Virtue signalling, with your money

I haven’t written about the New Zealand Superannuation Fund (NZSF) for a while, and a well-informed reader has been encouraging me to get back to the economics of the Fund (and some of the important issues raised in a recent review paper).  I will, but for now I remain of the view that the Fund is serving no useful purpose and should be wound up.

But while we have it, it needs to be run well.

One of the annoying aspects of the Fund is the way in which the Board and management get to take your tax money and mine, and invest (or not) in causes which they happen to find appealing.    Of course, the Act isn’t written that way, but that is what it boils down to.   I’m not too keen on my money being invested in abortion providers or private prison operators –  just to span the ideological spectrum –  but obviously Adrian Orr and his Board don’t have a problem with such exposures.   They, on the other hand, object to tobacco companies and whaling, which don’t greatly bother me.

But the other day, they announced a big new policy shift that has substantially reduced the carbon exposure of the Fund (somewhat puzzlingly, I saw no mention in any of their documents of methane exposures, and as we know in New Zealand at least methane exposures make up a very large chunk of greenhouse gases).

To their credit, NZSF pro-actively released several background and Board papers relevant to this move, as well as several pages of question and answer material (all at the link in the previous paragraph).

This shift is dressed up as a simple matter of economic and financial management.  Indeed, they are at pains to assert that ethical (or presumably political) considerations played no part in the shift.  But, on the material they have presented it just doesn’t ring very true.

For example, they released a presentation to the Board from a few months ago.  In it, the chief investment officer and the “head of responsible investment” told the Board that

We believe climate change is a material long-term risk for which the Fund will not be rewarded.

What they appear to mean is the market prices of shares with (adverse) exposure to climate change and any associated policy responses do not adequately reflect those risks.

It is an arguable proposition, for which you might expect that evidence would be marshalled.  But the Board appears to have been presented with no evidence whatever, just assertions, and questionable economic reasoning.  Thus, on the next page

Climate change is a market and policy failure: markets are producing too many emissions and are over-invested in fossil fuels. We believe carbon risk is under-priced partly because the time horizon over which the effects will manifest is too long for most market analysts – but it is relevant to the time horizon that matters for the Fund.

This is a hodge-podge paragraph. For a start, climate change itself isn’t a market failure, but may well arise from market failures (costs aren’t properly internalised etc).   But the fact of climate change –  whatever role past policy or market failures may have played – tells one nothing about whether shares in companies exposed to carbon are now fairly priced or not.  They are just two completely different things.

And there is still no evidence presented for the proposition (“belief”) that markets have overpriced these companies (such that expected future risk-adjusted returns on them won’t match those available elsewhere).  Other market participants know as much (or as little) as NZSF staff know.

There was a more detailed Board paper in April containing the final recommendations.   It has more text, but no more analysis of the risks or of why the Board (or we) should believe that NZSF is better placed than the market to appropriately value climate change related risk.    Instead, we get a repeat of the same assertions,

NZSF quote

followed by a sentence which is best summarised as “but we really don’t know”.

There are repeated references to lines such as “ignoring Climate Change presents an undue risk”, but that isn’t even remotely the issue.  The issue is whether (a) the market on average is mispricing that risk, and (b) whether NZSF staff, management, and Board are better placed to evaluate the complex mix of scientific, economic, technological, and political factors that determine how things will play out (and thus what fair value pricing will prove to have been).     Thus, it is quite likely that the market on average has the appropriate pricing of these risks wrong, because much of what is relevant is inherently unknowable.  But if it is likely that the market is wrong, there is no particular reason to be confident which side the error lies on.   And it isn’t obvious why it is easier for NZSF to be confident it is right about this, than about any of the other very long-term risks embedded in many sectors, or in the market as a whole.

There are also hints that really this has little to do with a careful evaluation of financial investment risk and a lot more about politics and “good causes” –  virtue signalling.


Consistent with this political focus, the very first item in the proposed communications strategy reads

“Recommend engaging with the Greens to explain to them the approach we have taken”

(And, sure enough, they were lauded by the Greens – although not for the quality of their financial analysis –  when the new policy was finally announced the other day.)

NZSF’s detailed public story is contained in the Q&A document they released.  This is text that they will have had months to refine, the Board having made this decision in April.

