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Government considering new fee structure for KiwiSaver as part of possible architectural overhaul for default funds. Your view?
By Amanda Morrall
To address the "inherent misalignment" of goals between investors in KiwiSaver and their fund managers, regulators are exploring new options for default funds including the imposition of a possible flat fee.
The suggestion, contained in a discussion document for KiwiSaver released by the Ministry of Business, Innovation and Employment, is one of several considerations put forward by the Government as part of its planned review of default funds for KiwiSaver.
Default providers Tower, Mercer, ASB, AXA, AMP, and ANZ, appointed by Government in 2007, have between them more than 75% of the market share for KiwiSaver. There are 31 providers running more than 200 funds in total.
A flat fee, as opposed to a percentage-based fee on funds under management, would theoretically see management costs constrained as account balances grew.
Over five years, KiwiSavers have cumulatively paid more than NZ$440 million in fees to fund managers and providers. (See Amanda Morrall and Craig Simpson's story here).
The 43-page report also proposes a "tiered fee" system (whereby the fee percentage reduces as funds under management increase) and the possible separation of administration fees from investment management fees.
Lack of transparency
Fees on KiwiSaver remains one of the most controversial aspects of the national savings scheme because of the lack of transparency around how they are calculated, reported and communicated to investors. In addition to an annual membership fee charged by providers, KiwiSavers are charged a whole host of fees including administrative, legal, trustee and investment management ones.
The report suggests that by centralising administrative functions for default funds (through a tendering process), it may able to reduce costs for members by achieving more effective economies of scale than can be achieved by individual providers. This is a model that has been successfully trialled in Sweden with a similar default fund scheme run there.
Although new regulation set to take effect next year will force providers to use a uniform system for reporting fees, the area has been flagged as one of concern for default members, who make up more than 22% of the 2 million New Zealanders enrolled in the scheme. While default schemes have relatively low fees compared with other fund options, the long-term impact of fees, given the long-term historical performance of conservative funds, can nonetheless be costly.
One example used in the report, shows a median earner making NZ$50,000 a year, paying 0.5% in fees over 40 years, losing 11.09% of their final retirement funds to the provider. Fees of 1% would have a 20.79% cumulative effect for the same earner.
'Misalignment between investor & fund manger interests'
"In general, in managed funds there is an inherent misalignment between investor interests (which are to maximise risk-adjusted investment returns over the long-term) and fund manger interests (which are to increase funds under management, usually best achieved through a focus on short-term gains rather than the long-term investment profile that their members may have,'' the report's authors state.
Because of the unique KiwiSaver features (namely auto-enrolment and Crown contributions) the Government is seeking to address both "obligation and opportunity to seek better alignment of these interests for better investor outcomes overall.''
International evidence suggests that the segment of the population that ends up in default funds tend not to move out of them despite them being designed as a "parking spot" for new entrants into the retirement saving investment sphere.
For example, 80% of the 12 million Australians paying into superannuation are in default funds. In contrast to New Zealand, the default option for Australians is a growth oriented fund, with a higher weighting of equities. The default option for KiwiSaver is conservative, with 80% cash and fixed interest and 20% shares.
Age appropriate asset allocation has also been flagged as a matter of concern by Government. The median age for default members is between 36 and 40. With 25 years or more to go to retirement, the concern is that this demographic could miss out on potentially much higher returns achieved through a higher allocation to equities, which have traditionally out-performed other asset classes over long periods of time.
More research needed on life stages funds
ANZ Wealth, in calling for a conversion of default funds into 'life stages funds' (which automatically adjust for risk with age) estimates that younger New Zealanders, over a life time of investing, could miss out on an average of NZ$72,000 in additional investment returns.
Owing to the complexity of these funds, and the higher associated fees, the Government said it would require more research and evaluation before considering such a move.
"If not offset by better earnings, higher fees would have a negative impact on members' balances,'' the report notes.
Earlier suggestions, to create a single default provider as a way to save on fee, also appear to have fallen out of favour.
"This is not the Government's preferred option because there is a risk of incumbency as well as concentration of risk in one provider,'' the report states.
Current default providers are required to report to the Financial Markets Authority and the Default Provider Review Panel on a quarterly basis. Additionally, the fees they charge are specified in a "deed of appointment." Any increases must by approved by the Government first. They're also bound by an "investment strategy specified" under the terms of appointment.
Using its current criteria, at least 10 to 12 providers would qualify for default status. Current contracts with default providers expire on June 30, 2014.
Submissions on the discussion document will be accepted up until Christmas Eve.