Sunday, October 18, 2015

Brian Gaynor: How KiwiSavers react to a market downturn


There have been a large number of letters in the media over recent weeks from concerned KiwiSaver investors. These investors are worried about the downturn in the world’s equity markets and the impact this will have on their portfolios.

Comments include; “we are a bit concerned we’ve bitten off more risk than we can chew”, “we have some concern about our KiwiSaver accounts”, “why would I not change to a lower-risk fund now, before the market truly takes a beating?” and we want “the flexibility to move into cash quickly when the market takes a dive”.

These are predictable responses to a market downturn; investor reaction to rising and falling markets offers a fascinating insight into human psychology.

Investors are fearless in a rising market and want to buy more and more shares while they are frightened when a market starts to fall and want to sell out.

KiwiSaver investors, particularly those under 55 years of age, should stick with growth funds regardless of short-term market conditions because these funds should deliver higher average returns over the longer term.

However, they also have to accept that higher risk funds will continue to be more volatile than conservative funds.

As KiwiSaver schemes have been investing since October 1, 2007 we can compare the performance of the different type of funds over this seven year and nine month period (the latest September quarter performance figures are not yet available).

The figures for the three largest KiwiSaver funds in the conservative, balanced and growth sectors – as defined by Morningstar – are as follows;

  • The three largest conservative funds have achieved an average return of 3.8 per cent per annum, after all fees and tax, since Kiwisaver’s inception on October 1, 2007
  • The three largest balanced funds have reported an average return of 5.0 per cent per annum
  • The three largest growth funds have delivered an average return of 5.4 per cent per annum.

These nine funds are fairly representative of KiwiSaver as they have total funds under management of $11.0 billion, representing 39 per cent of all KiwiSaver funds.

Growth orientated funds outperformed balanced and conservative portfolios by a wider margin in the five years ended March 2015. This essentially covers the post global financial crisis era.

During this five year period the average performance of the three largest conservative funds was only 4.6 per cent per annum while the balanced funds averaged 7.7 per cent and the three growth funds had an average return of 9.2 per cent.

The figures for the conservative, balanced and growth groups are consistent with expectations over the longer term. That expectation is that growth funds outperform balanced funds over a five year plus period and balanced funds outperform conservative funds.

However there are a number of points worth noting about these figures;

– High risk funds are more volatile than low risk funds. For example, the best and worst years for these nine funds since the start of KiwiSaver have been;
  • Growth funds; plus 49.0 per cent to minus 20.5 per cent
  • Balanced funds; plus 18.6 per cent to minus 11.2 per cent
  • Conservative funds; plus 15.4 per cent to minus 6.0 per cent
– Growth and balanced funds have higher fees than the low risk funds. The three largest growth funds had an average fee of 1.16 per cent for the March 2015 year, the balanced funds had an average fee of 0.98 per cent and the conservative funds 0.45 per cent.

With this in mind it is important to note that performance figures quoted in this column are after all fees.

KiwiSaver investors probably have a strong bias towards conservative funds because the higher risk funds are more volatile and have higher fees.

Recent media letters indicate that some KiwiSaver investors panic when sharemarkets fall and switch from a growth or balanced fund to conservative funds with the aim of switching back to growth funds when markets improve.

It is extremely difficult to get this timing right and investors may be best advised to have a mix of conservative, balanced and growth KiwiSaver funds if they are concerned about market downturns. Most KiwiSaver providers have a wide range of funds available and investors can mix and match these funds.

Meanwhile, KiwiSaver investors have became less conservative in recent years as growth and aggressive funds now represent 28.0 per cent of total KiwiSaver funds compared with 23.8 per cent two years ago. Conservative funds represent 27.9 per cent of the total funds compared with 35.8 per cent in June 2013.

Why do growth funds generate higher longer term returns, why are they more volatile and why do they charge higher fees?

The accompanying table compares the asset mix of the three largest conservative, balanced and growth KiwiSaver funds compared with the $29.5 billion New Zealand Superannuation Fund.

The main point to note is that the conservative funds have only 20 per cent in growth assets, balanced funds have 55 per cent allocated to growth assets, growth funds 79 per cent and NZ Super 88 per cent.

KiwiSaver asset – NZ Super has more growth assets



Although the performance figures are not strictly comparable because of fees, tax and the continual flow of funds in and out of KiwiSaver, it is clear that the growth orientated NZ Super Fund has had better performance figures than the larger KiwiSaver funds included in this analysis.

This outperformance is for two periods, firstly, since the inception of KiwiSaver in 2007 and secondly, for the five years ended March 2015.

It is reasonably clear that the higher the risk, the higher the return over the longer term. In other words, as the asset allocation bias moves down the left hand column of the accompanying table – from cash to equities to other (mainly private equity) – then the higher the return over the longer term.

However, this higher long-term return will be accompanied by far greater volatility than that experienced by low-risk conservative funds.

The other issue is fees.

The three largest conservative KiwiSaver funds have a substantial percentage of their investments in cash which doesn’t require a great deal of in-depth investment analysis.

In addition these low risk funds have fewer investments than balanced or growth funds. For example, the ten largest investments account for 50.4 per cent of conservative fund portfolios, the top ten account for 16.3 per cent of balanced fund portfolios and just 13.3 per cent of growth funds.

The higher risk funds usually have a far wider spread of investments in order to diversify their risk. They also hold a large number of shares in individual companies, rather than cash. A diversified portfolio, holding a large number of individual securities, requires much more in-depth analysis than a cash orientated portfolio.

Thus, it is more costly to run a successful growth fund than a conservative fund.

Given the small size of the New Zealand sharemarket it is inevitable that growth orientated KiwiSaver funds will have to invest more and more of their incoming money into international equities and other investments, including private equity.

The NZ Super Fund has shown that international equities and private equity can deliver very satisfactory returns but they are more suitable for younger KiwiSaver investors who are not overly concerned about volatility.

Nevertheless, older KiwiSaver members can have a mix of conservative, balanced and growth funds to ensure that they don’t completely miss out on the long-term advantages of higher-risk portfolios.

Brian Gaynor is an investment analyst and the Executive Director of Milford Asset Management. 

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