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Thursday 14th August 2003 |
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Why has the New Zealand Superannuation Fund been set up?
The New Zealand Superannuation Fund has been created to build a pool of money that will help the Government smooth the burgeoning costs of state funded superannuation payments. An ageing population means the cost of New Zealand superannuation to the Crown will double over the next 50 years. To prepare for this, the Government is allocating around 2% of annual GDP (around $2 billion a year in current terms) to the New Zealand Superannuation Fund over the next 20 years. Without this smoothing, the annual cost of providing New Zealand superannuation to retired New Zealanders would more than double from the present 3.6% of GDP to 8% by 2050. This cost will be incurred by future taxpayers.
As the cost of superannuation escalates, the Government will begin to draw money from the Fund to help smooth the impact on its finances. By law, no withdrawals will be made from the Fund before 2020 and while it is expected that withdrawals will start to be made after this time, the Fund will continue to exist, and continue increasing in size due to compounding investment returns into next century. Money in the Fund will be invested on a prudent but commercial basis with the aim of maximising returns without undue risk to the Fund as a whole. The more the Fund grows, the less the tax burden on future taxpayers from national superannuation.
Why does the Fund have a 20-year investment return horizon?
The Fund has a long-term horizon because there will be no draw down from the Fund until 2020 at the earliest. The intention is for the Government to contribute to the Fund over the next 20 years while the cost of superannuation is relatively low. As no money can be withdrawn from the Fund before 2020, and withdrawals will be relatively modest in the years soon after that, it is appropriate for the Fund to invest in a way that focuses on the long term gains. This means that the Fund will have a higher tolerance to short term volatility in returns than an institution that needs to call on its assets in the near future.
By establishing an investment portfolio, which has a target of maximising returns over rolling 20 year periods, the Board believes that it will achieve the best result for the Government in maximising the earnings on the contributions.
What is the size of the Fund? How large is it expected to become?
The Fund will commence investing by the end of September with $2.4 billion in cash. The Government will contribute around $2 billion a year to the Fund. The Fund is expected to reach $38 billion in 10 years and in 20 years the Fund is expected to total around $101 billion, which will comprise $45 billion in contributions from Government and $83 billion in gross investment returns (approximately $27 billion of these earnings will have been returned to the Government in tax).
What is the role of the Guardians of New Zealand Superannuation and what is their mandate? How is their performance measured?
A separate Crown entity, the Guardians of New Zealand Superannuation, has been established under the New Zealand Superannuation Act 2001 to oversee the management of the Fund. The independent Board of the entity comprises: David May (chairman), Rt Hon Sir Douglas Graham (deputy chairman), Dr Michaela Anderson, Ira Bing, Brian Gaynor and Bridget Wickham Liddell. The Board has appointed Paul Costello as the chief executive officer.
The Guardians has been charged with overseeing the Fund in a prudent and commercial manner. Their objective is to maximise investment growth without undue risk to the portfolio as a whole. At least every five years, the performance of the Guardians is formally reviewed by an independent person appointed by the Minister of Finance who must then provide that report to Parliament.
How are decisions made about which investments the Fund will make?
The Guardians will set investment policy, determining what proportion of money should be allocated to various types of investments and assets. The Guardians will not be involved in day-to-day selection of which shares or bonds to buy or sell. This role will be undertaken by a range of experienced investment managers appointed by the Guardians who will actively monitor the performance of these investment managers, preparing regular reports on the overall performance of the Fund against its objectives. The investment managers are appointed under a contract with Guardians that provides for their immediate termination if the Guardians form a view that they will not meet their performance targets over time.
How did the Guardians make the asset allocation decision? What advice did they receive?
The Board considered a detailed report prepared by the Guardians’ principal advisers, Mercer Investment Consulting, which was subsequently peer reviewed by Russell Investment Group. The asset allocation decision is based on these reports, as well as the considerations of the Fund’s own management and Board.
The process was completed over many months and involved testing how various portfolios would perform under a range of potential future economic conditions – whether it be periods of strong local and international economic growth, flat or negative growth, and high or low inflation rates.
INVESTMENT STRATEGY
What were the recommendations of the Fund’s advisers on the allocations of (i) growth versus defensive assets; (ii) NZ versus overseas assets? How did these compare to the final allocations made by the Guardians?
