Leverage up your KiwiSaver fund

Booster chief investment officer David Beattie says people should be taking more risk in their KiwiSaver funds.

Monday, October 30th 2017, 11:42AM

David, in a recent SIFA presentation, you claimed that people aren’t taking enough risk in their KiwiSaver portfolios, and they should maybe have geared equities in there. What’s the reason for that?

David Beattie: A good place to start is in the scheme of KiwiSaver investors making good decisions for themselves, other than making sure they’re actually contributing an appropriate amount for the long-term. The most significant decision they can make is to be in the right type of fund. If you look at the demographics of all the people that are in KiwiSaver at the moment – and we’re able to have a look at those fairly objectively – it’s simply based on broad concepts of what people in different demographics should be in. On average, I think people are over-conservative. There’s a whole lot of reasons why that may well be the case.

Do you think more shares should be held for longer?

In general, I think KiwiSaver has been a fantastic product and a great opportunity for New Zealanders to save for their retirement in a very efficient vehicle structure which is well administered by the IRD. However, one of the slightly negative things about it is that it’s stopped short of the appropriate length of time that people should be thinking about, because there’s been this cut-off at 65. A lot of the life phases-type products are well intentioned in terms of recognising that a lot of people don’t really have a good handle on what sort of fund they would be in. At least let’s have a look at your age, and then wind you down as you hit that magical 65. People are under the assumption - which I think is a false one - that at age 65, they are literally going to take their money out, cash it up, put it in the bank and think of what they’re going to do with it.

Are we seeing that at the moment?

There is an element of that, although the balance is obviously small. It’s early days. Going forward, we want to make sure that as the balances increase, people don’t keep thinking like that. The reality of a starting accumulation of some deferred consumption, in order to look after your retirement, goes right through until, literally, the last day that you live. It should be a continuum. On that basis, someone who is starting to work at age 20, based on the current life expectancy, is going to be living for 70 years. The whole process of accumulating money, then effectively spending it in retirement, is a 70-year planning process. If someone is looking 70 years ahead, you don’t need to be a rocket scientist to know that, based on the pretty basic assumption that equities generally will give you the greatest level of returns over the long-term, you should be 100% equities, unless you’re going to buy a first home and those sorts of things. For someone outside that, it should be 100% equities. And you don’t start de-risking the portfolio just because you’re hitting the magical age of 65.

Is 65 too early a point in your life to make that change?

It’s way too early. The reality is, all it gives you is a bit of freedom and a lot of flexibility to get your money out. Taking your money out at that point and doing something potentially suboptimal with it is one of the worst things people can do. At age 65, you’ve probably got another 25 years ahead of you. If you were someone with a 25-year time horizon and you walked into a financial adviser’s office and said, “I want this money to last me 25 years, where should I invest it?”, the general answer, putting aside any circumstances, would be 100% equities. Why, then, is there a life stages type of approach that de-risks people to the point that, at age 65, they’re 100% cash? That’s the complete opposite of where they should be, if they’re going to use that lump sum to generate a lifestyle that they want. A well-managed portfolio of 100% equities can then be de-risked, slowly, from that point onwards, but is should still have 100% equities and be managed on a 20-year time horizon.

So, when you hit 65, your KiwiSaver portfolio will have shares?

I can tell you that my KiwiSaver is still in the Booster geared growth fund, even at age 58, because I’m looking way beyond age 65. All of our staff, generally, have been in it. This brings up the issue of gearing, because as a fund manager and anyone involved in that area knows, equities outperform cash over the long-term. Particularly in a low interest rate environment, why would you not, therefore, borrow cash and invest it in equities?

We used to see a lot of geared equity products, particularly in Australia. Is the industry being far too conservative around equities?

Unfortunately, the example in Australia was typical Australians! No disrespect, it’s a generalisation! They don’t do things by halves. The typical geared superannuation fund over there was two to three times geared. When you’re investing in listed securities, that is way too much gearing. You can gear that much up when you go into long-term property; the downside risks are more limited and it’s not marked to market on a daily basis. The problem in Australia was that with three times geared, if you have a 30% downturn in your stock market (which they did in 2007), that wipes it out.

In your view, what’s an appropriate maximum gearing level?

About 50% maximum. Australia was 200-300%. If you’re facing a scenario where the markets might fall 20-30%, 50% gearing is only going to mean your maximum downside risk, which is the most important aspect, is about 50%. That in itself is still a big number, but if it’s a well-managed and well-diversified portfolio, then probably the downside risks – even at 50% gearing – aren’t too bad. However, you certainly don’t want to be going much beyond that.

Do you put some sort of protection in there?

Yes, we do. What we try to do, if we’re looking at a geared equity-type vehicle, is to just keep monitoring the level of the borrowing cost versus the underlying income stream that’s coming from the assets. A good rule of thumb would be for that to be fairly neutral.

Does it particularly make sense for a young person?

For someone who’s young, who is either past or not saving for their first home loan – where a geared fund is clearly inappropriate – in their 30s maybe, a geared approach is obviously the most sensible, rational thing to do from a capability perspective. The challenge, obviously, is having the knowledge, or someone nearby to hold their hand when the proverbial hits the fan, because they’re going to see more volatility on a day-to-day basis. If that freaks them out, they’re just going to be getting in and out at all the wrong times. It’s got to be a genuine partnership between an adviser and a client if they’re going to go in there, but it is definitely the most logical place for them to be.

Flipping right to the other side of decumulation products – we haven’t seen a lot happening in that space. Why do you think that is?

I guess partly because the actual lump sums aren’t that big at the moment, so there’s not a strong business model for putting too much time and energy into it. If you take a longer-term view, I think it’s only a matter of time before more and more things will be unveiled in that area. We’re clearly working in that area, because we think it’s important. When you start taking a view of a client’s financial needs from cradle to grave (literally), you can’t help but think about annuities and the post-retirement age decumulation phase. We’ve been doing a lot of thinking about that in the last couple of years and trying to answer the biggest challenge facing people. The reason why, at the other end, they go super-conservative is because they don’t know how long they’re going to live for. People are paranoid about running out of money. Solving that question is the key. Annuity-type products do that, but what we’re trying to recognise is the reality that, as people age through retirement, they want to have something that enables them to spend a lot of money early on, when they’ve got the physical and mental capabilities to do that. Then, as they approach their late 70s and 80s, their needs and ability to do that diminish. Therefore, so does the requirement on their financial capital drawdown. You need to have something reflecting the variability needed, which means that after a certain age, most people are only needing a small top-up to what is a really good underwritten payment for life from the New Zealand government by way of NZ Super. Providing some certainty around a top-up income to that is probably the trick to providing a good, long-term decumulation retirement solution.

Tags: annuities Booster David Beattie decumulation equities financial advisers interest rates investment KiwiSaver retirement risk superannuation