Investment risk tolerance statement
In 2023 the ACC Board undertook a review of its investment risk tolerance. The statement below summarises the key points and outcome of that review.
The ACC Board understands there is a clear trade-off between risk and return.
The Board has evaluated the investment risk and return trade-off, that is appropriate for ACC’s investment assets. The outcome is expressed here as the implication for ACC’s overall equity weightings, given ACC’s investment approach.
ACC’s investment approach results in different overall equity weightings for each scheme Account. Moreover, the equity weightings for each scheme Account vary, over time, in response to changes in funding ratios and ACC’s expected reward-for-equity-risk (for example, the expected return premium for equities over bonds).
Given this background, we can express ACC’s risk tolerance in terms of the overall exposure to equities for a specific, hypothetical ‘reference case’. That is, what the overall exposure to equities would be if the scheme Accounts were all fully funded, and ACC’s expected reward-for-risk was normal. Note that ACC’s exposure to equities at any point in time will normally be different to what it would be in the reference case. The actual equity allocation at a given point in time depends on the most recent Account funding levels and the current estimated equity risk premium.1 But in all cases, increases in the equity weighting for the reference case make the actual weightings higher than they would be otherwise.
At the time of the last review in September 2023, the risk tolerance was equivalent to an overall equity weight of around 40% for the reference case. The Board’s decision in that review was to increase the risk tolerance in a way that would lift the exposure to equities to 45% for the reference case.2
The Board decided to phase-in this change to risk tolerance, and for this phase-in to begin only when ACC’s expected return premium for equites over bonds is closer to what ACC considers to be normal.
When implemented, the change is expected to increase income by around $100m p.a. and reduce average levy rates by around 1.5%. The change is estimated to have a small impact on long-term funding ratios, with 20-year downside outcomes (at the 10th percentile) declining by 0.4% on average. The increase in estimated short-term downside risk is modest, with the 1-in-20, 3-year loss rising by $350m or less than 1% of the value of the reserves.
The Board has decided on this allocation as ACC is a long-horizon investor and can tolerate a moderate degree of equity risk.
The Board also recognises that adjusting the risk tolerance in reaction to short term market downturns, thereby locking in losses, is generally not a long-term rewarding strategy.
The investment risk tolerance is reviewed relatively infrequently. Any change to the Board’s investment risk tolerance will be accompanied by a public statement of the rationale for the change and the costs and benefits for making the change, including the expected impact on investment income, levy rates, long-term solvency risk and short-term downside risk.
1 For example, if the average Account funding ratio is 125% instead of 100%, the average equity weights will be around 5% lower than otherwise. Alternatively, if the equity risk premium is 1% lower than the assumed ‘normal’, average equity weights will also be around 5% lower than otherwise.
2 The target equity allocation of 45% was derived assuming an equity risk premium of 4.5% (All Countries World Index vs NZ Government Bonds, arithmetic average estimate), an equity beta of 0.5 for property & infrastructure assets and 100% account funding ratios.