Government Superannuation Fund Authority - Full report
This is the full copy of Parliament's Finance and Expenditure Select Committee report on the Government Superannuation Fund.
Tuesday, December 3rd 2002, 8:17PM
Government Superannuation Fund Authority
Recommendation
The Finance and Expenditure Committee has conducted the financial review of the 2001/02 performance and current operations of the Government Superannuation Fund Authority and recommends that the House take note of its report.
Introduction
We have reviewed the performance in the 2001/02 financial year and the current operations of the Government Superannuation Fund Authority. The Appendices to this report set out our approach, our membership, the evidence and advice we received and a transcript from our hearing of evidence. We wish to draw the attention of the House to the following matters.
Government Superannuation Fund Authority
The Government Superannuation Fund Authority (the Authority) was established as a Crown entity on 2 October 2001 by the Government Superannuation Fund Amendment Act 2001 and is governed by the Government Superannuation Fund Act 1956 (the Act). It manages the Government Superannuation Fund (the Fund), which currently has nearly 27,000 contributors and nearly 47,500 annuitants. The Fund had previously been administered by the Ministry of Economic Development.
While the Fund was closed to new members in 1992, it remains liable for benefit payments out for the next 60 years. The Act defines and guarantees the level of benefits paid to beneficiaries, and the Crown underwrites payment. As only approximately one-third of the benefit liabilities are covered by the assets of the Fund, the Crown must cover the remaining payments as an unfunded past service liability, which appears in the Crown Financial Statements. In the year ending 30 June 2002, this liability was $8,923 million, an increase of $436 million over the 2001 liability.
Prior to the establishment of the Authority, the Fund was invested in New Zealand Cash (23.2 percent) and New Zealand Fixed Interest Bonds (76.8 percent). The Authority is currently working towards establishing a diversified investment portfolio. By 30 June 2003, it is intended that the Fund be invested in New Zealand Fixed Interest Securities and Cash (14.0 percent), New Zealand Equities (12.5 percent), International Equities (52.5 percent) and International Fixed Interest Securities (21.0 percent).
The Authority does not retain significant in-house investment activities, but outsources these activities to investment managers to increase the level of expertise available to the Authority and to minimise the risk of personnel change. The schemes are administered by AXA New Zealand and JP Morgan Chase acts as custodian. The Authority has also established a joint venture with the Board of Trustees of the National Provident Fund (NPF) creating a company, Annuitas Management Ltd (Annuitas). This arrangement was reached as a means of achieving cost efficiencies through shared management between the two entities. Annuitas provides secretariat and executive services to both the Authority and the NPF under an arms-length service agreement.
Investment strategy
The Act requires the Authority to invest the Fund on a prudent commercial basis, consistent with best practice portfolio management, in order to maximise returns without causing undue risk to the Fund as a whole. The policy objective governing the investment strategy is to use investment diversification to maximise returns and reduce the Government’s unfunded past service liability.
In the year under review, the Authority changed the Fund’s investment strategy and portfolio. Of particular note was the investment in international equities, where the Authority had invested 33.2 percent of the Fund by year end. The Fund suffered a $242 million unrealised loss on its investment in international equities in the year, but the Authority claims much of this loss came from the final quarter between 1 April and 30 June 2002. We are also informed that the Fund has continued to experience losses, losing $135 million in the three months to 30 September 2002. However, the Authority estimates that the investment will have made a $96 million gain in the month of October 2002.
Given the significant losses suffered by the Fund, and the increase in unfunded past service liability that resulted from these losses, much of our examination focused on the appropriateness of the policies underpinning the Authority’s current investment strategy.
Larger market
The Authority highlighted what it believes are the benefits of investing in overseas markets. Investment in the New Zealand market solely would offer similar returns to international investment, but would involve a significant small market risk. The New Zealand market only offers 30 companies for the Fund to be invested in, resulting in greater risk and volatility. As an example, we were pointed to a recent instance where the New Zealand sharemarket suffered a three percent reduction in one day because of unfavourable announcements relating to only two companies. A wider investment strategy involving six markets offers 700 companies for the Fund to be invested in. It also reduces risk by ensuring that the Fund is not subject solely to the economic and market cycles of one single economy and can invest in a wider number of industries than are available in New Zealand. Over the long term, the world market will be significantly less volatile than the New Zealand market.
