1999 was another good year for the management of the Government Petroleum Fund. Measured in international currency, the return was 12.4 per cent. In 1999, as in the previous two years, the return on the portfolio outperformed the benchmark portfolio defined by the Ministry of Finance as a basis for measuring the Bank's management.
Throughout the year the return fluctuated considerably, as it did in 1998. There was a negative return during the third quarter, whereas the return in the fourth quarter was as much as 8.0 per cent. The return on the Fund is also likely to show wide fluctuations in the period ahead. It is possible that in some years the overall return will be negative.
The management strategy for the Petroleum Fund, which is set out by the Ministry of Finance, is based on a long-term investment horizon. The return in one year does not provide any reliable indication of the soundness of the strategy. For this reason, more emphasis should be placed on the average return over several years than on the return for one year.
Measured in international currency, the average annual return over the past three years was 10.2 per cent. In the same period, the annual inflation rate in the countries where the Petroleum Fund is invested was on average 1.3 per cent. This means that the international purchasing power of the Petroleum Fund's investments has increased at an annual rate of 8.8 per cent in the three-year period.
From a long-term perspective, such a high real return is far greater than what is considered normal. One should be prepared for an appreciably lower average annual real return in the period leading up to the need to draw on the Petroleum Fund.
Since the time the Petroleum Fund began investing in equities (January 1998) the total return on equities has been 52.0 per cent. The return on the fixed income portfolio has only been 8.8 per cent in the same period. The return on the Petroleum Fund in 1999 was marked by sharp advances in equity markets, whereas an increase in interest rates internationally has resulted in a negative return on the fixed income portfolio.
As early as in January 1998, many observers considered the prices for equities in some markets to be artificially high. Given the growth over the two following years, it would seem that there is even more evidence supporting these views. The strategy set out by the Ministry of Finance is based on the need for applying a long-term investment horizon. History has shown that it is better for long-term investors to hold positions in the markets at all times.
In the operational management of the Government Petroleum Fund, Norges Bank is to implement the strategy set out by the Ministry of Finance in a manner which is secure and efficient, and which inspires confidence. Historical experience shows that the strategy determines 90-95 per cent of the return for this type of fund. Norges Bank's objective is to achieve the highest possible net excess return relative to the benchmark portfolio within the limits which apply.
The excess return in 1999 was 1.1 per cent. The outperformance is largely attributable to the good results achieved by external active equity managers. The return is markedly better than expected. Large fluctuations in the portfolio's outperformance are also to be expected from year to year.
The management organisation, Norges Bank Investment Management, was further expanded in 1999. Considerable emphasis has been placed on developing satisfactory control routines and a good supervisory environment.
Norges Bank attaches great importance to providing information on the ongoing management of the Petroleum Fund. We hope that this annual report will provide readers with a proper background for evaluating the work being carried out.
Svein Gjedrem
Central Bank Governor
Knut N. Kjær
Executive Director, Norges Bank
Investment Management Wing