Our superannuation fund is world-leading but must continue to beat the odds if today’s young workers are to enjoy a meaningful state pension.
Forget about yacht racers or the All Blacks. New Zealand has another class of world beater: investment advisers. Their work propelled New Zealand’s state pension funder to the top of the world rankings.
The winning team is the NZ Super Fund, aka the Cullen Fund, which exists to help pay the future pension costs of retired New Zealanders. In the 10 years until 2022, the Super Fund (NZSF) earned better money than 49 other sovereign wealth or public provident funds tracked by think tank Global SWF. The Canadian Pension Plan was second and Sweden’s AP-fonden was third. A sovereign wealth fund is a state-owned investment fund using government money for long-term goals, often drawing on state reserves.
In 2023, the NZSF grew further, to hover around $72 billion in value, with a rate of return, pre-tax and after costs, of 9.9% since inception. It’s now about $74b.
“We performed very well by any measure,” says its head of asset allocation, Charles Hyde, who adds a 10% growth rate is emerging in the current financial year in the section of his portfolio that is continuously tracked.
The Super Fund was New Zealand’s third attempt in a half-century to navigate an obvious pothole in the economic road ahead, one large enough to swallow a truck. This was the extreme difficulty of paying state pensions to an army of ageing baby boomers when their healthcare costs will have already strained budgets to the limit.
The first solution was a universal, contributory pension scheme introduced by the third Labour government, which was killed off politically by Sir Robert Muldoon.
The second was a compulsory scheme proposed by Winston Peters, which was voted down in a referendum in 1997.
The third attempt was the NZSF, which won through in 2001 after relentless pressure from the late Sir Michael Cullen, who was finance minister in Helen Clark’s government.
Bucking trends
Cullen’s baby started with a rationed supply of ammunition (see “Wings clipped”, below), but it hurled itself into the fray regardless. From the start, it invested overwhelmingly overseas, shrugging off complaints from the New Zealand Stock Exchange about getting a mere 7%.
It also rebuffed the Key government’s demand for more local investment during the Global Financial Crisis (GFC), and insisted on investing 80-20 in growth stocks, against a then average of 60-40.
“Over the long term, there is a 98% chance that growth assets will outperform conservative assets,” says the NZSF founding chairman, David May.
He also hedged foreign transactions against the New Zealand dollar, to make sure investment profits could not be cancelled out by exchange rate losses.
Another investment strategy involved buying assets when they are at their most battered and bruised. This is known as strategic tilting. “If we saw a long-term opportunity, or we thought a particular class of asset was undervalued, we would bet against that,” May says.
“Strategic tilting has made a lot of money for the Super Fund over the past 20 years. Overall, it beat the [investment] index by about one and a half percentage points, which is remarkable in a zero-sum game.
“When we first did this, I thought that if we beat the index by 50 basis points over 20 years we would be doing really well.”
May adds the NZSF had far more money than other New Zealand investment funds, which reduced competition for acquiring so-called chunky assets such as the Shell service station chain (a $212.5 million investment in 2010 in a joint venture with Infratil). In addition, the fund was seen as benign overseas, and was able to get advice from global authorities such as America’s Charles Ellis and the British expert on market bubbles, Jeremy Grantham. Above all, the fund kept its nerve.
“We were hit really hard by the GFC; we were one of the worst performing funds in the world at that time,” May says. “But we leaned into it: we actually bought more after the market went down. Most funds were running for cover, but we actually kept our nerve, and there was never any debate on that; it wasn’t an agonising decision.”
Another policy was to buy illiquid assets. These are hard to sell in a hurry, such as rural land, but they can be rewarding to a long-term investor.
Hitching a ride
At around $74b now, and forecast to reach $110b by 2030, the NZSF is clearly a success story. Yet this outcome is not all its own doing. For example, the number of middle-class consumers in China and India has soared in the past 20 years, which must have helped the share price of companies trading or investing there, and enabled international investors to hitch a ride on their success.
