Finding your Goldilocks fund

Investing

Martin Hawes wonders how many KiwiSaver members are really in the right fund type and will be badly exposed when the economic tide inevitably recedes. He counsels against simplistic positioning

10th Oct 19, 1:33pm by Martin Hawes

We know that lots of KiwiSavers are in the wrong funds and have the wrong level of risk.

There are over 400,000 people in default funds for a start and chances are very few of these really need to be in such conservative funds. Many other KiwiSavers will have given little thought to how they should be invested and, unwittingly or through lack of care, have ended up in a fund either too aggressive or too defensive.

Most commentators and experts talk about people being in funds that carry too little risk – they say that KiwiSavers should amp up the risk and get better returns. But hold on a bit: we should also spare a thought for those whose KiwiSaver accounts are invested too aggressively. There will come a time when they also will lose out.

In fact, people need to be in a Goldilocks fund – not too hot and not too cold, a fund that is just right and that gives the best returns for a comfortable amount of risk.

Finding the right fund is not as simple as some suggest. Those who advocate a “life stages” approach to fund selection over-simplify because they think that fund selection is solely about years until retirement. This “life stages” approach works on age and the fund is then selected on that basis; no other factor is taken into account.

That is a very blunt instrument and ignores how investors will feel when they see their KiwiSaver balances plummet in the next major market slump. Of course, it is not just how they feel: more importantly, it is about how they will behave. In market slumps, many investors find that they are significantly more risk averse than they thought and end up so uncomfortable that they lower risk in the middle of the slump – i.e. at the very worst time.

Being rattled out of the market like this is almost always a disaster: effectively, lowering risk means that you will sell growth assets (shares and property) when the market is down and prices are low.

We are meant to buy in gloom and sell in boom, but most people do the exact opposite: they load up on risk as the market nears its peak and are panicked out in the bottom of the slump.

KiwiSaver has been going for 12 years and over that time KiwiSaver members have not really been put to the test of a good market crash. Sure, KiwiSaver was up and running when the GFC struck but account balances were so minuscule then that no-one cared.

With account balances now much higher, we just do not know how the 3 million KiwiSaver members will react when they see that their $40,000 KiwiSaver balances go to (say) $25,000.

As Warren Buffett said, it is only when the tide goes out that we find out who has been swimming naked.

Sure, there will be a lot of KiwiSavers who have not taken on enough risk. KiwiSaver is mostly a long-term retirement savings scheme and more risk ought to give more money and better retirements.

But better returns will not happen if people take on too much risk and are rattled out of the market at just the wrong time. Such a thing seriously disrupts returns.

It is possible that the next slump sees a sustained and synchronised fall in value of both shares and some fixed interest investments. That could see a granddaddy of a fall in KiwiSaver values; usually when shares fall, the value of fixed interest investments rises and provide something of a cushion for the overall portfolio. But the next major slump could be different and many KiwiSaver members will have had no experience of such a thing.

We do not know what will trigger the next major slump, nor which asset classes will be worst affected. But my guess is when it happens, the fall and people’s reaction to the fall will not be pretty.

As KiwiSaver balances grow and KiwiSaver becomes more important, finding your Goldilocks fund becomes critical. This is not difficult: there are plenty of on-line questionnaires where you answer a few simple questions and get given your risk profile. Five minutes of your time (or less) and it’s done. It just could be that little bit of time is the best investment you ever make.

*Martin Hawes is the Chair of the Summer Investment Committee. The Summer KiwiSaver Scheme is managed by Forsyth Barr Investment Management Ltd and a Product Disclosure statement is available on request. Martin is an Authorised Financial Adviser and a Disclosure Statements is available on request and free of charge at www.martinhawes.com. This article is general in nature and not personalised advice.

We welcome your comments below. If you are not already registered, please register to comment

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.

41 Comments

by bw | 10th Oct 19, 1:55pm 1570668938

If "$40,000 KiwiSaver balances go to (say) $25,000." rattles Kiwisaver contributors enough that they shudder in their financial boots, then we have a bigger problem than just asset allocation! But on the whole, the article raises the right questions. The primary one being "Do you know what might happen to your financial well being, if....?"

by Noncents | 10th Oct 19, 2:15pm 1570670153

I saw firsthand the devastation in Europe and Australia when 08 crash hit. Anyone hitting retirement that year was stuffed. People were losing upwards of 60% of their investment regardless of what they had invested in. A lot of retirees had no choice but to rejoin the workforce

Your risk profile is really irrelevant, ultimately it is what happens at the time of withdrawal that matters.

Kiwisaver was implemented so that those with minimal financial/investment knowledge should hopefully still have something.

