Money: Managed fund pot brought to boil

By Philip Macalister

A managed fund is a complex beast. Buying a managed fund is seen as a complex business. The managed funds industry is recognising this and trying to simplify and demystify the process.

Bank of New Zealand Financial Services Group general manager Rodger Murphy says simplifying managed funds is the single biggest step to encouraging greater investment.

"There is a lot of discussion about the role the Government can play to encourage saving, but we shouldn't overlook the role financial institutions have in creating a more investor-friendly environment."

BNZ, like other companies, has been focussed on this issue which has led to the number of retail funds on offer in New Zealand slowly declining from 575 two years ago to about 450. Also, the average fund size has risen from $19.6 million to around $30 million.

The Consumers' Institute has tried to make the process of choosing a managed fund easier by screening super funds, unit trusts, insurance bonds and group investment funds against a set of criteria.

The results are, on the face of it, sobering. It says just 21 of about 269 unit trusts "measure up well as retirement savings vehicles." Likewise it came to a similar conclusion with super funds.

In an article published last month Consumer magazine said only 11 super schemes out of nearly 200 passed muster.

"To our dismay only a handful passed our test and even then none is ideal."

But the process has been roundly criticised in the personal investment industry as being shallow and not particularly robust. The concern is that people will take the Consumer article as gospel and go out and buy the funds it recommends. This ignores matching funds to investors' individual goals and risk profiles.

Another concern is that Consumer is acting as an adviser while not meeting the legal disclosure requirements.

The Consumer test is based on eight criteria, then running all the funds on research house IPAC Securities' database through the screens.

IPAC general manager David van Schaardenburg says the process is "reasonably simple and intuitively logical" but mainly backward looking. IPAC has always said prospective investors need to consider qualitative research which is forward looking and assess fundamental criteria such as investment process and people, as well as past performance.

Actuary Michael Chamberlain says using past performance criteria to make an investment decision is not very smart.

"In my experience, nobody has a clue what is going to happen in investment markets."

When an investor buys on past performance the probability is high they will get it wrong, he says.

A managed fund is not like, say, a washing machine. With a washing machine the inputs are stable - electricity, suds and dirty clothes. A managed fund is like a machine, but each one is custom-built, as opposed to coming off a production line. And most of the ingredients which make it work (money, markets and individual investment skills) are variable.

You put your money into the machine (like the dirty clothes) and hope you get a bigger sum at the end, but as investors know markets move and things can get better or deteriorate.

The eight Consumer criteria are:

* Access - funds have to be publicly available.

* Initial investment - maximum lump sum $2000.

* Size - $10 million minimum.

* Up-front fees - 3.5 per cent considered reasonable.

* Ongoing fees - excludes any funds which have fees other than manager, trustee and auditor.

* Track record - minimum three years' history.

* Performance - funds have to have a four- or a five-star IPAC rating.

* Continuity - senior investment management had to be with the fund for at least two years.

Three of these criteria, performance, size and continuity whittled most of the funds out of the unit trust survey.

Two-thirds of the funds were removed on the star rating criteria alone. On the IPAC scale, funds are ranked on a risk/return basis against their peers and four- and five-star ratings are applied to only the top 35 per cent.

Likewise, a fund had to exceed $10 million in size, giving it critical mass and efficiency.

The startling revelation here is that nearly half of all retail funds have assets of less than $10 million.

Mr Murphy says this is a structural problem for savers and one the BNZ has moved to address. By rationalising its range, it has the largest average retail fund size of any manager in New Zealand - $96 million. The industry average is about $30 million.

BNZ will not launch a new fund unless it can attract between $25 million and $30 million at least.

"In all honesty if a fund is $10 million or less somebody is going to come along and realise they are offering a product which is not profitable and close it."

As many investors have seen this year the ramifications in terms of cost and tax liabilities are major when a fund is wound-up (see Business Herald October 2).

Mr Murphy says investors want to be in funds that have a reasonable size, as the likelihood is greater that they will be around tomorrow.

While the logic for the size criterion is sound it is not universal. Tower, for instance, is to announce on Monday a further rationalisation of its funds range. National marketing manager Steven Giannoulis says Tower used this proposition in its process, but then decided to continue offering some smaller funds to investors, because the fees being charged back to the fund were reasonable, and they had good growth prospects.

The third factor that culled funds from the survey was continuity. Consumer says almost half the funds that failed had not retained their key staff for at least two years.

This factor is considered by some to be a bit harsh, considering the large volume of merger and acquisition activity going on in the managed fund industry.

For instance, the National Bank sold its funds management business, Southpac, to AMP Asset Management (AMPAM) less than two years ago and in that process many of the portfolio managers changed. Since the sale, the performance of many of the funds, such as the New Zealand Equity Growth Trust, has improved significantly and AMPAM won the IPAC Fund Manager of the Year crown this year.

Consumer acknowledges merger and acquisition activity. It also says many fund managers in the industry are young and therefore tend to move on.

The people issue is a problem, but it does not appear to be large. New Zealand Guardian Trust chief investment officer Michael Good says things are okay at present.

Mr Good, who moved to Sydney to run Royal & SunAlliance's Australian business after it bought Guardian Trust, says there is relative stability amongst the investment teams, and the quality has improved.

But because the New Zealand industry is not big, people tend to be less mobile and they run out of promotion options pretty quickly.

The problem is a lack of depth. When they decide to leave the problem emerges of finding experienced replacements.

Mr van Schaardenburg says, assuming not too much further company rationalisation over the next 12 months, a few more funds will pass the continuity criteria.

But investors can expect to see many more funds closing in the future as managers rationalise their ranges, particularly in the superannuation and insurance bond sectors.

One of the big rationalisers is expected to be Royal & SunAlliance that has acquired Norwich Union, Guardian Assurance and New Zealand Guardian Trust.

Mr van Schaardenburg says that since the super tax surcharge was removed, insurance bonds have lost their key reason for existing. Also, many funds in these areas are older, legacy products which have reached the end of their life cycle.

Banks and fund management companies have generally been good at product management, he says, but insurance companies, that produced many of the insurance bond and super funds, have not been so sharp.

"Life insurance companies have been great product manufacturers, but not great product managers," he says.
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Philip Macalister is the editor of money management magazine Good Returns (at www.goodreturns.co.nz). The online magazine provides news on managed funds, mortgages and financial planning.