søndag 30. oktober 2011

The Norwegian Government Pension Fund Global Q3 2011 reports - comments

The Norwegian Government Pension Fund Global (also known as the "oil fund" or "oljefondet" among Norwegians) published their results for the third quarter of 2011 on Friday 28th October. The report can be found here.

The report, especially the large absolute losses ($52 billion), have been quite extensively reported on in Norwegian and international media. Here are some comments on some topics that may have received less coverage in the general news media:
  1. Active returns (excess returns) were negative with 0.33%. This is roughly equivalent to 10 billion NOK. The negative active returns are not surprising to those of us who believe that the fund over time will not succeed in generating positive excess returns through active management. Furthermore, the fact that the fund lost relative to the market in a quarter with broad market declines, indicates that the active management, at least in part, consists of giving the fund a higher exposure to the market than its reference index. Figures 2-1 and 2-2 on page 6 in the report shows, when read together, that there is a fairly clear correlation between the active returns and market return. An analysis done by NBIM (the fund manager) also seems to corroborate this.
  2. The fund has, disappointingly, stopped reporting excess returns in Norwegian kroner. Up until Q1 this year, the fund reported this as part of table 2-1 in the report (page 7). Given the complexity of calculations necessary to compute the fund's returns in "international currency basket", which is the currency the fund prefers to report in (instead of NOK or euro) and the innovativeness of this approach (I know of no other funds in the world that reports returns in "international currency basket"), it is not reassuring that the fund has dropped the additional reporting of excess returns in NOK.
  3. If I am understanding the fund's balance sheet correctly (page 21), the fund seems to have built up a not insignificant short position in some bonds in the last quarter. The liability side of the balance sheet states that the fund has "short-sale bonds" worth 36 billion NOK (€4.5 bn). If the fund has shorted Greece, Italy, French banks or something completely different is unknown.
  4. There has also been a large increase in the amount of unsettled trades. The asset side of the balance sheet indicates these totaled 108 billion NOK at the end of Q3. The comparative figure for Q2 was 40 billion NOK. I am not enough of an auditor to know if this should be a reason for concern or not.
  5. The fund also reports healthy revenue from its securities lending business. The cash-flow statement on page 22 shows that so far this year, sec. lending has generated 1.8 billion NOK in revenues. This is roughly the same as the total operating costs of the fund (1.9 billion NOK so far this year). The fund has lent out 12% of its portfolio of shares and 13% of its bond portfolio. Furthermore, assuming the revenue continue at similar level in Q4, the total revenue from securities lending by the end of the year will be 2.4 billion NOK, which is roughly 0.08% of total fund capital. If the fund was passively managed, this revenue would, in my opinion, ensure that the fund should be able to achieve a return somewhat above that of its reference index.
  6. The report also makes clear the costs of investing in real estate (footnote 5 on page 29) and the difficulties in valuing real estate assets (footnote 6, page 29). Despite this, there seems to be no immediate plans to report on the relative performance of the real estate portfolio versus the reference index set by the Ministry of Finance (box on page 14). The costs, challenges and absence of good performance measurement makes investing in real estate a risky business for the Norwegian people (the ultimate owners of the fund).

Finally, one can also note that the net return (after inflation and management costs) achieved by the fund since inception in 1998 is a meager 2.2%. This is a far cry from the 4% real return per year that the Norwegian Ministry of Finance and Norwegian politicians in general hope the fund will achieve. Norwegians should cross their fingers and hope that past returns are no guarantee for future outcomes.

PS: Regular readers of this blog will notice that this latest post is in English, rather than Norwegian. The reason for switching the language is to make the blog more accessible to international readers.

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