Jan F Qvigstad: On managing wealth
Speech by Mr Jan F Qvigstad, Deputy Governor of Norges Bank (Central Bank of Norway),
at the Norwegian Academy of Science and Letters, Oslo, 8 November 2011.
The text below may differ from the actual presentation. This speech does not contain assessments of the
economic situation or current interest rate setting.
* * *
I would like to thank Amund Holmsen, Marie Norum Lerbak and Øystein Sjølie for their valuable assistance in
preparing the speech. Thanks also to Ola Peter Krohn Gjessing, Espen Henriksen and Pål Winje for useful
comments. I would also like to thank Helle Snellingen for her contribution to the translation of the Norwegian text
into English.
Introduction
From Norges Bank we can see the corner of the two streets Tollbugaten and Kirkegaten.
This is where the Collett building was situated until 1939 when it was dismantled and moved
to the Norwegian Museum of Cultural History at Bygdøy. By then, the Collett family had not
occupied the building for years and their wealth was long gone.
Around the end of the 18th century, John Collett made a large fortune in the timber industry.
He also ran the great Ullevål farm and by the time of his death in 1810 he was managing one
of the country's largest wealth portfolios. Collett was also known to spend extravagant
amounts on lavish parties. The Napoleonic Wars and the English blockade took a heavy toll
on the family business. After his death, Collett's heirs insisted on maintaining an extravagant
lifestyle as if the income was still intact. Their wealth rapidly withered away and in 1829 the
coffers were empty. The farm was taken over by the state.1
The time it took Collett to make a fortune is about the same as it took Norway to build up its
oil-based financial wealth. Nearly 40 years after Phillips Petroleum discovered commercially
viable oil reserves in the Ekofisk field2, we have an oil-based sovereign wealth fund worth
more than NOK 3 trillion. Few other countries are sitting on such huge financial reserves. But
our wealth primarily comes from other sources than the oil fund, now called the Government
Pension Fund Global. The value of our current and future labour resources is more than ten
times as great as the value of our oil and the oil fund combined.3 The oil fund would be
depleted in three years if government tax revenues were to disappear entirely.
Our economic future depends above all on our capacity to produce goods and services that
others value. But the visible oil revenues may give the impression that we have a huge
treasure trove at our disposal. Sound wealth management is therefore first and foremost a
question of maintaining and developing the value of our productive resources, particularly our
labour resources.
A nation that comes into a large fortune must make a number of choices and trade-offs. They
can be considered from a legal, ethical or financial standpoint. In my speech today, I will
discuss in particular what sound management entails from an economic viewpoint. I will also
touch upon how we practice oil wealth management in Norges Bank.
Intergenerational saving
The first question that must be answered is: Who owns the oil wealth? Does it belong to the
present generation of Norwegians? Does it also belong to future generations?4
Even though I will be speaking from an economic vantage point, I will borrow a point made
by the philosopher Henrik Syse. He asks whether we have the right in the course of a single
generation to expend resources that it has taken nature millions of years to produce.
But there are also counter arguments. The next generations are likely to be wealthier than us
in any case. Should we save for them?
Saving for the future can also be supported with vicarious arguments by those who are
worried about their own upcoming pension payments. Today's pension obligations are
underfunded but can be more easily met if oil revenues are saved. Is this the "68 generation" that
first went on a spending spree and is now arguing in favour of saving to secure their own
pensions?5
Moreover, all we have to do is read today's press to understand that it is not a matter of
course that economic growth will maintain its current pace. It is not a given that our children
will be that wealthy.
For those with roots in agriculture, it is second-nature to leave the farm in at least as good
shape as when it was taken over. A policy of high and rising spending, which would crowd
out internationally exposed industries and lead to unsustainable public expenditure levels,
would be a heavy legacy to leave behind. The next generations would have to increase taxes
substantially because of our consumption. If we, as a nation, set money aside instead, our
wealth will grow and contribute to improving prosperity for our children.
Spending and saving are mutually exclusive actions. The definition of saving is quite simply
to abstain from spending. But with Norway's huge oil revenues and the return on the portion
saved we can increase spending while accumulating considerable savings. But spending
must be adapted to the return on the portion saved.
Sound and long-term management of oil wealth also requires separating saving decisions
from spending decisions. The fiscal rule sets an important cap.6 The rule states that
petroleum revenues are to be saved, while the government may spend the return on the oil
fund. Once the cap has been set, expenditures across worthy public programmes must be
made according to priorities - not by lifting the cap. If the ability to prioritise fails us and the
cap is lifted, the long-term margin of manoeuvre will be reduced fairly quickly. Less will be left
to our children.
