Money: Kicking on with our super cash

By PHILIP MACALISTER

Right now, it's highly debatable whether Michael Cullen's multibillion-dollar New Zealand Superannuation Fund will survive its political kicking and get off the ground.

Putting aside the outcome of the shenanigans, it's worth looking at what the Government is trying to do and use it as an education tool to focus on, and understand, some important investment issues.

(The other reason it is important is that the Government has given the same directives about how to invest to the EQC fund.)

The first question the super fund poses is a fundamental budgeting issue.

Pretend you are the Government. If you had a mortgage on your home and some disposable income what would you do with the extra money each week or each fortnight?

Would you a) spend it, b) invest it in a savings plan or c) use it to pay off the mortgage?

There is no clearcut answer to this question. To many people, the most sensible option is to pay off the mortgage before you start saving, for the simple reason that the interest on your debt will be higher than the net returns on your investment portfolio.

Once that is done, you divert the money which used to go into mortgage repayments into a savings fund.

In the Government's case the answer may be slightly different. It always has worthy areas - such as health and education - on which it it can spend money. Also, it is in a slightly better position than the humble old wage and salary earner.

While you and I have to rely on the generosity of our employer for a pay rise, the Government can give itself one whenever it likes simply by increasing taxes.

The Government has picked "b) invest it in a savings plan" as the correct answer to the quiz above. Now it becomes really interesting to see how the appointed guardians of this superannuation fund are going to invest the tens of millions of dollars of our money.

Before going into those details it's worth pointing out that the success of the scheme almost wholly depends on the way it is managed.

What's not widely known in New Zealand is that our Government's scheme isn't some sort of hare-brained, never-been-done-before type of thing.

Several other countries pre-fund their state pensions, and others are in the process of doing exactly the same thing.

Ireland, a country with an economy over which our politicians salivate, is setting up the Irish Sustainability Fund, an almost mirror image of the NZ Superannuation Fund.

A review of the Irish fund done by two international actuaries and published in the UK journal The Actuary says one important factor determining the success or failure of pre-funding is having an independent board and clear investment guidelines free from Government intervention.

"The key to success, it seems, is to appoint independent commissioners with a clear and concise mandate to produce excess performance while being cognisant of the risks taken," Tom Murphy and Jennifer Richards say in their article.

Finance Minister Michael Cullen doesn't want to give guardians who will be appointed to manage the fund a set of hard and fast rules.

Rather, it's up to the guardians to come up with specific investment guidelines within a framework laid out by the bill.

The key points of that framework are that:

* The fund must be invested on a prudent, commercial basis.

* It must be managed with best-practice portfolio management.

* Guardians must maximise return without undue risk.

* Guardians must avoid prejudicing New Zealand's reputation as a responsible member of the world community.

These guidelines are laudable, but they throw up some key issues for the guardians - which are identical for many investors:

* How much of the money should be invested overseas?

* How should it be divvied up among asset classes such as shares, property and bonds?

* Should the fund embrace socially responsible investment objectives, as suggested by the Greens?

The first of these three issues is a major point of debate among the political parties. Labour acknowledges the fund will have a significant proportion of its assets overseas, while the Alliance and the Greens are keen to see money invested locally.

Perhaps the most interesting position being espoused is one from National's deputy leader and finance spokesman, Bill English. In a number of speeches, he has railed against what he calls the "export of capital," or, in simple terms, investing overseas.

The arguments for investing overseas are already well known. They include the small size of the local market, poor liquidity, lack of diversity and total absence of some investment sectors.

Pure economic theory says that a diversified portfolio should mimic the makeup of the world market.

Because New Zealand makes up about 0.1 per cent (yes, one-tenth of one per cent) of the world market, that is the weighting an individual should have in his or her investment portfolio.

The reality is quite different, as it is common for investors to have a "home bias" in their portfolios.

Over recent years, New Zealanders have embraced the trend to invest overseas, and the level of overseas assets in portfolios has grown steadily throughout the 1990s.

Consulting actuaries William M. Mercer say that over the past three years, wholesale investment managers have steadily increased their exposure to international shares by nearly 10 per cent.

It says this type of investments now makes up nearly 35 per cent of a balanced portfolio.

Investment experts suggest that the NZ Super Fund should have a far higher exposure to this asset class for several reasons.

Because the fund isn't due to make its first payments until 2025, it should be solely focused on growth assets (shares). It does not need to have income-producing investments such as property, cash and fixed interest.

This idea means the Government will have to teach people about risk and return.

Frank Russell managing director Craig Ansley says that if the entire fund was invested in international shares the risk of a capital loss in any 12-month period is between 25 and 30 per cent. That means that every three or four years the fund would go backwards.

Explaining this to the public would be a political nightmare. But it may be an excellent opportunity to teach the public about basic investment rules.

The argument against "exporting capital" is, therefore, contrary to standard investment practice.

And investing the fund totally at home would give it a high level of risk and the likelihood of lower returns than could be expected if it was invested overseas.

The other issue that has been taxing experts' collective grey matter is whether the fund should be allowed to buy Government stock.

This has been described as a "circular issue." If the fund buys bonds issued by the Government, all it is doing is transferring items from one side of the Crown balance sheet to the other.

An AMP Henderson Global Investors investment strategist, Paul Dyer, describes it as being akin to investing in your own mortgage, or the Government writing itself an IOU.

One of the differences between the New Zealand and Ireland proposals is that the Irish fund is prohibited from investing in Irish Government bonds.

The question of socially responsible investment is one of the hardest elements to decipher. What the Government is trying to say in the bill is that the guardians must invest the fund in a socially responsible or ethical way.

Socially responsible investing (SRI) is relatively new, although it is growing quickly in popularity.

An SRI fund can be run in many ways, and one of the fundamental questions is, whose morals, beliefs and values do the guardians use?

Negative screening - avoiding companies which operate in "bad" industries such as tobacco, alcohol, gambling and arms manufacture - is a common tool for managers of SRI funds.

How would the guardians translate that into the super fund when the Government benefits from the first three of these industries through taxes, and buys defence force arms from the fourth?

Mr Ansley doesn't rule out SRI principles. He says they are becoming much more common and mainstream in the investment business.

In the United States, more than $US2 trillion (or one in every eight investment dollars) is put into SRI funds.

The difficulty is working out how to incorporate them into a portfolio.

If you think you have trouble budgeting and working out how to invest your money, spare a thought for the guardians of the super fund. They face many of the same issues, but on a much grander scale.

* Philip Macalister is the editor of the online money management magazine Good Returns. His e-mail address is philip@goodreturns.co.nz.