But again, there is no analysis presented or summarised to indicate why the Board is confident the market has it wrong. Instead they seem reduced to lines like this

We believe that now is the right time to act. Even if there remains some uncertainty about global policy, its general direction is consistent with meaningful carbon reductions.

This is the basis for a major strategic investment choice by the Board managing taxpayers’ money??   “General directions” are one thing, assessing market pricing and demonstrating with a high degree of confidence that market prices are wrong is quite another.

Or lines like this

The Mercer climate change study that we participated in during 2015 found that the biggest risk to investors from climate change was to be on the wrong side of strengthening global policy and/or technological disruption. Mercer found that investors who got ahead of the curve could mitigate the potential downside.

Well, of course.  If you read markets well, and judge policy correctly, there is plenty of money to be made.  But doing so is hard…..very hard, and NZSF provides no evidence that they are able to beat the market uniquely well is this particular area of their global exposures.

There is further evidence that this move is about politics and virtue signalling, rather than robust financial analysis.

Will your active managers be allowed to hold stocks that have been sold from the passive portfolio on the Fund’s behalf?
Our active NZ equity managers (who may also from time to time invest in Australia) will not invest in these stocks.

If this were just a strategic view that markets were systematically mispricing this risk, there would be no reason to bar active managers from holding such stocks from time to time (after all, even if one average the market is mispricing this risks, it doesn’t mean there won’t occasionally be opportunities in individual stocks that are exposed to such risks.)

There is very strong sense that NZSF decided to reduce its climate change exposures, and then back-filled the (rather weak) argumentation in support of that.  As it is put early on in the April Board paper, setting the scene for the recommendation.

“a reduction of climate-change related risks for the Fund is a key goal of the CCIS [Climate Change Investment Strategy]”

Perhaps there is some other economic and financial analysis, that they haven’t yet released, to support that strategic preference (I’ve lodged an OIA request to that end) but at the moment it looks like a political choice not a financial one.

The NZSF has implemented this strategic choice by the Board and management by altering their so-called Reference Portfolio benchmark.   They have long argued that the reference portfolio is what their performance should be benchmarked against  (the numbers scream out at one, in large type, when one goes onto their website).  I’ve long argued that is the wrong benchmark for citizens and taxpayers to focus on (useful as it might be for the Board to judge staff active management choices against).  In this case, the Board itself has taken what amounts to a punt (an active call) that the market is underpricing risk in a particular sector.  They need to be evaluated on the results of that call over time, not avoid accountability by burying the implications of their policy decision in what looks like a passive benchmark that is beyond their control.

Perhaps the NZSF choice will be widely popular.  But that isn’t their job.  In fact, it has always been one of the dangers of the Fund.    It isn’t their job to be playing politics by tilting the portfolio towards trendy causes.  If anything, long-term investors (the advantage they constantly assert) might be better positioned to take somewhat contrarian stances, leaning against the tide of opinion at times (but only when backed up with sound analysis).    And if they really believed that the market was underpricing climate change risk, why not be rather more open about the resulting investment choices  –  leave the reference portfolio unchanged, and implement the market call through active management positions?

And you do have to wonder how, in a country where policy is still aimed at opening up further oil and gas deposits, a New Zealand government agency now has an official ban on buying shares in companies that might be developing those resources.  Will an NZSF ban on dairy exposures be next?

We have elections to choose the people who will make policy decisions.  If the public want to ban dairying, or oil and gas exploration, then elect the politicians to make those calls, and hold them to account.   But lets not have bureaucrats and unaccountable Board members pursuing personal agendas (even popular ones) with our money.  If the economic and financial case is really there –  and remember that active management calls of this sort don’t have a great track record globally –  then lay it out for us to see.  On what they’ve released to date, this look much more like a virtue-signalling call than one consistent with the NZSF’s statutory mandate, or with the sort of professional expertise we should hope for from well-remunerated investment managers.





24 thoughts on “Virtue signalling, with your money

  1. Michael, you wrote: “But the fact of climate change – whatever role past policy or market failures may have played – tells one nothing about whether shares in companies exposed to carbon are now fairly priced or not. They are just two completely different things.”

