It is their long-term horizons rather than portfolio size that give sovereign wealth funds a significant edge over other investors in performance, according to a research note by JP Morgan Asset Management. The discipline they show in sticking to longer horizons mean they have increasingly taken advantage of liquidity premia from alternatives.
Looking at the five-year performance and portfolio make-up of eight sovereign wealth funds, the report says that an increased allocation to alternatives provided a lift in the environment especially coming out of the global financial crisis. The eight big funds had a median allocation of 18.5 per cent to alternatives and beat the returns of a 60:40 benchmark by 5.51 per cent a year over the past five years.
Although the funds are not named, NZ Super was the best performing of the eight with a 17 per cent annual return over five years and just over 21 per cent over three years. NZ Super had 21 per cent of its NZ$30 billion in alternatives, including real estate. In fact, the report notes that there was a seven-fold increase in investment in real estate by the eight funds in the past five years.
In a recent speech, however, Gavin Walker, chair of NZ Super, moved to hose down expectations of returns continuing at such a pace into the future. He said the recent returns were among the best the fun would experience “for some time”.
“It sounds too good to be true! Certainly, if I saw returns of 21 per cent pa advertised for an investment product, I would be thinking that it was too good to be true,” Walker said earlier last month.
“So, a word of warning is needed – these high returns are very much at the upper end of what we expect the Fund to return – our five year return is at the 93rd percentile…
“On average and over the long-term we expect to earn the rather less exciting figure of 8 per cent pa – but which will still provide a handsome return to New Zealander stakeholders.”
The JP Morgan report says: Long-term institutional investing, as practiced by the leading sovereign wealth funds, enjoys large strategic advantages and a decisive tactical edge over investing with a shorter time horizon:
> A long-term strategy allows for fundamental themes to fully develop.
> By taking positions with high potential payoffs despite possibly uncertain timing, the strategy both shapes the future and profits from it.
> Paradoxically perhaps, the long view, coupled with ample resources, can exploit tactical opportunities created by short-term investors under pressure to liquidate holdings due to margin calls and liquidity demands.
> More broadly, a long-term strategy stands to benefit from mispricings arising from errors in evaluation and elevated risk aversion.
> Finally, long-term investors’ ability to absorb the liquidity risk inherent in unlisted and illiquid assets can generate a premium return.
It notes, though, that long-term investing is not the same as ‘buy-and-hold’ investing and cites the philosophies and processes of Singapore’s GIC and that of NZ Super.
It says: “Long-term investing is not the same as buy-and-hold investing—it does not automatically equate to long holding periods. Rather, it creates optionality. Long-term investors may hold an investment only as long as prospects justify it. Singapore’s GIC, to cite that prominent example again, will exit an investment “if values converge quickly,” in its words. The New Zealand Superannuation Fund, another sovereign wealth investor with an outstanding track record, has stated that it will rotate out of a strategic holding if it identifies an opportunity that offers the prospect of a better risk-adjusted return.”