Time to wind-up the NZ Superannuation Fund

In their print edition last Friday, NBR ran a piece from me suggesting that it was now time to wind-up the New Zealand Superannuation Fund.  For those with NBR subscriptions, it is now available on line.

I didn’t assign my copyright to NBR or anything of the sort, but I won’t reproduce the full column here.  It was, largely, a much shorter version of a post I did here a couple of weeks ago (and in the process of generating it, I proved to myself again that one reason I write long posts is that short posts take much longer).  But this was the final paragraph.

There is a political debate to be had about both NZSF and about the future parameters of New Zealand Superannuation.  But the two simply aren’t very logically connected.   What NZS policy we run in future depends on all manner of things, including the overall state of the government’s finances.  But the performance of one part of the balance sheet simply isn’t a key consideration.    If it makes sense for governments to run speculative investment management operations, it does so whether or not life expectancies are increasing.   But short of Norwegian quantities of oil and gas being discovered here –  which give the government cash that simply has to be invested –  it is just isn’t a business the government should be in.  Fortunately, the Fund hasn’t done badly over its life to date, but let’s bank the gains, and wind-back the considerable future risks by closing the Fund and using the proceeds to repay government debt.   

In both my recent posts on NZSF (here and here) , I’ve tried to emphasise that those who run it probably haven’t done a bad job in the time they’ve been managing our money.  (Here I should note that the NZSF have pointed out, via a response to someone else’s OIA, that in my first post I made a mistake in annualising the rates of return on the New Zealand stock exchange, a number I had mentioned in passing in that post.  NZSF and I agree –  on this if little else –  that the New Zealand stock returns are not a particularly meaningful benchmark for these purposes.)

NZSF has been charged by Parliament with running a high risk fund, they’ve done that, and over a period in which global asset markets have done rather well, they’ve made quite a bit of money for the taxpayer.  But if the relevant benchmark isn’t the NZSE50, neither it is (as NZSF and its chief executive keep claiming) the Reference Portfolio that the Fund Board themselves construct and adopt.  The latter has some uses inside the organisation, but it is largely irrelevant for taxpayers and citizens trying to decide whether NZSF has (a) done a good job, and (b) should exist at all.

In their own official documents, the relevant performance benchmark is

It is our expectation, given our long-term mandate and risk appetite, that we will return at least the Treasury Bill return + 2.7% p.a. over any 20-year moving average period.

That expectation is hardly ever mentioned when, for example, the chief executive takes to the media.  It didn’t appear in the OIA response I linked to earlier either.

As it happens, the returns to date have been (quite a bit) better than that benchmark –  which is why I’m quite open about the fact that NZSF has probably done a reasonable job, perhaps as good as most other managers with their opportunities might have done.   But after only 13 years, their own official documents tell us that we can’t yet know how much of those returns is down to luck, and how much down to skill.   As they note, when you take as much risk as they do –  really big year to year fluctuations –  it takes a long time to tell.   When global markets are rising strongly it isn’t hard to make money.

Over the life of the Fund, their total returns have averaged around 10 per cent per annum.  As I’ve noted previously, over most of that period the Treasury required government agencies looking at investment projects to use a discount rate of 8 per cent real (or around 10 per cent in nominal returns).  Of course, what discount rate one should use depends on how risky the proposed project is, and what it does to the risk profile of the whole of the owner’s business.  A “high octane” (Orr’s words) investment management subsidiary is risky –  it might not be Wellington aiport runway extension risky or INCIS risky, but it will be riskier than, say, a new school in a growing city.   And these sorts of investment management returns tend to add to, rather than reduce, the variance of the Crown’s overall financial position –  in particular, the biggest losses tend to become starkly apparent in periods when there is the greatest pressure on other government finances (ie in severe global economic and financial downturns).  A 10 per cent (pre-tax) return over the period from 2003 to now –  even though it is better than they expected –  just isn’t that impressive.  And NZSF tell us that even they believe those sorts of returns can’t be expected to be replicated in future –  they tell us we should expect 2.7 per cent above the Treasury bill rate.  Who knows what a “neutral” New Zealand Treasury bill rate is, but even if it is getting up to around 4 per cent, that suggests expected future pre-tax returns of less than 7 per cent.   And there is no reason to think that the variances, or covariances, of the portfolio will be less in future than they have been.    (In recognition of the lower interest rate environment, Treasury now encourages government agencies to use a real pre-tax discount of 6 per cent –  or 8 per cent in nominal terms.)

