BNZ leak shows uncomfortable reality of many KiwiSaver schemes

Monday, 5 August 2019

OPINION: Last week, Stuff revealed internal bank communications that highlighted how BNZ's chief executive had concluded sometime prior that the BNZ KiwiSaver fund was charging customers more in fees than it should.

While the communications have shown BNZ was slow to change, and so continued to charge customers excessive fees, there is a bigger message to consider: Active management wasn't adding value for customers.

To understand this point, it is necessary to understand how fund managers invest your money.

Broadly speaking there are two schools of thought: active versus passive management. Active managers believe they can outperform the market by smart stock selection and asset allocation, basically picking winners and avoiding losers.

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BNZ was slow to change its fees but that's not the only thing we need to think about.

The result of this should be higher returns and therefore better outcomes for investors.

Passive managers, in contrast, believe it is better to simply replicate the market and accept the market return.

Complicating matters further is that active management appears to be a spectrum: A recent study conducted by colleagues of mine at AUT failed to find much active management. The research found that while many funds are actively managed, the portfolios they hold are very similar to what they would hold if they were passively managed.

The issue with active management is it costs more. Making smart asset selections requires a team of analysts constantly scouring the markets for good companies. In contrast, passive management is cheap: You simply need to invest in a portfolio of stocks that represent the market, and occasionally reweight your portfolio as things change.

How much is the difference? Simplicity, a passive manager launched in September 2016 with the aim to be cheap, charges $30 per year and 0.31 per cent of your balance for its growth fund. The average fee charged by growth funds is $27 per year and 1.23 per cent.

On a $10,000 balance, that's a $92 difference in the fees ($153 for the average, $61 for Simplicity).

But costing more is okay if the fund makes higher returns, right? Well, yes, except that there is little evidence active managers actually perform better. A huge amount of academic study internationally, and in New Zealand, has concluded that once you adjust for risk appropriately, few fund managers can consistently outperform the market in the long-term. And predicting winners is hard; the fund that did well last year may not outperform next year.

The Financial Markets Authority KiwiSaver Tracker supports this conclusion, providing information on the five-year returns and fees charged by providers. At this stage, because of its age, Simplicity is not included, but ASB is (it is a passive manager, too). ASB Growth is one of the better performers based on the past five-year returns, despite simply trying to match the performance of the market. It also has the lowest fees as a percentage of returns. In short, most active fund managers didn't return more to investors than a passive provider.

All this evidence supports the conclusion BNZ reached - that active management doesn't appear to pay off for most fund managers. They are returning mediocre performance and costing more in the process. Of course, this is not a universal truth. Several fund managers, such as Milford, do appear to provide the exception to the rule. But many KiwiSaver funds should also be reassessing whether active management is really in their clients' best interest.

Aaron Gilbert is head of the finance department at AUT.