MBIE’s ‘myopic focus on fees' hurts default KiwiSaver members
A white paper by Morningstar has criticised the government’s selection of default KiwiSaver providers for having a short-sighted focus on fees that is not supported by evidence.
Thursday, December 16th 2021, 7:45AM
KiwiSaver members who do not choose a provider are invested in one of the government-appointed default providers, which are chosen every seven years by the Ministry of Business, Innovation and Employment (MBIE).
The most recent round of changes – announced in May this year – were the biggest shakeup of the $87 billion scheme since it began in 2007, analyst Tim Murphy said.
There were two major changes made: the default funds were changed from conservative to balanced and a different set of providers were chosen.
Five existing default providers were sacked – AMP, ANZ, ASB, Fisher Funds, and Mercer – and two new passive fund managers, Simplicity and SmartShares, were added.
Other existing providers, BNZ, Booster, Kiwi Wealth, and Westpac were retained.
However, Murphy’s white paper argues the government agency got its selection criteria wrong and didn’t select funds that would maximise members’ finances for their retirement.
Puzzling outcome
While several criteria were used in the selection process, including lower fees and higher levels of service, it was clear that low fees were considered most important, Murphy said.
For example, ANZ appeared to have successful member engagement with less than 7% of members still in the default fund as of March 2021, he said.
In addition to what might be considered a “higher level of service”, it was also the default fund with the highest financial return over the past 10 years.
“It’s puzzling to understand why it failed the review and lost its default provider status,” Murphy wrote.
His conclusion was that MBIE made low fees the “dominating factor” based on international research which shows lower-fee funds tend to outperform higher-fee funds.
While there is a large body of academic work demonstrating this in the United States’ large and diversified equity market, the data is less clear in NZ.
Murphy said his analysis showed “little-to-no correlation between low-fee funds outperforming high-fee funds on average in a KiwiSaver setting”.
Morningstar’s analysis of the original conservative default funds found there was no relationship between fees and net returns on a three-to-seven-year basis.
While on a 10-year time horizon, high-fee funds actually delivered higher returns – albeit in a small sample size.
“With no empirical evidence to support the myopic focus on fees … is there any more compelling evidence in the balanced option category?” Murphy asks in the white paper.
Among balanced funds – which are now the default type – there is no correlation between low-fees and a higher net return in the seven-to-ten-year periods.
However, Murphy said there “was some evidence that lower fees have been mildly correlated with better net of fee outcomes” in the more recent three-to-five-year periods.
“But it is far from a compelling case that fees should be the number-one criteria for selecting go-forward default KiwiSaver options,” he said.
Passive push-back
Managing director of Simplicity, Sam Stubbs said Morningstar’s analysis was “fundamentally flawed” as the long-term data didn’t include low fee providers such as his firm and Smartshares.
The reason there was more correlation between low-fees and better returns in the more recent time periods was that more passive funds are included in the data, he said.
“Simplicity has only been going five years, and Smartshares even less, so when they start to look at the shorter time periods there does start to be a correlation,” he said.
“In the first five years, there weren’t any passive providers but in the two-to-five-year period, the low-fee argument seems to be winning”.
Morningstar’s Murphy did not agree with his argument, saying it was a “hypothetical” that couldn’t be proven with the available data.
Stubbs said globally there was a 20% chance that an active manager will outperform over 10 years and that number drops to below 1% over a 50-year timeline.
While NZ’s small market does give local active managers a better chance, he said, a large proportion of KiwiSaver money is invested overseas anyway.
“I have all due respect for Morningstar, but I respectfully disagree with their view here. As does Standard & Poor's and now, the majority of pension funds in the world,” Stubbs said.
Not for everyone
Milford Asset Management’s head of KiwiSaver, Murray Harris said his firm had not applied to be a default provider but knew of other active managers who had been snubbed.
“The process is a bit flawed when some of your best providers are not successful because fees are a focus for MBIE,” he said.
He said there had been “a race to the bottom” among those competing for default status with many deploying passive strategies to reduce overheads.
“I’m not sure if that is a great outcome for investors longer-term – although I may be biased as an active manager myself,” he told BusinessDesk.
Harris said Milford wanted to provide both excellent returns and customer service, which made the funds more expensive to run.
“We’ve got real people you can phone up and speak to if you are worried about markets, while the low-cost providers will probably have a chatbot,” he said.
This more hands-on customer approach didn’t align with being a default provider, he said, despite MBIE saying higher levels of service was a criteria for selection.
Harris said passive funds had done well during the 13-year bull run since the global financial crisis but would run into trouble in a sustained period of falling markets.
“You're going to have an awful lot of passive money in KiwiSaver, which will go down with the market with no opportunity to try to abate that with some active management,” he said.
Murphy said he was an advocate for lower fees, but they should be just one of several criteria in a more balanced assessment using a range of criteria.
“We would encourage the government to consider a more balanced range of criteria in future default provider reviews so that the best-performing funds are part of the default line-up in order to better empower the investment success of New Zealanders,” he wrote.
If the government continues to consider low-fees to be the single most important factor, he suggested it should consider creating and operating a single centralised default fund itself.
Members could be retained there and encouraged to opt-out into commercial KiwiSaver funds which only contain active-choice members.
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