While it may not have liabilities to pay out just yet, the NZ$11.2 billion (US$6.26 billion) New Zealand Superannuation Fund is not immune to the liquidity pressures facing institutional investors across the globe. Kristen Paech talks to chief executive Adrian Orr about the challenges facing the fund, and the potential investment opportunities.
As a sovereign wealth fund, the NZ$11.2 billion (US$6.26 billion) New Zealand Superannuation Fund (NZ Super) is in a unique position compared with many of its pension fund peers.
Being a buffer to the tax-payer funded pay-as-you-go retirement income system; NZ Super receives guaranteed yearly contributions from the government, which are expected to average $839 million a year over the next two decades.
While these guaranteed inflows mean the fund is in a reasonable position to withstand the pressures arising from the global financial crisis, NZ Super is not immune to the liquidity challenges that have wreaked havoc for many funds around the world.
“Liquidity management, even for a fund like ours which has guaranteed capital contributions coming in, even we have had to learn a lot and be very focused on managing liquidity throughout the period,” says Adrian Orr, chief executive of NZ Super.
“We have active market-neutral managers, we have passive physical and passive derivative exposures, and in the derivatives space we have FX, equity and commodity exposures. All of those have collateral requirements, and have liquidity calls on them, so we spend a lot of time making sure we’ve got the right and timely information in order to be holding sufficient cash to meet what has been an incredibly volatile period. One day you’re awash with cash, the next day you’re paying out.”
Fortunately, the Guardians of NZ Super decided 18 months ago to incorporate a strong focus on liquidity management in the fund’s strategic plan.
And as a long-term investor and believer in mean reversion of asset prices, Orr says the fund has the confidence to hold onto growth assets and ride out liquidity storms.
“We’d already made some significant enhancements around improved in-house Treasury Management and we’ve brought on board a new custodian (Northern Trust) and spoken to them a lot about these types of [liquidity risk management] activities,” Orr says.
“So we were in a good position, but you certainly learn a lot about your portfolio when it’s stressed, and it has been over the last six months in particular.”
As a receiver of guaranteed contributions, paid out of general taxes, NZ Super’s biggest advantage also proffers it toughest challenge.
Orr says being an investor of public monies means the fund is heavily scrutinised, and often judged on short-term performance.
Although the fund returned -4.92 per cent in the year ending June 30, 2008, the return is still within its five-year ‘confidence interval’, which forms part of the financial modelling used in setting the strategic asset allocation.
This modelling highlights that in any given year, the fund’s return is likely to be within a range of +/-10 per cent around the estimated average approximately two-thirds of the time (for example, 68 per cent confidence intervals).
“The most significant challenge for us is to be in a position to make sure we make the best of the opportunities that are available to us right now,” Orr says.
“It’s always very hard to explain to the general public that for a long-term fund like us, [these are] the times that you really take the risk on board and keep going. There’s a natural desire for people to run to cash and say ‘Wow, that was scary’, but if you don’t have to stop out, then get in.”
NZ Super’s investment philosophy is based on investing in asset classes that provide the fund with maximum return without undue risk.
Given its long-term horizon, Orr says NZ Super is always looking for investments from which it can pick up a liquidity premium.
In the current environment, the fund believes that there is a “very big equity risk premium” and a “very good liquidity risk premium” available to long-term investors.
“Looking forward, there’s likely to be enhanced access to long term funds in areas that previously you couldn’t [access],” Orr says.
“With government fiscal positions struggling like they are, outside capital might start to look a lot more palatable, say infrastructure investments, previously publicly owned assets globally.”
In addition to infrastructure, Orr says there are recapitalisation opportunities with regard to fundamentally good businesses that are currently liquidity constrained, and other distressed assets.
“These are all areas that we are actively engaged in seeking out at present,” he says.
NZ Super is also in the process of investigating alternative beta sources, such as tailored indices, and what a stronger focus on liability driven investment might imply for the types of assets the fund likes.
“For example the potential for more long-term inflation index-linked bonds, or other forms of inflation hedges,” Orr says.
“The only thing that restrains our investment universe is our commitment to being a responsible investor.”
There is, however, debate in New Zealand at present over the Federal Government’s pre-election promise to legislate to increase the amount NZ Super invests in New Zealand to at least 40 per cent – almost double its current allocation.
Orr says the fund has received no new direction from the government as yet, and has provided documents setting out the Guardians’ position.
“We’ve advised the government that 40 per cent is a long way north of where we are and that to get there would require some quite significant numbers,” Orr says.
In terms of real assets, NZ Super has around 22 per cent invested domestically, with an additional 5 per cent in cash.
“We talked to them about some of the challenges that would bring for specific asset classes etc,” Orr says. “They are well briefed and they are thinking hard about what they want to achieve from that.”
