By Craig Simpson
Back in May 2012 in an interview with interest.co.nz, Sean Hughes CEO of the FMA, signalled that New Zealand needed to adopt a greater level of prudential supervision over KiwiSaver providers. Australian regulators prefer prudential standards over legislation due to the greater flexibility and the ability to make changes quickly to market developments.
Almost one-year after the interview with Hughes, our Government has introduced the KiwiSaver (Periodic Disclosure) Regulations 2013, a piece of legislation, rather than the prudential supervisory system Hughes was suggesting we needed.
The upshot of the regulations is to impose a prescriptive and mandatory template for the way KiwiSaver providers report performance, fees and costs and communicate with investors.
The changes in the KiwiSaver space will undoubtedly flow through to the mainstream funds management market in due course.
Interestingly, the Chartered Financial Analyst (CFA) Institute, which lists several New Zealand portfolio managers as charter holders, has launched a new voluntary Asset Manager Code of Professional Conduct which outlines the ethical and professional responsibilities of firms that manage assets on behalf of clients.
So far approximately 900 global institutions have signed up to the code and Brook Asset Management (a KiwiSaver provider), was the sole New Zealand participant at last count.
There are always "black sheep" in any industry and this code is seen by the CFA Institute as providing investors with another layer of protection and another tool to help investors select a fund manager who they can trust.
The legislation our Government is implementing will give investors a greater level of comfort around the uniformity of the information being provided and allow investors to compare apples with apples.
A win for investors
I see the mandatory reporting requirements as a win for KiwiSaver investors (and KiwiSaver analysts) and invariably will put a greater spotlight on performance and fees which may not always be appreciated by the managers.
It is important for investors to keep in mind that the performance of KiwiSaver managers should be judged over longer time periods rather than on a quarter by quarter basis.
Until now the reporting of KiwiSaver provider returns and fund information has been left pretty much to each individual provider with no consistency across the market as to what information is made public and how returns are displayed.
One of the major discrepancies across providers was around reporting returns on either a net of fund manager fees but gross of tax basis, and reporting on a net of tax and fees basis. The latter is more aligned to what is considered best practice in the industry and better reflects the returns received by investors.
Some of the major providers in the past would not provide interest.co.nz with after tax returns saying it was not appropriate to provide returns that simply assumed tax at the top prescribed investor rate (PIR) of 28% was deducted. Now there will be no discrepancies as managers have to provide the returns on an after tax (at 28% being the current top PIR and also at a PIR of 0%) and fees basis.
I can imagine that some managers will be unhappy with the changes as this will mean additional compliance and reporting costs and changes to back office reporting systems. But for others, it will be very much business as usual.
The main changes that impact KiwiSaver investors are examined in greater detail below.
Performance and returns
The disclosure statement and its data file must disclose the return for each of the relevant periods net of all fund fees and accrued tax, for a New Zealand resident paying tax at the highest PIR. The manager must also provide returns based on a PIR of 0%.
All returns greater than one-year are calculated using an average annual compound return and these returns must be net of all trading expenses.
Historical returns will need to be shown graphically and the disclosure must contain a written example of the return for a hypothetical member of the fund who (a) invests only in the KiwiSaver fund to which the disclosure
statement relates; and (b) has $10,000 invested in the fund at the beginning of the period to which the disclosure statement relates and does not make any member-specific decisions, contributions, or withdrawals in that period; and (c) is a New Zealand resident individual paying tax at the highest prescribed investor rate as that applied throughout the period.
There are some fundamental changes to the way returns are reported as many of the current providers do not calculate returns on a net of tax and fees basis. The hypothetical return for an investor with $10,000 in their account will show investors how the value of this investment may have changed over time.
I believe this graph has limited relevance as it does not accurately represent the individual investor's experience due to the fact the calculations do not take into account the regular contributions.
Fees and Costs
For the purposes of these regulations, fees and costs are (a) fund fees including management fees, performance fees and all other fees or costs not categorised as either management or performance fees; (b) membership fees; (c) individual fees and; (d) trading expenses.
A synthetic Total Expense Ratio (TER) must also be calculated annually based on the total actual costs and fees as a proportion of the average net asset value of the fund for the reporting period.
The TER must be calculated using the following formula and excluding trading expenses: a = ((b + c + d) ÷ e) × 100
- a - is the synthetic TER for the 12-month period to which the disclosure statement relates
- b - is the total fund fees disclosed for the 12-month period
- c - is the total membership fees charged to members' interests in the KiwiSaver fund during the 12-month period
- d - is any other fees charged in respect of the KiwiSaver fund or underlying funds that the FMA, specifies must be included in the synthetic TER
- e - is the average net asset value of the fund for the 12-month period.
