Opinion: NZ Super Fund glosses over its risks

OPINION

Jim Rose

When Adrian Orr is paid $10 million per year to retain his services, we can take his claims about active investing is worth the risk more seriously.

RELATED AUDIO: Super Fund CEO Adrian Orr discusses changes to the age of eligibility (March 13)

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The New Zealand Superannuation Fund has done well recently but it lost the lot in 2009. It lost everything earned over its reference portfolio since its inception in 2003 and then some in just one bad year.

The Taxpayers’ Union and other critics of the fund simply say that market reversals are common. The risks of active investing outweigh the returns from chancing the taxpayers’ arm.

If the fund was defending its performance back in 2009, it would say that ‘losing the lot’ was a short-term setback in a 20-year strategy so stick with us.

The majority of the fund is managed passively. The rest, in its own words, is “under active management by a mix of local and international external managers and in-house investment professionals”. Is it still too soon to tell whether it was wise to go beyond passive investing?

The Sharp ratios published by the fund, a measure of the risk added to a portfolio for the return received compared to benchmarks such as a passively invested portfolio, show the fund is earning little in additional returns compared with the extra volatility on taxpayers’ shoulders.

A recent IGM survey found that all but one of a 100 or so top economists in the US and Europe agreed that the returns from passive investing were superior to active investing. I have never seen my profession so united. Warren Buffett also recommends a passively invested portfolio.

Debate settled
The debate within modern financial economics over the role of luck and skill in portfolio investment is pretty much settled. Active investing is not worth the risk. Those that beat the market for a few years in a row are just lucky, and their risk-taking will soon catch up with them.

The pioneering research into the efficient markets hypothesis in the 1960s found a far more than expected number of very good and very bad years at each end of a bell curve-shaped distribution of investment returns over the decades. Booms and crashes are not rare.

If the Super Fund is good at beating the market through active investing, check how many of its investment staff are headhunted by bigger investment houses. You should always ask this question whenever bureaucrats say they can pick winners while still on public service pay rates.

Hedge funds can pay bonuses 10, 100 and even 1000 times what Adrian Orr earned last year as chief executive. His near million-dollar salary is chickenfeed by hedge fund standards.

Rather than succumb to confirmation bias by pointing to a few good years to gloss over ‘losing the lot’ in 2009, the fund should look for evidence that contradicts its beliefs, not what confirms them. Look for inconvenient truths that are strictly forbidden if the fund is as good as it says.

If you employ good investment staff, successful at active investing, your biggest problem is they will be headhunted so you must pay them serious money. To qualify for the annual list of the top 25 hedge fund managers, you must earn at least $400 million a year.

Low staff turnover
The fund’s turnover ratio for its investment staff was 1.8%, 2.5% and 8% in the past three years. Staff turnover this low just cannot be at an investment house regularly beating the market through skill rather than luck.

A few good years can be followed by a few bad years. That is why the fund says it should be judged over 20 years. It had a terrible year recently, ‘lost the lot,’ a few good years since but almost all top economists think active investing is unwise.

The pioneer of behavioural economics and finance, Richard Thaler, said the IGM Forum question about active versus passive investing was, “The annual test to see whether panelists are awake.”

Thaler starred in the 2015 movie The Big Short as the expert breaking the fourth wall to explain how investors were blinded to the risks they were taking before the global financial crisis.

When Mr Orr is paid $10 million per year to retain his services, we can take his claims about active investing is worth the risk more seriously. It is the question asked at American MBA finance classes for decades; “If you are so smart, why aren’t you rich?”

Jim Rose is a research fellow at the Taxpayers’ Union


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Your article is contradictory

Do you expect NZ Super to be a more active investor and take more risk so that they pay their execs more and therefore risk losing them to a competitor

Sounds like an uninformed and naive comment from a lobby group that should be protecting the taxpayer not exposing them
Also sounds like you are waiting for them to have a bad year so your theory works. One bad year in 15 is not too bad to date

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I did not say that. I said if active investing is worth the risk, their staff will be head-hunted.

A passively invested Fund would have few staff paid accountant's and auditor's wages.

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Only an academic type could write something like this.

Sure Mr Buffett says invest passively, but that's for his heirs and ordinary investors. Does he do that with Berkshire's $100bn stock portfolio? No, he does not.

You are confusing volatility with risk. Sometimes the most volatile assets offer the best reward. Adrian Burr, along with the Canadian pension fund, appears to be one of the few that understands how to achieve good active returns.

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Charlie you have your wires crossed in a number of areas...firstly mr buffet is only just outperforming the sp500 over the last 10 years so he's not a great example of active investing of late...yes we all know he's outperformed since 1900 or whatever but it's getting increasingly difficult,secondly the majority of the super fund is invested passively not actively.

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Hi Brent

I was merely referring to Berkshire because the author used this is a data point to back up the passive argument. Some context and nuance is required..

