Sunday, September 11, 2016

Brian Gaynor: KiwiSaver investment issues blown out of scale


Recent media reports could give the impression that KiwiSaver has major problems, particularly fee gouging and illegal investment strategies.

KiwiSaver should be subject to media scrutiny but most of the recent commentary has been sensationalist and misguided.

 The retirement savings initiative has been a huge success, partly because individuals have personally contributed only $13.7 billion to a scheme that is now worth $35.1b according to Reserve Bank figures.

The $21.4b gain to individual members has been due to employer and government contributions as well as investment gains. The total gain is probably closer to $23.5b as $1.3b has been withdrawn under the first home and financial hardship provisions and 152,665 members have closed their accounts because of retirement, permanent emigration, death or other reasons. It is reasonable to assume that these 152,000-plus individuals withdrew at least .8b when they left KiwiSaver.

Thus, KiwiSaver investors have had an aggregate 172 per cent return, both realised and unrealised, on their personal investments of $13.7b.

One of the disappointing features of the scheme is that the total pool would be closer to $40.0b, rather than $35.1b, if members had been more willing to invest in high-fee growth funds instead of low-fee conservative funds.

High-fee growth funds have outperformed conservative funds, on an after-fees basis, and KiwiSaver balances would now be larger if members had taken a more adventurous approach.

These latest figures are a further reminder that KiwiSaver investors should take into account the type of funds they are investing in, and the performance of these funds, as well as their fees – rather than just fees alone – if they want to maximise their KiwiSaver balance on retirement.

The other recent media issue is whether KiwiSaver fund managers have acted illegally when they invested in companies that produce anti-personnel mines, nuclear armaments and other controversial weapons.

Commerce Minister Paul Goldsmith referred the issue to the Ministry of Business, Innovation & Employment, which wrote a brief paper on the subject. Goldsmith subsequently referred the issue to the police.

This is an extremely complex issue with the following three statutes pertaining to the topic. 

The Cluster Munitions Prohibition Act 2009

The Act sets out that it is an offence to use, develop, possess, transfer or assist in the use, development, possession or transfer of a cluster munition. It also specifies that: “A person commits an offence who provides or invests funds with the intention that the funds be used, or knowing that they are to be used, in the development or production of cluster munitions.”

A person who commits an offence under this act can be imprisoned for up to seven years or receive a fine of up to $500,000, or both. 

The Anti-Personnel Mines Prohibition Act 1998

The Act prohibits the use, stockpiling, production and transfer of anti-personnel mines, although it does not specifically cover the investment of funds in these activities. However, it states that it is an offence to “assist, encourage or induce in any way” a person to develop, possess or transfer to anyone an anti-personnel mine.
The same penalty applies as under the Cluster Munitions Prohibition Act. 

The New Zealand Nuclear Free Zone, Disarmament, and Arms Control Act 1987

The Act establishes New Zealand as a Nuclear Free Zone to “promote and encourage an active and effective contribution by New Zealand to the essential process of disarmament and international arms control”.

The Act does not specifically cover the investment of funds but it states that no person shall “aid, abet, or procure any person to manufacture, acquire, possess, or have control over any nuclear explosive device”.

A conviction under this Act carries a prison term of up to 10 years.

The New Zealand Superannuation Fund excludes 19 companies under these three statutes. Seven of the 19 are in Wall Street’s S&P500 Index with a total index weighting of 1.3 per cent. These seven companies are also included in the 1570-company Vanguard International Shares Index Fund with a total weighting of 0.7 per cent. The seven companies are: General Dynamics and Textron under the Cluster Munitions Act; Northrop Grumman under the Anti-Personnel Mines Act and Fluor Corporation, Honeywell International, Jacobs Engineering and Lockheed Martin under the Nuclear Free Zone Act.

There are a number of ways one can invest in these companies, including a direct holding, shares held through external managers, through Exchange Traded Funds (ETF) or through index futures.

From a strictly legal point of view the only way that a fund manager could be convicted is if they participated in a capital raising or an initial public offering (IPO) by a company when they knew that these funds would be used to develop cluster munitions.

Most of these companies have not raised new capital in recent years and those that have are extremely small and unlikely to have attracted any KiwiSaver funds. For example, one of the excluded companies is listed on the Tel Aviv Stock Exchange and is partly owned by the Israel Military, one is a private company, another has a sharemarket value of only US.1 million, while a further two are listed on the Korea Stock Exchange.

The purchase of shares from another investor does not breach the New Zealand statutes because none of this money goes to a company to “aide, encourage, assist or induce” it to produce cluster munitions, anti-personnel mines or nuclear explosive devices. Likewise, the purchase of second-hand goods doesn’t benefit the original producers.

However, there are clear ethical issues regarding direct investment in these enterprises and New Zealand investors should avoid them.

The NZ Superannuation Fund only applies its exclusion list to direct investments although it tries to convince its external managers to avoid its excluded companies. It is much easier for a large sovereign fund to encourage its external managers to adopt its exclusion list than it is for a small KiwiSaver manager.

However, the big issue is the KiwiSaver funds that invest in large passive funds – particularly the Vanguard International Shares Index Fund – that hold excluded companies. These passive funds are widely used by KiwiSaver funds to keep their costs down while obtaining an exposure to global equities.

One of the major KiwiSaver providers has 42.7 per cent of its $850m growth fund invested in the Vanguard International Shares Index Fund. As a consequence, this fund had a $2.4m exposure to the seven excluded companies included in the Vanguard passive fund at the end of June.

This is not ideal but the KiwiSaver growth fund has not invested directly in these excluded companies, no KiwiSaver funds have gone directly to them, and the New Zealand Super Fund does not ban these indirect holdings through passive funds.

KiwiSaver members will probably experience reduced returns if these passive funds are banned because alternative passive funds are more expensive.

The other issue is futures on indices that contain excluded companies. Any restrictions on these futures would reduce the ability of fund managers to protect the value of KiwiSaver funds during a sharemarket downturn.

This issue is far more complicated than it appears because the NZ Super Fund occasionally changes its exclusion list, companies move in and out of passive funds and the NZ Super Fund does not exclude any European armaments manufacturers.

In addition, Serco Group is an NZ Super Fund excluded investment – because of its involvement in the development, maintenance and manufacture of warheads for the UK’s nuclear defence system – yet the NZ Government has appointed the UK company to manage a number of our prisons.


These prison contracts show that this issue is not clear cut and the KiwiSaver sector would welcome some clear and realistic guidelines on restricted investments.

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

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