OSLO, Feb 12 (Reuters) - Norway's wealth fund, the world's largest, faces diminishing returns due to low bond yields and should reduce its fixed income portfolio in favour of real assets, its central bank governor said on Thursday.
The $860 billion fund, built up from oil and gas income, is now worth twice as much as Norway's non-oil gross domestic product. But measured in relation to the economy, its size has probably peaked, years earlier than expected, as oil income falls and budget spending increases.
"We must be prepared for the possibility that (returns) will be lower, perhaps below 3 percent," governor Oeystein Olsen told Reuters in an interview.
"To have 35 percent share of bonds in this very low-rate environment, which will remain for quite a few years, is challenging, so the bond share should be reduced."
The fund, managed by the central bank, has earned a real return of 3.8 percent since it was set up in 1996, below the government's target of 4 percent.
Olsen also warned that even its equity holdings, which usually yield more, are facing muted prospects as moderate growth in developed economies will probably feed into corporate earnings.
With stakes in more than 9,000 companies, the fund owns 1.3 percent of all global shares, holding 61 percent of its assets in stocks at the end of the third quarter.
It acts as a sort of national endowment, with the Norwegian government looking to spend only its returns while maintaining the principal indefinitely.
Olsen said the fund should increase its holdings of real assets, including equities, real estate and possibly infrastructure, but that the expansion of its asset portfolio depended on government approval.
Its real estate unit has been the fastest growing division but the fund is not currently allowed by the government to hold infrastructure assets or own shares in private firms not planning to go public. (Editing by Gareth Jones)