350

400

450

500

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Bn.

USD



From Oil to Equities

Basics behind the Norwegian Government Petroleum/Pension Fund



Mission for the Petroleum/Pension Fund

• Safeguard the petroleum wealth for future generations(also stabilizing the economy)

Function• Diversifying from one asset (petroleum) to a

portfolio of international securities reduces the risk and increases expected return



Strategy: Transition From Petroleum

• The Oil Fund’s key function is to diversify the Petroleum Wealth into a broad portfolio of international securities

• The transition takes down the expected risk significantly and increases the expected return

• The Fund makes the income stream from the non-renewable resources permanent

• The intention is to spend only the (expected) real return at the annual public budgets, thus preserving the capital of the fund for all future generations



Petroleum Wealth - Autumn 2006

Petroleum in the ground: Net present value of the government’s future cash flows from oil activities. Estimated at NOK 3660 billion at constant 2007 values (Source: National Budget 2007)

0

100

200

300

400

500

600

Petroleum InGround

Oil fund Equities Bonds

USD

Bn



Petroleum Wealth - Value at Risk

Value at Risk is defined as one standard deviation in this context.

The actual values will fluctuate outside the bands in one out of three years

020406080

100120140160180200

Petroleum InGround

Oil fund Equities Bonds

USD

Bn



Real Global Market Returns 1900 – 2006

Source: Dimson, Marsh & Staunton, Triumph of the Optimists, 2002, with updates

427

6

3

2

0.1

1

10

100

1000

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Money MarketBondsEquitiesOil



Portfolios of Equities, Oil and Bonds

0.00 %

1.00 %

2.00 %

3.00 %

4.00 %

5.00 %

6.00 %

7.00 %

0.00 % 5.00 % 10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Standard deviation

Rea

l Ret

urn

100% equities

100% oil100% bonds



From petroleum to financial wealthPer cent of total national wealth

0

1

2

3

4

5

6

7

1999 2030

Petroleum wealthFinancial wealth



The Fund Management Model,Governance Structure



Accountable to the People of Norway

• The Parliament has the ultimate responsibility towards the owners (the Norwegian population) and sets the risk appetite.

• The key decision is the strategic allocation to equities and to other asset classes (Defines risk tolerance rather than return requirements)

• The Parliament also sets ethical guidelines • The operational management is delegated to

Norges Bank (the central bank)



Norway’s SWF – Key Features

Accountability• The main decisions on objectives, risk tolerance

and ethical criteria’s lays with the Parliament• Clear investment strategy and principles• Clear division of responsibility between the owner

(Parliament, MoF) and the manager (NorgesBank)

Transparency• All principles, guidelines, risk and performance

data are made public.• All holdings disclosed in the annual reports



The Role of the Ministry of Finance

• Propose risk tolerance, strategic allocation and key guidelines to the Parliament.

• Define the benchmark portfolio • Set limits on active risk• Monitor the performance of Norges Bank• MoF use consultants and a strategic council to get second

opinions on performance and strategy• A ethical council give the MoF advice on exclusion of

companies (based on the ethical guidelines)• Reports to the Parliament



The Role of Norges Bank• cost-effective transitions and market exposure • active management to achieve excess return• risk control and reporting • exercise ownership rights / Corporate

governance• provide professional advice on investment

strategy



Pension Fund Global / Governance Structure

Ministry of Finance

Regulations

Performance reportsNorges Bank Investment

Management / NBIM

Norwegian Parliament

Pension Fund Act

Performance reports and strategic changes reported in National Budgets and National Accounts

Legislator

Principal

Manager

Management agreement

Office of the Auditor General

Norges Bank Audit

Advisors- Strategy Council- Council of Ethics- Mercer- Norges Bank

Advisory / consultancy agreements

Founded on Act, regulations and separate contracts



Transparency

• Performance, risk and costs are reported by NBIM every quarter. Focus on contribution to value added in operational management

