New Zealand Superannuation Fund’s most recent five-yearly review of its passive reference portfolio has concluded that the sovereign wealth fund will maintain its core asset allocation and hedging strategies.

The reference portfolio provides the guardians of NZ Super, the fund’s board of governors, with a gauge of how much the investment team is adding value by the use of active management.

NZ Super’s chief executive officer Matt Whineray told AsianInvestor that for this review, the investment team was looking at the composition of the reference portfolio, the fund’s overall risk tolerance and its risk/return assumptions, based on current and likely future market conditions.

Matt Whineray

As part of the reference portfolio review, two decisions had to be made, said Whineray – an asset allocation choice (the bond-equity split) and a currency hedge ratio choice.

.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. In effect, this means an 80/20 split between equities and bonds. The fund fully hedges its currency exposures.

“Management and the board considered whether there has been any change in material risks to the fund since the last review in 2015, and opted to stay with the current 80/20 split, Whineray told AsianInvestor.

“The modelling results also show that for the 80% growth allocation, hedge ratios in the range 70% to 100% are virtually indistinguishable on a return-per-unit of risk basis for short term tail risk.

“For long term tail risk, we found that moving away from a fully-hedged portfolio lowers return and actually increases risk. As such, the board is retaining the 100% hedge position.”

In recent years, the actual composition of the fund has become increasingly different from the reference portfolio and the fund has moved visibly ahead of the reference portfolio's returns.

OUTPERFORMED REFERENCE PORTFOLIO
 
According to latest data to May 31, 2020, since inception, the NZ Super fund actual portfolio has exceeded the reference portfolio return by 1.25% per annum. The investment team, prompted by the board, was conscious of the need to maintain the reference portfolio as a meaningful benchmark.

The reference portfolio review looked at the precise weightings and expected returns from a mix of cash, risk premia and pure alpha.

The fund’s portfolio needs to outperform the reference portfolio using strategies based on the fund’s role as a long-term sovereign investor with low liquidity requirements. But with investment returns on cash and bonds at historically lower levels, the NZ Super management team have consistently stated that expected returns are on a downward trend.

In 2019, the fund continued to outperform its benchmark. However, the exceptional circumstances of 2020 have seen the trend reversed and active returns have, as predicted, not matched the benchmark return.

The chart below shows that for the 11 months of the 2019-2020 financial year (ending June 30), the 'value add' has been -1.57%. For only the second time in the last 12 years, the fund's actual portfolio has underperformed against the reference portfolio in the financial year to date. The previous time it underperformed was in 2013/2014 due to its strategy in relation to the New Zealand dollar.

Taking the longer view, NZ Super has returned an annualised 9.54% per annum since inception.

The investment team intends to comment more fully on the reference portfolio review in its upcoming annual report expected in October. The exact timing depends on when the report is tabled in the NZ parliament and is also dependent on the outcome of a general election in September.

NZ SUPER RETURNS, 2016-2020          
Year Fund Return T-Bills L/T Expectation Net Return RP Return Value Add  Fund Size
 
NZ$ Million
2016/17 20.71% 1.83% 4.53% 18.88% 16.34% 4.37% $35,373.07
2017/18  12.43% 1.72% 4.42% 10.71% 10.42% 2.02% $39,368.89
2018/19  7.02% 1.66% 4.36% 5.36% 6.36% 0.67% $41,113.08
2019/20 -0.49% 0.88% 3.36% -1.37% 1.09% -1.57% $43,771.42
Since inception  9.54% p.a.  3.74% p.a. 6.27% p.a. 5.80% p.a. 8.29% p.a.  1.25% p.a. $43,771.42
As at May 31, 2020            

Source: NZ Super