The article in relation to NZ Funds that appeared in the Sunday Star Times on 8 March 2009 was neither accurate in its content nor in its portrayal of the experience that clients have enjoyed with our firm.

Given that the business of managing people’s money is one that relies on, among other things, transparency and accuracy, we feel it is important to let our clients know the facts.

NZ Funds Portfolio Management
NZ Funds manages client portfolios diversified across a wide range of investments and designed to meet client lifestyle needs through their retirement years. Generally, we manage several portfolios for each client, each designed to provide for their spending needs and goals at different stages of their life.

In the management of those portfolios, our foremost aim is to protect our clients’ retirement capital from the insidious effects of inflation and the deep losses periodically inflicted by financial markets. Either nearing or in retirement, most of our clients do not have the ability to replace their savings over their remaining lifetime. Our pursuit of returns above what can be achieved at the bank occurs as a secondary objective to protecting clients’ retirement capital.

Over the past eighteen months financial markets have endured a period of pronounced turbulence and wealth erosion. The precipitous decline in credit markets and credit availability has been a precursor to steep falls in most financial markets, property and shares being hardest hit. Most investors have been caught up in the turbulence in some way or other. Even supposedly conservative New Zealand investors have lost valuable retirement savings through the collapse of the finance company sector and the declines in value of many non-government fixed interest investments.

At NZ Funds, many of our client portfolios were, to varying degrees, exposed to the credit markets when they began to sharply deteriorate in late 2007. Over the ensuing months, instead of holding those positions in the hope they would recover in value, we chose to sell down those assets wherever possible and instead hold cash. In selling in that environment, certain of our portfolios suffered marked losses.

Relatively early on in the current financial crisis (November 2007), we concluded that the probability of a contagion effect from credit markets across to share markets was unacceptably high. Based on that conclusion, we decided to put in place share market protection strategies across our diversified portfolios to minimise the impact of any pronounced decline in share markets globally.

That share market protection strategy remains in place today and has prevented a sizeable erosion of client wealth in the portfolios we manage. Put in place fifteen months ago, it has produced gains of over $180 million against the shares held in our portfolios – a figure approximately three times greater than the losses we incurred in credit markets. That decision has, in aggregate, saved investors in our portfolios an amount equivalent to around 20% of their retirement capital. That is diversification and capital preservation in action.

This capital preservation decision, in the face of extreme market adversity, defines our approach as an organisation. Unlike traditional investment managers we do not console ourselves with the achievement of returns in line with “the market”. This benchmark driven style of investment management has no connection to whether or not clients are going to have enough funds to meet their expenses in the next year or two, or to fund their future plans during their retirement.

Our portfolio clients and their advisers have been, and continue to be, appreciative of the decisions we have taken. When they most needed our management to preserve their hard earned retirement savings, we have been prepared to make difficult and substantial decisions. Decisions which have been in stark contrast to those investment managers who have just “ridden” the market down.

On average, over the past twelve months, against a backdrop of substantial wealth erosion globally, NZ Funds has largely preserved our clients’ retirement savings with our diversified client portfolios posting returns somewhere between marginally positive and modestly negative.

During our 20 years of being in business we have been unwavering in advocating a philosophy of clients needing to be properly diversified with their investments and ensuring that their future cash flow needs are matched with investments of appropriate risk and timeframe. In the main, most clients follow this philosophy, although some decide, for their own reasons, to invest more narrowly. As a consequence, we do have some clients invested in a single investment sector.

When that particular sector comes under extreme pressure, which all sectors do at some point in the cycle, our ability to manage their overall risk position is much more constrained than if we were managing a broader, more diversified portfolio on their behalf.

In situations where the client has elected to pursue a narrow or sector specific strategy, there is more responsibility on the client to take actions when investment outcomes begin to deviate from those expected at the time of making the original investment.

The importance of being properly diversified is never more evident than in times of extreme market turbulence.

Super Yield Fund
In a properly diversified portfolio, not every investment is going to perform to expectations.

Taking a recent example, close to home, a reasonably diversified portfolio of New Zealand shares would likely have contained companies such as F & P Appliances or Nuplex - both companies having halved in value in the last month.

Our Super Yield Fund was over $300 million in size when it took a $9 million (or 3%) loan exposure to the Kensington Park project, directly behind the bank with the first mortgage and in front of the mezzanine financier and equity investors who had invested substantial amounts of cash.

Kensington Park is now in receivership and investors in the Super Yield Fund face the potential of capital losses from this investment.

In terms of exposure for our client portfolios this represents, on average, less than 2% and in terms of client capital preservation is highly manageable.

The direct mortgage to Kensington Park was within the mandate for Super Yield Fund. We expect the future of the project to be clearer in the next two months.

The investment performance outcome of the client referred to in the Sunday Star Times article does not accord with our records. The client has suffered losses, and we share his disappointment, but those losses are not of the magnitude conveyed in the article.

The disclosures in the Investment Statement of the nature of the risks and composition of assets in the Super Yield Fund have always been extensive and explicit.

Importantly, withdrawals from the fund occurred right up to closure in August 2008, over a year after the credit crisis began to emerge. Over the period July 2007 up until today we have written to investors on multiple occasions to specifically update them on the changes occurring in asset composition and emerging risks within the Super Yield Fund. Those letters also invited all investors to withdraw or switch to an alternative portfolio of their choosing if they were uncomfortable with the Fund’s assets or risks.