As long as the North Sea generates revenues, the value of the fund will rise, laying the basis
for a sustainable rise in petroleum revenue spending.7
Institutional challenges
Oil converted into money entails institutional challenges. A crucial question that arose when
we discovered oil was whether we had the discipline to refrain from spending all the money
at once. In 1983, the Committee on the Future of Petroleum Activity was chaired by former
central bank governor Hermod Skånland. He was of the view that it would not be possible to
set aside a share of the oil revenues in a fund:
"In the light of the prevailing attitudes among both politicians and the wider
population, it is difficult to imagine that hundreds of billions will be invested in
8
foreign assets while there are domestic needs that have not been met (...)."
For Skånland the solution was simple. If the political system did not manage to set aside the
revenues, the oil taps had to be opened very slowly. Wealth management could be carried
out by portioning exploration sites in the North Sea. Oil that had not been discovered would
burn a hole in the pockets of politicians to a lesser extent than money flowing into the state
coffers.
Skånland's scepticism was well founded. Future oil revenues were used as an argument for
allowing the central government to run a budget deficit. Moreover, it would transpire that the
actual pace of oil extraction - and oil-revenue spending - increased much faster than the
committee had recommended.
In the first 25 years, Skånland's prediction was right on the mark. All the oil revenues were
spent. But in the past 15 years, petroleum revenues have risen at such a fast pace that a
portion has been set aside. If we look at the period of oil revenues in its entirety, close to half
of the oil-based revenues have been spent.9
In 1994, the economists Bye, Cappelen, Eika, Gjelsvik and Øystein Olsen of Statistics
Norway estimated that government petroleum revenue spending came to about 10 per cent
of overall public expenditure at that time. Tax income from the petroleum sector and
petroleum sales revenue - current petroleum revenues - were spent over the government
budget. The economists at Statistics Norway expressed concern regarding Norway's oil
dependence.10
These economists can now rest assured knowing that around 10 per cent of public
expenditure is still financed by oil money, but with one important difference from 1994: The
source of these revenues is now the return earned on the oil fund - not current petroleum
revenues. We have thus succeeded in replacing oil revenues with a permanent flow of
income. We can draw on a perpetual source rather than from a well that is being depleted.
It may be that the oil fund has exceeded a critical value so that the ambition of a perpetual
fund will be achieved. But history remains to be written. The story of John Collett might also
have been written with a different pen when his wealth was at its peak.
Within a few years, as much as 15-20 per cent of the welfare state could be financed by the
return on the oil fund. But if we squander the capital in the fund, we will either have to match
the shortfall with tax increases or make substantial cuts in government welfare. The gains -
not only the costs - of building up an oil fund have thus been made visible. This also attracts
its defenders.
Large fortunes nevertheless give rise to concerns. As a minimum requirement, the
management of oil wealth must not impair the productivity of labour and real capital. This
may seem to be a modest goal, but is not a trivial one.
People of my generation may remember the German Gunter Sachs, one of the heirs to the
Opel fortune. He was known for saying that he had not worked a day in his life.11 Sachs
could live off his fortune and his spending was not confined to only useful things. For
example, he lavished thousands of red roses on Brigitte Bardot, strewn over her home from a
helicopter. There is no shortage of examples of individuals who have spent large portions of
their wealth on an opulent lifestyle. But nations do not have the possibility of living off wealth
alone. A nation thrives on each other's labour, as Finance Minister Erik Brofoss stated in his
address on the state of economy to the Storting (Norwegian parliament).
The economists Jeffrey Sachs and Andrew Warner12 have shown that countries with
abundant natural resources have generally experienced weaker growth than otherwise
comparable countries. Perhaps this is not so strange. Sudden wealth in one sector of the
economy also results in higher wages and cost levels in other sectors. Such visible wealth
can also weaken and crowd out internationally exposed business. Economists refer to this
phenomenon as the "Dutch disease" after the Netherlands pursued an expansionary
economic policy based on huge revenues from gas sales in the 1960s. When gas production
declined, a period of harsh economic restructuring followed. The sheltered sector had to be
reduced and the internationally exposed sector increased. There were too few left in the
business sector to bear the welfare state.
The resource curse also increases rent-seeking at the expense of value creation, as the
economist Trygve Haavelmo noted. Many countries that have experienced a windfall of
wealth have been victims of this curse.
