NZ T R E N D S Independent research and analysis Page 1 of 9 March 2015 KiwiSaver and Home Country Bias An interesting tendency of pensions markets around the world is the presence of home country bias. In essence, what this means is that most retirement investors hold portfolios that are skewed towards the local markets. While investment theory dictates a certain international weighting to create optimized portfolios most funds hold an overweight allocation towards the local market. For KiwiSaver, this phenomenon combined with conservative member investment selection has led to the total KiwiSaver asset pool showing a strong home country bias. The graph below shows the total KiwiSaver asset pool split between New Zealand and assets. 65% 60% New Zealand assets assets 56% The split between local and international assets for the main KiwiSaver multi-sector fund categories is shown next and the trend is for the home country bias to reduce as risk profile increases. New Zealand assets 44% assets 57% 61% 43% 39% 55% 50% 54% Low Equity (Conservative) Medium Equity (Balanced) High Equity (Growth) Underlying figures from the Financial Market Authority 45% 40% 35% Mar 08 Sep 08 Mar 09 Sep 09 Mar 10 Sep 10 Mar 11 Underlying data source: Reserve Bank of New Zealand 46% The weighting towards New Zealand steadily reduced to below 50% before rising to 54% at the end of 2014. It is not clear exactly how the listed property and equity funds that invest across New Zealand and Australia markets are classified but this should not alter the overall picture. While home country bias is common how much home country exposure is reasonable? Sep 11 Mar 12 Sep 12 Mar 13 Sep 13 Mar 14 Sep 14 Globalization and the associated increase in trade means that an analysis of equity exposure based purely on a company s listing domicile is less meaningful these days. Many companies are multinational and derive a significant portion of their revenues ( economic exposure ) from developed international markets and emerging markets. From this one can gather that a certain home country bias is understandable as there is more global representation in the local market than before and very few pure local companies exist these days. Different approaches to the local-international exposure issue exist at asset class level. Pension assets generally show a much higher home country bias for bonds i.e. international diversification via equities is more sought after. The United States pensions market actually has the highest local equity which takes into account their personal circumstances before making investment decisions. written permission from the author.
Page 2 of 9 weighting 1 but at the same its equity market may well be the most internationalised. In line with global trends the equity component within KiwiSaver multisector funds show a greater international weighting (relative to bonds). Analysis shows a declining home country bias for bonds as risk profile increases although the weighting towards bonds will naturally reduce as the target return increases. Australasian equities 66% 69% 69% 34% 31% 31% Low Equity (Conservative) New Zealand bonds Medium Equity (Balanced) equities High Equity (Growth) bonds Home country bias is well researched in attempts to explain the phenomenon. Investor familiarity with local markets a major factor but we must acknowledge that New Zealand is tiny (but respected) in the global context: 0.2% of global GDP and 0.1% of global equity market capitalisation. In this context a high degree of international diversification is warranted for New Zealand investors (all else equal). When regulating and developing pension markets the authorities like the idea of large institutional asset pools that can assist in the development of local capital markets and infrastructural development. Large pools of institutional assets translate into a steady source of funding for infrastructure projects. When reviewing home country bias key justifications include: - It is human nature. - Familiarity with local markets. - Tax advantages to local investing e.g. the availability of franking credits in Australia. - A prevailing valuation opportunity. Valuation opportunities are not permanent so only supports a bias until the valuation opportunity unwinds. - Some argue that pension liabilities are in local currency (although currency hedging policies can take care of this plus most people will spend on imported products). - Certain countries have exchange controls regulations that limit the amount of international exposure for superannuation funds. 53% 56% 47% 44% Low Equity (Conservative) Medium Equity (Balanced) 61% 39% High Equity (Growth) A good way to visualise how international diversification will aid portfolio construction is with correlation graphs and these can be found in Appendix 2 for New Zealand equities and bonds. Over the past 15 years the typical New Zealand institutional balanced discretionay portfolio has had an average exposure to New Zealand of 46%. The following stack graph shows the asset allocation progression over the past 15 years. There have not being massive changes. bonds have increased by 5% with a similar decline in local bonds while local equities declined by 3%. Over this period the New Zealand weighting declined by 8%.