In addition, then-US president Donald Trump’s tax cuts of 2018 produced a wealth transfer from the federal government to private pockets, and some of this money would have been invested. This and other trends in the US economy pushed the Dow Jones Industrial Average to stratospheric levels and enabled the NZSF to surf its way to prosperity on a wave it did not create.
But Hyde does not think this is a reasonable objection, saying it is hardly realistic to expect a fund from a small country like New Zealand to start its own wave.
“And you know, we have outperformed many if not all of our global competitors over the past decade, and so I guess you would want to ask why everybody else has not been able to surf that wave as effectively as we have.”
The key was following the same patterns of the past – opting for growth stocks and hanging tough through short-term losses.
The most recent annual report shows how the fund has grown. The top line shows its returns and the bottom line shows the cost of money borrowed by the state.
In some respects, the hard work of the NZSF represents a brave fight by good soldiers against an overwhelming enemy. That is because the sheer number of people approaching 65 is swelling markedly year by year.
According to Stats NZ, there were 876,300 pensioners in 2023 – 16.8% of a population of 5.2 million. By 2033, there are forecast to be 1.2 million pensioners, making up 20.7% of the population. By 2043, pensioners will be 22.7% of the population, rising over the following three decades to 28.2%. Paying the pension to all these people will cost a lot of money. And a proportionately smaller share of the workforce will be expected to prop up the pensions of a population living far longer post-retirement than even today’s ageing boomers.
For most retirees, the pension will remain their basic income source with KiwiSaver contributions the icing on top. Lower income workers, women, Māori and Pasifika in particular will depend heavily on the state.
The government allocated $19.65b for superannuation payments in 2023-24, dwarfing the next biggest item in the welfare budget, the Jobseeker benefit. The cost of funding, according to Treasury, is expected to double by 2039.
Stuck on 65
According to some critics, the NZSF is not a victim of its own success, but the country is. In their view, the fund’s success makes it seem bigger than it is, giving us a false sense of security. It provides a fig leaf for politicians who don’t do forward planning – a fig leaf so threadbare that the bits can still be seen. That’s because the fund – effective though it is – will still meet only 18% of the cost of pensions at their peak, according to the latest NZSF annual report. That will leave 82% charged to the taxpayer.
A former Labour leader, David Cunliffe, was strongly aware of this, and campaigned in the 2014 election to make NZ Super more sustainable. He wanted a second tier of state prefunding, using sovereign borrowings, which are cheap, to create either a second investment fund or to augment the first. In addition, the age of eligibility of superannuation would be gradually raised, with carve-outs for demographic groups with a shorter life expectancy.
Unless the fund was financially sustainable, not all New Zealanders would be able to count on NZ Super as being fully available when they retired, Cunliffe argued. But his view on the age of eligibility was not shared by his Labour successors, nor by the Green Party or Te Pāti Māori. It was supported by National and Act, but both parties gave it away last year as the price of a coalition deal with New Zealand First.
Keeping up appearances
During the years, the fund has faced several constrictions. One of them is the requirement to pay tax to the same government that partly funds it and wants to benefit from its returns. This was condemned by recently departed chief executive Matt Whineray as little better than taking money out of one pocket and putting it in another. He estimated total tax payments from the fund were $10b – and that cost will be far greater if foregone investment returns are taken into account.
Another problem was the Key government’s decision to halt contributions when it plunged into deficit after the GFC. It said at the time it refused to borrow money to buy shares, but in retrospect, this decision cost the fund a net $17.9b.
The government is once again in deficit, but Finance Minister Nicola Willis has pledged not to repeat the policy of her predecessors and says she will maintain contributions.
However, Willis has got it wrong, according to Eric Crampton, economist with pro-market think tank the New Zealand Initiative. He thinks the original scheme was a convenient way of locking in the financial surpluses of Cullen’s era without committing cash to unsustainable schemes thought up by politicians who were philosophically opposed to tax cuts. He says that argument no longer applies with the government in deficit. “Rather than building up the NZSF asset, the government could have chosen to drive down debt more quickly. Either would have helped manage future costs.
“Debt levels are now much higher. Governments have continued to make contributions to the fund while in cyclical deficit and while in structural deficit. It amounts to a leveraged play on equity markets.”
