New Zealand Superannuation Fund plans to continue adding to its actively managed agricultural assets and is biding its time before deciding if it wants to strategically calibrate its portfolio in light of global trade tensions, the chief economist of the $25.6 billion fund has told AsianInvestor.
One thing seems clearer though, Mike Frith said in an interview this month, and that is last year's strong investment returns will be hard to match as the end of the easy-money era leads to more market volatility.
Forestry products, in particular, generated good returns last year on the back of global growth.
"Active investments, largely in timber and forestry, did well on the back of the Chinese economy and US construction growth,” Frith said, noting their diversification benefits and the fund's continuing search for opportunities in this area.
Timber accounted for 5% of the fund’s portfolio at the end of May, NZ Super's results show.
“Timber has done exceptionally well for us. We have had investments in this asset for almost the life of the fund,” said Frith, who is currently also chair of the pension fund's investment committee.
But it requires expert handling, he added. “While it is an appealing asset, it’s not easy to purchase – you can’t just go out and buy a forest," Frith said. "It is quite an illiquid asset as well.”
Apart from acquiring timberland stakes at home, the fund also holds timber investments in Australia, Brazil, Uruguay, Chile, Guatemala and Cambodia, among other places, via funds.
A June 20 Moody’s report on the outlook for paper and forest products said the sector would likely continue benefitting from growth in US home construction, renovation and repair.
Timber aside, NZ Super also invests in farming assets such as dairy farms. It has a 1% stake in farmland assets and in June bought a 27% stake in fruit and vegetable export company NZ Gourmet.
NZ Super's agricultural assets form part of the superannuated fund's active investments, which account for about one-third of its overall portfolio.
The fund primarily operates via a passively managed reference portfolio, which underpins its asset allocation strategy and accounts for around two-thirds of the portfolio. Active investments are then made outside this reference portfolio.
Currently, the reference portfolio comprises 80% global equities and 20% global bonds, while the active value-added strategies include private equity, infrastructure and agricultural assets.
That mix makes it highly growth oriented -- which seems to have paid off as it generated an investment return of 13.2% in the 12 months to May 2018, during which time global equities largely soared.
“We had a good year last year; we achieved strong returns above the benchmark despite having a relatively low active risk allocation,” Frith said, assigning a 10.7% return to the reference portfolio and an additional 2.5% to NZ Super's active investments.
In addition to its agricultural investments, the latter includes a strategic tilting programme that in the past 12 months delivered "1% [in] value add" -- a return that was "above expectations and well above the allocation,” he said.
“Our strategic tilting programme works by tilting the portfolio towards or away from broad markets that are under- or over-valued,” Frith said.
Essentially that means buying when other investors want to sell and selling when other investors want to buy. It requires making an assessment of what to expect from asset prices over a market cycle, an assumption of fair value of assets and a belief in 'mean reversion', and last year resulted in NZ Super making adjustments to its bond and currency market exposures.
Right now, Frith said, “most markets are fairly well priced." The underlying economic fundamentals should also support growth and keep returns in positive territory in the next 12 months, even if, as expected, they fall short of last year's performance.
However, the escalating trade frictions between the US and the rest of the world, in particular China, are muddying the outlook.
“We are not certain where the trade situation will end or how far it will go or what the worst case scenario will be," Frith said. "At the moment we are in wait and watch mode, and not looking to tilt our portfolio one way or another.”
External global macro managers employed by NZ Super were nonetheless expected to "incorporate the trade situation in their investment decisions,” he said.
Adding to the uncertainty facing asset owners is the slow turn upwards in the global interest rate cycle after years of very accommodative monetary policy, with the Federal Reserve leading the way having raised US interest rate seven times so far since late 2015.
“We are clearly at a point where inflation expectations are arriving, reflecting the capacity constraints in many countries, and the fact that some central banks are changing their policy stances," Frith said. “We are mindful of the changes because a rate rise from a low level will be more significant for debt issuers than the same rate rise from a higher level.”