A research firm is questioning the Government’s decision to focus on fees in selecting new KiwiSaver default providers after it found no historical link between low fees and better performance.
In May the government announced a major shake-up of the KiwiSaver default providers with ASB, ANZ, AMP, Fisher Funds and Mercer all losing their default status at the end of November.
Bank of New Zealand, Booster, BT Funds Management (Westpac) and Kiwi Wealth kept their default status while Simplicity and Smartshares (NZX) are newly appointed to the roles.
Kiwis are randomly allocated to a default fund when they start or change jobs and do not select their own KiwiSaver fund. Around 381,000 were in the default funds at the end of March and about 230,000 ended up moving providers as result of the default change.
Tim Murphy, director manager selection APAC for Morningstar, said while several criteria were used to determine the new default providers including lower fees and higher levels of service it was clear from outcome that low fees was the most important determinant.
Murphy said there was lots of academic research around low fee funds outperforming high fee funds but most of it was based on large diversified markets like the US.
It analysed KiwiSaver returns against fees over three, five, seven and 10 year periods for the former conservative default funds and found the evidence for low fees being predictive of further net returns was not strong.
“In fact, over three years, five years, and seven years, it would be reasonable to conclude that there is no relationship between fees and net returns, while over 10 years, high fees were in fact more conducive to higher returns, albeit in a small sample size.”
It also undertook the same research on the balanced KiwiSaver funds and found over seven and 10 year periods there was no evidence to support low fees being the primary basis for default provider status leading to better investment outcomes.
“In fact, over 10 years, the opposite is true, with mild positive correlation between fees and returns, whereas if low fees were predictive of future returns, you would expect to see negative correlation.”
While there was some correlation between lower fees and a better return over three and five years Murphy said the outcome was skewed by one fund that was a particularly poor performer with high fees.
Murphy said based on real life data from the KiwiSaver market there were some unique elements about the New Zealand market that were different to some of those broader markets.
“There is basically no evidence to suggest in either the existing default settings or the balanced category which is now the new default setting that low fee funds outperform high fee funds on average.
“Therefore to use that as the predominant overriding criteria doesn’t seem to make sense to use based on the empirical evidence within KiwiSaver.”
He said the Government should have used a more balanced range of criteria in terms of making the overall assessment rather than letting fees alone dominate that.
“When the best-performing balanced fund provider over five years, seven years, and 10 years — Milford — doesn’t even bother applying for default provider status, knowing it would have little chance of success given that its fees are some of the highest in the market, then the process must surely come into question.
“Surely any review of default providers should be aiming to attract the best-performing funds over the long term, as that is what will best meet the stated objective “to enhance the financial well-being of default members, particularly at retirement” for the largest cohort of KiwiSaver members rather than a philosophical focus on just one data point—low fees.”
Murphy also questioned with several new entrants all offering low fees whether being a default provider was commercially viable in its own right or just a loss leader designed to attract new members that could then be upsold into higher margin products.
“I think there is a risk new providers won’t be able to make it work commercially.
It is one thing to grow funds under management but growing profit off the back of that is a different thing. You get some revenue but cost to service that isn’t zero.”
He suggested that if the government wanted low fees to be a focus for the KiwiSaver default funds it should set up one central low cost fund where it could control fees without commercial considerations.
“This would remove the risk of “loss leader” behaviour from commercial operators.”
On top of that change, the switch in provider default funds have also moved from conservative to balanced meaning they must invest more in growth assets like shares and property.
Murphy said the move from conservative to growth was long overdue but may not have gone far enough.
“With the exception of people who want to use it to buy their first home… If default assumption is that the median investor is using it as a retirement savings scheme that is going to be a multi-decade investment horizon in which case it should be a high growth option.”
He pointed to the fact that most of the default options for Australian superannuation funds were growth with some being high growth.
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