Orr on Super Fund

NZ Super Fund CEO Adrian Orr has an op ed in the Herald. Interestingly the Herald notes he won’t do an interview with them – only an op ed.

Before I respond, I should make clear that I think the Fund’s “Guardians” have generally done an excellent job. The fact the fund has made less money than we would have got by paying off debt, is because of the global recession – not because of bad decisions by the fund managers. All funds have been hit.

They key issue for me is whether one should borrow money to invest in the Fund, when the whole rationale for the Fund was that it would be “surplus” funds that gets invested. Anyway Orr says:

Investing for future retirement income is just one activity the Government does. It is equally valid to talk of government borrowing in order to fund tax cuts, or pay for schools and hospitals. All of these activities are funded through tax revenue and borrowing. This is an everyday practice across households, businesses and governments globally. In fact, the Government has done well, with one of the lowest government net debt positions in the OECD.

I think this is somewhat misleading. Investing in the Super Fund is not a core Government activity such as paying for schools. It was set up specifically on the premise that it would be funded out of operating surpluses. It is not just a competing expenditure like schools.

And if you look at th Treasury accounts, the contributions to the Fund are not expenditure. They are shown as the line after the Operating Balance, which is now heaving negative.

The Government has been running a public debt programme throughout the entire life of the fund. The fact that the Government’s operating accounts have gone into deficit makes no difference to the investment proposition of the fund.

I disagree. Borrowing to pay for capital expenditure is very different to borrowing for operating expendiiture. Let’s use a household example.

Household A has income of $100,000 a year and expenses of $60,000. So it has a surplus of $40,000.  It decides to borrow $400,000 to buy a house. So it is taking on debt, but it is running a surplus to allow that debt to be paid back. Hence while not stictly rational, it is quite reasonable that it may stick $10,000 of its surplus into a savings account and $30,000 into debt payments.

Household B has income of $70,000 a year as the husband has lost his job. And their expenses are $80,000 a year. And they still owe $200,000 on their mortgage. So every year they have to borrow $10,000 to just pay the household bills, and borrow $20,000 to meet the interest on the mortgage. Now in this scenario, would you also borrow a further $10,000 to stick into a savings account? Of course not.

The fund is a simple concept. The Government has legislated to invest money today to gain a return over the long term. That return is to be used in the future to smooth the tax burden of the rising cost of superannuation income.

Yes but it is not going to smooth the tax burden anymore. If we have a decade of deficits and debt, then we will still need to massivley increase taxes in the future to pay for it.

One measure of financial success is whether the returns to the fund over decades (not randomly selected days, weeks, months, or year-to-year) are above the cost of government borrowing.

Yes, and sadly the returns over the entire life-time of the Fund are around half the cost of borrowing. Now this is not the fault of the Guardians, but a consequence of the recession. But it is a fact.

When it comes to saving for the future, there is no free lunch. If we don’t save now the retirement payments time bomb in the future simply grows.

Borrowing to save, is not saving. It is like me borrowing $10,000 on the credit cards and claiming I am a saver as I have $5,000 in a low interest savings account.

A government is in a great position to benefit from investing over decades, more so than any individual. It can focus on the long term and, hence, make investment decisions not available to many. It can capture this premium. It has the ability to ride out the tough patches and avoid “fire sales”.

Here I agree. Mind you the Iceland Government might not.

Right now, the earnings prospects for long-term investors have also just improved significantly. This is especially so for a young Super Fund like ours, with the weight of money ahead. The global recession has seen asset prices fall and the rewards for accepting investment risk rise to historical levels.

This is probably right, but have we hit the bottom of the market? I’m not at all sure. I think Europe is looking very vulnerable.

That’s not to say investment opportunities may be better again in 12 or 24 months’ time. But, as long as we are able to buy more as value opportunities arise, and not be forced to sell assets at “fire sale prices”, we will succeed in our task. History also teaches that the best time for investment returns is after significant downward corrections. We must make sure NZ is positioned to benefit whenever this occurs. Stopping out now would ensure we suffer the downside and miss the inevitable leg up.

And in 24 months or so, maybe contributions could be restarted (if they are ever suspended – knows what the Govt will do).  But until the Government can start to make inroads on reducing the deficit, so it tracks back to a surplus at some stage, I would rather have lower debt by not making contributions.

UPDATE: Brian Fallow makes similiar arguments to Orr in his column today. I think he is wrong also :-). He also argues that investign in the Fund is just liek any other sort of expenditure and that you not argue it is all being borrowed. Again I disagree – the contributions were designed to be funded out of operating surpluses.

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