KiwiSaver

There should be more KiwiSaver investment in private equity as long as it’s done with the right capability and skill, says Pathfinder CEO John Berry.

“There’s a reason high net worth investors in large, long-term sophisticated endowment funds invest in private assets. Over the long term they pay higher returns than listed markets if managed and diversified properly.”

While Pathfinder and other boutique KiwiSaver firms such as Generate and Booster invest in private equity, not enough providers are, says Berry. And KiwiSaver members are missing out.

However managing a private equity inclusive fund “properly” comes at a higher cost.

Pathfinder charges 0.84% to 1.29% which among other things covers extra staff, including those who look at private deals, plus additional audit and compliance requirements.

Berry would like to see a refinement of fee reporting to break out underlying asset classes such as venture capital (VC), private equity (PE) and infrastructure.

“We've got this drive for transparency on fees but people don't understand what they're getting in return or what they're not getting. Knowing you’re buying everything in the market in a purely passive simple process for a low fee may be what a lot of people want. But they should be aware of missing out on the opportunity for private equity investment in a more active management style which can be more discerning around things like responsible and ethical investment.”

He says the most important factor is actual returns after fees with Morningstar tables not led by who has the lowest fee but who generates the best returns after fees. “It’s not the low fee providers.

“We need to reorient the conversation around what is important with some simple data points. Past returns and fees are obvious ones, current holdings is another but it's actually returns after fees, not the level of fees.”

Differing shades of active management

Pathfinder CFO Paul Brownsey says there are different levels of active management.

“We're not just active managers in an index fund. We're active managers in private equity, illiquid fixed income bonds and things like that. So we have a bigger opportunity set than an active manager who is deciding whether to buy more Microsoft or Alphabet”.

Berry cites Brownsey’s decision to swing into action when bond markets were wildly overpriced, putting Pathfinder’s fixed income exposure at zero. Another example was in Q1 2020 when Pathfinder’s KiwiSaver conservative fund gained 1.82% compared to an average decline of 2.44%.

“[The outbreak of Covid] was probably the most volatile time in the markets in a short period we’ve ever seen, even more than the GFC which happened over months.” says Brownsey.

“We didn’t have bonds, we had low weights to equities going into that period and took a lot of risk off the table but we put it back after the market bottomed.

“We didn't have any particular insight about it, we were just prepared to take an appropriate risk view on what was happening when the market sold off significantly and then when it came storming back with money chasing.”

He sees no impediments to any KiwiSaver providing having 1-2% in private equity providing they have sensible liquidity risk management.

“Managers could start thinking about clients’ best interests rather than trying to get rid of all risk, extra effort, costs to their business and maximising returns for shareholders.

“The largest [KiwiSaver] fund is now $20 billion; if they put 1% into private equity, that's a lot of investments. In venture capital right now people are writing cheques for $1m to $2m and in PE anything from $1m – $5m.”

Financial adviser role

He says financial advisers have an important role to help clients navigate KiwiSaver. “Don’t just look at fees, look at what you get for the fee and returns after fees. And think about exposure to assets other than conventional listed markets. I think that’s a really important value-add for financial advisers.”

Berry says the more sophisticated the product gets the greater the need for advice.

“If everyone on the market offered simple, standard passive low fee services there’s no room for advisers in KiwiSaver. But you've got around 35 providers and there's so much differentiation between them in terms of active, passive, ethical, private assets, no private assets, there's a real role there for advisers.”

BlackRock out but could come back in

Despite divesting its BlackRock shares, Brownsey hasn’t ruled out investing in BlackRock’s proposed NZ renewable energy fund announced with the government.

Pathfinder decided to ditch its very small global holdings (0.3 to 0.4) after the US mega manager put Aramco CEO Amin Nasser on its board.

But depending how BlackRock’s NZ energy transition fund eventuates, if at all, he would give it due consideration.

“It’s a decision to make at the time; does the good you're investing in stand alone as a positive investment? As advertised, it may well be a great thing, however, we've seen no detail.”

Passive investment and index funds are partly to blame for more KiwiSaver money being funnelled into businesses that harm the environment, animals or people, says Mindful Money CEO Barry Coates.

Of the $98 billion in KiwiSaver, $8.6 billion (8.9%) is invested in unethical stocks, according to new analysis from Mindful Money. This has risen from 7.2% in 2019 when Mindful Money began collecting the data.

