Capital Markets: Not enough big local fish for savings pool

By Alexander Speirs

The absence of domestic investment opportunities is seeing increasing amounts of KiwiSaver fund money finding its way overseas, reports Alexander Speirs.

Photo / David White
Photo / David White

Since its inception in 2007, New Zealanders have subscribed to the Government's KiwiSaver retirement scheme in numbers far surpassing initial projections. By the end of March, 2.3 million Kiwis were actively involved in the scheme - dwarfing the 700,000 Treasury expected to have enrolled at this point.

The substantial number of members has seen the pool of capital in KiwiSaver expand to $18 billion at present, set to grow to $80 billion by 2026 and $146 billion in 2036. The speed with which the capital has accumulated is promising, and the quantity significant by New Zealand standards - but the absence of domestic investment opportunities is seeing increasing amounts of that money finding its way overseas.

New Zealand stock markets don't have the capacity or exposure required by large fund managers to handle the investment now or into the future. Despite the significance of the NZX growing from 32 to 38 per cent of GDP, it remains small compared to the overall size of the economy.

"We don't have as good a representation of the economy on our sharemarket as a lot of other economies do," says Anthony Quirk, managing director at Milford Asset Management. "There remain large parts of our economy which aren't really represented on there at all."

Representation of the financial sector is the most glaring omission, with none of New Zealand's major banks listed, as in Australia or other major markets. Beyond that however, the number of new companies transitioning from private to listed status remains woefully insufficient.

"The birthrate of companies who are coming on to the stock exchange has been too low historically and it remains an issue today. Be it early stage growth companies or established businesses, we're not seeing enough companies listed."

The dearth of domestic opportunities in which to place the growing wall of KiwiSaver capital has seen increasing amounts channelled offshore. "Investors will always be looking for a balanced portfolio and will take advantage of offshore opportunities. The New Zealand sharemarket doesn't have comprehensive enough coverage and exposure to all sectors, it's imperative that some funds are divested offshore for effective risk management," says Jim McElwain, Executive Director of the New Zealand Institute of Financial Professionals.

"We shouldn't be xenophobic and say that all investment should be in New Zealand; overseas investment will always have an important part to play in a balanced approach to KiwiSaver. The more that we can see invested in this country the better though, because it's a positive for everyone - it's a win for the KiwiSaver investor because they're seeing positive returns, but it's also a productive investment for the New Zealand economy."

Simon O'Grady, Chief Investment Officer at Kiwibank notes that though productively using money in New Zealand is desirable, producing the best outcomes for investor capital had to remain top priority.

"Fund managers responsible for the invested funds have a fiduciary duty to their investors. We constantly have to look at the expected risks and returns, then ask where we are going to get the best risk adjusted returns from and increasingly that looks like it's offshore.

"As fund managers we don't really have a choice. There's a quickly growing pot of money and if the nation can't create opportunities domestically to invest that are going to return risk-adjusted rates high enough to justify it, the money will go offshore".

The challenge for New Zealand businesses across the board is to create opportunities for productive investment at home, while producing sufficient rates of return to stack up with international prospects.

"We foresee there being a supply side response where private or partially private companies will take the opportunity to become listed and open up new opportunities for investment which is very good for KiwiSaver.

"Nationally it doesn't create any new value though, all it does is transfer money out of the KiwiSaver pot and into private hands. Then you have the same issue - where are they going to put that money - and realistically, it's likely to end up overseas somewhere down the line.

"We need to focus on how we as a nation create globally significant and competitive industries that can really foot it on the international stage, rather than just recycle money between public and private hands," says O'Grady.

"It's an issue now and it's an issue into the future," adds Quirk. "One of the things you would hope it would do is provide more capital for growth in New Zealand where it can be productively utilised. It's important though that if you're investing in New Zealand, you don't just do it just for the sake of it."

If New Zealand is going to attract its fair share of the KiwiSaver investment pot, creating new opportunities which can transition to scalable and listable businesses is imperative.

"We have one of the highest rates of entrepreneurship in the world in terms of the number of companies started, but a real problem taking those fledgling companies through to critical mass," says McElwain.

"We need to take these smart Kiwi companies from $5 million-$10 million annual sales through to the $50 million-$100 million level. At that level they develop critical mass and become self-sufficient, helping to address the gap in the middle between our small businesses and our large-cap companies."

Headlined by Xero, New Zealand has seen the birth of some high-profile technology companies in recent years which have developed from small businesses through to NZX main board listings.

