Adrian Orr is the chief executive officer of the New Zealand Superannuation Fund, which manages 37.2 billion New Zealand dollars. It reported a 20.7 percent return for fiscal 2017, making it one of the best-performing sovereign wealth funds in the world. He currently serves as the chair of the International Forum of Sovereign Wealth Funds and the Pacific Pension Institute.
In this interview, Orr discusses the growth factors associated with the fund's impressive returns; what it's like investing through the lens of an economist; and how sovereign wealth funds leverage their natural advantages of long-term horizon, liquidity and operational independence.
Orr was named on Trusted Insight's 2017 Top 30 Sovereign Wealth Fund Investors. He graciously spoke with us on Nov. 28, 2017. The following interview has been edited for clarity.
Trusted Insight: The fund returned 20.7 percent in fiscal 2017. To what do you attribute this performance?
Adrian Orr: In terms of the straight attribution, equity markets performed strongly. Our fixed income, or passive listed portfolio also did very well. But we added about 450 basis points through our active investment strategies. A couple of the biggest attributors are very long-term strategies. One is around our strategic tilting, where we have a very disciplined framework where we will lean into or lean out of markets that we see being under or overvalued. And we can also lean across markets. We go long equity and short bonds, and in global markets we’ll go, as an example, short US equity, long European equity.
Now, it's not rocket science. It's more about the discipline. We're using very market-standard valuation tools. We're using the best pricing that we can get for the same markets. We can get some confidence around the price value gaps. And then we have a belief, which has different strengths across different markets, in mean reversion. If prices deviate significantly from fair value, our underlying assumption is that they will revert to value through time.
"Sitting underneath all of that, the longer-term drivers of our returns are as simple as holding strong investment beliefs."
Those two things, belief and framework, allow us to take that longer-term contrarian view on markets. And that has proved to be enormously profitable for us. I think that that's a strength that sovereign wealth funds have. If you aren't harangued by retail investors every day, if your liquidity needs aren't as urgent as a lot of the global mutual funds, then you can be more disciplined and play these games. Having said that, you have to be able to weather career risk and reputational risk, which is always in investors' minds. The discipline is about making sure that the board and management really understand the horizon over which we are tilting.
The other big areas that came home for us were our direct investing assets, where we bought specific assets well below fair value. And over the last few years, that's been proving correct. One of the great investments has been a very large forest in the central north island of New Zealand. That just keeps giving hope, but I probably just cursed it with that statement.
Sitting underneath all of that, the longer-term drivers of our returns are as simple as holding strong investment beliefs. Having the absolute discipline around the strategies that best exploit those beliefs, and then being honest about the capabilities that we need, either internally or externally, to run those strategies on an ongoing basis. That has been the real winner. We haven't been getting spooked by career or reputational risk.
Trusted Insight: Are you looking to partner and co-invest with other sovereign wealth funds and sophisticated institutions?
Adrian Orr: Continuously. I'm chairing the International Forum of Sovereign Wealth Funds (IFSWF) and the Pacific Pension & Investment Institute (PPI). We have IT collectives, tax, finance, risk and investments collectives amongst our peers. Both sovereign wealth funds and other peers try to stand on each other's shoulders to really leverage what our natural advantages are, which is our horizon, our liquidity and hopefully our operational independence.
I say hopefully because one of the downfalls of family offices is often the third generation. That third generation might have bigger liquidity needs than perhaps the first two thought. Our challenge is always about retaining that independence and being able to choose when to buy and when to sell an asset, which is our definition of long-term investment.
We run on the three Cs. The first C is to compare. Who is global best, and how are we relative to that? The second C is to collaborate. What are the areas where we can jointly work together? For example, when different clusters and funds meet together in a collaboration mind. The third C is co-investments, and that’s the hardest of all. They’re about truly understanding each other's institutions, having mandates that suitably overlap and being able to invest in a timely manner. Having a co-investment partner who's got very different decision-making procedures can be non-commercial.
Trusted Insight: Sovereign wealth funds, as an institution, have the unique ability to embody their country’s values. How does the NZ Super Fund fulfill that?
