Regulator Unhappy KiwiSaver not Getting Cheaper
KiwiSaver fees must come down. That is the main message of the FMA KiwiSaver Annual Report 2019 (KAR)released this October by the Financial Markets Authority (FMA). The FMA not only wants KiwiSaver fees reduced, but plans to move from words to action on the subject. The KAR's concern with fees was already well foreshadowed in the FMA's previously published Strategic Risk Outlook 2019 (SRO) and Annual Corporate Plan 2019/20 (ACP), so should come as no surprise
In the SRO, under "Sector risks" the regulator lists, " Fees and charges – high and/or complex fees and charges that are not reasonable and commensurate" (p. 7). Within the section headed "Longer-term opportunities and challenges", the following passage is included: "Value for money – high fees that are not commensurate with the services offered or value provided, along with the difficulty of comparing products and services (including the quality of service), raise issues around value for money across a number of sectors" (p. 9). In the chapter entitled "Investment Management" the SRO sets out in some detail the FMA's concerns around fee levels across both KiwiSaver schemes and other retail managed funds, and notes that there does not seem to be strong correlation between higher fees and higher fund performance (pp. 17-9). The ACP picks up on the same theme, stating as one of the "Activities for 2019/20" the aim, "Fees and charges – ongoing work to promote transparency and improved understanding of fees and charges, and value for money" (p. 13).
The KAR is by its nature concerned with a narrower ambit in KiwiSaver than retail managed funds in general. Of note is that the KAR goes beyond generalities about fee levels and starts to drill down into the interrelationships between fund management styles, fees charged for these various investment approaches (e.g. active versus passive), and the actual value for money that KiwiSaver scheme members get for paying these charges. In the long running active versus passive funds management debate, one well worn argument for active funds charging higher fees than passive funds goes that active managers add value through extra "human capital" input which deserves greater financial compensation. In the KAR, the FMA has signalled that it wants to dig deeper into exactly what that supposed extra value is and how it can be justified.
In the KAR section headed "Value for money for KiwiSaver members" the FMA states:
"We have previously said we were surprised costs per member had not fallen faster, given the growth in funds under management. Research conducted during the year appears to indicate that the fees charged by providers for KiwiSaver funds are high compared to broadly similar funds in the UK – although it is difficult to find directly comparable fund regimes. It appears the benefits of scale, at least for the larger providers, are not being passed on to investors. Our ongoing work to promote transparency and improved understanding of fees and charges will therefore continue. We will be asking KiwiSaver providers to demonstrate how they are providing value for money for members. This includes explaining investment styles and how higher fees are justified for services such as active fund management or responsible investment strategies [our emphasis]." (p. 4)
It is of great interest that the KAR speaks of responsible investment strategies in the same breath as active fund management in needing to account for associated fee structures, because "added extras" to fund management styles like "ethical investing" or "ESG" are sometimes used to justify higher fees due to alleged increases in work required. Other possibilities in the categories of interest to the FMA could also include absolute return funds, emerging or frontier markets, and fund of funds, wherein there can be additional fees included such as manager performance bonuses, related-party costs, and underlying wholesale fund fees.
Fashions come and go with investment styles and higher fund management fees might be embedded and explained as paying the price to be part of the latest thing. However, there are also more enduring questions to consider, such as how multiple fees charged for various investment-related services are stacked up to create the headline retail fee charged to the KiwiSaver member. These incorporated billings typically include wholesale fund fees with a wedge of costs superadded to arrive at the retail fee.
In many cases, wholesale fund fees are only a minor part of the retail fee, meaning that the wedge is proportionately the largest part of the final cost to the consumer. All these fees and charges need to be unpicked in order to understand whether their contribution to the total is fair and reasonable. Additionally, as pieces of the puzzle in finding out what the true fees are, there can be charges adhering to activities of a fund that are not reflected in the headline fee reported to the investor but instead absorbed as costs to the fund.
The View from Abroad
It was timely that about when the KAR came out, the Economist magazine published a lengthy analysis of how financial markets are traded these days, particularly by robots. In a piece entitled "The stockmarket is now run by computers, algorithms and passive managers" (October 5), the Economist explored various ramifications of the relentless move away from what might be called traditional active fund management, wherein teams of humans toil away to identify good investments and avoid bad ones, and in the process make most if not all the decisions about what and when to trade. It is this human toil that is meant to justify the higher fees charged by active managers. If one could eliminate that toil, the cost of it could be eliminated also.
The Economist article explores the way in which fund management fees have trended towards zero where passive funds are concerned, but also reveals significant trends in computerized quantitative analysis that are basically getting rid of people as active fund managers. This development goes beyond massive number crunching exercises designed to detect rapid-fire arbitrage trading opportunities and has evolved into developing algorithms that can synthesize trading strategies that supposedly must be done by suitably qualified and experienced human beings.
The lingering fund management hold outs against this robotisation of financial markets currently rely on the notion that, fundamentally, substantial participation by human decision-makers is essential to the success of active investment styles. If the thrust of the Economist article is correct, these people are on the wrong side of history and will sooner or later have their jobs replaced by machines that do their work faster, more efficiently, with fewer errors, and most importantly, at a mere fraction of the cost of their salaries and bonuses. Active fund management fees should collapse as a result, at least at the wholesale level, as has occurred with passive funds, leaving the additional retail wedge cost exposed for interrogation over how it reflects value for money to the investor.
Fund management is now being commoditised not just for passive managers, but for active managers as well. In this sense, the FMA's approach in trying to jawbone down fees through comparative analysis of existing KiwiSaver scheme retail pricing is arguably a bit old-fashioned. Instead of trying to persuade fund managers to pare back fees on their current business operations, possibly a more forward-looking analysis of the fee question could focus on international trends in market trading activities in order to encourage active investment managers to change their business models and catch up with the future. Fund managers could feasibly achieve this update through taking advantage of new and evolving technologies that drive down investing costs and create savings, passing those benefits directly on to KiwiSaver investors.
The FMA is onto something good when it wants fees to come down on KiwiSaver schemes. Literally millions of New Zealanders are going to rely on their KiwiSaver assets to help buy their first homes or fund lifestyles better than mere subsistence in retirement. How much of their savings they will have to shell out in fees along the way will have huge bearing on how reasonable and achievable their expectations are for reaching their savings goals. But if, as indicated by the Economist article, costs of fund management keep falling all the time as technology displaces increasingly obsolescent business models, there must be ways to import the fruits of this revolutionary change into New Zealand for KiwiSavers to enjoy.