Greens stir storm in tea cup

By Tim Anderson

Friday 4th October 2002

The Government Superannuation Fund (GSF) appears to have lost what seems a staggering $315 million off its value in just three months.

This prompted a knee-jerk response and concerted, if not ill-informed, debate from some quarters, including the Greens, who accused the government of gambling with the life savings of public servants on overseas sharemarkets.

Investing may seem to those outside the industry to be just that a gamble. Fortunately for the government, and public servants, this is one gamble (to keep the metaphor going) that is destined to pay off.

While $315 million is a considerable amount of money to lose, the reality is that it isn't a loss unless it is realised. A defensive acting finance minister, Trevor Mallard, stated that "rebalancing will occur as a result of this."

He added: "Clearly the New Zealand stockmarket is more attractive now relative to others compared to what it used to be."

Unfortunately Mr Mallard is guilty of a knee-jerk reaction typical of many first-time investors. You invest, you lose, you pull out, thus realising your losses.

In fact, you could argue Mr Mallard has it the wrong way round New Zealand equities may in fact be coming off and international equities on the up. That is a short-term focus, however, in what needs to be a long-term investment decision.

What is critical in this circumstance is to understand the essence of effective investment the long-term benefits of diversification. Diversification is essentially spreading your assets, or investments, across a wide range of risk categories to achieve the best risk-adjusted returns. In technical terms, diversification is used to determine an "efficient frontier" of risk-adjusted returns.

Diversification acknowledges that in some years particular asset classes will outperform other asset classes. The best performing asset class changes almost on a yearly basis.

It is no coincidence, however, that five of the past 10 years global shares have been the best performer.

For the previous 20 years, for example, the annualised return of international shares (as measured by the MSCI World Free Gross Index) is over 14%. Compare this with current long-term New Zealand government stock, which matures in 2013, paying a mere 6.0%. This differential is potentially worth billions, not the $315 million that is in dispute at present.

Think of this scenario: would a European investor with $1 million invest solely in a country that sits on the Pacific "ring of fire," that is prone to earthquakes, whose economy relies heavily on dead animal byproducts and forestry and that is extremely overexposed in the case of a foot-and-mouth disease or other outbreak? The answer is no.

The truth is that the current allocation of the GSF is not radical or irresponsible. In fact, professional investors would argue it is more irresponsible to not to invest into international equities. With a current asset allocation toward international equities of 44%, the fund remains conservative compared with the asset allocation employed in much of the $40 billion managed fund industry in New Zealand.

Within a balanced portfolio, for example, an investor would expect to have a 50-55% allocation toward international equities.

Remembering that the time-horizon of such a fund is realistically 30-50 years, whatever happens in any single three-month, six-month or one-year period is largely irrelevant as long as the long-term objective is achieved.

The problems faced by the GSF is not unique. Many managed funds are going through the same pains, with a sustained bear market in international equities. The principles by which they are investing the money are tried and tested.

In the long term they will benefit those with cash invested. This is true for all managed funds, and those long-term investors who are sticking to their investment plan will win out in the long term.

Tim Anderson heads FundSource Research, the investment strategy and managed fund research house. Email: tim.anderson@fundsource.co.nz

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