Super Fund reports success of active management strategy

The fund returned 14.64 per cent after costs and before tax in the year to June 30.

“The past year has continued a pattern of very strong, above-market returns by the Fund. These returns – 16.8% p.a. over the last five years – are the result of disciplined and consistent investing.

“Returns in the 10%-20% range are at the higher end of our expectations and will not continue indefinitely. Over the long term we expect the Fund to earn, on average, 8%-9% p.a.”

He said the fund’s active strategies had been successful, particularly its strategic tilting programme. It was for some time tilted heavily towards growth assets, beyond its standard 80% growth to 20% fixed income composition..

The fund exceeded its passive reference portfolio benchmark by $1.15 billion, or 4.45% over the year.

The Guardians expectation is to add value above the reference portfolio of about 1% per annum over the long term.

“These results provide a strong endorsement of the Guardians’ ability to add value, after all costs, compared to a purely passive approach to funds management,” Walker said.

The fund also exceeded its second performance benchmark, the Treasury Bill return, by $2.9 billion (11.14%) over the year. The Treasury Bill benchmark is a measure of the cost to the New Zealand Government of contributing capital to the fund instead of paying down debt.

Chief executive Adrian Orr acknowledged global markets were experiencing increased volatility and uncertainty. Global equity markets fell -6.49% in August.

“It is normal to see considerable volatility in our monthly and indeed annual returns. We remain focused on our long-term strategies. As an agile and highly liquid investor, we are well positioned to manage short-term volatility, and will look to take advantage of market disruptions as they occur.”

The Guardians recently re-committed to a long-run 80% growth, 20% fixed income reference portfolio composition.

“Given the fund’s long time horizon – it will keep growing until 2080 – this strong weighting to growth assets is appropriate,” said Orr.

Comments from our readers

On 16 September 2015 at 12:59 pm Brent Sheather said:

Hmmm. Success of active management strategy? 14.6% after costs, pre-tax for the June 30 year. That doesn’t sound that flash. The world stockmarket returned 30.5% in that period and the world bond market returned 19.3%. Given an 80/20 weighting, equities versus bonds, that is a weighted average return of 28.3% pre-fees, pre-tax which a robot could have done. Hope not too many people are getting big bonuses based on outperforming an unrepresentative benchmark.

On 16 September 2015 at 7:50 pm Kimble said:

That's some pretty weak analysis, Brent.

No, world stock and bond markets did NOT return 30 and 20 percent respectively for the year. The NZ Dollar returned somewhere between 15 and 25 percent. (Which is what happens when the NZD drops from 0.88USD to 0.68USD.)

And wouldn't you know it, the NZSF's benchmark is set at 100% currency hedged and has been for years.

Stripping out currency movements global shares did about 8.5% (plus a couple percent in hedging gain for NZers), and global bonds did about 7% (including the hedging gains).

Which means the NZSF's back-of-the-envelope benchmark hurdle comes out at around 10 percent, or roughly two thirds lower than your "representative benchmark".

I am sure there is a debate to be had on the currency positioning of the NZSF and its benchmark. But I would have expected someone who wanted to weigh in on THAT debate to have at least mentioned currency in their opening salvo. Certainly before they offered their opinion on what other people should be getting paid.

On 17 September 2015 at 8:58 am Brent Sheather said:

Thanks Kimble

The fx policy of the NZ Super Fund was actually the thing I was highlighting. That’s why I described their benchmark as being unrepresentative. If you check out the following story “You can trade your way over the fx cliff”, NZ Herald, you will see that there is a good argument that hedging fx actually increases risk rather than reduces it. Mum and Dad, living in NZ, are actually short the US dollar just by virtue of being alive. Investing overseas, unhedged, hedges that short.

Also from memory the Super Fund only hedges 50% of its equity portfolio. Certainly I can see why, in a period when the NZ$ has been so weak, the reason that the pro hedging fraternity would be so upset at any discussion questioning the fundamental rationale for hedging.