Coates says while the surge in fossil fuel prices caused by Russia’s war against Ukraine has seen KiwiSaver money pour into those stocks, passive investment and greater use of external index funds was also responsible. In particular, many passive funds invested in oil and gas companies expanding fossil fuel exploration and production.

Mindful Money divided fossil fuel companies into those transitioning to renewables, those expanding and those doing nothing. Investment in companies transitioning to renewable energy was flat and hasn’t increased as a percentage of KiwiSaver.

“One of the biggest investments in this area is Contact Energy but for other companies on a renewable pathway it is not big. Meanwhile, investment in companies that are expanding – Exxon, Chevron, BP and Shell –  is now $3.2 billion having more than doubled over the eighteen months to March 2023.”

Coates says many funds claim that stewardship and shareholder voting power will encourage companies to change, but over time this approach has been shown to lack credibility.

“There are still only a few fund managers who can show significant results from their engagement activity, and few have a credible pathway to sell their shares if harmful impacts continue.”

He acknowledges that putting more work into screening and engagement might be cause for higher fees.

“There are funds that have good processes to avoid the companies that members of the public are really concerned about. They have to work, and some managers actually are active managers globally.

“I think there's been kind of almost a glorification of low fees but the drive for lower fees is a drive for lower value. That being said, to run now, some index funds that do exclude a lot more than they used to.”

However the issue is not just about active versus passive management, says Coates.

“What kind of passive are we talking about? Are we talking about passive with very few overlays on ethical grounds or the funds that are strongly oriented towards responsible and ethical investment.

“There are now some index providers that provide stronger exclusions; fund managers should be looking at them. For example Beta Shares are passive funds and have a very strong overlay to exclude companies that are problematic.”

Animal harm and human harm

While fossil fuels companies accounted for more than $3 billion of KiwiSaver, $2 billion is invested in those that test products on animals for reasons other than human health.

Meanwhile companies which have or are breaching human rights, including labour rights, trafficking and violence against civilians, are the third biggest recipients. MIndful Money says a total of $1.4 billion is invested in companies such as Meta (digital harm and breaches of privacy), mining company Rio Tinto (environmental and community harm) and Johnson & Johnson which Sustainalytics rates as having a high level of controversy for quality and safety of several products across all three of its business segments — drugs, devices, and consumer products.

Just over $1 billion of KiwiSaver money is invested in companies that cause social harm, including alcohol companies such as Diageo, pornography, gambling and tobacco.

“It is now eight years since there was a public outcry over the amount of KiwiSaver funds in tobacco. The latest data shows an annual growth of 50% in investments in tobacco companies such as Philip Morris, British American Tobacco and Imperial Brands, to more than $21 million.”

Another $292 million is invested in weapons companies, including nuclear weapons producers, such as BAE and Lockheed Martin, and handgun producers and retailers, says the report.

Coates wants more transparency in KiwiSaver schemes. “Few KiwiSaver providers reveal the full list of companies they invest in and none identify the companies that are likely to be of concern to the public. Many people using the Mindful Money website are shocked to find out what companies they are invested in.”

He says the investment sector appears to be an outlier. “Retailers of most consumer products are acutely aware of their customers’ concerns.”

Earlier this year the annual Mindful Money and the Responsible Investment Association of Australasia consumer survey found 74% New Zealanders expect their money to be managed ethically and responsibly.

“The issue for financial advisers and fund managers is who’s going to listen to the clients? There is evidence that clients don’t always raise it proactively in meetings with their advisers but if and when it is raised they have very strong views. It’s an age of climate change and investment has a huge role to play but somehow advisers and fund managers are carrying on as if there is no link.”

Just 16% of Kiwi employers contribute more than the mandated minimum of 3% to employees’ KiwiSaver, according to National Capital’s KiwiSaver Value for Money report for the June quarter.

This compares to Australia where the employer contribution is guaranteed at 11%.

Meanwhile, on the employee side, the average contribution rate for the 12 months from June 2022 to 2023, was 4.3% according to the report – significantly lower than National Capital’s optimal index of 6.3%.

This doesn't bode well for the retirement prospects of New Zealanders, says the report, leaving most 65-year olds $142,000 short of the lump sum they would need for a normal weekly income in retirement.

