Fund big, but not a monster

The first thing that strikes you is the sheer size of the fund, with an investment portfolio quickly climbing to be almost $25 billion by 2009/10. This compares with the total funds under management of the entire New Zealand investment management industry which is currently around $45 billion.

Eventually the fund is likely to be larger than the total non-Government (employer and individual) superannuation market which is currently around $15 billion.

Finally, the fund will eventually become the biggest single New Zealand based investor. For example, its expected size of over $23 billion by 2010 is double the current size of the single biggest institutional investment company in New Zealand, which has just over $10 billion to invest.

Another measure of relative size is comparison of the fund against New Zealand’s GDP. Treasury projects this to be 16% of the country’s GDP by 2010. Private superannuation funds, which are currently $15 billion, could grow to be $39 billion over the same time frame, assuming a 10% annual growth rate. This could result in total superannuation as a proportion of GDP of over 40% by 2010. This compares with the current level of around 75% for Australia.

There seems little doubt that the potential additional funds flows from the fund will be relatively large, rising to over $2 billion per annum by 2004/05. This is significantly greater than retail product superannuation inflows that have averaged around $500m per annum in the New Zealand market over the past few years.

While this mix may not be applicable to the fund’s optimal portfolio mix, the balance between growth and income assets is not too far from the 50/50 split used as the base assumption in the Treasury forecasts. With (New Zealand) property arguably a yield rather than growth play at present, the mix of growth and income assets then becomes even closer to Treasury’s 50/50 ratio.

The next table provides a guide to the funds that might be available for investing in each asset class. For example, assuming the super fund portfolio has 18% of its investments in New Zealand shares would result in $108 million being invested into that market in the fund’s first year (2001/02). This rises to almost $500 million per annum at the end of this decade. Likewise, overseas share investments of $186m may be made in the first year of the fund, rising to almost $1billion per annum by 2009/10.

Clearly, overseas markets will have no trouble coping with these inflows. Of more interest is whether the fund could potentially become a significant investor in the domestic markets.

The following table looks at what proportion of the New Zealand share and bond current market turnover would be generated by the fund’s investments. It shows that the fund would initially be relatively immaterial for both markets (at 0.5% of total annual turnover for shares and 0.1% for bonds). However, its significance does rise over time, possibly being almost 1.6% of the sharemarket’s turnover by 2010 and 0.3% of New Zealand bond market turnover.

*based on an assumed annual turnover of $20.5 billion for the New Zealand sharemarket and $120 billion for the New Zealand Government stock market. A 5% annual growth rate in turnover is also assumed.

It shows that the while the fund might provide some support for equity prices it should not be a major influence in terms of its share of average market turnover. It will certainly be a secondary influence on equity values compared to company performance issues such as economic value added (EVA). However, there may be times when the fund is the marginal price maker which could sometimes influence equity prices in the domestic equity market, particularly in illiquid stocks.

If, (or when?), the New Zealand and Australian stock exchanges merge a "domestic" Australasian equity market should cope easily with the above cash inflows. Based on a similar methodology to the above table it suggests that the fund’s investments would represent only 0.1% of the annual turnover of an Australasian sharemarket. It also seems that, on average, the fund should not overly influence rates in the New Zealand bond market.

Another aspect worth considering relates to the fund’s potential ownership share of the New Zealand share and bond markets. The following table firstly estimates the total holdings of New Zealand shares and bonds to be held by the fund. For example, the fund could potentially have over $4.6 billion invested in the New Zealand share market by 2009/10. This would make it almost 7% of the total market size, probably making it the largest single investor in our market at that stage. (This is on the assumption of a 5% annual growth rate in market capitalisation for the domestic share market).

* assuming a current market capitalisation of $46.5 billion for the New Zealand sharemarket, $880 billion for the Australian share market and $32 billion for the New Zealand bond market (including corporate and local authority bonds). A 5% annual growth rate in these markets is assumed.

This contrasts totally with its relative immateriality if a combined Australia/New Zealand share market was used as a proxy for "domestic" share market investments.

The significance of the fund as a potential investor in the New Zealand sharemarket is reinforced by its current breakdown of ownership. It shows that, by the end of its first 10 years, the fund could already have half of the holdings of all of New Zealand’s institutional investors combined. This suggests a lot of market power, particularly if the fund’s New Zealand equities are managed by one or two investment managers.

Thus, the new superannuation inflows may help to broaden and deepen domestic capital markets and possibly fund new business ventures or existing companies which wish to list on the New Zealand Stock Exchange. Certainly, the ability to fund new ventures or new publicly listed companies would rise. In Australia, the venture capital industry seems to be more healthy and viable than in this country, partly because of the strong inflows from compulsory superannuation.

On the bond side, there is no doubt the Fund will be a very material player with potentially over 10% of the market by the end of this decade. I have also assumed a 5% annual growth rate in the amount of government and non-government bonds over this period. Thus, the potential importance of the Fund would be even greater if any Government debt is paid off over this period.

The traditional low risk investment area of government stock will become less significant if we do progressively pay off debt and this may raise the amount available to fund the corporate sector. Companies will therefore have more opportunities to fund from institutional sources, an already an increasing trend. However, given the political and public sensitivities involved there may be a need to ensure any corporate bond investment by the Fund meets minimum credit criteria.

A related outcome is the reality that with lower government debt being issued the Fund may have to progressively increase the weighting of overseas bonds in its portfolio or, like equities, include Australia as part of its "domestic" market definition.