The O'Brien Column: What could go horribly wrong with Dr Cullen's Super Fund

Friday 28th July 2000

Finance Minister Michael Cullen's proposed taxation-funded superannuation fund became a complex issue as more details were made public.

The political problems in getting the fund established are in the domain of specialist commentators, including the questions of a suggested
referendum and possible entrenchment of necessary legislation.

There was comment about the long-term economic impact of the proposed fund but that is outside the ambit of people dealing with investment, except that economic developments affect markets.

The proposed fund would get to $50 billion, have a management board and be farmed out to selected fund managers.

Therein lies the first problem.

The main management board can be assumed to comprise people of high integrity and substantial experience in investment, unless political cronyism entered the appointments.

Consultants - probably with local and international knowledge of the managed funds industry - could be retained to recommend suitable fund managers.

That process has two elements: selecting the consultants and appointing the managers.

It is an involved operation, particularly when historical returns on managed funds are no guide to future performance. Even famous international institutions and consultants can underperform when personnel change.

You can replace consultants and managers if they fail to measure up, but that is after the damage, and the fund's "contributors" (taxpayers) lack an individual's capacity to switch managers.

The potential for political interference in the appointment/reappointment of the main management board is obvious, irrespective of possible entrenchment of the proposed fund's legislation.

That could happen if politicians put pressure on the fund to finance industrial and commercial operations that would be considered relatively high risk under standard investment fund criteria, which is a lead-in to matters specifically related to investment markets.

No sane fund manager of $50 billion, or part of that amount, would put such a fund into New Zealand-based securities, although the Earthquake Commission has been forced to for years.

Assume the eventual $50 billion was invested in New Zealand. It would be divided among the three normal groupings - shares, fixed interest securities and property.

Fund managers vary the proportions between the three, depending on the state of each market but, as an example only, take an equal one-third split.

The sharemarket would get $16.66 billion in today's dollars. Total market capitalisation of the New Zealand sharemarket on July 21 was $58 billion, including the New Zealand part of dual-listed stocks and mining companies.

The tax-funded operation would own 28.72% of the equities market. Different managers would compete with each other for the same shares, a situation that could lease to false prices, divorced from fundamentals in the interests of relative performance. (Relative performance means beating the benchmark index.)

There is also potential for collusion when several managers invest parts of the same fund in the interests of preserving their contracts.

Anyone who thinks that could not happen probably still believes in fairy stories.

The accepted low-risk investment approach among fund managers is to diversify funds between local investment and overseas securities.

Assume a 50-50 split between the two areas; again it would vary, depending on market conditions. We now have $25 billion raised in New Zealand but invested outside the country, with associated management fees, a situation that would probably have sophisticated social democrats weeping into their chardonnay.

The locally invested $50 billion referred to earlier would be reduced to $25 billion.

As an example only, because the figure might not include other funds under management, The National Business Review's Ipac-provided management funds tables (based on figures at May 31) showed AMP-managed funds controlled $2.52 billion.

AMP is the country's largest fund manager. The $2.5 billion covered local and international funds in equities, fixed interest and property.

Administration of the proposed fund could cut into returns. The top board can be presumed to acquire staff.

Local and/or overseas-based managers will charge fees. Brokers and others will be in for their cuts and there will be other costs.

This may have been built into Dr Cullen's calculations but that is a kindly interpretation of the minister's activity.

Note: I wrote last week that a wage rise emanating from the effect of the higher excise duty on cigarettes and tobacco would console New Zealand's smokers whose higher costs would have an effect on the incomes of the nation's "toilers." That was produced as the "nation's toilets," probably due to the fact that keyboards have "t" next to "r."

Comments from our readers

No comments yet