I noted an article on goodreturns.co.nz on Friday 22 August 2003 (view previous article here) which referred to a recent press release from your office questioning the decision of the Guardians of New Zealand Superannuation to focus on pre–New Zealand tax returns.
You compared the after tax return to a New Zealand investor of a dividend payment carrying full imputation credits with the same dividend on a United States share. Quite appropriately you noted that the domestic share carrying imputation credits provided an enhanced return to the New Zealand investor on an after tax basis. This led you to question whether the Board had failed to take this into account in setting the asset allocation for of the Fund.
The Board is aware of this advantage and has factored it into its assessment of New Zealand shares as an asset class. The decision to focus on the pre-tax return means that when a dividend is received on a domestic share, it is grossed up by the value of the imputation credit. In this way the 6% dividend in your example would be treated as 8.95% of pre-New Zealand tax return in the Fund (assuming full imputation credits) compared to a stable 6% for the international share dividend. In this way, its superior contribution to the portfolio is clearly recognised. This approach has been addressed in correspondence between the Minister of Finance and the Board.
The decision to focus on pre-tax returns was largely driven by the expected value to the portfolio from active management of assets. As you would be aware, New Zealand investors are overwhelmingly attracted to passive investment portfolios due to the capital gains tax relief provided compared to active management. If the after-tax return had been the priority for the Guardians, passive investment would have been a key component of the portfolio.
It was clear from research, however, that active managers of most asset classes have been able to add significant value over passive portfolios in the recent past. The Board is confident that it will be able to construct a portfolio to achieve this out performance in the future. Accordingly, the decision to focus on pre-tax returns enables the Fund to pursue active management in order to maximise returns to the portfolio as a whole. This avoids the risk that a superior after tax return (as a result of passive investing) may in fact result in a sub-optimal gross return to the Crown by ignoring the value added by active managers.
I hope this explains the main rationale for the Guardian’s decision. I wish to reassure you that our approach does not minimise the return to the Fund of New Zealand imputation credits when compared to foreign income. We believe that we are able to capture these benefits, while providing a superior total return to the New Zealand taxpayer.
Paul Costello
Chief Executive
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