KiwiFund could have unfair advantage

Very surprising comment from banking “expert” Claire Matthews to the effect that KiwiSaver “is a relatively competitive market”. It is obvious to anybody that KiwiSaver is not a competitive market…. for the following reasons:

• Firstly if you look at the KiwiSaver offerings for a balanced portfolio from four of the largest banks you will see that the fee structure is in a very tight range of 1.04% to 1.17%. Hardly indicative of a competitive market and in fact suggestive of just the opposite.

• That high fees are inflicted on KiwiSavers is not surprising because, as a huge body of academic research shows, retail investors in general don’t differentiate products based on fees. This is most likely because their trusted advisors tell them that this isn’t an issue i.e. when they rock up to the ANZ, BNZ, Westpac or Kiwi Bank their advisor can only sell them the bank products and thus tells them that fees are not an issue. Similarly for those few independent advisors who actively advise on KiwiSaver the vast majority only recommend one providers products because it pays them trailing fees and those products have generally even higher fees than the banks. Despite these obvious truths, back in 2010, the then Commerce Minister, Simon Power said “I am confident that transparency along with various other standards will ensure that Mum and Dad investors can make informed decisions about whether to use a particular financial advisor and will ensure that advisers act in their best interests”. Shortly after making this statement Mr Power switched sides and became a client wealth expert at Westpac. Hmmm.

• The lack of competitiveness in the KiwiSaver market can also be estimated by looking at the extent to which the risk premium is appropriated. The equity risk premium is the excess return of global equities over global bonds. So in a US context the numbers are 6% – 2.5% = 3.5%. The average growth KiwiSaver fund has fees of 2% pa including transaction costs so that is more than half of the risk premium gone in fees. If KiwiSavers knew the impact of fees would they be happy to effectively lose most of the equity risk premium? Paul Marsh of the London Business School said recently “if returns are relatively low and you are charging 1-1.5% on a fund you are probably gobbling up half of the expected returns. I don’t think this is sustainable.” The reason KiwiSavers don’t differentiate on fees is because whilst they may know the fee they don’t know the context within which to assess whether fees are high or low.

• Last but not least we can compare the average fee of a growth orientated KiwiSaver fund at around 2.0% pa including transaction costs with the average fees paid by professional investors like the NZ Super Fund or a more competitive savings market like that of the 401(k) in the USA. The Super Fund is paying under 10 basis points pa for the bulk of its equity exposure and the average 401(k) fee for equities in 2015 was 53 basis points and it has fallen significantly since then.

One could have hoped for more informed comments from a banking “expert”. I do however agree with Ms Matthews view that the KiwiFund should not have a government guarantee. That’s ridiculous. What the KiwiFund should however guarantee is lower fees than the average provider.

It is interesting to try to work out what fee the Super Fund should charge if it accepted Kiwisaver money.

My understanding is it currently only charges the Government its actual costs.

So they will need to build in a profit margin into the fee to avoid distorting the market. In addition they will have marketing costs and higher costs associated with having many accounts.

But how would you work out the appropriate profit margin?

I suspect the most likely approach the Treasury would recommend would be to base it on the average private sector Kiwisaver profit margin.

So we end up in a circle. Super Fund Kiwisaver fees would probably be around the same as current Kiwisaver fees because otherwise the Government would be undercutting the private sector.

I certainly hope the Government does not create a Govt Kiwisaver fund charging only costs and with an implicit Government guarantee.

Given that industry commentators have been saying that it is not fees that are important but rather the returns then why should they be concerned about fees charged by a Government scheme at all? We all know the answer to that because fees are in fact critically important to returns over the longer term.
I think a sensible fee would be one based on best practice benchmarks not what the current NZ industry does because we all know that the fees are way too high and have not been impacted by huge growth in FUM. Given the government scheme would likely be a 'bare bones' service then fees should be low as their costs should be and so would the assets utilised.
If the Government's primary objective is to get fees down then they should look at the current returns of the existing 'players' in KiwiSaver and compare that to what would be reasonable in a truly competitive market place and set their fees accordingly.
I hope the Government does not get nobbled by the industry lobby (as National clearly did) and we can then expect a lot of squealing before providers knuckle down, reduce fees and costs to shore up their market share and profits rather than overpaying themselves for a basic service as they currently do.
In the long run everyone will benefit because the growing population of retirees will have more to spend in their retirement, not to mention that most of us will be retirees one day too.