Page 3 of 9 12% 4% 17% 40% 41% 57% 59% 32% 32% 6% 23% 18% 7% 20% 12% 60% 59% 43% 41% 1999 2004 2009 2014 New Zealand bonds bonds 9% 8% 1999 2001 2003 2005 2007 2009 2011 2013 NZ Cash NZ Bonds NZ Equities Property Int. Equities Int. Bonds Other The total New Zealand and weightings from the above graph are as follows (5 year intervals). 53% 47% 54% 58% 47% 42% 55% 45% 1999 2004 2009 2014 New Zealand Currently 45% of balanced discretionary portfolios are invested domestically whiles corresponding figures for Canada and Japan are 47% and 52% respectively 2. The local/internationals breakdowns for the equity and bond portions of balanced discretionary portfolios are as follows: 58% 42% 71% 66% 62% 29% 34% 38% 1999 2004 2009 2014 Australasian equities equities Reasonable expectations around the benefits of international exposure are useful as diversification benefits are not consistent. It is hard to answer the question of: what amount of international exposure is needed to provide reasonable diversification benefits? It is common these days to extend international exposure to emerging markets and a number of KiwiSaver fund managers have added a dedicated emerging market component to portfolios. Diversification can break down as was experienced during the Global Financial Crisis when correlations rose sharply. Investors are probably better served to think on after tax returns as the potential PIE tax advantages for New Zealand and Australasian equities are extremely important. Tax efficiency ratios for Australasian equity funds are the highest of any KiwiSaver fund category in the NZ Trends database. Fund managers such as Milford and NZX (Smartshares) favour Australasian equities in their funds. Portfolio theory dictates that portfolios with in-built biases are sub-optimal and KiwiSaver members will be well served to understand any home country bias within their KiwiSaver investment fund. This exercise should not be done to second guess the fund manager but to rather get attuned with the manager s approach in this regard. Understanding and accepting any bias should make KiwiSaver members more attached to the fund and fund manager.
Page 4 of 9 comparisons should be treated with caution as each country has a different contributions to global GDP and equity market cap plus nonportfolio factors, such as regulatory and tax, can impact the decision for each country. However, there is an argument that in countries such as the United States which is a sizeable part of global equity market cap - may be more susceptible to home country bias. Research by Northern Trust 3 for Defined Contribution participants in the United States shows the magnitude of the bias using two measures: Contact NZ Trends is an occasional publication providing independent research, analysis and comment on the KiwiSaver industry. The newsletter is produced by Collin Nefdt, an independent KiwiSaver analyst. He can be contacted at nz_trends@yahoo.co.nz Proxy DC Participant Market Geographic Allocation Cap Revenue U.S. Allocation 49% 28% 82% Non-U.S. Allocation 51% 72% 18% Market cap bias 33% Revenue bias 54% The phenomenon of home country bias in portfolios is both significant and fairly common. KiwiSaver funds and KiwiSaver assets in aggregate exhibit the same bias. While not wrong too much local exposure or too little international exposure can lead to suboptimal portfolios. Home country bias is not symmetrical across multi-sector KiwiSaver funds as international diversification tends to increase as the risk profile increases. Home country bias within KiwiSaver is exacerbated by conservative investment selection by members. KiwiSaver members will be well served to understand the approach to international diversification of their fund manager and the reasons for any excessive home country bias. Sources: 1. Global Pension Assets Study 2015, Towers Watson 2. Going Global 2013, Callan Associates 3. Home Country Bias: Why It Can Undermine Retirement Portfolios, Northern Trust, 2015
