An analysis of KiwiSaver Conservative Funds identifies a variation in underlying asset allocations, despite there being a generic look at a higher level (Income / Growth split).
The area of most pronounced difference is within the Income asset class allocations: Cash, New Zealand Fixed Income, and International Bonds. There are also nuances within each of these asset classes, particularly level of benchmark duration risk.
These differences will drive performance outcomes, having nothing to do with active management skill and very little in relation to fees paid.
Portfolio performance is primarily driven by portfolio construction and implementation decisions. The value of a good investment strategy.
Within the Income asset classes, the decision on duration and credit quality will drive performance (absolute returns and relative to peers). These decisions impact return outcomes over both the short and longer term.
A comparison to Australian Super Funds with similar objectives provides useful insights into asset allocation decisions being made in New Zealand.
Analysis of Balance and Growth KiwiSaver Funds has also been undertaken and will be provided at a later date.
Analysis of KiwiSaver Conservative Funds
The Table below provides average, min, and max allocations of the Strategic Asset Allocations of 12 KiwiSaver Providers’ Conservative Funds, sourced from their latest Statements of Investment Policy and Objectives (SIPO).
|Cash||Fixed Income |
|Fixed Income |
From a top level, by and large the managers are tightly grouped around 77% allocation to Income assets (Cash, NZ Fixed Income and International Bonds).
There are a small group of four managers which are outliners, with income allocations closer to 70%.
This group is materially different from the bulk of the managers. They tend to have lower cash allocations and much higher equity allocations. Only one of these managers has a material weighting outside of the listed equity markets e.g. Alternatives.
Within Income Assets
The variation within Income asset class occurs at both the asset allocation and performance benchmark level. Both of which drive performance outcomes.
As can be seen from the Table above the variation in the allocation to Cash is extreme. Ranging from 1.0% to 30.0%.
Maintaining high levels of cash does not make a portfolio less risky. High levels of cash can raise risks relative to certain investment objectives, particularly if the investor is seeking a stable and more predictable income stream in retirement.
High levels of cash increase the variation of income in retirement and is less effective in providing portfolio protection at the time of sharp sharemarket declines. On both counts, longer maturing fixed income provides a better solution. See here for why holding high levels of cash at retirement can be scandalous.
Given the current environment of very low interest rates and higher equity market valuations in the US and NZ, a higher weighting to cash could be warranted.
The key benefits of cash are that it is highly liquid, provides emergency funds without impacting longer-term investments, and can arguably be “dry powder” funds when sharemarkets decline sharply. The key to the dry powder factor is having the investment discipline to act accordingly.
The allocations to Fixed Income (NZ Fixed Income and Global Bonds) are tighter, ranging from 50% – 76%, and averaging around 62%.
The allocation International Bonds is higher relative to domestic Bonds, on average making up 64% of the Fixed Income Allocations. International Bonds are the largest asset allocation weight within the portfolios of just under 40%.
Risk and Investment Management
From a risk management, and investment management perspective, a portfolio’s capital allocations to cash, NZ Fixed Income, and International Bonds are less relevant relative to the Portfolio’s duration and credit exposures.
A more accurate way of looking at risk, and managing a portfolio, is a Portfolio’s level of duration and credit exposure.
Duration is a key risk measure, and in general reflects a portfolios capital value sensitivity to changes in interest rates. Duration is measured in years. For example, assuming your Portfolio’s duration is 6 years, if interest rates rise by 1% the portfolio will decline by 6%, all else being equal.
See here for an explanation of Duration and here for credit risk.
Generally, those with a higher allocation to International Bonds have a higher level of interest rate risk. These portfolios would have benefited more from the significant decline in interest rates over the last 20 years.
From a high level, the range in total Portfolio duration is estimated to be:
|Total Portfolio Duration|
These are estimates, based on current index duration and portfolio asset allocations. The key points are, this is a more accurate view of portfolio risk and there is a reasonable spread in duration risk amongst the managers.
From this perspective, investors must be careful in assessing the relative risk of a Conservative Fund based on asset allocations alone.
By way of example, some Managers manage to a lower duration international bond index. Thus, despite having a higher international bond allocation these Portfolios may have lower interest rate risk (duration) than a portfolio with a lower international bond allocation but managing to a higher duration index. They may also have the same level of interest rate risk!
Therefore, what is important is how much duration risk a portfolio should have in meeting its investment objectives.
From an investment governance perspective, Investment Committees should not be debating the level of allocation to cash, international, or NZ fixed interest without first considering what is the most appropriate level of portfolio duration risk to target in meeting investment objectives. This is a different conversation and focus.
There is evidence that at least one of managers takes such an approach, maintaining a very low allocation to cash and a high allocation to Fixed Income. This portfolio is not necessarily riskier than the other Funds just because it has a low cash holding.
Lastly, it should be noted that the duration on the International Bond Index has almost doubled over the last 10 years. Therefore, if portfolio allocations to international bonds have remained static over the last 10 years, the risk of this allocation has increased along with the total portfolio’s risk profile. Unfortunately, with interest rates so low, the return prospects are less, yet the risks have increased.
For more on the unintended risks within fixed income see here.
As would be expected, the Growth Allocation is reasonably tight around 23%, the flip side of the Income Allocation.
Listed equities, including New Zealand equities, international equities, and listed property and infrastructure dominate the growth allocations i.e. there is very little investment in Alternatives.
Direct Property dominates the Alternative allocations.
Of interest, on average Domestic equities (New Zealand and Australia) make up around 35% of the core equities allocations e.g. domestic and international listed equities ex listed property and infrastructure.
Overall, core equities make up 19% of portfolios, domestic equities are around 6.5% of a Conservative Portfolio.
|Ratio of Domestic Equities|
in Core Equities Allocation
|Core Listed Equities|
The Growth allocations will be discussed in more depth when presenting the results of the Balance and Growth Fund’s allocations.
Australian Fund Comparison
The Table below presents the average, min, max, and medium asset allocations of the largest Super Funds in Australia. This list is dominated by Industry Funds.
The list includes funds with Conservative in their name and/or have similar return objectives to the KiwiSaver Funds. The return objectives are express as inflation plus a margin e.g. CPI + 1.0%.
The following quick observations can be made:
- The Australian Funds have lower allocations to Income Assets than the New Zealand Funds, this is consistent with the Australian Funds having higher CPI + return objectives. A return objective is necessary to undertake portfolio modelling. Also, don’t always choose a Fund my its name!
- At the same time, the Aussie Funds have much higher Cash allocations relative to the NZ Funds.
- The above means the Australian Funds have much lower Fixed Income allocations. They also only show Fixed Income, not domestic and international bonds breakdown, which is consistent with the discussion above.
- Interestingly, the listed equity allocation is in line with the Kiwi Funds, around 20%. However, the weighting in Australia to domestic equities in the total core equities allocation is closer to 50%, compared to 35% in NZ. Domestic equities make up around 9% of a Conservative Fund in Australia, compared to 6.5% in New Zealand. Albeit, the Australian Funds do have a higher risk profile.
- The Australian Funds have significantly higher allocations to Alternatives than the NZ Funds. When you consider a similar core equities allocations and higher cash allocations in Australia, the higher Alternatives allocation comes at the expense of Fixed Income.
The Alternatives allocation will be discussed in more depth when presenting the results of the Balance and Growth Fund’s allocations.
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