Adrian Orr: That's exactly right. I wish more would be more explicit about what those are, across all funds not just sovereign wealth funds. We are required to maximize returns without undue risk. We are also required, under our legislation, to invest without prejudice to New Zealand's reputation globally. Now we've been very transparent about that since our website is an open book.
We have our responsible investment framework, where we will engage or divest with companies based on clear New Zealand legal frameworks and international law. If a product or service is illegal in New Zealand, we are not involved. There are international protocols that the New Zealand government has signed up to and been active in. One example is the international protocols around landmines and cluster munitions. We also sign up to what we consider third party independent measures of global best practice, both through the United Nations Principles of Responsible Investment (UNPRI), as well as the Carbon Disclosure Projects and some of the global employment standards. With that, we will engage with companies if we see them deviating from these areas. We try to engage with other large like-minded investors through the UNPRI.
"Viewing the portfolio through three lenses added a lot of richness and a much clearer conversation between team members."
So where has that led us? That's led us to some exclusions around illegality - whaling, landmines, cluster munitions and nuclear weapons. We have also excluded companies that manufacture tobacco. But likewise, we've got a huge list of engagements that we deal with companies around behaviors and product disclosures. A current focus is climate change. We set an active target for reducing our carbon exposure, both emissions as well as fossil fuel reserves. We’re reducing our exposure to those by 20 precent for emissions and 40 percent for carbon reserves by 2020. We're already a long way down that path on the divestment front, having sold out of a large number of high-carbon stocks, and now we're busy actively engaging around investment hurdles and investment disclosures.
The climate change strategy is based on investment considerations, given our mandate to maximize returns without undue risk. We believe that carbon is mispriced, and the risks around it. Hence, we aren't being sufficiently rewarded. We’re reducing our exposure and looking at ways to get better rewarded for the carbon and alternatives that we’re exposed to.
Trusted Insight: How has your background in economics shaped your approach to the New Zealand Superannuation Fund?
Adrian Orr: I think that question is absolutely on the nail. I turned up a little over 10 years ago with an economics background, not an investment one. And immediately I could see what we had bought, but I couldn't tell you what we had. We had the asset classes well-defined, under a typical strategic asset allocation strategy. A small percent went to property, infrastructure, timber and private equity, the usual suspects. But I couldn't tell you what risks we had, whether we were being compensated appropriately for those risks or whether we were more concentrated than what we really thought.
We sat back from an economic perspective, and said well, "What have we bought here? How much standard market risk, beta risk, have we got? How much credit, liquidity, concentration and illiquid risk?" That led us to completely abandon our old approach and move to our reference portfolio approach, where we have 80 percent listed equity and 20 percent fixed income as our base reference portfolio, notional portfolio. That would do the job for us even if we didn't have such a big staff. And then we thought, “now can we add investments that improve on that across those core risk sets?”
"The work that we do goes beyond time horizons of any one person's career, or any board member's reputation."
That led us to where we are today. We have our reference portfolio, and then we have our value-add investment strategies. And those value-add strategies are put under headings like diversifying strategies, market mispricing strategies, single-asset mispricing strategies and skill. It's a very different way of building up the portfolio and our teams are set up really similarly to those types of structures.
For someone explaining to me what we were doing, they had to break it down to first principles so that they could teach the dummy. And then we re-built it up. Now we all talk in that framework. We all have a particular hurdle rate for any investment based on those core risk factors that I've mentioned.
Viewing the portfolio through three lenses added a lot of richness and a much clearer conversation between team members. The first lens focuses on asset class. The second focuses on the risk factors that I’ve talked about. And the third lens focuses purely on the economic risks that we have bought, which helps us do the scenario and shock analysis.
It's created a single fundamentality rather than people just sitting in their asset class, siloed.
Trusted Insight: What advice would you give to aspiring investment leaders?
Adrian Orr: The number one lesson is to not underestimate the value of a supportive and educated board. The work that we do goes beyond time horizons of any one person's career, or any board member's reputation. They have to be in the role for the best purpose of the fund, not for the prestige of their activity. And I think that's absolutely critical. We would not be able to attract and retain the people we have here at the fund if we didn't have the operational independence that we've got, and board commitment to continue to run these very long-term strategies.
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