Warning on conservative funds' poor outlook

Savers are put in the default funds when they switch jobs and are automatically enrolled and do not actively choose their own fund. Photo / Thinkstock

Conservative KiwiSaver funds, including the nine government- appointed default funds, face a poor outlook, an economic think-tank has warned.

In its first research on the New Zealand investment sector, the New Zealand Institute of Economic Research said it expected conservative funds to barely outperform cash investments over the next seven years.

It says this is because the funds mainly invest in government (sovereign) bonds and cash and government bonds typically perform poorly when interest rates rise.

Around $7.9 billion is invested in conservative funds out of the total $27 billion invested in KiwiSaver, most of which is through the default funds.

Savers are put in the default funds when they switch jobs and are automatically enrolled and do not actively choose their own fund.

NZIER principal economist Andrew Drew said conservative funds had performed very well in the lowest interest rate environment the world had seen since the global financial crisis hit.

"But they are likely to significantly underperform growth funds in the long term."

Drew said it expected conservative funds to return only 4.6 per cent a year to 2022, just above what an investor could get through the 90-day bank bill rate of 4.2 per cent.

"NZIER believes sovereign bonds will perform poorly in the medium term, which would drag down the returns from conservative funds."

Drew said its forecast was based on previous investment cycles.

"We believe bonds, particularly sovereign bonds, are vulnerable to a correction when interest rates globally start to rise."

In a correction the returns on an investment or a market typically falling by more than 10 per cent.

Drew said balanced and growth funds, which invest more money in shares, would do better with forecasted returns of 5.6 per cent and 6.5 per cent a year.

But he also warned those returns would be lower than what savers had seen in the past few years, reflecting a view that markets across the board were no longer cheap.

"Equities are looking like a mixed bag, with Europe, Japan and the UK offering better value than the US, Australia, Canada and New Zealand markets."

Balanced funds have averaged a return of 8.6 per cent a year over the past five years while growth funds have averaged 9.8 per cent per annum.

Drew said KiwiSaver funds had too much invested in income assets such as cash and bonds and savers were missing out.

"Over 40 years the difference between a growth fund and a default fund could add up to tens or even hundreds of thousands of dollars for a KiwiSaver investor."