Friday, April 13, 2007


Financial Times reports that Norway's $300 bn government pension fund is to increase dramatically by exposing to global equities from 40 percent to 60 percent. Focusing on Norwegian specific oil revenue which compose nearly one fifth of the GDP, large size of oil fund revenues enables the country in Scandinavia to expand public investment and provide social security and welfare subsidies. The topic launched in the article should send a gut of lessons and warning signals to policymakers in countries facing a damaging demographic scenario (Slovenia) in terms of how to manage and implement pension reforms upon the approach risk management measures. The question is: what can Slovenia learn from the Norwegian fund management strategy?

According to several internationally issued reports, Slovenia is the most demographically sensitive and agingly unsustainable area in the EU. The birth rate is actually the lowest in the wider region while the number of early retired grows very fast. This means a flamed pressure on public finance which is the main source of pension liabilities settlement. It is estimated that by 2020, the negative demographic passage combined with a growing number of newcoming pensioners is about to start causing negative side-effects such as lower growth, and higher tax burden on employees and employers hampered by the overwhelming percentage of gross salary contributed to health care and public pension schemes. The costs of health for those whose age is above 65, are four times higher than the average cost of healing. As the health care sector is constantly getting technologically more and more sophisticated, the average life expectancy is increasing as well. The net effect is a rising tax burden levied upon employees and employers who actually finance public health care system and pension schemes via certain share of gross salary (in Slovenia: 22 percent of employee's gross salary goes directly into public health care scheme).

Regarding pensions, Slovenia faced a unique situation since it gained independence. In socialism, the goal of economic policy was to pursue full employment. As a matter of fact, when Slovenia geared up onto the road towards market economy, it was realized that a large share of employees employed in "social companies" (state enterprises) was made technologically redundant. The response of economic policy was to allow those employees to apply for pension and social security schemes and at the age of 40 and 50, a number of pensioners sparked briskly. The measures undertaken by the economic policy were levied on a permanent basis.

Going back to the original topic of this post, what Slovenia and its policymakers learn from Norway?

In Slovenia, KAD and Sod are the major capital asset funds.

The question is how will Slovenia fulfill pension liabilitiesand consequently implement pension reform.

Previously, Mićo Mrkaić wrote an excellent column describing how government asset funds (KAD, Sod) should be managed in order to settle a growing volume of pension liabilities. Unofficial estimatations show that the volume of generated pension liabilities is getting closer to 200 percent of the GDP.

To settle all the existing and future pension liabilities, Slovenia should invest government asset funds into securities negatively correlated with GDP growth because real GDP is the second source of settling pension liabilities. The abovementioned strategy is also a sort of insurance against macroeconomic shocks that could affect Slovenia. In general terms, Slovenian asset funds are ought to be invested in oil and energy because this startegy perceives a negative productivity shock lowering the GDP growth. If there is a sharp drop in oil prices, oil-exporting economies rapidly invested in oil and energy funds as their net value would brisk.

Norwegians used a similar strategy of investing into securites negatively correlated with the GDP growth. Due to enviable return opportunitiy, Norwegian fund managers decided to diversify the oil fund into global portfolios throughout the world. Such an approach implies a beneficial risk management position while it causes cost-push effects due to special measures and specifics underlayed in managing such an extensive fund. As every portofilo investor should behave, Norwegian fund managers and policymakers did not exercise a strategy of domestic investment.

Finally, recent investment strategies undertaken by Norwegian oil fund focused on investment into securities of small high-growth overseas companies listed on niche markets. Under the new guidelines, about NKr 1,070bn ($178bn) of the NKr1,800bn fund will be invested in equities worldwide, compared with around NKr 720bn under the old guidelines. Is such an investment strategy too risky? It depends on the enhanced relationship between perceived risk and expected return plus the experience of fund managers from the past especially on how to handle the volatility.

In Norway, government pension fund is entirely invested abroad. In 2006, it generated a 7,9 percent return in local currency terms in comparision with the average nominal 6,5 percent return from 1997 onward. The much smaller remaining portion of the fund, the Pension Fund - Norway, which invests in the country, reported a 11.7 per cent return. Together, the entire fund was worth NKr1,891bn at the end 2006. It is forecast to grow to NKr3,043bn by 2010.

Overall, risk management quality and portfolio investment strategies of the Norwegian pension fund is what policymakers in Slovenia can learn about according to the fact that Slovenia is far the most demographically threatened area in the EU and a country that will be severely shocked by the effect of aging population if necessary pension reform is still postponed (status quo) into the future time when the size of generated pension liabilities will quake the stability and sustainability of the public finance in the years to come.

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