Solid foundations

 

The conservative asset allocation within New Zealand’s voluntary savings vehicle KiwiSaver proved to be a blessing in disguise during the financial crisis. But three years after its launch, industry officials are questioning whether the safety will last, as concerns abound about the adequacy of such low-returning accounts. 

Since its launch, New Zealand’s KiwiSaver has amassed to NZ$5.8bn ($4.8bn) with 1.7 million member accounts, according to statistics in an annual report released by Inland Revenue (IRD) in September. Thus far, KiwiSaver accounts for 9% of managed funds under investment and a quarter of superannuation assets under management in New Zealand.

These account balances have grown in times of economic and financial duress and thus far rate highly in terms of member trust and satisfaction. Ironically, one of the reasons that KiwiSaver is so positively viewed is because the vast majority of funds are parked into default options – very conservative asset allocations heavily tilted towards income assets and away from growth assets. This fact has proved challenging for providers who are looking for ways to steer members towards funds that provide higher return and increased risk. In an immature and growing market characterised by high switching from one KiwiSaver provider to another, providers must balance the need to increase member interest in growth options against the need to keep a reserve of liquid assets, while providing products that build brand strength through safe returns. 

KiwiSaver schemes are funded by a minimum of 2% of gross salary contributions from employers and 2% contributions from employees, plus government subsidies to encourage membership enrolment. Those subsidies include a NZ$1,000 “kick-start” credit when a KiwiSaver account is opened by a person for the first time. In the three years since launch, employers have made NZ$1bn in contributions, the government has made about NZ$2.4bn in subsidy payments, with individuals making also nearly NZ$2.4bn in contributions. The majority of member accounts see inflows of 4% a year, meaning that by and large the contributions stop at the minimum levels.

 

Default option

The vast majority of KiwiSaver members are in the default option – a conservative investment allocation comprising 20% growth assets to 80% income assets. This allocation has performed well in the volatile economic and financial background of the past two and a half years, but is not consistent with actuarial projections of what yields sustainable post-retirement accumulations.

“A large amount of the assets under management has ended up in the default schemes,” said AXA NZ chief executive Ralph Stewart. “There has to be a better understanding or appreciation of age ranges in the default schemes, and therefore some tiering by some asset allocation providers. There has been an anomaly where the short-run has cast a shadow over the long-run. The asset allocation has been right over the short run, but over the long term, it will result in substandard retirement savings.”

The next popular member choice after default options – or funds that members are automatically enrolled in if they do not stipulate an active choice – are balanced option funds.

“We have six KiwiSaver options – the default and five others,” said Sam Stubbs, chief executive of investments at Tower, a KiwiSaver provider. “It goes from the growth, which is 100% equities, to most conservative, which is 100% debt. By far the most popular is the balanced fund in the middle, because the majority of KiwiSaver investors are not interested in excess risk. They see that it’s a moderately long investment for them, they have a balanced view of risk versus return. That’s by far the most popular after the default. About 50% of our default members, when contacted, want to switch to a more active fund.” 

While some managers speak of the need to shift asset allocation to reflect varying savings horizons, the need to keep funds in liquid investments complicates planning. Members in KiwiSaver programmes can switch from one provider to another with no penalties and fees. Combined with the fact that providers are generally only getting cash inflows of 4% of gross salary, KiwiSaver providers have found they do not have a large enough cash flow to sustain the switch to less liquid assets. 

“Liquidity pressures do have an impact on asset allocation policies for KiwiSavers,” said Mercer New Zealand head Martin Lewington. “The obvious is things like infrastructure, private equity, those assets with real liquidity restraints. You can’t have KiwiSaver or other investment schemes in them because they have to have liquidity. These are asset classes that may be underrepresented in KiwiSaver portfolios. But the industry is interested in liquidity, we’re interested in equitable pricing between investors over horizons, and I’m sure the industry will come to the party where pooled investments can be made”

 

Less is more

KiwiSaver is highly concentrated into the hands of a few, large providers. According to IRD, of the NZ$5.8bn assets under management in KiwiSaver, NZ$5.2bn – 89% –  is invested in fund managers that have more than NZ$100m in assets. In aggregate, 53%, or NZ$3bn, of KiwiSaver assets were invested in New Zealand assets, with 13% invested in NZ equities, according to IRD statistics.

Conservative asset allocation may also be taken from a strategic perspective by providers looking to establish a brand name for capital preservation of members’ assets, rather than risk downside losses by chasing higher returns. 

“KiwiSaver is only about 12.5% of funds under management at Tower,” noted Stubbs. “We tend to be a far more conservative, more liquid manager. You’re going to get some fund managers that will get into some long-dated, more illiquid investments, but I think that the brand, the importance of capital preservation of members’ money and of making sensible decisions means that the KiwiSaver offering will tilt toward the more conservative, particularly for the larger providers.”

Of course, the relatively strong performance of KiwiSaver default funds over the past three years has added additional drag on moves to shake-up asset allocation.

“There has been a lot of noise around how the default funds offered by the six default providers have had to be ultraconservative, bank deposit type funds,” said chair of peak body Workplace Savings New Zealand, David Ireland. “There have been industry representations that it would be better if the default option was a growth fund, with more money in growth assets, with more investments in ‘New Zealand Inc.’ The flip side of that is that with the economic crises, having the default fund as the most conservative was very, very smart. A lot of KiwiSavers have been protected from the full force of the economic downturn because of inertia.” 

AXA NZ CEO Stewart also noted that sheer timing of KiwiSaver’s launch, plus the structure of the default, sheltered most members from the worst impact of the global financial crisis.

“To some extent, the global financial crisis has shadowed a time in which KiwiSaver has been launched,” he said. “While the crisis has gone on, KiwiSaver has gathered assets, and managers are getting assets at cheaper prices as a result of the crisis, which as a market opportunity is not a bad way of launching. In a practical sense, account balances are very low, which is a far larger impact on KiwiSaver than the global financial crisis. In a practical sense, despite the [government subsidised] NZ$1,000 kick-off, the accumulated growth rate is a bit low. Combine that with the fact that two thirds of the total industry is in the default option, the vast majority have not really experienced the global financial crisis.”

 

Other advantages

Against the background of bias towards conservative investment regardless of actuarial suitability is the fact that KiwiSaver providers operate in a low-fee environment over a small population with thus far small account balances. While KiwiSaver has proved far more popular than initial projections with uptake by more than 50% of working New Zealanders, it forces providers to come up with communication strategies that rely on automation and electronic communication to encourage member participation.

At AXA NZ, where two thirds, or 68,000 members, are in default accounts to 22,000 in non-default KiwiSaver accounts, that means using a web portal.

“We need to keep the cost of delivery down as much as we can,” Stewart said. “We’ve launched a KiwiSaver portal to provide some help and assistance, and if they wish it, some education. As a consequence, an active approach to getting people to switch, and we’re seeing a reasonable amount of default providers switching out.”

To Stubbs of Tower, all of the above mentioned, plus the fact that 89% of assets are concentrated in very large managers’ hands, means that industry consolidation is coming, and evolution of what KiwiSaver is will have to happen.

“We need to stop seeing KiwiSaver as fund management but rather as administration platforms,” he said. “They’re huge ongoing investments. At the member level, there’s going to need to be more choice over time. We don’t think there’s room for more than ten to 15 KiwiSaver providers, and arguably, that may even be too many.”