The news was slightly more positive for National Capital’s KiwiSaver Allocation Index which measures how KiwiSaver members are invested. This rose three points to 58, representing a potential total gain of $48 billion in earnings, but again is below National Capital’s optimal index of 68.8.

National Capital assesses KiwiSaver funds’ value for money on six criteria each adding up to 100: performance after fees (25 points), value for fees (15 points), fund management capability (20 points), provider stability (10 points), portfolio composition and processes (20 points), and ethical investing (10 points). Top scorers are given an A rating.

Looking at performance, KiwiSaver funds added around $10 billion for the June quarter and gained another 25,000 members. The report data, which is after fees but before tax, shows that no funds had a negative quarter but they did not perform as well as the first three months of this year, with an average return across all funds of 2.71% compared to 4.21%.

However aggressive funds generally held their own, contributing around $438 million, with a steady return of 5.41%, similar to an average of 5.42% in the previous quarter.

In terms of value for fees, while a growing number of providers have been phasing out fixed monthly membership fees, 11 of the 24 KiwiSaver providers researched still continue to do so.

Simplicity maintained its position as the provider with the lowest fees among the growth, balanced, and conservative categories.

The average fees varied greatly across different categories. High Growth had the highest average fees at 1.12%, while Conservative had the lowest at 0.61%.

Some providers (BNZ, Booster, Fisher Funds, KiwiWealth, and Nikko) refer to buy/sell spreads, whereas Milford refers to swing pricing in their product disclosure statement.

The report says, the purpose of buy/sell spreads and swing pricing is to protect the value of existing units held by investors by apportioning the transaction costs associated with buying and selling of units to those investors doing so.

On ethical investing Booster KiwiSaver’s Socially Responsible Moderate fund topped the charts with a score of 9.83, while Booster’s Socially Responsible High Growth fund was second place. Nikko, Juno, Superlife, KiwiWealth and Pathfinder also rated highly by this measure but 37 out of the 110 funds analysed scored below the average ethical investing score of 6.

On process and portfolio the data showed KiwiSaver funds have increased their average net cash holdings from 9.26% to 11.40% funded by a reduction in equity assets, and most had a marginal increase in bond allocation. Most providers maintained their investing style between growth and larger value companies, while a consistent increment of current yield was observed across all portfolios.

Massively missing out

In a break out analysis the report tackles the problem of non-contributing KiwiSaver members missing out on the $521 Government contribution. Research from Massey University has revealed that between July 2021 and June 2022, more than one million members collectively failed to qualify for $423 million in Government payouts because their individual contributions for the year were less than $1042.

Breaking it down 580,000 non-contributing members missed out on a collective $302 million, and 484,000 partial-contributing members missed out on a further $121 million.

Applying National Capital’s optimal allocation of 6.3%, this means these cohorts would potentially miss out on $23.5 billion over their working lifetime.

The report says the Government needs to improve its efforts on educating Kiwis on the importance of making minimum contributions.

National MP Andrew Bayly does not think allowing New Zealanders to split their KiwiSaver savings over multiple providers would be too tricky to administer.

Instead it would provide consumer choice and a source of funding for infrastructure development among other things, he says. The proposed policy would allow KiwiSaver members to divide contributions over a maximum of three schemes.

But providers aren’t convinced and wonder whether such a change would add too much extra administration cost to members and the system as a whole.

Simplicity CEO Sam Stubbs says the devil will be in the details.

“If it lowers fees via competition – great. But if it’s an excuse to increase fees because of complexity, not great. So hard to know at this stage but more choice is desirable.”

Ruper Carlyon, founder and CEO of boutique KiwiSaver provider Koura Wealth says it’s an interesting proposal.

“It would be a good thing for us because people might be more willing to diversify towards smaller players in the market with some of their KiwiSaver. If it builds trust and further develops the product, it’s a step forward.”

But he has reservations around complexity, how it would work and whether it would require a rebuild of systems at the Government end.

“The big difference between New Zealand and international markets is that we have the IRD as the central repository for all things KiwiSaver. And so when you sign up to a new provider, what would you do? Would you say you want your balance transferred,  you don't want your balance transferred or  you want X per cent transferred. Or for first-home withdrawal, where would employee and employer contributions go?”

