Beyond Sovereigns—Norway’s Oil Fund Makes Our MBS Case

Norway’s proposed shift from government bonds toward agency MBS supports the case for using high-quality mortgage securities as a reserve asset.

• Norges Bank Investment Management proposed cutting government bonds in Norway’s benchmark bond index from 70% to 50%, reallocating roughly $80 billion primarily from US Treasuries to other developed-market fixed income, especially agency MBS.
• The proposal would not materially reduce US exposure: NBIM said dollar exposure would decline by only half a percentage point, while Norway’s finance minister reaffirmed that US allocations would not be reduced.
• Agency MBS issued by Fannie Mae, Freddie Mac and Ginnie Mae offer credit quality close to US government bonds because of their guarantee structure, while their yield premium compensates investors mainly for prepayment risk rather than credit risk.
• NBIM considers a 50% government-bond allocation sufficient to meet liquidity needs, including during market turbulence, leaving the rest of the portfolio to capture broader risk premia.
• Agency MBS yields remain attractive after the Federal Reserve’s run-off of its MBS holdings, while low refinancing activity and mortgages locked in below current rates constrain prepayment risk and support more predictable income.

Takeaway: Reserve managers may be able to replace part of their government-bond allocation with agency MBS to earn additional income without adding material credit-cycle exposure, provided they can manage mortgage prepayment risk and maintain sufficient liquidity.