The tide is going out for investors in KiwiSaver Default funds as the heavy allocation in fixed-income securities risks valuation readjustment down, cancelling any gains in yields

By David Chaston

Returns for KiwiSaver default funds are sagging.

In our report to December 2017, the top fund generated from-inception average returns of 4.8% pa, after-all-fees, after-all-taxes. The average of the five funds who have been active since 2008 was 4.46%.

Three months later to March 2018 this had slipped to 4.6% pa on the same basis, with the five-fund average at 4.20%. In only 90 days, that is a relatively speedy retreat.

Focusing on just the past three year returns, the reduction is from 4.18% to 3.44%, which emphasises how quickly returns for these default funds are falling away.

Even though the global economy is still in a relative sweet spot, the asset allocations of default funds - with more than a third in "cash" and almost a half in fixed-income funds - are working against out-sized returns.  The international rises in bond yields are taking their toll on bond prices.

And since December 2017 the New Zealand currency has appreciated by +2.1% going from 70.9 USc to 72.4 USc. This has the effect of adding 2.1% to bond and cash yields that come from outside New Zealand (and in fact, the cash yields will be minor from 'outside NZ'), but also has the effect of depreciating the capital value of those bonds (the bond price) by -2.1% - which is on top of the discounting in foreign currency that would happen as yields rise. Half of the 46% of default funds invested in fixed-income is in overseas funds, so this effect is not insignificant.

Readers of this website will be well aware of the 'bondcano' risks - and default funds are certainly exposed.

Still, default KiwiSaver funds continue to beat benchmarks (see our December review), but that may be of little comfort if the market track is an outgoing tide.

The fund with the greatest slippage in the past quarter is the ANZ Default Conservative fund, one that has been near the top performer for most of the past 10 years. Mercer Conservative and AMP Default are slipping almost as quickly. At the other end of the scale KiwiWealth Default and Westpac Defensive, both relative newcomers, are slipping the least.

We have long argued that KiwiSaver members should transition to other non-Default funds that best meet their investment goals and match their tolerance for risk. Staying in a Default fund is unlikely to reflect anything but laziness to do the work to seek a change.

However, there is probably a case for savers/investors who are close to retirement and close to decumulating the funds, to stay. Default funds have a long track record of returning better long term returns than either Cash, Conservative or even some Moderate funds. So 60+ year-old investors might find it the right thing to stay.

For just about everyone else, however, there are good track records and other more forward looking reasons to reassess (or even assess) staying in these Default funds.

In an era of rising bond interest rates (which mean falling bond prices), you need to get on to that reassessment with a professional you trust.

Over the long term you won't be able to grow your KiwiSaver nest egg much above average returns if you stay with a default option. But in theory, the downsides should be limited. The problem these days is that the averages, benchmarks and downsides are slipping.

* Assuming they were in the fund from April 2008. These levels will be less for a later start, or for funds that were formed later.

If you are not about to retire in the next five years or so, you should seriously review why you are in a default fund. We will review the track record performance of other classes of KiwiSaver funds over the next week or so, but being in KiwiSaver is a long term commitment and you should be applying long-term strategies to this investment.

That may well mean accepting some higher level of risk to gain a higher level of returns. Over a long-term, that is usually a sensible strategy. Sure, bumps in the road do come around (like the Global Financial Crisis) and they can knock growth fund returns. But as we have seen post-GFC, the bounce-back can turbo charge your results.

Here is where these managers have your Default funds invested. 

If you want your money allocated differently, you will need to change funds, either with the same manager, or with another. But before you do that, get some proper investment advice from someone who understands your investment goals and tolerance for risk. That involves work on your part. But it's not a good excuse to just leave it there because it seems too much effort.

KiwiSaver default funds are only part of a broader range of conservative funds available. Many of the 'traditional' conservative and cash funds are under performing the default funds. We will look at the rest of the conservative funds in another article.

For explanations about how we calculate our 'regular savings returns' and how we classify funds, see here and here.

There are wide variances in returns since April 2008, and even in the past three years, and these should cause investors to review their KiwiSaver accounts especially if their funds are in the bottom third of the table.

The right fund type for you will depend on your tolerance for risk and importantly on your life stage.

You should move only with the appropriate advice, and for a substantive reason.