Brent Sheather: KiwiSaver - choose carefully

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Call me cynical but it seems that just about every time anyone in the finance sector writes about saving for retirement their key message is that we should all be saving more and KiwiSaver should be compulsory.

What they don't say is that reducing management fees is a much more viable option for low income New Zealanders needing to increase their retirement savings.

If you look through the fee section on the Sorted website there is huge variation in the level of fees charged. This is important information because various academic studies show that fees are the best forward indicator of future returns in each asset class.

I don't advise on Kiwisaver because my clients are already retired but, up until now, had been under the impression that KiwiSaver was a relatively low cost savings option.

Prior to KiwiSaver kicking off the then Government Actuary, David Benison, told me that the default providers had been persuaded to offer low fees as a reward for them being awarded default provider status. Mr Benison's additional role was to approve the active provider fee levels as "not unreasonable".

As we will see KiwiSaver can be low cost but only if you are careful and then only relative to other KiwiSaver products. Not too long after that the Government Actuary's position was dis-established, which is a shame because he seemed to be one of the few genuinely independent experts on the side of retail investors and he had a good knowledge of what was important.

Since then the average fee charged on KiwiSaver funds appears to have crept up in part because of the entry of smaller players with high fees.

This is particularly incongruous because funds under management have increased and there are huge economies of scale, some of which should have been passed back to KiwiSavers.

There is thus an opportunity there for someone at the MBIE, Treasury or the FMA to do the right thing, and I don't mean to leave and go and work for a KiwiSaver provider.

Compare the "anything goes, she'll be right, efficient markets will sort things out" assumptions of the MBIE, Treasury and the FMA with the attitude of Britain's Labour Party who are determined to reform capitalism which includes challenging "rip off pension companies" by imposing a cap of 1 per cent on annual fees.

The Sorted website allows you to compare various KiwiSaver funds on the basis of fees and it does a good job but unfortunately it may overstate fees.

An example will illustrate - the Sorted website says that the ASB Growth Fund has an annual fee of 1.04 per cent but this is made up of a relatively moderate management fee of 0.66 per cent plus the $30.00 annual membership fee divided by the average KiwiSaver fund balance of $7,900 to get a total fee of 1.04 per cent.

Whilst this is correct the impact of the $30.00 fee won't be significant for individuals with larger balances and in any event will fall dramatically as KiwiSaver fund balances increase. So headline fees aren't as bad as they first look and in some cases better than conventional actively managed funds but much, much worse than the fees on index funds overseas.

The ASB fund looks to be a genuinely low cost option, in the KiwiSaver universe anyway but there are a number of KiwiSaver funds which, even adjusted for the impact of the membership fee, have fee levels which could severely impact the growth of mum and dad's retirement savings in the future.

We will look at some examples of those soon but let's first look at the average fees by asset class with portfolio turnover costs, as estimated by the London Financial Times, added.

The table uses data from the Sorted website (column 1) then adds the estimated costs incurred by the fund managers actions of buying and selling shares in the portfolio to the Sorted figure to give total estimated annual costs in column 3.

As previously discussed these numbers are probably a little high as they include an assumed 0.3 per cent or so administration fee. Having said that even reducing the 2.13 per cent estimated annual costs for the average growth fund by 0.3 per cent means that the average cost is still a rather alarming 1.8 percent pa.

To put this into perspective the estimated prospective return from a portfolio of NZ, Australian and international stocks is about 7.0 per cent pa so 1.8 per cent in annual costs reduces returns by 26 per cent. More perspective: Vanguard has an S&P 500 ETF which charges 5 basis points.

So much for the average...now let's look at some of the highest cost funds in the growth sector using data from the Sorted website.

The highest fee in the KiwiSaver growth sector goes to .... wait for it .... the AON Milford Active Growth Fund with fees of 4.22 per cent pa.

Runners up include the Fisher Funds KiwiSaver Growth Fund (2.7 per cent pa), the Staples Rodway KiwiSaver Growth Fund (2.36 per cent pa) and the Forsyth Barr Balanced Portfolio Growth Fund (2.19 per cent pa).

In most cases these excessive fees are due to the fund manager inflicting performance fee arrangements on their clients where they benchmark the performance of their share portfolios against a fixed interest or absolute return benchmark.

Some of the performance arrangements would be illegal in the UK and the investment statement of one of the funds has the temerity to describe its fees as "fair and simple". It could be a Tui advert. The writer has urged the FMA to do something about these issues on a number of occasions.

Now to preempt criticism from any of the winners we should note that the AON and Fisher Fund KiwiSaver funds have performed well and much of their high fees relate to their share of this good performance.

There are three caveats however; past performance is no indication of the future, the academics advise that high fees point to lower long term returns and last but not least, the computers that run index funds which would capture most of these high returns, don't demand performance fees in good years.

In two week's time we will, using realistic forecast returns, calculate what terminal sum will accrue to a KiwiSaver saving $100 per week, see how sensitive the terminal sum is to fees, contributions and investment horizons. We will then give the Government, the FMA, the MBIE and Treasury some free advice as to how the fund management industry might be persuaded to do the decent thing and charge reasonable fees on KiwiSaver and thus improve KiwiSaver's retirement outcomes ie what the Government Actuary used to do before the faceless Daleks had him exterminated.

Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have a financial interest in the companies mentioned in this article.