Ethics or profits?
A hallmark of the NZSF is its independence from government ministers. That principle has been sustained, according to former and current managers. But dealing with activist NGOs over alleged unethical investments is another challenge. The NZSF has long spurned obvious villains like tobacco or nuclear bombs. More recently, it has also vowed to exclude companies with unacceptable environmental, social or governance (ESG) standards. And it has embraced the campaign against climate change, pledging to cut the carbon intensity of its investment portfolio by 40% in the 10 years from 2016 and to become net carbon neutral by 2050.
These policies get headline praise, but raise the possibility that fund managers could lose a competitive edge. According to this argument, divesting money for non-economic reasons could reduce overall profitability, especially if rival funds face the same pressure and compete to invest in “benign” companies, driving up the entry price and pushing down returns.
This is a real danger, according to the long-time Labour and Alliance adviser, John Pagani, who sat alongside Alliance leader Jim Anderton at the birth of the NZSF. “It is a fundamental rule of financial portfolio theory that you must get lower returns if you narrow your range of asset classes,” he says.
“The Super Fund also got involved in issues like light rail in Auckland – this is just nonsense. If you want to do that, then set up an infrastructure fund, but don’t constrict my retirement savings for that.” Pagani says the NZSF is not a choice-based KiwiSaver fund, but is based on compulsion, and managers should be constrained by that fact.
The extent to which all this is affecting profitability is unclear. The most recent annual report suggests sustainable investment (SI) has so far not harmed returns too much.
Charles Hyde says there is another side to its SI policy. He says shunning fossil fuel-intensive or ESG-fraught companies is good risk management, since the NZSF is less likely to be stuck with owning them when no one else wants to buy them later – the so-called stranded assets scenario.
Meanwhile, there is an extra other problem with the NZSF – it might be aimed at the wrong target. After all, old age is a predictable event, so people might be expected to make retirement savings an integral part of their weekly expenditure. Perhaps a sovereign wealth fund would be better spent on helping countries recover from random disasters like earthquakes, pandemics or cyclones.
Hardly anyone talks about this – least of all politicians – but it crops up from time to time and is rarely adequately answered.
There are further problems – NZ Super might be expensive for the government, but it is not enough to live on, while KiwiSaver has so far not been able to make up the difference.
But the NZSF can’t be blamed for any of this, and the record suggests it is a safe pair of hands in a team that sometimes has difficulty holding on to a catch.
An alternative description would be to suggest the NZSF has had a remarkable run, given it was afflicted with a kind of Original Sin: it was designed by, and maligned by, politicians.
For our 2022 analysis of KiwiSaver, go here.
Wings clipped
The architect of the superfund, Michael Cullen, wanted an ambitious scheme from the outset, funded by an 8-cents-in-the-dollar contribution from taxpayers.
But in his 2021 memoir, Labour Saving, Cullen says his coalition partner, the Alliance, blocked this payment, and his support party, the Greens, opposed investing the money in stocks and shares.
So, he went back to meet the Alliance leader, Jim Anderton.
Cullen’s then press secretary, Patricia Herbert, says her boss’s twin disciplines of history and mathematics made him apprehensive about New Zealand’s long-term financial predicament.
“The purpose of the meeting was to get the Alliance to buy into this policy, which was very important to what he wanted to achieve as finance minister,” she says.
“I just remember the palpable relief and joy when he got the answer he wanted.”
Anderton’s stand effectively lowered government contributions, with the $2.56 billion paid in the most recent annual report being slightly more than half the level Cullen originally anticipated.
Furthermore, the 2023 Budget forecast still lower crown contributions in future, and there have been even lower numbers in the past.
“Looking back, I should have been tougher, and linked our policy with [the Alliance’s cherished] Kiwibank as a trade-off,” Cullen wrote in Labour Saving.
It later emerged that Anderton was mainly fighting Cullen’s planned use of personal taxes, not general crown revenue, and he lent support to the fund in the end, partly to lock in money that might otherwise have been used by the National Party for future tax cuts.