Unlocking the secrets of New Zealand’s super-duper sovereign wealth fund #NewsMarket

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The world is awash with Sovereign Wealth Funds. And with trillion-dollar whales like China’s CIC or the Norwegian Oil Fund Government Pension Fund Global it’s easy to overlook some of the minnows.

Take New Zealand. With AUM of NZ$75bn (US$46.5bn), the NZ Super Fund is only a quarter of the size of neighbouring Australia’s Future Fund.

Let’s show that with some utterly over-the-top dataviz — have a poke and prod the chart below to explore (mobile treemap version here, desktop radial version here):

With NZSF chief investment officer Stephen Gilmore having departed to take one of the worst (and biggest) jobs in finance, leading CalPERS, we thought we’d take a peek under the bonnet of his former employer.

Back in the late nineties, New Zealand reckoned its ageing population might one day put a big strain on public finances. So just like the Canadians and Swedes, they set up a fund to help with the demographic transition. They call it shifting from Pay As You Go to Save As You Go. They hope it will pay for around 20 per cent of the costs of the state’s old-age retirement bill. In what we can only understand as a nod to Tolkien, the government christened the fund managers tasked with handling this money “the Guardians”.

How’s it worked out for them? Pretty amazingly. Since 2003, the government says NZSF has contributed around NZ$25bn. A compound return close to 10 per cent per annum since inception has seen them triple their money:

Contributions aren’t free though. The New Zealand government could’ve used the money it contributed to the Fund to retire debt instead (or indeed not issued debt to fund contributions). So it’s reasonable to ask how NZ Super Fund returns stack up against its cost of financing. The Fund’s most recent annual report calculates the results as, again, pretty amazing: excess returns of just over NZ$41bn since inception.

Was this a Market Goes Up thing, or has there been something more to it? Usefully, the NZ Super Fund also shows its performance against a Reference Portfolio. We don’t know how this Reference Portfolio has evolved over time, but we do know that it’s currently 80 per cent equities and 20 per cent global fixed income. And that the Fund has beaten the relevant benchmarks pretty handily:

In fact, according to GlobalSWF — which tracks the activities of state-owned investors — NZSF is the single best performing SWF over the last ten years.

How did they do it? Almost as if to annoy Robin: with ever-increasing proportions of active management. Passive used to be around three quarters of the Fund, but is now down to around only half of it:

Some — maybe most — of the active management is external. And they seem to love global factor investing, although note that the groupings in the treemap below are FTAV’s best guess categories based on mandate description rather than labels assigned by NZ Super Fund:

All that external management doesn’t come cheap. NZSF’s CEM Benchmarking peer-ranking study puts external management costs at NZ$185mn per annum, of which hedge fund fees account for a cool NZ$123mn. Then there’s the further NZ$202mn they paid out in private asset performance fees. Total investment costs (excluding private asset performance fees) were just over 50 basis points of asset value, about two and a half times the proportion spent by CalPERS:

But if hefty fees deliver supernormal performance, that doesn’t seem like a bad thing.

Is this the deal? Is the secret to NZ Super Fund’s success constructing a carefully-chosen set of fiddly active mandates around some core passive building blocks?

The best answer we could find appears in the fund’s latest annual report, and you can be forgiven if you find it as confusing as we did at first glance:

In their words, the graph shows

…how each of our investment opportunities has performed over the past five years… The vertical axis represents the percentage returns each opportunity has delivered relative to its proxy. The horizontal axis represents the average amount of active risk we have allocated to each opportunity over the same period. The opportunities that sit above 0% have provided value above the Reference Portfolio, and those above the green line have performed above our long-term return expectations during the measured period. Historically, total portfolio performance has benefitted from the Guardians allocating the most active risk to the best-performing opportunities.

Of course, we don’t really know how the proxies against which the performance is measured are constructed, and that seems important.

But most of the dots, each representing a strategy, look like they added or lost maybe single-digit basis points of active return contribution over the past five years. And most of them have positive values. Developed Market Equity MultiFactor has just about broken even despite consuming a fair chunk of active risk. Infrastructure (Development) Tactical Credit and Timber have worked out pretty well.

But the standout is Strategic Tilting (up in the top left). This strategy is responsible for the lion’s share of the Fund’s outperformance of its reference portfolio over the past five years.

What is Strategic Tilting? We had to Google it. It turns out to be a term used pretty much entirely to describe an internal derivatives sleeve, overseen by outgoing CIO Stephen Gilmore. Luckily there’s a whole section on the fund’s website dedicated to giving us more detail about its investment process, with helpful insights like this one:

To add value, we aim to buy low and sell high. So the Guardians acts in a contrarian manner: we buy when others want to sell, and sell when others want to buy.

So, is it a macro-punting derivative overlay? NZSFdescribe it in this white paper as a ‘mean-reversion strategy’, where the means are their team’s estimations of market fair value, and the position sizes increase the further the market is from the team’s estimation. So, for example, in 2013 the Fund found itself with a short NZ dollar position that grew and grew as it became more and more out of the money until it reached nearly 40 per cent of NAV of the Fund in size. It came good in the end. (Yay.) So yes, it appears very much like a macro punting derivative overlay.

Over half a decade, this strategy of (excuse the jargon) buying low and selling high looks to have produced around two-thirds of the Fund’s excess return against its Reference Portfolio/benchmark. And since the strategy’s inception in 2009 it has added NZ$4.6bn to the NAV in performance.

Not bad.

The prospect of CalPERS building an FX position worth 40 per cent of its mighty AUM in the stubborn belief that the trade will come good in the end would be fascinating to watch. Sadly for us though, it seems vanishingly unlikely that the prospect of running a massive macro overlay will be included in Gilmore’s new brief.