• Quarterly reports published on web-site• Press conference on a quarterly basis • Annual report listing all investments,

both equities and fixed income



Transparency: ReportingThe annual report disclose all holdings of securities and gives detailed descriptions on absolute and relative performance, risk and costs



NBIM's Web pages

www.nbim.no



Transparency: Ministry of Finance



Building Blocks of Setting Strategic Asset Allocation (SAA)



• Governance. Asset owner responsibilities• Ability to cope with volatility in returns• Financial theory• Historical data• Simulation models

• Information, stakeholder dialogue



The Two Components of Financial Return

βMarket exposure The asset owner’s choice of long term strategic allocation. Based on robust assumptions. Does not rely upon information privileges

αExcess return by active management.The managers exploiting of information privileges

This presentation is based on the realistic assumption that alpha plays a less significant role in the long term returns for most funds



Governance

• The SAA defines most of the funds expected risk and return and must be understood and owned by the ultimate asset owner

• Norway: The Parliament represents the 4.6 million stakeholders and decides the SAA.

• NBIM give advice through the Ministry of Finance. They also use an Advisory Council and second opinion advisors



Ability to Cope With Volatility in Returns• Norwegian Oil Fund: Future governments can

easily cope with fluctuations in return. With no defined liability side – the key decision criteria is to set the risk as high as possible, but not so high that the strategy is adjusted in market draw downs

• Pension funds: The true long term benchmark is the pension liabilities

• Given diversified portfolio, all limits on expected volatility impose costs



Capital Asset Pricing Model (CAPM)

• Assumes efficient markets • In equilibrium, all investors hold a diversified

portfolio of all assets (the market portfolio) and a part in a risk free portfolio (dependent on the risk aversion)

• Not possible to enhance return without increasing the risk

• All investments give the same risk adjusted return (in optimum)



Expected Return Againts Expected Risk

11%

2%

3%

4%

5%

6%

7%

8%

9%

10%

0% 5% 10% 15% 20% 25% 30% 35%

CASH

DEF FI

VENT CAP

ACT FI

S/L IND FI

EXT MAT FI

INT'L FI

YLD EQ

CORE EQ

S&P 500

VALUE EQ

INT FICORE FI

INT'L EQ

REAL ESTATE

GROWTH EQ

SPEC EQ

Expected Rates of Return for Various Asset Classes

Source: Bridgewater Associates

Risk (standard deviation)

Expected return



Source: Bridgewater



Key Question: Risk Preferences

• Buy the global market portfolio

• If risk is too high, blend the market portfolio with a risk free portfolio. If too low, leverage up. And if you are to big to do that, increase the equity portion

• There is no way to get higher returns without being willing to increase risk



Basically Two Options

• Lender (Bonds)Lending to governments and companies.The cash flow is fixed. Lenders are contractually protected by collateral in the company’s assets, but have normally no ownership rights

• Owner (Equities)Equity is unsecured capital. Owners get the residual after the contract counterparties (suppliers, customers, employees, lenders) have got their share, but have the ownership rights (corporate governance) The cash flow is variable.



Capital Market Return Data From 17 Countries, 1900 to 2006

• Many empirical studies has been based only on short time series and/or data from a few countries

• Most of the research on equity premiums has been based on American data. USA has been a remarkably successful economy.

• Survivorship bias overstates capital market return

• Dimson, Mars & Staunton (DMS) at the London Business School present very relevant data in the book ”Triumph of the Optimists” -covering return in 16 (17) countries from 1900 to 2000 (2006)

• The next charts are based on this data, delivered by Morningstar



Year-To-Year Fluctuations in Return

Standard deviation global equities:

16.6%

Standard deviation global bonds:

