LONDON, Sept 4 (IFR) - Norway’s US$990bn sovereign wealth fund, the world’s largest, plans radical changes to its fixed income portfolio by cutting corporate and emerging market bonds from the benchmark index it uses, and shortening maturities.
If approved by Norway’s finance ministry, the changes will leave only government bonds in US dollars, euros and British pounds as part of the benchmark, compared with 23 currencies currently. The fund said they are the three most liquid currencies.
Norges Bank Investment Management, which manages the fund on behalf of Norway’s central bank, said the changes will cut transaction costs and volatility. It would have little impact on overall risk and should improve liquidity, it said in a letter to the ministry released on Monday.
The change will not trigger immediate asset sales and the fund can invest in segments that are removed from the benchmark. But it is likely to result in a shift away from the currencies cut from the benchmark, including bonds denominated in yen, Canadian dollars and Swiss francs.
The central bank also proposed limiting the maturity of bonds it holds to 10 years to reduce uncertainty about the fund’s volatility.
The fund’s focus has gradually shifted away from government bonds, which represented 100% of its holdings in the 1990s and now stands at around a third. The plan is to shrink this further to increase the share of equities to 70% from 65%, in an attempt to deliver higher returns.
The fund has about NKr2.66trn invested in bonds, or US$340bn, which under the changes could decline to about NKr2.4trn, or US$307bn.
The weighting of US Treasuries in the benchmark index for bonds will rise to about 54% from 44% now, euros will rise to 38% from 27% and UK Gilts will rise to 8% from about 6%.
The purpose of the fund’s bond investments is to reduce volatility in the overall fund, ensure adequate liquidity and get risk premiums from the bond market. But Norges Bank said not all bonds play those roles effectively.
“In the long term, the gains from broad international diversification are considerable for equities but moderate for bonds,” the central bank said in the letter.
Holding emerging market bonds creates a number of operational challenges and higher costs, it said.
“The need for portfolio adjustments following upgrades and downgrades of currencies will be reduced ... this will reduce transaction costs,” it said.
Corporate bonds make up 30% of the bond index, but the bank said they have not notably affected risks and returns in its portfolio, and result in unnecessary transactions. It said they should be removed.
Norges Bank also proposed removing inflation-linked bonds and bonds issued by international organisations, which currently make up 7% and 3% of the bond index.
Norway’s pension fund aims to provide long-term returns for when oil revenues run out, and the Ministry of Finance issues guidelines for how Norges Bank should manage the fund.
The ministry guides on the investment universe the fund can invest in, and the benchmark index that is the yardstick for fund management decisions. (Additional reporting by Terje Solsvik; Reporting by Steve Slater)