The Exchanges

Q So we take that as the problem. How do you approach it?

A So we start by saying, let's have a look at the mandate. So what the mandate says is, We need to maximize return without undue risk. We need to use best practice portfolio management, and we need to not prejudice New Zealand's position as a responsible member of the world community. So those are the three parts of our mandate. Then we say, okay, what is it about us? What's special about us? And we call that our endowments, and others might call those advantages, but what's innate to us? And so the things that we think are our endowments are our long horizons, so we talked about that, Our known liquidity profile. So we're not going to have the government ringing up tomorrow and saying, we need a big withdrawal. So we know what the liquidity profile looks like. Our operational independence, really fundamental, and our sovereign status. So we're related to the crown. That gives us some advantages in some places. So we spend a bit of time saying, those are our endowments. And then we say, well, what are our investment beliefs? How do we think markets work? And so we've got a set of investment beliefs. I think there are, there are nine These cover things like asset allocation, they cover things like mean reversion, governance, the importance of governance, beliefs around manager skill, beliefs around life cycles, around the importance of ESG, that type of thing, and those investment…

AI assessment note: “So we start by saying, let's have a look at the mandate.”

Q And what are those five baskets that you mentioned?

A So what we do is we've got a bunch of opportunities, investment opportunities. Some of them are sort of like asset classes, but they're slightly different, perhaps more, slightly more granular. And then we aggregate them into those five baskets by saying, what are the sort of the similar type of opportunities? So we've got the first basket is called structural and that used to be called diversification. So that's got things in it like timber, farming, life settlements, cat bonds, Or our factors, our equity factors programs, things that are driven by structural impacts on the markets. That's the one risk basket where we think we'll have some exposure through time always to those things. So that's the structural basket. Then we have a three, we call market pricing. We've got a real assets basket, we've got a broad markets basket, and we've got an ARB credit and funding basket. And those have different opportunities in them that That relate to that. So real assets is things like infrastructure and real estate. The broad markets basket has things like our strategic tilting program, mostly things like global macro, and then our credit and funding is where we do our internal credit mandates, we also have distressed credit, we have a couple of other more credit related, funding related opportunities, and then finally our last basket is one called asset selection, so that's one where e…

AI assessment note: “first basket is called structural... real assets... broad markets... credit and funding... asset selection”

Q miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai. And now back to the show. Are you going down to the security level? So you could do mean reversion across markets. You could do it tilt to value and growth. You could get into sectors. You could get into securities within sectors. How far down are you going?

A The genesis of it was it started with basically two levers. It was either a view on global equities versus global bonds, and it was a view on the Kiwi versus the basket of currencies. So those are two things. And then over time, we've significantly increased the breadth of it. So now, now we've got global equity markets like Japan, Canada, US, Europe, UK, emerging markets. We've got the same bond markets. We've got about four different credit markets. Australia, Japan, US, Europe. We've got all the major currencies. So we haven't gone down below to sector or individual securities because we're more confident at the whole of market level of being able to say, what do we think the long run equilibrium prices or value is? And then compare that to the current price. When you get to individual sectors and individual securities, we're just much, much less confident in that. So you can increase breadth, but I think you reduce confidence, and so we probably don't improve the performance of that by doing that. I think that's the key, is to have breadth of non, hopefully uncorrelated positions, but without destroying the confidence by just getting to a point where we just can't have a view.

AI assessment note: “we haven't gone down below to sector or individual securities because we're more confident”

Q The other internal effort you mentioned was the completion strategy. So how does that fit into the puzzle?

A The portfolio completion team Is what a lot of other organizations might call their treasury function, and so they're the team that do all of the market trading, so all of our derivative trading, all of our FX hedging, all of our transitions or rebalancing, so their job is to, is to basically take the actual portfolio, compare it with where we want to be from a risk perspective, and then rebalance to get back to that by using those liquid ones, as well as execute the strategic tilting Trades, as well as do the FX hedging, as well as trade the New Zealand equities that we might trade internally. So that's a really important team. We created that after the GFC. So going into the GFC, all of our stuff was outsourced, and we didn't have great views of almost anything, liquidity or risk or any of that. So it was a big program to create some critical functions, which allows us to have visibility and control over our liquidity management, and then also You know, a window into where markets are. So that team is a team that is doing all the market facing activity.

AI assessment note: “The portfolio completion team Is what a lot of other organizations might call their treasury”

Q What are your priorities for the coming year as you look at the things you're working on and how you're going to continue to try to evolve this model?

