(March 26, 2010) – The Norwegian Ministry of Finance recently said that while parts of the $450 billion Government Pension Fund will still be managed actively, the government was proposing to reduce the risk in its active management, Reuters reported.

The proposal is part of a report presented by the ministry to Stortinget, the country’s parliament, on new regulations for risk and active management. The ministry said it conducts a review of the fund’s active investment management once every four years.

In the report presented to parliament, the government proposed reducing the maximum expected tracking error to 1.0% from 1.5%. Additionally, the proposals aim to enhance alternative measures to reduce risk, such as limits to leverage. The Finance Ministry also recommended the tracking error limit become more flexible, so that during times of financial hardship, the fund wouldn’t be pressured to sell securities, Pensions & Investments reported.

The proposals are based on an evaluation process derived from expert advice from academic and professional parts of the international finance community, and advice from Norges Bank, the Central Bank.

“In our opinion there still ought to be some leeway for the fund to deviate from its benchmark portfolio,” Finance Minister Sigbjoern Johnsen said in a statement, according to Reuters. “The costs involved in closely replicating the benchmark portfolio are unnecessarily high. Moreover, the fund’s characteristics create a potential for excess returns that should be exploited to some extent.”

Norway’s SWF, which invests oil and gas money in foreign shares and bonds, is Europe’s biggest equity investor and achieved its best return ever in 2009, generating more than $100 billion in gains to wipe out it’s worst return on record from the previous year.

In related news, the Government Pension Fund has expanded its ethical investment rules, putting heightened emphasis on active ownership of the fund’s investments. In January, the fund blocked 17 tobacco companies, aiming to make its SWF an archetype for socially responsible investing. The new guidelines allow for slightly broader assessment of a company’s situation before excluding that company on the basis of unethical behavior.

Norway’s Government Pension Fund, which holds 1% of the world’s equities, is the world’s second-largest sovereign wealth fund following that of the United Arab Emirates.