Why have KiwiSaver investors received much lower returns, on average, than the New Zealand Superannuation Fund and Australia's Future Fund?

Is this underperformance due to the choice of funds, asset allocation or fees?

The figures in the attached table show that the Super Fund and Future Fund have out-performed aggregate KiwiSaver funds by a wide margin, particularly over the three and five years ended December 2015.

NZ Super achieved a return of 13 per cent per annum in the five years to December 2015, the Future Fund 10.5 per cent and aggregate KiwiSaver funds only 7.9 per cent.

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The Future Fund had A$118.4 billion under management at the end of 2015, NZ Super $29.5 billion and KiwiSaver $30.8 billion.

The objectives and investment mandates of the three schemes are as follows:

• The Future Fund's role is to strengthen the Australian Government's long-term financial position, particularly as far as unfunded superannuation liabilities are concerned. Its investment mandate "requires the board to maximise the return on the fund over the long-term".

• The Government uses NZ Super to help pay for the future cost of providing national superannuation. Its investment objective is to "maximise returns without undue risk to the fund as a whole".

• KiwiSaver's main purpose is "to encourage a long-term savings habit and asset accumulation by individuals who are not in a position to enjoy standards of living in retirement similar to those in pre-retirement". The Treasury believes that one of the scheme's main objectives is to "maximise accumulation of wealth".

If all three schemes have the main objective of maximising returns, without taking undue risk, why has KiwiSaver significantly underperformed NZ Super and the Future Fund over the past five years?

The first issue to look at is the choice of funds.

Long-term oriented superannuation funds usually have a strong bias towards growth assets, mainly shares, but KiwiSaver Survey members have 27.9 per cent of total funds invested in conservative funds and 14.8 per cent in moderate funds. This is an extremely cautious approach because conservative funds have an average growth asset allocation of only 20.4 per cent and moderate funds 32.4 per cent.

The original intention was that these conservative funds, which are predominantly default funds, were to be a short-term alternative for automatically enrolled members until they made an active choice.

These default funds are "conservative" with a growth-asset allocation in the 15 per cent to 25 per cent range and relatively low management fees.

The Treasury argues that the amount invested in default funds has declined as a percentage of total KiwiSaver funds but in absolute terms they have risen from $3.5 billion at the end of 2011 to $5 billion two years later and $6.9 billion at the end of last year.

The five original default funds, which now have total funds under management of $6.6 billion, have delivered a weighted return of only 5.9 per cent per annum over the past five years compared with 7.9 per cent for all KiwiSaver funds and 13 per cent for the NZ Super Fund.

KiwiSaver has been extremely successful in attracting 2.58 million members but one of its main problems is that too many investors have a low exposure to growth assets.

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Default funds have low fees but they have also had relatively poor returns.

Our choice of funds is the main feature determining KiwiSaver's overall asset allocation, which is outlined in the accompanying table. Long-term oriented superannuation funds should have over 60 per cent invested in growth assets but KiwiSaver schemes have only 46 per cent. This compares with 68 per cent for the Future Fund and 87 per cent for the NZ Super Fund.

The five major superannuation classifications in Australia, which have total assets of $1.75 trillion, have the following growth asset allocations:

• Retail funds have 61 per cent invested in growth securities.

• MySuper has a 72 per cent growth allocation.

• Industry funds have allocated 73 per cent to growth assets.

• Public Sector funds have 66 per cent invested in growth assets.

• Corporate funds have a 64 per cent growth assets allocation.

The difference between a growth asset allocation of just 20 per cent (KiwiSaver default funds), 46 per cent (all KiwiSaver Funds) and 87 per cent (NZ Super Fund) has been the main factor determining their relative performances over the past five years.

Growth assets (equities) don't always out-perform income assets (bonds and cash), particularly over short-term periods, but they should out-perform in the longer term, albeit with far more volatility than income-oriented funds. Accordingly, smart money, notably the NZ Super Fund and the Future Fund, has a high allocation to growth assets.

Nevertheless, an active management approach is important and the Future Fund cut its growth asset allocation from 76 per cent to 68 per cent over the past 12 months in order to reduce the level of risk in the portfolio "reflecting our view of the investment environment".

Finally, there is the issue of fees, which a number of commentators believe is the most important factor in determining the performance of KiwiSaver funds. This conviction is based on the belief that individual KiwiSaver funds cannot outperform the average over the longer term and, accordingly, fees will determine the difference between the best and worst performing funds.

The following figures show the annualised performance of the main KiwiSaver fund types over the past five years and their average fees or expense ratios. The data is derived from Morningstar's December Quarter 2015 Survey and it is important to note that the returns figures are after fees:

• Default funds had a weighted average return of 5.9 per cent per annum for the five years ended December 2015 and an expense ratio of 0.49 per cent.

• Conservative funds returned 6.1 per cent per annum and had an average fee of 0.79 per cent.

• Moderate funds achieved 7.1 per cent per annum and had an expense ratio of 0.94 per cent.

• Balanced funds achieved an annual return of 8.4 per cent on fees of 1.03 per cent.

• Growth funds achieved returns of 9.6 per cent per annum on fees of 1.14 per cent.

• Aggressive funds reported average returns of 8.5 per cent and fees of 1.5 per cent.

These figures, with the notable exception of aggressive funds, completely refute the belief that low fee funds out-perform higher fee funds over the longer term.

Admittedly, five years is a relatively short period of time but higher-fee growth-oriented funds should continue to outperform in the longer term.

KiwiSaver has been extremely successful in attracting 2.58 million members but one of its main problems is that too many investors have a low exposure to growth assets.

This is primarily due to the default fund system, misguided advice that places the main emphasis on fees and a lack of understanding of the importance of asset allocation, particularly the role played by growth assets in generating higher long-term returns.

The Treasury noted in its September 2015 KiwiSaver review that "the portfolio of assets in KiwiSaver is heavily weighted toward income assets relative to growth assets, in contrast to other comparable superannuation and savings vehicles in New Zealand and overseas which could lead to less than optimal future retirement incomes".

These comments are spot on but The Treasury's review was notable for the absence of any realistic recommendations to resolve this issue.

• Brian Gaynor is an executive director of Milford Asset Management which is a KiwiSaver Scheme provider.