SUBMISSION to Ministry of Business, Innovation & Employment on the REVIEW OF KIWISAVER DEFAULT PROVIDER ARRANGEMENTS 21 December 2012
INTRODUCTION 1. This submission is from the New Zealand Venture Investment Fund Limited (NZVIF). 2. NZVIF is happy to discuss any issues raised in this submission. To engage further on this submission please contact; Aaron Tregaskis, Investment Director on 09 9510170 or email aaron.tregaskis@nzvif.co.nz. About NZVIF 3. NZVIF is the Crown s lead investment agency addressing the capital market gap for emerging high growth New Zealand companies that require new risk capital (equity and quasi equity) for growth. NZVIF manages two investment funds: 4. VIF Venture Capital Fund a $160 million venture capital programme established as a fund of funds 1, and 5. Seed Co investment Fund a $40 million direct co investment programme. 6. NZVIF capital is leveraged to attract increased levels of private investment into high growth New Zealand companies. NZVIF forms investment partnerships with commercially focused investors and fund managers, who are also putting their own capital at risk, to invest in a portfolio of high growth companies. NZVIF does not participate in making investment decisions, although we do play an active role in partnership selection, fund manager investor governance and investment performance monitoring. 7. Since 2002, NZVIF has partnered with 14 angel investment networks and 8 venture capital funds and have invested, directly or indirectly, into over 130 companies. Of these companies, 35% are 1 A venture capital fund of funds is a fund that invests in venture capital funds as opposed to private companies. This model is widely used by Governments that wish to assist the development and growth of their local venture capital market and the commercialisation of innovative young companies NZVCA NZVIF Submission, Review of KiwiSaver Page 2
software companies, 21% biotechnology, 7% technology, 7% healthcare, and 5% produce capital goods. Currently, eight companies have annual revenues in excess of $10 million and two companies have revenues over $50 million. Over 80% of portfolio company revenues are earned offshore. 8. NZVIF is a Crown Entity Company established in 2002 responsible for accelerating the development of the New Zealand venture capital market. While NZVIF s primary role is investing, we also play an active role in supporting industry development and ensuring that the investment environment is conducive for early stage investing. 9. NZVIF has advised Government in recent years, on the tax and structural barriers existing in the NZ venture capital market, together with advice on suitable investment structures for venture capital investment 2. Background 10. This submission takes as understood the value of having a well developed venture capital market because of the role that venture capital plays in driving individual company growth and innovation and the benefit of this to the overall national economic performance. 11. Overseas, long term investors such as pension funds and other institutional investors are significant investors in private equity and venture capital funds. These institutions asset allocation typically include an allocation of 5% to private equity and ventures capital 3 due to the diversification and superior returns these asset classes provide. 12. It is widely accepted that a significant barrier to the growth of the NZ venture capital industry is the lack of investment from international and domestic institutional investors. 13. For New Zealand to achieve a well functioning capital market, which includes appropriate levels of institutional investor participation in the growth and expansion stage of investment, NZVIF estimates that at least $200 million of investment per annum is required. This level of investment will see NZ move into the top quartile of OECD countries on a percentage of GDP basis, as well as provide a pipeline of high growth companies for potential listing on the NZX. To achieve this industry needs to attract new institutional investors in order for the industry to develop both scale and maturity. 14. In 2011 NZVIF commissioned Fidato Advisory to conduct research with three aims: i. Develop a detailed description of the institutional investor landscape in New Zealand; ii. Improve our understanding of the factors that drive institutional investor allocations; and 2 NZVIF has undertaken extensive research and advice that culminated in the Limited Partnership Act 2008 3 Russell Investments 2012 Global Survey on Alternative Investing NZVCA NZVIF Submission, Review of KiwiSaver Page 3
