COMMENT:

No public discussion about KiwiSaver goes very far before stranding on fees.

Industry perspective is typically fuelled by self-interest — low-cost KiwiSaver providers want to focus only on fees. Providers with higher fees want to broaden the discussion, making the importance of fees relative — and usually secondary — to returns and asset allocation.

So, talking about fees is a well-trodden road, but remains important.

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Not least because of the Government process kicking off next year to refresh the rules for, and expectations of, the financial organisations who get to be "default" KiwiSaver providers.

Currently there are nine providers with the default badge, which is worth having as the Inland Revenue Department allocates all new KiwiSaver members who have not selected a provider to one of the default schemes.

Pressure on that process is coming from greater transparency to KiwiSaver members of the actual dollar cost to them of their provider's fees, because of disclosure changes pushed by the Ministry for Business, Innovation and Employment and the Financial Markets Authority.

Pressure is also coming from new providers, such as the JUNO KiwiSaver Scheme, willing and able to charge materially lower fees.

Depending how markets shape up (or down) between now and when the decision is made on how default status is earned or kept, pressure could also come from KiwiSaver members who may have suffered the harsh reality of paying fees while experiencing sustained losses.

If that pressure means fees in default schemes come down, it's likely to have a knock-on effect.

Default schemes are a pricing reference point for non-default funds and for all providers regardless of whether they have default status.

So does this mean the only good provider is a cheap one?

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This is the simple argument higher-fee providers hate because it ignores skill in asset allocation and choosing when to get into and out of individual investments, and the higher returns which should come with those capabilities.

This part of the industry believes KiwiSaver members should not be asking "what am I paying?", they should be asking "am I getting good value for what I'm paying?"

As we've said in previous pieces for Herald readers, it's true some investment managers have the repeatable ability to outperform the market and other managers. It can be particularly apparent when markets are as bumpy as they are now.

But some of those managers are among those saying fees make a big difference and you should pay as little as possible.

Warren Buffett is the most famous of the investor gurus who are also low-fee evangelists. Another is Meb Faber, of Cambria Asset Management, the Meb Faber Show podcast and author of several other books on investing.

In a recent book, Global Asset Allocation, Faber surveyed the world's top investment strategies.

He tracked the performance of portfolios recommended and used by very well-known investors including Ray Dalio from Bridgewater Asset Management, Warren Buffet, David Swensen from Yale University, and Mohamed El-Erian, formerly of PIMCO.

The strategies' performance is tracked from 1973 to 2013, spanning tough and benign periods in global markets. Some strategies did better than others during inflationary periods, but did worse when inflation wasn't a factor.

But the overall difference after 40 years between the worst-performing strategy and the best was 1.84 per cent per annum in real returns (after inflation). If the worst-performing strategy was excluded, the difference between best and worst shrank to less than 1 per cent p.a.

As Faber says in the book, this is astonishing. The portfolios used the same basic ingredients — shares, bonds and in some cases real assets like commodities and property — but had very different mixes of those ingredients.

For example, the best-performing strategy (El Erian's, with 5.96 per cent p.a. real return) had 50 per cent shares, 17 per cent bonds, 6 per cent treasuries, 13 per cent commodities and 13 per cent property.

The second-best-performing strategy (the Global Asset Allocation portfolio, adapted from Credit Suisse by Faber, with 5.43 per cent p.a. real returns) had 36 per cent shares, 48 per cent bonds, 2 per cent treasuries, 5 per cent each of commodities and gold and 4 per cent property.

A big difference in allocation but only a 0.53 per cent p.a. performance difference over four decades.

And there's more. Faber goes on to imagine someone in the amazing position of being able to predict, in 1973, the best-performing asset allocation for the next 40 years.

But he then imagines that person having to implement El Erian's strategy through a US investment manager charging the average annual fee of 1.25 per cent.

Faber worked out that with a 1.25 per cent annual fee, the difference between the best and worst strategy almost disappears. If the fee is higher than average, El Erian's strategy becomes the worst performing.

All that discipline and skilled investment management coming to nothing better — or perhaps even doing worse — than simply following the market, after 40 years of sustained effort.

The lessons for a KiwiSaver member, and New Zealand investors generally, are:

• Provided you have some mix of shares, bonds and real assets (although not all the strategies surveyed in Faber's book had real assets), and stick with them, rebalancing annually if necessary, you should have an acceptable result relative to the market over time. The test period here was 40 years, which is relevant to a KiwiSaver member's retirement timeframe.

• But, while a sensible asset allocation is important, most or all the benefit can be undone by paying too much to implement it. Even when it is done with skill and discipline (coincidentally, the average total fund fee charged for a KiwiSaver growth fund, on Sorted's Fund Finder, is *1.26 per cent — almost exactly the average US fee in Faber's book. The highest total fund fee shown on Fund Finder is 2.18 per cent ... ).

Faber's work does not mean it's impossible for an investment manager charging high fees to outperform. Every strategy surveyed for the book produced returns over some periods which were comfortably above the market, even with a 1.25 per cent fee removed.

Similarly, some managers in the New Zealand market charging more than 1.25 per cent annually have done well for their investors, after fees, over seven or even 10 years.

But Faber's book does strongly suggest that continuing to outperform over the multi-decade period required to fund retirement, and by a margin adequately compensating the investor for higher fees, is very difficult.

For KiwiSaver providers, this means thinking very carefully about the shape of their fee structures in the medium and longer term.

In the end, really the only feasible options for attracting and keeping customers from an increasingly sophisticated KiwiSaver membership base may be to charge low fees, be demonstrably better than Buffett, and ideally both.

* How much an investor with the average KiwiSaver balance would have been charged for the year ended March 31, 2018. Total fund fee includes management fees, underlying charges and any performance fees. It does not include the administration/annual membership charge (the average for all KiwiSaver funds in the Sorted dataset is $32).
- Mike Taylor is CEO of Pie Funds, which runs the Juno KiwiSaver scheme