NZSF: from bad to worse

Michael Reddell NZSF, Uncategorized

I’ve written various posts here about the conduct of the New Zealand Superannuation Fund when Adrian Orr was CEO.    Their investment returns have been no better than one might have hoped for given the amount of risk they (force taxpayers collectively to) take.  Formally, they will argue that their strategies are risky enough that one can really only judge based on 20 year runs of performance (the Fund is only 15 years old).   But they talk themselves up endlessly, making dubious claims about their contribution, and playing politics more often than sound economics.  We had the big call last year to reduce their carbon exposures, allegedly on the grounds that risk-return considerations didn’t support such investments any longer, but then they implemented the decision in a way that makes it impossible to see whether this big active management call was well-judged on financial grounds, or not.  As I say, they play politics more than good policy, good economics, or good finance.

Since Adrian Orr moved on, the Fund has been led by Matt Whineray, now confirmed as CEO.    From him we’ve seen the unsolicited bid to be owner or part-owner of the government’s planned new light rail projects.     As I noted when that news came out

I’m sure the government is delighted.  As their predecessors were when the NZSF and ACC teamed up –  off-market of course – to take part-ownership of Kiwibank, without actually providing any fresh expertise, and in the process reducing the transparency and accountability around (what is still 100% state-owned) Kiwibank.  But in the end these are votes of confidence from public servants, who know which side their bread is buttered on.

As I’ve written about here previously, NZSF aren’t great investment gurus.  They’ve made quite a lot of money taking big risks in a strongly rising global market, but the returns relative to risk, or to taxpayer’s cost of capital haven’t been particularly attractive and –  as even NZSF will acknowledge –  markets go down as well as up.   As for light-rail projects, the NZSF statement noted that around 2 per cent of the Fund is in infrastructure assets worldwide.  That doesn’t suggest any particular expertise in light-rail –  and they don’t point to any in the statement.   And almost any government project can be made viable for an investor if the associated contracts are skewed sufficiently favourably in the investor’s direction.

Perhaps a good deal can be constructed for NZSF (with appropriate pricing and risk shifting, silk purses for some parties can be created almost anywhere), but it doesn’t have the feel of NZSF doing its core job.  It has the feel of NZSF continuing to degrade the  New Zealand policy process, using its (our) moneypots to serve political ends.

This last week I see NZSF has had a press release out.

The NZ Super Fund has congratulated Bloom Energy on its initial public offering on the New York Stock Exchange.

“The public listing is a significant milestone for Bloom Energy as it works to deliver sustainable on-site electricity to organisations around the world,” said Acting Chief Investment Officer Mark Fennell. “We look forward to supporting Bloom Energy as a listed entity for mutual benefit.”

Bloom Energy appears to be fairly new company NZSF had invested in.   Unfortunately, it is one that NZSF has already lost money on.

Mr Fennell acknowledged that Bloom Energy, while performing strongly on listing (up 67%), was currently priced below the level at which the NZ Super Fund initially invested in the company.

But no matter.  Just stick the investment in the bottom drawer for long enough and hope it comes right…..

“As a long-term investor the NZ Super Fund’s primary focus is on what we buy an asset for and the value we ultimately realise. Our investment returns will only crystallise when we sell our stake. What our investment is worth at various interim time periods is not as important to the NZ Super Fund as it is to investors with a shorter investment horizon.”

Typically, the best estimate of what someone will see an asset for is closely related to the current market price for that asset.  I’m not sure why NZSF felt it necessary or appropriate to put out a press release on this occasion, but I’m quite uneasy about an organisation –  managing our money, not their own –  that thinks that in rising global markets, a mark to market loss is just irrelevant, and made so because somehow NZSF can take a longer view than some other investors.   Even NZSF should recognise that it would have been rather better for them to have paid the IPO price (had they done so, they’d already have been up 67 per cent), not whatever loss-making price they actually did pay.

And then, in this morning’s newspaper, comes news that NZSF is lobbying (via the Tax Working Group) for tax concessions –  subsidies and corporate welfare programmes –  for infrastructure businesses it wants to get involved it.  The full (quite short) submission is here, but the gist is that they want cut-price company tax rates (no more than half the company tax rate) for “nationally significant infrastructure projects” (one of the criteria for such projects would be “Alignment with the Treasury’s living standards framework”), protection against any changes in tax rates over the (multi-decade) life of the project, and exemptions from standard RMA, immigration etc procedures.