First - I don't have the figures at hand but what was the outperformance.. 1% p.a.? That adds up to a significant amount over 10 years.. and that is starting with an enormous asset base and up against the law of large numbers. The Superfund with, as you say a smaller percentage of funds under active management, actually has more opportunities to invest large chunks of their capital in good ideas, be they unfavoured, unpopular, illiquid, whatever.

Second, if Buffett thought outperformance was always impossible then why hire two investment managers to look after a portion of the portfolio? Why not index?

Third, most active managers are currently struggling to beat the S&P index, unless they own the fang stocks. These things go in cycles. Active will outperform passive at some point. Through a couple of cycles, passive will beat 90% of fund managers after fees. True.

So what's my point? It makes sense to invest a portion into active management - not to high fee active managers but where the superfund might have an edge - infrastructure projects, illiquid assets that offer long term outperformance etc. Nothing is predictable but the index is not a nirvana and Adrian Burr and co seem to understand this.

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I don't disagree with what you say but we need to be careful with words like outperformance...in the case of the superfund outperformance isn't easily determined as they don't publish their performance by asset class adequately and as regards illiquid assets like forestry what's the benchmark...it isn't the msci is it ...by the way the reason we should invest part of our funds in active managers is to help pay for a relatively efficient market.

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Fair points and agree. Did not realise they don't break out by asset class.. Would appear to be a serious omission and something the public ought to be able to look at and ask questions about.

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Accurate to describe this as Opinion.

I have a different opinion to the writer. I have a very high regard for the super fund, its performance and people.

I do agree with the writer they should be paid more for performance - and do expect that many of them will be headhunted by higher paying funds.

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There is no evidence thus far of any headhunting

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Given a couple of very big losses on a couple of active investments it would be interesting to see how the internal active managed portfolio has performed - that is the measure of their performance as active investors.

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What a load of tosh. The idea that if Adrian Orr and his team were any good they would be headhunted is ridiculous. Has it not occurred to you that many of the team at NZ Super have moved back to NZ from highly paid jobs overseas because they want to live in NZ?

As for your claim that "A recent IGM survey found that all but one of a 100 or so top economists in the US and Europe agreed that the returns from passive investing were superior to active investing", what does that mean? It means economists have read in the Economist and the FT that passive investing has done well in the last 8 years against the AVERAGE active manager, so it must be true. It says nothing about the risk taken in passive strategies (100% exposure to the market) vs the risk taken in active (many active managers hold cash and/or downside protection, even in bull markets).

We do know with certainty that crashes are not rare, so for many active managers it makes sense to give up some upside in boom times in order to protect investors from the inevitable crashes.

Please refer the to the quote below from a 31/05/17 Financial Times article about Prakash Loungani's findings about economists and their 'expertise':

"The record of failure remains impressive. There were 77 countries under consideration, and 49 of them were in recession in 2009. Economists – as reflected in the averages published in a report called Consensus Forecasts – had not called a single one of these recessions by April 2008.

This is extraordinary. The crisis was firmly established when these forecasts were made. The Financial Times had been writing exhaustively about the “credit crunch” since the previous summer. Northern Rock had been nationalised in the UK and Bear Stearns had collapsed in the US. It did not take a genius to see that trouble was on the way for the wider economy.

More astonishing still, when Loungani extends the deadline for forecasting a recession to September 2008, the consensus remained that not a single economy would fall into recession in 2009. Making up for lost time and satisfying the premise of an old joke, by September of 2009, the year in which the recessions actually occurred, the consensus predicted 54 out of 49 of them – that is, five more than there were. And, as an encore, there were 15 recessions in 2012. None were foreseen in the spring of 2011 and only two were predicted by September 2011."

I prefer not to give any credence whatsoever to the views of economists when it comes to investing. Having an economics degree tells them nothing about the future.

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William Sharp defines active investing as when you are not passively investing.

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Wow. It must have taken him ages to come up with that piece of genius.

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to quote sharp:

certain definitions of the key terms are necessary. First a market must be selected -- the stocks in the S&P 500, for example, or a set of "small" stocks. Then each investor who holds securities from the market must be classified as either active or passive.

A passive investor always holds every security from the market, with each represented in the same manner as in the market. Thus if security X represents 3 per cent of the value of the securities in the market, a passive investor's portfolio will have 3 per cent of its value invested in X. Equivalently, a passive manager will hold the same percentage of the total outstanding amount of each security in the market2.

An active investor is one who is not passive. His or her portfolio will differ from that of the passive managers at some or all times. Because active managers usually act on perceptions of mispricing, and because such misperceptions change relatively frequently, such managers tend to trade fairly frequently -- hence the term "active."

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I'm not sure what your point is. I think we can safely assume most NBR readers (including me) understand what active and passive management entails.