The state of Alaska has chosen its own institutional solution to avoid rent-seeking among
special-interest groups. Once the real value of Alaska's oil fund, the Alaska Permanent Fund,
is secured, dividends are distributed to the owners. Each resident receives an annual cheque
that can be spent as desired13, providing a strong incentive to protect the capital in the
fund.14
The choice of building up a sovereign wealth fund must also be seen in connection with the
state's substantial pension obligations under Norway's National Insurance Scheme. For the
Norwegian state it would not have made sense to choose a solution like the Alaska fund
without also addressing the issue of pension obligations.
So far our system has worked well, but the success of the system depends on broad-based
support for government spending programmes and the framework for saving oil revenues -
the cap.
If the system fails and our wealth is spent on welfare schemes to the detriment of future
labour income, our petroleum wealth may quickly become a bane. For example, if we were to
slack off - intoxicated by the vast new oil fields Avaldsnes and Aldous Major in the North Sea -
and reduce our work effort by extending our lunch break by five minutes every day, the sum
of our future labour income will be reduced by as much as the value of our latest oil
discovery.
Investments in Norway
How should oil revenues be saved?
An apt comparison is a family that wins a million kroner in the lottery. The family has to
decide how to manage the newly found wealth.
• One option is of course to give it away or share the wealth.
The family must then decide how much to spend and how much to save.
•
The money can be spent on a long holiday or purchases for the home.
•
If the family instead chooses to save the money, it will be faced with new choices.
•
- Should the money be invested in a family-owned business?
- In a neighbour's business?
- Or should it be deposited in a bank or lent through another channel?
Even before discovering oil, the state had long been a substantial direct owner of Norwegian
companies. The value of state investment in Norwegian companies is more than
NOK 600 billion.15 The state owns more shares in Norway than in the US where the oil fund
has its largest investments.16
But will substantial investment in one's own business - or one's own nation - guarantee
growth and prosperity?
Many OPEC countries received enormous income after the oil price shocks in the 1970s.
They later not only experienced low growth, but negative growth.17 Professor Ragnar Torvik
writes that one of the main reasons behind the decline was that such a large portion of the
additional income was invested domestically. Politicians invested in projects that may have
brought political gains - but resulted in economic loss.18
We can also draw on Norway's historical experience. In the post-war period, the Norwegian
economy was to be reconstructed through a large-scale investment programme.
Over several decades, the investment share of GDP19 was close to 30 per cent, markedly
higher20 than in other western economies. But the Norwegian economy still expanded at a
slower pace than nearby countries. A more efficient use of capital could have boosted
consumption without negatively affecting economic growth.
The high investment level entailed human costs in that consumption of important goods were
rationed. A visible cost was limited imports of fruit. As I recall, the selection of fruit and
vegetables at that time would have made the recommended "5 a day" serving of fruit and
vegetables far more difficult to follow than today.
In recent years, 15-20 per cent of GDP has been invested in the mainland economy, or
about the same percentage as our neighbouring countries. But we are always faced with
demands for more investment, which is perhaps not that surprising. All of us have probably
been stuck in a traffic jam and felt irritation over poor road conditions. It is easy to agree that
investment in knowledge is sensible and of benefit for the future. But funding these
investments by lifting the cap on petroleum revenue spending is a certain recipe for lean
times. Many of us have perhaps driven along lightly trafficked roads of a strikingly high
standard. Norway is already among the countries that invests most in education, without
achieving particularly impressive results.21 Norwegian companies that want to invest in
profitable projects have access to a well functioning capital market, both at home and
abroad.
An absolute precondition for ensuring the sound management of our oil wealth is that
investments in areas such as roads, education, cultural centres, hospitals and sports centres
are prioritised within the NOK 1 trillion allocated through the central government budget each
year.22
In order to maximise the return on the substantial financial wealth owned by the government
today, the oil fund must be invested abroad. But this gives rise to new trade-offs between
risk, return and ethical considerations.
Moderate risk
First, let me look at the trade-off between risk and return. How should we invest our wealth
without taking on excessive risk? When the oil fund is invested in other countries that are not
as commodity-dependent as Norway, our overall national wealth will become more robust to
oil price fluctuations.
Diversifying wealth does not of course insulate us from upturns and downturns. In autumn
2008, stock markets plummeted worldwide. There was nowhere to hide and the value of the
fund fell by close to 25 per cent. But the oil remaining under the North Sea lost even more of
its value when oil prices fell from USD 150 to USD 40 in the course of a half year.
On the other hand, oil prices may show a more favourable tendency than equity prices. The
slide in equity prices over the past quarter has not been accompanied by weaker oil prices.
