Australasia’s large asset owners have begun to make a habit of managing expectations downwards when it comes to fund performance. Yet despite their relatively gloomy forecasts, the sovereign wealth funds such as Future Fund of Australia and the New Zealand Superannuation Fund have continued to outperform their benchmarks.

In NZ Super’s case, it did so by a considerable margin, based on its latest results announced on Thursday (February 20). It reported an impressive pre-tax return of 21.13%, which saw it grow to NZ$47 billion ($30 billion). And two-thirds of the NZ Super Fund is invested in its passive reference portfolio, which returned 22.74% for the 2019 year.

Yet despite these robust results, chief executive Matt Whineray was characteristically downbeat; predicting a less lucrative market environment in the near term.

Matt Whineray, NZ Super

“We know markets are volatile and this coming year presents a range of challenges for investors,” he said in his official statement on the fund’s results.  

His caution is understandable. After all, the MSCI World global equity benchmark increased by 25% in 2019, but global equity markets are very unlikely to enjoy such strong returns this year. Indeed, with equities and bonds both looking expensive and global uncertainty exacerbated by the ongoing coronavirus outbreak, asset owners are naturally wary.

This prognosis could have an impact on the NZ Super’s forthcoming review of its reference portfolio. Speaking to AsianInvestor, Whineray noted that the fund used the review as an opportunity to re-examine its entire investment beliefs. With this in mind, NZ Super is looking to recruit a new member to its portfolio review team.

“The current review is looking at the composition of the reference portfolio, our overall risk tolerance and risk/return assumptions,” Whineray told AsianInvestor.

Source: NZ Super Fund

Given that investment returns on cash and bonds have fallen to lower levels than any time in living memory, Whineray and the investment team understand the reference portfolio’s current long-term return of 7.7% may need to be reduced once the review is complete at the end of this financial year, in June.

TIMELY REVIEW

NZ Super’s 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.

Whineray said the passive portfolio benchmark approach used by NZ Super and other major institutional investors, including Canada Pension Plan Investment Board, encourages them to consider the underlying economic drivers of risk, returns and correlations (such as growth, inflation, liquidity and agency risks).

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 exhausted most of 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. As that effect dissipates, investors cannot rely on historic return assumptions.

“In the short term the fund is taking less active risk, and we expect lower returns than we have enjoyed in recent years,” said Whineray.

He added that the reference portfolio did better than the fund’s actual portfolio in 2019 largely because of the timing of the fund’s private market asset revaluations, which are assessed less frequently than listed equity holdings.

The net effect is that during periods when liquid equity markets rally strongly, the performance of those infrequently valued assets tends to lag the reference portfolio proxy of listed equities and bonds.

REAL ASSET POTENTIAL

Looking ahead, the active investing team is exploring a range of potential investments in New Zealand and abroad, particularly in infrastructure and real estate. 

Real assets, including infrastructure, real estate, energy investments and expansion capital, were the largest contributors in 2018-2019 to what NZ Super calls its 'value add' holdings. Investments in alternative energy developer Longroad and dynamic glass company ViewGlass were the main contributors to the 0.35% outpeformance of the reference portfolio, out of a total value-add of 0.65%.

Taking the longer view, NZ Super has returned an annualised 10.32% since inception and has earned $8.9 billion in value over the reference portfolio benchmark. Whether it will be able to maintain that level of performance remains to be seen. To judge by Whineray’s concerns, it appears unlikely.