Incidentally whenever I see your name “Kimble” I have a bit of a laugh. At Whakatane Intermediate School the Headmaster had one arm and the “bros” used to call him Kimble after some shady one armed character off “The Fugitive”.

Regards
Brent Sheather

On 17 September 2015 at 9:32 am R1 said:

As a hopeful future beneficiary of the fund I want to know what it returned in NZ$ terms. Also what is the point of a long term fund 100% hedging its offshore investments? Taking a 2% currency gain for hedging looks like poor management to me. Perhaps Brent and Kimble can explain their perspectives and see which is the sensible approach for a fund such as NZSF.

On 17 September 2015 at 12:02 pm Kimble said:

Brent, you didn't mention currency at all in your first comment, so don't try to claim now that that is what you were highlighting. But I knew that is what you would try and say; reread my final paragraph, reprinted here for convenience:

"I am sure there is a debate to be had on the currency positioning of the NZSF and its benchmark. But I would have expected someone who wanted to weigh in on THAT debate to have at least mentioned currency in their opening salvo. Certainly before they offered their opinion on what other people should be getting paid."

No, you were complaining about the active management NOT the currency position, and you were (mis)representing the difference between your fantasy benchmark and the NZSF returns as a deficiency in that active management.

On 17 September 2015 at 12:13 pm Kimble said:

R1, I am not interested in getting into a debate about currency hedging. I just dislike it when people try and pull one over on casual readers.

Note however, that the 100% currency hedging is in the benchmark only (called the Reference Portfolio). That is set by the Board, not the investment or portfolio managers. Keep in mind the different goals and responsibilities of the NZSF. The Boards assumption might be that the 2% premium for NZ hedger's sufficiently covers the difference in the expected (very!) long-term returns from being hedged or unhedged.

On 17 September 2015 at 1:11 pm John Berry said:

Brent - enjoy your comments but find your views on currency hedging a bit binary. To me the question is not "is it right to be 100% hedged at all times or completely unhedged" (which is how you like to frame it). The question should be "at this point in time with a 1 year or 3 year (or whatever period) horizon do I have a view on where the currency may go?"

The next question is what does this mean for my equity portfolio? May be I see international equities as expensive which may encourage a bias to being unhedged (as generally when international equities fall, the NZD falls).

The question of whether I should be 0%, 50%, 100% or some other % hedged may have a different answer in different years and market conditions. Some managers in international equities were more hedged than unhedged as the NZD went into the mid 80s vs the USD, and then were predominantly unhedged as the NZD dropped to the mid 60s. Don't we want to generate the best outcome for our investors - which may mean adjusting views (like hedging) if circumstances change. That one currency hedging ratio change in 4 years has been a huge benefit for investors :)

On 17 September 2015 at 3:13 pm Brent Sheather said:

Hi John
There are two issues here, as always, return and risk. You seem to be focussing on return. Given that currency forecasting is a little uncertain to put it mildly I focus on risk and as I said earlier an unhedged portfolio hedges the risk. End of story. I went down this road with the Super Fund a few years ago but they seem to like to pick up the interest differential. The true test for “hedgers” will be if US short term rates exceed NZ short term rates and there is a negative carry. In that scenario I suspect most people will suddenly change their view on the appropriateness of hedging!

Regards
Brent Sheather

On 17 September 2015 at 4:54 pm Peter Urbani said:

A wise old broker, back when there were still such people, once told me that you should keep 50% of your wealth in your home currency because 1) You never know what might happen and 2) You will be spending local currency in retirement. These days the thinking is that because most people have a large chunk of their wealth in property you should have as much offshore as possible but to my mind that violates the anything can happen principle.

On 18 September 2015 at 9:13 am John Berry said:

Hi Brent

I agree with your Herald article that short term currency trading is dangerous - ending badly for most. But I don't think this tells us anything about appropriate medium / long term equity investment hedging. It just tells us not to be currency day traders.

The hedging discussion should be research based. You argue spending of NZers is based on commodities denominated in USD - is there research proving this means NZ investors' offshore equity investments should always be unhedged? Love to see the research.