I’m all in favour of lower company (and capital income) taxes more generally.  Standard economic analysis supports that sort of policy, and all of us would be expected to benefit from adopting such a policy approach.  But that isn’t what is proposed by NZSF; it is just a lobbying effort to skew capital towards particular sectors they happen to favour.  It is a pretty reprehensible bid to degrade the quality of our tax system.  There is no economic analysis advanced in support of their proposal –  so little it almost defies belief –  no sense of considerations of economic efficiency, just the success of lobbying efforts in a few other countries (including two struggling middle income countries not known for the efficiency of capital allocation or quality of governance, and the United States –  which not only has plenty of poor infrastructure, but a corporate tax code  riddled with exemptions and distortions).

NZSF is clearly in favour with the new government.  But the cause of good policymaking and the cause of efficient allocation of capital would, almost certainly, be advanced if it were simply wound up and the proceeds used to repay debt.  We should also stop the pretence –  advanced repeatedly by Fund spokespeople –  that we have a “sovereign wealth fund”.  What we have is a speculative investment fund, financed with borrowed money, producing no better than respectable, high risk returns, making no real difference to important questions around state-funded age pensions, and increasingly at risk of being used to skew capital allocation towards favoured political ends, backed by threadbare (or non-existent) economic analysis.

 

14 thoughts on “NZSF: from bad to worse”

    • Kiwibank has always been 100% NZ Post and as a result 100% government owned, a coalition agreement project of Jim Anderton when he led the New Labour Party.

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  3. I agree totally that efficiency of capital allocation supports the stated summary that the NZSF should be wound up with the proceeds being applied to debt reduction. Allocating what is an idealogically chosen amount of tax income into a separate slush fund to build a portfolio of asset investments (most of which are off-shore) by unelected officials for the supposed funding of pensions at some time in the future presumes that this is the best use of scarce tax payer resources. I am yet to be convinced. To then learn that investment decisions are driven by less than rigourous analysis is doubly disappointing..

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  5. i don’t often disagree with you Michael, but you clearly have a problem with the NZSF, and several public finance issues more generally. If you want a pension scheme (as most OECD countries including New Zealand do) you can choose to fund it on a pay-as-you-go basis or a save as-you go basis. Since the work of Diamond, Phelps and Samuelson in the 1950s and 1960s it has been clearly understood that a PAYGO funded pension scheme imposes large opportunity costs on all generations but the first generation of recipients (and any subsequent generations benefiting from its expansion) in a dynamically efficient economy such as New Zealand’s. The alternatives to a PAYGO funded pension scheme, which in New Zealand is forecast to impose increasingly large opportunity costs on future generations, are SAYGO funded schemes. These could be private (eg private saving or a compulsory saving scheme) or public, in which case you either need to “prefund” by an accelerated debt repayment programme or a a sovereign wealth fund invested in a diversified portfolio of assets. The advantages of a diversified portfolio are enormous, particularly as an indefinitely lived government can in principle manage risk better than private agents. There is a lot of theory suggesting a sovereign wealth fund can invest better than private funds, as it can invest in less liquid assets. All of these are standard positions in the international literature – as several of the reviews by Feldstein make clear.

    You keep harping on about this issue but never make it clear whether
    (a) you don’t like government run superannuation schemes (NZS, not the NZ Superannuation Fund)
    (b) you like pay-as-you go-funding, even though it is not intergenerationally neutral and even though it imposes large opportunity costs on young people and future generations. (It has imposed opportunity costs on people my age and you argue as well, but these have not been so large as we have benefited from relatively rapid population growth)
    (c) You like a SAYGO approach but don’t believe a sovereign fund can manage risk better than private agents even though they are indefinitely lived and have fewer liquidity problems, and therefore should not try and take advantage of the huge equity premium that exists in the world.
    (d) You believe that a SAYGO fund could potentially manage risks well, but is likely to be undermined by bureaucratic incompetence and political risk.

