Cullen: Address to CSRI Conference
2 December 2005
Friday 2 December 2005
Address to CSRI Conference: Reward, Risk and Reputation: Re-thinking the investment role of CFIs in New Zealand's Growth
KPMG Centre, Viaduct Harbour, Auckland
Within the next two years, one of the most important milestones in New Zealand history will be passed. Despite its importance, it is likely to go largely unheralded in the media; although I for one will do my best to draw attention to it, and to what it means for New Zealanders.
The milestone is, of course, the Crown's shift into a net positive financial asset position, due on current forecasts to occur in the 2006/07 financial year.
This will be the first time in modern history that the public of New Zealand will own collectively more than they owe collectively. Just as significant is the fact that this net positive position will continue to improve, and indeed, over the next twenty years the Crown balance sheet will come to be dominated by financial assets, rather than physical ones.
That may require a shift in thinking for New Zealanders, who are very comfortable with the notion of their government owning large public infrastructures, hospitals, schools and so on; but perhaps less comfortable with the notion of large Crown holdings of financial assets. For those who grew up in the era before the reforms to financial management in the public sector in the late 1980s, that discomfort was focussed on the fear of state ownership of the economy or the fear of state profligacy in the hands-on management of large pools of money.
In essence, there was a suspicion that politicians would be unable to avoid the temptation of using financial assets for purposes other than was originally intended. That suspicion ought now to have been put to rest. What we have achieved in the past twenty years or so has been a steady strengthening of the regime of financial management as it relates to both year-on-year revenue and expenditure issues and to long term management of the Crown balance sheet.
While we do not want to lapse into complacency, I think it is fair to say we now have much greater clarity and transparency around two key elements:
- Clear and transparent policies for the holding and management of Crown financial assets; and
- Clear and transparent governance of those assets.
This is the context in which any discussion of the role and contribution of Crown Financial Institutions must take place. If I might take slight issue with the topic of this session, CFIs do not have a direct role in New Zealand's growth. Each of them has a clear mandate to fulfil on behalf of the New Zealand public, be that managing particular large-scale risks or pre-funding some of the cost of NZ Superannuation. The investment strategies they will pursue need first and foremost to serve this mandate.
But while they are not venture capital funds, the strategies that CFIs implement will have an important impact upon the investment environment in New Zealand. For a start, allowing diversification of the EQC and GSF portfolios and the establishment of the NZ Superannuation Fund has put the investment of all the funds firmly in the public eye. This has been a good thing.
Investment returns since 2001 have been very volatile, and reported returns have occasionally provided the financial media, and the opposition, with a number of opportunities to have a go at the wisdom of some of the funds' investment strategies.
To their credit, the CFIs have stuck resolutely to the view that long-term value to the Crown will accrue from well planned and executed investment strategies.
The success of the funds so far convinces me that the model we have set up to manage the Crown financial portfolios is a very sound one. That model is based around three important principles:
- independence from government,
- commercial investment objectives, and
- public accountability.
Firstly, the assets must be managed by independent governing bodies. It is important that the investment of funds is free from political interference. Politically controlled public funds may produce unstable investment strategies, ultimately leading to poor financial returns. Funds managed by independent expert teams are more likely to achieve the long term financial objectives.
Secondly, it is significant that the legislation requires commercial objectives. The objectives of best practice portfolio management and maximising returns without undue risk ensure that the funds are set up to deliver sound long term results.
Thirdly, there must be clear accountability. Each of the entities is subject to rigorous public scrutiny.
I see no reason to change that model. In particular, I believe it caters very well as a platform for socially responsible or ethical investment.
I am referring here to the fact that the current legislation governing many CFIs includes a requirement to avoid prejudicing New Zealand's reputation as a responsible member of the world community.
As part of the Crown, the independent commercial nature of CFIs is ultimately tempered with a responsibility to avoid prejudice to New Zealand's reputation. Arguably all entities responsible for public money have an implicit requirement to avoid prejudice; however it was included specifically in the CFIs legislation to ensure that they develop explicit policies and did not overlook the implicit requirement. Those policies must be included in their statements of investment policies, standards and procedures, and be published in their Annual Reports.
While some have proposed that more specific criteria be set out in the legislation, all the CFIs have developed policies that address the issue of avoiding prejudice to New Zealand's reputation, and I think it is important to let those policies evolve and meet the test of the real world.
That is why I am strongly inclined to give the current policy framework time to work.
Having said that, it is essential that we promote a vigorous discussion within the investment community of what constitutes good ethical practice. I think it is important to begin with a broad view of the ethical issues that investors face. Ethical investment is not a matter of developing and enforcing a list of proscribed investments, a kind of seven deadly sins approach.
This approach invites endless sophistry around the boundary of what is acceptable and what is not. It ignores the fact that some industries - such as pharmaceuticals, biotechnology and fuels - are both fraught with ethical issues and nevertheless crucial to our economy and our way of life. And it creates a perception that there are some industries which are ethical "angels', when in fact we know that all businesses have ethical challenges from time and time and need to keep these under review.
There is no road map for investors through this ethical minefield. For example, several CFIs are exploring the question of whether engaging with companies whose practices, for example labour or environmental, may be close to breaching required standards may assist in changing that entity's behaviour while also enhancing economic returns.
That scenario offers the prospect of a win-win situation. However, I would not want a CFI to see it as their role to become an ethical crusader, and to offer their shareholders good karma as an alternative to good financial returns.
What is clear is that an organisation like CSRI can play an important role in highlighting the issues that investors need to take into account, and in working to improve the quality and consistency of information available to the investment markets. It is salutary to remember that a decade ago concepts such as environmental audits or the triple bottom line were regarded as somewhat left field. They are now firmly in the mainstream, and the investment community is becoming more adept at using them to assess long term value.
The task ahead is to refine these and other instruments so as to provide professional investment advisers and ordinary citizens with a better range of choices.
I trust that today's conference will make some important steps forward towards that goal.