Retirement decisions based on science not spin

KiwiSaver is rapidly proving as much of a bonanza for the marketing industry as it is for the wealth management industry

Some providers are spending seven figures annually to promote their various investment propositions. And as one would expect, if you let the ad executives loose, the key messages are, well… “loose”.

In addition to surveying clients to determine what they want out of KiwiSaver (see Good Returns article “What New Zealanders want from KiwiSaver may surprise you”), NZ Funds has been researching what really determines how much money a KiwiSaver member retires with. The answers are logical and intuitive to
long-term practitioners of financial advice, but will no doubt come as a shock to fans of Mad Men. 

To answer the question: “What matters most in maximising KiwiSaver by retirement?” the NZ Funds Wealth Technology Team started with an 18 year old on the average full-time youth earnings of $38,324 per annum. The 18 year old’s earnings increase by 3% each year until they retire at age 65. In this way
they approximate the national average wage of $68,588 per annum (with adjustments for expected inflation). The impacts of different variables were measured, holding all other factors constant.

Asset allocation is the largest single determinant of retirement wealth (which will come as no surprise to financial advisers). Re-orientating a portfolio from 100% Income (default) to 100% Growth adds an additional $950,000 by retirement. Obviously, this comes with a higher level of volatility which may not match the investor’s risk appetite. Interestingly, even a transition from 100% Income (default) to a diversified portfolio of 40% Income and 60% Growth, increases the terminal value by $429,000, while a life cycle process can add as much as $931,000.

The second most powerful determinant of retirement wealth is a member’s contribution rate. Assuming an employer contribution of 3% before ESCT tax throughout, an increase in the employee’s contribution rate from 3% (the current statutory minimum) to 10% (the proposed statutory maximum from 1 April 2019, which together with the employer contribution approaches the Australian 2025 compulsory savings level of 12%), results in an additional $778,000 by retirement.

Manager performance can also meaningfully contribute to, or detract from, a client’s final retirement sum. Assuming performance bands of plus or minus 0.5% per annum for Income and plus or minus 1.5% per annum for Growth, for the entire 47-year period, manager performance either adds $347,000 or deducts $243,000.

The research shows that fees rank fourth. We took the difference between the lowest and highest fees charged by a Balanced fund (0.4% and 1.4%). The difference by retirement is $164,000. This is without doubt a considerable sum, but is meaningfully less than the value that can be added in the other ways that the team identified.

Some things are in neither the investor’s nor the manager’s hands, such as bull or bear markets. Fortunately, for most members, their time in KiwiSaver is long enough that they are likely to experience both over time and end up with the average. However, the order in which they come makes a meaningful difference. Those fortunate enough to enjoy a strong market (defined as neutral interest rates, credit spreads and real equity returns all 50% higher than average) from age 42 to retirement, after experiencing a weak market (defined as neutral interest rates, credit spreads and real equity returns all 50% lower than average) from age 18 to 41, accumulate $547,000 more than investors who experience a strong market between age 18 to 41 and a weak market thereafter.

Finally, there are a growing number of studies which seek to quantify the value an adviser can add.

NZ Funds measured the benefit of a personal financial plan and regular portfolio reviews by comparing two outcomes. The first, for an investor who at age 53 switches from Income (default) to Growth near the end of an expansion, and then panics at age 57 and switches from Growth to Income (default) after a period of investment market volatility. The second, for an advised client who stays the course with a diversified portfolio of 40% Income and 60% Growth. All other things being equal, the advised client retires $403,000 wealthier.

A surprising outcome of the research is that it shows investors are more in control of their retirement wealth, through asset allocation and their choice of savings rate, than the investment manager who determines fees and manager performance. And as with most things in life, fate also has a role to play in determining whether investors enjoy strong returns earlier or later in life.

The research also suggests that the resources deployed to build and maintain government funded sites, such as www.fundfinder.sorted.org.nz which predominately focuses on fees, would be better deployed illustrating the merits of growth-orientated investments over the long term, and encouraging New Zealanders to select
a higher contribution rate. The requirement from next year for all KiwiSaver Annual Member Statements to illustrate the merits of different savings rates to investors is a meaningful step in the right direction.

Advisers face challenging decade

As the end of the decade draws closer, independent advisers face a dual threat: further regulation and lower returns.

While considerable debate surrounds the introduction of the new rules for financial advisers, returns may prove the bigger threat to incomes. How advisers and managers navigate these dual threats will likely determine who the industry’s winners and losers will be.

Low returns are an insidious threat. Investors, and their advisers, have enjoyed a great run. Since the end of the Global Financial Crisis in March 2009, investors have enjoyed strong investment returns, both here and internationally. The NZX50 Index has risen 317%, while the global share market (MSCI ACWI Index) has returned 245%. During the same period (March 2009 to August 2018) New Zealand and international interest rates have fallen, generating capital gains for long-term bond holders.

Share and bond valuations indicate that both asset classes are now between 1.3 and 2.4 standard deviations above their long-term average. Put simply, both bonds and shares are expensive. The corollary of a decade of above average returns is that advisers will need to navigate a period of below average returns. NZ Funds, with the help of US Strategist Barry B Bannister of Stifel Nicolaus, estimate 10-year equity returns will average 2%, less than the 14% enjoyed over the last decade.

Unfortunately, while valuation is a reliable predictor of long-term returns, it is of little use in timing markets or in predicting what form returns will be delivered over the coming decade. Below average long-term returns come in two forms. Markets can either deliver weak returns though a decade-long sideways movement, creating a war of attrition during which clients slowly lose faith and seek out alternative asset classes like cash and property. Investment advisers in the United States faced just such a period between 1976 and 1982, while New Zealanders experienced a similar decade following the 1987 crash.

