Part 1 of 2 of a Treasury Staff Insights: Rangitaki article by Andreas Heuser
The Treasury recently took an in-depth look at the market dynamics for KiwiSaver funds. In Part 1 of a two part article we discuss the competition aspects of the analysis.
We live in an age when price discovery is easier than ever. Consumers can instantly compare prices of consumer products: from petrol prices, airfares, electronics, cell phone charges and even power prices. Efficiencies are being generated in many spheres of daily life: car sharing and Uber are changing the way we use transport, holiday houses and spare rooms are being converted into short-term accommodation via websites and smartphone apps and smartmeters allow energy use to be instantly checked and moderated. Existing industries are having their profit margins tested as consumers become more aware of the range of options available and most importantly for the bottom line: prices.
Financial services prices are often not subject to the same pressures as other consumer goods. Funds management fees are one area where the fees paid have not changed, despite changes in technology and other innovations that ought to have lowered costs. Index tracking or "passive" funds are a 40 year old significant innovation in funds management which replicate a market or an index and typically have the lowest fees. Overseas, these index tracking funds are growing far faster than any other form of managed fund. This stands to reason, because as Nobel laureate William Sharpe pointed out: as a matter of simple arithmetic, the average actively managed portfolio of securities will return less to the investor than a passive portfolio of securities in the same market, due to the effect of fees.
Improvements and technological advances in monitoring, day to day management and even provision of financial advice should have made the business of funds management more efficient. However, the fees for these services have not dramatically changed internationally. There are also very clear economies of scale in the funds management industry which should be putting downward pressure on costs and therefore fees on a per customer basis.
KiwiSaver's size and the importance of competition
KiwiSaver represents a growing share of household balance sheets. With balances growing, and the significance for New Zealand households increasing, we examined how the market for KiwiSaver providers performs. KiwiSaver funds under management are $32 billion at March 2016. Management fees charged are approximately 0.87% per annum (total expenses as a ratio of total assets) and this has only changed slightly since KiwiSaver's inception in 2007. The simple average balance of all KiwiSaver members is $10,040.
The efficiency of the fund manager market is a critical element in the long-term success of KiwiSaver in meeting its legislative objectives. The scheme relies on competition between providers to generate optimal outcomes (net returns) for members. Six KiwiSaver providers hold 86.3% of the market which indicates it is moderately concentrated. The three largest firms hold 26%, 19% and 13% market share respectively which would not be likely to raise competition concerns under the Commerce Commission's merger application guidelines. However, there is a trend toward greater concentration in the market which is driven by the faster growth of funds under management and customer numbers of bank-affiliated KiwiSaver schemes.
In theory, competition between KiwiSaver providers ought to be occurring on the basis of price (fees), performance (returns), customer service (to the extent this is demanded) and qualitative factors ('brand'/reputation). As noted above, the effect of fees and also returns are what matters most for the balance saved at retirement and should be a high priority for consumers. In addition, the threat of a new entrant to the market should also ensure fees and performance are optimal. We should expect providers to be conscious of their fee levels, performance, customer service and reputation in order to attract and also not lose customers. This is the "discipline of the market".
Results of our analysis
We recently empirically analysed the funds and member flow of different KiwiSaver providers' schemes. We also carried out a qualitative review of the market to draw conclusions on the state of competition. We took data on the flow of funds to 134 KiwiSaver scheme funds across 17 providers from FundSource and Morningstar. Using statistical methods, we observed the relationships between fees, returns, type of fund, default/non-default status and bank status. We did not measure other factors which might attract customers, such as service levels, brand/reputation and convenience.
Using fund flow (ie, savings contributions and transfers going into a fund) as a proxy for membership, we found that fee levels are a poor predictor of fund flow. This suggests that consumers are not attracted to join or change to a provider's fund based on fee levels. Fund flow was also not responsive to good or bad historic one-year investment performance.
Given that fees and returns are the only factors that matter for improving the adequacy of KiwiSaver balance at retirement, it is noteworthy that the determinants of fund flow (and hence a provider's success in the market) are not driven by either. A more accurate predictor of success of attracting fund flow is the size of the fund. Larger and bank-affiliated funds attracted a disproportionately larger share of fund flow. These results are supported by what we already know about bank-affiliated KiwiSaver funds - these have had far more success in attracting customers and in growing their funds under management than non-bank KiwiSaver funds - as Figures 1 and 2 illustrate.
- Figure 1 - Growth of banks' and non-banks' KiwiSaver business
- Source: Financial Markets Authority, FUM = funds under management
Our analysis separately highlighted that KiwiSaver members also appear to be, on average, disengaged from their investment and uninformed about investment fundamentals. The Retirement Commission's FundFinder KiwiSaver comparison tool provides a like for like comparison of funds by fees and returns and also ranks funds within asset classes. The usage of FundFinder is relatively low (around 6,800 unique page views per month, compared to 88,000 for its sorted.org.nz parent website). We empirically tested whether the introduction of the FundFinder calculator in late 2013 changed the sensitivity of fund flow to fee levels (it did not). In addition, the FMA's MoneyWeek survey results suggest a high degree of misinformation among KiwiSaver members.
The results of our analysis raise a number of questions about the reasons for the current competitive behaviour in respect of fees and the market pressures on fund managers. These questions are pursued in the forthcoming part two of this article.
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Treasury Staff Insights: Rangitaki
See Treasury Staff Insights: Rangitaki for other articles in this series.