Review of KiwiSaver Default Provider Arrangements Submission by Fisher Funds Management Limited Ref Submission 1 No further comment. 2 Not applicable to Fisher Funds. 3 It s not a secret that New Zealanders tend to either take too little risk or too much risk with their savings. For example, some utilise bank term deposits for long-term saving objectives and are therefore likely to receive lower long-term returns than if they invested in a diversified portfolio of income and growth assets. Others have invested in poorly run finance companies or heavily geared property and ended up losing some or all of their savings. A lack of understanding and education regarding basic investing principles such as diversification and risk and return tradeoffs is evidently present amongst New Zealanders. As a result, some investors have suffered heavy losses with many others having observed from the sidelines. A typical reaction to poor savings experiences has been to focus on the negative outcomes (losses) while not focusing on the underlying fundamental errors (poor risk assessment) that led to these negative outcomes. These past experiences, especially those in more recent times, have led many investors to become overly cautious (despite what their true risk profile may be) and somewhat suspicious of financial institutions. Then there are investors who have had little to no exposure to investments, such as hundreds of thousands KiwiSaver investors, where convenience, inertia and procrastination are determining factors in their key investment decisions. As a result, we are seeing members choose conservative investment options without taking into account their risk profile or investment timeframe. We are also seeing KiwiSaver members join banks as they perceive them to be safer than non-bank providers as well as more convenient (approximately two-thirds of all KiwiSaver funds are now with the banks). During periods of sharemarket volatility, we have also witnessed members changing their investment strategies from growth to income oriented, regardless of what may actually be appropriate for them. Financial literacy amongst New Zealanders is in need of a drastic improvement in order to counter some of these behaviours. There are too many KiwiSaver members who do not fully understand how KiwiSaver works, do not know who their provider is, do not understand what the appropriate risk level for their situation and personality is, and do not understand the investment strategy they ve selected or been allocated to. If people were more financially literate, they would be able to make better informed decisions and invest accordingly. 4 If the Government regards itself as a de facto investment adviser then we think it should act consistently with investment industry best practice. In other words, the level of short-term risk and volatility the Government should be willing to impose on default members needs to be in line with that of a best practice investment adviser.
The purpose of the default product is to provide an investment option for those members who do not choose. However, as highlighted in the discussion document decisions around investing are hard. The subject matter is complex and requires a level of research, time and commitment that is beyond many people. In addition, many KiwiSaver members (especially those with small balances) do not have access to advice. This places more of an onus on the Government to do the right thing. We think that putting all members in a conservative investment option is doing the majority of the members a disservice. We all understand that growth assets outperform income assets over the long-term. In addition, we know that the longer we invest the smaller the risk of loss with a well diversified portfolio. KiwiSaver is a long-term investment and as such investing primarily in income assets without any regard to someone s investment timeframe defies best practice. A dynamic mix of growth and income assets which adjusts based on age (or investment horizon in the case of first home buyers) is needed when saving for retirement, regardless of an investor s specific situation. There are potential undesired outcomes with either approach - the short-term approach may result in a decreased level of financial asset accumulation due to inflation while the long-term approach may result in a greater degree of short-term risk and volatility but this is an inherent part of investing (again, another reason why financial literacy is critical). Investment best practice would centre on retirement income maximisation with a focus on appropriate asset allocation. 5 We utilise an investor profile questionnaire to assess a client s risk tolerance. We have seen a number of industry questionnaires that focus solely on a client s risk tolerance and completely disregard a client s investment timeframe. We believe that these two aspects are inter-linked as they re two dimensions of what we refer to as an investor profile. We have determined that an investor profile is derived from: - investment timeframe (based on an investor s desired retirement age or first home purchase timeframe); and - risk tolerance/risk profile. This means that a conservative investor with a long-term investment timeframe may end up with an investor profile that is either conservative balanced or balanced. Given the longterm investment timeframe, they can afford to take on more risk in the hope of achieving better long-term returns. On the other hand, a growth/aggressive investor with a very shortterm investment timeframe may end up with an investor profile that is conservative or conservative balanced as their investment timeframe simply does not allow them sufficient time to recover any potential losses that a growth-oriented portfolio might produce in the short-term. 6 In addition to Ref 5 above, we have two versions of our investor profile questionnaire: - A short version consisting of three questions which offers three investment options; and - A long version consisting of nine questions which offers five investment options. Not every investor will have the time or inclination to complete the long version and we determined that it was important to cater for all types of investors. We would rather they
