KEY POINTS:
With all the rhetoric from fund managers about how good they are, you might be excused for expecting that the new portfolio investment entity (PIE) structures had some real comparative advantages, like maybe low management fees or that they could reasonably be expected to outperform their relevant benchmark index.
Sadly none of the fund managers appear to be offering their services for free or guaranteeing to beat the index. In fact, while PIEs are a big improvement over your average capital gains tax paying unit trust, it is still not clear that they are a better bet for mum and dad than the best offerings from overseas fund managers like index funds, listed investment trusts and, in respect of bonds, sensibly diversified direct investment.
The fuss about PIEs reminds one of a gold rush without the gold. The simple facts are that, on the basis of realistic assumption of future returns from bonds and sharemarkets, the fee levels of most locally offered funds are still prohibitive.
Yields on international shares are so low that the typical annual fees are such that they almost offset the extra returns earned by taking a higher level of risk than money in the bank.
Throw in the additional risk that your fund manager may underperform the market average and local actively managed funds still don't guarantee a path to riches.
For sure the logic for property companies becoming PIEs is compelling but what about the other 90 per cent of your portfolio? There are only minor tax advantages for some investors in cash funds and these are more than offset by annual fees. There are, however, significant tax disadvantages from owning international share funds within a PIE structure vis-a-vis direct ownership of cheaper overseas managed listed share funds. The tax advantages of PIEs in respect of cash deposits are being trumpeted but for the typical portfolio investor cash is usually not a significant asset class.
As at June 30, for example, the NZ Super Fund had just 0.5 per cent of its assets in cash.
In most diversified portfolios, international shares at a 30 per cent weighting are where the action is and PIEs don't look so good here. Bonds frequently constitute 40 per cent of balanced portfolios but bond PIE funds typically have management expense ratios (MER) of 1.5 per cent meaning that all the tax advantages in the rare best case scenario (reducing tax from 39 per cent to 19.5 per cent) goes in fees.
Better to own low-risk bonds directly and avoid the fees. With interest rates more likely to fall than rise, the tax advantages of PIE-structured fixed interest instruments will likewise decline.
In any case, many retired investors have organised their affairs via a family trust which is taxed at 33 per cent, so a PIE structure typically only lowers the tax rate from 33 per cent to 30 per cent.
This produces a saving at an 8 per cent interest rate of 0.24 per cent. But hold on a minute, the MER of your typical fixed-interest fund is usually around 1.5 per cent. No one is going to get rich paying 1.5 per cent to save 0.24 per cent.
Fund managers frequently allude to the tax advantages of holding cash funds via PIEs but conveniently neglect to quantify them, then say nothing about the poor tax position of their international share funds.
Despite the latter yielding around zero after deducting annual fees, the new Fair Dividend Rate tax will assume a 5 per cent post-fee yield and calculate tax on this basis. Direct investors are subject to the same rules but to determine taxation can deduct any capital losses. This latter deduction is not available to locally managed PIEs.
Effectively investors in international share-orientated managed funds will be paying a capital gains tax each year assuming a 5 per cent capital gain whatever the market does, whereas with low-cost overseas funds and a bit of effort mum and dad can ensure they have a spread of direct FDR investments with a 5 per cent post-fee cash yield and losses deductible in a down year.
The whole area of fees in New Zealand financial planning area is in need of radical surgery, from managed funds to platforms to mastertrusts. While Bridgecorp and finance companies offered unusually high commissions, for the unscrupulous, misinformation and deceit is widespread. A few years ago the chief executive of one "fund manager of the year" made the ridiculous statement that "a fund's returns were independent of its fee structure" and investors should look at the returns after fees.
That sort of reverse logic might have worked when markets were rising by 20 per cent a year but it sure doesn't work in more normal times. And what of those hundreds of highly qualified financial planners the industry churns out each year? Won't they inject some realism into the market? Not likely if they want to stay employed. The industry produces investment plans which wax lyrical about the efficient markets hypothesis and benefits of diversification, then recommend six or 10 individual stocks to cover the New Zealand or world sharemarkets. Worse, some preach the "balanced" approach, then nominate five high-risk finance company debentures as the supposedly low-risk side of a balanced portfolio.
Even "financial planners of the year" it seems recommended Bridgecorp. A recent survey of financial advisers apparently reported that most were going to continue recommending finance companies. Heaven help us.
The New Zealand retail fund management industry sector has a long history of persuading mum and dad to take on more risk in the pursuit of higher returns over bank deposits, then grabbing the risk premium for themselves by way of over-the-top annual fees.
If New Zealand investors are to support a local savings industry it needs to be competitive on a price basis with the best that is offered overseas and realistic in terms of expected returns. For international shares that means management expense ratios of around 0.5 per cent and half that for cash funds. For advisers it means lower fees.
* Brent Sheather is a Whakatane-based investment adviser
