More knowhow will bring a change in investment choices

Brian Gaynor and Ralph Steward. Photo / Natalie Slade and supplied

Plumping for conservative funds has seen KiwiSavers weather the financial crisis, but things will shift as they get an appetite for risk, writes Nick Smith.

A little knowledge is a dangerous thing.

Fortunately for several hundred thousand New Zealanders investing in KiwiSaver, a little knowledge was distinctly absent - saving them from the worst ravages of the global financial crisis that laid waste to international markets.

Most Kiwis, notes Brian Gaynor, Milford Asset Management executive director, parked their money in default funds, meaning savings were invested in conservative funds, the only asset class to emerge virtually unscathed from the carnage of 2008.

As figures supplied by investment research firm Morningstar show, the average returns for growth and aggressive funds for the past two years barely topped 1 per cent. Conservative funds, by comparison, delivered an average return over two years of more than 5 per cent.

"They've been fortunate that it worked that way," comments Gaynor on the passive nature of people's approach to KiwiSaver. "They didn't have any idea where to put their money and they got into these default funds and they were protected in the downturn."

AXA chief executive Ralph Stewart also acknowledges the fortuitous nature of collective investment decisions. "But the problem with the asset allocation in the default scheme is it has benefited from accidents - and retirement savings can't be a result of accident," he says.

He argues that the only people benefiting from default decisions were those within a couple of years of retiring when the crisis hit. For someone with 10 years or more to go, they would be better served by a more diverse asset allocation.

Gaynor agrees, pointing to the yield from an average return "under certain assumptions" of 2.5 per cent over 40 years: "That's $225,000. At 10 per cent, it's $1.8 million but you can't get 10 per cent in a conservative fund."

"Longer term investment cycles show that balanced portfolios that aren't over-taxed or overcharged produce more reliability than the short term current KiwiSaver experience," says Stewart. Gaynor is not so sure - "there's not much difference between conservative or balanced funds". Given the short life span of the scheme and the extraordinary financial conditions under which it has operated, the past few years' results are not helpful in determining that disagreement.

But both men expect to see a change in investment decisions in the next few years as people acquire more knowledge and begin to compare returns as markets recover.

"It will take a while before they understand these things, and I'm not saying they're thickos or dumbos," Gaynor adds. "In future you will see more people move from conservative to balanced and balanced to growth."

Overall, the present split is 75:25 in favour of conservative income assets over growth assets (although younger savers might be more 60:40) and most commentators expect that ratio to pull much further back in favour of growth assets.

Part of that change will come from increased knowledge, says KiwiSaver provider Gareth Morgan.

"For me, the greatest benefit of this KiwiSaver thing is that it should raise investment literacy," Morgan says. "As the balance in people's accounts grow, they will become very conscious of the pot they own."

If success for Morgan means improved public understanding, for Gaynor it is the sheer weight of numbers with a stake in the KiwiSaver scheme.

When it was launched in 2007, expectations were for 680,000 members by 2014. Today 1.3 million New Zealanders have enrolled. By that measure, "unequivocally it's a success," says Gaynor.

The KiwiSaver scheme will turn three years old this year and, with an estimated $5.3 billion under management it already comprises more than 8 per cent of total managed funds.

Gaynor describes it as "a substantial amount" and one that surely is making a difference to national savings, a bugbear with Morgan.

"There is no evidence that compulsory superannuation schemes or like versions of them have any effect whatsoever on the national or even household savings rate," says Morgan.

"The Australian experience does, however, suggest the insertion of this type of superannuation scheme has a large impact on where the savings are invested - the fund manager community makes the call rather than the more disparate household sector."

In Australia, where total superannuation fund assets under management comprise more than A$900 billion, employer contributions have just been bumped up from 9 per cent to 12 per cent, a development which draws a scornful response from Morgan.

"Well, Australia already has the highest rate of super contributions in the world, so clearly they have caught the religion."

Morgan doesn't believe Australia's super-sized super scheme improves its economic growth prospects and the lucky country's ability to fund pensions in the future. New Zealand Inc is not missing out on a competitive advantage because its scheme is voluntary and contributions lower, he insists.

