This article was adapted from an interview that took place for AsianInvestor's Spring 2020 magazine in early March, before the global spread of the Covid-19 pandemic had fully taken hold.
New Zealand’s NZ$47 billion ($30 billion) sovereign fund uses a particular yardstick to measure its performance: a proxy set of passive investments that it calls the reference portfolio.
However, David Iverson, head of asset allocation for the NZ Super Fund, says the portfolio is much more than a measurement of performance.
“For us the reference portfolio is not only a benchmark for our actual portfolio, but a long term strategy which could do the job for the fund in the long term,” he told AsianInvestor in early March. “It plays two roles in that respect.”
This June, NZ Super will announce the results of its five-yearly review of the reference portfolio. The resulting changes, if there are any, will indicate how NZ Super’s investment team and its board of governors feel about the long term returns from its various market exposures.
The investment team’s aim is for its actively-managed portfolio to add more value to the fund than the reference portfolio offers, using strategies based on its endowments as a long-term, sovereign investor with low liquidity requirements.
For the vast majority of the time It’s done pretty well. Since inception, NZ Super’s actively-managed portfolio has exceeded the reference portfolio return by 1.49% per annum, after costs.
However, that sort of performance is likely to suffer a big dent this year, as the sovereign wealth fund sees the investment returns of many asset classes hammered by the impact of the coronavirus outbreak. The S&P 500, for example, has seen its year to date value plummet by 12.64% as of Wednesday (April 15).
Indeed, New Zealanders might need to brace for some very bad results, given the fund's mix of passive investments and riskier active alternative asset allocations. Chief executive officer and former CIO Matt Whineray told AsianInvestor in 2018 that another global financial crisis-like event could see NZ Super's assets drop by over 50%.
Indeed, on March 17, a few weeks after the interview with Iverson, NZ Super warned that its net asset value had fallen to NZ$37.78 billion from $46.68 billion at the end of 2019. That's a drop of $8.9 billion, or 19.5% on an unaudited basis, before tax.
NZ Super’s investment team of seven and another four staff that sit on the reference portfolio steering committee are deliberating on the possible changes to make to the portfolio.
The review is due to go before the board of governors in April, said Iverson.
“There will still be a number of implementation decisions that will flow from that. The decision has ramifications for any changes we need to work through, so we give ourselves time to make changes if they are necessary. For example, system changes, trading and so on. But we won’t release anything to the market until it’s all done.”
The reference portfolio review looks at precise weightings and expected returns from a mix of cash, risk premia and pure alpha. In the sovereign fund’s last review in 2015, it set an allocation of 65% in developed market equities, 10% in emerging market equities, 5% in New Zealand equities and 20% in fixed income. It fully hedges its currency exposures.
The current market environment may have some impact on what those long term assessments look like, but market conditions tend not to affect long term views of fair value.
The emphasis of the reference portfolio’s makeup is on long-term returns; Iverson stressed that the investment team won’t make changes with a view to the next five years alone.
“We use the word equilibrium, in the context of maintaining a very long term view of risk and return characteristics,” he said. “The current market environment may have some impact on what those long term assessments look like, but market conditions tend not to affect long term views of fair value.”
The changing valuations of equities, bonds, currencies and commodities in the reference portfolio are managed in a programme that Iverson’s team run, called strategic tilting.
One thing that all major institutional investors have to consider when formulating their 2020 investment policy is the fact that government policymakers (particularly in Europe, Japan and the US) have largely exhausted their ability to use monetary policy tools to ward off recession.
When NZ Super last reviewed its reference portfolio, quantitative easing was still artificially supporting markets. A lot has changed since, and particularly this year. There have been many other emergency measures by governments across the globe to support economies in the wake of Covid-19, but it’s far from certain renewed efforts will help financial markets regain any of their substancial losses before the end of 2020.
In the context of such monetary issues, Iverson told AsianInvestor the focus of the portfolio could well fall more on the interest rate environment and particularly the long term levels of rates.