8.6%

Money Market: 2.8 %

Glo b a l E q u ity M arket N o m in al R etu rn

-40

-20

0

20

40

60

80

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Perc

ent

G lo b al B o n d M arket N o m in a l R etu rn

-40

-20

0

20

40

60

80

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Perc

ent



Global Equity Real Return, 5 and 10 Year Horizons

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

1909 1919 1929 1939 1949 1959 1969 1979 1989 1999

Perc

ent

5 Years10 Years



Global Equity Risk Premiums, 5 and 10 Year Horizons

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

1909 1919 1929 1939 1949 1959 1969 1979 1989 1999

Perc

ent

5 Years10 Years



Global Capital Market Return 1900-2006

Excess return equities over money market: 4.8% annually

0.1

1

10

100

1000

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Money MarketBondsEquities

427

6

3



Global Capital Market & Copper Return 1900-2006

Excess return equities over money market: 4.8% annually

427

6

3

0.1

1

10

100

1000

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Money MarketBondsEquitiesCopper

1



Modelsimulations



Is the Past a Good Predictor for Future Equity Risk Premiums? Points made by DMS:

• No reason to expect persistent multiple expansion in the future (?), lower ERP with 0.7 pp

• Today’s dividend yield lower than historical average, lower ERP with 0.5 - 1 pp (?)



Report no 24 to the Storting / Main points

• Equity share to increase from 40 to 60 per cent

• Inclusion of small cap equities in the benchmark

• Approved country / currency list is abolished

• Exclusion mechanism for countries (Burma)

• (For private companies there is an exclusion mechanism)

• Positive assessment on real estate, but no implementation commitment



Pension Fund Global – Guidelines

• The Ministry of Finance has decided on the following guidelines:• Asset allocation until June 2007 (60% Fixed Income /

40% Equities)• Exchange listing (for EQ)• Maximum ownership share in any one company is 5%• Risk limit (1.5% expected tracking error)• No investments in Norwegian companies or in NOK

• A benchmark portfolio for bonds and equities is created based on well-defined market indices



Benchmark for the Pension Fund-Global

EQ - Asia / Pacific

6 %

FI - Americas21 %

FI - Asia / Pacific3 %

EQ - Europe20 %

FI - Europe36 %

EQ - Americas / Africa14 %

Strategic benchmark:

60 40 % Fixed Income

40 60 % Equities

“Smart” rebalancing:

• Monthly inflows

• Asset class / region with largest negative deviation from benchmark

Equity index:

FTSE All World Index Large & Mid Cap2 421 equities

Fixed income index:

Lehman Brothers Global Aggregate Government / Agency / Corporate / Securitized 9 9 205 bonds



Experiences 1998 - 2007

The Oil Fund increased the equity portion from 0 to 40% in 1998.. and met from 2000 the worst decline in global equity markets since the 1930’s…



Market Return 1998 - 2002

80

90

100

110

120

130

140

150

160

170

4.kv.

1997

1.kv.

1998

2.kv.

1998

3.kv.

1998

4.kv.

1998

1.kv.

1999

2.kv.

1999

3.kv.

1999

4.kv.

1999

1.kv.

2000

2.kv.

2000

3.kv.

2000

4.kv.

2000

1.kv.

2001

2.kv.

2001

3.kv.

2001

4.kv.

2001

1.kv.

2002

2.kv.

2002

3.kv.

2002

4.kv.

2002

Index, 1997:12 = 100

Equities

Bonds

Total



Aftenposten November 2002

”They make Norway more poor”

”Catastrophic numbers for the oil fund”



Dagens Næringsliv November 2002

Puts all assets into equities after having lost NOK 40 bn in the 3rd

quarter. Have bought equities for NOK 75 bnsince June



VG 27/11 2002 Klassekampen 11/10 2002



Market Return 1998 – 2007 Q2Index, 1997:12 = 100

80

100

120

140

160

180

200

220

4.kv.

1997

1.kv.

1998

2.kv.

1998

3.kv.

1998

4.kv.

1998

1.kv.

1999

2.kv.

1999

3.kv.

1999

4.kv.

1999

1.kv.

2000

2.kv.

2000

3.kv.

2000

4.kv.

