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KiwiSaver – opportunity, threat or both?

From an investor perspective the $20 billion KiwiSaver scheme is a great opportunity.  A long term savings tool with tax benefits (government contributions and PIE tax rates) and structural efficiency around reporting and fee disclosure.  This month’s Pathfinder commentary looks at KiwiSaver from an entirely different angle – not from the investor perspective but from the perspective of financial advisers and fund managers.

Tuesday, May 6th 2014, 10:24AM 7 Comments

by Pathfinder Asset Management

What does Kiwisaver mean from an industry perspective? The scheme’s evolution presents several challenges - we discuss four of these below:

1 – The effect of higher KiwiSaver contribution rates

Current minimum contribution rates for KiwiSaver are 3% from the employer and 3% from the employee.  Over time these are likely to increase -  Labour’s David Parker has suggested employee contributions of 9%. While that seems outrageously high, don’t be surprised when future governments phase this in over a long period.  Nine perscent is not an unrealistic end game.  Australia’s compulsory employer contributions are 9.25% which are increasing to 12% by 2019.  In Germany employers and employees must each contribute 9.75%.

Not only are KiwiSaver contribution rates likely to be higher over time, but scheme membership is also likely to become compulsory.  The unintended consequence of this is that as contribution rates (and KiwiSaver balances) go up, savers may feel less inclined to accumulate the same assets outside of KiwiSaver.  If they access shares, bonds and broader managed funds through KiwiSaver, then these may not be high on a saver’s agenda outside of KiwiSaver.

This poses a challenge for financial advisers – savings rates in shares and bonds (outside KiwiSaver) may decline.  The non-KiwiSaver managed funds savings pool (currently $80 billion) will remain a significant amount, but have much lower inflows than the continually growing KiwiSaver scheme. That’s also a challenge for fund managers – unless a manager can distribute product via a KiwiSaver platform then it will be fighting for a share of the slower growing non-KiwiSaver savings pool. 

Clearly this is not an issue yet – but it will be over time.  Some fund managers will respond by focusing on KiwiSaver and retreating from non-KiwiSaver managed funds.  Others will seek safety by locking in distribution channels.  Other managers will survive by satisfying very specific product needs.  Managers must fit one of these (or similar) categories to prepare for this new world.

2 – Downward pressure on fee structures

Managed fund fee structures face a number of pressures.  Here are some key areas:

  1. ETFs globally show that low fees are possible where a manager has huge scale.
  2. In a post GFC world there is a tidal wave of regulation and investor awareness demanding transparency of risk disclosure, transparency of investment holdings and transparency of fees.  (Fee transparency is problematic for some managers because fee layers will no longer be hidden).
  3. In our low interest rate and low asset return environment some fee structures seem to take an excessive share of an investor’s rewards.  Investors are becoming savvy enough to recognise when fees are not good value. 
  4. A little recognised downward influence on manager fees is gaining momentum – very low fee structures for Kiwisaver default funds.

 
By New Zealand standards KiwiSaver default fund fees are low – typically in the 0.40% to 0.60% range.  This is great for savers – but not for all fund managers.  KiwiSaver default rates will, through a slow process of peer group pressure and regulator encouragement, drive down all fund manager fees – both inside and outside KiwiSaver.  Within a few years base management fees which currently tend to fall between 1% and 1.5% will be forced down to a 0.50% to 1.0% range.  Performance fees will be more restricted and fairer – for example a cash benchmark for performance fees on equity funds will rightfully become a thing of the past.

Managers need to start re-configuring their way of doing business now to prepare for a lower revenue model.  Sensible corporate cost structures, scalable business structures and certainty of distribution become critical. 

Don’t just think this will be a fund manager problem – advisers will be caught in the same downward fee push. A world of low management fees means there will in future be little (or no) room to pay advisers trail commissions. Many managers have already phased out paying these and many advisers have already phased out their reliance on them.  Advisers should not fix their 10 year business plan around commissions from managers – particularly in the KiwiSaver space. (A separate but equally important downward pressure on adviser commissions is from the regulatory angle and the perceived conflict of interest commissions create). 