The Super Yield Fund was finally closed because of concerns of a liquidity risk for remaining investors. This was prudent, and the fund was valued appropriately to market at the time of closure. Subsequent to closure, which occurred in August 2008, we have witnessed a substantial acceleration of events in financial markets and the failure of numerous financial institutions. While perhaps obvious, this has markedly worsened the environment for realising the remaining assets in the Super Yield Fund, including the Kensington project, whose situation has become apparent only subsequent to the closure of the Fund.

Since closure, approximately one third of the closing value of the fund has been repaid to investors with a further repayment due on 26 March. Repayments will continue to occur as the remaining assets are realised or repaid.

Fidelity Limited
Our business joint venture with Martyn Reesby, Fidelity Limited, and the related party aspect of this relationship is a matter of conjecture within the article.

A critical part of our aim to achieve capital preservation for clients is to invest in investment sectors that provide true diversification in client portfolios. We also seek out managers that have an exceptional long term ability to excel in portfolio management in their respective sector.

Mezzanine property financing is a sector that has demonstrated true diversification benefits relative to the publicly traded investments we own on our clients’ behalf. Martyn Reesby and his team’s credentials and experience in this area are unparalleled.

In our view, investing directly in mezzanine property loans would expose clients to too great a risk of capital volatility. Only with a significant amount of shareholder capital and the ability to create adequate provisions is the risk/reward trade-off acceptable for clients. And, even then, only a moderate, but meaningful exposure in client portfolios is warranted.

So, in order to set up the mezzanine property financing component of client portfolios we set up a company, Fidelity Limited, to hold the capital and loans and create reserves.

Our clients would get their exposure to this investment sector by lending to the company with the advantage and comfort of knowing that the shareholders had their capital at risk first. Just like our clients’ retirement capital, the shareholder capital we have at risk is very meaningful to us.

That shareholder capital was provided, and the risk shared, equally by the shareholders of NZ Funds and Martyn Reesby.

On the surface, this structure creates a situation of loans to a related party, an activity which has been identified by various commentators as being open to abuse. In terms of the usual concerns with related party arrangements we have addressed them in the following way:

• There is no double up in revenue to NZ Funds. Fees earned in our portfolios on the assets lent to Fidelity are rebated to clients.
• NZ Funds earns a return on its capital invested in Fidelity Limited only by way of dividends. No dividends have been paid since July 2008.
• The existence of Fidelity Limited and its related party nature is disclosed extensively in the Investment Statements.
• Fidelity Limited, as disclosed in our Investment Statements, can not lend to related parties and has not done so.
• The shareholders position in Fidelity Limited is subordinated to (ie. ranks behind) that of the investors.
• A global banking group provides a loan facility to Fidelity Limited alongside our portfolios. This facility provides an independent benchmark for capital adequacy and other lending terms, including the rate of interest, for our portfolios.

This ensured that Fidelity Limited could begin with a diversified portfolio of seasoned loans, with a shorter period to repayment, rather than start-up loans and, accordingly, lowered the initial risk profile of Fidelity Limited. Most of these loans have since repaid in full and those remaining have comfortable security positions.

Fidelity Limited has provided a mezzanine loan to Kensington Park, separate to that made by the Super Yield Fund. When it became apparent that there was a significant risk of capital loss on this loan, the shareholders of Fidelity injected further capital to offset, for clients, the risk that exists in this loan.

Fidelity Limited maintains shareholders capital well in excess of its loan covenants and the loans continue to be managed with the excellence and professionalism that we have come to expect from Martyn Reesby and his team. They are the standout performers in a terrifically challenging environment for property financing.

Since its inception in 2005, Fidelity Limited has provided consistent positive returns to client portfolios and continues to do so. It has been a truly diversifying asset in client portfolios over a period where most other assets held to produce returns in excess of cash have declined in value - government bonds and our share market protection strategies being notable exceptions.

Specific Points of Clarification
In addition to the points made over the preceding pages there were a number of specific errors of fact in the Sunday Star Times article. These errors of fact gave the impression that NZ Funds could, using its shareholdings in associated companies, exert undue influence over decision making in those entities. Contrary to what the article said or implied:
1. Since Fidelity Limited was established, the shareholders have allocated a minority holding to one of the key employees. NZ Funds shareholders now have a minority ownership of Fidelity Limited with the majority ownership residing with the senior executives of Fidelity.
2. Money Managers has never distributed the Super Yield Fund, and it clients have never been invested in funds that have lent to Fidelity Limited or the Kensington project.
3. NZ Funds does not control the new Money Managers business. NZ Funds is a cornerstone (40%) shareholder in the new Money Managers business, in partnership with the Money Managers advisers and employees.

In Summary
As we said at the start of this letter, the business of managing people’s money is one that relies on, among other things, transparency and accuracy. Integrity in relationships stems from knowing and understanding each others’ positions and perspectives.

It is very important to us that our clients and those involved in our clients’ financial affairs know the facts. That is why we have set out the issues in some detail. If there is anything further you would like to know please do not hesitate to contact your adviser or, if you wish, feel free to contact us directly.

In the meantime, we will get on with the business of managing your money in what is a tremendously challenging but, as always, potentially rewarding market environment.

Richard James on behalf of The Directors and Principals of NZ Funds