NZ Super Shares its Manager Selection Secrets

“Skill is the ability to persistently outperform an appropriate benchmark.”

That is the finding of the NZ$26.8 billion (US$20.8 billion) New Zealand Superannuation fund, which has published a white paper—“Investment Manager Skill,” co-authored by Paul Gregory and Tim Mitchell—detailing their discussions on the subject of manager skill.

But there is more to selecting the best managers than simply identifying them, the duo wrote.

“Even where we identify skill in a manager and believe we have a good handle on its source, we must be able to access it in a way that maximizes the alignment between the manager and ourselves.”—Paul Gregory and Tim Mitchell, NZ Super

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While benchmarks can be constructed to strip out the effects of market beta and risk factors such as value or growth premiums, Gregory and Mitchell said “the best ‘centrifuge’ for separating skill from luck is time.”

“This is based on luck being, by definition, random, and skill being deliberate action and therefore, theoretically, repeatable,” they wrote.

The pair also emphasized the importance of the market in which a manager operates.

“A market can be conducive to manager skill because it takes effort to acquire information about how it works and the behavior of its participants,” the authors wrote, citing their home equity market of New Zealand as a good example. “Alternatively, it may be conducive to manager skill because, to use a fishing allegory, we are more likely to find a successful fisher if we first find a productive pond.”

Once a manager is identified, the NZ Super team then assesses a number of elements to ensure the pension’s strategy fits with that of the manager so that the full potential benefits can be accessed.

This can include ensuring fees do not erode the excess returns generated by the manager’s skill, as well as setting up legal agreements to ensure the optimum alignment between NZ Super and the new fund.

And it doesn’t end with a mandate being agreed. The authors stated that the team’s manager selection skills were “at least as important as the investment manager’s skill in generating extra returns.”

“The best way for us to assess our own competency in this regard is ongoing monitoring of the performance of the managers we choose, relative to other managers we could have chosen and did not,” they concluded.

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The unlisted real estate sector is becoming more concentrated with fewer managers operating larger funds, Preqin research has shown.

Private real estate funds that have closed this year have raised an average of $546 million, the data company said, a record high. However, this was down to “larger funds being raised by fewer managers.”

Among the funds closed in the third quarter was the Lone Star Fund IX, which raised $7.2 billion for a new global portfolio. But Preqin’s research also indicated that it is taking real estate funds longer on average to hit their targets. Funds closed so far in 2014 were in the market for an average of 19 months to raise capital, compared to 16 months in 2009 and just nine months in 2007.

“With a wall of capital chasing deals and pricing increasing, they will have to work hard to find value in an increasingly competitive marketplace.”—Andrew Moylan, PreqinAt the start of Q4, Preqin said there were 461 real estate funds seeking capital from investors, targeting an aggregate $156 billion.

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In the third fiscal quarter, 28 funds closed, the lowest number in three years, while the quarter’s aggregate $17 billion total capital raised was the lowest amount since the first quarter of 2013. However, the 2014 total of $62 billion exceeds the $57 billion raised in the first three quarters of last year, indicating a strong overall year is likely.

Andrew Moylan, head of real assets products at Preqin, said there had been “several consecutive quarters of strong fundraising” in the sector, which reflected a “growing institutional investor appetite for real estate funds.”

However, opportunities to put this money to work have not been forthcoming: Private real estate funds now have a record amount of dry powder at their disposal—$220 billion at the end of September.

“Fund managers are largely confident they can put this capital to work, with 63% of managers expecting to invest more capital in the coming 12 months than they did in the past year, but with a wall of capital chasing deals and pricing increasing, they will have to work hard to find value in an increasingly competitive marketplace,” Moylan said.