KEY POINTS:
A shortage of investment opportunities has forced the Superannuation Fund's investment team to make a big change to their strategy, says new chief executive Adrian Orr.
The state-owned fund - now the biggest in New Zealand - is increasingly shifting its focus to the murky world of private investment markets.
The Government and New Zealanders are relying on Orr and his team to take on a measure of risk when investing billions of taxpayers' dollars.
That is necessary in order to deliver the above-average returns necessary to enlarge the fund sufficiently to make a meaningful contribution to New Zealand's future superannuation requirements.
"In order to justify our existence we need to be taking risk in order to be rewarded, otherwise you may as well just be issuing government debt instead of going through this investment challenge," says Orr, who took over as chief executive of the Guardians of NZ Super Fund in February.
The fund's objective is to generate long-term returns at least 2.5 per cent ahead of the risk-free rate.
So far the risk free rate has been 6.38 per cent, giving the fund a target of 8.88 per cent. At the end of February, the fund's assets stood at $12.3 billion representing a return of 14.78 per cent.
"We have been well rewarded for our efforts but that has to be considered exceptional, not normal," says Orr in a refrain often heard from his predecessor, Paul Costello.
He says the fund tries to look across asset classes and determine their fair value based on normal cash flows.
Since it was established in 2003 public markets have been kind to the fund.
"Over the last few years we have really enjoyed the asset classes largely being below fair value. But across some asset classes you'd have to now say risks are very finely priced, and ask, 'Are we being adequately rewarded for taking on some of these risks at this point of the cycle?'
"Markets will trend back towards these fair value levels and returns will not be as exciting as they have been over the last four years."
Assets where there may now be limited upside included equities and property, he says.
But while the fund must now be more cautious, it must continue to find good, secure long term investments for about $2 billion in new funds each year.
""Those aren't always easy to find. The world has been awash with liquidity, there's a lot of cash chasing assets, we're just one of the groups competing in that market." So far, the fund has been just over 50 per cent invested in global stocks and 20 per cent in fixed income and the rest in property, local shares commodities and private equity.
Late last year the fund widened its allocations into private market investments.
From now it will be allocating 20 per cent into such assets which Orr says encompass, "effectively anything that is not listed" but typically include timber, infrastructure and property.
Private markets, says Orr have presented the fund with new challenges.
"As we increasingly fill that quota of private market investments the resource needs for the fund increase. It's just around the complexity in understanding the private deals as opposed to more of just the traditional outsourcing into public listed markets."
However private markets do not necessarily mean private equity, which is a smaller sub-set of the asset class, albeit one which Orr points out tends to get the headlines.
"Private equity is largely about backing a special team of people who you think can extract value over and above the normal market returns."
Private equity currently makes up 0.3 per cent or $41 million of the fund's assets, "It might get bigger in nominal terms over time but will probably always remain a reasonably small part of the total portfolio."
That total portfolio is expected to grow to about $160 billion by 2028 when contributions will cease and it begins paying out.
Orr says it is anticipated the fund will continue to grow in nominal terms as it will earn more from investments than it pays out but it will remain stable at about 35 per cent of gross domestic product.
Meanwhile, with the introduction of KiwiSaver fast approaching, Orr says the fund is increasingly fielding questions about its role in relation to the new workplace savings scheme.
The Super Fund's role is specific and easy to understand, he says. "We are here to assist future governments meet future superannuation costs.
"The important difference between that and KiwiSaver is that the Super Fund does not have individual names attached to it, it's just whoever happens to be receiving retirement income in the future," Orr says.
KiwiSaver, he points out, is a completely independent and separate voluntary workplace savings scheme, managed by private sector fund managers, under which individuals choose to contribute part of their wages or salary.
"Two or 4 per cent I think are the choices," says Orr.
It's actually 4 or 8 per cent but the fact that one of the leading lights of New Zealand's superannuation framework has a less than perfect knowledge of the scheme indicates how much work the Government has to do in educating the public about it.
Long-term growth the key
As former Deputy Governor of the Reserve Bank, and before that chief economist at Westpac, it's safe to say Adrian Orr knows the New Zealand economy inside out.
And despite the current angst about economic imbalances, Orr says the Superannuation Fund doesn't regard this country as a less attractive place to invest than elsewhere.
"Aside from the significant cyclical challenges, the country has shown that it's got some good longer-term growth aspects to it."
Positives Orr sees at present include the strength of commodity prices and strong tourism numbers. But beyond that he's reluctant to comment.
He certainly won't be offering any inside opinion on the workings of the Reserve Bank.
"This role gives me the good fortune that I don't have to stay too focused on near-term cyclical economic developments. We really are focused on that longer-term real growth expectations."
Super Fund
* Established: 2003
* Assets: $12.3 billion
* Target rate of return: 8.88 per cent
* Actual rate of return: 14.78 (up to Feb 2007)
