KiwiSaver has turned out to have been a hugely successful financial product but there are some nasty changes lurking over the horizon.

It's the old story - whenever anybody accumulates a large sum of money various undesirables start scheming to get their hands on it. Banks, which manage most of NZ KiwiSaver funds are keen to keep those fees flowing after you retire so are lobbying the government to force KiwiSavers to take part or all of their savings in an annuity. Treasury, mindful of the need to balance the budget is also likely to be looking enviously at the growing treasure chest that is KiwiSaver.

The original architect of KiwiSaver, Sir Michael Cullen with the assistance of a Treasury model, recently set out his views as to how KiwiSaver should fit into a national saving for retirement strategy in conjunction with the need to make National Superannuation sustainable.

Let's take a look at what Dr Cullen had to say. His thoughts were revealed in a paper he presented at an "Affording Our Future" conference in December of last year. It didn't get much comment in the media at the time which is interesting because Dr Cullen's proposals are radical and would, if adopted, substantially impact many people's retirement.


First off Dr Cullen's rehearsed the argument that due to demographic trends National Super is unsustainable so either we take small steps to avert this trend now or face the prospect of drastic corrective action further down the track. Dr Cullen adds that "we should not leave to our children and grandchildren harder choices than we are prepared to make ourselves and gradual adjustment is preferable to "big bang pyrotechnics". Good stuff! However Dr Cullen proposes radical change is in the area of funding retirement income. He says that "with life expectancy rising some increase in the age criteria is inevitable" which is fair enough but he rejects lowering the level of payment or income testing. His solution is to reduce the cost of National Super by:

* Making KiwiSaver compulsory
* Increasing mandatory contribution rates from individuals and employers
* Forcing KiwiSavers to take half their savings by way of an annuity
* Assessing eligibility for National Super on the basis of the annual National Super allowance less the annual value of their KiwiSaver annuity.

Mr Cullen commented "in effect this means this would result in half of people's KiwiSaver savings being income tested". That was one option Mr Cullen had for reducing the cost of National Super and his second option was a withdrawal tax on final KiwiSaver savings of 10-15 per cent. He seemed to favour the latter option.

Now I'm no expert on KiwiSaver but it seems inequitable and perverse to compel NZ'ers to save via KiwiSaver and then impose a greater tax on that savings option than other savings options. Better to just means test National Super and do it properly so people can't hide behind family trusts etc.

Next up was the Productivity Commission's (PC) attempt to improve the value for money proposition of KiwiSaver by helping KiwiSavers to more easily assess fees and switch to lower cost providers. The PC revealed that it was considering developing a website to help KiwiSavers to differentiate between schemes on the basis of cost.

Needless to say the PC initiative has provoked a lot of angst in adviser-land and one high profile fund manager even launched into print criticising the initiative. Virtually every comment from financial advisors on a financial advisor website gave the thumbs down to the PC proposal with one particularly vitriolic outburst being "this is a disgrace and an insult to advisors who are trying to get through regulation". Another volunteered the ridiculous view that "focusing on fees misses the main point of KiwiSaver and retirement in general". You have to wonder about the state of the Continuing Professional Development industry and the AFA qualification in general when confronted with this level of ignorance.

Fees are critical - the Government Actuary told me that a quid pro quo for getting default provider status was to have a low annual fee structure. The sad fact is that it is virtually impossible to consistently pick outperforming fund managers so investors need to focus on that information which you can be sure of and chief amongst those is .... fees. The PC is very much on the right track here, according to many unbiased experts and it shouldn't get bullied by people who should know better. Let's see what those experts have had to say on the fees/performance issue of late:

1. Writing in the Financial Times last year a senior visiting fellow of the Pensions Institute at the Cass Business School said "there is little academic evidence to support the argument that asset management and a potential for outperformance is more important than cost".

2. In "Why Do Retail Investors Make Costly Mistakes - An Experiment On Mutual Fund Choice" two law professors at the University of Pennsylvania write that there is "mounting evidence that retail investors make predictable, costly investment mistakes including the payment of excessive fund fees". The professors cite "the fact that high fee funds underperform".

3. In February of this year the US National Bureau of Economic Research based in Massachusetts under took a mystery shopping exercise and defined good advice "as advice that moves the investor toward a low cost, diversified, index approach" and acknowledged that this approach is the strategy that many text book analyses of investment suggest is the best approach. The NBER study further added that the market for financial advice "leans against those products which do not generate high fees".

4. Financial advisers and fund managers are fond of saying that investors "get what they pay for" but the truth is that you don't get what you pay for because, duh, what you pay goes to somebody else! We covered the "you get what you pay for" nonsense back in 2009 and highlighted two articles from the Journal of Finance. The first study concluded that funds with high fees underperform even before the deduction of fees! The other study, by Mark Cahart, in the March 1997 Journal of Finance concluded that "expenses have at least a 1 for 1 negative impact on performance".

At first glance the negative response from financial advisors might seem strange given that Code Standard 1 in the Code of Professional Conduct for AFAs says you have to put client's interests first so anything that reduces cost would seem a good thing. But the reality is that many financial advisors outside the banks who advise on KiwiSaver tend to limit their recommendations to KiwiSaver providers which pay commission and those KiwiSaver providers nine times out of ten have much higher fees than the default providers so the PC initiative is a direct threat to those financial advisors business models. If Mum and Dad switch the trailing fee stops.

Now to pre-empt the inevitable squealing we all know that some local fund managers have done well and it's even remotely possible that unlike virtually every other major stock and bond market in the world local share managers can beat the market in NZ. Maybe.

There are however other more plausible explanations for their outperformance and we touched on this on 27 February 2010 in an article entitled "Stats Police Put Fund Managers on Trial". Note that this column is not suggesting that investors should ignore actively managed funds - best practice as evidenced by pension fund strategies is to only index half of share portfolios.

But what everybody should be clear on however is that costs are important and unlike performance they persist. Until advisers acknowledge that fact how can they discharge their responsibilities under Code Standard 1? Fund managers are so conflicted it's not funny so when they feel the need to comment on fees they should reflect on the FMA's overarching objective of "fair, efficient and transparent financial markets" and ..... say nothing.