KEY POINTS:
In the New Zealand Superannuation Fund's latest annual report, it announced an investment return of 14.6 per cent pre-tax, post-fees for the 12 months to 30 June 2007.
This was a solid effort: international shares were down 2 per cent in the same period and the average pension fund is estimated to have returned 5 per cent pre-tax, pre-fees. Besides detailing the performance the report also comprehensively describes the investment thinking, processes and policies of some of the leading investment experts in New Zealand and overseas.
At the heart of any investment plan is the asset allocation and, in March, we discussed the strong growth orientation of the fund which has only a 17 per cent weighting in bonds and cash.
The aggressive stance has been vindicated so far and the annual report gives more details on the actual implementation of the policy: how they do it and what they are buying. It also provides details of the funds' rather sober view of future returns.
Consistent with normal practice, the biggest single asset class in the funds portfolio is international shares with a 52 per cent weighting.
Within this sector about 80 per cent is invested in large capitalisation stocks with just 13 per cent in small companies and 7 per cent in emerging markets. There is perhaps a good lesson here for retail investors who, as a result of IPOs and aggressive marketing from fund managers, often end up with large weightings in exotic areas which regularly go in and out of fashion.
Consequently, these fringe markets often exhibit much higher volatility than the overall equity market and, incidentally, have higher fees than usual too.
Sensibly, the vast majority of the Superfund's equity portfolio is in mega blue-chips like Exxon, Pfizer, Microsoft and JP Morgan Chase. Despite having the financial strength to attract the attention of the world's best fund managers, a large portion of the international equity exposure is achieved passively (allowing active decisions to be made separately and transparently accounted for) together with the entire fixed-interest and global property sectors.
In contrast, anecdotal evidence suggests the international equity portfolio of many mums and dads is made up either of just expensive actively managed funds (passive funds generally don't pay trailing commissions or sponsor financial planning conferences) or, worse still, individual stocks which their advisers have decided are so good they put aside the most sacred of investment rules, diversification.
Even with $13 billion to play with, the Superfund doesn't make any individual stock decisions, leaving this to its investment managers. The international equity portfolio is widely diversified with the biggest holding in the sector, Exxon, representing less than 2 per cent of total international equity exposure. The Superfund's global large cap portfolio returned 17 per cent in the June year versus a 2 per cent fall in the index.
Much of the relative outperformance was due to the funds foreign exchange policy, which protected the equity portfolio from the appreciation of the New Zealand dollar over the period, and a modest allocation to emerging markets which returned a useful 42 per cent over the year.
Next sector in size is the fixed-interest, portfolio which, at June 30, represented 17.3 per cent of total assets. Of the $2.3 billion invested here, some $900 million is in global bonds, with $1 billion in NZ Government bonds and $300 million in cash awaiting investment.
Of the $1 billion in government bonds, just under half was invested for over five years. As at June 30, five-year government bonds yielded 7.04 per cent and 10-year government bonds were yielding just 6.71 per cent, well below the call rate of 8.2 per cent.
With such a bias to long-dated bonds, the Superfund's fixed-interest managers appear to be anticipating a fall in interest rates - another hint here perhaps for mum and dad who frequently just invest in whichever term has the highest rate rather than diversifying over different terms. All of the Superfund's fixed-interest assets are rated investment-grade by proper rating agencies and it goes without saying that it had no exposure to local finance companies.
At 10 per cent, the "private markets" sector comprising infrastructure, timber (NZ and overseas) and private equity is the next most important part of the Superfund's portfolio. This sector was the second best performer in the year, returning 25.2 per cent. One aspect of private markets that investors need to be aware of is the fact that because the price of these frequently illiquid assets are not determined with reference to a market price but, through a valuation, the assumptions underlying the valuation model should be thoroughly understood. This pricing nuance has caused a lot of trouble for hedge fund investors recently as their managers argue for high valuations so that their performance fees kick in.
The NZ Superfund's annual report discloses that the performance fees amounted to 44 per cent of the total fees paid and these "particularly applied to the fund's private market managers". Management comments that the major contributors to the result were strong infrastructure returns and steady growth from timber.
The infrastructure sector is managed by Capital Partners and Morrison and Co and the assets are mainly toll roads and, in New Zealand, airports. Despite the recent hype and subsequent warnings from experts that the sector was looking expensive, private equity is just a small part of the portfolio and largely valued at cost.
New Zealand shares comprise 7.3 per cent of the Superfund's assets. In this sector, the fund uses three active managers - AMP Capital, Brook Asset Management and Fisher Funds together with Smartshares who run a passively managed indexed portfolio. Some 25 per cent of the $900 million invested here is passively managed and among the positions the fund has taken at June 30 was to be overweight Fletcher Building and underweight Telecom. Other major holdings in the portfolio include leading stocks like Contact, Auckland International Airport, Ryman Healthcare and Sky Network Television. The portfolio returned 22.7 per cent after fees versus 20.4 per cent for the NZ stockmarket average.
So much for the past - what of the future? Unfortunately, the Superfund's managers expect much more modest returns in the next 10 years than the 14.8 per cent per annum compound it has achieved since it began investing in September 2003.
Overall from its current portfolio, they project an average of just 8.1 per cent per annum over the next 10 years, with 8.9 per cent from international shares, 8 per cent from NZ shares and 6 per cent from bonds.
These are sobering numbers and they have at least two implications for mum and dad's investment strategy: firstly the 3 per cent annual fee implicit in Mr and Mrs Retail Investor's retirement plan (managed funds via a financial planning platform) will almost halve nominal returns before tax. Secondly, if shares only produce 8 per cent per annum and bonds 6 per cent, the 9 per cent on offer from short-dated NZ bank deposits is likely to be just that, short-dated.
* Brent Sheather is a Whakatane-based investment adviser.