(i) Mercer noted that growth assets offered the best opportunity for high, long-term returns. After comparing the likely performance of portfolios with different proportions of growth assets under a range of economic scenarios, a portfolio with an 80% allocation to growth assets was recommended. Russell supported the view that a portfolio with a large weighting to growth assets would best meet the objectives of the Fund, and noted that this allocation could be raised. The decision of the Guardians was to make a long-term allocation of 80% to growth assets and 20% to defensive assets, in order to balance the Fund’s desire for higher long-term returns with its mandate to guard against undue risk to the portfolio as a whole.
(ii) Mercer recommended that 20% of the Fund be invested in New Zealand, with 10% in New Zealand fixed interest securities, 5% in New Zealand cash and a long term allocation to New Zealand shares of 5%. The Board decided to make a long-term allocation of 7.5% of the Fund to New Zealand shares, 10% to New Zealand fixed interest, and up to 4.5% to other New Zealand growth assets. It was decided not to have a specific cash allocation but to leave that decision to the fixed interest managers.
How are similar overseas superannuation funds investing their money?
Most investment funds with a long-term investment horizon, including superannuation funds, allocate between 65% and 80% to growth assets. The main factor in determining the final proportion is the length of time until the funds will be drawn down. Given the long period of time until the assets of the New Zealand Superannuation Fund will be drawn down (at least 17 years by law), the asset allocation is in line with international practice.
How much will be invested in New Zealand?
In 20 years, the Fund expects to have allocated close to $22 billion in New Zealand. New Zealand investments will be made in listed shares, fixed interest securities, as well as in areas like private equity, property, infrastructure and commodities (eg forestry).
Will the Fund be investing in New Zealand icons like the railways or Air New Zealand?
The Fund’s investment decisions will be made on a purely commercial basis, with the overriding goal to maximise returns without undue risk to the portfolio as a whole. It is not the Fund’s role to invest in assets to meet other objectives. Accordingly, a decision to invest in major New Zealand companies will be made by the investment management firms appointed by the Fund only if they believe the companies will perform well and provide an appropriate return for shareholders. It is also worth remembering that, by law, the Fund is prohibited from taking a controlling shareholding in any company.
Why do shares form such a large part of the portfolio?
Even though there are periods when shares do underperform other asset classes (like the last few years), over longer periods of time taking an ownership stake in companies through shares has rewarded investors with better returns than other forms of investment.
Why invest such a large proportion of the share allocation in international markets?
There are four main reasons why it is appropriate to allocate a significant proportion of the assets to international markets.
The first is that the great majority of investment opportunities in the world are outside New Zealand. Shares on the New Zealand Exchange represent less than 0.2% of the world’s total sharemarket value so it is appropriate to seek returns from investing in some of the most successful companies throughout the world as well as successful New Zealand companies.
The second reason is that it is wise to diversify the Fund’s investments across a range of different economies to protect the assets from adverse economic conditions in one particular country or region.
The third reason is the size of the New Zealand Superannuation Fund, relative to the size of the New Zealand sharemarket. In 20 years, the Fund is expected to be approaching two-thirds the size of the New Zealand sharemarket (assuming the NZSX free float grows at 7.5% pa). If this growth rate were closer to 5% pa, in 20 years it is likely that the Fund would be larger than the free float of the New Zealand sharemarket.
The fourth reason is the limited size of the active funds management sector in New Zealand. Research indicates that once investment management firms reach a size where the assets invested in the sharemarket approach 2% of the free float, the ability of the fund manager to actively buy and sell shares becomes impeded.
The average New Zealand super fund invests around 15% of its assets in New Zealand shares. Why is the NZ Superannuation Fund allocating only 7.5% to New Zealand shares over its 20-year investment horizon?
The New Zealand Superannuation Fund is much larger than any other local fund. The average of the current top four funds (Earthquake Commission (EQC), Accident Compensation Commission (ACC), Government Superannuation Fund (GSF) and National Provident Fund (NPF)) is $3.25 billion.
Accordingly, while the NZ Superannuation Fund is allocating a lower proportion of its assets to the NZ market, it will, quite quickly, become the largest New Zealand investor. In 10 years, the Fund will have allocated $2.9 billion in New Zealand shares and in 20 years this will grow to $7.6 billion.
