Despite returning more than $3.5 billion above budget to the government coffers over the 12 months to June 30, the Accident Compensation Commission (ACC) fund had a disappointing year by its own exacting standards.
The latest ACC annual report shows that the almost $44 billion fund, headed by Nicholas Bagnall, underperformed its bespoke market benchmark by 0.7 per cent as both asset allocation and most active investment bets fell short of index returns.
During the annual period, the bond-heavy ACC fund returned 13.1 per cent against 13.8 per cent for the composite benchmark.
“Our overall portfolio return was lower-than-benchmark in 2018/2019 because our equity portfolios achieved lower returns than the benchmark indices and because our allocation between investment markets did not fully capture the gains from a decline in New Zealand long-term bond yields,” the report says.
As well as its slightly off-kilter local bond allocation, the ACC fund’s underweight position in the strongly-performing NZ listed property and infrastructure sector hurt relative returns.
ACC’s in-house managed NZ shares portfolio return of 15.2 per cent was 1.6 per cent behind the index due to its large exposure to Metlifecare and Michael Hill – both disappointments on the NZX this year – and an under-benchmark holding in Auckland Airport, one of the star performers of late.
The sovereign wealth fund owns about $3.5 billion of NZX shares, or about 2.6 per cent of the total market capitalisation.
Total global equity returns of 6.5 per cent also dropped under index (7.2 per cent) for the ACC with mixed results from both in-house and externally-managed portfolios.
According to the report, the main ACC internal offshore shares portfolio and two third-party mandates “significantly underperformed their benchmarks”. At the same time, “three externally managed and one smaller internally managed portfolio significantly outperformed their benchmarks”.
A couple of other outsourced international equities portfolios stayed more-or-less in line with benchmark, the report says.
About a quarter of the global shares underperformance was down to unrecoverable offshore withholding taxes but the rest was “real”.
The fund’s slight tilt towards value investing also hit returns in a period where the style “significantly underperformed the broader market in New Zealand and offshore equity markets during 2018/2019”, the report says.
ACC has over $7.5 billion in offshore shares and a further $1.8 billion in Australian equities. While the fund could not supply an up-to-date list, the most recent global managers on the ACC roster include: Arrowstreet; Harding Loevner; CPH (part of AllianceBernstein); Intermede; Marathon; Wells Capital; and, Orbis. As of latest information, the fund also uses Paradice and Independent Asset Management for Australian shares.
But there was better news from the PIMCO-managed $1.9 billion ACC global bond portfolio which returned 9.2 per cent compared to the benchmark 8.4 per cent.
While the ACC report says the fund could have made more of its NZ bond allocation, the asset class was the main contributor to its nominal return of almost $5.1 billion – well above the forecast of about $1.5 billion.
The budget-beating performance was largely due to “the impact of revaluation gains from declines in bond yields, as we maintain a portfolio that is designed to benefit from declines in bond yields, in order to provide a partial hedge against the impact that lower bond yields can have on the valuation of our claims liability”.
ACC invests about two-thirds of the fund in fixed income instruments including close to $12 billion in NZ inflation-linked bonds (equal to almost 60 per cent of the total on issue) and $12.7 billion in regular NZ government bonds (or 11 per cent of the market).
However, the part-hedge was not enough to defray the massive blow-out in the ACC overall claims liability (OCL) with a record $8.7 billion deficit recorded in the latest accounts as low interest rates played havoc with actuarial assumptions.
The ACC only recently reached an equilibrium where further government top-ups to the fund were deemed unnecessary and levies fell across the board.
But with future investment returns looking grim, the government may have to squeeze extra levies out of New Zealanders to refill the fund, the report says.
“Unfortunately, this scenario is looking more likely, as low interest rates create a significant risk that future investment returns will be insufficient to keep pace with the growth in the ACC’s OCL,” the report says. “Our best guess is that future investment returns will average about 4% per annum (less than half what they have been in the past), and our best guess is that ACC would need to grow its reserves portfolio by between 4% and 5% per annum to ‘keep pace’ with growth in ACC’s OCL…”
The ACC fund, which is almost exactly the same size as the NZ Superannuation Fund (NZS), incurred administration costs (including external manager fees) of $55 million, or 0.12 per cent of assets under management – below the budget target of 0.15 per cent.
By contrast, the similarly-sized, but more complex, NZS cost about double ($109 million) the ACC fund to operate over the 12 months to June 30 last year, equating to 0.29 per cent of assets under management.
Over the 12 months to the end of June this year, the NZS returned just over 7 per cent, outperforming its reference portfolio by 0.67 per cent.
Both the NZS and ACC have returned about 10 per cent since inception, although the latter has a longer track record (27 years compared to 16 for the former).
Including the latest below-index year, the ACC fund has bested its benchmark in 25 of those 27 years (albeit that in two years the outperformance did not cover investment costs). According to the 2019 report, the ACC bond portfolio outperformed in 25 years while the in-house NZ equities portfolio was above-index in 22 of the fund’s 27-year history.