Testing Consumer's managed fund test
Philip Macalister looks at moves designed to make managed funds more simple, plus he puts the latest Consumers' Institute test of funds through a test.
Sunday, October 17th 1999, 12:00AM
The managed fund industry is recognising these problems and trying to simplify and demystify the product.
Bank of New Zealand Financial Services Group general manager Rodger Murphy says simplifying managed funds was the single biggest step to encouraging greater investment.
"There is a lot of discussion about the role the Government can play to encourage saving, but we shouldn't overlook the role financial institutions have in creating a more investor-friendly environment," Murphy says.
BNZ, like a number of other companies (such as Tower Managed Funds and AXA) have been focussed on this issue which has lead to the number of retail funds on offer in New Zealand slowly declining from 575 two years ago to about 450 now. Also, the average fund size has risen from $19.6 million to around $30 million.
Consumers' Institute has tried to make the process of choosing a managed fund easier by screening super funds, unit trusts, insurance bonds and group investment funds against a set of criteria.
The results are, on the face of it, sobering. It says just 21 of about 269 unit trusts "measure up well as retirement savings vehicles". Likewise it came to a similar conclusion with super funds.
In an article published last month Consumer said only 11 super schemes out of a universe of nearly 200 passed muster.
"We've checked out nearly 200 super schemes available to the public. To our dismay only a handful passed our test and even then none is ideal."
However, the process has been roundly criticised in the personal investment industry as being shallow and not particularly robust. The concern is that people take the Consumer article as gospel and go out and buy the funds it recommends. This ignores the process of matching investment funds to investor's individual goals and risk profiles.
Additionally there is some concern that Consumer is acting as an adviser, however isn't meeting the legal disclose requirements investment advisers and financial planners are subject to.
The Consumer test is based on developing a set of eight criteria, then running all the funds on managed funds research house IPAC Securities database through the screens.
IPAC general manager David van Schaardenburg says the process is "reasonably simple and intuitively logical" however it was mainly backward looking. IPAC have always said people making decisions to invest in managed funds need to consider qualitative research which is forward looking and assesses fundamental criteria such as investment process, and people, as well as past performance.
Actuary Michael Chamberlain says using past performance criteria to make an investment decision is not particularly smart.
"In my experience nobody has a clue what is going to happen in investment markets."
When an investor buys on past performance there is a high probability they will get it wrong, he says.
While the Consumer criteria are quite valid, they need to be further developed. Part of the problem with this sort of product test is that a managed fund is not like say a washing machine.
With a washing machine the inputs are stable, that is all it requires is some electricity, water and dirty clothes. You chuck them in the machine and they come out clean.
A managed fund is like a machine, but each one is custom-built, as opposed to coming off a production line, plus most of the ingredients which make it work (money, markets and individual investment skills) are variable.
You put your money into the machine (like the dirty clothes) and hope you get a bigger sum at the end, however as investors know markets move and things can get better or deteriorate.
The eight criteria Consumer used to screen funds include:
Access - funds have to be publicly available
Initial investment - maximum lump sum $2000
Size - $10 million minimum
Up-front fees - 3.5 per cent considered reasonable
On-going fees - excludes any funds which have fees other than manager, trustee and auditor
Track record - Minimum three years history
Performance - Funds had to have either a four or a five star IPAC rating
Continuity - Senior investment management had to be with the fund for at least two years.
Three of these criteria, performance, size and continuity whittled the bulk of the funds out of the unit trust survey.
Two-thirds of the funds were removed on performance criteria alone. To have a chance of being recommended by Consumer a fund had to have either four or five IPAC stars. Under the star rating scale funds are ranked on a risk/return basis against their peers and four and five star ratings are applied to only the top 35 per cent of all the funds.
Likewise, funds had to exceed $10 million in size. The reasoning behind this is that size gives the fund critical mass and efficiency. If it is not profitable for the manager then a time will come when it is closed.
The startling revelation about this criterion once it was applied to the database is that nearly half of all retail funds in New Zealand have assets of less than $10 million.
Murphy says this is a structural problem for New Zealand savers and is one that BNZ has moved to address.
He says by rationalising its range BNZ now has the largest average retail fund size of any manager in New Zealand. BNZ's average retail fund is now $96 million, while the industry average is around $30 million.
Under BNZ's criteria it won't launch a new fund unless it can get a minimum of between $25 million and $30 million dollars.
"In all honesty if a fund is $10 million or less somebody is going to come along and realise they are offering a product which is not profitable and close it."
As many investors have seen in recent months there are major ramifications in terms of cost and tax liabilities when a fund is wound-up.
Murphy says investors want to be in funds that have a reasonable size, as there is a greater likelihood they will be around tomorrow.
While the logic for the size criterion is sound it's not universal. Tower Managed Funds for instance is to announce on Monday a further rationalisation of its product range. National marketing manager Steven Giannoulis says Tower used this proposition in its process, but then decided to continue offering some smaller funds to investors because the fees being charged back to the fund were reasonable, and they had good growth prospects.
The third factor that culled a number of funds from the survey was continuity. Consumer says almost half the funds that failed had not retained their key staff for at least two years.
This factor is considered by some to be a bit harsh considering the large volume of merger and acquisition activity going on in the managed fund industry. For instance the National Bank sold its funds management business Southpac to AMP Asset Management (AMPAM) less than two years ago and in that process many of the portfolio managers changed. Since the sale the performance of many of the funds, such as the New Zealand Equity Growth Trust, has improved significantly and AMPAM won the IPAC Fund Manager of the Year crown this year.
Consumer acknowledges the merger and acquisition activity and also says that many fund managers in the industry are young and therefore tend to move on.
The people issue is a problem, however it doesn't appear to be large. New Zealand Guardian Trust chief investment officer Michael Good says things are OK at present.
Good, who moved to Sydney to run Royal & SunAlliance's Australian business after it bought Guardian Trust, says there is relative stability amongst the investment teams, and the quality has improved.
However, because the New Zealand industry isn't big, people tend to be less mobile and they run out of promotion options pretty quickly. The problem is a lack of depth.
When they decide to leave there emerges a problem of finding experienced replacements.
Van Schaardenburg says, assuming there isn't much further company rationalisation over the next 12 months, quite a few more funds will pass the continuity criteria.
However, investors can expect to see many more funds closing in the future as managers rationalise their product ranges, particularly in the superannuation and insurance bond sectors. One of the big rationalisers is expected to be Royal & SunAlliance that has in recent times acquired Norwich Union, Guardian Assurance and New Zealand Guardian Trust.
Van Schaardenburg says since the superannuation surcharge was removed insurance bonds have lost their key reason for existing, also many of the funds in these areas are older, legacy products which have reached the end of their life cycle.
Banks and fund management companies have generally been good at product management, he says, however insurance companies that produced many of the insurance bond and super funds have not been so sharp.
"Life insurance companies have been great product manufacturers, but not great product managers," he says.
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