KEY POINTS:
KiwiSavers are faced with a myriad of financial decisions. The first one, whether to participate at all in KiwiSaver, has seen plenty of debate and thankfully many of the opinions that have been expressed give a sensible view. For most New Zealanders, enrolling in KiwiSaver is likely to be one decision which makes a positive difference to their retirement situation.
KiwiSavers face a series of additional choices which may also have a bearing on their outcomes at retirement: which contribution rate to select, whether to choose an active or passive manager and whether to go with a specialist provider or one using a "fund of funds" approach.
But probably the most crucial decision for many KiwiSavers is going to be the mix of growth and income assets in their underlying portfolio. Growth assets benefit from economic growth and would generally include equities, property and infrastructure, while income assets are more defensive and include debt securities and cash. Growth assets are more volatile and generally have to offer a return premium over income assets.
While investment strategists will argue over the size of this return premium, history has shown that over long investment time horizons, the difference can be great. For example, $100,000 invested for 30 years at a 5 per cent return (after tax) gives $430,000. At 7 per cent it gives $760,000.
The time horizon for the average KiwiSaver is likely to be very long. Other than those aiming to use the first home buyers option, most will be investing for between five and 40 years. Children whose parents have the foresight to enrol them could have investment horizons of 60 years-plus.
The long compounding horizons mean that the premium earned from investing in growth assets could make the difference between a modest retirement nest egg and a lotto-sized one.
Unfortunately, the allocation in KiwiSaver default products may send the wrong signal to investors. The weighting to growth assets in a typical default product is likely to be less than 25 per cent. This might be appropriate for investors who plan to use the first home buyers option; otherwise they should be shifting to growth assets as soon as they feel comfortable.
Getting the asset allocation right will make a great difference for investors but it will also have significant consequences for the economy. This is because increasing the level of savings is only one part of the formula for improved economic performance. The way capital is allocated in the economy is also a key determinant of our long-run economic growth. If investors select the right allocation for their long-term returns, then a very desirable byproduct will be a larger, more liquid equity market and stronger overall economic performance.
Academic research has highlighted the role of well-developed financial markets in the long-term growth of a modern economy. Unfortunately, New Zealand's performance in terms of equity market development is not encouraging. During the past 10 years, the total capitalisation of domestic companies listed on the New Zealand Stock Exchange has grown at only about 3 per cent a year. In Australia, the ASX has seen 15 per cent annual growth in total capitalisation.
If KiwiSaver flows are directed into debt securities, the economy will certainly see some benefit. We will be less reliant on foreign lenders and, all things being equal, our shocking current account situation will improve. But real gains in productivity, incomes and activity will only come if KiwiSavers also allocate capital to equities.
We all want companies to be more socially responsible, to invest for the long run and to allocate capital wisely. But only equity-holders can exercise corporate governance. Only equity-holders can vote at annual general meetings. Only equity-holders can remove directors who persistently destroy value and only equity-holders make the final judgment on takeover bids.
Because our equity base is small, we are failing to retain New Zealand ownership of our corporate sector. And there is little chance of stemming the flow of New Zealand businesses into foreign ownership if KiwiSavers allocate their portfolios toward income assets. If so, we will be effectively providing foreign buyers with the debt financing to make leveraged buyouts of our commercial enterprises.
Let's hope that Kiwisavers make sensible decisions about the portfolios they select. In addition to their retirement well-being, it could also have big implications for New Zealand's economic success.
* Mark Brighouse is managing director of Brook Asset Management
The choices
* Growth assets: Equities (shares), property, infrastructure.
* Income assets: Debt securities (eg corporate bonds) and cash (short-term interest-paying investments).