Norges Bank has been delegated the responsibility for managing the Government Pension
Fund Global and hence has an independent responsibility for limiting and managing risk. We
have therefore reduced the fund's holdings of southern European government bonds in
recent months. We have also reduced counterparty exposures to European banks.
Maximising returns
As a long-term investor, Norges Bank seeks not only to minimise the risk of losing wealth,
but to maximise the return on the fund's capital within the risk limits set by the fund's owner.
But how can we manage our wealth to promote capital growth?
Many have probably wondered as does the poet Jan Erik Vold when he writes:
"You put
as the advert says
20 000 kroner into a high-interest savings account
in one of our largest banks. After six years
you can go back to the bank and take out
35 532 kroner. The question is: From whom have they taken
15 532 Norwegian kroner?"23
Vold has called this:
"Capitalism's fundamental mystique - how a krone, by lying idle for a period of time, gives
birth to a 10-øre coin".
The poem is of course a few years old - both 10-øre coins and an interest rate of 10 per cent
(the rate in the poem) belong to the past.
A krone that yields a return does not lie idle, however. It represents resources used to build
production capacity. The 10 øre is value added generated when capital is put to work.
When our oil revenues are invested as financial assets abroad, we are buying a share of
future global value added, which can subsequently be brought home and put to good use
here.
As an investor, the oil fund in principle faces two alternatives: Should the fund be an owner
by investing in equities, or provide loans to companies and governments by investing in
bonds? The return in both cases essentially depends on developments in global trade and
industry, on the world's economic future. Even our loans to governments depend on the
success or failure of businesses since governments rely on tax revenues.
When we provide loans - by buying bonds - the borrower is obliged to pay us interest at
fixed intervals and repay the principal at maturity. If the payment obligations are met by the
borrower, the amount borrowed is recovered. In the event of a bankruptcy, bondholders are
given higher priority than shareholders.
Holding shares therefore carries higher risk. Shareholders are last in line when a company's
earnings are distributed. On the other hand, if the company thrives, potential gains are
unlimited. This is why equity prices fluctuate relatively widely. We reduce the risk associated
with equity exposures by spreading our ownership. We own equities in more than 8000
companies.
To compensate for the higher risk, shareholders demand a higher expected rate of return.
Over the past 110 years, returns have been on average 4 percentage points higher for
shareholders than for bondholders every year.24
If returns on equities are higher than on bonds, perhaps as much of the fund as possible
should be invested in equities.25 Bond prices tend to fluctuate less than equity prices and
tend to rise when equity prices fall. A good mix of equities and bonds can improve the
relationship between risk and return.
The Ministry of Finance has assessed the trade-off between risk and return and decided,
with the approval of the Storting, that 60 per cent of the oil fund should be allocated to
equities. The choice of equity allocation determines to a large extent the fund's return and
risk, and is therefore one of the most important decisions concerning fund management.
Almost 40 per cent is invested in bonds, including government and corporate bonds, and a
small portion is invested in real estate.26
Government bonds in particular were long regarded as safe investments. This was also the
thinking behind Statens Reservefond (Government Reserve Fund), established in 1904 to
provide for investment in "first-class" foreign securities, primarily French, German and UK
government bonds. High inflation in the wake of World War I reduced the real value of the
fund by half, and the fund was discontinued in 1925.27 Some would argue that investment in
government bonds provides "risk-free returns". In the context of current developments in the
euro area, it might be more accurate to refer to this form of investment as "return-free risk", to
quote Yngve Slyngstad, the CEO of Norges Bank Investment Management.
A third form of investment is the oil fund's direct purchases of real estate, so far in London
and Paris. We buy large stakes - usually between 25 and 75 per cent - in large real estate
projects.28 As a long-term investor, we hope to reap returns in this market as well.
A large investor with a long-term perspective
When we buy interests in a company both ethical and economic considerations come into
play. There are companies in which we do not invest. Companies that produce weapons in
violation of fundamental humanitarian principles and companies that produce tobacco are
excluded. Corruption or contributing to severe environmental damage may also lead to
exclusion. About 50 companies are excluded.29 There is often the dilemma of whether we
should withdraw entirely from a company or enter into dialogue. If we withdraw, we lose a
channel of influence.
24
See Credit Suisse Global Investment Returns Yearbook 2011: https://infocus.credit-suisse.com/app/
_customtags/download_tracker.cfm?dom=infocus.credit-suisse.com&doc=/data/_product_documents/_shop/
300847/credit_suisse_global_investment_yearbook_2011.pdf&ts=20110326172226
25
Private investors, with shorter investment horizons, should have lower allocations to equities.
