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The Super Fund - A fiasco in the making?

Christchurch based financial planner Charles Drace says the Guardians have got their asset allocation wrong and the NZ Super Fund will lose $59 billion in 10 years.

Wednesday, August 20th 2003, 11:04PM

by Charles Drace

The debate on whether the New Zealand Superannuation Fund should invest 78% of its assets offshore as opposed to onshore misses two vital points critical to the success of its strategy.

The first concerns the state of sharemarkets themselves.

The world’s sharemarkets enjoyed a boom and bubble from 1982 to 2000. In these 18 years sharemarkets in the United States, Europe, Asia and some emerging markets performed far better than the New Zealand sharemarket - hence the argument that the majority of the money should go offshore.

In addition, the New Zealand market is less than 0.2% of the world market by capitalisation, so in a properly diversified portfolio only a very small allocation to New Zealand would be appropriate.

It’s the first of these arguments we must look at, and dismiss. Over the last 400 years there have been many times when sharemarkets have enjoyed long bull markets. In fact, bull markets were the norm for about half that period.

What we need to recognise is that bear markets were the norm for the other half. On average bull markets tend to last 16.5 years and they always turn into bear markets that also last an average of 16.5 years. In every case, the excess of optimism and debt that provided the fuel for the bull market created long term recessionary periods where sharemarkets lost most of the gains of the bull phase.

In the last 135 years we’ve had four bull markets, 1878-1906, 1921-1929, 1949-1965, and 1982-2000. The bear markets have been from 1906-1921, 1929-1949, 1965-1982, and 2000 and counting.

If one had invested somewhere near the peak in 1906 it would have taken 20 years just to get back to where one started, in inflation adjusted terms, as the bear market wiped out 92% of the bull market gains.

From 1929 it would have taken 24 years to recover losses of 94%, and from 1965 it would have taken 28 years to recover 74% losses. Therefore, anyone investing in sharemarkets today can expect to have to wait 20-25 years to recover losses of 74-94%.

Unfortunately, the Guardians of the New Zealand Superannuation Fund have elected to follow ‘best business practice’ of the bull market phase, the investment strategies appropriate to the 1982-2000 period.

They have totally neglected to revise the strategy as required for the current bear market phase. Therefore, their strategy is likely to result in losses to the fund of a minimum of $59 billion (74% of the over $80 billion earmarked for sharemarkets).

Many will argue that having fallen by over 20% over the last three years, shares are now ‘good value’. In reality, the bottom of a bear market is never reached until sharemarkets get down to price/earnings ratios of 5 to 9.

P/Es in the United State are currently 33, higher than the 32 of the March 2000 peak and the 29 of the 1929 peak.

Standard and Poors have suggested that American P/E’s are actually higher by over 30% (or actually 43) if you take into consideration off-balance sheet liabilities like pension and option commitments. That means markets have another 80-85% to fall before the bear market phase of the cycle has been completed.

The basic requirement of a fund manager, custodian or other financial adviser is to balance risk against reward, having taken into consideration the goals and objectives of the investor.

This is achieved by investing in markets which have completed the bear market phase so one could reasonably expected 10-15 years of rising returns. If one invests in a market with historically high P/E’s (not to mention the worst debt problems in the world’s history) the upside is virtually nil and the risk is enormous, yet that is just what most fund managers are doing today and what the custodians recommend for the money that is supposed to protect us in our old age. This is not only unwise but also unethical.

The second major point that has been missed in the discussion is the purpose of the fund itself and how best to achieve its goals of supplementing New Zealand Superannuation once the baby-boomers start to ravage it.

These goals should not be isolated as ‘money goals’ alone, as Finance Minister Michael Cullen has suggested; they should be part of the long-term strategy to preserve New Zealand as a place we will want to retire in.

At the moment, most of our major companies and infrastructures have been sold to overseas owners. This results in an unmanageable and chronic balance of payments problem, exasperated by the more than $6 billion in profits sent to overseas owners every year, $6 billion that would otherwise be invested in the New Zealand economy and that would give it the growth it sadly lacks.

What is needed is for New Zealand money to be invested in our infrastructure and productive base as opposed to the overseas money that recent governments have been courting. Note that buying New Zealand listed shares doesn’t help our productive base unless doing so returns ownership to New Zealanders.

The most successful government superannuation fund in the world is that of Singapore. There, they invest the fund in the mortgages of the citizens and in local production companies, as well as local infrastructure. We should do the same.

Imagine how much value we’d add to our economy if everyone borrowed their mortgage from the Superfund. Every interest payment they made would be a payment towards their own retirement. Instead, most mortgage interest in this country goes offshore as profits to foreign owned banks.

Imagine if the Super Fund invested in small and medium businesses, thereby increasing employment, exports, and local profits. Imagine if the Super Fund invested in roads, schools, medicine and research, thereby helping to create a New Zealand we’ll want to retire in. As long as they avoided commercial release of genetically engineered organisms, which would destroy our economy, there are myriad ways that money could be invested in infrastructure to improve our economy and our standard of living.

Imagine if the money was used to buy back the companies that are owned by overseas interests, so the profits and the jobs could stay in New Zealand. Instead, New Zealand is becoming a country of ‘salarymen’, employed by overseas companies and paid miniscule wages to spend on goods imported from overseas companies.

This is the kind of debate we should be having about the Super Fund, a debate Dr. Cullen and the guardians are ignoring.

WHAT DO YOU THINK? HAS CHARLES DRACE GOT IT RIGHT OR WRONG? SEND YOUR OPINONS TO EDITOR@GOODRETURNS.CO.NZ

Charles Drace is a Certified Financial Planner based in Christchurch and a former Green Party candidate.

« Cullen defends Guardian's asset allocationUnited Future questions Guardians »

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