KiwiSaver

The recent announcement that the NZ Super Fund was considering investing in the Government’s proposed Auckland light rail networks has re-ignited calls for KiwiSaver to be used to fund local infrastructure investments.

On the surface, the case for investment in long-term infrastructure assets appears compelling. Infrastructure projects are long-term, defensive investments that often come with monopolistic characteristics.

Historically, many infrastructure projects have offered compelling rates of return. 

Auckland alone is estimated to need $7 billion in infrastructure spending over the coming decade as the city expands by the size of Tauranga every three years (1).

KiwiSaver, being a long-term investment vehicle with over $46 billion in funds, appears well placed to help fund these projects. 

But like many things in finance, when subject to rigorous analysis, cracks appear. There is no reason why infrastructure assets offer superior returns.

Over the long-term, sector analysis shows infrastructure assets offer no better or no worse rate of return than any other sector of the economy such as healthcare, media or telecommunications. 

The perception that infrastructure projects offer superior returns may come from the use of leverage. Because infrastructure assets are long-dated and defensive in nature, banks and private bond holders have traditionally been willing to lend a considerable amount of a project’s cost.

But debt turbo charges losses as well as profits, as investors in RiverCity Motorway Group, which funded construction of a toll road in Brisbane, found out when it went bankrupt in 2011 after traffic volumes fell short of projections. 

However, the biggest problem with funding a project like Auckland’s light rail through KiwiSaver is liquidity and asset pricing uncertainty.

The Guardians of New Zealand Superannuation can consider long-term private market assets like forestry partnerships or an infrastructure project because they have a single long-term client who is unlikely to withdraw their capital at short notice. 

In contrast, KiwiSaver is made up of 2.8 million individual accounts, each with its own time-frame and agenda.

Last year alone $614 million was withdrawn for first home purchases, $81 million for hardship and $631 million by retirees. More importantly, there are now over 240 options for KiwiSaver members to choose between.

Switching schemes is costless and quick, as long as the underlying assets are accurately priced and liquid. 

What happens, however, when the clients of one scheme holding a long-term illiquid infrastructure investment decide to switch to another scheme? Private market assets are both difficult and expensive to price, so pricing is only reviewed periodically.

Even where there is a recent ‘price’, there is often no ability to transact at that price. When a private market investment is successful, existing unit holders may suffer from undervalued asset prices as their investment is diluted by new investors entering the fund.

Even worse, if a private market asset goes bad, then it’s “first out, best dressed”.

This means the first investors to exit the fund will get a better price than those left behind. If a fund shrinks too fast, illiquid assets can grow in weight, even as they fall in value, as they cannot be sold to fund redemptions.

In the end, this leads to the fund being frozen, to prevent investor inequality, until the fund is wound down by selling the illiquid asset (or the asset is written off). This process can take years.

You do not have to cast your mind back very far to find a strikingly similar situation of liquidity mismatch.

Finance companies were billed as offering New Zealanders a superior rate of return to term deposits, for a “first ranking debenture” on long-term stable infrastructure like assets, in that case property.

Unfortunately, investors had the right to periodically withdraw their funds, while the underlying projects required years of funding to come to fruition.

There is absolutely no reason why KiwiSaver cannot be used to fund long-term infrastructure projects, as long as they are listed. The purpose of the share market is to provide companies with a source of long-term capital and investors with transparent pricing and daily liquidity.

The listed market also provides KiwiSaver investors with rigorous regulatory oversight, strict governance standards and continuous disclosure rules, all of which do not apply to private market assets.

Auckland International Airport, Port of Tauranga and Chorus are three excellent examples of listed entities which have used the share market to fund long-term New Zealand infrastructure investments.

Interestingly, there is currently no restrictions on KiwiSaver schemes investing in illiquid, private market assets, as long as they are ‘disclosed’ to investors. It is not a requirement to disclose the overall level of indebtedness, governance standards, duration of the project, or future funding requirements, or to provide the market with continuous disclosure. To date, a number of providers have taken advantage of this by purchasing private market assets.

Requiring KiwiSaver managers to invest members’ funds in marketable assets with liquidity would in no way detract from the ability for KiwiSaver to be used as a source of long-term infrastructure capital, but it would significantly enhance the structural integrity of KiwiSaver. KiwiSaver is not New Zealand’s first attempt at funding our retirements, but to date it has been our most successful, thanks to the growing relationship of trust between the public and the managers of their assets.

Anything that threatens this relationship of trust should be prohibited.

1. The Nation, Interview with Phil Goff, 3 June 2017.
2. Source: NZ Funds analysis: New Zealand Sharemarket sectors include Property, Infrastructure, Utilities, Retirement Villages, Chorus, Spark and New Zealand Refining. Australian Sharemarket sectors include Property, Infrastructure and Utilities.

 

Morningstar says there’s no clear differentiating factor that makes high-performing KiwiSaver funds stand out.

Its latest KiwiSaver survey, to June 30, showed returns bounced back after a tough start to the year.

“Australian and New Zealand equities led the way, while the falling New Zealand dollar helped ensure solid global equity returns. As a result, those KiwiSaver investors in the Balanced and Growth-orientated schemes had the strongest returns,” Morningstar director of manager research ratings Asia-Pacific Chris Douglas said.