2000

1.kv.

2001

2.kv.

2001

3.kv.

2001

4.kv.

2001

1.kv.

2002

2.kv.

2002

3.kv.

2002

4.kv.

2002

1.kv.

2003

2.kv.

2003

3.kv.

2003

4.kv.

2003

1.kv.2

004

2.kv.2

004

3.kv.2

004

4.kv.

2004

1.kv.

2005

2.kv.2

005

3.kv.

2005

4.kv.

2005

1.kv.2

006

2.kv.2

006

3.kv.2

006

4.kv.2

006

1.kv.2

007

2.kv.2

007

Equities

Bonds

Total



Key Learning Norwegian Oil Fund• The costs of not rebalancing in 2001 – 2002 and

even worse, start selling equities, would have been enormous

• Even with negative press articles and some critical politician- and quasi investors comments, there where no real danger of changes in long term strategy

• Why?– Strategy understood and owned by Parliament– Active and realistic information policy since 1998

(and we where not forced to change strategy by regulators…)



Average Annual Net Real Return Since 31 December 1996

• Average annual net real return (adjusted for management costs and inflation) is 4.57%

• Annual real return on the benchmark is 4.09% (β)

•α 0.51% annuallyInformation Ratio1.34

0 %

1 %

2 %

3 %

4 %

5 %

6 %

7 %

8 %

9 %

10 %

1999 2000 2001 2002 2003 2004 2005 2006 2007

Net Real Return on ActualPortfolioNet Real Return on Benchmark



NBIM’s Tasks and Organization



Norges Bank Investment Management (NBIM)

• NBIM was established in 1998 as a separate wing of Norges Bank. NBIM is organised as a business unit. Offices in Oslo, London and New York

• Funds managed by NBIM as of 30 June 2007 (billion USD):The Pension Fund - Global 328The Foreign Exchange Reserves 38The Petroleum Insurance Fund 3Total 369



NBIM’s Main Tasks

• Cost efficient market exposure (β) and investment of new funds

• Create excess return against the benchmark (α) by active management

• Safeguard long-term financial interests by active corporate governance (as a minority shareholder)

• Advice the Board and MoF on strategy• Risk management, control and reporting



NBIM / Organisation chartExecutive Director

Knut N. KjærExecutive Director

Knut N. Kjær

Fixed IncomeInvestments Operations

Dag Løtveit Bjørn Egge

Fixed IncomeInvestments Operations

Dag Løtveit Bjørn Egge

EquityInvestments Operations

Yngve Slyngstad Stephen A. Hirsch

EquityInvestments Operations

Yngve Slyngstad Stephen A. Hirsch

Corporate GovernanceHenrik P. Syse

Chief Financial OfficerEspen Klitzing

Offices in Oslo, London and New YorkEmployees as of 30 June 2007: 148

Chief Financial OfficerEspen Klitzing

Real Estate ProjectPaul Golding

Risk, Performance &AccountingEspen Klitzing

(Trond Grande from autumn 2007)

IT InfrastructureIlse Bache

Legal / Finance / HR Marius N. HaugBjørn TaraldsenKristin S. Kleven



Delegation, Line Management, Measurement, Control

Equities

Beta

Pos 1 Pos 2 Pos 3 Pos 4 Pos 5 Pos n

Strat.1 Strat 2 Strat 3 Strat 4

Relative Value Global Value

Alpha

Internal management External management

Fixed Income

ManagerNorges Bank

OwnerParliament/Ministry of Finance

The relationship between the Owner of the Fund and the Fund’s Manager is clearly defined all the way down to the level of each trading decision

All trading is executed within precisely defined risk limits

Performance measurement and investment guideline compliance are monitored regularly

Portfolio trading decisions are delegated to more than 70 external portfolio mandates and to 15 internal investment teams (and within these teams to individuals)

An important precondition for management, measurement and control: Benchmark portfolios