    After a fairly comprehensive reading of the international literature on the topic, I have come to the view that (a) government superannuation schemes can reduce poverty and improve welfare
    (b) Paygo funding for government superannuation schemes was an unfortunate economic mistake which benefited early generations at the expense of imposing large opportunity costs on subsequent generations, opportunity costs that are rising over time (I note that the since the 1950s the private sector has moved away from PAYGO based retirement income schemes towards SAYGO based schemes).
    (c) The advantages of having well managed sovereign wealth funds are immense, and it is worthwhile for a society to invest in governance schemes that allow it to take advantage of these schemes
    (d) NZSF has a decent governance structure and has performed credibly to date.
    (e) The governance of this scheme or alternative schemes could be further improved to reduce the risk of political interference.

    My views don’t matter a hill of beans, but I will argue that they are consistent with the mainstream economic literature, and I respect this literature because it is written by people who are much brighter and more experienced on this topic than I am ever likely to be.

    Yes, there will be downturns in investment markets. Yes, the returns in last few years have been extraordinary, and I don’t expect them to last. (As Shiller and Campbell have shown, mean reversion occurs in finance markets) But you have a rather pathological distaste for government wealth funds to believe the costs associated with PAYGO schemes in a dynamically efficient economy are a preferred alternative.

    So here’s a question, in the interest of debate: Do you have similar issues with the ACC fund? And if not, what is different about the ACC fund that makes it better than the NZSF fund?

    Andrew

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    • You raise some good points Andrew but surely it is inefficient for the NZSF, which was funded by taxpayer money in the first place, to fund NZ infrastructure projects when they could just be funded directly by the government from low interest overseas borrowing? These projects aren’t some private venture that may create super normal returns for NZ – if anything light rail will never earn its cost of capital and will only pay its way for NZSF because of huge subsidies.

      And investing in something for feel-good or political reasons like investment in questionable ‘green’ technology companies like Bloom is a dereliction of duty by NZSF.

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      • The NZ government can currently borrow at 2.8%. A fund manager has an expectation to earn around 10% plus more per annum. There is therefore a massive gap between what the NZSF is expected to earn versus what the government can borrow at in the current bond market. It does seem ridiculous for the NZSF to even consider government projects.

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      • Saving me the effort of writing it myself and converting the economic authority from amateur to professional, from your link: “”If NZSF continues I would at very least argue for it to be banned from any investment in NZ in which it holds more than a 5% stake, and prohibited from doing direct deals with govt entities (central govt or SOEs).””

        Your post a week ago comparing African and Asian economies and blaming failures on weak institutions was thought provoking. The difference between the life opportunities in a OECD country, a developing Asian country or an African country is so dramatic when you consider basic things such ‘can I afford medicine for a sick child’. I saw what could go wrong when large sums of public money were available for investment. NZ must keep its institutions above reproach; not just for fear that funds intended for pensions are being invested sub-optimally but also as an example to the many PI countries that emulate us.

        A discussion of what the differences are between weak and strong institutions would be instructive.

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      • This is one of the reasons I have become increasingly negative on NZSF over the last decade. In many respects, the paper governance provisions for NZSF are quite good, but they can’t protect fully against a weakening culture (ambitious people pursuing opportunities for their own future advancement etc). Perhaps in a sense it shouldn’t – if we have these state moneypots, they will inevitably be contested politically. Better not to have them.

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      • As a migrant, it never really dawned on me that the NZSF was a universal scheme available to all NZ residents and resident New Zealanders irrespective of wealth or alternative sources of income. But I must say I am impressed that NZ has been able to keep and maintain such a scheme even up to today. It is certainly a worthwhile goal to keep and to maintain such a scheme but it must be restricted to NZ residents only. The 10 year standdown period needs to be extended to Australian residents as well as the largest risk to NZSF is the 600,000 kiwis that reside in Australia who have paid no NZ taxes but would be entitled as soon as they decide to return to NZ.

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  6. It is already clear me to me that rail projects in NZ is already doomed to failure. The population density is too low and spread too far. As it is NZ rail struggles to make a profit. The losses will have to be paid by taxpayers and ratepayers unless NZFS is prepared to absorb operating and capital losses.

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