Our CIO: active investment, or passive investment? Hei tā te Tumu Haumi: te haumi mōrea nui, te haumi mōrea iti rānei?
At the Fund we use a mix of active and passive investment strategies. Most of the Fund is invested passively – two-thirds in line with an index-linked Reference Portfolio. This is a diversified growth portfolio (80% shares, 20% bonds) that is fully implemented passively at a low cost.
But active investment has some big benefits: in our case, it allows us to increase diversification and fully utilise our natural advantages. As a result, we have earned significant rewards with little additional risk.
We have two relevant investment beliefs:
- true skill in generating excess returns versus a manager’s benchmark is very rare. This makes it hard to identify and capture consistently.
- investors with a long-term horizon can outperform more short-term focused investors over the long-run.
The first belief forces us to be very clear about why any particular active strategy could improve the performance of the Fund (whether through lower risk or higher return, or both). Our commitment to selective active investing is informed by research and best practice in the investment industry.
The second belief is relevant to how we choose to undertake active investing. The Fund has some natural advantages which means it is ideally placed to be a successful active investor. It has a long-time horizon, a known liquidity profile, operational independence from the government of the day and sovereign status.
We invest actively only where there are clear benefits (after all costs) in doing so.
Our active investments fit into three broad categories.
The first contains investments that help diversify the Fund’s portfolio. Examples include our New Zealand timber and rural assets. These investments exploit the Fund’s long investment horizon and known liquidity profile.
The second category, which also exploits the Fund’s long investment horizon, contains investments that respond to current market pricing, adding exposure to asset classes that are relatively cheap and lowering exposure to those that are relatively expensive. Our decision to ‘double-down’ on equities during the global financial crisis is a clear case in point.
The third category, asset selection, contains investments that rely on the ability to select individual assets that will outperform relevant benchmarks. We agree with the contention that picking stocks in efficient markets is a zero-sum game (what one manager gains, another loses, and everyone pays fees). This is why we use very little of this type of active investing and, where we do, it is focused on specific opportunities where there is persistent evidence of market inefficiency.
Active investing, within well-defined constraints, is both prudent and commercial for an institutional investor with a long-horizon and the discipline to stay the course. Its value is highlighted by the fact that the Fund has outperformed its Reference Portfolio by NZD 6.2 billion after all costs since inception. In doing so, the Fund has earned more per unit of risk than the passive alternative. Taxpayers have had great value to date from our actives investment approach.