KiwiSaver

The risk with risk indicators

It is disappointing that a decade after the global financial crisis, New Zealanders continue to remain vulnerable because of the rules around risk indicators.

This is especially the case for bond investors, who are often conservative in nature and consider fixed interest a safe haven in times of volatility.

Unfortunately, after a decade of low interest rates, bond investors are also prone to “reaching” for higher yields, sometimes without understanding the risk they are taking. This is when risk indicators play a vital role – by helping New Zealanders understand how risky their “income” product is.

Given this backdrop, should a portfolio whose largest investment, comprising approximately a fifth of the fund, is an off-market, related party, private loan to a portfolio of shares, be given the same risk indicator as a term deposit from a major Australasian bank?

Sadly, this is what is happening. A portfolio (which we’ve chosen not to name) contains in its top ten holdings, an off-market, related party “geared investment loan” which makes up 19.09% of the portfolio. Of the top ten investments, seven are unrated. Yet its risk indicator is one, the lowest possible.

The fund is described as “entirely in income assets” and promoted as being “suited to investors looking for an on-call or term investment with a low level of risk and are willing to accept a relatively modest level of returns”. This is language which is commonly associated with bank accounts and term deposits. How is this possible?

HOW IS RISK MEASURED?

The Financial Markets Authority have done an excellent job establishing a standarised formula for risk which enables an “apples with apples” comparison. Risk is measured through a score of one (lowest risk) through to seven (highest risk).

Risk is assessed by taking the actual annualised volatility of the fund or asset class over the last five years.

WHEN IS VOLATILITY USEFUL?

Where an asset trades regularly, between a large number of willing buyers and sellers, with little transaction cost, then daily movements in price either up or down (called volatility) are an excellent measure of the risk. This is the case for listed (not privately held) shares, property funds, unit trusts and most commodities.

WHEN IS IT MISLEADING?

Unfortunately, volatility is a poor indicator of the risk of loss for assets that are priced infrequently and this includes bonds. For a start, most bonds including New Zealand Government bonds, are not listed, they trade off-market by appointment. Next, unlike perpetual assets, bonds are binary in nature: interest is either paid, or not, and at the end of the period your money is either repaid, or not. 

In a 150-year study of corporate bond default risk, the authors found bond defaults were not normally distributed. Instead, there were long-periods of little volatility or default, which were then followed by a short bursts of high volatility and a large number of defaults.

The investment grade bond credit default index is an excellent measure of the episodic nature of bond volatility and is shown below.

In the case of the income securities portfolio with its related party “geared investment loan”, the manager sets a “posted rate” in the same way as finance companies do. As a result, the volatility is low. Using the FMA’s current methodology for risk indicators, lower volatility equals a lower risk indicator.

WHAT IS THE ALTERNATIVE?

The alternative is to have risk indicators which reflect the type of assets a fund holds.

For example, a portfolio which is entirely invested in listed shares should attract the highest risk indicator, whereas one that is equally divided between shares and bonds should have a medium to high risk indicator, say three to five.

Funds holding cash, government bonds with a duration of less than three years, bank bills and investment grade bonds should have a lower risk indicator. In contrast, funds holding unrated bonds and related party loans should be required to have a higher risk indicator.

Interestingly, the website Sorted, run by the Commission for Financial Capability, categorises funds by asset allocation and not with the FMA’s prescribed risk indicator.

 

1. For further details contact NZ Funds.

2. Giesecke, K., Longstaff, F., Schaefer. S., and Strebulaev, I., 2011. Corporate bond default risk: A 150-year perspective. Journal of Financial Economics 102 (2011), 233 – 250.

NZ Funds KiwiSaver Scheme is designed for use by AFAs and RFAs and pays both planning incentives and an ongoing commission for advice. 96% of NZ Funds’ KiwiSaver members have a financial adviser. The average balance of members of the Scheme is $27,194 approximately one and half times the national average of $17,834.

BNZ has cut the fees it charges across its KiwiSaver funds and is shifting to an passive approach for international assets.

Chief customer officer Paul Carter said: “The onus is on financial institutions to do everything we can to remove obstacles, to make things simpler, and give people better tools and advice. That’s why we’re making major changes to our KiwiSaver offering."

From May 1, BNZ will remove the $1.95 monthly member fee and reduce management fees from up to 1.1% a year to a maximum of 0.58%.

