Most KiwiSaver funds are actively managed. Yet overseas, passive index trackers are popular with investors who are sick of paying for poor performance by fund managers.
Passively managed KiwiSaver funds have an equal spread of the top companies in an index and on balance the fund will grow over time just as well if not better than an actively managed fund.
Unlike some other countries Kiwis have few choices when it comes to passively managed funds. The two pure passive KiwiSaver funds are ASB and Smartkiwi from NZX.
Each is different. Smartshares' Smartkiwi invests in NZX and ASX Smartshares funds, and ASB's funds invest in a range of index tracking funds such as the MSCI World (Australian) Index fund from leading international tracker fund provider Vanguard Investments.
SuperLife also describes itself as passive. But it doesn't simply follow an index as the ASB and Smartkiwi do. The KiwiSaver's manager actively chooses 25 good-quality New Zealand companies to invest in here, but holds them passively for the long-term, preferring not to buy and sell. The overseas portion of its fund is held in index tracking funds. "We find that funds with low turnover are more successful," says principal Michael Chamberlain.
Ask an active fund manager if their stock picking is better than a monkey with a dart and they'll point you to the pros of active fund management, some of which are:
• Superior returns
• Reduced volatility
• An ability to make money or shield investors from falling markets with their nimble investing.
It's logical that some active fund managers will beat the index and others won't. But Chamberlain questions whether those that succeed do so through the manager's prowess. When they beat the index, he says, it's often thanks to their investing style not stock picking. "Where they outperformed the market it can usually be explained because they excluded property or had a bias towards smaller companies," he says.
The latter in particular can make a difference because smaller companies can be more nimble and often grow more rapidly than their larger counterparts. Indexes by their nature contain the largest companies in the market.
Sam Stanley, head of Smartkiwi, says: "In the US, 67 per cent of fund managers don't outperform their indexes, they underperform them."
KiwiSaver fund fees are a big issue that I've written about before. They eat into growth. As well as standard fees based on the amount of money invested in someone's KiwiSaver, a few funds such as Fisher Funds KiwiSaver charge performance-related fees. Fisher Funds, for example, takes an extra performance fee in years when returns are above the benchmark it aims to meet. The justification for a performance-related fee is it gives the manager an incentive to do their job well.
Passive funds argue that often those good years are simply because markets were rising anyway and investors still have to pay fees in the bad years when active managers don't make a profit.
Chamberlain points to the March quarter, when his passive fund performed just as well if not better than many of the actively managed funds, some of which charged additional performance fees for the growth. "I know why I outperformed and I can assure you there was no skill in it," says Chamberlain. It was thanks to a rising market, which brought SuperLife's fund up with it. "There is luck as well as skill with active management and over the short term luck dominates."
Passive funds usually have lower fees than equivalent actively managed funds. They argue that the fund's returns will do better in the long run because of this, thanks in part to a slightly larger proportion of the returns being reinvested. Some other arguments against active funds are:
• They can't guarantee they will outperform the market
• The manager responsible for last year's performance may move on
• The fees - especially performance fees - eat into returns
"Another point of difference between active and passive," says Smartkiwi's Stanley, is active funds turn over stocks far more than a passive manager because they're buying and selling all the time rather than at set times. This increases trading costs through higher brokerage fees and through the "spread" - the difference between the buy and sell price. Passive funds don't escape these costs totally because they do need to rebalance every quarter - or sometimes at month end if companies enter the index or drop out.
The proof is the actual returns over time. ASB's funds and Smartkiwi aren't at the top of the performance tables - although neither is doing badly. This could be explained, however, by the argument that five full years isn't long enough to tell the real return of a KiwiSaver fund. Unless you're saving for a first home in the short term, then KiwiSaver is for the long term, says Stanley. It's a long-term investment and 10 or 20 years or even longer might be a better period over which to judge.
So can a monkey do better than your KiwiSaver manager? Researchers have speculated about this since the 1970s when a Princeton University professor claimed that "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts".
He was wrong, according to research released earlier this year. Lucky monkeys did better than the average.
That research by the Cass Business school at City University London found that a "virtual" monkey beat the index.
The researchers used computers to create 10 million "monkey" fund managers to pick and weight each of 1000 shares over 43 years. Every one of the "monkeys" beat the performance of the market cap-weighted index.
This might be viewed as just an argument against passive index tracking funds. But considering most of the KiwiSaver managers in New Zealand can't beat the index trackers, it doesn't reflect well on them either.
Stanley points out that many active fund managers also invest in passive funds as part of their investing strategy. Some, in fact, invest in Smartshares funds on which Smartkiwi is based, although mostly they choose index trackers for the overseas portion of their funds.
Passively managed funds do have their downsides. They include getting what the market gives you.
Even if the KiwiSaver manager would rather eat tripe than invest in Auckland International Airport, he must still buy those shares. Investors will also see their investments go up and down more dramatically than actively managed funds; their funds are forced to buy expensive stocks that have made it to the top of an index; and money is invested at the peak of the market when an active manager might hold more cash back.
So what's the answer? It's complex. There are some experienced investors who would never invest in anything other than actively managed funds and those who only use passive tracker funds.
It may be a case of horses for courses - watch this space 10 or 20 years from now to see which wins.
