KEY POINTS:
Like many countries around the world New Zealand has an ageing population with the number of retired people expected to double by 2050. Throw in lower bond yields, more expensive stock markets, increased longevity and there are no prizes for guessing that the cost of providing New Zealanders
with superannuation is going up fast.
The New Zealand Super Fund (NZSF) was created by the Government to partially provide for the future cost of sustaining retired New Zealanders.
NZSF commenced operations in October 2003 with an initial $2.4 billion and since then the Government has contributed about $40 million per week. As at the end of 2006 NZSF's assets had grown to $11.9 billion and management has achieved a very impressive total return of 15 per cent a year after fees since inception. This compares with an estimated 12 per cent a year before fees and tax for the typical NZ pension fund.
While the investment metrics for NZSF are somewhat larger than those in your average financial plan, the rules, rationales and processes underlying NZSF's investment decisions will be similar and therefore potentially of some interest to Mum and Dad in Mt Maunganui with more limited resources. NZSF's mandate is to invest the money in a way that maximises returns without undue risk and the investment objective is to generate a return of at least 2.5 per cent a year more than 90 day treasury bills.
Because the NZSF is publicly owned and funded it provides one of the few windows into the rarefied world of international investment consulting. The NZSF originally enlisted two of the world's biggest players in the field - Mercer Investment Consulting and Frank Russell - to determine just how the money will be invested.
So how has the NZSF managed to do so well? The answer seems to be by taking on more risk. A key part of any savings plan, be it for $50,000 or $5 billion, is the asset allocation decision - how the money is allocated primarily between bonds, property and shares and, within these areas, the extent to which it is invested locally or offshore. At the end of 2006 the NZSF had what could be termed an aggressive, growth portfolio with just 18 per cent of its assets in low risk bonds and a whopping 82 per cent chasing higher returns. For some perspective on this recall that the average pension fund in New Zealand has, for the last 20 years or so, averaged a 40 per cent weighting in bonds with 60 per cent in shares. NZSF has around half the average weighting in bonds and has instead loaded up with alternative assets such as commodities, infrastructure and timber.
Not everyone is convinced alternatives are the answer. In fact, some academics argue that publicly owned pension funds like NZ Super shouldn't have any shares in their portfolio and instead just stick to risk-free bonds. Investment consulting firm AON regularly surveys New Zealand's largest pension funds and the January report shows that balanced funds with $1.4 billion in assets in their summary had an average of 37 per cent in cash and bonds as at 31/12/2006.
Overseas the trend is very much toward cutting equity weightings in favour of bonds with so called Liability Driven Investment the new fashion. According to London's Financial Times, pension funds, concerned about gaping deficits and increasing longevity, have been shifting their exposure to bonds from equities.
Bonds allow fund managers to match assets and liabilities and are also less volatile than equities. What's more the February 2007 Financial Analyst Journal from the US contains an article entitled "The Case Against Stock In Public Pension Funds" in which the authors argue that what this generation of taxpayers gains from the higher returns from equities, the next generation pays for with higher risk - and the only people who truly benefit are the investment bankers.
So why is NZSF overweight growth and underweight bonds? Chief investment officer Paul Dyer says because NZSF has a longer investment horizon than most and with no need for liquidity it can diversify much more widely (into asset classes which can be difficult to sell and price correctly) than many other funds. Furthermore, by combining assets with low correlations with each other the NZSF hopes that its portfolio, despite having half as much in low-risk bonds, will not be a great deal more volatile than the average 40/60 fund.
The lesson here for Mum and Dad starting a savings plan is that they might consider having a relatively low weighting in bonds if they can handle the stress of a crash every now and then. However, world stockmarkets have had a very good run over the last few years and don't offer much in the way of dividends.
It is worth noting also that in the NZSF's short existence its risk assumptions haven't been put to the test and some sceptics worry that when there is a major equity market sell-off, commodities, infrastructure, private equity and timber may all go down together.
* Brent Sheather is a Whakatane-based investment adviser