Regular contributions to the Fund will be around $35 million to $40 million per week in its first few years. The free float of the New Zealand Exchange, as represented by the NZSE50 Index, is worth around $36 billion. As the Fund grows to be worth around $30 billion within the next decade, it is easy to see how it could have a distorting effect on the local sharemarket were it to invest most of its money there.
Given the Fund's size relative to the domestic market, what is the likelihood that investing in New Zealand will make it difficult to buy and sell local investments without driving prices against the Fund? Should the allocation be lower than 7.5% to avoid this?
While one option was to place investments entirely with global managers, and leave those managers to choose the amount to invest in New Zealand, the Board decided there were sufficient advantages in being close to the local market to justify a specific allocation to the domestic listed market and to target opportunities within the unlisted market in New Zealand.
The Board therefore initiated research by its principal adviser on the capacity of the local market to absorb the assets of the Fund. There is no precedent for investment by a NZ fund of this scale and no precise formula for determining the amount that can be invested without constraining the ability to trade effectively.
However, advice from Mercers based on overseas studies and analysis of the current additional capacity of quality active managers in the NZ market indicated that placing more than $1.2 billion to active managers, given the current size of the New Zealand sharemarket, would be difficult. This is because it is difficult to have an active approach and outperform the market if a fund invests more than 2% of the free float.
The strategic asset allocation is to place around 7.5% to the New Zealand listed equity market. At this level, over time considerably more than $1.2 billion will be invested in the local market. The Board has set the investment at this level because it believes there is a significant chance that the Fund’s presence will encourage growth in the market and the emergence of new quality managers. It will, however, keep local capacity under regular review and will change the allocation if market developments indicate that this would be appropriate.
Will the allocation to New Zealand shares change over time?
Yes – while this is an expected long-term allocation, it will be kept under review. If the New Zealand sharemarket grows, so will the Fund’s relative level of participation. Maintaining the current allocation of 7.5% to the NZ sharemarket is dependant on the size of the NZ sharemarket growing by between 5-10% per year to avoid the Fund becoming too significant an investor. If the capitalisation of the sharemarket grows at a faster rate, this will enable the Fund to consider a higher allocation. However, if the size of the market does not increase at this level, the Fund will need to review its allocation.
Why has active, rather than passive, equities management been chosen?
The advice the Fund received from its professional investment advisers suggests that over the long-term investment horizons under which the Fund is operating, greater returns are probable from active rather than passive management.
Under New Zealand tax law, many institutions choose a passive investment strategy because of tax benefits. The New Zealand Superannuation Fund is aiming to maximise returns for the ultimate benefit of the New Zealand Government (and taxpayer). The Government will benefit from the Fund’s total returns, including any tax that will be paid by the Fund on its investment income. For this reason, the Fund has focused on pre-tax performance and the tax advantages of a passive investment policy are not relevant to the Fund. Accordingly, the management of the equity portfolios in the Fund are heavily weighted towards active management.
What other types of growth assets apart from shares will be in the portfolio?
Property, private equity, infrastructure and commodities. It is expected that there will be sufficient high quality investment opportunities in New Zealand to have up to one third of the total allocation to these asset classes in the local economy.
How will investment managers be appointed and how many will there be?
Around two dozen investment managers will be appointed from New Zealand and overseas for the whole portfolio. They will be appointed by a formal selection process that takes account of their track record in managing specific classes of assets. Each of these managers will be on a contract which gives the Fund the ability to terminate them without notice if their investment performance is causing concern.
How many investment managers will there be in New Zealand?
It is planned that, at least initially, four New Zealand equity managers will be appointed. This will include up to two managers with investment styles which track the market reasonably closely, and up to another two who take more concentrated investment decisions including focussing on the smaller companies listed on the sharemarket.
In the New Zealand fixed interest sector, the allocation will be split between a portfolio of government bonds invested in line with the total pool of bonds available for investment and a smaller allocation to an investment management firm with capacity to select quality corporate bonds for additional returns.
How will the Fund manage its foreign currency exposure given the substantial assets invested overseas?
The Guardians is aware that the Fund will be a substantial participant in foreign exchange markets, particularly in the forward hedging market, in the future. While in the short term it is not expected that the Fund will have an impact on foreign exchange markets, it is recognised that this may change over time.