    Let’s not use the euphemism “climate change”, because the climate has always changed, and most likely will continue to do so. Let’s go back to the original term for climate change purportedly caused by mankind’s emissions of carbon dioxide, previously known as Anthropogenic Global Warming (AGW).

    As a person who champions evidence-based policies, I am hopeful that you will acknowledge that there is so far no physical evidence that mankind’s emissions of carbon dioxide have had any measurable affect on our planet’s temperature, or on its climate. What we have, is projections based on so-called climate models, which are mere mathematical models, formulated on the basis of a set of assumptions about how atmospheric carbon dioxide affects the planet’s temperatures. However, time and time again, the projections of these models have turned out to be false.

    It’s time to acknowledge that mankind’s emissions of carbon dioxide have had, and will never have, any significant effect on the planet’s temperatures.

    We humans have much more serious things about which to concern ourselves!


    • Peter

      I deliberately stay clear of that material, because I just haven’t invested enough time in understanding the scientific arguments and evidence. My interests are more about policy responses to what people believe we are experiencing and are going to experience, including how best to think about and price the uncertainty that exists on numerous dimensions (including adaptation and new technology).

      At a slightly flippant level, as someone stuck living in Wgtn, I’ve always had one hurdle to get over in bothering about climate change, human induced or otherwise: a Wgtn that was a degree or two warmer would be a more pleasant place to live.


      • Truthfully, I was thinking that it would actually be great for Auckland as well to be a couple of degrees warmer.


      • That you say you haven’t looked at climate change science much explains why you have not addressed the fact that we cannot afford to use more than about 2/3 max of known gas, oil and coal reserves if we are to have an even chance of limiting temperature rise to 2 degrees or less compared to pre industrial levels. And therefore do not understand at all that oil, coal and gas conpanies have a poor outlook. Which goes a long way to explainibg the intelligent actions of the super fund.


      • Different point. Mine is simply the economist’s perspective asking “well, whatever the truth – and your view on stranded assets might well be correct – what gives you confidence that you are better able to price those risks than the market (ie all other investors everywhere). Because that is what NZSF claim to be doing – not taking a moral, ethical, political or policy stance.

        I’m just pointing out that, on the documents they’ve released, it looks a lot more like the latter than the former. (Then again, as I noted and as a commenter highlighted, not only aren’t they pulling out of cattle exposures, they appear to be planning to increase those exposures.)

        You might well think it is good for the Fund to be taking a policy leadership position. But that isn’t their job, and it isn’t what their legislation envisages. It would be a recipe for allowing the assets of the fund to be swung around according to the whims and preferences of whoever happened to be in govt at the time – through their powers of appointment. As ever, judge actions not by how you view it if those you favour as doing things, but how you’d react if your opposition was using those powers.


    • I am surprised that Trump’s claims of the nonsense over Climate change is being echoed here in NZ. There has been a massive number of studies linking carbon dioxide and methane as potent greenhouse gasses that is accelerating the warming up of the planet. To do my part, my next car will definitely be an electric car instead of my petrol guzzling SUV. I have stopped drinking milk. Can’t quite give up on my burgers yet though.


  2. If I turn to my wife and say “great news we have made a fortune with those tobacco shares I bought” it might not play well if say she was nursing someone dying of lung cancer. And NZSF do not want to be in the situation of boasting about profits from coal mines when South Dunedin is under water.
    Fairly sane action on their part but with a pitiful justification.

    Does unethical investing outperform ethical investing? Logically it should since those selling are not doing so for rational financial reasons.


    • I guess the problem is that there aren’t shared views on what counts as ethical and what doesn’t. I don’t like smoking, and would urge anyone to stop it, or not to take it up, and I probably wouldn’t from choice take an exposure to a tobacco company. But I (personally) happen to feel much more strongly about abortion providers (US hospital chains etc) and private prison operators. Some will feel a high degree of ethical discomfort with banks, or with alcohol producers/purveyors – and there is a whole movements wanting to boycott/divest any exposures to Israel. I’d respect – after a fashion in some cases – all those indvidual views, but there is no good way to respect them all in a big fund, especially when as here (NZSF) there is no economic need for the Fund in the first place. My bottom line is that NZSF shouldn’t invest in companies doing demonstrably illegal stuff, and beyond that choices around ethics and political preferences should be left to individuals and their own money management.