Managers in the past have been very transparent on the fees and the inclusion of the TER, which has up until now been calculated by external parties based on information included in the annual accounts, will allow for easier comparisons across competitors.
Asset Allocations and holdings
A large number of KiwiSaver providers already disclose their top 10 holdings and country allocations as part of their regular client communications. The new legislation simply tidies up the format managers must report this data in and removes any remaining shrouds of secrecy.
KiwiSaver managers will also have to provide a pie chart showing how the fund is allocation across the various assets and is able to use a category termed "unknown" for anything the manager does not know, and cannot reliably assess, the appropriate category.
I find the use of the 'unknown' category puzzling as the fund managers must know what they are investing into and what asset class these assets would most likely belong to or at least mimic.
A better term would have been 'Alternative Assets' which is more mainstream and is used to described investments such as hedge funds, commodities, infrastructure, timber and other similar investments.
Ensuring transparency in holdings and country allocations will assist investors in understanding what holdings or country exposures may have contributed to any performance variances away from either the market or competitors.
Liquidity and liabilities
This is a new development and will be interesting to monitor over time.
The annual disclosure statement’s data file must contain a statement of the KiwiSaver fund’s liquidity ratio as at the last day of the 12-month period to which the disclosure statement relates.
The liquidity ratio must be calculated using the value of the KiwiSaver Fund's assets that are able to be fully liquidated within five working days under normal market conditions divided by the net asset value (NAV) of the fund.
We expect most funds managers will have a reasonably high liquidity ratio, however for those managers who can invest into less liquid markets or unlisted securities which may take longer to sell.
In addition to the liquidity ratio, KiwiSaver managers must also calculate a debt ratio.
The annual disclosure statement’s data file must include a statement of the KiwiSaver fund’s debt ratio as at the last day of the period to which the disclosure statement relates. The debt ratio must be calculated using the value of the liabilities of the KiwiSaver fund, other than net assets attributable to members and the Total Asset Value (TAV) of the KiwiSaver Fund.
Many managers either invest into directly held securities and do not borrow against their funds (leverage). It will be interesting to see who the outliers are and monitor the debt ratio over time.
Key personnel and conflicts of interest
Section 35 of the legislation states that the disclosure statements must disclose information in relation to each of the five directors and employees of the manager who have the most impact on the investment decisions (e.g. the chief investment officer, the chairperson of the investment committee, and the senior investment analyst in relation to the fund).
The manager must provide the person's name, position, tenure, previous positions and tenure (if relevant). If there are fewer than five directors and employees the information must be disclosed in relation to each of those directors and employees.
Information about conflicts of interest is contained in section 36 and the disclosure statement must state whether, during the three-month period ending on the last day of the period to which the disclosure statement relates, there have been any material changes to the nature or increases in the scale of the KiwiSaver scheme’s related party transactions (as they relate to the KiwiSaver fund) disclosed in the previous quarterly disclosure statement. If there have been material changes, these must be described.
Individuals must state whether all related party transactions that occurred during the three-month period referred to were on arm’s-length terms and, if not, identify the transactions that were not on arm’s-length terms.
The requirements apply even if the material change to the nature, or increase in scale, of the KiwiSaver scheme’s related party transactions during the three-month period is because of a single transaction.
Other disclosure items
To be included in KiwiSaver disclosure statements is information about;
- material changes to a fund’s trade allocation policies, trade execution policies, and proxy voting policies
- changes to the KiwiSaver fund's valuation and pricing methodologies
- revised disclosure statements to be made publicly available in certain circumstances
In addition to the above changes it is noted there is a transition period and managers are not required to complete a quarterly disclosure statement after the first quarter of the 2013–2014 disclosure year (refer s11 (1) of the legislation).
Greater levels of disclosure and consistency in reporting
This legislation will enable investors to compare apples with apples and allow investors to choose the most appropriate KiwiSaver fund for them.
The template managers must follow for reporting is quite prescriptive and not as flexible as a prudential supervision or other code that could have been introduced.
For some managers the changes will create some additional work and likely incur some costs related to system changes. But at the end of the day the investor should be the winner.
The most interesting part of the legislation for me is the inclusion of liquidity and debt ratio's and the calculation of a TER.
The TER is probably the most useful of these three ratios as it represents the total costs associated with managing the money as a proportion of the investment pool. Investors will be able to accurately line up and make comparisons between the various KiwiSaver returns and the TER.
Investors should always keep in mind that a fund with a low TER will not always be better. Sometimes managers with higher TER's have produced superior returns.
All in all I see these changes as being a positive step forward and it should lead to greater reporting of the KiwiSaver sector and this must be good for all concerned.
Story updated: Funds with low TER's will not always be better. Sometimes managers with higher TER's have produced superior returns. Also CFA Society replaced with CFA Institute.