When it comes to KiwiSaver, performance trumps fees

As Kiwis we are unfortunately very familiar with what I would regard as our worst behavioural trait:  the “Tall Poppy Syndrome” of taking-down or not rewarding success.  Sports get a...

As Kiwis we are unfortunately very familiar with what I would regard as our worst behavioural trait:  the “Tall Poppy Syndrome” of taking-down or not rewarding success.  Sports get a pass, you can never be too good, but when it comes to business or financial success, that’s a different story.

It reminds me a bit of the New Zealand funds management and KiwiSaver sector which has in most cases moved to, or is being moved towards, the lowest common denominator:  it’s all about fees.

We hear about fees all the time (scolding those who charge too much and holding high on a pedestal those with the lowest).  We don’t see many (or even any) articles in the media saying that XYZ fund had a stellar return this quarter and made its investors X%.  The corollary holds true, we seemingly don’t really hold those with a tough year accountable either.  That looks like an opportunity for a “specialist” financial journalist writing on the $260 billion Funds Management Industry (of which Kiwi Saver is approximately $90 billion).

Our sector regulator, the Financial Markets Authority (FMA), has been very focused on fees over the last few years.  To its credit though, and quoting from its Value for Money Industry Report, the guidance explicitly states “value for money does not necessarily mean cheapest.”  It further states “providing value for money is a core aspect of a fund manager’s responsibility.”

You will all have likely heard of hedge funds, that elusive class of asset investing for rich people where the returns are “amazing” (well some, yes) and there is strong emphasis on downside protection.  The great hedge fund managers which do deliver the best returns can and do charge for their expertise, and investor-clients are only too happy to pay.  The fee structure for the investors in these products are typically structured as a Management Fee plus a Performance fee.  The long-standing ratio (albeit it’s come down in many cases) is referred to as 2/20 (ie a 2% Management Fee and a 20% share of the profit or gains in portfolio value).  For example, if a hedge fund manager is looking after a one billion dollar portfolio, its fee management fee will be $20 million.  If the fund earns a 20% return in one year (ie: $200 million of profit or gain, its manager earns a 20% share of that profit, in this case $40 million).  You, the investor enjoys a net return in this example of +16%.  Personally, I like performance fees that are structured properly as I believe they align the interests of both the investor and fund manager.

In New Zealand, we are relentless on the idea that low fees are just better.  Don’t get me wrong, we love low fees for our clients.  Last week we wrote about John C. Bogle, the creator of Vanguard (the inventor of low fee instruments).  We very much understand the drag on compounding of say a 1.0% per annum fee as opposed to, say, 0.20% per annum.  However “net” performance supersedes the fees discussion everyday.  One needs to understand the combination of the two in totality.  We don’t really hear much about it, except in fund manager newsletters (because they must!).  I would rather pay my investment manager 1.5% per annum and receive 9.0% annual average returns, or 7.5% net, than pay someone 0.75% per annum for 6.0% average returns or 5.35% net (all things equal).  Any day and all day long…

Yes, someone might like to talk about how low their fees are, but the first question asked should always be “what is their net performance like”.  Don’t just talk about fees as an isolated conversation, instead ask about return net of fees.  To take it a step further again would be to discuss “Risk Adjusted Returns” – how much ‘risk’ did the investment manager take to achieve the return they did – we call this a ’Sharpe Ratio’ and we like low numbers – but that’s a topic for a separate article.

Arguably one of the most successful fund managers in the world is Renaissance Technologies founded by Jim Simons:  its Medallion Fund returned 62% annualised returns (before fees) and 39% annualized returns (net of fees) from 1988-2021 on US$165 billion of capital.  (Read the book “The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution” if you want to understand how).  At the end of the 30-year study (in the book) Jim had bought most investors out as the fees were seemingly and increasingly too high for them.  Jim and his three partners now own approximately 70% of the funds they manage and in the last year of the study fees were 4/44 (a 4% Management Fee and a 44% Performance Fee).

We had a look at the Morningstar Kiwi Saver data for the 12 months to 30 June 2023, specifically Balanced Funds as it’s the largest group of providers.  The average fee was 0.94%.  The top three performing funds net returns were in the +10-12% range and they all charged more than 1% management fees.  The bottom three performing (or under-performing) funds delivered net returns of +1.81-5.96% but also charged more than 1% in fees.  The funds of the six lowest fee providers (0.28 – 0.35% of fees) underperformed the top three funds by approximately 2%.  There are a multitude of Kiwisaver Funds claiming low fees – some digging will show you in many cases they continuously underperform even their own benchmarks (pre fees).

Some good news. A KiwiSaver provider we know well recently commissioned a report from Deloitte looking at superannuation fees in NZ, Australia and the UK.  Its conclusion was that the fees paid within the KiwiSaver sector are on average lower than similar products in the Australian or the UK retirement systems.  Further, KiwiSaver fees were reported to be “highly competitive” in relation to their much larger scale Australian and UK peers.

So, beware the fund that talks low fees but never talks performance – that is a path not well travelled.    Performance trumps fees every day.