Most people have no idea what is going on, so I can only think that a conservative default scheme is best for them. After all, should you really be changing from an approved default scheme if you have no idea on anything financial.

by Grendel | 10th Oct 19, 4:36pm 1570678563

I feel like you are missing something point a little here. If you are nearing retirement and need to rely on investments for lively hood then you need to be moving it to more conservative profile as you will have assets that will hold value over those periods. Had the people you saw in 08 been in more conservative investments (e.g. Cash) they would have been fine if not slightly better off.

by Audaxes | 10th Oct 19, 2:27pm 1570670838

Should investors actually expect a rate cut from the Federal Reserve in the months ahead? In my view, the answer is yes. One of the easiest ways to see this is to compare the prevailing level of Treasury bill yields with the prevailing level of the Federal Funds rate. Notably, Treasury yields are now below the Fed Funds rate by more than 0.25%, and there’s good evidence to indicate that those differences are typically followed by commensurate changes in Fed policy rates over the subsequent 3-month period.Link

New Zealand Government Treasury Bill rates are certainly below the RBNZ OCR bench mark, currently at 1.0%.

In the short run, investors are celebrating the likelihood of Federal Reserve rate cuts – producing a knee-jerk, obligatory pop in the market. Historically however, initial rate cuts usually mean that something has gone wrong. The misplaced exuberance of investors is something my friend Danielle DiMartino Booth calls a “Recession Party.” We doubt this party will end well. Blind faith that rate cuts are always positive for the stock market is a mistake. This assumption is likely to be the hook that keeps investors holding on through a 60-65% market collapse over the completion of this market cycle.

by printer8 | 10th Oct 19, 2:44pm 1570671852

Good article and very good points made.

One of the good thing about KiwiSaver is that many (if not all?) fund managers allow one to change funds at no cost so that shift to either a more aggressive or conservative fund does not incur a fee unlike most other managed funds.
It should also be noted that not only can aggressive funds be more volatile with high exposure to the share markets, just like the share market, that volatility can mean very sudden and very significant change; think "crash". By the time one realises the consequence for one's KiwiSaver account and by the time the fund manager actions the change, it is likely that the most significant impact has probably already occurred.

by powerdownkiwi | 10th Oct 19, 3:00pm 1570672807

"We do not know what will trigger the next major slump, nor which asset classes will be worst affected".

That will be because of your narrow education.

The next major slump - which almost certainly will be bigger than '07/8, and possibly terminal - is already triggered. Exponential increase in combined future bets vs exponential draw-down of underwrite. It's not an if, it's a when.

by J.C. | 10th Oct 19, 3:05pm 1570673120

Exponential increase in combined future bets vs exponential draw-down of underwrite

Yes. Playing the "safe game" as espoused by the financial industry is risky in my opinion.

by streetwise | 11th Oct 19, 10:36pm 1570786564

Unless you have had older relatives pass down experiences of the Great Depression of the 1930s it would be difficult to imagine what it was like. My 95-year-old mother was a
child in the 1930s and my grandparents and her younger sister were actually renting what is now (or was?) the very house that Helen Clark lives in (lived in ?) in Cromwell Road, Mt Eden. My mother can distinctly remember at some stage asking her mother why so many of the houses around neighbourhood were empty. So I guess owners just walked away from their mortgages. No one could afford to buy them; there were no mortgagee sales. Can you imagine this happening today? Could it happen again? Her father had started a gramophone and radio shop in Hamilton and when the Depression struck he had to walk away from it. Hence, he had to move up to Auckland where he managed to get a job as a French polisher in Atwaters Piano shop. He was lucky.
My paternal grandfather who had fought for over 3 years on the Western front was a carpenter by trade in the 1920s but was reduced to trying to get a job in the meatworks during the Depression; my grandmother remembers him coming home all bloodied and bruised one day because he had been a fight with someone trying to push into the queue lining up for a job. It was common for tramps to come knocking at the door trying to get odd jobs to feed themselves.
I don't think most younger people would have a clue as to what a real depression would look like. The likes of the so-called recessions in 2008 and 1987 and so on were mere mosquito bites by comparison. Everyone talks about a 'recession' but no one seems to mention the word 'Depression' because no-one today knows what they would look like. My father became a teacher and my mother a nurse in the late 1930s because they were considered among the 'safest' and 'securest' jobs in those hard times.
A recession is a mere trifle to everyone who is sensible with his savings and has acquired useful skills but God forbid we ever get another depression.

by J.C. | 10th Oct 19, 3:03pm 1570672982

I don't mind saying that since Kiwisaver's inception, if Kiwisavers had taken the equivalent of their contributions and bought the GOLD ETF in lump sums annually, they would have done reasonably well. The following chart explains (using AUD as a proxy for NZD).

