Oslo — Norway’s sovereign wealth fund proposed sweeping changes to its $333bn bond portfolio, including dropping the Japanese yen, emerging market and corporate bonds, as it beefs up on liquidity amid an expansion of its stock holdings.
The $980bn fund recommended paring its bond index from 23 currencies to only include securities denominated in dollars, euros and pounds, according to a letter sent to the Norwegian Finance Ministry. Emerging market and corporate debt should be removed but "systematic strategies" should be put in place to invest in these, it said.
"In the long term, the gains from broad international diversification are considerable for equities but moderate for bonds," the fund said. "For an investor with 70% of his investments in an internationally diversified equity portfolio, there is little reduction in risk to be obtained by also diversifying his bond investments across a large number of currencies."
The proposal will need to be approved by the government, but could have a large impact. It held 169-billion krone ($21bn) in Japanese government bonds at the end of the second quarter, 63-billion krone in Mexican government bonds and 53-billion krone in South Korean government bonds. About 12.3% of its 2.6-trillion krone bond portfolio was held in emerging market currencies at the end of the quarter.
"The Japanese bond market is large but far less liquid than those for the other currencies that currently have a substantial weight in the index," the fund said. "An index consisting of bonds issued in dollars, euros and pounds alone will be sufficiently liquid and investable for the fund."
The currencies in the index should be assigned weights based on GDP, the same as now. The index consisting of dollars, euros and pounds will result in the following weights based on the current calculation method: 54% in dollars, 38% in euros and 8% in pounds, it said.
Keeping, and even proposing to boost, the pound as one of its currencies is another vote of confidence in the UK post-Brexit. The fund rushed in to buy UK real estate right after the referendum last year in which UK voters decided to leave the European Union. It owns large swaths of central London in a partnership with the UK’s Crown Estate.
Since its inception as a pure bond fund in mid-1990s, the fund has steadily added risk. Earlier this year, the government approved a plan to boost the stock holdings to 70% from 60% to generate higher returns. It has been struggling to meet an expected real returns amid record-low interest rates.
The fund also faces increased liquidity needs after the government last year started its first-ever withdrawals from the fund to cover budget needs amid a slump in oil prices. Norway is western Europe’s biggest oil producer and had as of last year stashed most of its offshore revenue into the fund.
The letter on Monday also recommended that an upper maturity level of 10 years be set on its bond holdings. This would improve liquidity and reduce "uncertainty about the fund’s volatility", according to the letter.