Fund's rules present problems

Investing the Big Cullen Fund along the lines laid out in the New Zealand Superannuation Fund Bill may provide far more problems than realised, Frank Russell managing director Craig Ansley says.

The big issue is dealing with the ethical, or socially responsible component of the fund.

He says the reason for this is that two parts of the bill are in conflict.

On one hand the fund has to be invested to "avoid prejudice to New Zealand's reputation as a responsible member of the world community." On the other it has to maximise return without undue risk.

Ansley argues that the first of these directives encourages socially responsible investment (SRI), while the second means that the fund's Guardians have to take a style neutral approach to investing. That is they cannot show bias to either value or growth styles.

The problem, in Ansley's view, is that SRI tends to be a form of growth investing.

He illustrates this point by comparing the Domini 400 Social index (a US index often used as a benchmark for SRI funds) against the S&P 500.

Over the past 9 years the Domini has outperformed the broad market by 2.9% annually, he says.

However its performance has been strongly influenced by size, style and sector exclusion.

The table (right) shows that the Domini has a slightly higher p/e ratio than the S&P 500, meaning it has a greater orientation towards growth stocks. Also it tends to favour the smaller companies and sectors such as healthcare, technology and financial services.

Ansley says if they fund's Guardians adopt an SRI approach "it is clear they will be introducing additional risk.".

The bill says they have to take minimum risk for the expected return. "That means the fund can't have a style bias," he says. "It needs to be style neutral."

Ansley says there is a "management problem" with the rules. "They sound great but they are quite hard to apply."

Ansley says the criteria laid down for the fund's managers to follow also presents some other investment problems.

For instance it will need a higher exposure to offshore equities than is the norm for a New Zealand balanced fund because the New Zealand market is too limited and illiquid.

SRI funds also will be a tax disadvantage for the fund.

While it will pay tax just the same as the funds management industry, there is a strong argument for it to use passive (tax-free) offshore equity funds. If the Guardians choose to use SRI funds they will then have to pay tax as there are no SRI index funds available.

On the bond front there is the "circular issue" of the fund buying New Zealand Government debt. He describes it as being akin to investing in your own mortgage, or the government writing itself an IOU.

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