Title: Fiscal Policy Frameworks: Monetary Policy Implications, and Intergenerational Financial Funds
1Fiscal Policy Frameworks Monetary Policy
Implications, and Intergenerational Financial
Funds
Adrian Orr Chief Executive Officer 24 August 2007
2Outline for today
- Objectives and structure of the New Zealand
Superannuation Fund - Strategic Asset Allocation
- Challenges Ahead
3New 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
4Demographic shift underway
Source New Zealand Treasury
5Demographic 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
6Governance 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
7Governance 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)
8Governance 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
9Legislative 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
10Strategic 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
11Distinguishing 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
12Long-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
13Key modeling results 30 years(versus
liabilities)
- Expected value added 21 2037 GDP
- Downside standard deviation 14 of 2037 GDP
- Probability negative value added 8
14Risk depends on time horizon
Return Volatility (Annualised Standard Deviation)
0
5
15
30
10
25
20
Horizon (years)
Correlations also horizon dependent
15Some simulation results
NZSF Estimate
16Investment process - evaluation
- Evaluation Process
- Quantitative increment to total Fund risk-return
- Alignment managers/counter-parties
- Uniqueness and re-investment options
- Implementation risk?
17Investment 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
18Our 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
19Market 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
20Challenges 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
21Implications
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
22Fiscal Policy Frameworks Monetary Policy
Implications, and Intergenerational Financial
Funds
Adrian Orr Chief Executive Officer 24 August 2007