More than 30.000 positions

More than 10.000 prices updated daily



Achieving Excess Return by Active Management



Challenges in Alpha Management

• Create excess return against the benchmark• targeting 0.25% over rolling 3 year horizons• with costs less than 0.1% ex performance fees• and annual inflow at USD 20 – 50 bn / year

Excess Return, Basis Points

0

2 0

4 0

6 0

8 0

1 0 0

1 2 0

1 4 0

1 99 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 20 0 3 2 0 04 2 0 0 5 2 0 0 6



The Principles behind Our Active Management

• Very high respect for the market. Applying financial theory. Humility and discipline

• Active management only where there may be some less market efficiency and where we find/develop managers with unique expertise

• Specialization. More than 100 sub-portfolios• Extensive delegation. No committee structure• Incentives linked to performance



"Financial Market Theory for Cautious Investors"*

"The possibility of achieving an above average return lies in being able to identify cases of incomplete market equilibrium. To be able to detect what is abnormal, it is necessary to know what is normal."*

* Jan Mossin, Markedseffisiens (Market efficiency), TANO, 1986



Textbook Approach to Active Portfolio Management

• Active management is a process. Active management begins with raw information, refines into forecasts, and then optimally and efficiently constructs portfolios balancing those forecasts of return against risk

• Active management is forecasting, and a key to active management performance is superior information

• Active managers should forecast as often as possible (the fundamental law)

• Mathematics cannot overcome ignorance/lack of information

R.C. Grinold & R.N. Kahn, Active Portfolio Management, 1994, 1999



”The Fundamental Law of Active Management”• Information Ratio = Return / Risk

Information Coefficient (IC) = corr[α, θ]α = expected (ex ante) return θ = actual (ex post) return corr[α, θ] = correlation between α and θBReadth (BR) = number of independent positions

• The Challenge: Improve IC (hit ratio)• and/or increase breadth by taking many independent

positions and trade often

BRICIR ⋅=



Management strategy Tactical allocation

Factor-based strategies

Fundamental strategies

Relative value

Analytical ability + + ++ +++

Number of independent positions - - +++ ++

Implementation costs +++ + ++ +

Experience - ++ +++

Expenses Low Moderate High High

Expected information ratio Low Moderate High High

Move to More Scalable Alpha-Strategies May Imply Lower Information Ratio • NBIM prefers relative value and fundamental

strategies• Our IR is now 1.34 However, we may be forced to

move to more factor based strategies

http://www.norges-bank.no/english/petroleum_fund/articles/2004/highest_excess_return/



Neccessary Conditions for Creating Alpha

• Talented people

• Motivated and challenged in a rational, efficient and supportive structure



Rational and Supportive Structure

• Clear investment philosophy• Various investment strategies• Specialization• Large number of independent positions• Good access to information• Alpha separated from Beta• Low costs in trading and transitions



Specialization and Independence

• Specialization, focusVery clearly defined mandates. Specialist expertise to provide the competitive edge needed in a near efficient market

• Independence, low correlationDifferent types of investment strategies in various units; a large number of individual investments.No committee decisions; no predefined processes



Talented People

• NBIM learning from external and internal management: Alpha creation is mostly about the quality of the people. Only special talents create alpha.

• The key issues is then: How to recruit, develop, motivate and retain talents?



Empowerment and Ownership

• Individual investment mandates and considerable freedom to develop own investment style, methodology and tools

• Individual incentive structure• clearly defined and measured• ‘managing own money’

• Ownership in all other processes• operations included in the business units • division of responsibilities, defined work task

• Independence in team structure• optimal size for flexibility and communication• accountability and visibility without ‘atomization’• blending competition and support• avoiding ‘group think’



Internal and External Management

51 external fund managers are responsible for appr. 60 percent of the active risk. (86 different mandates)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Internal External

Portfolio Active ris k Cos ts



Annualised contribution to gross excess return the last three years (from Q3 2004 to Q2 2007)

