Dialogue: Future is super if our super fund thinks big

Superannuation fund expert RON LIESCHING* likes the way New Zealand has tackled the pension issue. But he has some words of warning.

Around the world, governments are facing up to a major and inevitable problem - ageing populations and the consequent need to finance retirement for pensioners.

The new New Zealand super fund may be late in arriving, but Finance Minister Michael Cullen's team has worked out a world-class solution to this problem.

But first, some background. Historically most countries paid pensions on a pay-as-you-go basis under which employed people paid the pensions for retirees.

The Government stood between the two groups, collecting taxes from the working population and paying pensions. This led to a paternalistic and entitlement mentality that "the Government will take care of us."

But three issues make pay-as-you-go unsustainable.

First, the whole population is ageing. In New Zealand the number of retirees will go up by about 50 per cent in the next 20 years but the working population will rise by only 26 per cent.



Second, we are all living longer; life expectancy has risen by six years in the past 20 years. Today's woman can expect to live into her eighties. This has created a global pension-funding time bomb.

Third is the fall in long-term yields. We all complained when New Zealand interest rates shot into the high teens, but at least it gave retirees a high return on their bank savings. With interest rates around the world now low, the amount that we have to put aside for retirement is much larger.

More retirees living longer - and with lower bond returns. The arithmetic of the pension problem is inescapable. As Dr Cullen put it in his report last October, "Doing nothing is not an option."

Different countries have dealt with issue in different ways. In the United States, Britain and Holland, governments have given big tax incentives to private pensions for decades. As a result, these countries have very large private pension funds.

Australia played catch-up with the introduction of compulsory super funds. Annual contributions now equal 9 per cent of wages.

Norway has the petroleum fund - Norges Bank - and Sweden the AP Fonden systems.

Now a first - and surprising - observation. All the countries which set up proper pension funding arrangements have had significantly better relative economic performance than those which haven't.

Look across the Tasman and consider how Australia fared in the South East Asian crisis compared with New Zealand. Holland has a thriving economy, with an unemployment rate less than those of its neighbours.

And the reason this is so surprising? Those pension systems all invested very large amounts of their money overseas.

Some politicians have difficulty accepting the idea of sending money overseas. They want to keep all their citizens' money at home - and preferably under their direct control.

I work with large public funds around the world. And as night follows day, the desire of politicians to control large pension pools is irreversible.

This is why the New Zealand legislation is laudable. The investments will be managed on a prudent commercial basis by an independent board not subject to political direction.

Look across the Tasman and see the politicians hungrily moving in on the now very large superannuation funds. They have introduced taxes on the superfunds to claw back some money for the politicians to spend buying votes.

The political pressure is subtle at first. It usually starts with the demand for socially directed investment. We should use such a large pool of money, the argument goes, to build jobs and support social goals at home.

Why should workers' savings be sent to build factories, and create employment in foreign countries - countries where we may not even agree with the political system and employment practices?

The argument is as well-intentioned as it is naive. This whole idea that governments can permanently direct flows of money to help the economy is a fallacy.

It was New Zealand's Reserve Bank deregulation, which was admired and copied around the world, that helped make governments realise they are now small participants in the world's financial system.

Take, for instance, the European Central Bank. The ECB is a very important institution. It has foreign exchange reserves equal to $91 billion.

That sounds like a lot of money. But it is equal to roughly 20 minutes trading in the currency market during the London morning. So we can understand why the European Central Bank cannot control the euro exchange rate.

Now turn back to New Zealand's pension funding issue. Short of extending the retirement age and cutting pensions, only two variables can be managed to make a difference. These are the amount of pension money put aside for retirement, and the return achieved on the investments before the pension payments are made.

A fundamental difference on investment policy exists between small countries such as New Zealand, Sweden, Finland, Canada and Singapore and large countries such as the United States, Britain, Germany, France and Japan.

Small countries are economically more vulnerable to external developments. As well, domestic financial investment opportunities are very limited and, compared with global opportunities, usually sector-concentrated.

The problem is simple to understand. If New Zealand had a disastrous foot and mouth outbreak, such as has hit Britain, the impact on the economy and investments would be very large.

This has unambiguous investment implications for pension funds in small economies. It means a large proportion (well over 30 per cent) of retirees' money should be invested in a diversified international investment programme. If things go badly at home, the overseas investments will do better.

This is not just a New Zealand issue. For example, I meet Canadian funds concerned that one company (Nortel) is equal to more than 30 per cent of their entire equity market. In Finland, another company (Nokia) was equal to some 40 per cent of their equity market.

I work with funds in 14 countries, and the response to these challenges is the same everywhere.

First, the only way for a large fund to truly enhance investment performance is by diversifying.

Individual investors want hot investments. It is possible to get high returns, but only on small amounts of money. When your fund exceeds $10 billion, it is not possible to use this approach.

Driving a supertanker is very different to driving a speedboat. This is why investment in a broad range of global markets and assets is so important for large funds.

Second, we cannot expect to see over the next 10 years investment returns anywhere close to the spectacular returns of the last decade. Share prices have gone so high that it is impossible for companies to deliver the implicit earnings growth assumptions.

That is why large US companies are delivering such a rash of earnings disappointments at the moment. This reinforces the need for prudent diversification with a mix of equities and bonds.

Again, the New Zealand super plan is well thought out in addressing these issues.

Investing overseas also brings up the issue of currency risk.



Invest outside New Zealand into the US and you will have made huge returns from the fall in the NZ dollar. But the US dollar may fall by the same amount. Global investment requires prudent hedging of the currency risks.

This raises the point that there has already been capital flight from New Zealand. It is one reason for the low dollar.

Anyone with wealth knows the retirement issue and, as the Government had not addressed the issue, individuals did so themselves.

While the New Zealand super fund was overdue, it has been crafted with care. What is most impressive is the recognition of the need for a world-class solution to this issue. It is also impressive that the inevitable future pressures to raid the fund have been addressed in advance.

If the super fund had not been put on a proper basis, New Zealand would ultimately have faced an inter-generational struggle - an unacceptable reduction in pension benefits versus unacceptably higher taxes on capital and labour. In today's world of global mobility of capital and skilled labour, both would leave New Zealand.

With secured pension benefits, New Zealand has a super future. Capital and skilled labour will return.

* Ron Liesching is chief research officer of Pareto Partners, a UK-based global fund management firm. He manages $65 billion for institutions such as Calpers (America's largest pension fund), General Motors in the US, and ABP (Europe's largest pension fund) in Holland.