Why KiwiSaver funds couldn’t match the NZX
According to the March quarter 2019 Morningstar KiwiSaver Survey, 151 of the
153 KiwiSaver funds underperformed the NZX50 Gross Index in the 12 months to March 2019.
The only funds to outperform this NZX benchmark index, which returned 18.3 per cent for the March
2019 year, were two small property funds with total assets of only $25 million. These two funds represent only 0.05 per cent of total KiwiSaver assets of $54,661m.
How could this happen? How could the vast majority of KiwiSaver funds, including all passive funds, underperform the benchmark New Zealand sharemarket index in the March 2019 year?
The first point to note in the accompanying table is multi-sector funds dominate the KiwiSaver sector.
These multi-sector funds invest in a wide range of asset classes, including New Zealand, Australian and global equities, as well as property, alternative assets, fixed interest securities and cash.
These multi-sector funds account for $51,789m, or 94.7 per cent, of total KiwiSaver assets according to Morningstar, while single-sector funds represent only $2872m of KiwiSaver assets.
Morningstar’s assessment of the total KiwiSaver asset allocation is as follows:
Cash & NZ bonds 31.7 per cent International bonds 18.6 per cent NZ property 2.4 per cent International property 1.6 per cent NZ shares 10.5 per cent Australian shares 5.2 per cent International shares 28.9 per cent Other 1.1 per cent.
The overall position is that 49.7 per cent of KiwiSaver is invested in growth assets, mainly shares, and
50.3 per cent in income assets, mainly fixed-interest securities and cash.
This relatively conservative asset allocation is partly due to individual choice — 40.7 per cent of KiwiSaver assets are in cash, conservative or moderate funds — but portfolio managers also took a more cautious approach after the sharp downturn in equity markets at the end of 2018.
Multi-sector funds will never outperform the top performing asset class and the New Zealand sharemarket has been the best performing investment in the March
2019 year. In this 12-month period,
the NZX had a gross return of 18.3 per cent, the ASX 12.1 per cent (9.7 per cent in NZ dollars), the MSCI World Index 6.7 per cent (10.0 per cent in NZ dollars). In addition, NZ investment grade corporate fixed interest securities returned 6.1 per cent and cash around 2.0 per cent.
As total KiwiSaver funds hold only 10.5 per cent of their assets in NZ shares, it is totally predictable that multi-sector funds will underperform the NZX50 Gross Index when the NZX outperforms all other asset classes, particularly when the outperformance is by a relatively wide margin.
There are five KiwiSaver single-sector Australasian equities funds with total assets of $62.9m, representing just 0.1 per cent of total KiwiSaver assets. These five also underperformed the NZX benchmark index in the March 2019 year.
This multi-sector approach has been adopted by most large pension, superannuation and sovereign funds, including the New Zealand Superannuation Fund and Australia’s Future Fund.
Unfortunately, the NZ Super Fund, which has assets of $41.6 billion and a strong growth mandate, no longer discloses monthly asset allocation information but its reference portfolio is as follows: Global equities 75 per cent, NZ equities 5 per cent, and fixed-interest securities 20 per cent.
Australia’s Future Fund, which has assets of A$154.4b ($162.7b), had the following asset allocation at the end of March: Global equities 26.4 per cent, Australian equities 6.5 per cent, other growth assets 44.6 per cent, and fixed interest and cash 22.5 per cent.
The NZ Super Fund had a 7.3 per cent return for the March 2019 year, after cost but before tax, while the Future Fund returned 9.7 per cent.
KiwiSaver growth and aggressive funds slightly outperformed the NZ Super Fund, on average, in this 12-month period.
In the 10 years ended March 2019, the NZ Super Fund had an annualised return of 14.9 per cent and the Future Fund 10.4 per cent.
In the same 10-year period KiwiSaver growth funds had an average annual return of 10.9 per cent and aggressive funds 9.6 per cent.
The best performing multi-sector KiwiSaver fund delivered an annualised 13.3 per cent return for this 10-year period. This is the Milford Active Growth Fund, which Mary Holm wrote about in her last two columns because investors asked why it has underperformed on the NZX50 Gross Index and why it held fixedinterest securities when it is a growth fund.
The multi-sector approach, which has been adopted by most global superannuation funds, has its foundation in the work of several academics, notably Harry Markowitz. Markowitz was one of the pioneers of Modern Portfolio Theory (MPT), which assumes investors are risk averse.
For example, MPT is based on the principle that investors would prefer to have consistent returns of 8 per cent per annum compared with, for example, consecutive annual returns of plus 35 per cent, plus 4 per cent, minus 15 per cent, plus 30 per cent and minus 5 per cent over a five-year period — even though the latter would deliver a slightly higher return than 8 per cent per annum.
Industry experience in New Zealand also indicates a similar attitude among investors — they prefer consistent returns even though more variable annual returns may deliver higher long-term results.
Markowitz wrote in his 1959 book
Portfolio Selection; Efficient
Diversification of Investments that “uncertainty is a salient feature of security investment. Economic forces are not understood well enough for prediction to be beyond doubt or error. Even if the consequences of economic conditions were understood perfectly, non-economic influences can change the course of general prosperity, the level of the market, or the success of a particular security. The health of the President, changes in international tensions, increases or decreases in military spending, an extremely dry summer, the success of an invention, the miscalculation of a business management — all can affect the capital gains or dividends of one or many securities.”
Consequently, Markowitz recommends that a portfolio should have a range of uncorrelated assets — assets that don’t always go up and down together. He wrote: “To reduce risk it is necessary to avoid a portfolio where securities are all highly correlated with each other. One hundred securities whose returns rise and fall in near unison afford little more protection than the uncertain returns of a single security”.
This is one of the reasons why multi-sector growth funds hold fixed interest securities and cash because they are usually uncorrelated with share price movements.
Another MPT principle is Markowitz’s Efficient Frontier Theory, which is the asset allocation that will deliver the highest return for the lowest risk.
In general terms this mix is usually around 80 per cent growth assets and 20 per cent income assets because once a portfolio goes above an 80 per cent allocation to growth assets, its risks increase at a greater rate than expected returns.
The NZ Super Fund is a good example as it has a 20 per cent target for fixed-income securities even though it has a strong growth mandate and withdrawals are not scheduled to start for at least another decade.
Consequently, KiwiSaver members have two main options if they believe their fund or funds are too cautious.
The first is to put all their money into single-sector funds, a strategy that would receive limited support from most qualified financial advisers.
The other, and preferred, option is to keep investment money outside KiwiSaver and place this in higher risk single-sector funds.
In other words, KiwiSaver should be viewed as a lower-risk investment option while higher risks can be taken through non-KiwiSaver investments.