External

managementInternal

management Total Excess return within

each asset class

Equity management 0.15 0.25 0.40 1.04 Fixed income management 0.05 0.15 0.20 0.30 Total 0.20 0.40 0.60



Information ratio last three years (from Q3 2004 to Q2 2007)

The IR is a measure of risk-adjusted return, and is an indicator of the degree of skill in investment management. It is calculated as the ratio between excess return and the actual relative market risk to which the portfolio has been exposed. The IR reveals the level of excess return generated for each unit of risk

External

management Internal

management Total

Equity management 0.59 1.43 1.21 Fixed income management 2.10 2.25 2.78 Total 0.78 2.45 1.75



Excess return over the last three years

-0.2 %

-0.1 %

0.0 %

0.1 %

0.2 %

0.3 %

0.4 %

0.5 %

0.6 %

0.7 %

0.8 %

Juli 0

4

Sept 0

4

Nov 04

Jan 0

5

Mars 05

Mai 05

Juli 0

5

Sept 0

5

Nov 05

Jan 0

6

Mar 06

Mai 06

Jul 0

6

Sep 06

Nov 06

Jan 0

7

Mar 07

Mai 07

-0.2 %

-0.1 %

0.0 %

0.1 %

0.2 %

0.3 %

0.4 %

0.5 %

0.6 %

0.7 %

0.8 %



Excess return since 1998

Average annual excess return since 1998: 0.50ppAggregate excess return: NOK 36.2bn Information ratio: 1.34 (a measure of quality in active management)

-0.4 %

-0.2 %

0.0 %

0.2 %

0.4 %

0.6 %

0.8 %

1.0 %

Q1 98

Q3 98

Q1 99

Q3 99

Q1 00

Q3 00

Q1 01

Q3 01

Q1 02

Q3 02

Q1 03

Q3 03

Q1 04

Q3 04

Q1 05

Q3 05

Q1 06

Q3 06

Q1 07



Excess Return and Contribution to Total Risk From Active Management

Excess return and return on the benchmark portfolio

Benchmark Excess return

Risk contribution due to active management

Risk due to active management Benchmark risk

• Active management has increased the return with noincreased risk



NBIM Critical Success Factors

• Time is spent on professional challenges – not marketing• Empowerment of individuals (mandates and resources)• Delegated power matters more than placement in org

charts• No committee governance with unclear responsibilities• Meritocracy – rewards and positions are based on

performance• Ability to change leadership and structure when

performance or new challenges requires it• Incentive level and structure is competitive and fosters the

targeted risk-taking and behavior



NBIM’s Salary and Incentive SystemObjectives:• Play an important role in NBIM’s strategy to achieve the

excess return targets• Reward outstanding performance• Facilitate desired turnoverMain features:• Fixed salary• Performance-based salary

• Quantitative and qualitative criteria• Compensation benchmarked to other local competitors

• Focus on transparent, non-discriminating and non-inflating system

• Certain common evaluation criteria across the org. (e.g core values) =>Fair, efficient and cost effective system



The Ethical Dimension



Background: Ethics in the Norwegian Pension Fund

• Financial return is a key ethical concern in itself. The fund safeguards the oil wealth for future generations

• The return shall, however, not be achieved in ways that conflict with the overlapping consensus of the Norwegian citizens

• The ownership power shall be used to enhance ethics and sustainability, when this is in the interest of the long-term financial return of the portfolio



Ethical Guidelines / Corporate Governance

• The government has issued Ethical Guidelines for the Pension Fund Global. Based on three pillars:• Exercise of ownership rights• Negative screening• Exclusion of companies

• NBIM shall exercise ownership rights• The Executive Board has established principles for corporate

governance and the protection of financial assets• The Council on Ethics shall advise the Ministry of Finance on

negative screening and exclusion of companies



Companies excluded by the Ministry of FinanceDate Company Reason26.04.2002 Singapore Technologies, Singapore Land mines

