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An embarassment of riches

By Nick Stride

Friday 21st March 2003

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It's not a problem any New Zealander has had to face before ­ how to invest $300 million a year without upsetting the politicians or the public and without blowing share prices sky-high.

The members of the Guardians of New Zealand Superannuation Board have rolled up their sleeves in earnest and expect to start investing Finance Minister Michael Cullen's mammoth fund from September.

Their task is huge ­ by the end of June the fund will already hold $1.9 billion, or 1.75% of last year's gross domestic product. Using the Treasury's assumptions of investment returns the fund's size will rise to around $58 billion by 2032.

Investing those amounts of public money will be fraught with political risk, as the managers of the public servants' Government Superannuation Fund have already found out.

But the guardians will also have to find answers to some tricky technical questions.

Not least of these is that, shortly put, the New Zealand sharemarket is too small for the amounts the guardians are likely to want to invest here.

The capitalisation of the sharemarket ­ the value of all the shares of all listed companies ­ is about $41 billion. Assuming the fund invests about $300 million a year ­ the consensus of the "average" 15% local fund managers allocate to New Zealand equities ­ it will have $4.5 billion invested in 10 years and $13 billion in 20 years.

That will double the $6.5 billion of New Zealand equities fund managers currently hold.

Buying around 1% of the sharemarket each year will also create serious liquidity problems, depending on what index if any the fund elects to use.

According to a study last year by sharebroker JB Were, if the fund had tried to get an NZSE40 index weighting in the shares of fishing company Sanford it would have to have bought all the shares traded in the market for 250 days, or a whole year ­ an obviously impossible situation.

If it follows the new NZSE50 index, on which companies' weighting is adjusted for shares held by "strategic" investors and unavailable for trading, it will avoid some of those problems.

But it will still end up with around 4% of the total fund invested in a single company, Telecom, a situation no fund manager would regard as prudent.

In fact, according to JB Were strategist Campbell Millar, strict adherence to traditional fund management practice would see New Zealand get only its minuscule weighting on the global MSCI sharemarket index.

"Given the purpose of the fund, 0.2% in New Zealand is a highly prudent decision," he says.

"Our economy could be wiped out by a single earthquake."

But even a beefed-up 5% allocation would be unlikely to be acceptable to governments or to business, who will want such large flows of public investment to benefit our economy, not someone else's.

So even though the government has set up careful "fire walls" against political interference in the fund's investment decisions the guardians will have to temper traditional prudence with political pragmatism.

That still leaves the problem of the too-small sharemarket. Mr Millar sees a number of possible solutions.

First, companies with a primary listing on the Australian Stock Exchange ­ for example, supermarket operator Foodland, NGC owner Australian Gas & Light, or National Australia Bank ­ collectively earn, according to Millar, as much profit from New Zealand as NZSE-listed companies.

Counting shareholdings in those companies as at least in part "New Zealand" would make $300 million a year much more "investable." It might even encourage Australian companies to issue "New Zealand class" shares as Westpac has done.

Second, the government could "self-privatise" some of the chunky state assets that it would not sell to private owners ­ for example Transpower, New Zealand Post, or the generators ­ by selling stakes to the fund.

Third, the fund could look to buy equity in private companies.

Mr Millar estimates these, together with the state-owned enterprises, generate three-fifths of all the corporate profits earned in New Zealand (with listed companies and ASX companies accounting for a fifth each).

Combining these strategies would change the definition of "New Zealand" equity investment from "listed" to "all forms of corporate ownership."

Nor would they all have to be "growth" companies, just manufacturers, for instance, that beat their cost of capital.

But to do this effectively, Mr Millar argues, the fund would have to set up structures that don't yet exist. It would also need to retain the ability to respond to events as they happened rather than delegating all individual investment decisions to fund managers.

This would allow it, for example, to bid for strategic parcels in new share issues.

"The fund can afford to wait," Mr Millar says. "Most industries will have a crisis over the next 20 years and there will be huge opportunities if the politicians will leave [the fund] alone to take them."

"But every year you delay investing the pressure gets greater, that is, the deals you need to do get bigger."

If the fund has problems of its own setting up the structures to invest such large amounts of money, fund managers and sharebrokers will also face challenges.

"Many fund managers are already stretched and to invest, say, another $100 million a year they'll need to build up their infrastructure, with no guarantee the extra business will always be there."

The sharebroking industry is also keenly interested. It's likely small brokers will lobby to get their "fair share" of trading and commissions.

For humble punters with only a few million to invest the fund is most definitely good news. Mr Millar says it will become the "marginal buyer," underpinning the sharemarket for the next decade.

"The New Zealand sharemarket has historically been a relatively expensive place to raise money. The Super Fund is likely to lower the cost of capital, pushing up share prices."

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