I could add into the mix the point that few private companies will be using hurdle rates of return of less than 10 per cent in deciding on investment projects, or the acquisition of a subsidiary.  And that is what NZSF is –  a fairly aggressive investment management subsidiary of the New Zealand government (with deteriorating governance/transparency –  eg when a large chunk of a government-owned local retail bank is in the portfolio).

And so my bottom line is that we should be thankful for the reasonable returns we’ve had from NZSF to now (through some mix of luck and skill), but that since we can’t count on anything like those sorts of returns in future (even NZSF say so), and even the returns to date are really only sufficient to compensate us for the risk run on our behalf, we’d be better off locking in the gains we’ve had, closing down the Fund,  liquidating the assets over a couple of years, and using the proceeds to repay public debt.    Our government does not need to be in this game –  unlike, say, the governments of Norway or Abu Dhabi, with genuine wealth to manage and smooth –  and the returns to doing so don’t look that attractive.   As the Crown is already heavily exposed (both through the tax system and its other extensive asset holdings) to the ups and downs of the domestic economy and global markets, strategies that reduce risk, rather than increase it, seem intuitively more appealing.  The NZSF logic is the opposite of that.

To accompany my NBR piece, they did an NBR Radio interview.  The one question that got me thinking –  and really the reason for this post, which to some extent is traversing old ground –  was along the lines of “wouldn’t winding up the NZSF leave ordinary people worried about whether their NZS pension would be there for them when they got old?”.

That the question slightly rattled me probably just reflected the fact that I’m a macroeconomist not a political scientist.    Perhaps it is also a testimony to Michael Cullen’s political skill in constructing the NZSF, initially to safeguard surpluses from spending ministers as anything else, and linking it to the NZS regime.      But why shouldn’t people worry?

  • NZSF is only a small part of the government’s overall balance sheet,
  • Our government finances are –  thanks to a succession of Labour and National led governments –  among the stronger in the advanced world,
  • Even the staunchest advocates of NZSF never saw it contributing more than a moderate proportion of future NZS costs,
  • We’ve had a universal government pension since around 1940 –  with brief interruptions in the means-testing years of the 1980s and 1990s – and a government old-age pension for those in need since 1898,
  • Our universal old-age pension is high enough to keep most old people out of poverty (even those who earned low enough incomes through their lifetimes that they’d have had little effective capacity to save), but doesn’t (of itself) deliver high incomes to people beyond basic needs (so it isn’t like some state schemes elsewhere in the OECD),
  • And there is nothing about NZS that is unaffordable in the long run, provided that sensible, well-foreshadowed, adjustments in the age of eligibility are made, in line with continuing improvements in life expectancy.  Ideally, we’d have the age at 67 already, and be increasing (by statutory formula) a little each year as the life expectancy rises.   Simply shifting the age to, say, 67 doesn’t resolve the issue, but a suitable resilient formula-based adjustment would.

In modern times, the greatest period of uncertainty –  by far –  about future state pension support was during the years from around 1985 to 1998 when a means-testing regime was instituted and then constantly revisited.  That had to do with some combination of the overall stretched state of the government’s finances, as well as essentially ideological debates about universality vs targeting.