A So the government announces its budget in May every year, and so in this new budget, the government announced a new mandate for the guardians to manage, and that is a mandate for the development of domestic venture capital, domestic venture capital market. And there's quite a chunk of work at the moment going on. Okay, well, let's define what that mandate is going to look like. Let's help with the drafting of the legislation. Let's deal with the entity that's going to manage that for us, which is a, a crown entity called the New Zealand Venture Investment Fund and define what the terms of that mandate are. And so there's quite a lot of work across the organization to figure out how to do that, because to date, we've got the guardians, which is us, that's our investment management company. And then we've got the fund and the guardians had one mandate and one purpose. And that was fantastic. We've now got an additional mandate, which we've been given because government regards us as competent investors. So they've said, right, you can do this as well. So now we're going to run These two mandates. The new mandate's small comparatively. It's only going to be about three hundred million compared to forty two billion, so you've got a lot of disparity, but actually it's going to take quite a bit of work to set that up. That's a big one is getting that going. We've got, within the inve…

AI assessment note: “the government announced a new mandate for the guardians to manage”

Q And so let's frame out the rest of the other side of this, the investment equation, which is the purpose this serves. When do you expect to start seeing money coming out?

A So what the legislation does, it has a formula in the legislation which is aiming to smooth out the cost of national superannuation over a 40 year period. So it makes a bunch of assumptions around what our returns will be, what GDP growth will be, this type of thing. And then it produces a cash flow model that says the government needs to contribute to us at a certain rate, and then at some point we will start contributing back to the government. And so at the moment that model shows Some withdrawals from the fund in the mid- twenty-thirties, but it's a function of the way that model's working that there are some withdrawals then, but really the big withdrawals start in the mid- twenty-fifties. But even after those big withdrawals start, the fund is still forecast to continue to grow through the end of the century.

AI assessment note: “Some withdrawals from the fund in the mid- twenty-thirties, but... big withdrawals start in the mid- twenty-fifties”

Q What questions are you asking to determine whether you're going to try to bring the resources in-house or hire externally?

A We start with a few questions like, can we get satisfactory alignment? And that probably is one of the biggest drivers. Not so much a cost one, because while you can get some cost improvements, I think the bigger driver of our decisions, especially where we are down in the bottom of the Pacific, it's going to be very hard for us to Build teams in the US or in Europe or whatever and replicate what we might get from managers. So the cost one is less of a thing. A lot of it is alignment or we can't get some sort of critical risk control that we might want or the ability to move it. So strategic tilting is a good example. Strategic tilting is entirely managed through derivatives. It benefits from the liquidity management that our portfolio completion team runs and the counterparty risk that we represent as a fund as a whole. So, but also The thing about strategic tilting is that you can be for a long time underwater, and because you're waiting for these markets to mean revert, and they might be slow, or they might move further away from whatever you think the mean is, and so that one we thought is really hard to get alignment with external managers, and also what we've seen is where managers are running those types of programs, sometimes they have a pooled program, And other clients in that program start to lose their nerve and want them to take the risk off, and that's exactly the…

AI assessment note: “We start with a few questions like, can we get satisfactory alignment?”

Q So I'm going to circle back to two of the beliefs you talked about and really bring them into the present market. So one is the notion of markets that are conducive to active management and the ability to generate alpha. Where are you seeing those markets today?

A We don't see that many, to be honest. So we do think that in New Zealand, so the New Zealand active equity market is an interesting one in the sense that the median manager Has been able to generate alpha or, you know, excess returns over time. And you say, why is that? Is that because there's a bunch of real special managers, or is that because there's something About the benchmark, or is there something about the structure of that market? So we think that the New Zealand market is one of those that's conducive to it. So, so as a result of that, we have actually relatively few listed market active managers. So I could count them on pretty much one hand. We've got two managers in New Zealand that run active equities. We've got one global emerging markets active manager, and that's it. Right. So we don't have any developed markets, active managers. We don't have any fixed income market active managers in those listed spaces. And that's really because we look at those and we say, in those really large developed markets, there are lots of really smart people trading with each other. And we don't think that there's a persistent production of excess return. Contrast that with the New Zealand market where we think there is, although that, that might also be declining over time, and we think what's happening in the New Zealand market is that the New Zealand market is made up of retail…

AI assessment note: “We don't see that many, to be honest. So we do think that in New Zealand”

Q Why would you have as much as 20% in fixed income when you have such a long duration liability?

A Because we don't have a bunch of explicit liabilities against us. I think that what that does is it provides a bit of a buffer that allows us to rebalance that portfolio. It provides some diversification benefit, so it is not obviously as volatile as a, for example, a hundred percent equity case. When we talked with the board about the reference portfolio last time, we did show them different mixes of those, which included 90% equity, a hundred percent equity, And really, ultimately, it comes down to a desire for the institution to be able to survive through the long term. You want to be able to control those drawdowns a little bit. So we want to have exposure to that equity risk premium, because we think that's the big driver over time. But the fixed income provides us some diversification, as well as some liquidity provision for rebalancing. The board says, okay, let's land on the reference portfolio. And then what the board is wanting to know is how's our actual portfolio performing versus that reference portfolio, because that's the decisions that management are making in order to try and improve it. And for the large part, we've added value. I think we've had 11 positive value add years over the last 15. We've added nearly one and a half percent a year, which is worth sort of eight billion to the New Zealand taxpayer. So that's been good, but that's by looking at the refer…

AI assessment note: “fixed income provides us some diversification, as well as some liquidity provision for rebalancing”

Q And how do you think about sizing the strategic tilting effort as a percentage of the whole?

