Building a Fund from $30 bn to $324 bn While Keeping the Alpha - PowerPoint PPT Presentation

Norges Bank Investment Management “Exploring Capacity Issues:” Building a Fund from $30 bn to $324 bn While Keeping the Alpha Capability The Q-Group Spring 2007 Seminar, Georgia, 28 March Knut N. Kjaer, CEO Norges Bank Investment Management 1 WWW.NBIM.NO

Norges Bank Investment Management Agenda • Background and Facts • Transition in Two Dimensions: Strategic: From Oil to International Securities Financial: From Cash to Equities • The Alpha Challenge • Results • Discussion The Advantage of Size Capacity Constraints 2 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Background and Facts 3 WWW.NBIM.NO

Norges Bank Investment Management The Ranking of Oil Producers 2005 (mill b/d) Production Net export 9.47 Saudi Arabia Saudi Arabia 7.38 9.44 Russia Russia 6.64 USA 7.27 Norway 2.74 Iran 3.91 Iran 2.34 Mexico 3.76 Kuwait 2.18 3.63 China Venezuela 2.12 3.03 Canada Nigeria 2.09 Norway 2.97 UEA 2.09 Venezuela 2.64 Mexico 1.66 Kuwait 2.51 Libya 1.38 Source: Fact sheet 2006 4 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management The Norwegian Oil Fund and NBIM • Norway is the world’s 3 rd largest exporter of oil • Since the late 1990’s the bulk of oil revenue has been saved to the Oil Fund for future generations • NBIM was established in 1998 and manages the Oil Fund and the bulk of the Central Bank’s currency reserves • The Ministry of Finance owns the Fund and sets the benchmark • Asset under management in NBIM increased from USD 30 bn at inception in 1998 to USD 324 bn at year end 2006 5 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Projected Growth of the Government Pension Fund - Global 500 450 400 350 300 Bn. USD 250 200 150 100 50 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Source: National Budget 2007, October 2006 6 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management A Possible Scenario Ownership in Equity Markets 1.40 % 1.20 % Percent of FTSE Market Cap 1.00 % Europe 0.80 % America Asia 0.60 % Total 0.40 % 0.20 % 0.00 % 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 7 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management 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 31 Dec 2006 (billion USD): The Pension Fund - Global 286 The Foreign Exchange Reserves 36 The Petroleum Insurance Fund 2 Total 324 8 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management NBIM / Organisation Chart Executive Director Executive Director Corporate Governance Knut N. Kjær Knut N. Kjær Henrik P. Syse Risk, Performance & Equity Fixed Income Accounting Equity Fixed Income Ilse Bache Investments Operations Investments Operations Investments Operations Investments Operations Dag Løtveit Bjørn Egge Yngve Slyngstad Stephen A. Hirsch Dag Løtveit Bjørn Egge Yngve Slyngstad Stephen A. Hirsch IT Infrastructure Ilse Bache Legal / Finance / HR Marius N. Haug Bjørn Taraldsen Kristin S. Kleven Offices in Oslo, London and New York Number of Employees as of 31.12.2006: 132 9 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Benchmark for the Pension Fund-Global Strategic benchmark: FI - Americas 21 % 60 % Fixed Income EQ - Europe 20 % 40 % Equities FI - Asia / Pacific 3 % “Smart” rebalancing: • Monthly inflows EQ - Asia / Pacific • Asset class / region 6 % with largest negative deviation from benchmark EQ - Americas / FI - Europe Africa 36 % 14 % Equity index: Fixed income index: FTSE All World Index Lehman Brothers Global Aggregate Large & Mid Cap Government / Agency / Corporate / Securitized Approx. 2 400 equities Approx. 9 300 bonds 10 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Transition in Two Dimensions: Strategic: Oil to International Financial Securities Financial: Cash to Equities and Fixed Income Securities 11 WWW.NBIM.NO

Norges Bank Investment Management Petroleum Wealth - Autumn 2006 600 500 400 USD Bn 300 200 100 0 Petroleum In Oil fund Equities Bonds Ground 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) 12 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Petroleum Wealth - Value at Risk 200 180 160 140 120 USD Bn 100 80 60 40 20 0 Petroleum In Oil fund Equities Bonds Ground 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 13 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Real Global Market Returns 1900 – 2005 1000.00 Equities 376 Bonds Money market 100.00 Oil 10.00 6 3 1.00 2 9 6 3 0 7 4 1 8 5 2 9 6 3 0 7 4 9 0 1 2 2 3 4 4 5 6 6 7 8 9 9 0 8 9 9 9 9 9 9 9 9 9 9 9 9 9 9 0 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 2 0.10 Source: Dimson, Marsh & Staunton, Triumph of the Optimists, 2002, with updates 14 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Portfolios of Oil and Equities 7.00 % 100% equities 6.00 % 5.00 % Real Return 4.00 % 3.00 % 2.00 % 1.00 % 100% oil 0.00 % 0.00 % 5.00 % 10.00 % 15.00 % 20.00 % 25.00 % 30.00 % 35.00 % Standard deviation 15 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Portfolios of Equities, Oil and Bonds 7.00 % 6.00 % 100% equities 5.00 % Real Return 4.00 % 3.00 % 2.00 % 1.00 % 100% oil 100% bonds 0.00 % 0.00 % 5.00 % 10.00 15.00 20.00 25.00 30.00 35.00 % % % % % % Standard deviation 16 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management 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 17 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Implementation:Transition From Cash Inflow LHS Inflow as % of MV at the beg. of year RHS 50 70 45 60 40 50 35 Inflow in USD (bill) Inflow in % of MV 30 40 25 30 20 15 20 10 10 5 0 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 18 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Trading Efficiency • Given the expected large inflows and expected large size, NBIM knew early on that efficient trading was critical to success • If trading was not efficient, NBIM would easily spend any alpha generated and more • System advances over the last 9 years along with management willing to focus on trading has enabled NBIM to build the infrastructure and gain the expertise to compete in a competitive part of the marketplace • Data is the key to improving trading efficiency. Tracking all data components of the trading cycle is extremely difficult but more than pays for the effort 19 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar

Norges Bank Investment Management Total Equity Trade Volume 98 - 06 25 Billions 20 15 USD 10 5 - Mar99 Jun99 Mar00 Jun00 Mar01 Jun01 Mar02 Jun02 Mar03 Jun03 Mar04 Jun04 Mar05 Jun05 Mar06 Jun06 Sep98 Dec98 Sep99 Dec99 Sep00 Dec00 Sep01 Dec01 Sep02 Dec02 Sep03 Dec03 Sep04 Dec04 Sep05 Dec05 Sep06 Dec06 Singlestock (phys) Program Futures Equity Swaps FX Equity trading volume tripled from the end of 2004 to the summer of 2006 and is expected to increase for the foreseeable future 20 KNK 260307 WWW.NBIM.NO The Institute for Quantitative Research in Finance, Spring 2007 Seminar