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Benje Patterson thinks there is a good case to expand self-managed Kiwisaver, and it should become an essential revision if KiwiSaver becomes compulsory

Posted in KiwiSaver

By Benje Patterson*

Ever since the introduction of Kiwisaver in 2007, there have been calls to follow Australia’s lead and make retirement fund contributions compulsory for all employees.

However, there is a huge concern that comes with such a change – the idea of the Government mandating that all employees place control of a significant portion of their wealth into the hands of fund managers, with no reasonable option to “save it yourself”.

We wouldn’t be too worried about handing over this control if we thought that fund managers were so good that they essentially provided a free lunch, but there are reasons to be sceptical of these managers’ ability to consistently provide risk-adjusted returns which outperform the market’s overall performance.

In academic circles, this idea traces its origins to Eugene Farma and his thoughts on financial market efficiency. Farma argued that financial markets are generally efficient to the extent that share prices quickly reflect all available information. Given this assumption, little room is left for fund manager to repeatedly make extraordinary profits above and beyond general market movements.

A 2006 study by Bauer, Otten, and Rad* supported this theory in the New Zealand environment, using data for the period 1990-2003.

Although this is one study and somewhat out of date, it still picks up on a common theme from similar international studies – that fund managers who consistently beat benchmark indices are few and far between. Bear in mind, this isn’t saying that active fund managers won’t deliver you positive long-run returns, it just means that funds won’t necessarily make you any more money than you could have made from passively following the market itself.

In light of this evidence, it is interesting to consider the 2012 performance of Kiwisaver funds.

According to data from Morningstar, equity-orientated growth and aggressive funds returned an average of 14% and 13.8% respectively over the year.

At face value these statistics look impressive, but they aren’t actually all that amazing when you think that the NZX50 benchmark index had a cracker 2012, rising 24.2%, the ASX200 rose 14.6%, and the MSCI world index of global shares rose 9.5%. Although there were many active managers who beat these benchmark returns, there were also a large number who came in below.

Despite my scepticism of fund managers’ ability to outperform markets, it may seem surprising that I do still believe the industry offers a valuable service to a large cross-section of investors.

Not every investor is disciplined enough to maintain an adequately diversified portfolio and abstain from making rash decisions based on gut feelings. Managed funds can help solve this problem by acting as a commitment mechanism to a more rational investment strategy.  In other words, managed funds can protect some investors from themselves.

But what about those investors, who are disciplined enough to follow a rational investment strategy?

If Kiwisaver contributions were made mandatory, it wouldn’t be fair to force these investors to hand over control of a significant portion of their wealth to fund managers, particularly if this shift isn’t expected to bring higher returns.

To appease this more sophisticated type of investor, the introduction of mandatory Kiwisaver contributions would need to be accompanied with more options for active self-management of investments.

At present, there is a dearth of self-managed Kiwisaver options.

Only Craigs Investment Partners offers a truly self-managed scheme and its lack of competition in this space is evident in the exorbitant fees it charges. The actual fees paid depend on specific circumstances, but with a base management fee of 1.25%pa and brokerage fees of 1.25% per transaction to buy or sell a security in your portfolio, Craigs’ fees for its self-managed Kiwisaver scheme quickly outstrip its professionally managed alternatives.

Although Craigs must be applauded for leading the pack in bringing flexibility to Kiwisaver, the fees it charges are significant. After all, self-management essentially only involves the fund manager providing a custodian service, which holds investments behind a firewall to stop an investor withdrawing funds until they are 65. Simple custodial services, outside of the scope of Kiwisaver, cost as little as $250 per year through online brokerage houses like ASB Securities, while trade fees cost around 0.3% per transaction. Given this price differential, there seems to be significant room for fee reductions should more competition appear in the self-managed Kiwisaver fund space.

If fee reductions do occur, then the flexibility of self-management will be an attractive prospect for many investors, particularly in the event that Kiwisaver contributions are made mandatory.

For evidence of the demand potential for self-managed retirement funds, one only needs to look to Australia where around one third of mandatory retirement savings are self-managed.

There is no reason to expect that a similar shift won’t happen in New Zealand.


Benje Patterson is an economist at Infometrics Ltd

* Bauer, R., Otten, R., & Rad, A.T. (2006), “New Zealand mutual funds: measuring performance and persistence in performance”, Accounting and Finance 46, pp.347-63.

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Another advantageous tweak

Another advantageous tweak for Kiwisaver would be to allow people to have more than one provider.  Sooner or later some scheme manager is bound to turn feral and lose the lot.  So the rule could be (at peoples choice)   Once you have $10,000.00 in one provider you can have a second provideer.  And maybe, once you have over $100,000.00 in the second provider you could have a third provider.
Absolutely agree that self managed funds should be an option.  And apparently are.  Hopefully some more providers will do this at a low cost.

You can already have as many

You can already have as many investment accounts, with as many different providers, as you like.   The Government's only going to subsidise one of them, and only one of them is locked up until you're 65 - that is, the one called KiwiSaver - but there is nothing that says you must put all your savings into that one.

Fair enough Ms.  But many

Fair enough Ms.  But many people will have only Kiwisaver anyway, especially low income people, and they will be exposed if they can have only one provider.  Further Kiwisaver will become compulsory at some stage

It may become compulsory.  At

It may become compulsory.  At the moment it is not.  If it were to become compulsory, then the balance of the argument would be different. 
Further, these low income people who cannot afford to save enough to make it worthwhile having additional savings over and above their KiwiSaver - do you really think they are likely to have the expertise to deliver better returns, at less risk, than (say) a conservative fund run by Westpac?  Do you think they're the right people for the Government to invest taxpayers' money with?
Actually though, I would turn the argument round the other way.  Many people do indeed think that they are better able to manage their own finances than are professional fund managers.  Some of those people are probably right.  That's not an argument for allowing self-managed KiwiSaver; it's an argument against making KiwiSaver compulsory.

"one only needs to look to

"one only needs to look to Australia where around one third of mandatory retirement savings are self-managed."
And how are they doing?

Probably better than the

Probably better than the managed ones as there is no ticket clipping.