https://snbchf.com/2018/01/skoyles-gold-highs-priced-emerging-market-cu…

That goes against all the 'common sense' rules.

by Lanthanide | 10th Oct 19, 3:20pm 1570674038

Except you can't "take the equivalent of their contributions" since your employer and the government won't hand over the cash unless you sign up to kiwisaver.

by J.C. | 10th Oct 19, 3:32pm 1570674765

Yes. I was referring to the individual's "own contributions." Kiwisaver to me is a farce in that it's centralized to a degree and takes decision making away from the individual.

by Lanthanide | 10th Oct 19, 11:21pm 1570702900

Yes, and you missed my point.

If your employer is matching your contributions at 3% (and this is additional to your salary) then you are already getting 100% return on your investment contribution before anything else. Then add in the government contributions. Then add in regular investment returns. Don't forget that kiwisaver is taxed at PIE rates too.

There's no way someone can achieve those kinds of returns on their contributions by investing in gold.

by lastlegs | 10th Oct 19, 3:07pm 1570673257

so if you are over 65 and still have money in kiwisaver time to wake up and get it out of there before it melts away.

by printer8 | 10th Oct 19, 3:58pm 1570676292

Hi lastlegs
. . . And do what?

by lastlegs | 10th Oct 19, 6:13pm 1570684413

Hi,printer looks like Martin and others predict a turndown,in a slump it doesnt matter what fund you are in you are bound to lose so why leave it trapped in there.forget about return on your money and concentrate on the return of your money.

by Nzdan | 10th Oct 19, 7:49pm 1570690165

Notes are now conveniently made of polymers, so much easier to store. Buy a water proof safe (or a sistema container if you're cheap) and find somewhere inconspicuous in your backyard to bury your savings? Be creative, bury it below a white cross with "RIP Snowy" written on it or something.

If you need to access it on a semi regular basis, use flag stone pavers as a path to your clothesline and bury your safe flush with the ground level under one of the pavers. Need cash, lift paver.

by Glitzy | 10th Oct 19, 3:24pm 1570674298

For investors the biggest single controllable variable with Kiwi saver is the management fee.

Get this minimised and the rise in your 'to retirement' return will make a huge difference to your pot size.

by kiwimm | 10th Oct 19, 4:00pm 1570676420

In terms of returns, the biggest variables are:
1 - asset allocation
2 - tax
3 - fees

So get you asset allocation sorted first.

by CN | 11th Oct 19, 2:03pm 1570755819

Most people would exclude their owner occupied property in that asset base. A few others would include their owner occupied property in that asset base.

Those that are nearing retirement, and dependent upon the owner occupied property sale proceeds (perhaps from downsizing) being a source of funds for retirement should include that in there asset base.

by JediNight | 10th Oct 19, 3:43pm 1570675420

Um. Corrections in asset price are banned, so no there will be no price slump in your Kiwisaver. The value of the NZD however and the cost of living might render that 40,000$ to FEEL like $25,000, if you're lucky.

by Independent_Observer | 10th Oct 19, 4:41pm 1570678872

I think if we see kiwisaver balances crashing by 40%, then it might be just my imagination, but wouldn't the 40% loss of value on your average house price in Nz ($600,000) cause far more pain than the equivalent loss on your average kiwisaver value ($40,000). I mean in one instance you lose $250,000 in value, in the other you lose $15,000. A factor of around 16 between potential losses in houses vs kiwisaver.

Why do we worry about one scenario but don't worry about the other which could impact the average NZ'ers financial position around 16 times more?

by Nzdan | 10th Oct 19, 7:50pm 1570690240

uH dUr WeN hAs HoUsEs GoNe DoWn In PrIcE iN nEw ZeAlAnD?

by Lanthanide | 10th Oct 19, 11:25pm 1570703130

Because in the GFC various managed funds were down by 40% or more, but the average house lost no more than 10% of its value over a longer period?

by Independent_Observer | 11th Oct 19, 8:56am 1570737390

In New Zealand yes...what about other countries that had massive house price inflation prior to GFC? (like what we have seen the last 10 years?). How did their housing markets perform?

by CN | 11th Oct 19, 1:58pm 1570755496

Something that is forgotten about the GFC in 2008 is that the NZ government guaranteed the debt of banks, so that the banks could access funds from overseas investors.

If the government hadn't provided these, then the banks would have faced funding pressures, and there would have been an even bigger credit crunch, which would have resulted in higher unemployment, more mortgagee sales, and even larger property price falls.