  3. You make a really good point about whether this is more appropriately a benchmark alteration or in fact an active investment decision. What adds to the confusion is that while they are modifying the benchmark to exclude carbon emitters, they look to be piling into carbon polluters actively, in particular NZ farms:
    If this article is correct (and it does quote a rep from the fund) then although they have pivoted $950M of passive exposure away from carbon emitters, they are currently $200M+ actively into farting cows with what looks like a plan to triple this (some of this increase in agricultural plants which should be carbon absorbers but the article also clearly flags a plan to put some in farting bulls).
    Sure they look to have applied a carbon exclusion to their own active NZ equity mandate but it doesn’t look like they have extended it to their external fund managers (I guess that in time means no investment exposure to Air NZ and NZOG, but in reality how meaningful is this as the rest of the NZX would be pretty low carbon? Even the power generators are for the most part reasonably clean energy?).
    So is this in fact a bait and switch? Is their internal belief really that they think carbon emitters are oversold and undervalued today, so let’s rebase the benchmark to exclude them, then pile in to them actively and reap the rewards from beating the benchmark when their prices rise???
    What would the Greens say to this?


    • Surely the “bait and switch” possibility is too cynical…..

      But it is extraordinary that they were touting their planned new cattle investments in that Herald article in May when the Board had already approved this “carbon reduction” active management play, complete with the marketing effort to the Greens.

      Liked by 1 person

  4. Private prisons Michael as a completely side bar question. Your first aversion would not surprise your regular readers. And I know your aversion to prisons. But am very interested in what what it is about private prisons that concerns you. Fully aware of all the general concerns – a number of which I have myself – but very interested in your take on them. Cheers

    Liked by 1 person

    • I’m afraid you’ll only get my potted version, given family connections to Justice sector policy: I just think it is wrong (morally, philosophically) to have private agencies (for profit or not) exercising the coercive powers of the state. And I’d take that stance even if private operators were in particular instances doing a “much better job”, on whatever conventional metrics people like to use.

      Trying to think across other areas where the state exercises coercive power, I’m sure there must be a line somewhere where I’d be unbothered about some low level state activities being undertaken by private agents, but where imprisonment is concerned powers are so asymmetric and the potential for abuse so great that I’m not even close to think private prisons are appropriate.

      Liked by 2 people

      • And here I thought it was the judiciary that exercised coercive powers granted by the state – to grant freedom or not – prisons are merely the receptacle and not the decision maker


      • Judges may make the orders, but it is (a) the Police who will arrest you and (b), once sentenced it is the Dept of Corrections who will take you into custody, lock the door, and ensure (or not) that you are fed, watered, not brutalised or worse (or not).

        But I’d certainly be oppposed to privatising the judiciary – altho I’ve not heard anyone suggest doing so.

        Liked by 1 person

  5. Aren’t you expecting the impossible of the Superannuation Board. If they laid out a perfectly convincing case for their proposal, given the propensity for the “market ” to respond (and I’m working on the assumption that private institutions/funds might react more quickly) then their perceived benefit for exiting certain market sectors could well dissipate by the time their consultation has agreed to the proposal. On the flip side has market analysis of any private fund manager convinced you that their involvement in particular sectors is fully justified for the current market price? I guess I’m saying that trying to judge market/sector movements well ahead of the present is unlikely to be an exact science, but staying put and doing nothing is possibly a less attractive alternative.


    • I guess I’m making a number of points:

      – a general scepticism about the case for active management (which this shift is),
      – a criticism of them executing this by changing the reference portfolo rather than leaving the RP as is and implementing the strategy thru identifiable active mgmt positions (where we could then track performance), and
      – given that this was a strategy developed over months, executed a month ago, and that they claim was based on analysis, there is scant sign of that analysis in the documents that went to the Board

      If we are going to have the Fund, I’d favour just keeping it wholly passive. NZSF people just aren’t remunerated at levels that suggest they are likely to be able to systematically beat the market, especially in a really complex area like climate change. But, in many ways, the comment would be warranted quite as much if we were talking about a big duration bet in the bond portfolio.

