Norway oil fund looks into factor risk model

Norway is looking into adopting a new investment model for its sovereign wealth fund that would imitate a so-called factor risk approach.

The $650 billion Government Pension Fund Global, Oslo, might adopt the technique after its use of traditional indexing methods generated returns that fell short of government targets. Factor risk investing is a strategy that seeks to take advantage of specific risks and attributes such as market value, momentum, volatility or leverage when building a portfolio.

The sovereign wealth fund, which derives its income from Norway's oil wealth, is struggling to meet a 4% return target as interest rates have plunged to record lows and global stock markets failed to retrace a 2007 peak. Fund officials have added asset classes such as real estate and are expanding into emerging markets while rejiggering the bond portfolio to a gross domestic product weighting, from market weighting, to avoid nations with growing debt burdens.

“Much of the fund's risk is concentrated in equity market risk,” Paal Haugerud, head of the asset management unit at Norway's Finance Ministry, said in an interview in Oslo this month. “In the longer-term efforts of developing this strategy further, it's natural to look for other sources of risk premiums. One way to enhance returns and develop the strategy further would be to look at different risk categories.”

Norway's oil fund, which mostly buys securities by following global indexes, argues it's well-suited to take on systematic risk because it has a longer investment outlook than most funds and isn't limited by short-term obligations.

Other funds, such as Dutch pension fund manager PGGM, which oversees $160 billion for health-care and welfare workers, have already adopted a factor-based approach. PGGM dedicates 40% of its equity portfolio to factor exposures such as value, minimum variance and quality.

Norway's fund has generated a real return of 2.5% on average since 1998, and an average annual loss of 0.63% over the past five years. In the second quarter of this year, the fund saw its assets decline 2.2%.

Any major shift in the fund's asset management would need to be presented to and approved by the Norwegian parliament. A minor shift could be done in its tactical investing, or within the leeway it has currently.