Long term view
The Authority emphasised the importance of adopting a long term view when looking at the investment performance of a superannuation fund. There is recognition of some short term risk that the unfunded past service liability will deteriorate in any year due to market volatility. However in the long term, a diversified portfolio should offer greater returns for the Fund than investment in Government bonds. The Authority predicted that, over a ten year rolling period, a diversified portfolio should offer a return of three percent above the return offered by Government bonds.
Managing a superannuation fund requires a balance between long term objectives and short term risks. Therefore, the Authority argues that, while its overall investment strategy is reviewed annually, it is premature to reach specific conclusions or make reactive decisions based on one year’s result. It also suggests that substantially changing its portfolio intentions because one bad investment year has resulted in unrealised losses would be comparable to selling the family home because of a decrease in the government valuation.
Investment in New Zealand economy
Some members are concerned that the Fund invests substantial funds overseas that could be invested in New Zealand to the country’s benefit. They suggested that if the targets for investment internationally were reduced from 73.5 percent to 40 percent, this would offer over $1 billion that could be invested into the New Zealand market and economy, increasing the level of capital available for businesses to access. The Authority noted, however, that the Act specifies what the Authority must have regard to in determining its investment policy. The Authority is required to establish an investment strategy that will in the long term minimise the level of unfunded past service liability paid by the Crown, and maintaining a substantial level of international investments offer the best opportunity to minimise this liability. The Authority is not required to have regard to the macroeconomic needs of New Zealand when making investment decisions.
Timing
We discussed with the Authority whether the entry into the international equities markets could have been better timed. The Authority disputed this proposition. While the markets have continued to fall following the investment, at the time it appeared that the market was in an ideal position for entry. Investment decisions were made based on the best advice available, considering expectations of future market activity based on past performance. At the time of investment, the international equities market was at a level approximately 30 percent below the previous peak (which had occurred two years earlier). It therefore appeared reasonable to believe that the market decline would soon end, the investment value would rise, and this was therefore an appropriate time to invest in international equities. In hindsight we can see the Authority was unfortunate to enter the market when it was subject to its worst performance since 1929, but this could not have been foreseen.
Review process
The Act requires the Authority to conduct an annual review of the investment policies, standards, and procedures governing the Fund, to ensure they continue to be appropriate. Preliminary work on this review commenced two months ago. The scope of the review has been defined and the review obligations of the prime adviser have been established. Currently, work is progressing on making arrangements for peer review, establishing areas to be reviewed and timetabling of the process. The review is likely to be completed in February or March 2003.
The review will be considering the assumptions underlying the investment policies, whether there is any evidence of changes to the traditional risk/return relationships, different strategies necessary to address issues in the markets, and whether changes need to be made to risk and the tolerance of risk. It is too early to know whether there are likely to be changes to the policies as a result of the review.
Hedging arrangements
We were interested to learn about the hedging arrangements taken by the Authority to protect itself against foreign currency movements. All international fixed interest bond portfolios are fully hedged while the capital currency exposure of international equities is 50 percent hedged after tax. We note the Authority made its first international equity investment in November 2001 but only started hedging its currency exposure from 1 April 2002. The Authority has decided not to fully hedge against currency movements based on an assumption that, in the long run, equity returns will dominate currency returns. Any volatility caused by currency movements will not ultimately be material.
Annuitas
We discussed the varying roles of both the Authority and Annuitas, the joint venture company established between the Authority and the Board of Trustees of the NPF. The division of roles between the Authority and Annuitas appears to be reasonably defined. The Authority is responsible for setting the investment policies, allocation of assets, selecting investment managers, and establishing mandates governing the performance of investment managers. Annuitas has a role in implementation of board decisions, supervision of the performance of investment managers, as well as reporting and offering recommendations to the Authority.
We also asked the Authority whether there is any connection between Annuitas and the Guardians of New Zealand Superannuation, established under the New Zealand Superannuation Act 2001. We are informed that Annuitas has been contracted to provide initial secretarial services to the Guardians while that entity is being established. However, there is no long term connection between Annuitas and the Guardians.
Ethical investment
The Act requires the Authority to manage and administer the Fund in a manner that will avoid prejudice to New Zealand’s reputation as a responsible member of the world community. The Authority is currently developing a framework that will assist it to understand the meaning and obligations of this requirement and to determine key ethical issues to consider when investing. Following this, a revised policy on ethical investment will be released, including standards that will cover both corporate and sovereign investments. The Authority is satisfied that its current investments are consistent with the requirement for ethical investment, and plans to further develop its ethical investment policies in the future beyond the strict technical requirements of the Act.