Kernel Wealth CEO Dean Anderson says one of New Zealand’s strengths is the simplicity of our systems – from a simple tax regime to a simple KiwiSaver structure administered centrally through IRD.

Both Carlyon and Anderson refer to the UK and Australia which are now dealing with the problem of investors having pockets of superannuation scattered across the market place.

“Often balances get forgotten, or aren’t regularly reviewed and you tend to see self-managed results are worse than simply getting the asset mix right and keeping costs low,” says Anderson.

Carlyon says over the past five to 10 years, both countries are going through a massive effort to consolidate pension schemes.

Both question how greater administrative complexity would result in lower fees. The upshot for Anderson is that he is indifferent to the policy, as 95% of the market will see little value and it might even add more confusion. He is skeptical on whether it will foster higher innovation, greater innovation or lower fees.

Likewise Mike Heath, general manager of InvestNow which already allows members to spread their KiwiSaver across a choice of 40 funds from 15 providers.

He says while he applauds National for identifying a long-known issue with the KiwiSaver system, much of the complexity, expense and risk would fall on the IRD. Members of more than one scheme would also lose the benefit of consolidated KiwiSaver reporting where all costs and investment returns can be viewed in context.

“The National Party emphasis on ‘flexibility and choice’ in KiwiSaver is on the money,” he says. “But the proposed policy is more likely to introduce confusion and expense when cost-effective solutions already exist.”

Sophisticated investors

Bayly, who is National’s Commerce and Consumer Affairs spokesperson, doesn't think the policy would require major changes to IRD systems. “What we’re thinking at this stage is that you would go to your employer and say you want to split your contributions and they feed it through to the IRD.

“The idea of the IRD’s new BTP [business transformation programme] is that it has full visibility around everything. They’ve now got the systems to do it. There might be some administration costs, but we don't think it's substantial and we can work through in absolute detail with them.”

He says National would probably put restrictions on the proposal. “We wouldn’t want people with a balance of $15,000 spreading their KiwiSaver unnecessarily. Obviously it’s directed at sophisticated people with larger balances and we’re talking for the next five to 10 years.“

As well as InvestNow, Kiwis can also self-select KiwiSaver funds from Consilium and Craigs Investment Partners. Also, Sharesies announced in May that it will allow members of its forthcoming KiwiSaver scheme to choose between six base funds.

“That’s a market solution to the existing situation,” says Bayly, “and that’s great. But people may want to choose their own options. We are going to do as much as we can to encourage KiwiSaver investors and fund managers to participate in alternative forms of investment such as expansion capital, VC, infrastructure. As balances grow people can make the choice for themselves.

Funding new infrastructure

“If you’ve got several hundred thousand, you might want to target your money in certain areas. You might have a social conscience or want to get into infrastructure.”

Bayly says only a few KiwiSaver providers have built the expertise to do alternative investments.

“Many of the larger ones for instance, like the banks, are basically passive managers. And then you’ve got the likes of say Booster, which extensively invests in wine, Sam Stubbs into housing, and Milford which has built an M&A team. So some of them have taken on the capability to do it.”

He says National wants to get third party providers involved in infrastructure and what better investors than KiwiSaver providers with their long term view.

A general review?

Sharesie’s joint founder and CEO Leighton Roberts says, “Giving more choice and control leads to a greater connection, which is what investors have told us they want, and is reflected in our self-select Kiwisaver scheme to be rolled out  in coming months.

“What National is proposing will benefit some investors, but to drive better outcomes for the significant portion of people who are really concerned about having enough money to retire in comfort, there are other policy changes to consider.

“For a step change, why not do a proper policy review of Kiwisaver that considers access, contributions, tax incentives, and compulsion.”

In a similar vein Anderson says he would rather see an ambitious policy announcement on growing KiwiSaver engagement, enhancing financial literacy in schools and tackling the key issue of raising savings rates overall.

On the topic of a general review Bayly says, KiwiSaver is important to the fabric of New Zealand now, and we need to make it even more successful. “So, I think there'll be other elements we'll look at in time.

“We’ve already made a couple of announcements on KiwiSaver so this shouldn’t be read as the only thing we will do.”

Last month National said it would allow tertiary students to access the scheme to pay for tenancy bonds.

Bayly wouldn’t say whether there will be any more KiwiSaver announcements coming out before the election.