complete the short questionnaire than no questionnaire at all. At the same time we make investors aware that a longer version of the questionnaire is available if they re still unsure or wish to further pinpoint their investor profile. 7 No further comment. 8 We believe that a traditional life-cycle investment approach is appropriate for a default fund because: - This asset allocation approach is in line with both conventional investing wisdome and the advice that financial planners traditionally give to their clients; - Life-cycle funds de-risk an investor s assets over time by transitioning the mix from growth to income investments; - Life-cycle funds offer a greater probability of asset growth than a conservative fund; and - Life-cycle funds are often thought of as set and forget funds, which offsets behaviours often exhibited by investors, such as inertia, over-trading and procrastination (not to mention poor risk assessment). As point 41 in the discussion document highlights, life-cycle funds have been widely adopted internationally as the default investment option. Life-cycle KiwiSaver funds are also not new. AMP, ANZ, Aon, Civic, National Bank and SuperLife all offer them. We disagree with the statement that life-cycle funds are more administratively burdensome than target-date funds. We believe it s quite the opposite. 9 Whatever decision is made, we know it s not going to suit a subset of default members because the risk level may be inappropriate given their overall financial situation has not been taken into account. No default option can deliver maximum customisation based on an individual s own circumstances however life-cycle funds perform the best in this regard, and better than the current default arrangement. In our opinion, age is the dominant factor in determining a KiwiSaver investor s investment approach. Should the Minister decide to pursue this option, there will need to be agreement on what asset allocation ranges and age transitions within the life-cycle investment approach are most appropriate. Further research and industry consultation may be needed to establish parameters appropriate for a life-cycle arrangement. 10 We are not in favour of target-date funds for the following reasons: - We feel it would be more difficult for the Government to monitor and oversee how these different funds are managed due to the sheer volume of funds; - As such, it would be difficult for investors to tell exactly how their savings will be managed over time as the underlying asset allocations of these funds will continually change; - Target-date funds would be administratively burdensome for providers which may lead to a lack of perceived transparency for investors (for example, we would need to have 65 fund fact sheets, 65 unit prices and therefore performance updates, etc.); - Compliance and regulatory costs would mean an increase in fees; - It may be more difficult to assess the reasonableness of fees and the product offering may become unattractive to members; - Many investors will not be accessing their savings at the completion of the fund s
target date; and - It would make switching to a non-default provider who may not offer target date funds less likely. 11 Yes. At present we find that funds under $20 million face challenges in terms of keeping management expense ratios down because of the fixed nature of some costs. If we assume $50 million is sufficient for a fund to operate efficiently then you d need to have $3.25 billion per provider (assuming 65 target-date funds). 12 Capturing an investor s age is a mandatory part of the KiwiSaver enrolment process. Inland Revenue will reject any KiwiSaver enrolment if the name, age and IRD number of an investor does not match their records. As such, we see no issues or barriers to capture this data. 13 Our underlying concern is that the majority of investors in default schemes do not have an asset allocation that is appropriate to their circumstances. Given the current conservative investment mandate utilised by default funds, members with 10 or more years until their retirement (or first home purchase) are likely to be under-invested in growth assets compared to what an investment adviser would recommend to them unless they plan to withdraw money in the near future to purchase their first home. We believe that life-cycle funds are more appropriate. See Ref 8 for more details. 14 No further suggestions. 15 There is no evidence to reasonably assume that some people are in the default fund because they re intending to withdraw funds for a first-home purchase although we cannot discount that may be the case for some members. Default members generally lack full understanding of KiwiSaver and its features. From our experience, those who are saving for their first home through KiwiSaver have taken an active interest in KiwiSaver and have therefore made an active choice within their default scheme (switched to a 100% cash fund or a conservative fund) or have transferred to a non-default KiwiSaver provider. 16 The first home withdrawal facility is an important part of KiwiSaver. While the number of first home withdrawals to date is less than one percent, this facility has only been available since July 2010 (and only for those who have been in KiwiSaver for three years or more). We currently have over 625,000 members under the age of 24. Also around half of the eligible population are yet to join KiwiSaver. Many of these people who are yet to join will be automatically enrolled in KiwiSaver, especially the younger ones, which means the number of first home withdrawals is only going to increase in future. As such, it should be taken into consideration when designing the default product. 17 To date, we have seen a lack of engagement by KiwiSaver members once they re enrolled. For this reason, any engagement must happen upfront at the start of someone s KiwiSaver journey. The current automatic enrolment process does not require employees to complete any form; this responsibility falls on employers with the completion of the KiwiSaver Employee Details Form (KS1). Although not compulsory, most employers ask their employees to complete a KiwiSaver Deduction Form (KS2) where they can choose one of three contribution rates (otherwise, they re simply allocated to the default rate of 2%). There is an opportunity for automatically enrolled members to be screened by their employers at time of enrolment. This could include completing a form with a couple of simple questions in order to