3 – Opening the architecture

For fund managers, securing a piece of the KiwiSaver market has been a land grab.  Banks with retail distribution, default providers and managers with strong brands have been able to win a piece of the market.  This market is competitive but not efficient. KiwiSaver providers resemble breweries 40 years ago – the beer manufacturer controlled the pub and only its beer was sold.  No other brewers had a look in.  Why would you open your pub chain distribution up to other brewers when you’ve spent a small fortune building it – why share access to the profits….?

KiwiSaver in NZ will, in a few years’ time, reflect a modern wine bar rather than a traditional pub.  There will be a range of wines and craft beers.  The “closed” architecture” will be forced to “open”.  This presents an opportunity for fund managers in NZ – boutique managers (the craft brewers of fund management) typically don’t have their own KiwiSaver but could well get some access to the KiwiSaver platforms of others. 

What will drive this change toward open architecture?  Firstly investors will demand change as they accumulate larger KiwiSaver balances and become more sophisticated in their approach to investing.   Secondly, regulation will force change as institutions accept that acting in the client’s best interest cannot always mean using an internally manufactured solution.  Promoting client interests means outside providers will be considered and true best of breed funds chosen. 

Open architecture KiwiSaver (resembling self-managed super funds in Australia) has not yet arrived in New Zealand.  The Craigs KiwiSaver platform appears (so far) to be the one scheme heading in this direction – a direction that should be welcomed by investors and by financial advisers.  Why should it be welcomed by advisers?  Read reason four below. 

4 – The challenge to add value

The hard part for financial advisers with KiwiSaver is answering the following two questions:

  • Where can the adviser add value? 
  • How much will investors be prepared to pay for adviser input? 

Advisers will only get paid if the client recognises that adviser input is valuable.  Getting to the point where KiwiSaver is a genuine revenue stream for advisers requires three things:

  1. Open architecture KiwiSaver where investors are faced with choices and need professional help to navigate
  2. Savers having very large KiwiSaver balances so a “fair” fee can be charged (i.e. a fee that doesn’t drain the account balance and delivers something meaningful to advisers for their time) 
  3. Investors being motivated to seek financial advice for KiwiSaver – again this is a function of larger balances.  

Conclusions

What does all this mean for financial advisers and fund managers?  There are no certainties on where this is heading, but here are some quick concluding thoughts –

  1. KiwiSaver will become increasingly important to savers over time and will  dominate the managed fund space (i.e. Kiwisaver savings will grow faster and eventually exceed the size of non-KiwiSaver managed funds)
  2. Many aspects of how KiwiSaver operates will change in ways that benefit investors – our world of 3% employee contributions and closed architecture will be replaced in a decade by 9% employee contributions and open architecture
  3. The nexus between industry professionals (financial advisers and fund managers) adding value and getting paid will be very clear to investors. 

In short, financial advisers and fund managers will need to find their place in a world where fees are compressed and investors demand more value. To survive (let alone thrive) in this new world many proven and well established business models will be forced to change.  These changes will challenge the industry – but on a positive note this will bring clear benefits to New Zealand savers and investors.

John Berry,  Executive Director
Pathfinder Asset Management Limited

Pathfinder is a fund manager and does not give financial advice. Seek professional investment and tax advice before making investment decisions.

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Comments from our readers

On 7 May 2014 at 9:11 am Fred said:
A very thoughtful & thought-provoking piece. One sure hopes the market ahead leaves scope for such original, boutique & innovative contributers.
On 8 May 2014 at 1:05 pm Tom said:
A lot of investors, regardless of the size of their investment still don't want to select (or have selected for them)loads of assets. The next evolution towards open architecture might be to to allow KiwiSavers to have accounts with multiple KiwiSaver schemes rather than having to select a single scheme.
On 9 May 2014 at 11:56 am John Berry said:
Tom, thanks for your comment. Yes, the ability to invest in multiple Kiwisavers is another possibility - although this requires a legislative response. Open architecture for Kiwisavers will hopefully over time be a market driven response. Allowing savers to access multiple kiwisaver products doesn't address the question of whether providers should be looking to offer best of breed product to investors.
Fred - thank you also!
On 9 May 2014 at 4:33 pm Wayne Ross said:
John I agree KiwiSaver will undoubtedly dominate the future landscape but I am not convinced open investment architecture is a necessary or welcome outcome. KiwiSaver is currently designed and priced to be non-advised, both for planning advice and investment options. What limited advice options there out there are 'partly' paid from and hidden in the investment margin. I would argue the biggest challenge for the advice industry is to be fairly paid for their advice while keeping the investment solution separate, simple and scalable. I guess the challenge for boutique managers is proving they should be part of those simple solutions. While I am advocate of best of breed investing providing direct investor choice can just as easily create uncertainty and add unnecessary cost.
On 9 May 2014 at 7:01 pm John Berry said:
Wayne, thanks. As I see it "open architecture" covers a range of ideas. At one extreme providers could open their platform to all products in the market - ie create a "funds supermarket". As you point out that could increase cost, and as Tom pointed out that would also bring complexity for investors. I'm advocating that this would be an interesting product - but totally agree not every Kiwisaver should look like that.

