By Amanda Morrall
A few weeks ago ANZ Wealth floated an idea to modify the way defund funds in KiwiSaver are structured to automatically adjust asset allocation according to the investor's age.
The rationale was that young KiwiSavers who found themselves in a default fund, and whom couldn't be bothered to change out of this conservatively structured fund, could potentially cheat themselves out of NZ$72,000 over 40 years of investing. That's based on the assumption, supported by historical investment data going back 100 years, that over longer time frames equities markets will out perform other asset classes, namely cash and fixed interest.
ANZ Wealth estimated that there are roughly 191,000 investors who could inadvertently lose out on these gains, leading the default provider to label the situation a NZ$14 billion timebomb. (Find your fund here).
Simon Botherway, general manager of investment, said despite recent KiwiSaver performance data showing conservative funds outperforming growth funds on average, investors with 40 years to go could be disadvantaged. (See Amanda Morrall article here for more).
"What we're saying is that the asset allocation implicit in the default fund is so conservative that the returns they will generate over the full period are substantially less than they could be if they were invested in a more suitable asset allocation profile which would include a significantly higher percentage of growth assets, particularly in the early years of investing.''
The $72,000 figure that ANZ Wealth bandied was based on a worker earning a base salary of NZ$36,000 and contributing 2% of their salary as well as receiving 2% contributions from their employer. It also accounted for the $1,000 kick-start and wage growth of 2.5% per year with a final salary of $104,000. Total contributions to KiwiSaver would be approximately $140,000.
Based on average returns delivered by a conservative fund, the compounding effect over 40 years, would see that balance grow to $248,000. By comparison, a KiwiSaver invested in a "life stages" type of fund (that has a higher allocation of "growth" assets such as shares at a younger age) would end up with $320,000.
Past performance is no indication of future returns
Given the global financial crisis (which has had the effect of giving funds more heavily weighted in fixed-income investments superior returns) and on-going economic instability world-wide, one might question the tenets of modern investment theory and some of the assertions made by fund managers about conservative funds being long-term losers for young investors.
Investors are constantly reminded and cautioned that past peformance is no indication of future returns. The exception to that rule would appear to be time, according to fund managers.
Botherway concedes there are no guarantees in investing but argues the past few years have been exceptional in history and should not over right 100 years of historical market data.
"There isn't any absolute certainty (about growth funds) but there isn't any absolute certainty in income assets either. If you are invested in Greek bonds, there isn't the certainty you felt there was when people invested in them,'' he said, in an interview with interest.co.nz
"If you look back at history, taking 110 years worth of data, since 1900 to 2010, what it shows in 19 major developed nations, is equities outperformed bonds by an average of 3.8% per annum. The cumulative effect of that out-performance over that extended period of time makes a big difference to the final outcome. That's the nature of compounding returns.
"The last decade has been the exception where bonds have substantially out-performed equities but when we look at equities now we perceive them to be relatively cheap. There are no guarantees but once we get to flat economic waters equities markets will be substantially higher, there is no doubt about it.''
Playing it conservative for the sake of a home
For younger investors looking to use KiwiSaver funds as a deposit on a first-time home, going for growth is a high risk proposition. That's because with few exception, most growth funds under-performed conservative funds over shorter periods of time. For someone with a three-year time horizon in KiwiSaver (which is how long you have to be active in the scheme before being eligible to draw down on your money) conservative-oriented funds are a safer bet, adds Botherway.
"What we're saying is that for those who make no active choice in KiwiSaver and who are intended to save for retirement via their KiwiSaver this is the right option (a lifestages funds) but for those saving for their first time home that's different and they need to get some advice. Ideally, everybody would get advice but that's something that they should get specific advice on.''
And what about investors in their 30s or early 40s?
While life stages funds automatically reduce the weighting of shares in one's portfolio as you age, Botherway said even 30-year-old investors had time on their side.
"If you still have 30 years of time to save for your retirement, it will still be our view that a conservative fund is not appropriate.''
Don't count on NZ Super
Counting on NZ Super as a supplement or even a primary source of retirement income is not something most financial advisors recommend. In fact, they exclude it from retirement modelling projections altogether and suggest you treat it as bonus money.
Botherway said New Zealand was no different from many nations worldwide struggling with ageing populations living longer than ever on top of a relatively diminished pool of workers to finance the system.
"The affordability issues of NZ Super are front and centre and a number of nations have either raised the age of retirement or changed the nature of entitlements at retirement. New Zealand is not exempt from that. We have the same problem with an increasing number of retirees and few workers per retiree.''
Botherway said it raised inevitable questions about the NZ Super's long-term viability and security.
"Will it be there and on what basis will it be indexed and will it be means tested?''
The uncertainty of the social security reinforced the importance of KiwiSaver, he said.
"What we're saying is that the KiwiSaver scheme is the one that is your own. The Cullen Fund (for the NZ Super) could be wound up any time by this government or a successive one. We're proposing that people take destiny in their own hands.''
ANZ Wealth has found support for its proposal from the funds management industry and Government but nothing concrete at policy level so far.
"We're engaging with stakeholders (this week),'' said Botherway.
"We consider this to be an important issue. At worse, it may encourage people to think about whether they are in the appropriate scheme.''
Support for a similar move across the Tasman seems to be gathering strength as well with policy makers taking a more paternalistic approach toward investors who either can't be bothered or don't know how to take care of their retirement savings.
"There is also a real focus on financial literacy in recognition of those people with low level literacy and a view that those who are not availing themselves of information should not be disadvantaged.''
Implications for SOE sell offs
Botherway said the upcoming privatisation of New Zealand's sovereign owned entities (SOEs) was all the more reason for investors to take a more active interest in the nature of the fund they are invested in through KiwiSaver.
Again, conservative investors could have the most to lose here, he argued.
"If you are in a default conservative fund, 80% of your funds will be invested in cash or fixed interest. So only 20% of your money will be invested in growth assets such as shares and of that a maximum of 40% would be invested in New Zealand shares.
"If you think about the SOEs that are subject to a mixed ownership model (with Government maintaining majority ownership), if you think about how much of the NZ share market they will make up eventually.We're sort of thinking it will be between 12 and 15%.
"Even at 15%; 15% of 8% means you have about 1% of your money invested in those SOEs which have great long-term inflation protected cash flows. And depending on pricing probably attractively priced. If you are a 25-year-old and only 1% of your money is going to be invested in those SOEs, I think you'll probably feel at 65 that you might have been short changed in term of your investment profile."