New Zealand Super set to pursue factor investing

New Zealand Superannuation Fund is turning to factor-based strategies to squeeze better long-term returns from the roughly 75% of its NZ$30.3 billion ($21.4 billion) portfolio invested now in passive strategies.

New Zealand Super is close to moving forward with allocations to two factors — value and “low risk” — that are particularly well-suited to the fund's beliefs and advantages as a long-term investor, said Roland Winn, manager-investment analysis with the Auckland-based sovereign wealth fund, in a June 22 interview.

Mr. Winn declined to say exactly how big those allocations will be, beyond saying they will likely become “a material portion of the portfolio over the next 12 months and beyond.”

Mr. Winn said New Zealand Super will pursue those allocations with external managers, but with the fund exerting “greater control (over) the way the signals are constructed.” He declined to go into details about the managers.

The sovereign wealth fund will start off by moving a “quite small” sleeve of its passive allocations into those “systematic” strategies, Mr. Winn said.

The passive portion of the portfolio, meanwhile, has become bigger this year, with most asset classes now trading close to, or a little above, fair value, effectively raising the hurdle New Zealand Super's investment team needs to clear before shifting money into active strategies from the fund's passive reference portfolio.

The reference portfolio is, by definition, passive — it's the basic beta exposure targets in which the investment team takes as a starting point, and then will shift money into active allocations only if it sees market opportunities promising enough to justify such a shift. The portfolio currently calls for an 80% weight in growth assets — 65% to developed markets global equities, 10% to emerging markets equities and 5% to New Zealand equities. The remaining 20% of the portfolio is in fixed income.

Over the past six months, passive investments have risen to 75% of the portfolio from 70%, Mr. Winn said. Even 70% was higher than the passive weighting in recent years, when markets were offering more attractive opportunities, he said.

For the past 12 months through May 31, the sovereign wealth fund earned an investment return of 1.3%, well below its annualized return since inception of 9.6% but better than the -0.73% return for its reference portfolio.

That roughly 2 percentage points of outperformance reflects the combined returns from New Zealand Super's active strategies and its strategic tilting program, which employs overlays to add exposure to markets the investment team judges to be undervalued or cut exposure to overvalued markets.

Mr. Winn suggested the strategic tilting program was able to extract value from the sharp sell-off of global stocks at the start of 2016. With most markets at or near fair value now, however, the outlook for near-term gains from strategic tilting is relatively limited, he conceded.

Mr. Winn called the current moment “a very good time to start to look at these more systematic strategies,” in terms of the amount of data and the computing power available.

He said New Zealand Super's team looked at a large number of factors but quickly narrowed the list to the two that meshed best with the fund's advantages as a long-term investor.

The value factor has underperformed for the past few years, but over the long term, it has outperformed, Mr. Winn said, adding that it's “well-aligned with our endowments.”

The low-risk factor — which he called a variant of low-volatility and managed-volatility strategies, but different in that its returns are driven by beta as opposed to volatility — likewise “suits us well,” he said.

A number of quantitative money management veterans said they don't see the distinction between low risk and low volatility/managed volatility as significant.

Mr. Winn said for New Zealand Super, the thesis regarding what drives a factor strategy's returns is important, and for low-risk strategies, the degree that a particular stock or sector moves relative to the market — its beta — can be distinguished from a volatility strategy focused on how much each of the prices moves. “It works better using beta,” he said.

“Other factors aren't as closely aligned” with New Zealand Super's endowments, but that doesn't mean the sovereign wealth fund won't use those as well at some point, Mr. Winn said.

The fund is looking at “factors” in a broader sense to better gauge its risk exposures across asset classes.

For example, “if China had a material slowdown or major credit issues, that's going to impact both equities and fixed income, as well as real estate in certain markets, so your traditional strategic asset allocation approach” with investment buckets “wouldn't protect you in that instance,” Mr. Winn said.

New Zealand Super officials are working now to better understand those “common risks ... trying to work out how risks interplay with each other,” he said.

Meanwhile, even as the fund's investment team believes there are no “outright broad cheap markets” currently, Mr. Winn said from a longer-term perspective emerging markets stocks look “very attractive,” having been beaten down over the past year, mainly on worries of a slowdown in China.