The return on a portfolio is essentially determined by the strategy and framework laid down for its management. The most important strategic decisions concern the distribution of investments among various asset classes, such as bonds and equities, and the distribution by country. These decisions can determine as much as 90-95 per cent of the return. The balance of the differences in return is a result of the manager's choice of equities and bonds.

There has been a broad consensus in the Norwegian Storting concerning the Government Pension Fund's investment strategy. The Fund shall be safely managed based on the objective of high return subject to moderate risk in order to contribute to safeguarding the basis of future welfare, including national pensions. This can be achieved best when the Fund acts as a financial investor. The ownership share in individual companies is small, and the Fund is invested in such a way that the return is in line with broad-based equity and bond indices in countries with well-developed corporate, stock market and securities legislation.

The Ministry of Finance is responsible for defining the strategy for the Government Pension Fund. The strategy is reflected in a benchmark portfolio that forms the basis for Norges Bank's management of the Fund. Norges Bank shall also seek to achieve the highest possible return compared with this benchmark portfolio by selecting an actual portfolio which differs from the benchmark portfolio. The Ministry of Finance has stipulated limits as to how large this difference may be. These limits for relative risk (tracking error) are relatively low compared with the absolute market risk represented by the benchmark portfolio.

Relative risk / Expected tracking error

The benchmark portfolio is used as a tool for managing risk. It sets limits for how much the expected return on actual investments may differ from the expected return on the benchmark portfolio.

The Ministry of Finance uses the risk measure expected tracking error to manage the market risk of the Fund. This measure is defined as the expected value of the standard deviation of the difference between the annual return on actual investments and the annual return on the benchmark portfolio. When deviations from the benchmark are restricted by setting an upper limit to expected tracking error, there is a high probability that the actual return will vary within a range around the return on the benchmark. The lower the limit placed on the tracking error, the narrower this range will be.

The Ministry of Finance has set the risk limit to an expected relative tracking error of 1.5 percentage points. Put simply, this means that in two out of three years the Fund will have a return that does not deviate from the return on the benchmark portfolio by more than plus/minus 1.5 percentage points, assuming that Norges Bank makes full use of this margin.