Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: KiwiSaver investors should be thinking local

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Kiwis aren't as committed to the flag as sports fans when it comes to investing. Photo / Ron Burgin
Kiwis aren't as committed to the flag as sports fans when it comes to investing. Photo / Ron Burgin

New Zealand investors are incredibly conservative and unpatriotic. This conservatism is likely to have a negative impact on KiwiSaver returns and our strong bias towards offshore investing does little to alleviate the country's chronic capital shortage.

Our low-risk approach is demonstrated through our reliance on residential housing as the major wealth creator and KiwiSaver funds have a strong emphasis on cash and fixed interest securities rather than equities.

We are unpatriotic because a high proportion of KiwiSaver money is invested overseas.

According to Reserve Bank figures New Zealanders have $615 billion invested in housing compared with only $219 billion in financial assets. The latter includes bank deposits, fixed interest securities, shares, KiwiSaver and other saving schemes.

By comparison Australians have A$4049 billion invested in residential property and A$2773 billion in financial assets.

Thus financial assets represent only 26 per cent of gross household assets in New Zealand compared with 41 per cent in Australia and 69 per cent in the United States.

Most New Zealanders believe that residential property is a low-risk way to create wealth yet United States and European house owners have recently realised that a decline in prices can lead to huge losses on geared residential property investments.

But this column will focus on financial assets and the incredibly conservative approach we take towards asset allocation.

As the accompanying table shows KiwiSaver funds have 57 per cent of their assets in bonds or cash according to Reserve Bank of New Zealand statistics. By comparison Australian, UK and USA pension funds have between 27 per cent and 41 per cent in income assets according to Towers Watson's Global Pension Assets Study 2012.

Only Japan and the Netherlands have a higher allocation to income assets than New Zealand but both these countries have predominantly defined benefit schemes. In other words beneficiaries are guaranteed a specific outcome regardless of the performance of their fund whereas in Australia and New Zealand the financial outcome for the investor is totally dependent on investment returns.

The low-risk approach has worked for KiwiSaver investors during the global financial crisis but now is the time for individuals to take a more aggressive approach. It is totally inappropriate for anyone under 40 to be invested in a KiwiSaver fund holding cash and bonds because well-managed portfolios, with an equity bias, can generate better returns without taking too much risk.

A notable exception is those wishing to use KiwiSaver's first home facility.

Cash and bonds on their own will not generate sufficient returns over the long term for a comfortable retirement.

Another KiwiSaver characteristic is the large percentage of funds invested overseas, 49 per cent compared with just 30 per cent for Australian superannuation funds.

The small size of the NZX is a contributing factor but it also indicates that we may be taking a more theoretical, rather than a practical, approach to investing.

The theoretical attitude was reflected in John Carran's column in Tuesday's Business Herald. Carran is the senior economist at Gareth Morgan Investments.

Carran argued that investors should reduce their exposure to New Zealand because "in times of economic hardship the local sharemarket is no haven for local investors".

He wrote that KiwiSaver managers would flood "the local sharemarket with funds beyond its capacity to absorb them" and this would be "a recipe for poor quality investments and low returns".

He then went on to argue that overseas investing offered a wider choice of companies, including Nike, McDonald's, Apple, Samsung, Google and Coca-Cola, and emerging economies offered attractive opportunities as they are growing rapidly.

Such opinions are fine from a theoretical point of view but the investment world is far too volatile to take a fixed and intractable long-term view. Practical considerations are more important, including when to be in or out of a domestic sharemarket and when to buy into and sell out of emerging markets.

Long-term buy and hold strategies will not generate superior returns in the current environment.

Firstly, New Zealand companies are continuing to perform relatively well in low growth conditions and the upcoming reporting season should confirm this. An increase in the company tax take, reported by the Treasury, indicates that our larger companies are in relatively good shape. As a result the New Zealand sharemarket has been one of the best performing markets in recent years and KiwiSaver funds with an offshore bias have not performed as well as those with a domestic orientation.

In addition, New Zealand investments offer large tax advantages, including imputation credits.

Offshore investments also carry significant risks and costs, in terms of currency exposures and higher management fees, and most of the popular international funds have generated low returns in recent years.

For example, the highly regarded Templeton Emerging Fund, which is listed on the NZX, had a 14.4 per cent negative return - in New Zealand dollar terms - over the past twelve months and a positive return of only 0.9 per cent per annum over the past five years.

There will be a time to invest in emerging markets but portfolios with a large allocation towards emerging markets would have had far lower returns in recent years than those with an NZX bias.

The New Zealand economy and sharemarket are a better proposition when global economic growth is low but global equities, including emerging markets, are more attractive in high growth situations.

New Zealand assets are also more appropriate for older KiwiSaver members because they are usually less risky than offshore investments.

Carran argued that KiwiSaver funds would swamp the domestic sharemarket and this would be "a recipe for poor quality investments and low returns".

This argument is both flawed and inconsistent with some of his other opinions.

According to Reserve Bank figures New Zealand superannuation funds, including KiwiSaver, have invested $3.2 billion in domestic equities.

This represents just 5.4 per cent of the NZX's $59.1 billion capitalisation.

By comparison Australian pension funds represent well over 30 per cent of the ASX's A$1229 billion capitalisation and no one is arguing that this is a negative for investors and the Australian market.

Self-managed superannuation funds across the Tasman, which are becoming increasingly important, have a particularly strong bias towards ASX listed companies.

On the other hand if Carran is correct, and the NZX is swamped with KiwiSaver money, then it should produce excellent returns over the next few years. If this occurs then investors would be advised to keep most of their money in New Zealand.

It is important to have a diversified investment portfolio with offshore assets but the timing of any overseas move is important and New Zealand securities should continue to be an important part of any portfolio.

There is an old saying that the best time to invest in an asset class is when it is unloved, and the fundamentals are positive, whereas the best time to exit an asset class is when everyone believes that prices can only keep on rising.

We saw these positive expectations in relation to the domestic sharemarket in the mid-1980s and we see it now with residential property.

The domestic sharemarket has good fundamentals at present but it is almost totally unloved. This indicates that it may be a good place to be over the next few years.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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