Fund managers’ inconsistent performance measurement and cost of fees reduces benefits to investors

The managers of New Zealand managed investment schemes (MIS or KiwiSaver/fund managers) are showing repeatable performance, relative to appropriate market indices. However, the benefits of their skill to investors in some funds is reduced by fees, and the costs of commission paid by managers to third parties.

Value for money is also undermined by some fund managers not using an appropriate market index as a reference point for the performance of their funds and to benchmark performance fees.

These are key findings from a report detailing the outcomes of a pilot study, testing how fund managers would implement value for money guidance published by the Financial Markets Authority (FMA) – Te Mana Tātai Hokohoko – last year. The report, from the FMA and the four Supervisors of fund managers (Covenant Trustee Services Limited, New Zealand Guardian Trust Limited, Public Trust Limited and Trustees Executors Limited), found:

  • Performance data shows skill is present among some (not all) fund managers in the pilot study, with fund managers using both active and passive strategies performing competently relative to an appropriate market index and to logically chosen selections of comparable funds. However, the impact of fees caused the benefit of this competence to investors to disappear for most funds.
  • Fund managers are not using an appropriate market index for their funds and/or their performance fee models – typically, through using a cash-based market index as a reference point for the performance of an equity-based fund – and there is wider fund manager scepticism about the value of a market index to determining value for money.
  • Fund managers commonly pay substantial commission to third parties¹ for introducing new members to their funds – only some of which are financial advisers helping investors make good investment decisions. This has a significant, ongoing impact on fund costs, the fees paid by investors and, ultimately, on fund performance, which is the most important aspect of value for money to investors.

The FMA is pursuing specific matters with individual managers and, together with Supervisors, will engage with industry on the market index and commission issues. This will be first step in the FMA’s response to these issues. The FMA has other regulatory tools available if it finds persistent conduct issues arising.

The guidance expects fund managers and their Supervisors to review the value for money of the funds offered by the fund manager at least annually – the first to be completed by mid-2023. The FMA and Supervisors agreed a trial of the value for money questionnaire self-assessment tool, in a pilot study, was necessary to ensure a consistent approach to the reviews across fund Managers and Supervisors. Accordingly, the study involved 14 fund managers selected by supervisors, plus some volunteers.

The guidance and questionnaire assists fund managers and their supervisors to meet their statutory duties to act in members’ best interests.

Paul Gregory, FMA Director of Investment Management, said: “If a fund manager is not using an appropriate market index, how do they or their investors know what their strategy is, or if it provides value for the risk investors are taking and the cost they are paying?

“We are keen to understand the basis for fund manager scepticism about the relevance of an appropriate market index to value for money. An appropriate market index is not – and is not supposed to be – easy to match or beat for passive and active fund managers, respectively.”

Third parties paid substantial commission

Regarding the substantial sums paid in commission to third parties, Mr Gregory said: “We saw very few instances where the third party continued to provide advice or of members being made aware the fees they pay are inflated by the cost of commission.”

Mr Gregory said some fund managers used commission as part of their business model to achieve and sustain scale – particularly important in KiwiSaver. “The FMA and Supervisors are conscious many fund managers without a bank branch network must acquire new members, and grow, through a mix of commission, marketing, and incentives. Our expectations governing all three factors have been set out either through new guidance on value for money, and marketing and advertising, or industry engagement. Financial advice legislation reform, including the removal of the class advice distinction, is also relevant.

“The FMA, Supervisors and fund managers agree investors benefit from financial advice. The FMA and Supervisors want a discussion with industry on how investors get the help they need to make good decisions, how an offering delivering that help could be structured to represent value for money and disclosed to members, and how the FMA can assist. This should involve both the advice and banking sectors,” Mr Gregory said.

“We received feedback during the pilot, as we did in guidance consultation, that market forces would resolve poor value for money and there was no need for FMA intervention,” Mr Gregory noted. “The FMA has never disputed the market has a significant role in addressing and eliminating poor value for money. However, the FMA will continue to do what we can – and should – to enable the market to do so sooner. This view is strongly supported by large KiwiSaver providers removing or reducing their fees shortly after our guidance was published, some explicitly referencing value for money.”

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