Meet your investment managers

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OverviewWe have a secret. We do not manage your money. Well, not all of it. Instead we partner with a small number of exceptional managers. They are some of the most influential and successful individuals in finance today. If you are invested in the Global Equity Growth Portfolio or NZ Funds’ KiwiSaver Growth Strategy, you are invested with Crispin Odey, one of Britain’s wealthiest hedge fund managers, whose early backers included George Soros, the man who infamously broke the Bank of England by selling the pound. Soros is also one of the founding backers of another specialist manager, TT International. While you may have heard of Warren Buffett, you may be surprised to know that one of his first share brokers, Tweedy Browne, who have been in business for over 90 years, also manage money on your behalf.

These relationships have not developed by chance. NZ Funds has devoted over 25 years to building international investment manager relationships. This paper outlines the role specialist managers play in managing your savings and discusses how we believe they differ from the thousands of generic funds available.

ospraie 320 park avenue

civic capital 400 madison avenue

blackrock e 52nd street

international standard asset management 400 lexington avenue

pimco 1633 broadway

franklin templeton 101 barclay street

3nz funds : : why own inflation-orientated assets : : february 2014

How we manage your moneyEach of the portfolios we manage has a set of clearly defined client-orientated investment objectives. And while the objectives for each portfolio in an investment category are the same, the assets which each portfolio holds in order to meet those objectives, are likely to differ. The first step of the investment process is therefore to estimate the expected rate of return for each major asset class which meets the risk, liquidity and tax constraints of the mandate. Once an asset class has been marked for inclusion in a portfolio, the best way to gain exposure to it needs to be determined.

Your investments are broadly split between three management groups. Around a third of your money is managed directly by our in-house investment management team. They primarily manage cash, Australasian shares, bonds and property trusts as well as foreign currency and select global investments. Another third is managed against global indices constructed by entities such as Standard & Poors or Financial Times. The final third is managed by specialist managers selected and monitored by NZ Funds. We seek to work with specialist managers where we believe the manager will significantly enhance the probability that your portfolio will achieve its stated objective1.

nz funds kiwisaver scheme lifecycle option accesses a range of specialist managers over time

0

40%

80%

120%

160%

200%

NZ Funds managed securities

NZ Funds global indices

BlackRock

Commodity Strategies

Eclectica

Franklin Templeton

Invesco

ISAM

Magellan

Nuveen

Odey

Ospraie

Paulson

PIMCO

Platinum

Resolution

TT International

Tweedy Browne

UCM Partners

Universa

Van Eck

Wellington

Proshares

Jul 2011

Nov 2011

May 2012

Mar 2013

Oct 2012

Aug 2013

Jan 2014

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

140.00%

160.00%

180.00%

200.00%

5/07/2011 29/11/2011 9/05/2012 5/10/2012 12/03/2013 13/08/2013 14/01/2014

Wellington

Van Eck

Universa

UCM Partners

Tweedy Browne

TT International

Resolution

ProShares

Platinum

PIMCO

Paulson

Ospraie

Odey

Nuveen

Magellan

ISAM

Invesco

Franklin Templeton

Eclectica

Commodity Strategies

BlackRock

NZ Funds (active exposure)

NZ Funds (passive exposure)

source: indicative nz funds kiwisaver scheme client 0 to 46 years old.

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Selecting and reviewing specialist managersThe efficient market hypothesis would have you believe that great managers do not exist. The most commonly cited “proof” is a hypothetical situation where people flip coins. The argument goes that if you have enough people flipping coins and calling heads or tails, the odds are a small group of individuals will get 10 in a row right. Warren Buffett provides some tongue-in-cheek insight into how these talented individuals might start to behave: “This group will probably start getting a little puffed up about this, human nature being what it is. They may try to be modest, but at cocktail parties they will occasionally admit to attractive members of the opposite sex what their technique is, and what marvellous insights they bring to the field of flipping coins”. And there you have it - the most comprehensive argument that modern academia can assemble to “prove” exceptional managers do not exist is that they could have gotten lucky.

