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Default provider Tower supports calls for conversion of default funds into life-stages funds

Posted in KiwiSaver

By Amanda Morrall

KiwiSaver provider Tower says it support the call for changes to the way default funds are structured from a low-risk conservative investment to one that automatically adjusts for risk with age.

Under a "life-stages" type of fund, the younger the member, the higher the proportion of shares and other growth assets. The asset allocation would shift over time to include a greater proportion of cash and fixed interest investments to reduce the risk of capital loss with retirement drawing nearer. Advocates of life stages funds, including default provider ANZ Wealth, maintain they will benefit members over the long-run by generating higher returns. This is based on classical investment theory that holds that shares, over the long-run, will outperform other asset classes.

Tower Investment CEO Sam Stubbs, said that while the current default provider system had been a "great success" it was time "to consider fine tuning the design of default funds'' in keeping consideration of the above.

“We continue to support the KiwiSaver default system being run by a relatively small number of private sector providers of proven ability to cope with scale in the business, but also consider that default funds might do a better job for their members if they were modified into life cycle funds,'' Stubbs states in Tower's December KiwiSaver report.

Stubbs said the current structure of default funds, which took in 750,000 members, didn't make sufficient allowances for the "risk profiles typical of each of the age cohorts that are automatically enrolled especially younger member who could afford to take more investment risk."

FundSource, the research arm of the New Zealand  stock exchange, in a recent paper discussing the merits of life-stages funds, notes that similar schemes have been adopted by the U.K., Australia, Sweden, Chile, Mexico, Peru and the U.S. It also cites research from the Organisation for Economic Cooperation and Development concluding that life-cycle schemes are "likely to be the most appropriate default fund.''

One potential draw-back of life-stages funds, highlighted by FundSource, is higher fees.

Unless higher fees were offset by better earnings, "life-cycle schemes may have a negative impact on members' balance,'' the report notes.

FundSource also points out the risk of sub-average performance during the early days of an investment plan if it coincides with period of prolonged market volatility.

"The possibility of higher returns in the early stages of a life-cycle scheme where the majority of the assets will be equities may be attractive but the risk of greater volatility and increased vulnerability to market shocks is increased. Exposure to these market downturns can be especially disheartening for members, particularly during the early investment phase.''

Any move toward a life-cycle type of fund would have to take into account the first time home withdrawal facility of KiwiSaver as those enrolling in the scheme for this reason would most likely benefit from a more conservative type of fund.

"Should the market experience a downturn during the years leading up to this first home withdrawal, a members deposit may be smaller than if they had invested in a more conservative fund," warned FundSource.

Stubbs suggests this issue could be overcome by maintaining a low-risk option for investors with the first time home deposit as their main objective in KiwiSaver.

FundSource proposed having life-stages funds start off as a "mostly conservative" investment in the first few years, "moving to a more growth oriented assets followed by balanced and finally conservative assets as is originally the case in life-cycle funds.''

A third option flagged by FundSource would be for new members to specify the date that they aim to make their first time home withdrawal.

"This would allow their money to be invested in a conservative fund until this date and a new date could be set following this withdrawal to reflect their new tolerance.''

Submissions on the Government's review of default funds will be accepted until Monday. They can be emailed to investment@med.govt.nz.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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2 Comments

Is there a chance that TOWER

Is there a chance that TOWER can see a higher fee return if this happens?.
HELL YEAH.

That withdrawal for a first

That withdrawal for a first home thing is such a pain, isn't it? :-)  
The trouble with these ideas is that automatic enrollers do not interract at all with the provider - so how does the provider know if the member's objective is to buy a first home?    
If they did start to gather this information, who would do it - the employer or the IRD or the provider?  How would they do it?   Remember, automatic enrollers do not sign any forms.
Anyway, for those interested in what I reckon - the link is here  http://trulyindependentnz.blogspot.co.nz/