KEY POINTS:
The New Zealand Superannuation Fund has been one of the current Government's more successful innovations.
The fund has produced outstanding investment returns, on a risk adjusted basis, and has introduced a number of best practice standards to the New Zealand investment community.
Investors, including KiwiSaver participants, can learn a great deal from the Super Fund's investment decisions and portfolio construction.
New Zealand has two main public pension funds, the Government Superannuation Fund (GSF) and NZ Superannuation Fund (NZSF).
GSF provides pensions for Government employees including the armed forces, police, prison officers, judges and parliamentarians.
GSF's main investment objective is to minimise the Crown's contribution to these pensions by maximising the return of the fund over the long term, without undue risk, and within the best practice framework.
The main purpose of NZSF is to partially provide for the future cost of funding New Zealand Superannuation payments. The investment objective is to maximise returns without undue risk and with a focus on the long term.
This long-term objective is important as no payments will be made from NZSF until the 2020s.
The secret of success for these big funds - and for most investors - is portfolio construction. In other words the most important decision is how much is invested in income assets, compared with growth assets, how much is invested overseas compared with New Zealand and whether overseas exposures are hedged back to NZ dollars.
This asset allocation decision normally has a bigger impact on returns than individual stock selection as it is more important to get the income/growth asset mix right than, say, the relative weighting of Fletcher Building compared with Contact Energy and Mainfreight.
Investors with a long-term horizon should have the majority of their investments in growth assets, mainly shares. This is because growth assets offer the best return over the long term although they are relatively volatile and have negative as well as positive annual returns.
Investors with short-term commitments should have a higher percentage in income assets, mainly fixed interest securities and cash, as these are less volatile and can easily be converted into cash when required.
Young investors should have a greater percentage in growth assets than older individuals because the former have a much longer investment horizon.
Not surprisingly, GSF has a higher percentage of income assets than NZSF because it has ongoing commitments to beneficiaries. In the June 2007 year, GSF received contributions of $742 million but had benefit payments of $888 million.
As the table shows, GSF had 30.4 per cent of its total fund in income assets as at June 30, 2007 compared with just 17.3 per cent for NZSF.
The other big differences between the two funds are New Zealand equities and alternative assets.
NZSF has only 7.3 per cent of its money invested in the New Zealand sharemarket, mainly because the NZX is relatively small. The Super Fund will grow from $13 billion to more than $100 billion compared with the NZX's current value, excluding overseas companies, of just $70 billion. Unless the market capitalisation of the NZX increases NZSF will have limited domestic opportunities, particularly as the NZX's free float is lower than $70 billion when major shareholdings in Air New Zealand, Auckland International Airport, Contact Energy, Sky Television, Vector, The Warehouse and other companies are taken into account.
As at June 30 NZSF's ten largest individual equity investments were Fletcher Building, worth $103 million, Telecom ($89 million), Contact Energy ($82 million), Exxon Mobil ($77 million), Pfizer ($51 million), Microsoft ($50 million), JP Morgan Chase ($48 million), Auckland International Airport ($47 million), Bank of America ($45 million) and Ryman Healthcare ($43 million).
Its US shareholding percentages are relatively small but NZSF is quickly climbing up the share registry of a number of New Zealand companies.
The other big difference is alternative assets, mainly infrastructure, private equity and timber. NZSF has 10.8 per cent of its money invested in this asset class, with a long-term objective of 20 per cent, whereas GSF has no investments is this area because alternative assets are relatively illiquid.
In the June year NZSF's alternative assets had a pre-tax return of 25.1 per cent, which was second only to emerging market equities with a phenomenal return of 41.8 per cent.
The Super Fund would have had a much higher return if all of its money had been invested in alternative assets and emerging market equities. This approach would have been far too risky as emerging markets are extremely volatile and market timing is exceedingly difficult to execute successfully.
NZSF should have had a better June 2007 year than GSF because it has a greater percentage invested in growth assets and these assets had higher returns. But the GSF had a return of 14.9 per cent, compared with 14.6 per cent by NZSF, for a number of reasons including:
* GSF had a higher percentage invested in NZ equities, which produced greater returns than either large cap or small cap global equities
* GSF had a higher percentage of its income assets invested offshore and these produced a higher return than NZ fixed interest securities
* NZSF's property had a return of only 16.8 per cent compared with 22.1 per cent by GSF
* Finally GSF had a positive return of more than 5 per cent on its commodities, whereas NZSF had a negative return of 11.4 per cent.
The diversified portfolio approach of GSF and NZSF doesn't produce many, if any, 20 per cent-plus years but it does generate fantastic returns over the longer term.
There are important similarities between NZSF and KiwiSaver in terms of portfolio construction and long-term horizons.
An individual who joins KiwiSaver at the age of 18, contributes $1,000 per annum over the next 10 years, quits at 28 but leaves the money in until he or she is 65 will end up with the following lump sums:
* Assuming an annual return of 10 per cent after tax, the $10,000 invested between 18 and 28 will be worth nearly $2 million when the contributor reaches 65.
* Assuming an annual return of 12 per cent per annum the $10,000 will be worth nearly $4.4 million at the age of 65.
Yes that is correct. A $10,000 KiwiSaver contribution between the age of 18 and 28, assuming similar employer and government contributions over the same 10-year period, will turn into nearly $2 million at an annual rate of return of 10 per cent and $4.4 million at 12 per cent per annum.
The important point is that the difference between annual 10 per cent and 12 per cent returns is massive over the long term and highlights the benefits of joining KiwiSaver at an early age.
The Super Fund and KiwiSaver are tremendous innovations because the former enables New Zealanders to observe the benefits of a long term investment focus while the latter allows them to take advantage of this approach.
* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.
