Exposure to global equities is the ultimate driver of portfolio risk and return
Global Investment Insights
with Paul Bevin, General Manager Investments, NZ Government Superannuation Fund and the National Provident Fund
Paul is the General Manager Investments at NZ Government Superannuation Fund Authority (GSF) and the National Provident Fund. A position he has held since July 2005. The funds have NZ$4.5 billion and NZ$1.8 billion in assets under management, respectively.
Paul leads a team of four responsible for advising both Fund Boards on investment strategy and implementing the selection, engagement and monitoring of almost 30 external managers. The funds are mostly invested in global markets, covering public and private equities, bonds and alternative return sources.
Currently, the focus for Paul in his role is threefold:
Assessing the balance of risk allocation between traditional asset classes and alternatives. “We have been invested in risk factors (style premia) and insurance-linked assets for some time and this has not been rewarding compared to traditional bonds and equities to this point”, Paul remarked.
Aligning the actively managed portfolio with global climate objectives without adversely affecting performance. “We believe our managers, and the market in general, are addressing climate transition risk but we also have to align with Government commitments to support Paris Accord goals”, Paul highlighted.
Reviewing investment processes to ensure the Funds are following best practice. “The GSF is currently subject to a five-yearly statutory review which was preceded by an independent external review”, Paul said.
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Government bonds represent our default or minimum risk asset class and the market has been distorted by quantitative easing and large scale government borrowing. There is an increasingly widespread view that global and national indebtedness does not matter.
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The big challenge for Paul is gauging the outlook for government bonds. He explained, “Government bonds represent our default or minimum risk asset class and the market has been distorted by quantitative easing and large-scale government borrowing. There is an increasingly widespread view that global and national indebtedness does not matter. This poses a question about the extent to which future inflation risk is embedded in long term bond prices and the exchange rate risk arising from differential monetary policy stances. Future interest rates are also a critical driver of relative equity valuations, notably value versus growth stocks.”
Paul continued, “as far as global equities are concerned, we try to maintain exposure to a range of rewarded factors and time horizons and rely on our active managers to capitalise on various thematics and market pricing dynamics to add value. We do not tilt heavily to one or even a few themes. The rebound in ‘value’ is encouraging and, despite COVID-19, our private equity programme is developing well. The key thematics relate to working in a world with ongoing pandemic risk and climate transition risk. Exposure to innovation through small caps, private equity and venture capital is also important.
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We rely on our active managers to capitalise on various thematics to add value. Key thematics relate to working in a world with ongoing pandemic risk and climate transition risk.
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Paul believes that for the vast bulk of investors represented by institutional funds or otherwise, their core portfolio should comprise a market cap weighted global equity portfolio.
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Younger people should be largely, if not fully, invested in equities and leveraged, including any leveraged home ownership. Over a lifetime, leverage can be reduced to the point of zero at retirement.
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Younger people should be largely, if not fully, invested in equities and leveraged, including any leveraged home ownership. Over a lifetime, leverage can be reduced to the point of zero at retirement. From there the equities and home can be progressively cashed up into later retirement. This strategy can be accessed at extremely low cost without any loading for advice fees. This would be adequate for most and implies a lot of the cost structure of the savings industry does not add value. The key decision then is the individual’s average saving rate, including deleveraging (repaying a mortgage for example) which is where some relatively formulaic advice is useful. Discretionary investment decisions can be made around this core without disrupting the plan.
Active management of portfolios is worthwhile, indeed necessary, to ensure market pricing does not stray too far from underlying value, but the reality is that the bulk of one’s risk and ultimate return is driven by that core exposure to global equities.
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Active management of portfolios is worthwhile, indeed necessary, but the reality is that the bulk of one’s risk and ultimate return is driven by that core exposure to global equities.
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In terms of the Funds’ asset allocation mix, Paul revealed that there aren’t any major shifts expected to be made over the coming three years. He highlighted that, “the key variable is the equity risk premium and, while there are pockets of extreme valuation in the market today, we believe there is reasonable reward for global equity risk. For GSF we are increasing the relative share in private equity modestly because we think there are more opportunities there than in public markets. Further, we are more concerned about bonds where investors are effectively paying for safety via negative yields.”
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We are increasing the relative share in private equity modestly because we think there are more opportunities there than in public markets.
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Finally, “we have tweaked our alternatives exposure reducing both risk factor (style premia) and insurance-linked exposures”, Paul stated.
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We are concerned about bonds where investors are effectively paying for safety via negative yields.
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Paul left us with some of his reflections from his career as a veteran of the 1987 and 2000 market crashes as well as the GFC.
He explained, “I am acutely aware of the damage wrought by such events. I think 1987 and 2000 were predictable because market valuations were extreme, although the timing was always somewhat random. The GFC was not as predictable as it was really the financial system backwash from a government stimulated housing bubble. The lesson I take from these experiences is that, in general, you get rewarded for investing in equities but the price matters. You do not get rewarded for over-paying even though it seems painful to watch others enjoy big run-ups in price over several years as bubbles build. In other words, you can gauge fair value but you cannot time the market.”
“It is also hard to beat a simple market cap weighted equity portfolio over any long period, which is why I favour provision of very low-cost passive alternatives for most people, rather than trying to educate them to be financially smarter. That should certainly be the core option for any compulsory saving scheme. Discretionary investment choices should be built around that, i.e. secondary in importance”, Paul concluded.
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In general, you get rewarded for investing in equities but the price matters.
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