Sovereign wealth funds now play offense as markets swing

The NZ$20 billion New Zealand Superannuation Fund's program of making investments outside of its strategic asset allocation framework when markets diverge sharply from underlying fundamentals has added value since its February 2009 launch, becoming a fixture of the Auckland-based system's investment strategy, executives say.

In its annual report released last month for the fiscal year ended June 30, David May, New Zealand Superannuation's outgoing chairman, cited the fund's “strategic tilting” as “the major contributor to the value we've added” during the latest year. The “new way” has produced “promising results,” he said.

Market veterans say New Zealand Superannuation's efforts are part of a broader trend that has found sovereign wealth funds, spurred by the heightened capital markets volatility of recent years, looking for ways to play offense when they sense stock and bond prices are getting out of whack.

Neil Williams, chief investment adviser and head of strategic tilting with the fund, confirmed in a telephone interview that a reduction in the fund's hedge on foreign currency assets back to the New Zealand dollar was a key factor in the strategic tilt program's NZ$295 million (US$241.2 million) boost to the portfolio for the latest fiscal year — the bulk of the value added above its passive policy benchmark.

But with the program designed to take advantage of the fund's ability to provide long-term capital at moments when risk aversion is stifling the broader market's risk appetite, New Zealand Superannuation's board is more focused on medium- and long-term results than on returns for any given year, he noted.

Other elements of New Zealand's strategic tilt program last year left the fund's allocation to global equities significantly above its target of 70% of overall assets, and fixed income significantly below its 20% target. Citing the market sensitivity of its strategic tilt positions, fund executives declined to provide specific allocation figures.

Providers of long-term capital, such as sovereign wealth funds, are simply adjusting to a changing opportunity set in markets characterized by volatility and dislocations, noted Peter N. Horn, Melbourne-based head of J.P. Morgan Asset Management's Australia business and a member of the firm's global sovereign client group.

Sovereign wealth funds emerged from the market turmoil of 2008 convinced of the need to become more agile than “set-it-and-forget-it” asset allocation targets allow, but they've continued to grapple with the question of “how” — the framework, the infrastructure, the tools around that, noted Rumi Masih, a senior investment strategist with Boston-based BNY Mellon Asset Management's investment strategy and solutions group.

The move from the classic mean variance, efficient frontier model based on long-term assumptions has spawned interest in more tactical, dynamic approaches to asset allocation, and SWFs have moved toward risk-factor-based allocation frameworks and tactical asset allocation strategies, said Stephen Hull, a Hong Kong-based director with BlackRock Inc. overseeing the firm's multiasset portfolio strategies business in Asia ex-Japan.

Against that backdrop, a number of sovereign wealth funds have tweaked their rebalancing disciplines in recent years.

According to Peter Ryan-Kane, Towers Watson & Co.'s head of portfolio advisory for Asia, ex-Japan and Australia, such responses have included:

• widening target ranges for rebalancing;


• introducing dynamic TAA overlays; and


• turning breaches of asset allocation ranges into signals for investment teams to consider action, rather than automatic triggers for rebalancing.

Market participants differ on whether those moves away from rebalancing orthodoxy will stand the test of time.

In an interview, Hon Cheung, Singapore-based regional director-Asia with State Street Global Advisors' official institutions group, said the “wake-up call” of the global financial crisis has rightly prompted investment officers of big institutional portfolios in the region to consider whether more dynamic approaches — in effect, “putting your finger on the scale” — make sense at times of extreme market volatility.

Mr. Ryan-Kane said while it's hard to generalize, SWFs that relaxed their rebalancing disciplines at the depths of the market's plunge in 2008 probably did more harm than good for their returns when equity prices rebounded strongly starting in March 2009. He declined to discuss specific clients.

It will take years to see the compounded effects of different approaches to asset allocation and rebalancing on investment results, but from Towers Watson's standpoint, the more systematic the rebalancing regime, the better — even if reviewing the “envelope” for rebalancing ranges is a necessary part of the process, he said.

Mr. Williams said he and the New Zealand Superannuation Fund team agree that systematic rebalancing is essential and argue the fund's strategic tilt program can be seen as “enhanced rebalancing.”

“The critical point is that tilting is a valuation-based strategy,” rather than one dependent on momentum or short-term market volatility, he said. Unlike a market timer, New Zealand Superannuation would invest in equities, for instance, when they look very attractive on a medium-term basis, in full knowledge that the market could go lower, he noted.

That focus on taking “the other side of a momentum trade” when New Zealand's investment team sees medium- to long-term payoffs to doing so, while being completely agnostic about near-term market movements, underlies the strategic tilt program, Mr. Williams said.

He noted the same contrarian fortitude needed for systematic rebalancing is key to sustaining New Zealand's strategic tilting program, along with painstaking work on infrastructure, compliance and execution. While four years is too short a time to reach definitive conclusions on performance, Mr. Williams said New Zealand's board and management are “very committed to the strategy.”