For example, investors in the passive SmartKiwi Growth Fund, which is run by the NZX, have their money invested in the SmartFONZ, which replicates the NZX Portfolio Index, and SmartMOZY, which tracks the Australian S&P/ASX MidCap 50 Index.
Thus SmartKiwi Growth money is invested according to the individual stock weightings of these indices even though the portfolio manager may not like some of these companies.
SmartFONZ's largest holdings are Sky TV, which has a 5.53 per cent weighting, Trade Me 5.05 per cent and SkyCity 5.02 per cent.
SmartMOZY's largest holdings are Ramsay Healthcare 4.1 per cent, Tatts Group 3.95 per cent and Bendigo and Adelaide Bank 3.64 per cent.
SmartKiwi Growth fund will own these companies in the same proportion as their index weighting.
Passive funds should have much lower fees because they don't require any investment expertise and don't employ investment analysts to assess company prospects.
However, passive funds don't always have low fees as SmartKiwi charges an annual fee of 0.85 per cent on its conservative, balanced and growth funds for investments between $4500 and $29,999 and 0.65 per cent for KiwiSaver holdings in excess of $30,000.
The 0.85 per cent fee is probably the most common at present because 2.15 million KiwiSaver members have an average balance of around $8000 each. This 0.85 per cent is high compared with many actively managed conservative KiwiSaver funds.
ASB, the other passive KiwiSaver manager, charges 0.4 per cent for its Conservative Fund, 0.65 per cent for its Balanced Fund and 0.7 per cent for its Growth Fund.
Most long-term KiwiSaver funds, including the SmartKiwi Growth Fund and the ASB KiwiSaver Growth Fund, started on October 1, 2007 with unit prices of $1 each.
The performance of these funds from October 1, 2007 to June 30, 2013 has been as follows:
The passive SmartKiwi Growth Fund has fallen 14.5 per cent.
The passive ASB KiwiSaver Growth Fund has appreciated by 11.6 per cent.
The NZX50 Gross Index has risen 3.7 per cent.
The three largest actively managed KiwiSaver growth funds have had an average positive return of 25.7 per cent over the five years and nine months since inception.
Diana Clement wrote last week that "most of the KiwiSaver managers in New Zealand can't beat the index trackers".
It is difficult to know how she came to this conclusion as she provided no supporting evidence and most active KiwiSaver funds have performed remarkably well in the difficult GFC environment.
These positive performances are why New Zealanders continue to pour more and more money into the schemes. Most of this money is going into active funds because they have met, or exceeded, investor expectations.
Passive KiwiSaver funds have had below average performances and their inability to make any active investment decision has resulted in some disappointing returns.
For example the S&P/ASX MidCap 50 Index, which is the basis of SmartKiwi's SmartMOZY strategy, appreciated by 15 per cent in the June 2013 year yet SmartMOZY was up only 3.2 per cent over the same period, mainly because the NZ dollar appreciated against the Australian dollar.
If SmartMOZY's manager had taken an active approach towards currency, and hedged the fund's exposure to the Australian dollar, the SmartKiwi Growth Fund would have had a much better performance for the June 2013 year.
But fees and returns are not the only issues we need to take into account when looking at the merits of passive versus active investment styles, we should also look at the role of the sharemarket and financial intermediaries.
The first New Zealand stock exchanges were established in Thames and Reefton in the 1870s, primarily to assist gold exploration companies to raise equity funds.
It is easier to raise equity if a company has a stock exchange listing because this gives investors liquidity and the opportunity to realise their investment. It is much more difficult to raise equity if a company is not listed because investors are deterred by the lack of liquidity.
Thus the primary function of a stock exchange is to facilitate the raising of new capital. Passive funds are mainly excluded from this activity because they cannot participate in IPOs as these companies are not included in an index.
Thus passive funds did not participate in the Diligent, Moa, SLI Systems, Synlait Milk, Wynyard or Xero IPOs and they could not invest in Mainfreight, Ryman Healthcare and TrustPower, three of the best performing NZX companies, until these companies were included in an index that these passive funds track.
Passive funds have to invest all new money in companies in their tracking index and in the exact proportion to the index weightings of these companies, regardless of the prospects of these companies.
The role of financial intermediaries, including fund managers, is also important as far as the effective allocation of a country's capital resources is concerned.
Total KiwiSaver funds, which are around $17.5 billion at present, are expected to grow to $80 billion in 2026 and $146 billion in 2036, according to a study commissioned by the Financial Services Council.
It is vitally important that these funds are allocated effectively to give the highest return to investors as well as making a positive contribution to the domestic economy.
Active management is a far more effective way to achieve these goals because if KiwiSaver was dominated by passive funds then most of the money would be invested in the largest listed companies with the highest index weightings. None of this passive KiwiSaver money would go into IPOs or fund the growth of small companies.
Under this scenario passive funds would perform extremely well because their money would flow into a small number of large listed domestic companies and boost their share prices.
Surely that is not the main objective of KiwiSaver?
Finally active managers usually play a major role in corporate governance issues whereas passive managers do not.
A large number of studies show that corporate governance is important and active managers can boost the performance of a company and its share price by taking a proactive approach on these issues.
Passive managers get a free ride from corporate governance surveillance by active managers.
KiwiSaver will not achieve its full potential if it is dominated by passive funds that invest most of their New Zealand allocations in Fletcher Building, Telecom, Sky TV, Trade Me and Sky City, avoid IPOs and don't monitor these companies from a corporate governance point of view.
Clement started her column last week with the comments; "Could a monkey do a better job at investing than your KiwiSaver manager? The answer may surprise you".
The investment management sector is not perfect but it has come a long, long way in recent years in terms of regulation and performance.
KiwiSaver investors are allocating the vast majority of their funds to active managers because they are doing a better job than passive managers and - I am please to reveal - monkeys, although we do not have any performance figures on the latter.
* Brian Gaynor is an executive director of Milford Asset Management.