The alternative is that markets will continue to rally strongly, only to slump later, giving up most of or all the decade’s gains. Many advisers will remember the vintage of clients who invested in global shares during the strong rally that preceded the 2000 equity market peak and who by 2010, despite enduring a rollercoaster of volatility, had earned nothing more than the return of their capital. Little wonder that during this period advisers and managers sought to maintain client returns through alternative forms of investments – such as infrastructure, private equity, structured credit and finance company debentures – with mixed results.

In the past New Zealand equities have provided something of a safe haven. During the period  2000 to 2009 when global equities delivered an annualised loss of 0.5%, New Zealand shares outperformed most other developed countries, delivering an annualised return of 7.1%. This strong return was almost entirely due to the high dividends paid by New Zealand companies at that time.

Fortunately (or unfortunately), New Zealand shares’ outperformance has continued. From 2010 to August 2018 New Zealand shares have risen 222%, outpacing global shares by 94% over the same period. Today, New Zealand shares trade at a premium to global shares, implying the average New Zealand business will outperform the average American company. Even if this were to occur, overall valuations in both countries still imply low returns for a decade.

The upside for advisers is that financial advice will have a larger impact on long-term client wealth than over the previous decade. When New Zealand equities are compounding at 14% a year, clients can more than double their wealth every six years, and multiply it over sevenfold every 15 years. Whether clients save at 3%, 6% or 9% makes little difference. However, when returns compound at 2, 3 or 4% a more aggressive savings strategy becomes the only way to meaningfully increase clients’ wealth over the same time frame.

Further, with the return of volatility, clients are more likely to need counselling as markets crash and rebound. Similarly, ensuring clients own a well-diversified portfolio and have not become overextended in one asset class, as they are prone to do when DIY investing, will rise in importance.

Another strategy for advisers, to add value to their client base, is to plan to provide clients with a broader range of financial services. Following the introduction of a similar licensing requirement in Australia, many advisers moved from selling only one financial product to offering a “triple stack” of services, and in particular: mortgages, insurance and retirement saving advice.

Irrespective of how advisers tackle the coming decade, valuations suggest they have an important role to play. Perhaps it is fitting that the final word goes to financial engineer of the last decade, Ben Bernanke: “Smart financial planning, such as budgeting, saving for emergencies and preparing for retirement, can help households enjoy better lives while weathering financial shocks”.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Michael Lang is Chief Investment Officer at NZ Funds.
New Zealand Funds Management is the issuer of the NZ Funds KiwiSaver Scheme.

Quiz failures show advisers could do more

The Financial Markets Authority says the results of a recent KiwiSaver risk quiz show financial advisers have a role to play in the sector.

More than 11,000 people took the KiwiSaver quiz which was created as the FMA’s contribution to the Sorted Money Week. The quiz will remain on the FMA’s website as part of its investor resources.

From that, 17% of people who took the quiz got the question “Funds with lots of shares and property have more ups and downs than funds investing mostly in cash and bonds” wrong. The answer is true.

The question which saw the highest percentage of incorrect answers was question  six: “Choosing a low risk fund means you can stop worrying about market ups and downs.” A quarter of people who took the quiz got this question incorrect. The FMA said the answer s false.

More than nine out of ten people got the other questions right.

Simone Robbers, FMA acting director of external communications and investor capability said, “It was great to see so many people who took the quiz understood the need to continue investing through any downturn and the risk of switching to a low-risk fund when markets are choppy.

“One of the things we want people to take away from the quiz is funds with lots of shares and property like growth funds will be more volatile than investments in bonds or cash, but will tend to deliver better returns over the long-term.

“Investors should also understand that even a low-risk fund is not a no-risk fund, with the value of any investment being impacted by market movements.”

A spokesman for the FMA said it showed advisers had a role to play in behing proactive in their discussions about market movements making sure clients or members are in the right type of fund for their needs before storms hit, rather than after.

“Advisers and providers can also add real value by helping their clients or members make an objective decision if they seek help during a period of major market volatility.

“The returns data we receive shows that most AFAs advise very few clients about KiwiSaver. There is a real opportunity for them to do more to support KiwiSaver members make better decisions.”

AFA concerns on back-burner for now

Financial advisers who raised concerns about KiwiSaver have been told a review of default provider arrangements will consider those issues – but not until next year.

A group of AFAs, headed by John Cliffe, wrote to Commerce Minister Kris Faafoi, Finance Minister Grant Robertson, Reserve Bank Governor Adrian Orr and FMA chief executive Rob Everett.

The advisers want 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.

They said banks had been the big winners out of the retirement savings scheme.

In response, Faafoi said he agreed KiwiSaver was essential to improve New Zealanders’ wellbeing in retirement and it was crucial to get the settings right.

“Next year the Minister of Finance and I will start a review of the default provider arrangements, recognising that the current appointments expire in 2012. The review will include consideration of the default provider settings and will enable us to consider many aspects, including the points you have raised.”

NZ First’s KiwiFund Bill, which would have had a working group set up to investigate a government-owned and run KiwiSaver provider, has been withdrawn.

But its backer, Fletcher Tabuteau, will be involved in the review of default funds, which may indicate the idea has not been as completely abandoned as some have suggested.

Cliffe said he expected the review to be the subject of greater focus over the coming year.