A blow to US bonds? Recommendation for the Norwegian sovereign wealth fund to cut holdings

Managers of the Norwegian sovereign wealth fund, which manages assets worth $2.3 trillion, are proposing a comprehensive change in government bond holdings, under which they would reduce US government bond holdings by $80 billion, according to a report in the Financial Times. The move is intended to allow the fund to examine different types of bonds with the goal of increasing returns.

NBIM, which manages the fund — the largest of its kind in the world — has submitted a recommendation to the Norwegian Ministry of Finance to reduce the weight of government bonds in the fund's benchmark bond index from 70% to 50%. The proposal would reduce the value of government bonds in the portfolio to around $106 billion, according to calculations made by the Financial Times.

The proposal comes in light of growing concerns surrounding the rise in government debt levels around the world and the rise in yields recorded this week, against the backdrop of the war with Iran and fears of an outbreak of inflation. A lower allocation of government bonds will be offset by the purchase of higher-risk securities, primarily mortgage-backed bonds. These securities are mostly backed by government agencies, and therefore Norway's exposure to the risk of default by the US government is reduced only moderately. However, they offer slightly higher yields than US bonds, due to the risk that borrowers will repay mortgages earlier than expected.

"Government bonds at a rate of 50% will be enough to cover liquidity needs, including during periods of turmoil in capital markets, while the remaining part of the bond index should provide exposure to additional sources of risk premiums," reads the letter signed by Ida Wolden Bache, Governor of the Central Bank of Norway, and Nicolai Tangen, CEO of NBIM.

According to the letter, the proposal is to reduce the fund's exposure to US government bonds by 12.2 percentage points, while simultaneously increasing holdings in non-government US bonds by 11.4 percentage points. A spokesperson for the fund stated that these are "advice" only, representing the recommendations that will be passed to the Ministry of Finance in January. The final recommendations will be passed by the Ministry of Finance to parliament around April. "The reason behind the change is to achieve diversification in sources of returns," he said.