Top performers over the quarter against their peer group include ANZ Default KiwiSaver Scheme Conservative (Default) 1.85% (Multisector Conservative),Generate KiwiSaver Conservative Fund 3.51% (Multisector Moderate), Summer Investment Selection 5.50% (Multisector Balanced), Generate KiwiSaver Growth Fund 5.85% (Multisector Growth), and Booster KiwiSaver Geared Growth 7.04% (Multisector Aggressive).

Evaluating the performance of a KiwiSaver scheme during longer periods provides a more meaningful assessment.

During the 10 years to June 30, Milford Active Growth, Milford KiwiSaver Balanced, Fisher Funds KiwiSaver Growth and Aon Russell Lifepoints, and ANZ KiwiSaver were the top-performing options in their respective categories.

Douglas said there was no clear factor that made those successful.

“Managers like Milford are very active and started out with a very large New Zealand book and have done well out of the New Zealand market and then become more diversified as they’ve grown larger.”

Fisher Funds had been similar, using small-cap investments to leverage growth. Aon Russell had large biases to global fixed interest and equities, which had been a sweet spot over the past few years, Douglas said.

ANZ was consistent with a consistent framework and some tactical asset allocation. “In some ways ANZ shows the most resilience of all of them. They’re all very different with different biases in their with the potential to general returns from different parts of the portfolio. That’s what makes KiwiSaver interesting.”

KiwiSaver assets on the Morningstar database grew to $48.8 billion at June 30, from $35.7 billion at the end of 2016. ANZ is the largest KiwiSaver provider with a market share of 25.2%.

Pie Funds is to launch a KiwiSaver scheme in just over a week.

The scheme, called Juno, will go live on August 1.

Documents have been lodged on the Disclose register, showing it will offer a conservative, balanced and growth fund.

The balanced fund had an investment objective of returns of 5% to 10% per year over a five-to-10-year period. The growth fund aims at 10% or more.

Directors of the scheme are Mike Taylor, founder of Pie Funds, Steven Nichols, Roy Knill, Roger Kerr, and Noah Hickey.

Juno magazine founder Jacqueline Taylor is an adviser to the board and Paul Gregory, formerly of the Financial Markets Authority, is head of investments.

Monthly charges are applied to the fund on a tiered basis, ranging from free for those with less than $5000 or who are aged under 18, through to $50 a month for investments between $100,000 and $1 million.

There is then an ongoing fee of 0.42% per year for all funds.

Pie Funds says responsible investment is taken into account in the investment policies and procedures of the scheme.

A group of financial advisers says big banks are using KiwiSaver to line their pockets.

The group wants changes to the way default KiwiSaver schemes operate.

The group is made up of John Cliffe, Phil Ison, Alistair Bean, Rachelle Bland,  Michael Lay, John McLean, John Milner, Tony Walker and John Wood.

The group wants all default funds to be balanced options, to ensure IRD gives default managers the correct tax rates for members, to remove all members in a default fund after 12 months by switching them out, and to introduce a white-labelled government balanced fund for those members.

New default member flows should be stopped to any default provider that did not meet specific engagement and switch-out rates for members and the white-labelled fund should be told to minimise investments in Australian-owned bank securities, the group said.

Fund managers with conflicts of interest in security selection should be investigated and management fees should be refunded when they were charged for placing and keeping investments in their own issued securities.

The group also wants explicit identification and disclosure of conflicts to members.

It estimates  $1.5 billion of KiwiSaver funds are invested in securities issued by Australian-owned banks and insurance companies.

“The problems with default KiwiSaver funds are systemic and long-standing,” Cliffe said, speaking on behalf of the group.

“They are well-understood, yet little of real substance has been done to resolve them by those involved, including the banks and insurance companies, the Financial Markets Authority, the Reserve Bank of New Zealand or successive governments.” 

He said the government’s decisions to keep default funds conservative rather than balanced has resulted in default members missing out on approximately $830 million over the six years ended March 31, roughly $2.7 million every week.

Many of the lowest-income earning KiwiSaver members are paying tax at the highest possible rate of 28%, when they should have been taxed at 10.5% or 17.5%.

The IRD supplies default KiwiSaver funds with default member account details but not the member’s tax rate, so unless a fund successfully contacts members and gets their tax rate, it is required to deduct tax at 28%, the maximum rate. This problem is likely to have affected the majority of those who have been enrolled in a default KiwiSaver fund.

The group said the real winners in the scheme were Australian-owned banks, which had been able to invest the default funds in their own and each other’s securities.

As at March 2018 this amounted to 31% of the ASB’s default fund, 30% of ANZ, 31% of BNZ, 27% of Westpac and 34% of AMP. If a balanced fund option for default funds was implemented, the exposure to Australian-owned bank securities would decrease by approximately $1 billion. The banks charge KiwiSaver members management fees for investing their funds in this way. 

“The FMA, Government Ministers and others responsible for overseeing KiwiSaver have frequently asserted that better financial literacy education of default investors is required along with better fund manager performance in switching out default members to solve the problem,” Cliffe said. “After a decade of failure with this approach it is time to take action.”