Oily rates of return
Earlier this week, the Norwegian central bank released the annual report for the sovereign wealth fund, which NBIM administers on behalf of the Ministry of Finance. According to the report, the average annual net real rate of return since 1998, i.e. over the last 20 years, has been 4.2%.
The problem with this figure is that its only straightforward component is NBIM's management fee, which on average has been 0.09% of the fund's assets under management since 1998.
Contrary to what is customary, the sovereign wealth fund's nominal rate of return is not calculated in a base currency. It is instead calculated in a currency basket. The basket, which consists of 34 currencies, is not determined by where the Fund is invested; it is fixed by the reference portfolio's currency composition. Calculated with this basket, the average net nominal rate of return, according to NBIM's annual report, was 6% from 1998 to 2017.
Extracting the real rate of return from the nominal rate of return is somewhat complicated. The real net rate of return is the nominal net rate of return minus the average weighted CPI inflation rate in the countries that are included in the reference portfolio. This leads to the abovementioned 4.2% since NBIM's inception.
As I see it, this way of calculating the funds rate of return is misleading.
The government owns the fund, and the purpose of the fund is to finance future government expenditure – payments that due to demographics and welfare programs are expected to be higher than future tax revenues.
The government budgets revenues and expenditure in NOK. The king's men deal with foreigners, but their main focus is purchase from, and transfers to, Norwegians. And when they commercially interact with foreigners, they first calculate in NOK, and subsequently, depending upon the terms of the deal, either pay in NOK or purchase foreign exchange in order to settle their deals.
Irrespective of how NBIM's managers internally find it most relevant to measure their performance, the owner's natural base currency is therefore, as I see it, NOK.
Anchored in purchasing power
In addition, the calculation of the real rate of return must be anchored in the owner's purchasing behaviour. For the relevant question is how much real purchasing power the fund's nominal return gives the government.
The government spends money differently from typical Norwegian households. Hence, what is relevant when the government calculates its purchasing power is the price index for government purchases, not the consumer price index. Calculating the net real rate of return in such a perspective, i.e. using NOK as base value and the price index for government expenditures as deflator, I get an average annual net real rate of return of 3.4%, based on data from NBIM's annual reports and the Ministry's National Budgets.
Please note that I do not claim that NBIM dupes us. Norges Bank is commendably transparent about its fund management operations.
My point is that the citizens of Norway, whether they live off or pay for the government's expenditure, should understand as fully as possible the ramifications of the sovereign's savings abroad. As such, the arithmetic behind the 4.2% number leaves something to be desired.
Statements reflect the writer's viewpoint at a given time, and this viewpoint may be changed without notice. This article should not be perceived as an offer or recommendation to buy or sell financial instruments. SKAGEN AS does not assume responsibility for direct or indirect loss or expenses incurred through use or understanding of this article.