Comment: The Financial Markets Authority’s Paul Gregory says the latest KiwiSaver annual report shows global and local factors are driving overdue improvements to our national savings scheme
KiwiSaver enjoyed an ‘annus mirabilis’ – a miraculous year – in the 12 months to March 31, 2021, gaining over $13 billion, or more than triple its previous best year.
For members who contributed to their accounts during the year, the average balance rose 27 percent to $35,480.
Turbo-boosted by the market’s abrupt recovery from the Covid slump, some funds produced returns so remarkable we had to ask managers not to promote them in isolation, lest they give a misleading impression to investors.
We didn’t want KiwiSaver members chasing outsize returns that were unlikely to be repeated – especially if those members had already crystallised Covid losses by fleeing to conservative funds.
Investment guru Howard Marks recently said investors trying to “out-think the market” in the short term typically “get in the way of the compounding machine”. In other words, they miss out on the long-term benefits of compounding gains. This becomes more serious as KiwiSaver balances increase and the ‘money weight’ of poor decisions gets larger.
Our KiwiSaver annual report looks at three factors, two global and one local, which should help drive KiwiSaver’s ‘compounding machine’ and support members choosing the right fund and staying with it.
Value for money
Globally, most capital flows are to funds with Morningstar ratings of three stars or more, with average or below-average pricing. This makes sense when fees always reduce returns. Higher fees drag on that ‘compounding machine’, so paying higher fees is worth it only if their drag is consistently offset by higher returns.
Sure, value is more than performance. But if investment managers want to charge for services that are not performance-related, they must be clear how those extras help investors make good decisions (e.g. advice); and/or improve the risk and return of their investors’ portfolios (e.g. good research).
This was the FMA’s view in recent guidance on managed fund fees and value for money. The need for such guidance is clear in the report, showing average fees for ‘active choice’ KiwiSaver members rising 17 percent in one year – from $206 to $240 per member – the largest increase in the 2016-2021 period.
Higher returns may have reduced the proportionate impact of fees on member balances in 2021, but can’t hide the fact KiwiSaver providers are generally not passing on the benefits of scale – the financial appeal of which is obvious when the report shows 12 months of extraordinary market performance yielded $657 million in fees for the 37 KiwiSaver schemes.
There are positive signs. Administration fees have fallen steadily, which is appropriate as they were intended to help providers cover costs at the outset of KiwiSaver when scale was low.
More encouragingly, during and after the period covered by the report, several large providers announced fee reductions, with two explicitly linking scale to their decision.
Globally, consumers increasingly choose investments to reflect their personal values. For the investment management industry, sustainability is becoming table stakes.
This was recognised in our recent guidance on integrated financial products, requiring providers to explain and substantiate any claims their products integrate social or environmental factors and/or have benefits of that nature. Investors cannot be misled about what they are buying.
Again, our report shows such guidance is timely. At March 31, 2021, more than 22,000 KiwiSaver members had $554 million in funds labelled ‘socially responsible’ (or similar). That membership number is up roughly 50 percent in 12 months, but still significantly understates the demand for such funds.
FMA research showed 31 out of 37 KiwiSaver schemes claimed to take environmental and social criteria into account. The Responsible Investment Association of Australasia found two-thirds of the $328 billion run by New Zealand investment managers (including KiwiSaver) were in funds “self-declared” as practising responsible investment.
We’ll be reviewing these responsible investment claims in providers’ disclosures and reporting on it early next year.
KiwiSaver default funds are where Inland Revenue puts members who have not yet chosen a KiwiSaver provider, typically when they start working and are first enrolled. At March 31, 2021, that was just over 356,000 people.
The Government reviews providers of default funds every seven years, and its latest review in 2020 emphasised the need for price competition. This resulted in significantly changed default settings, in force from this December, including a requirement that total fees fall to between 0.2 percent and 0.4 percent – a big reduction.
Other changes included the appointment of new providers, switching default funds from a conservative to a balanced setting, cutting fossil fuel and cluster munition investments from equity portfolios, and more detailed service and member engagement requirements.
Under previous settings, default products were regarded – mostly rightly – as a ‘parking space’ for members’ money until they made an active choice. Hence, government efforts were focused on providers helping default members switch to a ‘proper’ fund.
The new settings change that. The balanced allocation, lower fees and better engagement all mean inertia is more in members’ favour; which, in behavioural finance, is the proper purpose of defaults.
The FMA’s focus will now be on testing whether members being switched out of new default funds is in their interests. We will also be checking if members wanting to switch or transfer into the default funds – which they can do and, given the settings, is a rational choice for many members – are not obstructed by providers wary of too many members in low-fee, high-attention funds.
What were once just parking spaces, are now more like high-quality, low-cost housing.
What demand for the same benefits might that create among members not in default funds? If providers become concerned their members are shifting to those low-cost default funds, they will act to improve the value proposition to prevent it.
In other words, the latest default upgrades have the potential to improve KiwiSaver across the board: fuelling the compounding machine; strengthening member resilience; and potentially setting us up for more ‘anni mirabiles’ in years to come.