My point is this: asserting that 99% of economists think passive outperforms active is a meaningless statement. Firstly the evid nice proves economists get things horribly wrong even in their own field of 'expertise', and secondly talking about returns without also talking about risk is meaningless.

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You need to get your facts straight..passive portfolios have a lower average standard deviation and outperform in down markets as well as up....

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1. Where's your evidence? That may be true in some markets, but not all.
2. I didn't claim 'all' active managers protect the downside. I said 'many'. One of the big problems with the active industry is that probably 80% of active funds are just index trackers with active fees. I'm talking about the other 20%.

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If what you say is correct...that 80 % are trackers and they are regulated by the fma whose overriding objective is fair and transparent markets then you are suggesting that the fma aren't doing their job properly which I agree with.many local international equity funds charge active fees but just invest in index funds.if that isn't duplicity I don't know what is.at least European regulators are onto the passive masquerading as active scam.

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I think this article confuses active investing with equity investing...ie risking taxpayers money.small differences aside passive investing in equities has a similar risk to active so the writer needs to be clear what he's focusing on...is he saying we shouldn't be investing taxpayers money in shares or is he saying it should all be invested passively which it pretty much is.if there is a problem with the super fund it's the fact that they don't publish their returns by sector...something most other funds like this do including Yale and the Norwegians.

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My understanding is the area where they do most of their active invest in are areas is hard or impossible to do passive investing, such as farms, forestry and early stage investing. Add in a few private equity plays like MetLife and Z energy which again can't be done passive. Domestic and international share markets, best to go passive and they are.

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Another interview google article to knee cap tall poppies
Umm - they are making money
For disclosure why did author not detail his 20 investment actuals (other than the house)

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The last decade of returns on investment in stockmarkets have been more to do with the printing of money that central banks have been up to. It has to park itself somewhere.

Just how long this ponzi scheme can keep going is the big question. Interest cant keep paying interest, and big business cant keep charging more from customers whos wages are not seeing the benefit of this money printing.

The fact is you only see how wise management are in the bad times. Most are fair weather sailors, who jump ship before it hits the rocks. The bigger the ship, the more time there is to abandon before they can pin it on captain. They tend to get off a port or two before the fateful journey becomes obvious.

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Translation: " I thought the market was overvalued 10 years ago ,sold out,and totally missed the boat so I'm not happy and trying desperately to justify my dumb decision "

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Thank goodness some of these contributors do not get anywhere the taxpayers funds.
It would be interesting to review their own finances and see just how well there decisions worked out.
The bottom line....this is tax payers money and needs to be treated with the utmost respect at every level.
Forget the would be advisers some of them could not look after the tea money in the work canteen......certainly do not allow them near this package they would think they were in a lolly shop and suck it dry.

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I have faith in Alan Orr and his team. I wish my Kiwisaver money (and other discretionary funds) could be invested by them. My returns would be higher (usually). fees lower and best of all the profits (i.e. the fees) would be retained within the country. This was the very socialism Muldoon successfully campaigned against in 1980 that cost the country so much subsequently.

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That is my point. If the investment team were at the Super Fund were as good as you say, the would go out on their own forming their own investment house as all successful investment analysts do.

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Not true.david swensen hasn't started his own firm and he's been pretty successful at Yale.

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By the way there is a lot of fake news around these days so readers need to be careful.

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This seems to be the logic that drives CEO compensation - if you're any good, you will be paid lots so let's pay you lots and you must be good?! It just seems a very cart before horse way of assessing if they are any good.

Also, it seems a bit glib to say 'all successful investment analysts do' - I would have thought there could be any number of reasons of why a successful analyst might stay with the Super Fund eg being able to stay in NZ/for lifestyle or they simply might not be entrepreneurially-minded to take on the risk of starting their own shop?

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What comes first is the overall approach to asset allocation and the respective weightings at a point in time, and second is how good your selected active and passive placements are. NZS would have mix of everything under their headline allocations.

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There are some real "drinking the cool aid" comments here. Analysis of NZ Super's returns need to take into account the volatility (risk). If you can get the same return for lower risk, wouldn't you? The Government actually has another fund manager, ACC, that gets almost the same annual returns with a small fraction of the NZ Super volatility. So ACC gets far superior risk adjusted returns (but they don't appear to court the media so much, so fly below the radar). Where would you rather put your money?
Value add vs benchmark is important but you also always need to ask who chooses the benchmark?
On staff churn in fund management, it's not the %s, it's who the leavers are who matter. Would be interesting to see who has gone from NZ Super over the past 5 years and how many were the thought leaders, architects and responsible for the winning deals/strategies vs who is left... and where the leavers ended up (to test the article's thesis above).

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How does the NZ super's 2009 loss compare with other big super funds around the world? In terms of loss during this time, has it managed to do better than the average super fund from other countries?

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