So with the bank debt guaranteed by the NZ government (giving banks access to much needed funds), one part of the deal that the government reached with the banks is that the banks pledged that they would help struggling borrowers, and provide mortgage relief. If this wasn't done then the banks could have forced many more into mortgagee sales, unemployment would have been much higher and property prices would have had a more dramatic fall, and the economy would have fallen into an even deeper recession, with a potentially longer period for economic recovery in NZ. In the next recession, the banks may not be as forgiving on financially stressed borrowers. If you believe that the property prices will only have a small fall in the future, then implicitly you may be assuming that the banks willing to provide mortgage relief to struggling borrowers - that assumption is something that some have been willing to bet their entire future financial security on.

Here is an excerpt from an article in 2008:

Mortgage relief for troubled owners
Hawkes Bay Today
03 November 2008
Pledge to help struggling borrowers part of banking guarantee scheme
Banks have promised to relax mortgage repayment conditions for struggling home-owners as part of a deal with the Government guaranteeing their overseas debts.
Announcing the wholesale funding guarantee on Saturday, Finance Minister Michael Cullen said he had been assured responsible borrowers could ``count on support from their banks'' during the hard times ahead.
Westpac bank said it had assured the minister it had dedicated more resources to helping people who were struggling.
It had told the Government it would not force mortgagee sales lightly.

by CN | 11th Oct 19, 1:18pm 1570753115

Yes. For most owner occupied households in NZ, the house is their major asset.

If house prices fall significantly, remember the impact of leverage on the equity value. This will be magnify the impact on their net worth. This will be more of a concern for capital gain oriented property investors - typically those that are younger and in wealth building mode. Typically, owner occupied households with younger people have more leverage than households with retirees as they have not had much time to reduce the principal on their mortgage via P&I payments.

For income oriented property investors (i.e higher priority on income, lower priority on net worth), the fall in price will be less of a concern. Their primary concern will be stability of the income stream. These are typically retirees.

All households have their own unique circumstances. For those households focused more on their net worth / equity (and less focused on the income stream from their investments), each person should look at their own personal / household balance sheet and see where the major proportion of their assets are invested and focus on managing that asset.

by Due Diligence | 10th Oct 19, 6:54pm 1570686878

I’m in a growth fund. Don’t care if it drops by 90%. I just hope my fund manager buys as much as possible with cash reserves on the way down. Will just wait it out and pop out on the other side eventually. 33 years until retirement, so ups and downs along the way mean very little to me.

by Nzdan | 10th Oct 19, 7:52pm 1570690326

If your fund drops by 90% increase your contributions.

by Due Diligence | 10th Oct 19, 8:03pm 1570691024

That’s the spirit

by Brutus Iscariot | 11th Oct 19, 8:47am 1570736836

Your fund manager won't be buying anything on the way down, in fact they'll be selling everything to raise cash for investor withdrawal requests.

by Due Diligence | 11th Oct 19, 11:02am 1570744959

Rubbish.

It’s called “averaging down”. Even the likes of NZ Super Fund increase clash reserves when a downturn is anticipated to take advantage of this, and undervalued stocks generally. They won’t be selling everything - they wouldn’t sell my share of the equities for example, unless I withdrew from the fund. Anyone that withdraws from a growth fund when times get tough shouldn’t have been there in the first place.

by Brutus Iscariot | 11th Oct 19, 1:48pm 1570754903

I know what averaging down is. The fact is, in a fund structure you are beholden to the decisions of other investors. Have the growth funds you invest in got enough cash to genuinely buy in on the way down? I suspect if they did, they wouldn't be classified as Growth funds.

If Kiwisavers switch en masse from Growth to Conservative/Balanced for example, it wouldn't take much to wipe out the cash on hand in most equity funds. Dry powder comes in the form of contributions but these could be small relative to total fund size.

by Due Diligence | 11th Oct 19, 2:25pm 1570757150

You have no evidence or factual basis whatsoever to proclaim that my "fund manager won't be buying anything on the way down". As I explained previously, prudent growth fund managers increase cash reserves when a downturn is expected to maximise their ability to average down and buy cheap equities. The NZ Super Fund is a classic example, it is like an aggressive KiwiSaver fund. Growth funds do hold cash reserves, and the NZ Super Fund is an example of one that will use theirs to do exactly what I have described. See this clip, specifically 04:30 - 0:700.

https://www.interest.co.nz/news/96323/nz-super-funds-matt-whineray-expl…

You're clueless.

by CN | 11th Oct 19, 3:22pm 1570760569

It depends on the type of fund and the investment objective of the fund.