“These changes remove important barriers to choosing the best fund for a customer’s needs, with the moderate, balanced, and growth funds now all on the same low fee. By this action, we’re removing fees as a consideration when deciding what fund to go into,”  he said.

Under the new structure, a person with $20,000 invested in the BNZ Growth fund would have their fees more than halved, from $243 to $116.

“We’ve re-written all of our disclosure documents and communications in plain English," Carter said.

"We’re rolling out new tools for our bankers to help them have better conversations with customers and help them pick the right fund for their needs. We’re also putting more tools in the hands of customers, with calculators to help compare the different funds and returns over time."

BNZ is also changing the way the underlying investments are managed, shifting to an index management approach for international assets, while keeping the actively managed approach for Australasian investments.

A strong quarter for share markets has helped KiwiSaver funds back into positive territory.

Morningstar’s latest KiwiSaver survey shows all the funds on its database turn in a positive result for the March quarter, after almost uniformly losing money the previous three months.

Over the March quarter the S&P/NZX 50 Index was up 11.7%, erasing the previous quarter’s loss of -5.8%.

Australian shares gained 10.9% over the quarter and 12.1% over the year.

The Australian market was led by the IT sector, the miners, and consumer discretionary stocks.

Morningstar said international equities had enjoyed a remarkably strong rally for the quarter.

The MSCI World Index was up 11%.

Morningstar said the returns of KiwiSaver funds generally reflected the underlying market conditions.

All surveyed KiwiSaver funds made positive returns.

Average multisector category returns ranged from 10.1% for the aggressive category to 3.6% for the conservative category.

Top performers over the quarter against their peer group included Simplicity's conservative fund at 4.6%, AMP Income Generator at 6.9%, Summer Investment Selection at 7.8%, ANZ Default Growth at 11% and Booster Geared Growth at 14.3%.

Annual returns for multisector options ranged from 11.7% down to 0.8%.

Over 10 years, the growth category average had given investors a double-digit annualised return of 10.9%, followed by aggressive (9.6%), balanced (9%), moderate (7.2%), and conservative (6.6%).

ANZ still has the largest KiwiSaver share, with $13.4 billion of the total $54.6b under management.

“A strong rebound in markets over the first quarter saw KiwiSaver balances bounce back, with every surveyed KiwiSaver fund making positive returns”, said Tim Murphy, Morningstar’s director of manager research, Asia-Pacific.

“The last six months have highlighted the importance of KiwiSaver investors taking a long term approach and not reacting to short term market movements.”

KiwiSaver fund performance has rebounded in the first few months of 2019, more than recovering last year’s losses after a volatile quarter in the markets saw many member balances dip.

In the first three months of 2019, ASB’s growth fund performance was 9.11% after tax and fees, significantly higher than the -8.14% seen in the previous quarter in the same fund.

The S&P/NZX50 was up 11.7% over the same period, Australian shares 10.9% and the MSCI World Index 11%.

Morningstar said all the KiwiSaver funds it surveyed had positive results in the quarter.

ASB head of KiwiSaver Aidan Vince said the bounce back was a reminder of the long-term nature of the savings vehicle.

“We always encourage our members to make a plan for their KiwiSaver and then stick to it. There are always going to be ups and downs so having a fund aligned to your plans mitigates this. 2018 was a volatile year for local and global sharemarkets, particularly in the fourth quarter, which did impact KiwiSaver balances. While we understand this can be uncomfortable for members, it’s important to get a plan and stick to it – we’ve seen the benefits of that over the last three months,”he said.

“This volatility has also been seen in more conservative funds although to a lesser degree. But our message to members is the same – get in a fund that aligns with your investment plan. People looking to use their KiwiSaver in the next few years should have less invested in shares than those investors with a longer time frame. It has been pleasing for us to be able to help our investors continue to focus on plans that help them achieve their long term goals."

Understanding the value of regular contributions to KiwiSaver was also important, especially in times of volatility.

“When you invest in a KiwiSaver fund, the price for the units you buy will vary day-by-day. But all of the units you own are worth the same when you see them totaled up as your KiwiSaver balance. In periods like the end of last year, you could buy units at a lower price than you could have the month before. It’s the time to think your retirement is ‘on sale’.”

Morningstar's top performers:

Simplicity Conservative 4.6% (Multisector Conservative),
AMP Income Generator 6.9% (Multisector Moderate),
Summer Investment Selection 7.8% (Multisector Balanced),
ANZ Default Growth 11.0% (Multisector Growth), and
Booster Geared Growth 14.3% (Multisector Aggressive).