iii. Identify approaches that could be taken, to overcome obstacles to investment and stimulate increased investment in private equity 4 and venture capital. 5 15. A summary of the Fidato report is attached to this submission and the key findings of this research are: i. Institutional investment into NZ private equity, while low relative to international standards, has grown over the past decade. ii. For some categories of institutions the case for private equity is strong, given their asset/liability profile, and some institutions within the Crown Financial Institutions and Ecumenical Funds categories have built a material exposure to the asset class. iii. For other institutions there are a number of barriers and obstacles that limit the ability to include private equity in their portfolios. These include concerns regarding illiquidity of the asset class, member lock in provisions of schemes, the level of fund manager fees and an overall lack of understanding of the asset class. iv. Default KiwiSaver providers which are the fastest growing category have a nil exposure to private equity. v. There appears to be a mismatch between the case for private equity and actual allocations for some entities in the Corporate Pension Schemes category. In particular, the investment case is moderate for large and growing schemes, but actual investment in private equity by these schemes is very small. vi. Venture capital has little investment support from New Zealand institutions. This is perhaps not surprising, given that there is little observable performance data to attract investor support. vii. Addressing the investment gap will require a mix of industry, regulatory and capital markets policy initiatives that result in a better understanding of the private equity asset class, suitable fund structures that make the asset class more accessible and adjustments to KiwiSaver design, to encompass some portion of illiquid assets. 16. In regards to KiwiSaver specifically, the Fidato report identified that while KiwiSaver schemes are prima facie able to support investment in private equity, actual investment by major schemes is non existent to date. The illiquidity of private equity is a key issue, as is the effect of fund management fees on the schemes expense ratios (TER). 17. The design changes recommended by the NZVCA submission on Review of KiwiSaver Default Provider Arrangements will, in NZVIF s opinion, make the asset class more accessible for KiwiSaver schemes. 18. NZVIF also notes that there is a natural bias amongst some of the default providers to allocate KiwiSaver contributions to their own branded products as opposed to considering third party 4 Private equity is the provision of equity capital by financial investors over the medium or long term privately held companies with high growth potential. Private equity at its broadest covers a range of business stages from venture capital through to growth capital and buy outs, although it is also commonly used to describe later stage growth and buy out investment. 5 Venture capital is a subset of private equity that covers equity investment in start up and early stage high growth companies. NZVCA NZVIF Submission, Review of KiwiSaver Page 4
products. This is another potential barrier to the allocation of capital into private equity and venture capital funds. 19. NZVIF is a member of the New Zealand Private Equity and Venture Capital Association (NZVCA) and endorses the recommendations made in the submission from the NZVCA. NZVCA S RECOMMENDATIONS Critical to Expansion of Private Capital Markets 20. The 35 day maximum permitted transfer period imposed by clause 56 (4) of the KiwiSaver Act 2006 should be amended so that it applies to default funds only. Managers of non default schemes should have freedom to set the notice or redemption periods of their funds on a caseby case basis. This will facilitate investment in private assets by enabling fund managers to set notice or redemption periods that are consistent with the investment horizons of the assets in which the funds invest. 21. The KiwiSaver Periodic Disclosure Regulations should be amended to provide for the fees charged by managers of unlisted private asset funds (in which KiwiSaver funds may invest) to be excluded from the calculation of TERs. Alternatively, KiwiSaver scheme providers should be permitted to apportion these fees into their investment management and asset management components, with only the former being included in TERs. This will put unlisted private asset funds on an equal footing with listed funds and acknowledge the significant proportion of total fees that are associated with asset management (and therefore should be excluded from TER calculations). 22. Clause 53 of the KiwiSaver Act 2006 should be amended so that a person may be a member of multiple schemes, rather than being restricted to one scheme. Permitting membership of multiple schemes is the next step in the evolution of member choice. This change will also enable persons to be members of multiple funds with differing liquidity characteristics, e.g. Provider X s Balanced Fund, Provider Y s Property Fund and Provider Z s NZ Private Equity Fund. This is the choice that members of many superannuation master trusts have enjoyed for years. Supportive of the Expansion of Private Capital Markets 23. When setting policy around the investment strategies to be pursued by default funds, Government should be indifferent to the potential for the members of such funds to avail themselves of the First Home Withdrawal facility. Experience suggests that the number of persons who will actually take advantage of this facility will be small as a proportion of the total KiwiSaver member base. NZVCA NZVIF Submission, Review of KiwiSaver Page 5
