Diana Clement: Gains tax change only part of story

COMMENT

Savers are in for a bonus if the Government sticks to its word and slashes capital gains tax from actively managed unit trusts and superannuation funds.

Returns on these funds have been cut to smithereens thanks to a 33 per cent tax on the income they produce. As a result, many of the investors who've tucked a total of $19 billion into these funds would have been better off ploughing their money into term deposits.

In case you missed the news, the recommendations proposed by independent adviser Craig Stobo and given broad support by Finance Minister Michael Cullen will see investors with managed funds taxed in the same way as they would be on a bank deposit. So if you're on the 19.5 per cent marginal tax rate, that is the amount that would be deducted at source.

Under the existing system, an investor who had $24,000 invested in the Fisher Funds NZ Growth Fund a year ago would have seen that increase to $29,983 after tax and fees. Under the proposed system, that investor's pot of money would have grown by an additional $2981, says Warren Couillault, the fund manager's investment analyst.

"This is a real coup for investors," says Tim Anderson, business manager at researcher FundSource. "With this distortion removed, we will get more competition, economies of scale that come with critical mass, and downward pressure on management fees. In Australia, the industry is 15 times as big as it is here with only four times the number of people."

But the removal of capital gains tax is only part of the story. Managed funds have had a lot of bad press this year.

First of all Consumer magazine slammed the funds' returns, concluding that most balanced funds failed to beat the benchmark of term deposits. The Consumer report concluded that big-name funds from organisations such as Tower, BNZ, ING and BT had dismal returns after tax and fees that saw only 30 per cent of the real returns finding their way to the customer's pocket.

Then industry expert Dr Gareth Morgan attacked his peers in a three-part demolition of the industry in this newspaper.

Anyone who read the articles would be hesitant to write out a cheque to their financial planner or a fund management company believing instead that the white-shoe brigade populates the industry.

If Consumer and Morgan are to be believed, then actively managed funds still suffer death by 1000 cuts through fees.

Consumer took the example of the Tower FuturePlan Balanced Growth Fund, which earned 8.3 per cent before paying tax, expenses or fees. Investors received just 3.65 per cent. Fees and expenses were equal to 35 per cent of total gross earnings.

Consumer's senior research writer, David Hindly, said his organisation welcomed this week's tax proposals, but added: "They don't take away the whole problem, because fees are still a major issue. While there are some flexible, low-cost funds available, too many are inflexible and expensive.

"We think the companies don't do enough to explain the real impact of fees. Yes, companies do meet their minimum legal requirements by giving the raw details of fees in the fine print, but often they are expressed in ways which don't give a picture of their true impact and which don't allow easy comparison between funds."

Anderson argues the higher fees paid for actively managed funds, as opposed to passive funds which aim to track a basket of shares such as the NZSX50 - are worth it because the active managers typically beat their passive cousins, by hand-picking stocks they think will perform better than the average.

Financial planner Robert Oddy agrees that a well-managed fund is a good investment, but says only the minority of actively managed funds actually deliver the promise.

He says most are closet index huggers following the index and often failing to add value by smoothing out the ups and downs.

Oddy, managing director of International Financial Planners, recommends that his clients invest in actively managed funds, but all but a small percentage of his clients' money is invested in funds based overseas including Australian-based Platinum Management's funds and RIT Capital Partners products in Britain.

Exorbitant fees and excess taxes aside, actively managed funds offer opportunities to private investors that are difficult to access directly.

If you believe in diversifying your investments, and you should, say financial planners, then the 600 or so managed funds available in New Zealand offer you the ability to spread your investments across many companies, countries and asset classes.

A private investor has little opportunity to buy and sell commodities on their own behalf. But they can by investing in fund management company Liontamer's commodities fund.

Should you choose to go it alone, there are cheaper ways of investing in managed funds than going to a financial planner. FundSource offers a service to DIY investors where they can select and invest in funds directly through its website Fundsource.co.nz and pay just 1 per cent up front.

Or if you go direct to the fund management company itself, you can save even more. If you buy into the Fisher Funds NZ Growth Fund, via a financial planner, you'll pay up to a 4 per cent entry fee. If you were to pick up the phone to Fisher Funds and invest direct you'd pay up to 1 per cent, depending on your negotiating skills.

But take heed. DIY investing can be a dangerous thing in the wrong hands and Anderson certainly wouldn't recommend to his grandmother to buy investments direct.

"Quite simply, most New Zealanders and people around the world are poor investors," he says. Many an investor has seen the headlines and plunged money into booming markets just before they crashed.

Some investors can and do research and manage their own investments successfully.

However, unlike some overseas countries such as the US and UK, public sources of investment research and data to enable you to make an informed decision are thin on the ground. In the UK, should a private investor be interested in investing in a China fund, he or she can go to websites such as Trustnet.com and III.co.uk, and view a range of data such as fund rankings compared with the sector average, compare particular funds with each other, view graphs, click on related news items and view the fund's largest holdings.

Here, investors need to rely on their financial planners providing them with data from third-party companies such as FundSource or Morningstar and as we all know, data can be manipulated to look good.

Charts can show a fund to have the biggest growth rate in its class. But that may hide the fact that it is still languishing in the bottom half of performance tables.

Finding your way through the minefield is tricky for private investors and Oddy reckons that many financial advisers also struggle.

But he points out that it's important not to get diverted from the bigger investment picture. "At the end of the day saving is the most important aspect. If you want to save, then managed funds and exchange-traded funds (such as the Fonz fund launched this week that tracks the 50 top shares in New Zealand) offer an opportunity to build up wealth."