Vast loss not a super start

By ELLEN READ

It wasn't a great start for the idea of a Government body investing New Zealanders' superannuation savings in overseas shares.

In the first 12 months since its rules were freed up to allow overseas investment, the Government Superannuation Fund lost $352 million on foreign sharemarkets.

The 75,000 past and present public servants who rely on the fund can rest easy in the knowledge that their pensions are guaranteed, but the loss was bad news for taxpayers, who will have to dip a little deeper into their pockets to help pay for those pensions.

Was it also bad news for anyone whose future national superannuation payments will depend partly on the giant New Zealand Superannuation Fund being set up by Finance Minister Michael Cullen? Could we reach retirement age and find that our super, too, has gone down the international equity drain?

No, says the conventional wisdom from many in the markets.

Despite its early losses on international equities, they say, it is far too soon to judge the performance of the Government Superannuation Fund (GSF) in investing some of its money overseas.

Investment performance is long-term ... it will take at least three years to deliver a a realistic judgment on the GSF, they say.

Fund managers who have the job of investing superannuation funds say it would be foolish to write off the GSF's foray into international sharemarkets so soon - and it would be even more foolish to react by excluding international shares from the Cullen fund.

But another school of thought questions the overseas investment strategy, saying the fund would be better off financially and ethically if it supported the local capital market.

By international standards, the local superannuation fund is unusual in that it invests a much smaller proportion in its home market than most other countries.

Whatever your view on investment, it is certainly true that the timing of the GSF's venture beyond New Zealand's shores could hardly have been worse.

For several years international shares had out-performed other investments, but the GSF was barred from enjoying a slice of that largesse by a requirement that it stick to low-risk New Zealand investments - mostly Government stock.

But by the time the Government loosened the rules, so that from November 2001 the GSF could invest in overseas sharemarkets, those markets were suffering their worst fall in years - the worst ever by some measures.

The GSF invested abroad, the falls continued, and have since been exacerbated by the rise in the kiwi dollar.

Parliament's Finance and Expenditure Committee looked at whether the GSF's entry into the international markets could have been "better timed".

The committee's report noted that the GSF "disputed this proposition, saying that while the markets have continued to fall following the investment, at the time it appeared the market was in an ideal position for entry".

"We agree the fund has had a disappointing result in the past year, but do not believe this necessarily equates to poor performance on the part of the authority."

Green Party co-leader and committee member Rod Donald disagreed: the Government was gambling on overseas sharemarkets with the life savings of public servants, he argued.

But standard measures of managed fund performance suggest the authority that now manages the fund has done a reasonable - if not exactly wonderful - job.

The returns on its various classes of investment have been much the same as the industry benchmarks (see table).

David van Schaardenburg, executive chairman of FundSource, which compiles data on the investment industry, said the figures indicated that the GSF performance in the past year was about average. But it was normal to assess fund managers over three years, not just 12 months.

The GSF's long-term performance was a genuine public interest story, he said: if the fund failed to cover its liabilities, taxpayers would have to bail it out.

Furthermore, "there's a much larger fund [Cullen's super fund] coming up with similar investment rules so you'll need to take a similar long-term view with that."

The GSF annual report shows that from October 2, 2001 to June 30 last year, the first period under the new rules, the GSF suffered a loss of 2.55 per cent return. The benchmark index - the CSFB Government Stock Gross Return Index - had a -2.71 per cent return over the same months.

Between October 2001 and the end of October last year (the latest month for which figures are available) the GSF has lost $352 on its international shares, although gains on other investments have reduced the overall loss to $145 million.

The fund is still moving towards its final asset allocation: 14 per cent of its money in New Zealand fixed interest and cash, 12.5 per cent in New Zealand shares, 52.5 per cent in international shares and 21 per cent in international fixed interest.

Investment experts generally support that mix. Tim Anderson, research head of FundSource, a company which researches investment products, says it is neither radical nor irresponsible.

He says professional investors would argue that it would be more irresponsible not to invest in international equities as part of a properly diversified portfolio.

He points out that over the past 20 years international shares have returned more than 14 per cent a year (as measured by the MSCI World Free Gross Index). By contrast, long-term New Zealand Government stock pays less than 6 per cent.

Anderson also points out that a fund like the GSF should be looking 30 or 50 years ahead; whatever happens in any single three-month, six-month or even one-year period is largely irrelevant if the long-term objective is achieved.

While on paper the fund has lost several hundred million dollars "the reality is that it is not really a loss unless you realise that loss - that is, pull out of the investment - [and] as that is not going to happen then it's more a case of gains foregone rather than losses sustained."

The GSF's gains and losses will be magnified many times over by the New Zealand Superannuation Fund.

That fund does not plan to start investing until its investment strategy has been finalised, in the second half of this year. By then it will have more than $2 billion salted away.

In the meantime, lack of action has paid off. While Treasury's Debt Management Office has been getting the fund a 5.75 per cent return, tax-free, superannuation funds with traditional diversified investments lost an average of 6.9 per cent last year.

By the time it peaks in 2030 the fund is forecast to have some $142 billion, or slightly more than half New Zealand's gross domestic product by that time.

It is going to make a big difference to all of us whether it earns a nice, safe 5.75 per cent a year as it does now, loses in the order of 6.9 per cent as most funds did last year, or picks up something more like that 14 per cent a year that international shares yielded over the past 20 years.

To help show why the Cullen Fund's investment policy matters so much, FundSource has calculated the fund's size if, as planned, it invests $2 billion a year for 40 years in various types of investment.

If all the money was left as short-term deposits, likely to earn about 5.5 per cent a year, after 40 years there would be $273 billion (pre-tax) in the fund.

If it was all put into Government bonds paying 6.5 per cent the fund would peak at $351 billion (pre-tax).

But if it was put into shares (and insured against currency movements, in the case of overseas shares) which produce an average annual return of 10 per cent - modest by historical standards - the fund would climb to $885 billion (pre-tax).