Mitigating Financial Risks Related to Fund Withdrawal: A Data Science Study of Norway's Withdrawals From Its Sovereign Wealth Fund, Government Pension Fund Global

Abstract

Norway has accumulated a large fund stemming from activities related to hydrocarbon extraction in the North Sea. A primary purpose of this fund was initially to mitigate economic issues related to oil-based economies. Currently, the Norwegian Government is restricted to use 3% of the total value of the fund in any given year, with the purpose of limiting the withdrawals to the real returns of the fund. Contrary to the purpose, the current budgetary rule poses a significant risk of the withdrawals exceeding the real returns, causing depletion of the fund over time. The fund has grown to such a size, that the small 3% withdrawal, is now a large, and growing share of Norway’s public financial income, currently shy of 20%. Due to the fund’s size and investments in the global equity market, it is exposed to downturns in the markets creating financial risk for the national budget income. This thesis projects the current budgetary rule on 20-year simulations of the US equity market, USD-NOK foreign exchange market, and Norwegian inflation, and finds evidence that there is a non-trivial risk for large drawdowns. This has an unfortunate effect, where the national budget will be subject to sudden budgetary revenue shocks. This thesis explores alternatives for the current withdrawal strategy, with the aim of finding a withdrawal method that can better fit the budgetary needs of the Norwegian state while still giving a high and sustainable portfolio. Similar to other research projecting withdrawal methods to market data, this thesis finds that a hybrid withdrawal approach, regulating withdrawals based of both the portfolio value and inflation can reduce the risk for depletion and increase the stability of the allowed withdrawals from the fund. However, the implications of imposing a more complex and stricter rule regulating the allowed withdrawals amounts can have unpredictable political consequences.