NZ Super’s strategic tilting program is one of the key reasons why the fund has been such a successful investor over the past 20 years. In a recent podcast interview with [i3] Insights, Matt Whineray took us through the genesis of the program and shared a few war stories.
One of key characteristics that makes New Zealand Superannuation Fund (NZ Super) unique is its strategic tilting program. Since the inception of the program in 2009, strategic tilting has added NZ$4.6 billion in value to the portfolio. Last year alone, the program provided NZ$935 million in value-add.
But it hasn’t always been an easy ride. Strategic tilting can be volatile and since it relies on mean reversion, it can be underwater for substantial amounts of time.
In light of the 20-year celebration of NZ Super’s investment journey, we asked Matt Whineray, Chief Executive Officer of the fund, who also previously held the Chief Investment Officer role, about the genesis of the program and the experience over the years.
Whineray explains during the [i3] Podcast that the program was initially the brainchild of Neil Williams, the former Chief Investment Adviser and Head of Strategic Tilting of NZ Super, who joined the organisation in 2008.
Before joining the fund, Williams worked as Head of Asset Allocation at UBS Asset Management in London, under Brian Singer, who was then Head of UBS’s Global Investment Solutions Business. Singer, a disciple of asset allocation behemoth Gary Brinson, built an impressive dynamic asset allocation (DAA) team that also included Renato Staub.
Singer and Staub eventually established their own business in 2007, which was subsequently bought by United States fund manager William Blair in 2011. Singer spent more than a decade at William Blair running a fund based on DAA. He now runs a private equity firm, ViviFi Ventures, focused on investments in medical and social cannabis.
Williams joined NZ Super shortly after Singer left UBS.
“Neil had been in the asset allocation team at UBS Asset Management and had brought with him this thinking around the dynamic asset allocation approach,” Whineray says in the podcast.
“The idea was to take advantage of our belief that we can have a more constant relative risk aversion than the market. If we have a long-run view of the equilibrium value of a particular asset class, then as it gets depressed, we can add exposure or as it gets excited, we can reduce exposure and do that in a systematic way.”
By creating a systematic DAA approach, NZ Super aimed to remove behavioural biases in the process. It then took incrementally larger positions in an asset as it got further away from what the investment team assessed was its fair value.
“It’s not about waiting for a market to get to an extreme and then putting a position on, it’s saying: ‘Hey, if the market’s gone down, and there’s a gap between what we think value is and prices, then we will add exposure and we’ll be systematic about how we size that,’” Whineray says.
“Then if it goes down the following day, then we’ll add some more. If it goes down the next day, then we’ll add some more.”
But as the fund increasingly takes more exposure to an asset as it drifts away from fair value, the fund also incurs a greater loss until the price reverts to the mean. It took some time to make the board feel comfortable with the idea of holding onto losses for an extended period of time.
“It took quite a bit of work with the investment committee and also with the board to approve that strategy because the darkest hour is right before the dawn as you get further and further away from fair value and you’ve increased your position, either in a long way or in a short way,” Whineray says.
“Your mark-to-market loss will be at its peak at the moment when you have the highest expectation of return.”
The strategic tilting program kicked off in March 2009, which turned out to be good timing as equity markets were at a low point then.
“It was interesting because we had said to the board: ‘Look, we may be out of the money for a long period of time and we will all have to hold hands and make sure that works.’ And then what happened was we put some positions on and the market immediately went off and the board said: ‘Oh, that was easy. Why don’t you do some more?’”
But the strategic tilting program also has had its challenges, Whineray tells the [i3] Podcast. One particular moment he remembers well was in 2013 when the fund took a short position on the New Zealand dollar as the currency was richly valued versus a basket of global currencies.
But as the position grew, the NZ dollar showed no signs of abating.
“What happened was [that] we increased the short position in the Kiwi and it got very large, like up to nearly 40 per cent of the NAV (net asset value) of the fund. And that starts to create nervousness because to get to that short position as the Kiwi continues to go up, we’re losing money each day on what we had put on yesterday,” Whineray says.
“And so that really focused the mind of the board and of the investment committee and of the tilting team and everybody on that position. But we saw in the end that the Kiwi reverted.”
The annual report of NZ Super for the 2014 financial year shows the entire tilting program cost the fund 1.39 per cent in value compared to the reference portfolio, partly due to the currency position. But the fund stuck to its guns.
“The main reason the fund underperformed [the reference portfolio] this year was the impact of the rising New Zealand dollar on our currency tilting strategy. We have taken a view that the New Zealand dollar is overvalued and will revert to a more normal level in time,” the report says.
“We remain comfortable with this view. Tilting is a long-term, multi-year strategy, and movements up and down from year to year are to be expected.”
A year later, the fund reported an outperformance of 3.23 per cent from the strategic tilting program in its annual report.
“So this is ultimately a mean reversion strategy. We expect things to revert to that long-run equilibrium at some point; there will obviously always be volatility, but it did [in the end],” Whineray says.
“But that was a real moment of tension and one that required careful understanding of the basis for the strategy. Step away from the positions and the P&L and go back and say: ‘The basis for the strategy, does that still exist? Do we still believe in some long-run value? Do we still believe in mean reversion?’”
The answer so far has always been ‘yes’ to these questions and, in fact, NZ Super has increased the risk budget for the program several times.
“Over time, we have increased the active risk allocated to that. We doubled it a couple of times from the outset. But you always need to make sure that you size a strategy right. I pinched this one from [billionaire hedge fund manager] Cliff Asness: ‘Don’t size a strategy so that if it goes wrong, you’re dead,’” Whineray says.
As the fund has grown more comfortable with the strategic tilting program, it has expanded the number of asset classes it can bring into play. It initially started off with equities and currencies and has more recently been expanded into commodities and real estate investment trusts (REIT).
“We took REITs out of equities and thought about whether they might provide us with a different exposure or a way of expressing views in a way that wasn’t perfectly correlated with the other markets,” Whineray says.
The commodities tilting program has remained relatively modest to date.
“Commodities are a bit trickier because you’ve got both levels and curves and so there are more variables,” Whineray says.
“The team is looking to learn a bit more about how our models work in that situation and our confidence in our models because in all of these different markets we have a different level of confidence in our view of equilibrium or our view of how it might track over time.
“And that explicit level of confidence will affect how much risk we allocate to it. So what the team is looking to do is thinking about: ‘Well, are there other ways we could express this strategy? Are there different signals we might use? How do we think about trading, not necessarily frequency, but size, positions?’
“In the very early days, we traded once a month. Now the team trades every day and sometimes a couple of times a day, depending on which markets are open.”
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.