The Risky Business of Government – A response
POSTED ON: 18 September 2015
An abridged version of the following article by Guardians CEO Adrian Orr was published in the NBR on 18 September 2015.
In his 21 August “Order Paper”, Rob Hosking described the New Zealand Superannuation Fund as presenting a “big risk” on the Crown balance sheet.
Hosking’s spotlight on the comprehensive balance sheet is needed, but I believe he reaches the wrong conclusion about the risks the Fund presents.
In analysing any balance sheet, an assessment of the assets in isolation of the liabilities they are intended to meet will—by definition—only provide half the picture.
New Zealand’s universal superannuation costs will rise over time as the population ages. The Fund is an asset built to partially offset this known liability, and its assets are structured in this context.
An important aspect of this structure is the long-term perspective taken in managing the Fund. As a sovereign investor with few demands on liquidity, full control over its capital, and a goal to help meet superannuation costs over several decades, the Fund is ideally suited to long-term investment.
These endowments are provided by the Fund’s governing legislation—widely considered ‘best-in-class’—and are not available to the typical investor. The Fund therefore has certain advantages in the market. Importantly, these include the ability to weather short-term price volatility and short-term losses in the pursuit of longer-term gains.
So, does the price volatility of the NZ Super Fund’s holdings truly introduce outsized risk to the balance sheet? Unfortunately, understanding the balance sheet’s resilience to different kinds of shocks over time is no simple task.
The Government’s balance sheet is a snapshot of the Crown’s financial health at a given point in time. Its resilience and vulnerabilities, however, must be evaluated across time, factoring in future risks and the anticipated interplay between assets and liabilities.
The biggest balance sheet risk from the NZ Super Fund is not a short-term risk around price volatility. Instead, it is the longer-term risk that, come 2030 and beyond, the Fund is unable to pay out as much money as envisaged because of low investment returns. This has obvious implications for future New Zealanders and future governments.
However, to get the required return and meet the Fund’s purpose of reducing the tax burden on future New Zealanders, we must assume investment, or market, risk now. To focus on these risks without considering the returns they offer as compensation is to take a narrow and disappointingly short-term view.
Taking a broader view of the balance sheet, a successful NZ Super Fund is a diversifier and can reduce risk for the Crown over the long term. Should a future domestic economic shock compromise national income and the tax take for a period of time, a large and successful NZ Super Fund will act as a buffer.
Similarly, if a shock creates an unfavourable credit environment, a successful NZ Super Fund will help position New Zealand positively in global debt markets.
It is great that we are talking about the Crown balance sheet and its resilience. But let’s measure what matters, and then we can properly manage the real risks.