At the other end of the "open architecture" scale consider a kiwisaver provider offering NZ equities as part of their growth fund. Should they ask themselves whether (after fees) their internal solution for managing NZ equities is likely to be as good as what an external manager could achieve? If they cannot reasonably justify using in-house management and decide to use the external manager, that is also opening the architecture.

On the face of it no one would volunteer to open their platform like that, but what is best for Kiwisaver investors? That form of best of breed open architecture does not increase cost or complexity - it simply improves product for investors.
On 9 May 2014 at 8:17 pm John said:
A very timley article. The KS Industry has already gone past infancy 7 yrs and the growing number of 65 plus or unlocked- just need educating.

This band will expand quickly absorbed by KS to get competetitive lower fee return. This then allowing Deaccumulation.


On 23 August 2014 at 10:48 pm vital99 said:
NZ Kiwisaver is still very young by international standards. Fees must be lower, as will happen with increased funds, as must the contribution rates increase as we can't rely on or trust politicans not to tamper with superannuation, although they give themselves very excessive payments whilst in parliament.

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ANZ Term Fund - 150 days 2.80    -    -
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ANZ Term Fund - 18 months 3.00    -    -
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ANZ Term Fund - 5 years 3.20    -    -
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ASB Bank Term Fund - 2 years 3.65    3.81    3.98
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ASB Bank Term Fund - 9 months 3.60    3.75    3.92
BNZ Term PIE - 120 days 2.35    -    -
BNZ Term PIE - 150 days 2.40    3.38    3.53
BNZ Term PIE - 5 years 2.60    3.86    4.04
BNZ Term PIE - 2 years 2.60    3.91    4.09
BNZ Term PIE - 18 months 2.60    3.65    3.81
BNZ Term PIE - 12 months 2.70    3.38    3.53
BNZ Term PIE - 9 months 2.75    3.44    3.60
BNZ Term PIE - 6 months 2.75    3.75    3.92
BNZ Term PIE - 90 days 1.90    2.72    2.85
Co-operative Bank PIE Term Fund - 6 months 3.40    -    -
Heartland Bank Term Deposit PIE - 12 months 3.20    3.53    3.69
Heartland Bank Term Deposit PIE - 6 months 3.15    3.43    3.58
Heartland Bank Term Deposit PIE - 9 months 3.15    3.85    4.02
Heartland Bank Term Deposit PIE - 18 months 3.20    -    -
Heartland Bank Term Deposit PIE - 2 years 3.25    3.43    3.58
Heartland Bank Term Deposit PIE - 5 years 3.50    3.85    4.02
Kiwibank Term Deposit Fund - 90 days 2.65    2.72    2.82
Kiwibank Term Deposit Fund - 6 months 3.40    3.49    3.65
Kiwibank Term Deposit Fund - 12 months 3.50    3.39    3.55
Kiwibank Term Deposit Fund - 150 days 3.15    3.65    3.81
Kiwibank Term Deposit Fund - 120 days 2.95    3.03    3.17
Kiwibank Term Deposit Fund - 9 months 3.40    3.49    3.65
Westpac Term PIE Fund - 150 days 2.60    2.88    3.00
Westpac Term PIE Fund - 120 days 2.40    3.38    3.53
Westpac Term PIE Fund - 18 months 2.70    3.29    3.43
Westpac Term PIE Fund - 12 months 2.70    3.49    3.65
Westpac Term PIE Fund - 6 months 2.80    3.44    3.60
Westpac Term PIE Fund - 9 months 2.75    3.17    3.32
Westpac Term PIE Fund - 90 days 2.15    2.56    2.67
Westpac Term PIE Fund - 2 years 2.70    3.79    3.96
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