      I suspect they do have some more analysis, and if so presumably they will release it in response to my OIA.


  6. The idea that commission-driven fund managers, CEOs, and so on have a short-term bias that might be rational for them (maximizing commission) but sub-optimal for the funds they manage is kind of popular in popular left-leaning discourse. This seems to be what NZSF are drawing on. Surely you’re aware of economic research which might support or repudiate this idea? It would seem relevant to NZSF’s position here.


    • It is a line they are invoking, but I don’t think it is particularly relevant to this specific issue. It is, to the extent valid, an argument for a heavily equities-oriented portfolio (as NZSF have) – a long-term holder like them may (I stress, may) be better able to withstand mark to market fluctuations across cycles – but it offers no insight at all on whether they should or should not emphasise particular sub-sectors of the market (which is what the climate active position is doing).

      There is little doubt that many investors trade overly frequently, and many find it difficult psychologically (or otherwise) to cope with volatility. But again the point is more about how one needs to learn to live with volatility if one is going to have a big equity position, rather than something about an issue where the long-term trend is more the focus (and is quite uncertain). In equity market crises all correlations tend towards 1 and climate-related stocks won’t be exempt from that.


  7. “The fund is serving no useful purpose and should be wound up”
    This is an extraordinary statement, Michael.

    New Zealand has a tier 1 pension scheme that is largely funded on a pay-as-you go basis. It is relatively small now – there were relatively few people born in New Zealand before 1950 – and set to become a lot larger. Even so, at the moment it accounts for some $13b of the budget, and is by far the largest single part of the social welfare budget.

    Standard theory demonstrates that if a country funds pensions on a pay-as-you-go basis and the economy is dynamically efficient (the rate of return to capital investments exceeds the growth rate of the economy) then a pay-as-you-go pension scheme imposes large opportunity costs on current and future generations. If you started from scratch, it would be much cheaper for current young generations to fund their own future pension funds by paying taxes to the government and having these taxes invested than it would be to adopt a PAYGO system. Under conservative numbers, the cost is about half.

    The opportunity costs are likely to be rising because growth rates are slowing down – or will be if the population growth declines. The PAYGO funded pension scheme is likely to be placing much higher costs on people born in 2000 or 2020 than those born in the 1960s and 1970s. People born now are inheriting a scheme in which they pay a much higher cost for a similar level of benefits than their parents.

    Raising taxes now and investing the funds in a sovereign wealth fund is a way of redistributing these costs. If we raise taxes now and invest the funds, the earnings on these funds will reduce the amount future tax rates will have to increase. It is an intergenerational redistribution that recognizes a PAYGO funded pension scheme unevenly distributes the costs and benefits of the scheme – and that the costs disproportionately land on young cohorts and future generations.

    Incidentally, the evidence suggests this is a popular policy. When asked in a survey a couple of years ago whether they would prefer no change in current taxes and a 5 percentage point increase in future taxes (“taxes on the next generation”), or a 2 percent increase in current taxes and a 3 percent increase in future taxes, 65% of people of all ages and income levels said they would prefer an increase in current taxes and a smaller increase in future taxes if that were possible. It is possible – and it involves the NZSF.

    It would of course be possible to raise taxes and pay off government debt. But this produces a much lower expected return. A long term sovereign wealth fund is ideally situated to absorb the risk of long term investments as much of the risks are associated with the liquidity risks and governments have long (indefinitely long) horizons and a comparative advantage at managing liquidity. (This is the basis of the recent work by Tirole and Holmstrom that examines the role of private sector liquidity in financial markets.) This is why government debt interest rates are typically much lower than private debts interest rates and the returns to equities.