Page 5 of 9 Appendix 1 Local and exposures for selected KiwiSaver funds All figures are from stated strategic asset allocations. Property exposure has been split between local and international based on available information (otherwise a 50:50 split is assumed). All alternative assets are assumed to be international exposure. Default Funds 60% 40% AMP Default ANZ Default ASB Conservative BNZ Conservative FF TWO Cash Enh Grosvenor Default Saver Kiwi Wealth Default Mercer Conservative Westpac Defensive Split of Total Assets Local AMP Default ANZ Default ASB Conservative BNZ Conservative FF TWO Cash Enh Grosvenor Default Saver Kiwi Wealth Default Mercer Conservative Westpac Defensive 33% 67% Split of Total Equities Local Equity Int Equity AMP Default ANZ Default ASB Conservative BNZ Conservative FF TWO Cash Enh Grosvenor Default Saver Kiwi Wealth Default Mercer Conservative Westpac Defensive 45% 55% Split of Total Fixed Interest / Bonds Local FI Int FI
Page 6 of 9 Low Equity (Conservative) Multi-sector Funds AMP Conservative ANZ Conservative Aon-Russell Conservative ASB Moderate BNZ Moderate Fisher Funds Conservative FF TWO Conservative Grosvenor Conservative Kiwi Wealth Conservative Milford Conservative Westpac Conservative 53% 47% Split of Total Assets Local AMP Conservative ANZ Conservative Aon-Russell Conservative ASB Moderate BNZ Moderate Fisher Funds Conservative FF TWO Conservative Grosvenor Conservative Kiwi Wealth Conservative Milford Conservative Westpac Conservative 41% 59% Split of Total Equities Local Equity Int Equity AMP Conservative ANZ Conservative Aon-Russell Conservative ASB Moderate BNZ Moderate Fisher Funds Conservative FF TWO Conservative Grosvenor Conservative Kiwi Wealth Conservative Milford Conservative Westpac Conservative 42% 58% Split of Total Fixed Interest / Bonds Local FI Int FI
Page 7 of 9 Medium Equity (Balanced) Multi-sector Funds AMP Balanced ANZ Balanced Aon-Russell Balanced ASB Balanced BNZ Balanced FF TWO Balanced Grosvenor Balanced Kiwi Wealth Balanced Mercer Balanced Milford Balanced Westpac Balanced 42% 58% Local Split of Total Assets AMP Balanced ANZ Balanced Aon-Russell Balanced ASB Balanced BNZ Balanced FF TWO Balanced Grosvenor Balanced Kiwi Wealth Balanced Mercer Balanced Milford Balanced Westpac Balanced 33% 67% Split of Total Equities Local Equity Int Equity AMP Balanced ANZ Balanced Aon-Russell Balanced ASB Balanced BNZ Balanced FF TWO Balanced Grosvenor Balanced Kiwi Wealth Balanced Mercer Balanced Milford Balanced Westpac Balanced 40% 60% Split of Total Fixed Interest / Bonds Local FI Int FI
Page 8 of 9 High Equity (Growth) Multi-sector Funds 42% 58% AMP Growth ANZ Growth Aon-Russell Growth ASB Growth BNZ Growth Fisher Funds Growth FF TWO Growth Kiwi Wealth Growth Mercer High Growth Milford Active Growth Westpac Growth Split of Total Assets Local AMP Growth ANZ Growth Aon-Russell Growth ASB Growth BNZ Growth Fisher Funds Growth FF TWO Growth Kiwi Wealth Growth Mercer High Growth Milford Active Growth Westpac Growth 39% 61% Split of Total Equities Local Equity Int Equity AMP Growth ANZ Growth Aon-Russell Growth ASB Growth BNZ Growth Fisher Funds Growth FF TWO Growth Kiwi Wealth Growth Mercer High Growth Milford Active Growth Westpac Growth 40% 60% Split of Total Fixed Interest / Bonds Local FI Int FI
Page 9 of 9 Appendix 2 - Asset Class Correlations (rolling 3 years) 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0-0.1-0.2 Jan-95 May-96 New Zealand Equities and Equities Avg. = 0.42 Sep-97 Jan-99 May-00 Sep-01 Jan-03 May-04 Sep-05 Jan-07 May-08 Sep-09 Jan-11 May-12 Sep-13 Representative indices: NZX 50 Gross for New Zealand equities and MSCI World for equities 1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Dec-97 Jan-99 New Zealand Bonds and Bonds (hedged) Avg = 0.64 Feb-00 Mar-01 Apr-02 May-03 Jun-04 Jul-05 Aug-06 Sep-07 Oct-08 Nov-09 Dec-10 Jan-12 Feb-13 Mar-14 Representative indices: NZX NZ Government Stock Index for New Zealand bonds and Barclays Global Aggregate Index (hedged) for bonds