Conclusion
The majority of us are generally satisfied with the performance of the Authority in the period under review, and believe it has generally operated according to recognised best practice. We agree that the Fund has had a disappointing result in the past year, but do not believe this necessarily equates to poor performance on the part of the Authority. We believe that the performance of superannuation fund investments should not be considered on the basis of an unfortunate result in one year, especially if the losses are unrealised. Instead, recognising that superannuation funds are long-term investments, we believe that criticism of the performance of the Authority can only come after the Fund has been subject to a longer term of investment underperformance. At the same time, we note that the Authority has listened to concerns expressed by committee members and has agreed to consider several areas of concern as part of the annual review of investment policies. We hope to see an improved performance of the Fund’s investments in coming years.
Green Party minority view
However, the Green Party member disagrees with our conclusion, and is not satisfied with the performance of the Authority in the period under review because he believes it has failed to achieve its own objectives. The poor performance of the Authority in its first year has reinforced the Green Party’s original concerns expressed at the time the Authority was established.
According to the Authority’s Annual Report it took over an investment portfolio of $3.518 billion on 2 October 2001. In eight months that portfolio had reduced in value by $266 million to $3.253 billion. This was primarily because of unrealised losses on international shares.
The Authority confirmed that the deterioration of the unfunded past service liability (UPSL) as a result of factors within the control of the Authority was $253.5 million. In the member’s view, this puts in jeopardy the Authority’s risk objective of ‘no more than one year in six (17 percent) chance of an unexpected deterioration in the UPSL of more than $200 million’ and calls into question not only the Authority’s investment strategy but also its ability to respond to market signals in a timely fashion.
Further, he believes that the Authority has failed to meet its own first general objective of a well-managed investment portfolio that has ‘risk characteristics such that there is a low probability of a substantial impact on the Crown accounts in any one year’.
The member is particularly concerned that despite this poor performance the Authority has confirmed its target of investing 52.5 percent of the Fund in international equities is still appropriate and further that it has not yet revised its investment return target of 9.6 percent on those equities. In his view there can be no justification for the Authority to hold these positions when it provided information that income from interest and dividends for the quarter to 30 September 2002 was only $23 million (compared to $234 million for the 2001 financial year) and that the net market value of investments from the same quarter had deteriorated by $152.8 million, including unrealised losses on international equities of $146.3 million.
The Green member does not accept the view of the Authority that it was ‘unfortunate to enter the market when it was subject to its worst performance since 1929’ and instead believes it was imprudent and irresponsible of the Authority to progressively invest over $1 billion on the international share market after September 11, after the collapse of Enron and even after the collapse of WorldCom.
The Green member has no confidence in the ability of the Authority, its investment adviser Frank Russell, or its investment managers to achieve the Authority’s investment objective of a 7.1 percent rate of return after tax. That is because he does not share the Authority’s expectation that equities will out perform fixed interest over this ten-year period. At a minimum, he believes that the Authority should halt further disposal of Government Bonds and investment of that money in overseas shares until it has completed its annual review of the statement of investment policies, standards and procedures.
APPENDIX I
Approach to this financial review
Committee members
Clayton Cosgrove (Chairperson)
Gordon Copeland (Deputy Chairperson)
Dr Don Brash
David Cunliffe
Rod Donald
Rodney Hide
Luamanuvao Winnie Laban
Janet Mackey
Craig McNair
David Parker
Rt Hon Winston Peters
Dr the Hon Lockwood Smith
Evidence and advice received
In addition to the 2001/02 annual report, we considered the following evidence and advice during this financial review:
- 2001/02 financial review of the Government Superannuation Fund Authority, Audit Office briefing to the Finance and Expenditure Committee, dated 6 November 2002
- Government Superannuation Fund Annual Report, presentation to the Finance and Expenditure Committee, dated 6 November 2002
- Responses from the Government Superannuation Fund Authority, dated 6 November 2002
- Responses from the Government Superannuation Fund Authority to additional questions from the Finance and Expenditure Committee, received 11 November 2002
This is a copy of the Finance and Expenditure Select Committee report on the Government Superannuation Fund Authority
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