26
For more about the Government Pension Fund Global's investment strategy, see the NBIM website:
http://www.nbim.no/en/Investments/
27
Aanund Hylland (2005): "Statens reservefond 1904-25. Et forsøk på å binde politisk handlefrihet? [The
government reserve fund 1904-25. An attempt to bind the political room for manoeuvre?]", Norges Bank
Penger og Kreditt, no. 3, p. 182 (Norwegian only).
28
For more on the fund's real estate investments, see the NBIM website: http://www.nbim.no/en/Investments/
asset-mix/Real-estate/
29
The Ministry of Finance decides which companies to exclude. For more on exclusion from the Government
Pension Fund Global, see website:
http://www.regjeringen.no/en/dep/fin/Selected-topics/the-governmentpension-fund/responsible-investments/negative-screening-and-exclusion.html?id=447009
We now own shares in more than 8 000 companies worldwide. As shareholders, we are
entitled to vote when important decisions are made about companies in which we have an
ownership stake. Should we actively seek to influence developments or should we remain
passive observers? Many large funds choose the latter. It requires time and effort to consider
the issues to be addressed at company AGMs, and not least: We may be confronted with
uncomfortable questions.
The fund now owns around 1 per cent of the world's listed companies. This is both a lot and
a little. For less than 0.1 per cent of the global population to own 1 per cent of global equities
is a lot. But 1 per cent may seem too little to exert ownership influence.
Nonetheless, we have chosen to exercise our voting rights. In many companies, ownership is
spread across many shareholders, in which case even a 1 per cent interest is a large stake.
The fund also has larger holdings - up to 10 per cent - in a number of companies, which
gives us the opportunity to steer companies in what we consider to be the right direction.
Voting is governed by a few main principles.30 As a minority shareholder, equal treatment of
shareholders and board accountability are two key elements of our long-term management.
In addition, as the fund is invested in a wide range of companies with a long investment
horizon, our concerns must go beyond the purely business-related. A manufacturing
enterprise that emits pollutants and harms neighbouring enterprises may not be of concern to
the enterprise itself. But it is of concern to us because we own shares in the enterprises
affected by the pollution. Water management and climate change are two of our strategic
focus areas.
In addition to voting, we engage in dialogue with management teams in a number of
companies. We must remember that when we point a finger at a company, we are also
pointing a finger at the laws, regulations and practices of the countries where the company
legally operates. We make demands, yet we are at the same time a guest in our neighbour's
house.
Excessive activism in other countries may defeat its own purpose. Scepticism towards
foreign investors, and in particular towards large sovereign funds, is not an unfamiliar
phenomenon. We could risk being perceived as a political fund rather than a financial
investor. We have therefore chosen ethical guidelines and corporate governance principles
that are based on OECD and UN principles.31
Our experience is that the fund is perceived as a welcome financial investor - not as a
political player. Former South African central bank governor Tito Mboweni told me he
preferred investments by the oil fund to development assistance. "Assistance means you feel
32
sorry for us," he said to me, "investment means you believe in us."
Conclusion
The larger the visible wealth is, the greater becomes the risk that sound management
principles are relegated to the background. Both John Collett and Gunter Sachs had
considerable wealth, and spent it generously all their lives. At the same time, both were
interested in developing more permanent values through research. Sachs established an
institute where advanced mathematical methods were applied to study the relationship
between the position of the stars and the fates of human beings.33 Collett was more
down-toearth. He studied new methods of crop cultivation and was a keen supporter of the cultivation
of potatoes here in South-Eastern Norway.34 As a contributor to sustainable growth, we
would have to say that Collett was closer to the mark than Sachs.
Norway's proximity to valuable natural resources has created substantial opportunities. New
technology and new oil finds are still increasing the value of our oil wealth.
Two North Sea fields where oil and gas were recently discovered, Galtvort (Hogwarts) and
Gygrid (Hagrid), have been given names from the Norwegian version of Harry Potter. One of
the books features the lucky potion Felix Felicis. This magical potion is difficult to make. The
consequences can be catastrophic if the ingredients are mixed incorrectly. But if mixed
correctly, the drinker will succeed in all that he undertakes. The potion also has some highly
detrimental side-effects. If taken in excess, it may cause giddiness, recklessness and
dangerous overconfidence.35
The economic policy choices made by the authorities and Norges Bank as manager of the
Government Pension Fund Global must have legitimacy and credibility. Without long-term
thinking, the management of our wealth will not be a success story. So far, it would seem
that we have managed to mix and drink an adequate dose of Felix Felicis, but we must not
let down our guard.
Thank you for your attention.