Michael Littlewood: Investing makes no sense when in debt

The NZ Superannuation Fund has cost taxpayers dearly. Photo / Mark Mitchell

In 2001, the last government established the New Zealand Superannuation Fund to partially pre-fund the future costs of New Zealand Superannuation.

The present government suspended contributions last year, saying it intends to resume those when economic conditions allow. The Finance Minister says this is more likely to be in six years rather than, as advised last year, by 2020.

However, the Government should not resume contributions in six years unless it has by then repaid all debt. As explained here, that is a straightforward investment decision.

In the extremely unlikely event that all debt was repaid, the Superannuation Fund still wouldn't be a good idea. The case for that rests on economic arguments.

This is not to suggest that the Government should repay all debt - only that, in the presence of debt, the fund makes no investment sense and little economic sense.

The Government has argued, correctly, that borrowing to make new contributions in 2009/10 was not sensible. That argument still holds despite good returns from financial markets since July 1 last year.

If borrowing money to invest in financial markets isn't a great idea, the same logic must also apply to the $16 billion already in the Superannuation Fund. The Government had debt of $62 billion on its consolidated balance sheet at last June 30.

Each day, it effectively has a choice - either sell the fund's assets and repay debt or maintain borrowings and retain the assets.

Investing in, say, shares or petrol stations in the presence of debt is the same as borrowing to buy those investments.

Every dollar of assets in the NZ Superannuation Fund is, effectively, financed by a borrowed dollar. That makes the fund's portfolio 100 per cent leveraged. It's the same as a household asking its bank for a loan and putting that all into, say, international shares.

If the Guardians do not achieve a return of at least the cost of the Government's most expensive debt each year, the NZ Superannuation Fund has lost taxpayers real money. Over the six years to last June 30 (the last period for which audited accounts are available), the fund's Guardians have missed that most basic target by a significant amount.

The accumulated loss was about $2.6 billion at June 30. This is on the basis that the contributions to the fund could have been allocated instead to repay the longest-dated (10-year) government debt instead of investing it through the fund.

The recovery in investment markets to last November reduced that estimated loss to "only" $1.4 billion, based on the NZ Superannuation Funds' reported returns.

But even just beating the cost of debt isn't good enough.

Again, if the household had persuaded its bank to lend that borrowed money for investment in shares, achieving a return of just the cost of the loan isn't good enough. There has to be more than that to justify the effort and risks involved.

So the Guardians need to do somewhat better than the cost of government debt to compensate taxpayers for the risks involved with a fully leveraged strategy. Because the Guardians have so far missed the cost of debt, they have not come close to compensating taxpayers for that additional investment risk.

Even if the Guardians had managed the more demanding but essential target, that still would not make much difference in the long term if we are really concerned about the impact of demographic change on future taxes.

The NZ Superannuation Fund won't and can't change the cost of NZ Superannuation - it only slightly rearranges its incidence. The actual cost of superannuation will be the benefits paid so the fund is unlikely to make any significant future contribution to the security of NZ Superannuation payments.

The existence of the NZ Superannuation Fund has instead raised financial and investment risks for taxpayers. It may also increase the total amounts spent on superannuation including investment losses, which has been the experience to date.

The Government's balance sheet would have been better off by more than $1 billion had it repaid debt instead.

The present government's intention to resume contributions when Budget surpluses return is unrelated to the basic investment decision described above. A Budget surplus is simply not relevant to this discussion.

Every dollar contributed from that surplus will still, in effect, be a dollar borrowed (unless all debt has been repaid).

Despite the compelling fiscal, investment and economic case against this fund, politics will probably protect its existence. As John Key himself has said with regard to both superannuation and the fund, "The Government is committed to these settings and I have said many times that I would rather resign than change them."

That political commitment will come at some cost to future taxpayers. It is also a distraction to debate on issues that really matter,such as the future size and shape of NZ Superannuation.

Whether the NZ Superannuation Fund continues or not, New Zealand still needs that debate.

* Michael Littlewood is co-director of the Retirement Policy and Research Centre, University of Auckland.