    Once a PAYGO funded pension scheme is in existence it is possible to “artificially” reconstruct it as a SAYGO system invested in government debt along with an issue of government debt. “PAYGO = SAYGO+ debt” The interest costs on the debt is the opportunity costs imposed on current and future generations from the adoption of the PAYGO system – a cost that rises when the rate of population growth declines and rises when the PAYGO system is expanded. (For example, the size of the scheme expands when life-expectancy rises but the age of eligibility does not). Even if the government were quite happy with the initial adoption of a PAYGO system because it provided a transfer to the first generation of recipients, and it thought that the value of these transfers was sufficiently large that it was worth imposing large opportunity costs on all subsequent generations, It can still use a sovereign wealth fund to reduce these costs. It can restructure the current PAYGO system in two steps. The first step is to create a tax-funded SAYGO fund for future pension liabilities, and issue instructions that it invests in soverign bonds. The second is to issue debt to pay off the existing libabilities. By construction, this scheme has the same costs as the current PAYGO scheme. It has the same costs because of the restriction that the SAYGO-fund invests in government debt. The second step is to remove this restriction and let the fund invest in anything. The expected returns from this strategy are much higher, lowering the costs on current and future genrations by reducing the taxes they paid to fund their own pensions. Essentially the government would borrow to invest in a diverse portfolio of assets – something that is likely to have positive value because of the government’s enormous comparative advantage at liquidity management (the same comparative advantage that means that governments can intervene int he event of financial crises.) One of the ironies of this strategy is that it may even reduce the fundamental risks that people face. At the moment working age New Zealanders receive a wage that is dependent on the performance of the NZ economy, and they receive a pension that is tied to the performance of the NZ economy. This is a particularly risky strategy – and a risk that has paid off very badly for people my age (50s) given the sub-par performance of the NZ economy. Investing in a pension fund that is diversified reduces this risk (if the fund does well, I might still get the same pension, but the taxes necessary to pay for it are lower.)

    Of course, none of this standard analysis says that you shouldn’t adopt a PAYGO pension fund. It merely says that if you do so, the costs of the system will be unevenly spread and (in a dynamically efficient economy) disproportionately shifted onto young and future generations. If today’s middle age people want to do this, sobeit, they control the purse strings. It is slightly odd that a country that makes a song and dance about achieving low debt (a position shared by all major political parties) is quite prepared to ignore the opportunity costs of PAYGO funded programmes and shaft future generations with high tax rates. But that is their right, whatever the morality of it.

    As to serving no useful purpose: it is the efficient way to reduce tax costs on future generations if that is what you want to do. You may not want to do this. But standard theory suggest the returns to sovereign wealth funds should be higher than the returns to privately traded wealth funds (eg a private pension fund) because the sovereign funds have a liquidity advantage (they don’t face the threat of immediate withdrawal of funds should they have a few bad quarters, for instance.) This is probably why the NZSF is consistently outperforming private sector alternatives.

    As to the carbon issue: I expect the NZSF to make portfolio calls precisely because they do not have to replicate the private sector due to their liquidity advantages. Yes there are costs to managing funds, and it can go wrong. But there are good reasons to expect a properly managed sovereign wealth can outperform. So far we don’t have much evidence that they are doing their job badly.

    Disclosure: not associated with the NZSF at all, but I have had a free glass of bubbly (“mirumiru”) from them at one of their functions. While the bubbly released C02 into the atmosphere, this was before their new policy.


    • Andrew

      I’ll have to leave the substance of your argument for another day (altho I suspect many of our differences are about political economy rather than about narrow economics – many points I’ve made in earlier posts including here, but just quickly on carbon:

      You say
      “As to the carbon issue: I expect the NZSF to make portfolio calls precisely because they do not have to replicate the private sector due to their liquidity advantages. Yes there are costs to managing funds, and it can go wrong. But there are good reasons to expect a properly managed sovereign wealth can outperform. So far we don’t have much evidence that they are doing their job badly. ”

      My summary view outlined in earlier posts is that NZSF hasn’t done particularly well or badly, although on their own telling, it is too soon to tell (from memory they talk about 20 year rolling returns). The issue here is not whether they might have some advantages as a long term fund (altho I’ll debate that too) – they’ve already taken that stance in being heavily weighted in equities – but whether (a) they have any specific advantage on carbon (but not methane) issues relative to the many other long term trends and policy risks that affect the overal economy and thus any equity portfolio, and (b) if they want to make discretionary calls like this, why they would not leave the so-called benchmark unchanged and implement the strategy thru identified active management positions.

      As it is, it looks as lot like political positioning and virtue signalling. Perhaps they have some good analysis to back up their specific judgement on carbon, but there was none of that in the material they chose to release, or to prepare specifically to explain a move they have already implemented.


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