A We have a view on what we think the overall information ratio is, what we can make in terms of active return versus the risk that we take. Then we have individual views on the different markets, how confident we are. So there's a, there's a sizing thing going on within tilting about how much we allocate to equities versus bonds or currencies versus each other's or whatever. For strategic tilting itself, strategic tilting is the biggest chunk of our active risk budget. And that comes from being really consistent with our beliefs and our endowments, and us having a lot of confidence in our ability to execute that, which is sort of developed over time. So we look at what we expect to make on that, so our confident, our risk-adjusted return expectations, we adjust that by our confidence versus every other thing that we'd allocate active risk to, and that gets the biggest chunk of active risk.

AI assessment note: “strategic tilting is the biggest chunk of our active risk budget”

Q And what metrics are you using to determine equilibrium and markets that move away from equilibrium?

A Yeah. So the team builds DCF models for all of these markets. We have long run views on, on the big drivers. So growth, inflation, real interest rates, and then that's, which come from our internal economics teams, as well as gathering data externally. And then with those, we form views on what the long run equilibrium values are. We use, particularly in the rates and the impacts on the currency as well, we use the sort of the near term market pricing, because what we're not trying to do is, is forecast where things are going over the next couple of years. What we're trying to say is, is there some sort of reasonable difference from the long run equilibrium value? And then if we think it's a little bit lower, then we'll buy it. You know, if it goes down at that point, we'll buy some more, and we'll do that incrementally, and then if it starts to go up, then we'll start to sell it. So long-run economic drivers try to have economic identities so that you don't have these sort of divergent models, but they are all ultimately consistent with each other.

AI assessment note: “the big drivers. So growth, inflation, real interest rates”

Q You mentioned that you want these managers to be able to help you with the flexibility and shifts in asset allocation and strategies. How much do you come to those judgments on your own, and how much are those inevitably informed by the very managers you're giving the money to?

A Often they are at least partially informed, but also you get quite a bit of information by their activity, because generally speaking, if a manager is slow from allocation perspective in terms of, well, slow versus what, but you know, not seeing lots of opportunities, that's pretty useful information for us, because that says, well, actually, maybe this isn't that attractive. So, so you often probably, if you really looked at it, you'd say there's a reasonable correlation between the pace at which managers are allocating risk And our view on attractiveness, as you'd expect, because they're close to it, and if they're not seeing opportunities, then our other indicators would probably tell us that we don't think it's that attractive either.

AI assessment note: “Often they are at least partially informed, but also you get quite a bit of information”

Q Do you run the risk that the managers as a group sort of form a consensus, and as a result, you're tilting towards a market consensus instead of, as you want, a mean reverting kind of contrarian approach?

A Possibly, but that's where having a bunch of them, and particularly a bunch of them who think in sort of different ways is quite useful, because then you're, you're not totally driven by a single information source or data source. You can talk to them, and what's really useful from some managers is, notwithstanding that they might not be in a particular asset class, they'll, they've got sort of frameworks and structures for thinking about how they would view the retractiveness, so they can be really helpful outside of their Immediate area for us for thinking about that, and the other way we try to deal with that is those risk basket teams have got a bunch of different people in them, so that it's not just the person who is dealing with the manager at the access point level who is doing the target allocation, it's that team that's doing it, so you get a bit of protection against capture, if you like, through that process.

AI assessment note: “Possibly, but that's where having a bunch of them, and particularly a bunch”

Q And then when you add up the current portfolio, let's say, using the framework you're using with risk allocation and budgets, and then if you compared that to the older way of doing it with strategic asset allocation and assets, and maybe you have like a absolute return bucket for the things that you might have in structural now, how different are those two portfolios?

A We moved nine years ago to the reference portfolio, in And since then, what it means is that we can be a bit more dynamic with opportunities, so we don't have to try and jam it into one of the SAA categories. And when we had the SAA last, we had things like timber and infrastructure and private equity, and we had this thing called other private markets, which was like a, just a, whatever else you got, kind of chucking in that. This one is a more granular approach. Doesn't require us to go and change the whole SAA construct to add an opportunity. So an opportunity can be added on the, on the recommendation of the investment committee and the approval of the CIO. We can then allocate risk to it. The board has given us the overall umbrella of how much active risk we can have, but then that, the job of allocating that across the vast opportunities is sits with management. And so I would say always, you're going to be anchored a little bit from where you started with. But we have moved that quite a way. So what I guess we wanted to get away from with the SAA was the SAA says you're going to have five percent infrastructure whether you think it's attractive or not. You're going to have five percent timber whether you think it's attractive at the time or not. We wanted that to be a little bit more dynamic and a little bit more responsive and not just put it in just because we've made …

AI assessment note: “you're going to be anchored a little bit... But we have moved that quite a way.”