The interim policy is that 60% of the Fund's foreign currency exposure in the international growth assets sector, and 100% of the international fixed interest portfolio, will be hedged back to New Zealand dollars. This reflects the research made available to the Guardians that there has been an historical advantage to New Zealand investors for hedging their foreign currency exposure.
This will be examined more closely in research to be undertaken before June 2004 to determine the optimal currency hedging strategy.
Given the Fund is commencing with $2.4 billion in cash, how long will it be before the funds are fully invested?
We expect this amount to be substantially invested by June 30, 2004. Until then, any money not invested in markets will continue to earn interest.
Why is the allocation to international shares split into large cap/ small cap and emerging markets?
Small capitalisation companies offer opportunities for very good returns as such companies are often on a strong growth path. The long-term horizon of the Fund enables it to invest a relatively high amount in smaller companies as it has the time to wait for these benefits to be realised.
Similarly, investing in emerging economies which are undergoing significant structural change, and often high rates of economic growth (eg China, South East Asia, Latin America and Eastern Europe), can be very rewarding. However, there are risks involved in these markets as well and the allocation will be kept modest and in line with the proportion of economic activity across the world which these countries make up.
How many managers will be appointed for each asset class?
Each asset class will have a number of investment managers appointed who will have quite specific mandates. Generally there will be a range of investment styles used by these managers.
The initial portfolio construction is outlined below. This will be subject to review.
a) New Zealand Equities
ACCOUNTABILITY AND REPORTING
What rate of return can be expected from the Fund? How certain is the Fund of achieving this?
The hurdle rate for the Fund’s performance is to exceed, before tax, the risk free rate of return (generally accepted to be the interest rate on cash) by at least 2.5% p.a. over rolling 20-year periods.
Achieving the 2.5% hurdle would add an extra $22 billion to the gross assets of the Fund over the next 20 years.
Extensive modelling of the portfolio, taking into account expected investment conditions over the next twenty years, indicates that the average gross return over this period is expected to exceed cash by 3.5% pa. This gives the Board comfort that the hurdle of the risk free rate plus 2.5% pa is realistic.
It is also relevant to note that as the cost to the Crown of providing superannuation is linked to the increase in Average Weekly Earnings (due to the indexation of NZ Superannuation to AWE), the Guardians have also adopted a hurdle of exceeding AWE by 4.5% pa over rolling 20-year periods.
In planning to achieve its 20-year objectives, the Fund’s performance over rolling five-year periods will represent important milestones. The Board will be aiming to achieve similar performance over these shorter periods, but it must be recognised that there will be greater volatility of returns over the five-year timeframes.
Why will the Fund measure its performance before tax?
The New Zealand Superannuation Fund is aiming to maximise returns for the ultimate benefit of the New Zealand Government (and taxpayer). The Government will benefit from the Fund’s total returns, including any tax that will be paid by the Fund on its investment income. For this reason, the Fund has focused on pre-tax performance.
How will the performance of the Guardians be reviewed?
Each of the Board members of the Guardians has been appointed for a fixed term. Just as the investment managers chosen by the Fund are accountable for their performance to the Guardians, so the Guardians’ board, and its management, are accountable to Government for their performance. A formal independent review of the performance of the Guardians is to be carried out at least each five years and this will reported to Parliament. Treasury will monitor the activities of the Guardians on an ongoing basis on behalf of the Government.
How often will the performance of the investment managers be reviewed?
Their performance will be reviewed against such criteria as the performance of their peers and their performance against benchmark returns, depending on the type of asset class they are managing. The Board meets monthly and reviews the performance of each manager as well as the portfolio as a whole.
All investment managers will be formally reviewed at least once a year.
How does the Fund intend to communicate or account for its performance?
The Fund has a policy to be as transparent in its activities as commercial sensitivities allow. It will report regularly to the public and the Government on its operations and performance, including via a website: nzsuperfund.co.nz (which will report monthly performances).
At the beginning of each year, the Fund will publish a Statement of Intent which sets out its objectives and financial forecasts for the year. The Fund’s performance against that Statement will be reviewed each year in its Annual Report. The Annual Report must include a detailed statement of investment policies, standards and procedures as well as a full list of all investment managers and the assets they are managing. Both documents will be tabled in Parliament.
GOVERNANCE ISSUES
How were the members of the Board of the Guardians of New Zealand Superannuation appointed? Who are they and how long are they appointed for?