If one believes –  as I, somewhat reluctantly (but for good second-best reasons) do –  in a modest but universal state age pension, the best protections of that over the long-term, and the best way to provide predictability to individuals (avoiding jerky discontinuous policy adjustments) are

(a) sound overall government finances (low debt levels, and tax and spending shares of GDP that don’t push historical or international limits), and

(b) agreed, or at least broadly accepted across the main parties, statutory provisions that lay down well in advance how the age of eligibility will adjust in future as life expectancy increases.

NZSF really isn’t relevant to either.    It is just a high-risk investment management business, and that isn’t a natural business of government.

And veering slightly further off topic, I’m still puzzled by that Labour-Green commitment I discussed yesterday to keep core Crown spending to around 30 per cent of GDP while doing nothing to alter NZS parameters.  This was the chart from the Treasury’s long-term fiscal statement released late last year.

ltfsThey would be okay for the next few years, but once you get even 10 years out from here, there would need to be a lot of other expenditure cut to keep spending to around 30 per cent of GDP, even if (a) the two parties resume NZSF contributions soon, and (b) investment returns proved to be pretty good.   I’m genuinely puzzled how they propose to square that circle.

14 thoughts on “Time to wind-up the NZ Superannuation Fund

  1. My gut feeling is that central government and local government should invest only in businesses that are natural monopolies, such as we used to do for electrical energy production and distribution. Note what’s happened to electricity prices since that ‘brilliant’ national party politician Max Bradford privatised our electricity!

    For a good understanding of the topic, reading the summary of New Zealander Dr Sharon Beder’s book “Power Play – the fight for control of the world’s electricity”, at https://www.buffalolib.org/vufind/Record/1235807/Reviews

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  2. I think the answer depends on what roadmap NZ adopts to get out of the low-productivity trap. This blog has laid out a set of suggestions which I think are sensible and internally consistent, but haven’t yet been adopted as policy. These would address the macro imbalance by reducing the amount of public investment needed. However, there’s another way to address the savings-investment imbalance and that’s through pushing harder to increase the savings rate. Notwithstanding the Savings Working Group was a bit of a fizzer, I think it is still worth looking at.

    Philosophically, I would say that if govt is going to take care of providing a basic standard of living in retirement, then someone else needs to make up that precautionary saving – either govt, business, or households themselves. (If not, the country will end up in permanent low productivity trap, poorer than say India or China).

    I don’t believe govt can run massive surpluses indefinitely, and I think it’s hard to influence business saving at all, (other than by removing the imbalance that causes the upward pressure on the exchange rate). So I reluctantly comes to the conclusion households need to increase private saving. As folks these days don’t seem to care about bequeathing to their offspring, this would have to be sold to households as a combination of “topping-up” living standards in retirement plus precautionary saving for education, voluntary medical expenses and first home deposit. (Similar to the system in some Asian countries – I am assuming some combination of nudging, compulsion, and financial incentives).

    In order to be effective this saving needs to be in the form of financial assets, not investment property. In practice this means broadly diversified managed funds. However, there are lots of principal-agent problems with managed funds. In my experience the best diversified pension funds are run on a not-for-profit basis and have at least $20bn funds under management to be able to recruit decent staff. In Australia the non-profit industry funds have beaten the retail funds by 2.2% per annum over 10 years which is in line of NZ Super vs the Kiwisaver funds. (Source: http://www.abc.net.au/news/2016-07-21/industry-super-funds-outperform-retail-lower-share-exposure/7649306)

    With these priors, I get to a different set of policy prescriptions than you. Yes, NZ Super should return capital to the govt and enable it to pay down debt. And the govt should target 0% net debt not 20%. But NZ Super should also begin accepting contributions from private investors, along with other institutional grade non-for-profits (e.g. ACC and EQC, if considered worthy, and other new entrants). So it keeps going, but as a civil institution rather than a government one.

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    • Interesting alternative – which I could probably live with.

      Re the margin over Kiwisaver funds, as NZSf note here https://www.nzsuperfund.co.nz/sites/default/files/documents-sys/R%20-%20-v1-OIA_response_NZSF_performance_vs_NZX50_and_Kiwisaver.pdf they aren’t aware of how much risk those funds are running. Any idea whether it would be less or similar?

