Investment outlook
With a large, global fund and a 70 percent allocation to equities, we have to be prepared for considerable fluctuations in the fund’s return and market value.
20 February 2025
Risk management and volatility
The risk in the fund is largely driven by how much of it is invested in equities and how much equity prices fluctuate. Movements in interest rates, credit risk premiums and exchange rates will also affect risk, as will changes in the value of investments in real estate and renewable energy infrastructure. As an investor, we need to have good systems for analysing and managing this risk.
Measuring the fund’s risk exposure is a challenge. To obtain full picture, we use a variety of risk analyses and calculations. We monitor the fund’s concentration risk, expected fluctuations in markets and fund value, factor exposure and liquidity risk. We also perform stress tests and hypothetical scenario analyses on the portfolio. Some investment strategies can expose the fund to an increased risk of rare but large and unpredictable losses, and we closely monitor exposure to strategies of this type.
Expected absolute volatility is a measure of how much the annual return on the fund’s investments can normally be expected to fluctuate. This is calculated using standard deviation based on a three-year price history. The fund’s expected absolute volatility was 11.2 percent at the end of 2024, or about 2,200 billion kroner, meaning that the value of the fund can be expected to fluctuate by more than that amount in one out of every three years.
Expected absolute volatility for the fund. Percent (left-hand axis) and billions of kroner (right-hand axis).
Expected return on the fund
The expected real return on the fund is an important consideration. Expected returns are not directly observable and hence need to be estimated. We outline our framework for estimating expected returns on the key asset classes the fund invests in in a discussion note published in 2022.
At the end of 2024, our models indicate that the expected real return on the fund is around 3 percent. The estimate is marginally higher than last year, but considerably higher than the low point of around 2 percent reached at the end of 2020. The increase in the expected return on the fund has been driven by a large increase in real interest rates over the past few years. The increase reflects monetary policy tightening around the world in response to the post-pandemic rise in inflation. It marked the end of a near-decade of negative real interest rates.
Expected real returns on the fund's benchmark and key asset classes, in percent.
An increase in real interest rates without a corresponding increase in expected equity returns points to a decline in the equity risk premium, which is the compensation investors demand for taking on stock market risk. Developments in real interest rates and risk premiums are both important for the expected return on the fund. It should be noted that estimates of expected returns are uncertain and can vary considerably depending on the methodology.
Scenario analysis
Macroeconomic developments, financial conditions such as real interest rates and risk premiums, and geopolitical risk are all important drivers of the fund’s expected return. To analyse the risk associated with events that may occur, we use forward-looking scenario analyses. Such analyses look at the expected return on the fund in various scenarios and provide us with insight into what may lead to serious losses for the fund.
Each year, we publish the results of analyses of a number of hypothetical scenarios. These scenarios may change from year to year to reflect market developments and events that impact economic performance. This year, we look at whether a combination of high equity valuations, high debt levels and increased geopolitical tensions could result in substantial reductions in the fund’s value over time.
This year’s scenarios build on last year’s analyses, where we considered how repricing of risk, a debt crisis and a fragmented world might impact negatively on the fund’s value. The AI correction scenario can be seen as a continuation of last year’s risk-repricing scenario and places particular emphasis on the concentration of AI stocks in the market. This year’s debt-crisis scenario is more wide-ranging than last year’s and looks at a broad loss of confidence among investors, while the fragmented-world scenario has been expanded from focusing on two economic blocks with geopolitical tensions to cover multiple regions.
AI correction
A significant correction in the technology sector is triggered by investments in AI failing to generate the expected earnings and value creation. This might be due to stricter regulation, technological challenges or a lack of necessary resources. This correction has a particular impact on the US technology sector but also spreads to other sectors and regions.
Debt crisis
High global debt levels combined with an ageing population, climate change and international conflicts trigger a bond crisis. Decreased confidence in the markets leads to a substantial increase in yields and risk premiums, which in turn have adverse effects on both equity and bond markets.
Fragmented world
The world fragments into multiple economic blocks with reduced level of co-operation. This leads to increase trade barriers, stricter regulation and reduced foreign investment. Developing countries are hit particularly hard. Decreased economic co-operation leads to lower global growth, higher inflation and increased market volatility.
We analysed how these scenarios might affect the fund’s value and calculated potential losses over a period of up to five years. The equity market is vulnerable in all these scenarios. The sharp rise in real interest rates over the past two years means that the risk of losses on fixed-income investments has fallen.
Estimated market value of the fund under each scenario and potential losses in percent.
