Call for simple KiwiSaver benchmarks to replace ‘Frankenstein constructs’

KiwiSaver benchmarks, while fulfilling a government mandate, don’t serve much purpose, a new study says.

While the first part of Russell Investment NZ’s research, released last year, focused on institutional benchmarking practices, the second considers KiwiSaver. It concludes that most benchmarks are composed of a hodgepodge of unrecognisable underlying fund benchmarks providing little relevant information to members.

For example a survey of the ten biggest providers found 40 different indices used to represent seven asset classes, and for one Balanced Fund, a bewildering 17 separate indices including six for one asset class – Australasian equities – were used.

Report author, Russell CEO Matthew Arnold thinks the practice should stop.

Under KiwiSaver, employees rather than employers have the responsibility of choosing a retirement product and strategy, so given low levels of financial literacy, KiwiSaver needs to be simple and transparent. It would also provide an easier means for financial advisors to judge the overall results of KiwiSavers, both stock selection and asset allocation, he says.

“KiwiSaver providers are required by law to assign an appropriate performance benchmark so members can compare their performance to the market. They should be widely recognised and reflect the nature and risk of the underlying assets so members can assess whether their returns are appropriate given the fees paid and risk taken. Added value and underperformance should be clear.”

So are KiwiSaver benchmarks delivering this objective? Arnold says no, with most being inaccessible and giving people no clue as to what they are, what’s in them, and how they are constructed or managed.

They are also investable – not representing any alternative to investors, change regularly, so are not consistent, and are highly customised, so hard to compare to each other.  “Their use as a comparison tool and KiwiSaver measuring stick is limited.”

Arnold thinks the industry should follow the lead of the National Super Fund which takes a reference portfolio approach.

“KiwiSaver would benefit from the introduction of Reference Portfolios – KiwiSaver Benchmarks – that are consistently applied to all funds of the same risk category – conservative, moderate, balanced, growth, and aggressive growth.” Arnold says a good portfolio benchmark should reflect the opportunity set, be transparent and measurable, and unambiguous in its construction and, hopefully, represent the basis of an investable alternative.

A better way forward

The  ideal would be straightforward, transparent and  representative of the opportunity set with 20% of the benchmarks made up of  local assets, and with a consistent ‘neutral’ hedging strategy – 100% for global fixed interest and 50% for global shares.

They would use  widely accepted global indices as component benchmarks such as MSCI All Country World Index (ACWI) Net Total Return for global shares; Bloomberg Global Aggregate Bond Index NZD-Hedged, Total Return for global bonds; S&P/NZX 50 Total Return with imputation credits for local shares; and, the Bloomberg NZBond Composite 0+ Yr Index Total Return for local bonds, be rebalanced annually, and be investable.

Some KiwiSaver providers such as Pathfinder are using Morningstar’s NZD Target Allocation indices which calculates a selection of diversified multi sector fund benchmarks for the New Zealand market but Arnold says while these indices share many of the positive characteristics of the KiwiSaver Benchmarks proposed in the report, there is still an undesirable level of complexity and lack of investability.

Benchmarking for active decisions

The impact of Responsible Investment decisions (and other active decisions) should also be clearly attributed and accounted for. That means tracking total portfolio or KiwiSaver fund results versus broad market benchmarks rather than heavily modified ESG indices.

“Then, members would be better able to assess whether their Responsible Investment decisions have added or detracted value enabling a greater understanding of whether the KiwiSaver fund was meeting their needs.

“To be clear, we are not making an assessment of the Responsible Investment practices of local fund managers, or suggesting that investors avoid considering ESG factors (we have a detailed set of beliefs, policies and procedures ourselves). We are simply stating that investors should consider any moves away from the broad, investable universe as active decisions.”

Arnold thinks the KiwiSaver benchmarks could also be used by other comparable defined contribution schemes such as corporate, public and industry retirement plans to monitor their progress and performance. This would benefit all members in New Zealand retirement schemes by improving transparency, and making progress comparable.

What about the Default KiwiSaver schemes, which are mandated to exclude securities from certain sectors? “While some may argue there is cause to exclude the securities from the manager benchmarks given the restrictions imposed on them by the government, we believe the full impact of these decisions should be made clear through benchmarking, i.e. core broad benchmarks should be used.

“An equitable, low cost strategy for default schemes would be for all providers to manage their schemes passively against the relevant benchmark, all for the same fee. That would be fairer than the current situation where chance plays too great a role in deciding the relative outcome for members simply due to a random allocation process.”