In any open ended investment fund with a dedicated investment objective (e.g growth, balanced, US equities, Emerging market equities, long duration corporate bonds, short duration T bills, Index fund, NZ Top 50, etc), the cash portion is only a small portion (typically less than 3%) - this is to meet redemptions. Most of the funds are invested in their investment strategy, and there is little discretion over the cash portion being uninvested (as it results in tracking error - i.e underperforming the performance benchmark).

For example, imagine if you invested in Smartshares NZ Top 50 (https://finance.yahoo.com/quote/FNZ.NZ?p=FNZ.NZ) but you discovered that they had 50% of their fund in cash because they were anticipating lower prices? Most institutional investors such as insurance companies, sovereign wealth funds, NZ SuperFund, family offices, etc would not like this - they allocated their money to a fund which was to invest all in the NZ stockmarket index. Take a look at the investments of the NZ Top 50 Fund on page 326 (it has about 1% of total assets in cash) - https://smartshares.co.nz/document-library/financial-statements-smartsh…

In a multi-asset portfolio (like NZ Super Fund, insurance companies, family offices, sovereign wealth funds, pension funds, endowments, etc), they are responsible for asset allocation, and may have excess cash for any tactical asset allocations. The NZ Super Fund has about 2.8% (1.2/42.4) of total assets in cash - refer page 118 - https://nzsuperfund.nz/sites/default/files/documents-sys/Annual%20Repor…
So even if NZ Super Fund sees an opportunity to invest, how much difference is investing 2.8% of the fund going to make to the overall performance of the fund? The bigger contribution to performance will be through reallocation of their assets (e.g from changing the portfolio asset allocations of global listed equities, fixed income securities and private equity - these are the largest allocations of the fund outlined on page 151)

by Due Diligence | 11th Oct 19, 6:14pm 1570770842

What specific statement of mine do you disagree with? I’m talking about growth funds like ANZ Growth, NZ Super Fund and Milford Active Growth. Many of them use cash reserves, and potentially sell other holdings, to buy on the way down. My fund, like the NZ Super Fund, will likely average down. Nowhere did I claim that they hold vast cash reserves, and anyone that thinks you need vast cash reserves to average down is wrong. Its not just my opinion that they do this - the Chief Exec of the Super Fund explained it in the clip I linked above, and said that they are the same as aggressive KiwiSaver funds.

by SmoKey | 11th Oct 19, 7:44am 1570733068

I am not worried. Like the major banks, Kiwisaver has also become TBTF. With excess of $60 billion in it, any major fall in value say 50% will trigger government protection. Though this is not built in, the politics of election will ensure that.

by steven | 11th Oct 19, 9:36am 1570739790

As per usual a comment from someone who believes in exponential growth for ever on a finite planet. ie boom and bust and then boom again, rinse and repeat. My view is we are in for a Long Depression mk2 and quite possibly OBR events. The risk profile on even moderate funds is therefore way to large IMHO.

by lastlegs | 11th Oct 19, 10:28am 1570742931

averaging down,wonder if anybody is doing that with sky shares,could they keep paying a 10 cent dividend?

by kiwiana02 | 11th Oct 19, 1:23pm 1570753398

House prices dropped by around 15% in real terms after the GFC (MOTU, April 2015, What did the GFC do to house prices in NZ?)
Nationwide, house prices crashed 40% in real terms between 1974 and 1980 (Peter Nunns, July 2016, Remember the last time house prices crashed 40%, Greater Auckland website). However in nominal terms prices remained relatively flat, due to the high inflation at that time.
I understand house prices also fell significantly during the Great Depression, and the impact would have been more severe due to the deflation that was experienced at that time.

by Dave2 | 12th Oct 19, 4:08am 1570806506

Don’t look at the hill, think what’s behind the hill.
As long as listed equity remains a significant part of the economy, and share holdings or your fund are weighted to value stocks well diversified by sector and geography, major value falls will probably correct over time as they did in 08 and continue to do. Any major, or in fact even relatively small share market movements like last December generate a monetary and fiscal policy response -such as QE and rate reductions, looser Govt spending which stimulate a recovery, because the sharemarket is the engine of employment and growth. The growth in private equity hasn’t changed that.
A share investor is sitting on 10 years of mostly gains since 09 - which have compounded up to about 3x a $ invested in 09, so losing 25% - or more likely misplacing it for a year or two - shouldn’t phase. It’s a buying opportunity. The biggest threat of loss of portfolio value is sustained good news, a return to gdp growth, and as a result increase to inflation and interest rates.

by Dave2 | 12th Oct 19, 4:14am 1570806856

https://www.investopedia.com/portfolio-management-4689745

Value of $ invested in shares in 2009.