Amid volatility spurred by the US-China trade tensions and a dovish stance by central banks that has flushed markets with liquidity, New Zealand Superannuation Fund (NZ Super) has tweaked its investment strategy: Run a lower active risk and increase equity exposure.
Taking stock of the investment environment, the NZ$42-billion ($28.2 billion) pension fund noted this week: “With the amount of liquidity in markets and financial assets fairly priced, the amount of active risk we are running is lower than we would expect to run on average over a business cycle.”
The fund believes that while plentiful liquidity continues to be a characteristic of financial markets currently, there is approximately $2 trillion in private markets looking for a home.
In a discussion, NZ Super Fund Chief Economist Mike Frith and portfolio manager Dan Snowden talked about the possibility of a global recession, the major drivers of the economic and investment environment, and the implications for financial markets and asset prices. They also touched upon how NZ Super was responding to the market conditions.
The trade war (US-China) and the central bank’s responses have generated plenty of volatility in the assets market. Support is being provided through large amounts of liquidity by central banks at low interest rates. Going forward, this volatility could make future returns slightly harder to standby, Snowden said.
A volatile year with big market swings led the fund to drop 10 per cent in the fourth quarter of 2018, but it reversed the situation the following quarter. The fund saw a 4 per cent drop in May which was again reversed out in June. The key thing has been to maintain and refine the fund’s strategies to align with its long-term outlook.
So, as it gets “harder and harder to lean into those markets,” NZ Super is still finding investments likely to add value to the Fund. In fact, over the past 12 months, the fund has invested in data centres in North America, rural land, a portfolio of hotels and is “looking to increase exposure to equity factors”.
In April, NZ Super said it will invest up to $115 million in a North American data centre by co-investing alongside CIM Group, a real estate and infrastructure owner and operator. The investment includes access to CIM Group’s existing portfolio of six data centres, owned through joint ventures with CIM’s managed vehicles and its future data centre transactions.
Last month, the fund disclosed that it was investing in a $201.5-million (NZ$300 million) hotel portfolio managed by local construction company Russel Group and private investor Lockwood.
Global growth revised downwards
In recent months, the expectations for global growth have been revised down slightly and this has generated some commentary about the possibility of a worldwide recession. However, most experts believe a worldwide reversal of growth is unlikely.
Keeping in line the economic climate, policymakers have responded to the weaker outlook. Central Banks like the United States Federal Reserve have cut interest rates and the Chinese Government has provided stimulus to its economy by cutting tax rates and increasing infrastructure spending.
The trade war between the United States and China remains a weight on growth expectations and a successful conclusion to negotiations between the two countries will remove much uncertainty from markets, NZ Super said.
“At the same time, current investment and employment growth matched with low interest rates suggests there shouldn’t be a big growth meltdown. This doesn’t seem to be a ‘normal’ cycle like we’ve had in the past 20-30 years. There’s no crazy credit expansion over nominal GDP and no inflation, all of which has delivered moderate growth across developed economies for the past decade,” the pension fund added.
Asset prices and central bank support
Financial markets have been more volatile over the past 12 months than in recent times. Equity markets, which fell towards the end of 2018, rallied hard at the start of 2019 in response to supportive Central Bank announcements.
Further, bond markets also rallied (bond yields fell), but market behaviour seems more consistent with a view of persistent low growth and low inflation.
“It’s worth remembering that until the end of last year, most predictions had the US Federal Reserve hiking rates through 2019. Now we’re expecting 3-4 cuts, and we’re seeing the same response from NZ and Australian central banks, as well as fiscal loosening in China, which should provide support for the local and global economy,” NZ Super added.
On what the future will bring, the fund said, “We don’t know what will happen in the future and we don’t invest this way. Our investment framework and long run investment horizon allows us to look through market ups and downs, but also ensures we are prepared for future developments in market conditions.”
However, Firth noted during the discussion that he expected the financial year to get “quite better” than what the fund reported in May.