You and I also agree that "currency forecasting is a little uncertain to put it mildly". Yet you take an extreme high conviction position (being fully unhedged at all times) - you're forecasting which way the currency will go - and yet you say no one else can forecast it?

Regards
John

On 18 September 2015 at 11:10 am Brent Sheather said:

Hi John

Yes I agree the hedging discussion should be research based. My firm hired Infometrics in Wellington to do that analysis and whilst I have the hard copy the soft copy of the report is long lost. They concluded that a high proportion of spending was denominated in US$ just as commonsense would suggest. As you know lots of things we consume are priced in US$ and if the NZ$ weakens the local price is the export equivalent price less transport costs. I don’t forecast which way the currency will go – simply hedge my short.

Hope this helps.

Regards
Brent

On 18 September 2015 at 1:49 pm John Berry said:

Thanks Brent

understand where you are coming from "hedging a short position". But isn't the short position different for every consumer? Some spend more than others each year. Some are young and so have many more years of future consumption ahead (vs older investors). Some already have larger hedges than others (US$ assets offshore) - in fact some may have so much invested offshore that they are overhedged in relation to their future consumption!

If you were truly hedging the US$ short of each investor you would calculate the actual size of the short for each. You'd then know what you were hedging. But you just use "a one size fits all" by leaving everyone fully unhedged at all times - not convinced of your logic

Regards
John

On 18 September 2015 at 3:36 pm Brent Sheather said:

Hi John

Thanks for that. Agree that the short position is different for everybody but the common denominator is that most people are short. Agreed?

So my question for you is – if you accept that most people are short US$ why does the industry as a whole advocate hedged overseas exposure? I acknowledge that maybe one in a hundred investors already have US dollar assets offshore but if these people present in my office I accommodate this fact in their asset allocation.

So it’s the NZ industry that uses “a one size fits all” strategy by hedging when the facts by and large support an unhedged position - correct?

Any analysis is going to be an abstraction of reality but unhedged more closely incorporates the reality of liability matching than hedged, doesn’t it!!

Actually quite sad that with all the resources the fund management industry has they get the wrong answer on hedging but I’m sure there is a good reason for that. Maybe it relates to the needs of the manager rather than the managed.

Regards
Brent Sheather

On 18 September 2015 at 4:43 pm John Berry said:

Hi Brent

Fund managers do not ask each unitholder if they are short US$ and then construct a fund portfolio to match needs and circumstances of investors. The fund manager's role is to provide the best risk / return exposure for a given asset class. Advisers then decide if that exposure is suitable for the needs of a particular investor.

You seem to think all fund managers are 100% hedged all the time - that is simply wrong. Some are unhedged all the time, some have a fixed hedge (i.e. 50%), some fully hedged, some vary their hedge depending on valuations and some have nuanced positions like hedging 100% Yen back to US$ but not fully hedging US$. There is no consistent industry practice.

For my fund a (roughly) 75% hedge until mid 2014 (mid 80s vs USD) and then reducing to (roughly) 25% since, has been far superior to an unhedged investment. Perhaps we can simply agree that when it comes to risk and return there is no single right answer....

Have a good weekend.

Regards
John

On 22 September 2015 at 2:35 pm Graeme Tee said:

Hi John Berry

I am intrigued by your comment that advisers decide an apporpriate hedge for a client and fund managers have hugely diverse and dynamic hedging strategies. Ive looked at a few (not all) managers and they have the ability to fully hedge or not hedge at all.

If an adviser sees a move in hedging strategy that implies their client should move out of that fund, does it not? This would encourage a lot of churning and additional costs in moving from fund to fund as the manager announced their change in hedging strategy. This would all be done after the fact because managers don’t usually announce these things before they move? This sort of thing could end up costing clients a lot of money when we are supposed to be working from them, aren’t we?

Or should we just trust that “one manager fits all” because currency trading is easy?

Regards
Graeme Tee

Super Fund reports success of active management strategy

The New Zealand Superannuation Fund is celebrating what it says has been a highly successful year for its active investment strategies.

Wednesday, September 16th 2015, 10:48AM 15 Comments

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