You often hear the suggestion that if state-owned enterprises (SOEs) are sold, the government should limit shareholding to ‘Kiwi mums and dads’.
Putting aside arguments about the wider benefits of foreign investment, let’s look at the practicalities of this proposition.
Analysts calculate that the New Zealand share market as a whole is majority owned overseas, mainly by Australian institutions.
One estimate is that overseas shareholders account for about 60% of the market. In the case of New Zealand’s largest listed company, Fletcher Building, the figure is around 58% (with half of that investment coming from Australia).
Why is this? Quite simply because it would not be prudent for New Zealand investment funds and other institutions to have higher weightings. The additional risk outweighs the expected return. Instead, funds need to be diversified across countries and asset classes. Institutions are of course the major shareholders: in the case of Telecom, investors with shareholdings of 100,000 or more account for 92% of total shares issued.
You can see this pattern with the investment portfolio of the New Zealand Superannuation Fund, which is tasked with achieving competitive returns for a given level of risk. As at 28 February 2011, the NZSF held just 5.1% of its assets in New Zealand equities. By contrast it held 62.6% in global equities.
It follows that if the government were to attempt to restrict ownership in privatised (or partially privatised) SOEs to New Zealanders, the businesses would end up with a very distorted and more costly capital structure. Moreover, restricting foreign ownership in certain asset classes (eg former SOEs) would mean higher foreign ownership of others. Similarly, New Zealanders who increased their ownership of SOEs would have less invested in other New Zealand or foreign assets. Would there be any logic to that?
A likely implication of ownership restrictions is that the government would receive a lower price for the privatised assets. Local institutions and investors would be forcibly exposed to idiosyncratic risk and so would require a higher expected return (discount rate) as compensation, whereas for foreigners the New Zealand asset risk would be at least partly independent of their home risks – and hence diversifiable – thus allowing a lower discount rate.
For example, the Commonwealth Bank of Australia reports funds under its management hold over 10% of Telecom’s shares, and depending on the trustee arrangements these holdings might well be reported as held by an overseas investor. But thousands of New Zealanders have an ownership interest in these shares through superannuation and other funds managed by CBA.
One could even take the argument further and suggest that taxpayers as current owners of SOEs are exposed to undue risk. On average they already have most of their assets in New Zealand (in the form of housing) and are dependent on New Zealand sources for wages and other incomes. If New Zealanders are not willing to own entire SOEs voluntarily, because the return does not justify the risk, why should the government force them to do so by investing in SOEs on their behalf, either directly or through the NZSF?
If we look at our external accounts, foreign equity investment in New Zealand is barely higher than New Zealand equity investment abroad. The difference is that foreigners tend to invest directly in large stakes (which are visible) whereas New Zealanders hold mostly portfolio investments in securities markets. In both cases these transactions are welfare-enhancing for New Zealanders: outward investment because it diversifies portfolios; inward investment because foreigners have paid more than locals were prepared to.
New Zealanders would be most unhappy if they lost a large chunk of their retirement savings due to concentration in a single market. (The foreign exchange element of investing abroad is easily hedged.)
So the message for those who want to restrict shareholding in privatised SOEs to ‘Kiwi mums and dads’ is: be careful what you wish for (if you really have their interests at heart).