Norges Bank Recognises Time-Variation in Expected Returns

Our intrepid CEO, Tony Morgan, noticed an article on CNBC ( that reported on the post-GFC inquiry into the activities of the USD 700B Norwegian Sovereign Wealth Fund, Norges Bank. Many had expected that the inquiry was going to berate Norges Bank for not cutting risk during the Global Financial Crisis. On the contrary, to the astonishment of many, the inquiry criticised Norges Bank for not allocating toward risk assets as their prices were falling.

The argument the committee accepted was that the risk premia offered by risky assets rose considerably during the GFC. Consequently, investors such as Norges Bank were offered cheap assets with high expected returns and they should have taken advantage of this opportunity. While some may argue this is obvious, the findings represent a watershed shift in official thinking.

Traditionally, expected asset returns have been viewed as static values that do not change through time. Asset consultants and practitioners operating on this assumption then proceed to recommend a static strategic benchmark allocation that must be followed irrespective of market conditions. This traditional approach is challenged once expected returns are accepted as time-varying. In fact, this opens the door to active asset allocators such as Global Macro investors.

Our investment process at First Degree is predicated on time-variation in expected risk premia and it is heartening to read that this concept is catching on with major institutional investors. The trick is to identify temporary changes in valuations that signal asset allocation shifts. Our guess is that this will be a growth industry within asset management over the coming years.

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