The latest KiwiSaver data clearly shows that the scheme has been a phenomenal success with one notable exception: a large number of scheme members are receiving no advice or poor direction and are in the wrong funds.
As a consequence, these investors are throwing away tens of thousands of dollars of potential retirement savings.
KiwiSaver had 2,642,068 members at the end of June, substantially ahead of original Government forecasts. In addition, 150,050 members have closed their accounts because of retirement, permanent migration, death, serious illness or other reasons.
The voluntary scheme has been a massive success, mainly because of the initial $1000 kickstart, the annual tax credit and positive investment performances, particularly during the Global Financial Crisis.
The cash subsidies gave KiwiSaver a fantastic start and the Crown has been able to reduce these incentives as New Zealanders have recognised the enormous value of the scheme. The Crown's support has fallen from 55.2 per cent of total contributions in the scheme's first year to just 13.6 per cent in the June 2016 year.
Nearly $29 billion has gone into KiwiSaver since its inception, with individuals contributing 47.3 per cent, employers 27.4 per cent and the Crown 25.3 per cent.
The scheme has had widespread appeal as the average investor has received 100c of investible money for every 47.3c contributed since the scheme began in July 2007.
But KiwiSaver has a number of issues including an overly conservative asset allocation, the increasing dominance of the banks and an overemphasis on fees rather than asset allocation, investment returns and tax.
Morningstar's June Quarter 2016 KiwiSaver Survey shows that KiwiSaver members have only 45 per cent of their total funds in growth assets while 66 per cent of Australian superannuation fund assets are allocated to growth assets.
Our 45 per cent allocation to growth assets is far too conservative, particularly as KiwiSaver investors have a median age of 36, with 29 years to retirement.
Although growth assets (mainly shares) are more volatile than income assets (predominantly bonds and cash), these growth assets should generate much higher investment returns over the longer term.
One of the main issues is that the banks are increasingly dominating KiwiSaver and banks are relatively risk adverse, as you would expect them to be.
The banking sector's share of KiwiSaver funds under management has surged from just over 51 per cent at the end of 2010 to 65.5 per cent as at June 2015 and 66.9 per cent at the end of the June 2016 year.
The major trading banks are massive organisations that completely dominate the New Zealand financial sector and are increasingly dominating KiwiSaver as well.
Recently released Financial Markets Authority figures show that KiwiSaver providers received total fees of $1b between July 2007 and March 2015. A number of commentators made an issue out of this, yet KiwiSaver providers had to pay all their costs out of the $1b while New Zealand based banks reported total pre-tax profits of $36.7b over the same period.
Banks received approximately .6b of the $1b of KiwiSaver fees between 2007 and 2015.
In general, banks have lower KiwiSaver fees than non-bank providers because of their focus on low-risk funds coupled with their huge economies of scale. These low-risk funds, which hold a relatively low level of growth assets, are much easier to manage. They also require considerably less analysis, and a lower cost structure, than growth-based funds.
Non-growth funds should also generate much lower returns than growth funds over the longer term.
The accompanying table contains information on the largest KiwiSaver conservative, balanced and growth funds. Eleven of these 15 funds are bank managed.
The table also contains information on the five best performing large funds (funds with assets in excess of $150m) that are not included in the 15 conservative, balanced and growth funds. These top five funds are either balanced, balanced growth or growth.
A number of observations can be made:
• The five conservative funds are by far the largest both in terms of funds under management and the number of investors.
• These conservative funds have also had lower returns and lower fees (all performance figures are after fees).
• The balanced and growth funds have had higher fees and higher returns, as one would expect.
• The performance gap between the balanced, growth and conservative funds is not as wide over the longest period because balanced and growth funds had negative returns during the GFC.
• The top five funds performed well above average even though they also had negative returns during the GFC.
These 20 KiwiSaver funds, which represent 62 per cent of the value of all KiwiSaver funds, clearly show that lower fees have not resulted in higher after-fee returns over the longer term. There is no guarantee that this trend will continue, but KiwiSaver members who base their investment decisions solely on fees are probably depriving themselves of tens of thousands of dollars of retirement savings.
The most important decision for KiwiSaver members is whether to invest in conservative, balanced or growth funds or a combination of the three.
Another important issue is tax.
Additional disclosure in a number of periodic disclosure statements allows us to assess the impact of tax on low-risk and high-risk funds.
It is clear from this data that cash funds have the highest tax rate while conservative, balanced and growth funds have progressively lower tax rates.
Growth funds had the lowest tax rate over the past five years, partly because New Zealand capital gains are largely tax exempt while income is mainly taxable.
Fees are also tax deductible within a fund.
As a rough estimate, if we take the 0.53 per cent average conservative fund's fee and 1.00 per cent growth fund's fee in the accompanying table, then conservative funds are clearly better off if both of these fund types have returns of 6 per cent or less.
However, once the returns of these two asset classes exceed 6 per cent, the after-fees and after-tax returns of growth funds should be higher than the after-fees and after-tax returns of conservative funds even when they both have identical before-fees and before-tax returns.
This can have a major impact on long-term KiwiSaver returns, yet most KiwiSaver commentary focuses on after fees and pre-tax returns.
Finally, there is the important impact of our conservative KiwiSaver approach on the New Zealand economy.
The main object of retirement saving is to generate a high return for investors but a secondary, and important, objective is to allocate these saving to areas where they can generate economic growth and well paid jobs.
Our KiwiSaver funds fall short in this regard because only 8.5 per cent of total funds are invested in New Zealand growth assets, compared with 30.3 per cent of KiwiSaver invested in Australian and international shares.
Our largest KiwiSaver fund, which is bank managed, has more funds invested in the bank's own income securities than in listed and unlisted New Zealand equities. There is absolutely nothing wrong with this investment style but the conservative approach is expected to deliver below average long-term returns for investors.
This approach also doesn't contribute much to New Zealand's economic growth.
KiwiSaver is a huge success but it is important that scheme members, particularly those with 20 years or more to retirement, have a bigger exposure to growth and balanced funds even though they have higher fees than conservative funds.
Brian Gaynor is an executive director of Milford Asset Management, which is a KiwiSaver plan provider.