Opinion: Craig Simpson reviews the Generate KiwiSaver offering, the latest entrant into the KiwiSaver industry

Generate KiwiSaver is the latest entrant into the already crowded KiwiSaver market. The prospectus is available on the issuers website here.

Having said this, Generate's KiwiSaver offering of three funds offer savers a point of difference from the mainly vanilla schemes currently on offer from the major banks and institutions.

The manager is offering investors the option of a life stages approach which invests in predetermined percentage proportions in each of the three funds available. The asset mix will change over time and become more conservative as the investor gets older.

Generate invests only in a subset of hedge funds being predominantly in international equities (equity long and short) and diversifies the portfolio with high quality equity long only funds and property, infrastructure and fixed interest assets.

The manager aims to be transparent around their fees and holdings although at the time of writing the managers used are not disclosed.

Generate's points of difference

We see two key differentiating points. Firstly, Generate KiwiSaver will be the first scheme to predomiantely use hedge fund managers as part of their investment portfolio; and secondly they do not have a target exposure to NZ or Australian shares.

Some existing managers have mandates that permit the use of hedge funds and other alternative investment strategies and may from time to time have small exposures to these.

Historically it appears KiwiSaver managers have been reluctant to implement a significant or meaningful exposure to these alternative assets. We are not sure why given the risk and return benefits that can be achieved as shown in recent research.

Nearly all other managers will have an exposure to New Zealand and / or Australian shares. Only one other mananger that we are aware of also does not have a target exposure or allocation to New Zealand or Australian shares and that is Gareth Morgan KiwiSaver.

Generate will run a concentrated portfolio of between 10 and 15 investment managers. Most of the more concentrated portfolios run by KiwiSaver providers are in directly held New Zealand and / or Australian shares rather than via investment managers.

What are hedge funds and what strategies do they use?

There are several types of hedge funds and hedge fund strategies available so it is not easy to provide a simple all encompassing explanation.

In general, hedge funds can take both long and short positions, use arbitrage, trade options, bonds and invest in almost any opportunity in any market. The principal goal of a hedge fund manager is to make money no matter which way the market goes. A brief explanation of the various strategies adopted by hedge fund managers follows.

Aggressive Growth:
Invests in equities with generally high P/E ratios, low or no dividends; often smaller and micro cap stocks. Can be sector specific and hedges by shorting other equities where earnings are expected to disappoint or by shorting stock indexes. The expected volatility of this strategy is high.

Distressed Securities:
Buys equity, debt, or trade claims at deep discounts of companies in or facing bankruptcy or restructuring. Managers seek to profit from the markets lack of understanding of the value of the securities. The expected volatility is low to moderate.

Emerging Markets:
Invests in equity or debt of emerging markets that tend to have higher inflation and volatile growth. Short selling is not permitted in many emerging markets, and, therefore, effective hedging is often not available. d currency markets. The expected volatility of this strategy is very high.

Funds of Hedge Funds:
Mix and match hedge funds with different strategies and styles with the aim of providing more stable long term returns. Returns, risk, and volatility can be controlled by the mix of underlying strategies and funds and capital preservation is generally an important consideration. Volatility depends on the mix and ratio of strategies employed, but could be expected to be anywhere from low to medium or medium to high depending on the asset allocation.

Income:
Invests with primary focus on yield or current income rather than solely on capital gains. May use leverage to buy bonds and fixed income derivatives profit from principal appreciation and interest income. The expected volatility is low.

Macro:
Aims to profit from changes in global economies, typically brought about by shifts in government policy that impact interest rates, in turn affecting currency, stock, and bond markets. Managers will use leverage and derivatives to accentuate returns. Leveraged directional investments make the largest impact on performance (both positive and negative). The expected volatility of this strategy is high to very high.

Market Neutral - Arbitrage:
Attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. May also use futures to hedge out interest rate risk. Focuses on obtaining returns with low or no correlation to both the equity and bond markets. The expected volatility is low.

Market Neutral - Securities Hedging:
Invests equally in long and short equity portfolios generally in the same sectors of the market. Effective stock analysis and stock picking is essential to obtaining meaningful results from this type of strategy. Leverage may be used to enhance (or negatively impact) returns. Usually this strategy has low, or no correlation to the market as a whole. The expected volatility is low.

Market Timing:
Allocates assets among different asset classes depending on the manager's view of the economic or market outlook. Unpredictability of market movements and the difficulty of timing entry and exit from markets add to the volatility of this strategy. The expected volatility of this strategy is high.

Opportunistic:
Investment theme changes from strategy to strategy as opportunities arise to profit from events such as IPOs, sudden price changes often caused by an interim earnings disappointment, hostile bids, and other event-driven opportunities. The expected volatility can be variable from this strategy.

Multi Strategy:
Investment approach is diversified by employing various strategies simultaneously to realise short- and long-term gains. Other strategies may include systems trading such as trend following and various diversified technical strategies. This style of investing allows the manager to overweight or underweight different strategies to best capitalise on current investment opportunities. The expected volatility can be variable from this strategy.

Short Selling:
Securities are sold-short in anticipation of being able to rebuy them at a future date at a lower price due to the manager's assessment of the overvaluation of the securities, the market, or in anticipation of earnings disappointments often due to accounting irregularities, new competition, change of management, etc. The expected volatility of this strategy is very high.

Special Situations:
Invests in event-driven situations such as mergers, hostile takeovers, comnpany restructures or leveraged buyouts. May involve simultaneous purchase of stock in companies being acquired, and the sale of stock in its acquirer. Managers may also utilise derivatives to leverage returns and to hedge out interest rate and/or market risk. Results from this strategy tend not to be dependent on the direction of market. The expected volatility of this strategy is moderate.

