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Craig Simpson says the IRD should offer the only default fund and the proposed fund manager selection criteria is biased against the smaller players

Posted in KiwiSaver

By Craig Simpson

The KiwiSaver default provider beauty parade will begin in earnest shortly. The prize is a not a diamond tiara but a multi-million dollar payday.

The Ministry of Business Innovation and Employment (MBIE) estimates the projected fee income generated from default members over the next 10 years could be $400– $500 million.

The process is supposedly a free for all with the incumbents: AMP, AXA (now owned by AMP) ASB, Tower (now owned by Fisher Funds), Mercer & ANZ's OnePath, not guaranteed a spot on the podium. I would be extremely surprised if AMP, ASB, Mercer and OnePath were not reappointed.

Ministerial documents indicate that up to 10 institutions could potentially be appointed as default providers. But you really have to question firstly whether we need default providers, and secondly why so many.

Role of the default fund

KiwiSaver includes an auto-enrolment feature and there is a need to have a short-term solution to park funds until they are reallocated. Default funds are also acting as a longer term investment solution for those who either make a conscious decision not to move their funds, don't have the necessary information or skills to make an active decision, or for those who simply can't be bothered.

MBIE in its November 2012 consultation paper re-iterates that the objective of KiwiSaver is to encourage a long-term savings habit and financial asset accumulation by individuals who are not in a position to enjoy standards of living in retirement similar to those in pre-retirement.

MBIE also goes on to highlight that international experience indicates there is a persistent group of savers remaining in the default product, even though it may not be appropriate to their own circumstances and risk preferences.

To my mind there is a conflict between the underlying principles of KiwiSaver, as set out in the MBIE paper, and the current actions to retain default providers and adopt a conservative long term strategy.

Keeping in mind the underlying principles behind KiwiSaver default funds, is there any need to have so many potential institutions as default fund providers?

Sweden and the UK provide a single default product and the Savings Working Group supports this approach. However, the government does not because of what it perceives as incumbency and concentration risks.

My opinion on this matter is that one cash fund could act as a default proposition. A majority of the contributions coming into KiwiSaver pass through IRD via employer deductions. Therefore it would seem plausible that IRD could provide a quasi default fund for investors.

Let the default position be cash

I would argue that adopting a cash fund solution is more aligned to the underlying principles that default fund(s) are a short term parking space and not intended to be a long-term investment strategy.

Cash funds (or cash deposits) are traditionally low cost solutions used to park money that is needed in the near term and where the investor requires both liquidity and capital assurity. Having a conservative fund as your default strategy does not ensure a low cost solution with a high degree capital assurity as up to 25% of the funds are invested into higher risk assets such as shares.

Further, investors knowing they are getting minimal returns on their capital are more likely to be proactive and seek advice on what is the best solution for them given their personal situations.

If the default position was cash and it was run by IRD then we would see a smaller number of people in default funds and more money spread across the various fund managers rather then just a select few.

The current selection criteria is potentially biased to banks and large institutions

A summary of the high level criteria is below:

Performance:

  • a proven track record in investment capability and delivering funds management performance the ability to deliver the government's specification for the default investment option and meet the standards required;
  • an ability to provide a full suite of KiwiSaver funds in addition to the default fund
Corporate strength:
  • the provider is a reputable organisation with the financial capacity and infrastructure to maintain and enhance the proposition, while pursuing ethical standards that will not bring the KiwiSaver provider into disrepute.
Administrative capability:
  • the systems and processes to undertake a large volume of transactions and in a timely manner;
  • administration systems that are both scalable and flexible enough to adapt to frequent changes in legislation and provider features.

Track record and stability:

  • a commitment from the organisation to the NZ to accept the mandate and to carry it out to the best of its ability.

Investor education and advice

  • the ability and commitment to provide investor education and impartial financial advice including to proactively contact default enrolled members to ensure they are invested appropriately.

Based on what we know today there is scope for the selection criteria to be biased against smaller boutique operators. I say this because some smaller and boutique KiwiSaver providers do not offer a full suite of products. Some in fact do not have a conservative fund and many smaller operations do not have the infrastructure, scalability of systems or manpower to be able to commit to ongoing education of the general public. .

