-2.16 Petroleum Fund Annual Report 2014 Eng ver 1

For example, Japanese equities measured by MSCI Japan valued in Yen performed strongly in 2014, posting a return of 9.8. However, Japanese equities fell 3.7 over the year when converted into USD. That is the depreciation in the Yen against the USD more than offset the increase in equities in local currency terms and resulted in on overall loss for the year. How has foreign exchange impacted o the Fu d’s portfolio? Non- U“D e posure i pa ts the PF’s alue a d retur s as the are reported i U“D. The i pa t o the Fu d’s reported alue a e positi e or egati e. The Petroleum Fund incurred a foreign exchange loss of US 425.5 million for the year 2014. The appreciation in the USD in 2014 is attributed to the stronger economic growth in the US and diverging monetary policy expectation across the world. Our large US Treasury holding in prior years limited the foreign exchange gains when the US Dollar depreciated. Overall, foreign exchange losses on equities and bonds have totalled US 444 million. Table 1 – The Petroleu Fu d’s Foreig E cha ge Gai sLosses si ce 2009 Year 2014 2013 2012 2011 2010 2009 FX gainslosses in USD 425.54 19.35 0.72 0.05 0.02 0.16 Why have non-US dollar exposures? The Petroleum Fund recorded significant losses on foreign exchange as the USD appreciated in 2014. We continue to hold non- U“ urre ies as it is elie ed to e i the Fu d’s lo g-term interests. Over the long- ru there are e pe ted to e e efits i ter s of urre di ersifi atio a d hedgi g the go er e t’s non-USD spending. Di ersifi atio is a ke pri iple u derl i g the Petroleu Fu d’s i est e t strateg . We e efit fro diversifying across two key asset classes: equities and bonds. In equities, we diversify across companies, sectors and countries. Diversification within the bond portfolio increased following the introduction of non- US sovereign bonds in 2013. We ould hoose to hedge or re o e the foreig e ha ge exposure by taking offsetting derivative positions in the foreign currency. The Government, on advice of the Investment Advisory Board, decided to maintain the foreign exchange exposure in both the equity and bond portfolios. The objective was to redu e the Fu d’s o e tratio i the U“ Dollar. B spreadi g the e posure a ross urre ies, the Fu d’s international purchasing power is protected against the possible scenario where the USD is systematically weaker over a prolonged period. In addition, a broader holding of currencies better reflects the o positio of the Go er e t’s spe di g. I ir u sta es su h as a d he the U“ Dollar has been stronger, expenditure denominated in other currencies will be lower in US dollar terms. In other ords, our fi a ial assets pro ide a i pli it hedge of the go er e t’s o -US dollar expenditure. Di ersifi atio i this ase a tuall i reases the olatilit i the Fu d’s reported retur s. While this a seem counterintu iti e, it is si pl e ause the Fu d’s retur s are reported i U“D a d ill flu tuate ith the e ha ge rate. Cha gi g the Fu d’s u eraire to a asket of urre ies – as employed by some other Sovereign Wealth Funds – was considered but our appropriate currency mix was uncertain, and interpreting a multi-currency numeraire presented challenges. Instead, our approach requires looking through the short-term volatility in returns associated with currency movements. Including exposure to currencies other than the USD is believed to be in the long-term interests of the Fund. This is a long-term strategy that will be subject to short-term volatility as we report in USD.