Poor choices making KiwiSavers worse off

The latest KiwiSaver fund updates show that scheme members are probably leaving hundreds of thousands of dollars on the table because of their conservative approach to investing.

New Zealanders scour the web looking for the cheapest clothes, airline tickets, hotels and electricity deals but this low-cost approach may backfire when it comes to KiwiSaver because the lowest-fee funds have generally delivered the lowest returns in recent years. This low-fee strategy could be costing investors $100,000 or more on retirement.
It is highly likely that future retirees will look back 20, 30 or even 40 years and regret that they didn't pay more attention to their KiwiSaver investments.

The accompanying table ranks the 20 largest KiwiSaver funds at the end of March. The name of the providers have been omitted because this column is about fund types and styles, rather than individual investment manager expertise.

The first point to note is that these 20 KiwiSaver funds had total funds under management (FUM) of $25.6 billion at the end of March.

This represents 66 per cent of total KiwiSaver FUM of $38.8b, according to the latest Morningstar data.

The five biggest KiwiSaver funds are bank operated, as are 14 of the 20 largest funds. Morningstar figures show that the five banks and three overseas owned non-bank companies account for 84 per cent of total KiwiSaver FUM of $38.8b.

The 20 largest KiwiSaver funds have 2,020,917 members with an average balance of $12,660 per member.

These 20 funds had an average return, after fees and tax, of 6.1 per cent for the year ended March 2017, with the best performing fund returning 10.3 per cent and the worst just 2.9 per cent.

The latter had 54 per cent of its money invested in fixed interest securities, 22 per cent in cash, 22 per cent in listed equities and 2 per cent in other assets while the best performing fund had 81 per cent in listed equities, 18 per cent in fixed interest securities and 1 per cent in cash.

There is no question that KiwiSaver is a fantastic innovation but members are not taking full advantage of the scheme.

However, this column focuses on the five-year figures because KiwiSaver is a long-term investment scheme and March 2012 to March 2017 is a more appropriate period to assess the scheme.

These five-year figures, which are also after fees and tax, can be summarised as follows:

• The average return of the 20 funds was 7.7 per cent per annum and the average fee 0.83 per cent. The best performing fund returned 14.1 per cent per annum and the worst just 4.4 per cent
• The five default funds in the top 20 group had an average return of only 4.8 per cent and an average fee of 0.49 per cent, while the 15 other funds had an average return of 8.7 per cent and average fee of 0.94 per cent
• The three funds with a five-year return of less than 5 per cent per annum had an average fee of 0.45 per cent while the three funds with returns in excess of 10 per cent per annum had an average fee of 1.12 per cent.

These figures clearly contradict a widely promoted view that low fees deliver higher returns over the longer term, particularly as all the performance figures in this column are after fees and tax.

Fees are important but the most critical issue is whether KiwiSaver members should be investing in low-risk conservative funds, medium-risk balanced funds, higher-risk growth funds or a combination of the three.

It is important to note that none of these 20 KiwiSaver funds are particularly high risk when measured under the new risk classifications included in quarterly fund updates. These risk classifications range from one (low risk) to seven (high risk).

One of the 20 KiwiSaver funds has a risk two rating, ten have a three rating and the remaining nine have a four rating. None of the 20 funds are rated five, six or seven in terms of risk.

The five-year performance of these conservative, balanced and growth funds has been as follows:

• The eight conservative funds have FUM of $11.6b, an average return of 5.2 per cent per annum and an average fee of 0.59 per cent
• The four balanced funds have FUM of $4.5b, an average return of 7.6 per cent and an average fee of 0.91 per cent
• The eight growth funds have FUM of $9.5b, an average return of 10.2 per cent per annum and an average fee of 1.03 per cent

Growth funds won't outperform balanced and conservative funds every year but they should over the longer term.

As a consequence, anyone with 30 or more years to go before retirement should have a strong bias towards growth funds.

This is clearly demonstrated by a simple example. An initial investment of $10,000 would turn into $174,500 at the end of a 30-year period when the annual return is 10 per cent, after fees and after tax.

The final figure would be only $43,200 when the annual return is 5 per cent.

The gap would be far greater than this $131,300 on retirement when regular KiwiSaver contributions are added to the $10,000 starting figure.

This is why young KiwiSaver members are potentially throwing away hundreds of thousand of dollars by not paying more attention to their KiwiSaver investment strategy.

The other issue is the asset allocation of the 20 largest KiwiSaver funds compared with the asset allocation of professionally managed compulsory superannuation across the Tasman.

The following is a summary of the asset allocation of these two schemes:

• The 20 KiwiSaver funds have a 48 per cent allocation to growth assets, mainly listed shares, while professionally managed Australian superannuation funds have a 67 per cent allocation to growth assets
• The 20 KiwiSaver funds have 35 per cent allocated to fixed interest securities compared with 21 per cent for Australian superannuation
• The 20 NZ funds hold 17 per cent, or $4.3b, in cash compared with 12 per cent for Australian superannuation

These KiwiSaver asset allocations are too conservative, particularly for young members.

This may reflect the fact that conservatively oriented banks dominate the New Zealand retirement sector whereas they play a much lesser role in Australian compulsory superannuation.

Finally, the quarterly KiwiSaver updates include a list of the 10 largest investments for each portfolio. The most regularly included NZX companies are: Fisher & Paykel Healthcare (included in seven of the 20 funds); Kiwi Income Property Trust and Spark NZ (six times each); Auckland International Airport and Precinct Property (five times each) and Fletcher Building (included in four of the 20 funds).

New Zealand companies are losing out because of our focus on conservative funds as the eight funds in this category in the accompanying table have far more invested in New Zealand Government Stock than listed NZX companies.

There is no question that KiwiSaver is a fantastic innovation but members are not taking full advantage of the scheme.

Our investment approach is too conservative, particularly as 64 per cent of members have at least 20 years to go before retirement and 47 per cent have a minimum of 30 years before they reach 65 years of age.

- By Brian Gaynor

Disclosure of interests: Brian Gaynor is an Executive Director of Milford Asset Management, which is a KiwiSaver provider offering conservative, balanced and growth funds.

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