Compulsory scheme has been tried and failed before

Friday 2nd June 2000

Finance Minister Michael Cullen's proposal to set up a superannuation fund from dedicated taxes shows there is nothing new under the sun. Such funds have existed in the past, the most notable being the social security fund that was scrapped in favour of funding from the consolidated fund when the subsidy became too great.

A state superannuation fund financed from dedicated taxes may be a better way of funding New Zealand superannuation than a straight allotment of money through some government department, particularly as the fund could be expected to earn substantial income each year.

But there is at least one catch, among many.

There is no guarantee the "expected" income would materialise regularly and evenly. Some fund managers were enthusiastic about the fund proposal when it was mooted in March but that was mainly self-interest.

It is unfortunate but true that fund managers' returns have shown wide fluctuations over the years. They have a neat way of overcoming that unpalatable fact. They compare their performance with particular "benchmarks" - relevant indices.

A fund has outperformed the benchmark if its return in the relevant time period - one, three or five years - has been better than the index.

That is a fine concept but it can lead and has led to publicity about outperformance when the fund has actually decreased in value.

In the aftermath of the Asian economic crisis, many overseas-based funds had 10-15% cut from their value but reckoned they came out ahead because the benchmark declined 20%. That analysis had the possibly beneficial point of keeping the fund's individual managers safe in their jobs but did nothing for the investors who had less money invested than a year or two earlier.

In March the enthusiastic fund managers were saying a state fund would help local investment markets, particularly the sharemarket, through a substantial investment of new money.

Maybe, but things are unlikely to turn out so clearcut. No sensible manager would invest all of a substantial fund in New Zealand unless they were satisfied with a high-risk profile.

The managers may also be unable to invest all the money here if, as always happens when a swag of money is chasing a modest amount of securities, prices rise to levels that materially outstrip the fundamental value of the underlying potential earnings and asset values.

Managers of Dr Cullen's proposed fund can be expected to invest up to half the money in their charge overseas, a similar proportion to the one they use in asset allocations of their private current managed funds. The proportion varies as circumstances change and managers reassess asset allocations between asset classes and countries.

It is interesting to note an idea that managers would be making the total money pool available for the New Zealand economy.

The misconception turns up in surprising places. The April issue of the Office of the Retirement Commissioner's Future Focus included an article from Employers Federation executive director Anne Knowles in which she said "retirement savings go into the big managed funds which are used for loan capital for New Zealand companies."

That was plain wrong and should have been picked up before the Employers Federation sent off the article.

Some money in managed funds goes into debt securities of some New Zealand companies but it is usually a relatively small proportion of the total. Most fund managers require the particular company to have a high rating from an appropriate international credit rating agency.

Nothing will change with the management of a state-generated fund unless the government's requirements alter the managers' normal approach. That could happen because, as one leading fund manager pointed out, New Zealand had a history of government-directed investment and not just in the days of the late Sir Robert Muldoon.

We had capital issues control from the 1940s until the early 1960s and governments consistently told banks and other financial institutions what they had to invest in government and local authority securities and in house and commercial mortgages.

There is a rump of government direction where, for example, the Earthquake Commission is still required to invest its funds in local public securities, although that seems to be under review.

The policy is asinine because, in the event of a major disaster, the resulting reconstruction costs and immediate economic disruption would have a dramatic upward impact on interest yields and consequent slump in the value of debt securities and capital loss to the commission. That does not take account of the probability there is insufficient money to meet claims and reconstruction costs.

When NBR Personal Investor surveyed the retirement savings scene before the 1997 referendum on compulsory savings, it noted there were problems with pension systems in the UK, France and the US and there had been a considerable number of changes to rules governing Australia's compulsory system.

A fund from dedicated taxes is effectively a compulsory fund under another name and similar problems could arise, given the legitimate capacity of governments at anytime to change the rules in the light of changing circumstances.

The proposal has the advantage of being an attempt to tackle a problem that was consigned to the too hard basket for the past 15 years.

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