New Zealand has a weak track record when it comes to saving and an even worse scorecard when it comes to looking after what savings we have.
It hasn’t been helped by the low standards in our funds management industry.
A 2010 report marked New Zealand’s fund managers with an overall “D” in the investor experience survey, last out of 22 countries surveyed.
The survey considered a range of aspects including regulation and taxation, disclosure, fees and expenses, and sales and media.
For a government keen on league tables coming last should have been an embarrassment.
New Zealand’s problem is more about how well we manage our savings rather than how much we save.
Look no further than the sad examples of finance companies seducing savers, mainly retirees, with seemingly secure debentures used to fund property developments.
The returns looked good and people thought, ‘surely finance company debentures promoted by pillars of the community will carry very little risk’.
The destruction of billions of dollars of savings highlights the need to lift our understanding of what investment returns mean.
To do that savers need information to help them understand the risks they are taking with their savings and financial market regulators could help by requiring fund managers to make the appropriate information available.
New Zealanders are projected to have a whopping $60 billion invested in KiwiSaver by 2020 and with almost two million Kiwis already enrolled, we have gone all-in on this retirement savings scheme.
This series of articles will outline why Kiwis don’t have the information they need to avoid making a cock-up with their KiwiSaver nest egg, and what information the government needs to force providers to cough up so that investors can make intelligent decisions.
From my perspective there are four pillars of portfolio performance, all of which an investor should have a reasonable understanding of if they’re to make smart decisions.
They are: returns, volatility, liquidity and catastrophic risk.
This article focuses on the first of these – returns.
It’s ironic that investors and fund managers focus mostly on returns, while the risks are virtually ignored.Typically investors focus on what return they think they will get when deciding where to put their savings.
Sometimes they realise only too late that there is a lot more to investment returns and the safety of their capital than meets the eye.
Their knowledge of what risk actually is, remains woeful.
Providers are only too happy that investors remain at an information disadvantage.
Investment performance is not the same thing as investment returns.
Returns are purely what’s earned on an investment, both capital gains and income, and to be of relevance to the investor any measure of return must be net of tax, fees and all other investment costs.
Investment performance is a wider concept and involves returns, volatility, liquidity, and the chance of losing the lot (catastrophic risk) – what I call the “four pillars”.
Returns are what you want to get, the other three all relate to the risks you take in chasing those returns.
It’s ironic that investors and fund managers focus mostly on returns, while the risks are virtually ignored.
No wonder the return on New Zealanders’ savings remains abysmal.
Even in this area, the simplest of the four, reporting is poor. That is to say, there are still no standards for KiwiSaver providers to follow when calculating and reporting returns, which makes any meaningful comparison of returns next to impossible.
For instance, KiwiSaver returns’ tables show returns before tax and after most, but not necessarily all, fees and costs have been deducted.
Given that different funds face different tax liabilities, that limits the value of before-tax comparisons from the perspective of a retail investor.
They don’t tell you what you get in your pocket.
The government is promising to bring in new reporting requirements for KiwiSaver providers by next April to help make returns data more comparable.
However, there seems little appetite within the industry for adopting international standards for reporting investment returns – the Global Investment Performance Standards.
Will the government have the guts to put the interests of KiwiSaver members before those of the funds management industry and require world best practice for reporting investment returns?
The industry’s value proposition is that it can deliver returns that match or better the market. But without rigorous standards for reporting returns and a measure of the appropriate market return savers simply can’t see when a fund manager is adding value.
Best practice dictates that fund managers compare investment returns against a relevant benchmark. Few fund managers in New Zealand do this. Most provide no benchmarks at all.
The valid comparison is with a benchmark that reflects the nature of the fund being offered.
A growth fund’s returns should be benchmarked against the relevant market indexes.
So if the manager is investing in international equities the appropriate benchmark is the world share market index.
If the manager is running a mix of world shares, NZ shares and NZ fixed interest, then the appropriate benchmark is the weighted returns of all three of those markets.
Returns should be compared to a relevant benchmark. It would be silly, for instance, to have a benchmark for a growth fund that is the market cash return plus a margin, but that is what’s happening in KiwiSaver land.
If the government required all funds to state their investment proposition and produce a relevant benchmark it would be a great leap forward for investors.
Not all returns are the same. Let’s demonstrate that by example.
How often do you think the buildings that make up the property allocation inside your KiwiSaver fund are valued?
Is the 10 per cent property allocation in a fund independently valued every time money flows in or out, so that exiting and remaining investors are treated fairly?
No! More likely it’s independently valued every year – and even that is more of a guess as to what it would fetch if sold.
Two issues arise here.
- Comparisons of month-by-month returns of this sort of fund with another whose assets are all listed, and therefore valued daily, are meaningless. One contains assets that can’t be valued with anything like the reliability of the other.
- Secondly investors aren’t treated fairly when money flows in and out of the fund if asset values cannot be relied upon.
Another problem comparing past returns across funds is “survivorship bias” – where managers euthanise poorly performing funds.
Within the large group of funds that we have in New Zealand, it’s guaranteed that one or two will exhibit stellar returns, or very poor returns, simply by luck.
It’s in the fund managers’ interest to wind up the poorer returning funds and promote to high heaven the lucky funds.
Backward-looking fund comparisons thus become more and more inaccurate over time, as the universe of funds that make them up become distorted by the omission from the data of poor performers and the addition of new funds.
Investment managers who are adept in “fund rotation” amass an undeserved reputation via this practice.
Investment returns are not the same thing as investment performance.
The latter takes into account volatility, liquidity and exposure to catastrophic risk.
KiwiSaver providers are not required to follow any rigorous standards when calculating and reporting returns, making robust comparison of providers all but impossible.
Yet publishing tables of these meaningless numbers isn’t outlawed.
Furthermore, providers are yet to be required to publish an appropriate benchmark against which fund returns can be measured.
Given our funds management industry scores so poorly across a number of important criteria it’s high time the regulators looked at adopting world best practice, such as the Global Investment Performance Standards, that would go a long way to addressing the problems I’ve outlined above.