      Re surpluses, yes I agree one can’t run material surpluses for ever. But even surpluses of half a per cent of GDP, in a country with 1-1.5% popn growth pa, would mean it didn’t take that long to get net debt very close to zero, and net assets start building up.

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      • I think its not a bad idea. One of the issues I had with kiwisaver was the level of fees charged to run your money, usually in excess of 1% per annum. Funds in the US can be charging as low as 0.05% per annum to run an S&P 500 index fund, e.g., Vanguard (which is a kind of cooperative – the shareholders own the funds, rather than a management company).

        We get the usual argument that ‘oh, NZ doesn’t have the scale to charge fees that low’, but ultimately, that means savers lose out, and you end up with the principal agent issues you mention above. I think the idea was that competition would reduce the level of fees over time, but there is not much evidence this has happened, perhaps due to inertia.

        However the NZ super fund does have scale – and can charge commensurately low fees because of it. If there was a low cost vehicle, not for profit, who operated at a large scale where I could make contributions and watch the capital grow, I would use it.

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      • I suggest checking out Simplicity Kiwisaver if you are looking for a great, innovative low cost fund.

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  3. I had a quick look at the annual report and it doesn’t disclose a Sharpe ratio or tracking error. A look at the asset allocation shows around 70% in equities (mainly global) and the balance roughly split between bonds, real assets and private equity. I don’t follow the Kiwisave scene but a quick google check of their asset allocation doesn’t suggest they would be any less risky than NZS – in fact they may be a little less hedged as they lack the scale (and time horizon) to diversify into areas like international timberland, or US private equity.

    If we compare that to a well regarded fund like the Australian Future Fund, the latter had a lot more hedge funds and alternative investments, and less equities. That bet has played out well for NZS so far (hedge funds haven’t performed well as their asset gathering tendencies overwhelmed the number of profitable arbitrage opportunities).

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  4. Some quick comments you seem to view government debt as a bad thing and that the NZ super fund has added limited value to the NZ economy. First government debt levels are very low as are borrowing costs so as the lowest cost borrower the government should borrow as much as it can at the moment to generate full employment or in this case a return above the cost of debt. Second what’s wrong with a little government debt most government debt is created through deficits which are function of a weak economy lower tax take and higher welfare payments, there is very little discretionary spend driving deficits. Finally if the Super fund did not manage the money those 50 high paid jobs at the superfund would be shipped offshore to London or the US reducing NZ GDP. Also the Super fund has helped create a larger and more professional investment industry which at some point in future might turn into an export industry. The talent might setup funds and attract offshore capital to manage thus creating an export service from which NZ can generate foreign fx . The NZ Super fund could help NZ move up the export value chain by creating more high paid jobs.

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  5. If the government coffers is looking healthy then they should resume the targetted 5% Employer contribution to Kiwisaver which was frozen unfairly due to the GFC. This was in effect stolen from Employees. It is about time this was paid back to Employees. To recover the lost money from lost years, the Employer contribution should be increased to 7% for as many years necessary to catch up with the lost years.

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    • Where is Labour? Andrew Little and Grant Robertson asleep as usual or just busy trying to steal the average employees retirement form Investment properties through CGT and loss of tax losses from Investment property. What is the Not Labour Party scheming against employees again?

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    • If they increase the employer contribution, they should also ease up on the increases in the minimum wage they hand out. If not, they would see unemployment go up.

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      • Not likely in this current bouyant market conditions. Plenty of work out there. Best to start moving Kiwisaver contributions upwards in bouyant market conditions. Best to save for a future rainy day before the RBNZ decides to drive the economy into a recession again.

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  6. By the way, I cannot remember if you ended up writing a newspaper op-ed on teh super fund.

    I Remember you wrote one recently but I cannot remember the topic nor can I find it because I cannot remember the title for sure

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