The NZ Super Fund’s Matt Whineray on explaining the difference between volatility and risk, the Fund’s focus on equities & not being forced to sell

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By Gareth Vaughan

New Zealand Superannuation Fund CEO Matt Whineray says he’s “not trying to freak everybody out” with the section in the Fund’s annual report talking about the Fund losing $20 billion, half its value, if the Global Financial Crisis (GFC) was to strike again now.

The Super Fund’s annual report was issued on Thursday, with the running of this GFC scenario catching the eye. This was even though the Super Fund estimates the massive losses could be recouped within about 20 months.

 Whineray told in a Double Shot interview the Super Fund is not predicting or forecasting another financial crisis. Rather it’s using a familiar scenario as a way of illustrating volatility that could occur.

“What that section in the annual report is called is Volatility and risk, understanding the difference. And what we’re trying to do with that is say ‘we make a choice in terms of our portfolio construction and our choice is to take a reasonable amount of market risk.’ That’s 80% of our reference portfolio comprises growth assets, so equities. We do that because we have a long horizon. At the moment we’re not expecting to have any sustained [fund] withdrawals for more than 30 years, into the 2050s,” says Whineray.

The Fund’s high exposure to growth assets is set by its board through its ‘Reference Portfolio’, a simple passive low-cost portfolio of listed equities and bonds that serves as a benchmark for the Fund’s investing activities.

Whineray says the long-term focus allows the Super Fund to look through short-term market fluctuations and earn the premium over time that comes with owning equities.

“You earn that premium because you are able to weather the ups and downs along the way. So that’s what volatility is and we’re saying ‘look our portfolio comes with a reasonable amount of volatility.’ We look like an aggressive KiwiSaver fund.”

“Risk is different. Risk is often conflated with volatility because you’ll hear financial reports and they’ll say ‘VIX today,’ which is a measure of really short-term one month volatility, ‘is up, so markets are riskier.’ But for us risk is different. Because for us the risk is not that we see volatility, we know we’re going to, that’s an outcome that we’ve made in terms of choice of our portfolio. The risk is that we don’t have the discipline, or the capabilities or the support from our stakeholders and in a broader sense stakeholders are government, media, public, that we don’t have the support to hold the course on our investment strategy,” Whineray says.

“So that’s the distinction I’m trying to make.”

“I’m not trying to freak everybody out with the maths of the GFC. That’s all it is. This is application of maths. It’s a recent event, it’s in people’s memories, we’re a lot bigger now than we were then, we’re about $40 billion now, we were about $14 billion then.” 

“I just want people to understand we’ve made this choice, it comes with these consequences. We’ve made it for a good reason, which is we will earn more over time as a result of that. But we’ve got to be able to hold the course and so I want everyone to understand that that’s our risk. The risk is that you cannot see through the short-term stuff to be able to earn the long-term returns,” says Whineray.

Furthermore he acknowledges that all financial crises are different and when the next one strikes it won’t be the same as the GFC either in how quickly it takes effect, or how quickly global financial markets recover from it.

“There are so many variables in this. I absolutely take the point that the next one will be different and your starting point will be different, and your starting point in terms of the leverage in the financial system will be different. So there’s a lot of different variables. We’re not trying to forecast a crisis, we can’t do that, we certainly can’t forecast the shape of what that will look like,” says Whineray.

“What we need to do is be resilient.”

“So what we do in response to this is say ‘we’re going to maintain a bit more liquidity in the fund, we’re going to hold higher levels of liquid assets than we might on average.’ And we’ll end up with a fund that has less active risk. And for us active risk is the difference between our active portfolio and reference portfolio and the easy way of saying that is we just think there are less opportunities to step away from it so we do two things; 1) we’ve got more liquidity available and 2) we’ve got more active risk available. And that does a couple of things for us 1) it allows us to weather the storm, whatever form that storm comes in, we can make sure we can survive the storm. And the second point is it allows us to take advantage of those times when markets are panicking and people are selling. We don’t have to and that’s really important. That’s our key endowment as a long horizon investor – don’t ever be forced to sell,” Whineray says.

Meanwhile he says there no pressure on the Super Fund to move away from its equities heavy asset allocation.

“One of our critical advantages that we think we have is that we have operational independence,” says Whineray. “So critically there is no pressure on us to change our asset allocation right now.” 

Nonetheless an independent review of how effectively and efficiently the Guardians of NZ Super, the Fund’s manager, is performing is carried out every five years, as required by the New Zealand Superannuation and Retirement Income Act 2001. The next review is due in 2019. Whineray says Treasury is currently working on the terms of reference. Among other things, the review will look at the reference portfolio framework, the choice of asset allocation, how performance is calculated, and how risk is measured. Treasury will appoint someone to undertake the review early next year.

*This is part 1 of a two part interview.

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