Borrowing could boost fund's impressive returns

Friday, April 29th 2011, 11:40AM 2 Comments

The NZ Superannuation Fund’s results for the 12 months to March 31 were truly impressive I thought and also an interesting lesson in investing. While some media reports focused on the month of March (a return of 0.41%), the real story was the 23.04% return for the year. It also brought up the question of whether the government should be contributing to the fund or not at the moment. Radio NZ asked me the question and I said that they should still continue to contribute, maybe not at the rate used previously, but they should continue to do so. Part of my argument was that if the government is expecting individuals to save for their retirement, despite the tough economic times, then it should lead by example and continue to save. There are bigger arguments around this idea. Of course they are economic. The main argument is that any contributions would be borrowings. The government already borrows too much at the moment and its interest bill is too large. I guess one could be pedantic and say borrowings are only part of the government’s finances and that money is used for other purposes. Things like plastic whaka, America’s Cup funding, BMWs etc and that contributions to the fund come from other government revenue. However on a bit more serious note if we considered the contributions as borrowed money is that really a bad thing with this sort of performance? I haven’t done the maths but a bit of leverage in the fund, especially when the markets are rising (and interest rates are low) could be beneficial. It is important to put the borrowing into perspective. Overall it would only be a small portion of the $19 billion fund and when you have performance like the past year then it would be a positive investment outcome. I thought it was useful too looking through the fund’s major holdings. While it has been acquiring long term assets it also appears to have a focus on infrastructure and income producing assets too. While there can be a discussion around the contribution question, the fund is also useful to illustrate to investors the importance of a diversified portfolio, the need for equities and how being in the markets, especially after a big downturn, can provide good returns.

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Comments from our readers

On 30 April 2011 at 12:36 am Lincoln said:

Hi Phil, not relating to your blog above but replying to your comment today..

"It's a bit tragic that Kiwis are so risk adverse and have this fixation with income generating assets. A couple of pieces on the site this week made me think of this issue and wonder how we can change people's attitude".

Personally, I know nothing about the sharemarket, hence I have not put a penny into it. I am not risk averse but i'd have to be stupid to invest in something which I knew nothing about, don't you? And even if I learned about it, my personality type would constantly worry about the performance of my shares and would track it several times a day.. and that does not excite me one bit.

On the other hand, we started in 2001 with a net worth of $80,000 in our family home worth $200,000. Within 7 years we had grown that to 15 properties worth $4.5 million, and with mortgages of $3.5 million, makes our net worth $1 million. I would challenge you to do that with shares. Starting with the same $80,000 and invested over ANY 7 year period in the sharemarket over the last 50 years. It is called leverage.. buying an INCOME PRODUCING ASSET which makes it cashflow neutral from day one. AND, the kicker? When properties double over the next ten years (historical fact, and the next ten will be no different), our values go to $9 mill, mortgage stays at $3.5 mill.. our $1 mill turns into $5.5 mill.

Personally, i'd actually call that smart and if it IS a fixation, I have no problem with that. Cheers, Lincoln :O)

On 30 April 2011 at 10:31 am Forthright said:

A bit of leverage is OK when the markets are rising and interest rates are low. I suppose I could agree with low interest rates, but markets are rising! For how long? Nobody, especially Journalists, would know.

It is all very well being gung-ho about leverage when you are coming off FYTD +23% returns. But this sure isn’t the best time to consider leverage. The best time for adding leverage was during the depths of the GFC when borrowing money was near impossible and good quality assets could be purchased at ridiculous discounts. I vaguely recall an elderly gentleman from Omaha doing just this and also several USA investment banks using free money to do the same thing and all making obscene and magnificent profits from the leveraging.

The leveraging equation will work if the Super Funds borrowing cost is less than the average absolute return after fees and tax.

There is also the argument the fund is already leveraged by virtue of investing in shares of companies which use leverage as a natural way of running the underlying companies activities.