There are over 15,000 investment management organisations globally, and countless more individuals managing money today. It can be overwhelming if you do not know where to look. Large institutions frequently rely on third party rating systems however, as with bond ratings during the global financial crisis, we have found these to be useful but not infallible. When selecting a manager, we follow a seven point due diligence process covering people, process, performance, risk management, legal structure, tax and fees2. Fortunately, over time we have found that exceptional managers share a number of traits.

“Four hundred seventy-three million to one. Those are the odds against George Soros compiling the investment record he did as the manager of the Quantum Fund from 1968 through 1993.”

- Paul Tudor Jones II, Forward to the First Edition, The Alchemy of Finance by George Soros

First, we like managers who think like their investors and as a result, wish only to manage money well - managers who, commercially speaking, live or die by their ability to meet their clients’ objectives. What seems like common sense is in fact increasingly rare. Most global financial brands seek to do many things. Banks established to manage deposits and loans now manage everything from insurance to KiwiSaver. Large insurance companies have become mortgage lenders, brokers, and fund managers. We believe a single-minded focus on managing money and the mentality of a client is a necessary ingredient for managing money well, not a luxury.

Such an approach manifests itself in different ways. At TT International, the partners refuse to be protected by a limited liability company structure. Instead, like bankers of yesteryear, they wish to be personally accountable - and liable - to clients to the full extent of their wealth. At Tweedy Browne clients’ funds sit alongside $US888 million of ex-employees and employees’ money. While managers like ISAM, Commodity Strategies, and Universa are businesses based on the highly successful personal investment strategies of the founders. Their purpose for being is as much to manage the founders’ money as it is to attract new money from outside investors.

“All market participants use the same model of how the world works… I work with a different model, and the fact that I have been successful using it as a market participant makes nonsense out of rational expectations.”

- The Alchemy of Finance by George Soros

Second, we like managers who think independently. At the centre of a master investor’s research process will be a disciplined, rigorous and independent thought process. It is impossible to deliver better results reading the same broker or banking research that every other manager is reading. Consequently, a master investor will never outsource their research, preferring to do their own work or think about an issue independently and for themselves. As a consequence, we look for tangible evidence of proprietary research and independent thinking. For example, Vikram Kumar at TT International aims to meet the management of two companies a day. Mark Spitznagel, Chief Investment Officer and founder of Universa Investments, has spent a lifetime studying the “Austrian School” of economic thinking and has developed an investment style that has consistently profited from the mania and panic caused by loose monetary policy – a bugbear of Austrian economists.

5nz funds : : why own inflation-orientated assets : : february 2014

vikram’s meeting schedule: ashtead group plc. seven meetings with one company over approximately two years

source: tt international.

crispin’s chart of barclay’s bank “if an investment is not working, it is vital to act quickly”

1

1 Bull market 2 Sell 3 Bear market 4 New bull market

23

4

source: odey asset management, january 2005 to april 2009.

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“When I was an adolescent, the Second World War gave me a lesson in survival that I have never forgotten. If I had to sum up my qualifications, I would use one word: survival”.

- The Alchemy of Finance by George Soros

Third, they control risk. At the heart of a master investor’s philosophy is the desire to preserve clients’ capital, or in Soros’ words “survival”. Warren Buffet once quipped: “The first rule of investing is to not lose money. The second rule of investing is to not forget the first rule”. Talk long enough to a master investor and this trait will appear. Tweedy Browne wrote to clients in January 2009 to say: “We were nominated for mutual fund managers of the year by Morningstar, an acknowledgement we would have gladly exchanged for positive returns in our funds”. Crispin Odey expresses the same sentiment in a different way: “Living in denial must be avoided. If an investment is not working, it is vital to act quickly” which he did during the global financial crisis, helping clients to profit from both the decline in English banking shares and their subsequent recovery.

“To others being wrong is a source of shame. To me, recognising my mistakes is a source of pride.”

