27 October, 2017

ANZ’s Ana-Marie Lockyer recently commented on goodreturns.co.nz that KiwiSaver members need to focus on returns-after-fees, not just fees. By choosing low fee funds, members may be losing out on returns, she says.

Fees can eat into KiwiSaver returns but some players suggest they can deliver more

We believe fund comparison is important, so how we compare funds?

The Morningstar KiwiSaver Survey for December 2016 presents information for 24 KiwiSaver growth funds, of which 16 have returns for the past five years.

There is a wide spread in the returns for these funds, ranging from 8.9% per year to 13.1%, with an average of 11.1%.

Importantly, there are significant differences in the composition of the portfolios in this category.

While Morningstar only gives a very general breakdown, we can see that funds hold between 60% and 84% in growth assets.

What is a growth asset?

This is how much each fund has invested into shares and property assets, investments we consider to be more risky, and that as a result should have a higher expected return. A 24% difference in exposure to growth assets can account for a lot of return!

This is also a very general breakdown, and ignores factors like international exposure.

In the last year the New Zealand market performed well below other international markets, although in prior years a high exposure to the New Zealand market resulted in significant returns.

How does this relate to ANZ’s comments?

ANZ argues that when compared to several peers they perform well, and that this justifies their fee structure.

Ignoring the fact that past returns are a poor indicator of future returns, their naïve comparison overlooks the potential for very significant differences in the level of risk being taken.

Back to our original question: how should we compare between funds?

The academic literature tends to focus on what is referred to as risk-adjusted performance.

These models benchmark a fund against the performance of a purely passive strategy (you simply buy the market portfolio).

If your fund had the same risk as the market, then you should earn at least the same return as the market. Only if you earn more than the market can you claim to outperform.

What does the academic literature say?

In general there is no evidence to suggest that funds can consistently outperform the market on a risk-adjusted basis, after fees.

There is a wealth of literature to support this point from all over the world.

Some fund managers have suggested that due to its size and under-developed capital markets, New Zealand is a market that allows local funds to outperform consistently.

The academic evidence on KiwiSaver, conducted by colleagues at AUT, find this is not the case.

When you look at whether funds can outperform the market the answer is no.

The results show that once you control for risk appropriately, rather than simply comparing to the performance of broadly defined categories or against select peers, virtually no funds outperform.

And if funds do not outperform the market (what is known as a passive strategy) then the question becomes: is it worth paying for funds to spend YOUR money on researching the best stocks if you do not get any benefit?

ANZ has clearly shown that there is a difference over 10 years in the returns between themselves and select other funds, BUT without showing that they generate true outperformance after accounting for risk appropriately.

They haven’t yet justified charging higher fees in our opinion.

Associate Professor Aaron Gilbert and Dr Ayesha Scott, AUT Business School.