Fiscal Policy Frameworks: Monetary Policy Implications, and Intergenerational Financial Funds

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Fiscal Policy Frameworks Monetary Policy
Implications, and Intergenerational Financial
Funds
Adrian Orr Chief Executive Officer 24 August 2007
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Outline for today

• Objectives and structure of the New Zealand
  Superannuation Fund
• Strategic Asset Allocation
• Challenges Ahead

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New Zealand Superannuation Fund

• Crown financial institution
• Began investing nearly four years ago
• FUM currently around NZ13 billion
• Projected to be over NZ30 billion in five years
• Total staff now 31
• Including seven investment policy staff

Purpose is to smooth the cost of New Zealand
superannuation
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Demographic shift underway
Source New Zealand Treasury
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Demographic bubbleSmoothing superannuation
costs over time
Source New Zealand Treasury
(Year ended 30 June 2006)
8
7
6
5
4
Percentage of Nominal GDP
Net NZS Expenditure
3
Capital Contribution Plus Net NZS Expenditure
2
1
0
2007
2013
2019
2025
2031
2037
2043
2049
2055
2061
2067
2073
2079
2085
2091
2097
2103
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Governance arrangements of the NZSF

• A clearly defined portfolio of Crown financial
  resources
• Property of the Fund
• - Clearly defined in legislation
• Capital contributions
• - Transparent funding process set out in
  legislation
• Capital withdrawals
• - According to legislated algorithm
• - From late 2020s
• Policy credibility and commitment by establishing
  legislation

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Governance arrangements of the NZSF (Continued)

• managed by an independent governing body
• Separate Crown entity Guardians of New Zealand
  Superannuation
• Independent nominating committee for board
  membership
• Expertise requirement for board membership (not
  citizenship)
• Ministerial directions must be consistent with
  boards duty, be published, and board has regard
  to them
• Conflicts of interest handled through disclosure
  (and securities legislation)

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Governance arrangements of the NZSF (Continued)

• and clear accountability
• Statement of investment policies, standards and
  procedures
• Audited financial statements
• Independent performance review
• Official Information
• Statement of Intent and Annual Report

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Legislative objectives of the NZSF

• The Guardians . must invest the NZSF in a
  prudent, commercial basis, and in doing so, ..
  consistent with
• Best-practice portfolio management and
• Maximising return without undue risk to the
  Fund as a whole and
• Avoid prejudice to New Zealands reputation as a
  responsible member of the world community.

Add-value by returns gt risk-free rate
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Strategic Asset Allocation

• The Funds comparative advantages include its
• Long-term investment horizon matching long-term
  liabilities
• Ability to invest across the near full range of
  asset classes globally and
• Liquidity risk premium due to no capital
  withdrawals until at least 2020
• Key decision
• Mix of markets and assets that the Fund will on
  average be exposed to

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Distinguishing characteristics of New Zealand
Superannuation Fund

• Long-term horizon
• Little need for liquidity
• Long-dated real assets more appealing given
  Funds smoothing role
• Tax status

Key Factors shaping the asset allocation
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Long-term Strategic Asset Allocation
Emerging
Markets
Global Small-
Equities, 2.0
Cap Equities,
6.0
Property (NZ
and Global),
10.0
New Zealand
Equities, 7.5
Private Markets,
Commodities,
20.0
5.0
Global Large -
Fixed Interest,
Cap Equities,
15.0
34.5
Listed Equities
Other Growth Assets
Fixed Interest
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Key modeling results 30 years(versus
liabilities)

• Expected value added 21 2037 GDP
• Downside standard deviation 14 of 2037 GDP
• Probability negative value added 8

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Risk depends on time horizon
Return Volatility (Annualised Standard Deviation)
0
5
15
30
10
25
20
Horizon (years)
Correlations also horizon dependent
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Some simulation results
NZSF Estimate
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Investment process - evaluation

• Evaluation Process
• Quantitative increment to total Fund risk-return
• Alignment managers/counter-parties
• Uniqueness and re-investment options
• Implementation risk?

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Investment process - approvals

• Approval Process
• Basic model is to appoint, align and delegate
• Executive gt Investment Committee gt Board
• Must pass
• Legal
• Tax
• Financial / Accounting
• Investment hurdles

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Our performance to date

• Fund size 13.3 billion as at 31 May 2007
• Returned 15.30 p.a. since inception (Sept 2003),
  against risk free rate of 6.45.
• Diversification is on track
• But
• Many markets are full priced and volatile
• Everyone is chasing private markets and alpha
• Need to be able to take advantage of stressed
  asset prices

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Market performanceFour consecutive strong and
stable years(NZSF current portfolio back-cast
on historical data pre-2003)
Annual return
Average annual return 4.3 Standard deviation
9.9 A 10 standard deviation 1.2bn in
returns for the Fund
Excess return relative to risk-free rate
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Challenges ahead

• Organisation transition
• From development to established institution
• Building scalable processes to achieve
  sustainable excellence
• Managing sustainable growth
• Management complexity (investment discovery,
  assessment, implementation, relationships)
• Employing skilled people

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Implications
Conclusion
NZSF Example

• Inter-temporal smoothing
• Compensate government for investment
  risk
• Compare versus risk-free alternatives

1) Be clear about objectives

• Forward looking returns
• Monte Carlo balance sheet impact

• 2) Consciously decide what risks
• are worth bearing

• Look beyond headline returns
• Avoid agency issues

• Risk-adjust all investments

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Fiscal Policy Frameworks Monetary Policy
Implications, and Intergenerational Financial
Funds
Adrian Orr Chief Executive Officer 24 August 2007