KiwiSaver's unintended consequences
Small but critical changes are required to KiwiSaver to benefit both investors and the New Zealand economy.
That is the view of expatriate Kiwi Phil Veal, a partner in advisory firm Growfire in New York City and chairman of the Kea expatriate network.
Veal told the Law & Economics Association of New Zealand, last month, that unintended consequences of the structure of KiwiSaver were hampering both investor returns and the ability of fund managers to invest for the long term.
Veal and two United States-based Kiwi mates had the idea of forming a "fund of funds", now called Matakite Capital, to enable Kiwis to invest in alternative asset classes such as global leveraged buy-outs and venture capital. The obvious place to look for investors, he said, was KiwiSaver - but what they found was surprising.
"It certainly wasn't what I'd expected," he said.
"First, even though KiwiSaver is intended to accumulate wealth over the long term, the asset allocation in the scheme looks very different from those of other long-term investors."
Long-term investors held very little cash, Veal said, and had significant holdings in illiquid assets such as private equity, venture capital, infrastructure, and real assets (see chart).
"The KiwiSaver allocations were dramatically different: cash holdings were close to 20 per cent, and illiquids practically zero. In some more recent estimates, I've seen cash figures quite a bit higher than 20 per cent."
The paradox of KiwiSaver, he said, was that the savings were long-term, but the investments were short-term.
Investment managers Veal talked to told him they could not invest in alternative assets, even if they wanted to, because liquidity was required.
"This didn't seem right: the scheme was largely illiquid - from the saver's point of view the money was out of reach - there were only limited opportunities for withdrawal and account holders had to jump through hoops to do it.
"However, the scheme provides for significant mobility, meaning account holders can move funds readily from one manager to another - this is not liquidity from the KiwiSaver point-of-view, but the manager has to be ready to liquidate any account on short notice - and therefore they can't choose investments that have liquidity constraints."
Veal said government mandated the "liquidity” features when it defined the parameters of the scheme to soothe the perceived feeling of being locked in and to enhance competition among managers, but they were now restricting investment.
"The KiwiSaver Act contains no such restrictions and none were ever seriously proposed," he said. "In fact, no serious consideration was given to the investment side of the scheme - that was left to the market - the managers would find investment products and offer them."
Veal said KiwiSaver had been a phenomenal success as a saving mechanism, but funds could not be invested like other long-term investment plans and managers could not follow "best practice" allocation models because the liquidity requirement wouldn't allow it.
"And maybe what's worse is that as well as being unintended, it seems that this problem is also largely unappreciated," he said.
"If we're truly only interested in savings then perhaps this problem doesn't matter - but we think that to make KiwiSaver a scheme that will ultimately make a real and positive difference to New Zealand in the long term we need to make sure the investment side of the scheme isn't artificially restricted."
Veal wants the Government to make a simple change to the scheme and allow investment in illiquid assets.
This will broaden investment choices, enhance individual engagement and increase financial literacy in those new asset classes. It will also enhance diversity within the funds, which is best investment practice.
"Illiquid assets are a significant and diverse global asset class, providing numerous, often unique opportunities for diversification: by geography, by sector and by risk/reward profile," he said.
Finally, the current scheme is denying New Zealand's economy access to capital. He cites attempts by Pacific Fibre to build a new cable to Australia and the US as an example of a project that could have benefited from such long-term investment.
"Down the road we have Crown asset sales imminent, Christchurch reconstruction projects starting, possibly a second harbour crossing in Auckland. Are we prepared to stand by and watch more project failures or more expensive foreign investments? And shouldn't New Zealand investors have the same return opportunities?"
Veal said the NZX wasn't and shouldn't be regarded as the only way to invest as there was a "huge amount of economic activity around the world that isn't reflected in publicly listed companies traded on open exchanges".
"This is especially the case in New Zealand - the NZX is capitalised at $62 billion, or less than a third of New Zealand's GDP."
New Zealand's public capital markets are also not representative of the economy as they are concentrated in select industries such as energy and infrastructure. Those exercising the option would have their illiquid allocations fully locked in until the underlying investment was realised, but the balance of the account would be unaffected.
"In essence our proposal is that the act should allow individual KiwiSavers to voluntarily suspend their statutory liquidity rights with respect to a discrete portion of their savings - they would agree to do this simply by selecting a fund that has this feature," Veal said.
FEES ARE THE ISSUE, NOT LIQUIDITY, SAYS STUBBS
The chief executive of Tower Investments, Sam Stubbs, said the fees associated with venture capital and private equity investment are the main barrier to KiwiSavers gaining access to that class of equity. "They are right about the lack of private and unlisted equity investments," Stubbs said. "But the fees for that are too high for a low-cost scheme." Stubbs disagrees with Matakite Capital founder Phil Veal that KiwiSaver liquidity requirements are a barrier to investments in illiquid assets, pointing out that Tower has $250m of KiwiSaver money invested in illiquid property. He added that just because an investment is listed on the NZX does not mean it is liquid. "Most of the NZX is an opportunity to invest in small illiquid companies," he said.
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