With the advent of the Financial Markets Conduct Act, the FMA, electric cars and men on the moon one might think that that sort of information would be easily obtainable. Fail. It took my staff around twenty calls to the various providers to get access to this information.
This is surprising because data like the cost of a product and what it comprises is basic stuff and fundamental in making a rational decision. Goodness knows what a novice investor would do faced with these multiple layers of confusion and obfuscation - probably give up.
After two days of exchanging emails Milford were the only provider that had come back with sensible answers to the questions. Virtually none of the bank Service Centre staff could answer any questions and most said it could take up to 2 working days to get a (wrong) answer.
One other key dimension that investors must think about when moving from bank deposits is risk.
Anyway we eventually got there and it appears that the average fee excluding turnover costs of the balanced funds in the sample we looked at was 1.35 per cent. This figure however excluded performance fees and various other fees that the regulations don't require to be disclosed. We will consider these fees when we look at prospective returns.
One other key dimension that investors must think about when moving from bank deposits is risk. Investors considering such a switch know that they are going to a higher risk instrument but it takes a lot of digging to know the extent to which the average balanced fund is different to a bank deposit.
Bank deposits are almost risk free, unless you live in Cyprus so in order to understand the extent to which balanced funds are different we asked for information detailing the extent to which each balanced fund was invested in risk free assets defined as cash or government bonds. There is a large degree of variation within balanced funds.
The ANZ fund for example has almost a quarter of its portfolio in risk-free assets whereas the Milford fund had only a 2 per cent weighting.
This is significant - without understanding this variation it's impossible to rationally assess the historic performance of the funds - higher performance may simply be due to higher risk rather than skill.
It is important to note here that fund managers and investors can have different agendas as far as risk is concerned. Fund managers ideally wish to charge as much as possible whilst still delivering a reasonable return to investors otherwise the investors will leave and the fees will stop. One way of achieving this aim is to overweight risky bonds and/or have higher weightings in other risky assets like shares.
Note that all of these funds are described as being balanced however, as George Orwell might have said, some are more balanced than others. At one end of the spectrum the Milford Balanced Fund has less than 3 per cent in cash and NZ Government bonds whereas almost a third of the BNZ Balanced Fund is in these sorts of investments.
It is thus very difficult to assess the relative riskiness of these balanced funds. Having said that someone with a little knowledge could use the 5 year standard deviation data required by the new FMC Act to assess relative risk.
The obvious problem with this is that the data is historic, asset allocation is dynamic and, as the latest research from the FCA in the UK suggests that one in three investors can't work out what the interest on their savings account should be, standard deviation is likely to be a little too complex for most.
Anyway, the bottom line in a bull market/low interest rate environment is returns so with 1 year bank deposits available at a 3.5 per cent yield - how do these funds shape up after fees?
We calculated the prospective return of the average balanced fund based on average asset allocation, average fees and realistic return forecasts given current interest rates and stockmarket valuations. We estimate that the average balanced fund is likely to return about 5.30 per cent pa pre-tax, pre-fees in the long run.
If you then deduct the average annual fee of 1.3 per cent that brings the return down to about 4.0 per cent so the fund managers are appropriating an average of almost a quarter of pre-tax returns. Given that some of these balanced funds are a lot more risky than bank deposits investors should think carefully about the risk reward balance i.e. they may be assuming higher risks for not a great deal of extra return.
This brief look at balanced funds highlighted one other problem and area of mis-information for retail investors which unfortunately hasn't been addressed by the Financial Markets Conduct Act. Looking at the investment statement for a balanced fund from one of the banks I noticed a graph purporting to show how an investor in this fund could expect his/her savings to grow over thirty five years.
As always the devil is in the detail and after much searching I found that the graph assumed 4.6 per cent pa returns after tax and fees from the balanced fund. This looks to be a highly optimistic assumption and most unlikely to be achieved. Given the asset allocation that balanced fund is likely to achieve returns of 5.02 per cent pa pre-tax, pre-fees. Deduct 1.3 per cent in annual fees and 28 per cent in tax, adjusting for FIF tax, leaves you with just 2.7 per cent so someone basing their retirement plan on 4.6 per cent is likely to be disappointed.
Hard to believe this sort of calculated mis-information can occur in the post FMC environment, isn't it?
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have an interest in the companies discussed.