- Soros on Soros: Staying Ahead of the Curve by George Soros

Finally, a master investor learns from their mistakes. Shortly after Crispin founded Odey Asset Management, he accumulated a large position in United Kingdom war loans in the belief that disinflation – a slowdown in the rate of inflation – would drive down interest rates. Ultimately Crispin was right but, in the interim, Crispin’s hedge fund became hamstrung by the illiquidity of the position, leading to a 43% loss. The lesson Crispin took from 1994 is that liquidity (the ability to sell an investment if things go wrong) is an essential ingredient if one wishes to preserve clients’ capital during downturns. Having learned this lesson in 1994, Crispin applied it with aplomb in the 2000 tech wreck, rewarding his hedge fund investors with a 18.7% gain and again during the 2008 Global Financial Crisis, when his hedge fund returned 55% and his global share fund outperformed the share market by 12.1%.

Another manager who has navigated his clients through both success and failure with equal skill is the tall American from North Carolina, Dwight Anderson. Dwight rose to prominence as commodity manager for Julian Robertson’s Tiger Fund. Dwight went on to found Ospraie which rapidly became the world’s largest commodity manager. In Dwight’s own words, the expansion was too rapid and when the Global Financial Crisis struck, he liquidated much of what he had built. Today, Dwight guards against being “too big” as carefully as he seeks to manage risk. Most importantly, Dwight’s willingness to liquidate his portfolio when clients require it demonstrates that he is willing to put his clients’ interests ahead of his own - the true measure of a fiduciary.

While the specific mistakes that an investor can make are as numerous as there are investors to make them, master investors respond to these mistakes in an identical way. They will acknowledge the mistake, learn from it, and capitalise on that knowledge for clients’ subsequent benefit.

We like to work with specialist managers over long periods of time however, if we believe the initial reasons for appointing a manager are no longer valid, or we become uncomfortable with the way in which a portfolio is being

7nz funds : : why own inflation-orientated assets : : february 2014

1 In the last twelve months NZ Funds has travelled to Australia, the United Kingdom and the United States to meet with, or has conference called with, over 30 managers.

2 More information on the specialist managers and our selection process is available through NZ Funds’ website - http://www.nzfunds.co.nz/ourmanagers.html

managed, we will not hesitate to withdraw.

SummaryIn managing your wealth, our overriding philosophy is to seek to maintain a balance between preserving your capital and growing your wealth in a manner that is consistent with each portfolio’s objective. Appointing the right specialist managers is a key part of this process. Over the years we have assembled a small group of exceptional managers whose commercial interests are aligned with yours, usually through being substantial shareholders in their own investment strategies. You will not find any random walkers or index huggers amongst our investment managers. We believe exceptional outcomes come from investing in the right people, not just in the right asset classes. Consequently, our managers are partnerships with individuals and not just global financial brands. The fact that these individuals would all give (with some personalisation) exactly the same answer to the question “What does risk mean to you” is beyond the math of probability. As a result, we view your investment with them as anything but a gamble.

new zealand funds management limited

aucklandlevel 16, zurich house

21 queen streetprivate bag 92163, auckland 1142

new zealand

phone - 09 377 2277 email - info@nzfunds.co.nz

www.nzfunds.co.nz

wellingtonlevel 10

49 boulcott streetwellington 6011

phone 04 473 7701

christchurchunit 7a

9 sir gil simpson dr burnside

christchurch 8053

phone 03 366 9088

wanakaunit 7

12 frederick street wanaka 9305

phone 03 443 2300

dunedinlevel 2

bracken court 480 moray place

dunedin 9016

phone 03 477 4647

invercargill98c yarrow streetinvercargill 9810

phone 03 218 2895

disclaimer: this document has been provided for information purposes only. the content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter. the views expressed in this document are those of nz funds and are based on information and sources believed but not warranted to be correct. while the information provided in this document is stated accurately to the best of our knowledge and belief, nz funds, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed in this document, except as required by law. © 2014 nz funds. updated february 2014.