This week we will estimate what terminal sum will accrue to a KiwiSaver saving $100 per week and getting the $1,000 kick start and the annual $521.00 contribution from the Government investing in a growth portfolio. We will also see how sensitive the terminal sum is to fees and to contributions.
To do this the first thing we need to do is estimate the long term return that our savings will earn using realistic forecasts from non-conflicted experts. The key word is realistic because the investment sector has a long history of overstating expected returns. Possibly the most outrageous local effort was by two executives from Armstrong Jones who estimated total returns on a balanced portfolio, after tax, fees and inflation, of 10 per cent per year.
Thanks Paul Volcker
The bad news for KiwiSavers is that we have had, thanks to Paul Volcker of the US Federal Reserve, a huge bull market in bonds and shares.
The unfortunate side effect, for new investors, of bull markets where shares get more expensive and bond yields fall is that prospective returns go down.
Back in 1982 ten year US government bonds were yielding 14.6 per cent. Today they yield 2.5 per cent. The same story is repeated in virtually every asset class so that prospective returns today are much lower than they were 30 years ago in both nominal and real terms.
Anyway let's get to work. We will model the savings performance of a KiwiSaver in a growth oriented portfolio. These are typically made up of 30 per cent bonds, half of which are hedged international bonds, 10 per cent in NZ property and 60 per cent in shares of which some 15 per cent are in Australasian shares. Now we need to estimate returns, tax and fees.
Have a look at the table attached.
Without going into too much detail the table suggests that of the 6.4 per cent return generated by a growth portfolio 1.8 per cent will go to fund managers, 1.1 per cent to the Government leaving mum and dad with 3.48 per cent. Take off 2.2 per cent for inflation and goodness me there is not much left!
With these numbers we can use a computer model to estimate what someone saving for retirement via KiwiSaver will end up with. For example we estimate that someone saving $50.00 per week for twenty five years and picking up the $1,000 kickstart, the $521.00 annual tax saving and paying an average of 1.8 per cent in total costs to fund managers would end up with a terminal sum of about $96,000 in twenty five years time, in nominal terms.
He or she would have contributed about $78,000 including the government's contribution. Fees would have taken $23,000. A sensitivity analysis to see the extent to which the terminal sum would rise if fees were reduced showed that if fees were reduced to 0.5 per cent the terminal sum would grow to $113,000, an increase of 17 per cent.
The same result could be achieved by the individual increasing their contributions to $60.00 per week and holding fees constant at 1.8 per cent. What this analysis shows is that reducing fees is an effective alternative to raising contributions which might be a particularly useful piece of information for all those New Zealanders who, despite the frequent exhortations from the banksters to increase their savings, don't have the free cash flow to do so.
Obviously the key variables in all these sort of calculations are the return you are going to get and the fees you are going to pay. The finance sector likes overstating the returns because it makes the fees look less significant. In the light of a long term 6.4 per cent pa prospective return from a growth portfolio fees of 1.8 per cent look huge.
Are KiwiSaver fees unreasonable?
Peter Nielson, perennially smiling Chief Executive of the Financial Services Council, in a recent Herald article argued that NZ KiwiSaver fees were not high. He said that KiwiSaver fees for non-default providers have to be approved by the FMA as "not unreasonable". That's a huge worry for mum and dad as the 172 basis point fee of the average KiwiSaver Growth Fund, as per the Sorted website, looks a teeny bit unreasonable relative to the 6-8 basis points charged by your average S&P 500 Index Tracker.
Mr Neilson made a couple of other comments also which bear scrutiny. Firstly he said "as fund volumes rise .... that is likely to reduce fees". The facts suggest otherwise. Despite funds growing from $12 billion to $21 billion in the last two years management fees don't look to have fallen at all. This is not surprising because that is exactly the experience in the Australian superannuation market where one study says that scale economies have accrued to managers rather than investors.
Next Mr Nielson stated that "investment fees in KiwiSaver are much lower than those in the Australian Compulsory Superannuation Guarantee Scheme and he cited a Grattan Institute study on the subject.
I read the report and spoke to the author of the Grattan study, Jim Minifie, and in an email to me he said that his view was that "that quote is misleading". In Australia they have what's known as industry super funds and one of the biggest of these, the Australian Super Fund, offers an indexed diversified growth option with total annual management fees of just .11 per cent and no performance fees.
The difference between KiwiSaver and the Australian Superannuation market is that Australian's are able to buy genuinely low cost funds. NZ'ers cannot and that is something the NBIE, the FMA and the Treasury should work on. Just recently it has been reported that the major low cost Industry Funds are lobbying a competition enquiry into the Australian Superannuation system to ban banks from using their influence as banking providers to make themselves default superannuation providers.
Get tough on the managers of high cost funds
What to do? The Government needs to get tough with the managers of high cost funds. Probably the best option would be to try and persuade someone like Vanguard or iShares to offer a low cost Kiwisaver option and tell the banksters that the tax deduction won't apply to any funds with high fees where high is defined as, for example, above 50 basis points for growth funds.
That would make KiwiSaver a genuinely attractive investment option irrespective of any subsidy from the government or employers.
The world is changing... a recent Yale Law School study of US superannuation funds for the Department of Labour is recommending that new investors have to sit an exam to show they are not stupid before they are allowed to opt into a high cost fund. That sounds very sensible and my guess is if it were adopted here funds under management would show major moves amongst providers. The Yale paper is a forth coming story.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have a financial interest in the companies mentioned in this article.