Brian BollenInvestment excellence is something the world has come to expect from New Zealand. It has become almost as much part of the country's DNA as excellence in rugby union. Forgetting Saturday's test match loss to the British and Irish Lions for a moment.
Adrian Orr, chief executive of NZ Superannuation Fund, often described as a New Zealand sovereign wealth fund, addressed the subject at the State Streets Global Markets research retreat on 11 May this year.
The fund is a buffer fund, saving today for a cost that will come a long way into the future. The first withdrawals are not expected until the early 2030s and the Fund will continue to increase until the 2080s.
A brief history
The Guardians of NZ Superannuation is a double arms-length crown entity that was set up to manage the fund. In Maori, the concept it represents is kaitiaki, which means caring, looking after something precious for the future.
The Guardians is required to invest the fund in a manner consistent with
- Best practice portfolio management
- Maximising return without undue risk to the fund as a whole
- Avoiding prejudice to New Zealand’s reputation as a responsible member of the world community
Investment secrets of The Guardians
The Guardians has just published a 'How we Invest' paper on its website. It says it uses a number of active investment strategies to add value to the fund. Of these, the most significant is the strategic tilting programme, says Matt Whineray, chief investment officer.
He says that tilting has added substantial value to the fund since it began in 2009. The new paper aims to explain how tilting works and also explain the performance of the strategy to date.
The essence of tilting
Strategic tilting is a value-adding strategy which alters the fund’s exposures to certain asset classes, including equities, bonds, credit and currencies. This strategy is designed to capitalise on certain investment advantages that the fund has.
These are a long-term investment horizon, a certain liquidity profile and a belief in mean reversion of asset prices and risk premiums. Strategic tilting increases exposure to cheap assets; it cuts exposure to expensive assets.
This is sometimes called dynamic or tactical asset allocation, it notes.
Three key elements for operating a successful strategic tilting programme
- a supportive investment philosophy that links to the fund’s advantages as an investor
- a disciplined risk allocation approach
- strong governance and alignment of interests
Investment philosophy
The tilting programme incorporates a number of investment philosophies in its design. The investment philosophy relies on (i) mean reversion and (ii) long horizon. It does not rely on momentum trading or short-term forecasting.
Mean reversion is a belief that asset prices tend toward their values over time. This belief makes no claim about the specific path prices may follow, nor how long it will take. The programme does not rely on an ability to forecast short-term price movements.
Long horizon leverages the fund’s long horizon endowment, stable risk aversion and operational independence. The fund can weather short-term volatility and can look through short-term changes in market risk aversion.
A disciplined allocation approach
The Guardians believes that a disciplined approach to allocating capital is important for achieving long-term success in the strategic tilting programme. The approach is a formalised process and mechanism for translating valuation signals into portfolio positions.
The approach aims to ensure discipline in allocating to asset classes and markets, to be more objective and to avoid the temptation to allocate based on “gut feel”. The Guardians says this approach is designed to monetise the belief in mean reversion.
Governance
Successful implementation of the strategic tilting strategy requires robust governance and decision-making processes. The elements seen as critical to support the implementation of strategic tilting include strong board commitment and alignment of interests.
Board commitment. Strategic tilting is a contrarian strategy that may result in an extended period of losses. Being underweight an asset class in a bull market or overweight in a bear market can bring to bear enormous pressure to unwind the strategy.
The worst possible outcome would be to abandon a position when valuations for an asset class prove to be, ex-post, at the extreme end of the trading range. For this reason, it is imperative that the Board is strongly committed to the strategy.
In particular
In particular, this means sizing the amount of risk used carefully when establishing the strategy – to avoid the losses created by abandoning the strategy at the wrong time.
Alignment of interests. Strategic tilting is managed internally at the fund. Therefore, the Board’s commitment to strategic tilting also rests upon their confidence in the management of the strategy.
The thinking is that internal management of strategic tilting makes most sense in order to avoid alignment of interest problems given that the strategy can produce large losses over an extended period of time.
Power of performance
The NZ Super Fund was set up in September 2003 to reduce the burden on future taxpayers of the rising cost of New Zealand superannuation. It started with a contribution of NZ$2.4bn from the New Zealand Government and a plan of regular contributions.
This has been suspended since the GFC (global financial crisis). It grew to nearly NZ$15bn in the space of five years, using a traditional investment model of strategic asset allocation. At the end of May this year, the fund stood at NZ$34.98bn.
Since it was set up, it has achieved annual growth of 10%. Over the past five years to March, the annual rate of growth was nearly 15%.