Floats of businesses like Wynyard Group and Snakk Media have broken the historic perception of New Zealand markets providing low growth and high-dividend yield. "The abundance of high-end technology listings we've seen in New Zealand of late does suggest that there is an appetite for high-risk, high-growth opportunities," says McElwain. "We've seen new options for businesses to raise finance and become more mature investments of late. With the opportunity to partake in peer-to-peer lending and crowd funding for example, we're seeing new ways in which capital can start to accumulate and growth can be accelerated."

The introduction of a proposed new growth market on the NZX is one way small to medium-sized businesses may be able to secure growth capital in the future, while instilling the requisite discipline and processes for a potential main board listing down the line.

Aimed at businesses with a market cap of $10 million-$100 million, the new market will support the listing process for more types of businesses than it has been accessible to in the past.

"I think to start with any change we see will be around the margins, but I certainly hope over time you'll get more companies coming to list on the share market - both smaller growth companies and also larger companies which have opted to stay unlisted in the past," says McElwain.

"We've had seed experts and angels in the past, but hopefully the NZX new market can help fill the remaining void. There will be a clearer transition to raising finance as a small business through to raising capital as a large business. That's very important because too often in the past you see innovative Kiwi companies getting to the $5 million-$10 million sales mark then being sold offshore".

David Wilson, Investment Strategist for New Zealand Funds Management however is not so impressed with the new market as a realistic option to place KiwiSaver funds in the short term.

"I think what we'll see is more issues, but the problem with the new market will be a question of liquidity. We've seen new markets try to start before in New Zealand, but we feel that that market is probably too illiquid for us to invest KiwiSaver funds in, from what we've seen so far."

If more investment is to remain onshore, Wilson would like to see further incentives offered for doing so. "The only real bias we have toward buying in New Zealand at present is the tax advantage through imputation credits," he explains.

One policy response O'Grady thinks can be effective is creating an easier framework in which the incubation of local fund managers can be improved and better ex-pat talent attracted home. "We don't have a strong global investment capability here in New Zealand."

Improving the calibre of talent within New Zealand to take concepts through their growth stages from start-up to international business would create new wealth locally, while also providing productive uses for the expanding KiwiSaver pot.

McElwain agrees: "There's a whole bunch of people whose talents and expertise could be harnessed and brought on as mentors, directors, investors. You need smart money - that's money that's not just finance but access to skills, expertise and knowledge - to take Kiwi companies and their innovative products into the foreign marketplace."

"Its all a step in the right direction," adds O'Grady. "At the end of the day we've got to create some economic value adding activity which generates value beyond just facilitation of capital exchange and capital raising.

"It's not so much about the engine of capital markets and the flow of money from those who have it to those who need it, it's about creating the actual opportunities in the first place."

Kiwisaver enrolements

Year / Members

2008: 856,487
2009: 1,338,065
2010: 1,733,152
2011: 2,056,599
2012: 2,286,833
2013: 2,468,435

What the fund managers say

Anthony Quirk

I think the front-end of KiwiSaver is working well, the capital is accumulating and if it ain't broke, don't fix it. The back-end of KiwiSaver however needs some serious attention - addressing what happens when people retire and the decumulation period begins as they start to draw on their savings. If the government is assuming people have retirement savings but in reality they've blown it all, it's not a good thing because they're going to go back to the state and rely on government superannuation. There's a real government interest in making sure those funds are used wisely. One solution could be to have a mix where half of the money for example may have to be kept in a long-term fund, while the other half can be drawn on. The government can play its part by actually issuing some longer-term debt which is a key part of developing some of the sorts of products which could work in this space. We really need a political agreement or long-standing accord on this issue.

Simon O'Grady

Anecdotally I've noticed that there is a strong ex-pat community offshore with interest in coming home, who are skilled across a range of investment areas yet find it quite difficult to set up and incubate investment funds. We've not proved adept at supporting the creation of an offshore focused funds management industry locally.

"We have a wealth of global talent offshore, competitive advantages in terms of Asia Pacific connections and being a good place to operate and set up fund management businesses. Bringing it all together has been a riddle we haven't been able to crack yet. There's no one magic policy bullet. It's about implementing a range of changes which will have an effect incrementally. I'd like to see changes around making it easier for domestic money to be invested offshore, which requires improvements around tax transparency and compatibility to ensure we're not continuing to create tax barriers.

David Wilson

What we are looking for is good returns. There is nothing in our KiwiSaver mandate saying we would prefer domestic investments over international investments. In that sense we feel our universe is truly global and unless there is a reason to invest domestically - generating a better return - then we see no real reason to do it. We are only a very small part of global markets and there are some very good opportunities overseas for investment. The New Zealand equity market is very narrowly focused and isn't well represented by a lot of sectors, as overseas. Our market size has not grown for several years. It's a very small market and it's susceptible to one-off shocks, part of the KiwiSaver programme is to diversify away from that.

- NZ Herald

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