AXA's Stewart is not so sure the mix is right at New Zealand's two plus two contribution.

"We're an advocate of closer to eight [four plus four] rather than four," he says.

"It would be nice to see that added to the momentum that we have in KiwiSaver at a time that's affordable for New Zealand households."

The National government cited household affordability as reason for reducing Labour's four plus four formula but, realistically, capping employer contributions at 2 per cent was as pressing an issue to the party as household poverty.

Morgan is undoubtedly correct More knowhow will bring a change in investment

We've got retiring KiwiSavers now; the bubble starts to blow in the next five to 10 years.Ralph Stewart

there is a trans-Tasman cultural difference in attitudes to super schemes, a point picked up by Gaynor.

While business advocates and some business press in New Zealand waged a campaign against compulsory employer contributions and then the four-plus-four formula, in Australia there has barely been a peep of protest at businesses' gargantuan contribution, notes Gaynor.

He does see Australia gaining a competitive advantage and the only benefit from its turbo-boosting change to super contributions, from Gaynor's perspective, is it means finance minister Bill English is less likely to meddle with KiwiSaver.

Given playing catch-up with Australia is a stated government goal, the minister can hardly then turn and scotch one of the perceived pillars of Australian prosperity, compulsory employer contributions.

Stewart is diplomatic, saying the Government has "found a good compromise with KiwiSaver, national super, private provision and, to some extent, the Cullen fund". Even national super capped at 65 per cent of the average wage, however, raises future affordability issues for Stewart.

Increasing the two-plus-two formula would "give people more security, make a postitive retirement more of a certainty and reduce reliance on national super," he says in a nod to speculation the pension may eventually be income-tested.

For Stewart, a more pressing issue than compulsion or size of employer contribution is the imminent exit from the scheme of a large baby boomer bulge.

A tragedy could unfold, to Stewart's mind, if this large demographic follows the cultural tradition of pursuing the beach, bach and BMW.

A mass withdrawal of funds would potentially reduce KiwiSaver's beneficial impact on NZ Inc but also pose a boom-bust threat to individual retirees, Stewart says. "It's great for retirees to have the freedom to do what they want with their lump sum but if it leaves them destitute in 10 years after 20 years saving, then..." he leaves the thought hanging.

What is needed, he argues, is a tax efficient mechanism for the gradual withdrawal of KiwiSaver funds, what he calls, in an example of industry jargon, "a de-accumulation vehicle".

It would mean the difference between having conversations with retirees about cash life expectancy following retirement and one about future opportunity, Stewart argues.

At a minimum, the Government needs to look hard at the way its tax code affects annuities, in particular: "The regime as it applies to annuities is tax ineffective."

Stewart's point is there is no tax recognition of how KiwiSaver payments remove future liability for Crown provision of retirement services from its balance sheet, a comment that reveals the widespread industry belief that pensions will eventually become asset-tested, income-tested or both.

"We need to find a way to reduce the taxation of annuities because it means that people will rely less on the state because their own savings will last longer," he says.

"We've got retiring KiwiSavers now; the bubble starts to blow in the next five to 10 years.

"We need to have a discussion now, something on the workbench for completion in the next three to five years."

Change is certainly coming but before tax relief, there will be further regulation of the industry.

The Government has signalled some changes - tidying up the liability of trustees for individual decisions, for instance.

But the big change, signalled by Commerce Minister Simon Power will be bringing all KiwiSaver providers under the regulatory supervision of the new Financial Markets Authority and the imposition of the same disclosure requirements that default providers meet.

Morgan and Gaynor are philosophically opposed on most economic matters, including the impact of KiwiSaver, but agree there should be a level playing field for all KiwiSaver managers and greater disclosure requirements imposed on managers.

Morgan and Gaynor also agree on another point: the wisdom of joining KiwiSaver is a no-brainer.

"You have to join given the extent of that (employer and government) subsidy," is Morgan's view.

"If they remove it, why would you bother contributing at all?"

Gaynor mounts a similar argument - "It's $1 for every 40c you put in; you don't get that often in life" - but also notes the scheme can plan a key role in creating in prosperous society.

"Capital is capital," he says, "and you need capital to fire up a capitalist society."