Does this mean they are inferior managers? Not at all. Many of the boutique offerings are outperforming some of the bigger managers and banks. Surely they are worthy of consideration and should not be discounted before the pageant has even begun.

In my mind, the institutions likely to meet all the criteria are the banks (e.g. ANZ, ASB, BNZ & Westpac), consulting firms (e.g. Aon, Mercer, Superlife etc) and large insurance companies (e.g. AMP) who manage corporate superannuation schemes already.

It will be interesting to see whether BNZ is afforded a default position despite only operating a KiwiSaver scheme for less than one year and whether the panel of judges look past this and view the performance of the underlying manager who has been successfully operating via Aon's KiwiSaver scheme.

Fisher Funds could also be a bit of dark horse in the equation as they already own Tower who were previously a default provider.

Impartial advice - what's that?

I applaud the provisions that the default providers must commit to increasing financial literacy, however I have an issue with is the providing of impartial financial advice.

Impartial by definition means; not partial or biased; unprejudiced.

If a customer rocks up to their local bank (which is a default provider) are they going to receive unbiased or unprejudiced advice? I would like to think they would but having been around the financial services industry way too long I know the answer is a resounding NO they won't.

To potential investors I say, good luck finding someone who can give you impartial advice and who does not have conflicts of interest.

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?

We welcome your comments below. If you are not already registered, please register to comment in the box on the right or click on the "'Register" link at the bottom of the comments.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current Comment policy is here.

9 Comments

Agree re impartial. Big banks

Agree re impartial. Big banks etc should thus be automatically excluded.

KH I believe the banks should

KH
I believe the banks should be able to compete just like any other fund manager or service provider, my real gripe is with the wording in the high level arrangement that impartial advice is to be available.
Some of the banks have a very good offering and these will stand up on their own merits.
If the banks employ AFA's, those advisers are code bound to survey the market and provide their customers with the best available option for them.
Craig

I understand you believe

I understand you believe impartial advice is there Craig.  But many of us don't. 

KH I would like to believe it

KH
I would like to believe it is there but having been in the industry for over 25 years in advisory and fund management roles I know the chances of getting it is remote because of the remuneration models adopted by many institutions.
Having worked for one of the big 4 banks as Partner Portfolio Management, I saw first hand the behaviours of front line staff. Building long lasting relationships has given way to a toxic environment built around meeting monthly, quarterly and annual sales targets.
As they say, tell me how I will be paid and I will tell you how I will perform.
 

Hmmm...the cost of doing

Hmmm...the cost of doing God's work, no less.

Hi Craig Referring to your

Hi Craig
Referring to your point about AFAs having to survey the market, I don't think that's entirely true.
AFAs are bound by the code to "...place the interests of the client first."    That doesn't mean that they are code-bound to survey the whole market.   As long as they are clear to the customer their limitations and how they are paid (all of which should be disclosed).     

Hi Austin If you are putting

Hi Austin
If you are putting your clients interest first as per code standard 1 and ensure the client has sufficient information from which they can make an informed decision per code standard 7, does this therefore not imply (indirectly) that the AFA should have a reasonable knowledge of the market within which they are advising?
AFA's have to take reasonable steps to ensure that the personalised service is suitable to the client (code std 8) - again you can only do this if you have knowledge of the market and have done research or have access to research which looks at the entire market - we both know research houses do not cover the entire market in their reports so there are funds and providers which may be suitable but are overlooked.
As you rightly point out the clients must be aware of any limitations in service, advice etc, how they are paid and conflicts of interests as you point out via the disclosure statements (primary and secondary).
If an adviser is limited to offering one specific product or are restricted to a specific product list I struggle to see how they can possibly put a clients interests first and meet their obligations.
Craig.

Thanks for the response

Thanks for the response Craig.
I agree with you - it sounds like we are on pretty much the same page.  However, an AFA that works for a provider might argue that they *are* meeting code standard 1 - because the advice is given with the client knowing the AFA's limitations to their scope of advice. 
But impartial advice from an AFA aligned to a provider does sound like a contradiction in terms, I must say.

Hi Austin Yes agreee re being

Hi Austin
Yes agreee re being able to meet arrangements under Code Std 1 so long as limited advice disclosed etc.
It would be similar to walking onto a car yard and only being shown 25% of the available stock on the lot.
Why would anyone tolerate receiving limited advice?