determine whether they re intending to use KiwiSaver for a first home purchase. For example: Do you currently own a home? Yes No If No, do you intend to use KiwiSaver for a first home purchase in the next 10 years? Yes No If they do intend to use KiwiSaver to purchase their first home, they would then be allocated to a conservative fund. Otherwise, they would be allocated to a life-cycle fund in relation to their age. Once a member has purchased their first home, the provider has some responsibility to engage with that member to ensure their investment approach is revised for future goals. One suggestion is to incorporate these questions into the KS2 form and make the completion of this form a mandatory part of the automatic enrolment process (employers can simply forward the KS2 form along with the KS1 form to Inland Revenue). 18 We disagree with much of your analysis of active versus passive management. The study you ve cited by Malikel, Cremers & Pejtajisto et al. identifies that many self described active funds are closet indexers and charge active management fees but closely track a benchmark index. The performance of the few truly active managers is obscured by them being lumped in with other less active managers. The discussion document lists as benefits of passive management: - reduced risk of underperformance relative to benchmark indices; and - reduced variation across a selection of managers. We would argue that neither of these are benefits to KiwiSaver members their risk is a shortfall in their financial resources for retirement, not a variation compared to indices or other managers. 19 We agree that some markets are less informationally efficient than others. Small and mid capitalisation equities, emerging markets and smaller markets (such as New Zealand) are likely to be less efficient. However, this does not mean there are not opportunities for active managers to add value in these or larger markets. In larger markets such as US large cap or sovereign bond markets, the construction of benchmark indices encourages investment in the most expensive securities due to the influence of security prices on market capitalisation and in turn on the weightings in indices. Example of this include the high weighting of Japan in global benchmarks in the late 1980s or the weighting of technology companies in the S&P500 in the late 1990s. 20 We are already investing in private equity for our KiwiSaver scheme but agree that greater scale is needed before we will see such asset classes used across the KiwiSaver industry. 21 We expect that alternative asset classes will become more attractive for KiwiSaver investment as the amount of funds under management (FUM) in growth oriented funds increases. 22 No further comment. 23 We agree that scale is important. We feel the examination of fees presented in the discussion document does not take into account the full value that the actual members receive from
their providers. According to Morningstar s research titled KiwiSaver Fee Analysis How We Compare to Australia, KiwiSaver fees stack up reasonably well relative to global managed fund fees. KiwiSaver fees are also significantly lower here than in Australia despite Australia s significant economies of scale relative to New Zealand. Category Australian Retail % 2010/11 Average KiwiSaver TER % Multi-Sector Conservative 1.93 0.80 Multi-Sector Moderate 1.77 0.89 Multi-Sector Balanced 1.76 0.93 Multi-Sector Growth 1.92 1.02 Multi-Sector Aggressive 1.77 1.31 We agree that fees are one constant that will impact returns so it is an important aspect to consider. However, as fees in New Zealand are lower than in most countries, it is the asset allocation and tax considerations that will have a much bigger impact on KiwiSaver investment returns. Discussing fees in isolation of the value members receive in return is futile. We believe that value for money from an investor s perspective is a critical consideration: - Who is managing their money? More importantly, how? - Do they know where their money is invested, why and how it is performing? - What level of service do they receive from their provider? - Do they receive ongoing assistance with their asset allocation to make sure they re invested in accordance with their age/goals and risk profile? - Are they sent member tax credit top-up reminders? - What is their after-fee performance? The current fee arrangement with default providers has meant they have no choice but to run a low cost service model which we think means a worse experience for the member. We talk to people who know they have been enrolled in KiwiSaver but have received no information from their default provider. In 2012 financial year, five default providers experienced a net loss in the transfers market while 21 providers gained as a result of transfers. Our preference is for the fees to be fair and reasonable in reflecting the overall value that investors will receive. A reduction in fees without amassing significant scale is likely to compromise the service and performance investors will receive. We agree there is some valuable brand equity accrued for providers but believe the extent of the spill-over benefits for other non-kiwisaver products to be minimal. 24 Our thoughts on the suggested approaches are as follows:
a) A fixed fee providers have endured and will continue to face numerous compliance, governance and regulatory changes which have significantly increased our fixed costs; it would be difficult to incorporate these additional costs into a fixed fee structure that would be mutually fair to providers and investors b) A tiered fee this has some merit although we do not believe scale is significantly sufficient at this stage c) Consider separating the administration functions from the asset management functions while we agree that economies of scale could be derived from such an initiative, we could only see this working in practice if Inland Revenue operated the administration function; many providers differentiate their product offering by way of service and administration which would largely be made redundant or negatively impacted in this case 25 We do not think the industry should entertain the idea of no fees in case of negative performance as the accrual of this (with members constantly entering and leaving the scheme) would be extremely complicated. The existing competition and focus on fees in KiwiSaver are going to keep every provider in check removing the need for such an initiative. We think there is too much of a singular focus on fees. We suggest that fees should be increased and more of an onus placed on providers to: - Contact default enrolled members (we speak to many members who don t know they are in KiwiSaver because they haven t received any information); - Provide financial education - those who haven t made an active choice but are working are likely to need advice and financial education; and - More ongoing engagement with members letting them know where their money is invested, why and how it s performing. This will improve the overall KiwiSaver member experience by ensuring members understand KiwiSaver, their options and more importantly that they have the right investment strategy which will ultimately lead to a better outcome. 26 We consider a limited number of qualifying providers the most appropriate option. KiwiSaver is a vital element of New Zealand s retirement income saving policies and default providers play an important role here. Criteria such as sufficient size and scale and ability to meet the standards required ultimately limit the number of potential qualifying providers. 27 Benefits of fewer providers: - Having fewer providers has been proven to operate efficiently to date; - Sufficient size and scale is present; - Crown s governance and monitoring is easier attainable; - Variance in performance between providers is less likely; and - Comparison of service and performance easier for members. 28 Key criteria: - Sufficient size and scale; - Ability to meet the standards required; - Proven track record in running of a KiwiSaver scheme(s); - Infrastructure to deliver excellent service to members; - Ability to provide investor education; - Resources to proactively contact default enrolled members; and - Ability to provide financial advice.
29 Separation of investment management and administration costs would be difficult as both functions are performed alongside other non-kiwisaver investment products. Ultimately, we see no value in splitting these costs; the focus should be on the overall fee members pay. 30 Financial literacy is the cornerstone of a buoyant and vibrant economy and needs to be strongly supported by all KiwiSaver providers, especially default providers. Default providers receive a couple of distinct advantages: - New KiwiSaver members to their scheme; and - Valuable brand equity. As such, it is reasonable to impose a requirement for default providers to provide financial education for reasons already stated in Ref 3. We also believe that default providers should go one step further and be required to provide financial advice. Given the sufficient size and scale of default providers, they re likely to be Qualifying Financial Entities (which means their employees can provide advice on their own products, which is what s needed here) or have a large number of AFAs to be able to provide advice. These initiatives would also benefit default providers by way of increased retention rates of default enrolled members. The only disadvantage is the cost to implement such initiatives however we feel this is warranted given the distinct advantages gained by default providers (assuming the fees do not stay at current levels). 31 Suggestions for a programme of engagement: - Proactive contact by providers either by phone or email (high cost) - Seminars and workshops (medium cost) - Interactive website with educational content, games and tools (low to medium cost) Improving financial literacy should be a nationwide initiative with a focus on young children and adults. There is an opportunity to instil financial literacy programmes across primary, intermediate, and secondary schools, as well as polytechnics and universities. Budget advisors and community groups can also play a part in raising financial literacy levels amongst New Zealanders. 32 We agree that any changes to the default provider investment mandate should apply equally to future and existing members. For this reason, options 2 or 4 would be appropriate. We prefer option 2 that includes a written letter sent to members explaining the changes that have taken place and who they can contact for further information or advice. 33 We proactively contact all of our eligible members one month in advance of their eligibility date. They re provided with an information pack that details the options available to them (continue to save with KiwiSaver; make a full or partial withdrawal; set up a regular withdrawal facility; or transfer into our non-kiwisaver managed funds). To date, we have seen one in three members make a withdrawal once eligible. Approximately 80% of withdrawals are full withdrawals with the remaining 20% partial. Less than 1% members have set up a regular withdrawal facility. We believe this will become more popular as KiwiSaver balances grow over time. Even though the average account balances are not substantial at this point in time, two-thirds
of members have continued to remain in KiwiSaver. Of those who have remained in KiwiSaver, the majority have carried on making contributions. This is an indication that not all KiwiSaver members will simply retire at 65 and that many of them will continue to utilise KiwiSaver as their savings vehicle while working. 34 Barriers: - Set up and administration costs by providers; - Lack of sufficient size and scale; - Demand for such products is currently non-existent; and - A deviation from traditional investment products for some providers who are solely investment managers.