24. NZVCA believes that default funds should not be short term parking places, but retirement savings vehicles to which default members are assigned based on the information available, i.e. the number of years until they reach the age of entitlement for NZ Superannuation. It is better for default members who have not made an active choice to be assigned to a fund based on their years to retirement, rather than being randomly assigned on the basis of no investor specific information at all. 25. However, the default arrangements should be enhanced by the addition of a mechanism that leads toward default members making active choices within a short period of enrolling in KiwiSaver. 26. The mechanism should be extended to engage the 447,000 members of current default funds with the objectives of (1) ascertaining which members have not made an active choice, and (2) providing those members with the tools and/or advice they need to make an active choice. Those that choose not to avail themselves of the support to make an active choice should be migrated by their provider to an appropriate life cycle fund. 27. Default funds should pursue life cycle approaches to varying the asset allocations of KiwiSaver members over time. Capital markets research clearly demonstrates that members with suitably long investment horizons should invest their savings to take advantage of the return premiums associated with equity and illiquid assets. NZVIF S COMMENTS ON SPECIFIC QUESTIONS 28. NZVIF endorses the comments made by NZVCA on the specific questions in the review document. NZVIF would like to highlight the response to questions 20 and 21 in this submission. Question 20 29. The characterisation of the reasons for KiwiSaver schemes lack of investment in private equity and venture capital as articulated in the Review of KiwiSaver Default Provider Arrangements discussion document is not entirely consistent with the Fidato research. The Fidato research found the following: a. High fees the level of fees may be cited as a reason for not investing in private equity or venture capital but this is due to the reporting of TER s. Most KiwiSaver scheme providers that were interviewed acknowledged that the returns generated more than compensated for the higher relative fee level. Refer the earlier comments on total expense ratios and the complexity of the services provided by managers of alternative asset portfolios. NZVCA NZVIF Submission, Review of KiwiSaver Page 6
b. High risk while KiwiSaver schemes (along with most institutional investors) that were interviewed regarded venture capital as higher risk, they did not require private equity as being any risker than listed equities. c. Lack of performance track record it is important to note that while there is limited track record for venture capital funds, some private equity funds have a long established track record. NZVIF has published performance data on the performance of private equity investment in NZ companies in 2010 and 2012 6. d. Relative illiquidity in the view of NZVIF it is not the relative illiquidity of private equity and venture capital which is the problem; it is the design of KiwiSaver which constrains providers ability to allocate to such investments and gain the return premiums that they generate. The Fidato research identified that many NZ institutions whose asset/liability profile could support illiquid investments (such as Crown financial institutions and ecumenical funds) had made meaningful allocations. e. In the view of NZVIF, the many KiwiSaver funds have already reached more than sufficient scale to contemplate material investment in private equity and venture capital. The strong cash inflows that KiwiSaver schemes are experiencing further support this case. The Fidato research identified a number of institutions whose funds under management are smaller than a number of the KiwiSaver schemes, which had made allocations to private equity in the 2% 5% range. f. Retail managed investment schemes outside of KiwiSaver are reluctant to invest in private equity clearly for any retail scheme, which by design has a short redemption period, the illiquidity of private equity and venture capital will be a barrier. i. NZVIF s view is that it is inappropriate to compare KiwiSaver schemes with other retail schemes in the manner suggested by the statement in question 20. This is because from a savers perspective the lock in provisions of KiwiSaver schemes suggest that the liabilities of schemes are predictable and long lived. ii. Given these schemes are long term investments they are well placed to tolerate relative illiquidity, therefore the real issue is the design of KiwiSaver schemes, with their short redemption periods, that restricts investment in private equity and venture capital. iii. The Fidato research has shown that NZ institutions, that have similar asset liability profiles as KiwiSaver schemes, have made meaningful allocations to private equity. Question 21 6 New Zealand Private Equity Returns 1994 2012; (http://www.nzvif.co.nz/documents/publications/nzpe Returns Nov2012.pdf) NZVCA NZVIF Submission, Review of KiwiSaver Page 7
30. NZVIF endorses NZVCA s suggestions for making alternative assets more attractive for KiwiSaver investment are provided above. (NZVCA Recommendations.) To reiterate the key recommendations: i. Remove the 35 day limit on scheme transfers; ii. Exclude from the calculation of TERs some or all of the management fees for unlisted private assets to allow a like for like comparison with listed asset classes; and iii. Permit members to invest in multiple KiwiSaver schemes. NZVCA NZVIF Submission, Review of KiwiSaver Page 8