Value:
Invests in securities perceived to be selling at deep discounts to their intrinsic or potential worth. Such securities may be out of favour or not followed by analysts. Long-term holding, patience, and strong discipline are often required until the ultimate value is recognised. The expected volatility of this strategy is low to moderate.

Who is behind Generate?

The people behind Generate are all experienced investment professionals but not necessarily well known by the average investor.

Probably the name most recognised by investors is Warren Couillault. Couillault spent time at Fisher Funds and was a shareholder, director and Chief Investment Officer prior to leaving the company in 2008 in what could be best described as a messy divorce.

Couillault is currently a director and CEO of Richmond Investment Management GP Limited. He has more than 20 years experience in financial markets. From 1993 to 2002, he was with two sharebroking firms, working in research and sales roles in Auckland, Sydney and London.

He moved back to New Zealand in 2002 to join Fisher Funds Ltd. Since leaving Fisher Funds Warren has focused on selective private, direct investments. Warren is a member of the Institute of Finance Professionals New Zealand Inc., a Trustee of the Diocesan School for Girls Heritage Foundation and a director of several other private companies.He also runs Richmond

Other members of the Generate KiwiSaver Investment Committee are:

Peter Brook - Chairman & Investment Committee Member

Peter has 20 years’ experience in the investment banking industry, retiring as Managing Director of Merrill Lynch (New Zealand) Limited in 2000 to pursue his own business and consultancy activities. He is currently a director of Argosy Property Limited, Chairman of Burger Fuel Worldwide Limited and Trust Investments Management Limited. Peter is also a Trustee of the Melanesian Mission Trust Board, a member of the Institute of Finance Professionals New Zealand Inc., and a director of several other private companies.

Sam Goldwater – Executive Director & Investment Committee Member

Sam has 15 years of financial markets experience. Locally he worked in fixed income sales and trading for the National Bank of New Zealand Treasury, co-managed the bond desk at First NZ Capital, and most recently led the investment management of a New Zealand family office. He also worked for three years in London in fixed income trading and origination.

Henry Tongue - CEO & Investment Committee Member

Henry has 15 years experience in the financial markets, beginning as an equity analyst for a New Zealand stock broking firm before moving to London in 1999. In London he worked as an analyst for global investment bank Credit Suisse before joining Abbey National’s industry-leading funds management team. Returning to New Zealand in 2003, Henry joined a private investment company managing their equity and property portfolio in the Australasian markets. In 2007 he was appointed Senior Portfolio Manager responsible for investments across all asset classes at Huljich Wealth Management. Huljich managed one of the largest New Zealand owned KiwiSaver schemes until it was bought by Fisher Funds in 2011.

Jonty Edgar - Investment Commitee Member

Jonty Edgar is Managing Director, Country Head of Hong Kong and China/ Head of Sales – Asia for Religare Capital Markets. He has over 13 years of experience in Asian Equity Capital Markets - most recently as the founder of Aviate Global which he grew to a team of 30 sales and sales traders across Asia. Prior to that, Jonty was with Credit Suisse for 12 years where he had roles in London and Hong Kong focused on Asia and Hedge Fund products.

What do I pay in fees?

Any manager that states in their marketing material that investors compare returns after fees rather than the fees of different KiwiSaver schemes is pretty much waving a red rag to a bull in the New Zealand market where investors are obsessively fee conscious.

It will be some time before we can with some certainty say that the fees you pay in the Generate KiwiSaver scheme don't matter so much. 

The fees charged by Generate are a combination of management fees, Trustee and Custodian Fees, Administration Fees and the fees paid to the various investment managers. There will be an additonal Performance Fee paid to managers who achieve returns over a stipulated minimum return benchmark.

The manager estimates the total fees each year approximately to be:

No allowance has been made for GST or tax.

No allocation to NZ or Australian shares

Like Gareth Morgan's KiwiSaver proposition, Generate does not have a set or target exposure to New Zealand or Australian shares. The proposed target asset allocations are illustrated in the table below, but keep in mind the manager uses an active management style so the actual exposure to each sector may vary from that outlined. Included in brackets is the asset allocation range for each asset class within the various portfolios.  

More information on the target asset allocations can be found in the prospectus here.

Hooray for coming to the market with something different

After being totally underwhelmed by the BNZ KiwiSaver offering which came to market last month, it is refreshing to have something which is out of the ordinary in the market.

Hedge Funds through their multitude of trading strategies, some of which we have tried to outline as simply as we could above, have the ability to make money in both up and down markets. Get either the strategy or the mix across the various managers wrong and you can also see massive destruction of wealth as was seen by some hedge fund investors during the Global Financial Crisis.

Combining the various strategies together to reduce risk and generate above market returns is a skill that not many managers have. We need time to assess whether the team at Generate have the necessary skill.

The fees are high compared to some more vanilla KiwiSaver schemes. It is difficult to fully assess the impact of the performance fee and calculate the Total Expense Ratio (TER) until we have a full year's trading.

Obsessively fee conscious and / or less experienced investors will probably shy away from the Generate KiwiSaver scheme. 

With no track record it may be difficult to convince investors who are in top performing KiwiSaver schemes already to switch so it may be a while before the team at Generate can get to critical mass to ensure it is profitable for both investors and the manager.

Story updated: includes additional information on the strategy being via a subset of hedge funds being predominately international equities.