This article is based on an interview that took place in early March, before the full extent of the coronavirus outbreak was clear. It originally appeared in AsianInvestor's Spring 2020 edition.
New Zealand Super has had a lot of reflecting to do in current market circumstances. The drop of equity markets and cuts in interest rates to near zero or negative levels have left it with many questions to ponder - particularly in the run up to a rebalancing of its passive reference portfolio.
Even before the onset of the coronavirus outbreak began partially shutting down economies across the world, chief executive Matt Whineray said the fund's total return target of 8.7% may need to be reduced once it completed its review of the portfolio. And speaking to AsianInvestor in early March, David Iverson, head of asset allocation at NZ Super, said the sovereign wealth fund's total investment returns may come down.
However, he said the fund would be seeking to keep a view to the long-term as it considers its total return target.
“The main area of focus would be around cash. We’ll be asking if there is something about the current environment, whether it be the long-term cash rate or the long term equity risk premium that would cause us to revise the target.”
The 8.7% target is not so important in the scheme of things, he added. “The real focus is on the difference between what we say our immediate liability is, which is the government’s cost of capital – what we short-hand as the treasury bill rate – and the total return rate.”
The total return target has essentially three parts to it. Under the 8.7% target was a 5% cash rate, then an additional 2.7% of extra return from the reference portfolio. Finally, the internal team of managers expect to add another 1% through active management.
“If we drop the 5% cash rate to a lower number, that affects the total return, even if we keep the same reference portfolio which gave us 2.7%,” said Iverson.
“So the part that is important to focus on is the 2.7% extra return above cash. If we reduced the 2.7% to 1.7% in an 80% equity portfolio, that would be a meaningful statement about long term equity returns.
“But I have to say that’s not where we are leaning at the moment. Long term returns tend to be quite stable, despite five year shorter-term outcomes. There would have to be some major change in the way markets price risk for us to rethink our very long-term assumptions.”
Long term returns tend to be quite stable, despite five year shorter-term outcomes. There would have to be some major change in the way markets price risk for us to rethink our very long-term assumptions.
While most market experts believe future investment returns may be lower, Iverson thinks the only way that would matter for NZ Super is if it concludes that bonds and equities will permanently provide lower returns.
“You’ll see this if you compare us with defined benefit plans. That’s the bare essential for them when they look at their assets and liabilities. They’re looking at what interest rates are doing to their asset and liability valuations.”
FACTORS TO CONSIDER
NZ Super’s portfolio constituents haven’t changed materially in the last five years, apart from one area, which is risk factors. “We now put more money into equity risk factors, predominantly in the developed markets,” Iverson said.
Factor strategies make up 19% to 20% of the total portfolio. Iverson said it’s difficult to say how much it is purely active, because active doesn’t capture things like tilting. For these factor strategies, NZ Super uses Northern Trust, AQR and Robeco.
The current review is also being used as an opportunity to review the sovereign wealth fund’s underlying investment beliefs.
“We’ve reviewed and revised them over time. There are no wholesale changes. We’ve made a few tweaks based on our view of how markets function and we use those directly in our active risk budgeting – and we will be publishing details soon.”
Fundamentally, he considers the benchmark passive portfolio to be on sound footing. “None of the core asset class segments is in need of major change. They are still the core building blocks for the portfolio.”
He said the big decision for the board of governors will be a focus on the 80/20 split between growth and income. “This decision is primarily a risk profile choice decision; it’s primarily a bond/equity decision. But none of the allocations need radical revision, they’re fine as they are.”