Investment

Commentary - Year ended 30 June 2023

The Authority is required to invest the Fund on a prudent and commercial basis. In so doing, its investment objective is to maximise returns without undue risk to the Fund as a whole, while managing and administering the Fund in a manner consistent with best practice portfolio management.

We define this objective as being to maximise the Fund’s returns over and above New Zealand Government Bonds (before New Zealand tax), while limiting the chance of under-performing New Zealand Government Bonds over rolling ten-year periods.

The Fund relies largely on equities to achieve returns greater than New Zealand Government Bonds because, economically and historically, equities are the most reliable source of excess returns over longer time horizons.

We use a notional Reference Portfolio to measure the additional risk and to benchmark the Fund’s performance over interim periods. The Reference Portfolio is a simple, globally diversified portfolio that is expected to meet the long-term investment objective by investing passively in liquid public equity and bond markets at low cost. Additional information can be found in the Board’s Statement of Performance Expectations which can be found at www.gsfa.govt.nz/publications.

About 90% of the Fund is invested internationally to avoid concentration of risk in New Zealand assets. The foreign currency exposure is 20% of the Fund on average over time.

To add value, as measured against the Reference Portfolio, without increasing overall risk, the Fund invests in private equities and insurance-linked assets that offer a diversified return source. We seek additional returns through active management of most asset classes. The Fund also tilts dynamically towards cheaper asset classes and away from more expensive ones, because we believe this pays off over longer periods.

All investment decisions are benchmarked against the Reference Portfolio to assess whether they add value in terms of higher returns for equivalent risk, net of investment management fees.

The Fund is managed to have similar risk to the Reference Portfolio but is more diversified. When global equities rise strongly, the Fund may underperform the Reference Portfolio but is more likely to outperform bonds, which is the primary goal.

The Reference Portfolio is expected to outperform New Zealand Government Bonds by 2.3% pa over the next ten years. That compares with 2.8% pa since the Fund’s inception and 6.5% pa over the last decade.

The Board is satisfied the overall risk level remains acceptable, as the probability of the Fund underperforming bonds by more than 10% over ten years is currently estimated at 15%. The added value over New Zealand Government Bonds over the last 10 years was 6.7% pa. The alternative assets and active managers are estimated to contribute moderate performance risk relative to the Reference Portfolio.

Global share markets have rallied significantly since October 2022 as recession fears overseas have abated somewhat. The rally has been particularly marked in the USA where the latest fad is for stocks perceived to benefit from developments in artificial intelligence (AI) – the rally in the USA is quite concentrated in a few AI related names. Global interest rates have stabilised in recent months as central banks have slowed the pace of monetary tightening.

The Fund returned 10.0% in the year to 30 June 2023, net of investment management fees and before tax, still far in excess of the (negative) -0.8% return of New Zealand Government Bonds. Since inception, the Fund’s return is 2.9% pa above New Zealand Government Bonds, as shown in Table 1 below.

Table 1: Total Fund Return – Summary

Return comprises gross of fees returns prior to 30 June 2009 and net of fees thereafter.

The Fund’s 2023 return of 10.0% was 2.2% behind the Reference Portfolio.

Active managers of global listed equities and bonds contributed positively to this outcome, handily outperforming their benchmarks. However, the Fund’s private equity investments detracted material value relative to the Reference Portfolio. In large part this is due to the time lag in relation to the revaluation of private equity investments. The Fund’s investment in alternative assets, such as insurance-linked securities did not materially impact on added value.

Total returns over 5 year and greater time horizons were broadly in line with the Reference Portfolio. We aim to add 0.8% pa on average over ten-year periods from alternative return sources, active managers and strategic tilting programme. Added value in the last ten years was 0.2% so this is some way behind where we would like to be. More positively, we have achieved these Reference Portfolio matching returns at a lower level of risk (8.0% vs 9.0%) so the difference in return per unit of risk taken is consistent with our expectations.

Returns by Asset Class for the year to 30 June 2023

Table 2 below shows the investment returns by major asset class compared to the relevant asset class benchmark. All returns are annualised, in New Zealand dollars (NZD) before New Zealand tax and after investment management fees.

[1]The Total Fund return includes currency hedging to the NZD. Returns for global bonds, catastrophe insurance, life settlements are fully hedged. Returns for global equities and global private equities are unhedged.

[2]The benchmark for the Total Fund is the Reference Portfolio.

[3]The benchmarks for global private equities and New Zealand private equities are the same as for global equities and New Zealand equities respectively plus 3% pa.