Australasian shares more tax efficient than cash
How much default KiwiSaver investors’ pay in tax and the surprising disparity between the tax treatment of different assets has been revealed by Morningstar.
Wednesday, September 19th 2012, 6:30AM 
8 Comments
by Benn Bathgate
The KiwiSaver After-Tax Performance Survey revealed the Tax Cost Ratio –the amount of tax KiwiSaver funds pay on their assets – for all the default funds bar Mercer, which failed to submit its data by the Morningstar deadline.
The survey revealed default funds managed by AMP, ASB, AXA, OnePath and Tower paid between 1.30% and 1.92% of their assets in taxes.
Morningstar co-head of research, Chris Douglas, said that while tax is a determining factor in fund returns, “investors and advisers should be wary about selecting investments on the basis of the likelihood of the amount of tax which will need to be paid.”
The survey also revealed the differing tax treatment of various asset classes, and how efficient Australasian equities are compared to other asset classes.
For instance cash had a tax cost ratio of 0.8% and 0.82% for one and three year periods compared to Australasian equities which came in at 0.50% and 0.22% in those periods.
Morninstar says a Tax Cost Ratio of zero indicates that a fund is very tax-efficient, while a 5% Tax Cost Ratio indicates a less tax-efficient offering. For example, if a fund had a 2% Tax Cost Ratio for the three-year time period, it means that on average each year, tax cost an investor 2% of their return.
Douglas said that an absence of capital gains tax on New Zealand and Australian shares meant they were even more tax efficient than cash.
“In fact, when imputation credits are taken into account, we have heard of some KiwiSaver funds providing investors with tax refunds,” he said.
International assets are taxed differently. Any geographical tilts in the investments owned by KiwiSaver funds will therefore have a meaningful impact on the tax paid."
The survey also revealed the vast majority of total KiwiSaver funds under management, 40.2%, is invested in cash and New Zealand bonds.
International shares and international bonds were the only other two categories to have double-digit amounts of KiwiSaver cash invested at 20.3% and 19% respectively.
Despite its tax efficiency, New Zealand and Australian shares account for just 9.5% and 4.6% respectively of KiwiSaver cash.
“A lot of them [KiwiSaver fund managers] are looking to diversify across global equities as well as New Zealand and Australia,” said Douglas.
“But we’re a very small part of the world and a very concentrated market with some very sector-specific concentrations.”
Benn Bathgate is a business reporter for ASSET and Good Returns, email story ideas to benn@goodreturns.co.nz
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Comments from our readers
Firstly, we believe that the Tax Cost Ratio is a useful measure for accurately displaying the tax impacts on a PIE fund, especially for peer analysis. PIE funds pay tax in a variety of ways, none of which have any discernible relationship with the return of the fund. Rather, the tax paid is driven by where the assets are invested. In most cases, investors will pay tax on a PIE fund whether it makes a gain or a loss.
Australasian share investments are taxed only on dividends, and therefore while a fund’s total return could be low or negative, investors pay tax on the income, which for some securities can be in the mid- to high single-digits. International assets are subject to the Fair Dividend Rate (FDR) of five percent, so irrespective of the return that will attract a tax liability. We believe that the Tax Cost Ratio also ties in nicely with the other cost to investors - fees. We display the two side-by-side in our KiwiSaver After-Tax Performance Survey.
The other possible option we assessed was an effective tax rate (ETR). However, we found a number of issues with this. For example, if you have an international share fund with an 0.10 percent total return, and it’s paying tax on the FDR, investors could end up with a 160.0 percent ETR.
We encourage readers to read our full report and explanation of the Tax Cost Ratio and the quirks of the PIE tax regime at www.morningstar.co.nz. We’re also happy to answer other questions – please contact us directly.
Finally, in response to Phil Harris, if you had a KiwiSaver fund with NZ$10,000 and had a Tax Cost Ratio of 1.30 - 1.920 percent, you would be paying around NZ$130 - 192 in tax.
Within an asset class the TCR can also be problematic - i.e. for cash funds high return (good thing) means high TCR (bad thing).
Tax paid relative to net income (Effective Tax Rate or ETR) rather than relative to fund size is more useful. Where FDR applies the TCR will show a much lower result in the "bad" years (i.e. favourable for fund managers). But from the investor perspective the ETR shows the reality of tax paid - ie your example where tax is 160% of net income. That is the unfortunate reality of FDR tax in a bad year. (Hope references to ETR, TCR and FDR haven't confused everyone!).
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This seems semi plausible as an average tax rate on funds with higher growth orientations in the absence of capital gains tax but cash funds do not have that advantage.
I'm wondering if the average tax take of 1.30% to 1.92% for default providers is across all funds or just the default funds themselves? If so the article is highly misleading.