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Source: MIL-OSI Submissions
Source: New Zealand Superannuation Fund

The NZ Super Fund expects a slightly less turbulent market environment in the near term, following an eventful 2019. The Fund has reported a strong 2019 calendar year performance return of 21.13 percent (unaudited, before NZ tax, after costs), which saw it grow to $47 billion.

The Fund was established to help smooth the future cost increases of providing universal superannuation. It has a long-term time horizon and invests contributions from the Government into a growth-oriented and diversified global portfolio of investments.

“We are really pleased with the calendar year result against a backdrop of strong market returns,” says CEO Matt Whineray.

“It is a strong contribution to the future economic health of our country. At the same time, we know markets are volatile and this coming year presents a range of challenges for investors.”

Market dominating issues from 2018 and 2019 such as Brexit and the US-China trade war have been suppressed, at least for now. However, unforeseen events, such as the Coronavirus outbreak, illustrate how quickly new risks can emerge and upcoming events, such as the outcomes from the US general election and UK-European trade negotiations, could see those former risks resurface.

At the same time, interest rates remain low and asset prices are high, meaning there are fewer attractive investment opportunities available.

“In the short term the Fund is taking less active risk and we expect lower returns than we have enjoyed in recent years. Looking further ahead we remain well positioned to exploit emerging opportunities and are exploring a range of potential investments in New Zealand and abroad, particularly in infrastructure and real estate.”

As at 31 December 2019, the NZ Super Fund has returned 10.32 percent per year since inception (before NZ tax, after costs) and has earned $8.901 billion in value-added returns over its passive reference portfolio benchmark.

Two-thirds of the Super Fund is invested in its passive reference portfolio, which returned an impressive 22.74 percent for the 2019 year.

Mr Whineray says the reference portfolio did better than the Fund’s actual portfolio largely because of the timing of the Fund’s private market asset revaluations, which are assessed less frequently than listed equity holdings.

The net effect is that during periods when liquid equity markets rally strongly, as was the case during 2019, the performance of those infrequently valued assets tends to lag the reference portfolio proxy (of listed equities and bonds).

Economic and investment environment for 2020

Some of the risk-off drivers of market uncertainty have eased in recent times in response to policy negotiations.  However, some of the damage from those drivers will remain and the permanence of some of those policy solutions is not necessarily clear.

The IMF expects global growth to rise from 2.9 percent in 2019 to 3.3 percent in 2020 and 3.4 percent in 2021. The increase reflects tentative signs that trade and manufacturing activity has bottomed out and favourable news relating to US-China negotiations and the possibility of a no-deal Brexit.

However, there are some reservations. The IMF notes the hard global macroeconomic data is yet to display any turning points and the forecasts were published before the Coronavius outbreak.

Efforts to contain the outbreak will negatively impact first quarter economic growth, particularly in China, those countries reliant on Chinese spending, and corporates reliant on supply chains through China. Some of that growth will be recovered when the outbreak comes under control, but some of it is lost for good.  Markets were volatile at the start of the year in response to Coronavirus, but have priced in a near-term resolution. However, this could reverse quickly if the impacts prove to be enduring.

The US and China have recently negotiated a deal that has brought some relief to markets that the trade war at least will not worsen in the near term.  At the same time, the lingering damage from the past 18 months of tariff escalation is real and will not reverse quickly. The trade war has had a big impact on global manufacturing activity and countries that are reliant on it .

Europe was particularly hard hit – it is heavily reliant on manufacturing, has demographic challenges, and has little-to-no room for policy maneuver. The outcome of the US presidential election will have the biggest impact on future US-China relationships for the better or worse. Markets will be watching developments closely and volatility will increase or decrease accordingly.

Equities – Despite geopolitical risks, central bank support underpinned global equities, which increased 25 percent in 2019 calendar year. The US market performed strongly, with S&P500 total return up 31 percent. Emerging Market lagged, rising 19 percent, bringing Developed Market vs Emerging Market outperformance to 12 percent.

Rates – 10 Year US Treasury (UST) yields plunged from 3.23 percent (8 Nov 2018, Fed meeting) to 1.46 percent in early September. The 10-2 UST yield curve finally inverted in late August, but has since moved into slightly positive territory. A slew of economic data releases showed a slowdown, particularly in global manufacturing, helping to reinforce central banks’ dovish tilts.

Commodities – Gold rose 10 percent in the second half of 2019, benefitting from easing monetary policies globally and safe-haven flows driven by economic uncertainty. Oil spiked at the end of 2019 on the back of Middle East tensions, but has since come back.

FX – The USD continued its march higher against most other major FX with the exception of the Yen. Cross-asset correlations have risen over the past year suggesting we may be returning to a ‘Risk On – Risk Off’ world. USD-CNY depreciated through 7.0 in August on trade war and China growth concerns; this is a level not seen for 11 years.

Developed Markets vs. Emerging Markets – Developed Markets (DM) have outperformed Emerging Markets (EM) handsomely since the GFC – relative earnings performance being a key reason. Over half of DM’s earnings (Earning-Per-Share) out-performance originates from lower interest/tax expenses vs. EM. The effects of the US tax cuts are well understood, but it is also notable that net leverage has been trending in opposite directions for EM vs. DM, which helps to explain higher interest expenses in EM. Yet for DM, that trend may be reversing raising questions about the durability of DM’s earnings out-performance.

Fragilities rising – The market now exhibits pockets of elevated corporate leverage and vulnerabilities. The US leveraged loan market has more than doubled in size to over $2trn since 2012, which is a particular area of concern given reports of some deterioration in lending standards. In addition, slower earnings growth and technological disruption suggests there could be trouble ahead.

MIL OSI