The Board members were appointed by Government on the basis of independent advice. They were chosen for their commitment to the Fund’s goals, their experience and their mix of complementary skills.
The Board members, and the dates when their appointments expire, are:
David May (Chairman), the Deputy Chairman of the Government Superannuation Fund Authority and the former Managing Director of the Colonial Group in New Zealand. (31 May, 2007)
Rt Hon. Sir Douglas Graham (Deputy Chairman), a former Cabinet Minister and chair of the Lombard Group, a private banking firm with total assets under management of $100 million. (31 May, 2007)
Dr Michaela Anderson, the Director of Policy and Research for the Association of Superannuation Funds in Australia. (31 May, 2006)
Ira Bing, a private investor with a strong investment banking background in Britain. He previously held senior positions with investment banking firm, Merrill Lynch, in Europe. (31 May, 2005)
Brian Gaynor, an independent investment analyst and a director of the New Zealand Investment Trust Plc. He is a business columnist for the New Zealand Herald. (31 May, 2006)
Bridget Wickham Liddell, formerly a Director of CS First Boston NZ Ltd and Chairperson of the Carter Holt Harvey Superannuation Fund. She has been a Director of a number of New Zealand public companies, including Fisher and Paykel Appliances Ltd and SkyCity Entertainment Group Ltd, and Chief Executive of University of Auckland Development Ltd. (31 May, 2005)
What is the organisational structure of the Guardians?
The Guardians of New Zealand Superannuation – a Crown entity – is directed by a six-person Board, under which sits a management team headed by a CEO. The Board members are listed above. The CEO is Paul Costello, a New Zealander who was appointed after a worldwide search. His position prior to taking up this role on 1 April 2003 was as the chief executive of the A$4 billion Superannuation Trust of Australia.
A small team of quality staff is being built up under the CEO and is based in Auckland.
Can the Minister of Finance direct the Guardians to invest the Fund's assets in a particular way?
Under the law, the Minister may give directions to the Guardians regarding the Government's expectations as to the Fund's performance but must not give any direction which is inconsistent with the duty to invest the Fund on a prudent commercial basis. The Guardians must have regard to any direction from the Minister. Any direction given by the Minister must be tabled in Parliament and no directive has been received to date.
Given its size, will the NZSF be a major shareholder in New Zealand companies?
The Fund may not take a controlling interest in any companies. Under New Zealand’s Takeovers Code this is considered to be 20% or more.
What is the policy for voting on corporate actions for shares held by the Fund?
The Guardians recognise that taking an active involvement as a shareholder in companies in which the Fund invests is important in seeking the best return on shareholder funds. Accordingly, a policy is being developed which will set down the general principles which the Guardians would encourage in companies in which the Fund invests and which will be used to guide voting behaviour. This will incorporate the views of the New Zealand Exchange, and similar institutions overseas, as well as the local funds management community.
In the interim, voting will be delegated to the appointed investment managers who will be required to report their voting behaviour, and reasons, to the Board.
What is the Fund’s policy on ethical investing?
The Fund, by law, is required to develop a policy on ethical investing including policies to ensure that in the management and administration of the Fund, New Zealand’s reputation as a responsible member of the world community is not prejudiced. The Fund’s initial ethical policy has been developed following extensive research and consultation with other international pension funds, international ethical screening organizations, the Ministry of Foreign Affairs and Trade and experts in the diplomatic field. The Fund recognises the importance of representing its stakeholders through responsible and effective ethical policy in respect of its governance and investment. The Fund will continue to consult widely to explore new practices and methodology in order to enhance its policy over time.
What is the objective of the ethical policy and how will it work?
The objective of the ethical policy is primarily to avoid prejudice to New Zealand’s reputation as a responsible member of the world community. The Fund will avoid investments in countries or companies that have breached widely adopted international sanctions regimes or agreements in relation to human rights, labour and employment, the environment and arms trading. Initially investments will be analysed by specialist companies who will seek information from reputable sources such as the United Nations and International Labour Organisation and those that do not meet the standards will be referred to the Board for review. Investment managers will be instructed by the Board to avoid or dis-invest from those countries and companies that do not comply with the policy’s standards. In time, further consideration will be given to extending the scope of the analysis, which may involve engaging directly with companies to implement its policy.
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b) International Equities
c) New Zealand Fixed Interest
d) International Fixed Interest
e) Property and Illiquid Assets
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