31.05.2005 Kerr-McGee, USA (*) Western Sahara

31.08.2005 Alliant Techsystems, USAEADS (Airbus), The Netherlands (**)General Dynamics, USA

L-3 Communications, USALockheed, USARaytheon, USAThales, France

Components for cluster bombs

Northrop Grumman, USASafran, FranceUnited Technolog., USA

31.05.2006 Wal-Mart Stores Inc., USA (1)Wal-Mart de Mexico (1)Freeport McMoRan, USA (2)

Violation of human / labour rights (1)Environmental damage (2)

30.11.2006 Poongsan Corporation, South Korea Components for cluster bombs

31.12.2005 BAE Systems, UKBoeing, USAFinmeccanica, ItalyHoneywell, USA

Nuclear weapons

(*) KerrMcGee (now merged into Anadarko Petroleum) was included again from 30 June 2006

(**) EADS has stated that the company no longer invests in the production of cluster munitions. The company is, however, involved in the production of nuclear weapons and on this basis the Ministry reaffirmed the exclusion on 10 May 2006



Norges Bank’s principles approved by theExecutive Board December 2004

• The principles are based on internationally recognized guidelines, such as– OECD Corporate

Governance Guidelines– OECD Guidelines for

Multinational Enterprises– UN Global Compact

Corporate Governance in more than 3000 Companies



Ethics Focus of Financial Investors• In addition to focus on board performance & elections,

incentive systems for top management, basic mission and business strategy, and capital structure, a long-term investor must also look to:

• The values & normsof the portfolio companies:

- Human rights policies- Anti-corruption work and respect

for laws and regulations- Environment / climate - Social responsibility:e.g., child labour, children’s rights



Externalities and Financial Returns Are Woven Together in the Long Term

• Many companies cannot realistically contribute to serious externalities over long time, without risking return capabilities: Pollution, climate change, social unrest, disorder in economic and contractual structures, etc.

• Still, the individual companies and most investors don’t see and take into account the consequences of collective (in)action: Therefore, a need for national and international regulations.Investors and companies cannot do this alone.



Our Position

• Our time horizon nearly infinite (future-generation endowment)

• We own broad stakes in the global capital market• Our return depends on the sustainability of the

markets• Can’t avoid this by selling stocks• We have to influence the companies



How to Get Such Influence While Being Only a 0.5 % Owner?

• Long-term perspective in the engagement with companies: Contribute to the understanding of long-term consequences of company actions or no-actions, and get acknowledgment of ethical, legal and environmental obligations

• Build alliances and networks with other investors• We can only mobilize other investors if we succeed in

arguing for long-term financial benefits and act as a serious investor (and not as politicians)

• (The financial investor’s toolbox is different from the government’s!)



Our Strategic Priorities (1)

Ownership rights and Corporate Governance:a precondition for corporate responsibility.Examples:

• The right to vote• The right to nominate and elect board

members• The right to sell• The right to open, timely information



Our Strategic Priorities (2)

Externalities: Future social and environmental sustainability

• Children’s rights within the value chains of multinational companies, particularly related to limiting child labour and measures to protect children’s health;

• Companies’ lobbying towards national and supranational authorities on issues related to long-term environmental change – including the risk of pronounced climate changeResponsible investors can make a difference on such issues through consistent engagement



Discussion points

Can a public entity achieve excellence and high performance?

Some key learning from Norges Bank / NBIM



• The owner of a fund must set clear objectives, the preferred risk/return balance and the strategic asset allocation

• For a public fund – these key decisions must be taken by the political authorities. The main decision – how much risk is to be taken – should not be delegated

• But the operational management must be carried out by investment professionals. To avoid a mixture of politics with investments, the mandates to the manager(s) must be defined very clearly



• A public fund management organization can and should be run like a private company: Key focus on the value added, a line structure where every financial position has an ”owner” and a compensation system that rewards people according to results

• Transparency on objectives and performance is a necessary condition for building a professional business culture

the norwegian government pension fund

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