If an economic crisis hits, Oslo could be forced to use the fund more aggressively.

In 2008, as the global financial system crashed, the investment portfolio of Norway’s oil fund had its worst year ever, yet the sovereign fund managed to increase in size.

Its equities and bond investments dropped 23 per cent that year. But the world’s largest sovereign wealth fund was saved by both a big inflow of money from Norway’s petroleum revenues as oil prices remained high and a large boost from the exchange rate as the krone weakened.

Many are now wondering what would happen to Norway’s $1tn oil fund if things are different in the next crisis.

The fund itself warned last week that a crash could wipe away more than 40 per cent of its value, particularly if the Norwegian krone became a safe haven currency and strengthened.  That has many experts worried that one of the few sovereign wealth funds located in a democracy could be drained rapidly in a real market crisis.

“The fund is untested in a crisis. The political system is untested in a crisis. By being poorly prepared we are running the risk of screwing the fund,” says Espen Henriksen, associate professor at the BI business school in Oslo and an ex-fund official.

The problem is that Norway’s government has become increasingly used to the doping the oil fund provides for the state budget. Under the so-called spending rule, which was revised last year, the government is allowed to use up to 3 per cent of the fund annually. This year it will use about 2.9 per cent, or NKr231bn.

That is a record amount in krone, and represents fully 18 per cent of total government spending.

The concern of some in Oslo is that, in an economic crisis that hits Norway hard, use of the oil fund may have to increase significantly to offset any fall in government income. “It is not unthinkable that you could have to use 10 per cent of the fund,” says one government official.  That would drain the fund further, while the alternative would be to cut spending just as the economy needs it most.

For Prof Henriksen, such a dilemma would test the fund and the cross-party political support it enjoys as never before.

“These are the really hard questions about the fund. This political consensus may extremely quickly evaporate in a crisis. The robustness of the savings mechanism has not been tested. To say we have a NKr5tn fund — and we’re going to cut spending on hospitals, schools?” he asks.

It is little wonder, therefore, that fund officials have stepped up their warnings about what could happen in a future market crash.

No press conference with Yngve Slyngstad, chief executive of the fund’s manager, goes by without him intoning that the exceptional market conditions of the past decade are unlikely to last.

Asked about figures that show last year the fund’s cumulative return on investments exceeded the inflows from petroleum revenues for the first time, he tells the Financial Times: “It is a pause for reflection about this enormous tailwind we had with regards to the growth of the fund during the past six years, or even since the financial crisis. The numbers are mind-boggling with regards to the size of the fund we have accumulated.”

The fund is now worth NKr8,000bn or $1tn and on average it owns 1.4 per cent of every single listed company in the world. It is worth four times the amount it was in 2008.

Oystein Olsen, Norway’s central bank governor who oversees the fund, has made regular warnings as well about the possibility for the fund’s value to fluctuate.

But he says this is not done for “tactical considerations of any kind — what we observe is the data”.

Senior government officials argue that the fund is robust and the spending rule is flexible enough for the government to ride out any market downturn.

“We can smooth our spending over the cycle. There is very strong consensus around taking care of the fund,” one says.  Still, concerns remain. One is that any fall in markets might not be followed by such a strong rebound as in 2009. If 2008 was its worst year, 2009 was its best with a return of 26 per cent on its investments.

Mr Slyngstad cautions: “You never know whether history will repeat itself or not, so you have to be prepared for a situation where we do not get a rebound in markets if we have a considerable correction.”

Another is over how the public might react. The 23 per cent fall in 2008 was greeted with much hand-wringing and the fund was forced to change strategy.

Mr Slyngstad concedes there was “a lot of discussion internally on whether we should state” that a more than 40 per cent fall was possible.  Asked if it would be his nightmare scenario, he laughs nervously. “It’s very hard to guess in advance what the political and media discussions would be in advance of events,” he adds.

Prof Henriksen argues the fund is more vulnerable to a crash in other ways now as well. Petroleum revenues from the government have slowed to a trickle at best, the budget is more dependent than ever on oil money, and the fund itself has taken on more risk by increasing its equity holdings to almost 70 per cent from 47 per cent at the start of 2008.  “In 2008, 09, 10, it [the size of the fund] never went down. It was massive inflows first, then a massive bull market. Now, it’s a really worrisome question,” he says.

Decision time in Oslo on fund’s future

Norwegian politicians face a number of big decisions about the oil fund this year and beyond. The centre-right government has tried to park some of the trickiest ones for a while yet. Most controversial of all is the recommendation from the fund itself that it be banned from owning oil and gas shares — it says not because of climate change but to help Norway’s diversification away from petroleum. The finance ministry in Oslo has set up an expert group to report on it by the autumn. The government is also hoping to postpone a decision on whether the fund should invest in infrastructure such as power stations, airports and roads abroad. What is coming next month is a decision on whether the fund should be allowed to invest in private equity with mixed signals coming from senior officials as to the answer. The government’s white paper on the fund, out after Easter, will also consider the investor’s active management performance amid suggestions from some experts that it should be little more than an index-tracking fund. Finally, the government should also publish its proposal for what to do with the organisation of the fund. An expert panel recommended setting up its own organisation by taking it out of the central bank. But another possibility is that the fund could get its own board while remaining within the central bank.

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