Amanda Morrall talks to Milford Asset Management's Brian Gaynor about their high performing KiwiSaver fund and why Brian is bullish on equities

By Amanda Morrall

When it comes to growth funds in KiwiSaver, there's not many that hold a candle to Milford Asset Management's active growth fund when it comes to performance.

In the past 12 months, the fund has delivered a 21.9% return. Over five year's it's averaged an after fee return of 11.3% per annum. That compares to a peer group a average in the growth funds category of 1.2% per annum over five years.

Milford's executive director Brian Gaynor joined me for an interview Monday to discuss the fund's above average performance and shared some of his views on KiwiSaver and the markets in general. 

The following is a transcript of that interview which can be viewed in the video above. 

Q) What's behind the active growth fund's performance?

A)  There's two factors: Firstly, we gave ourselves a lot of flexibility in terms of the percentage of equities you can hold any at one time. What that means is that when markets are bad we can move into cash or into bonds and when markets are good we can move into equities. So we did pretty well during the difficult market conditions because we didn't hold any more than 50% in equities. Secondly, our stock selection has been quite good. It's not just a matter of picking the right companies it's a matter of avoiding the ones that have done badly. We've managed to make some very good choices in terms of some companies have been performed quite well; Diligent, Restaurants Brands for awhile Ryman Health Care and Delegats in NZ. 

Q) You favour NZ and Australian companies. Any reason why you've limited your exposure to other international markets?

A) We've opened the exposure to international equities. In the beginning we started off with an Australasia focus mainly because they are the areas we know best. I'm a great believer in sticking to the areas that you know. There's no point in us trying to pretend we're good at picking companies in Hong Kong or Malaysia or places like that when we just don't have the size or expertise to do that. So we've focused on the areas that we're good at but we've changed the prospectus so that we can go up to 5% offshore and we've employed some people who have come from overseas back to NZ. We are going to take that slowly. We do know it's good to be diversified but you want to walk before you can run. It was important to us that we got the KiwiSaver fund off to a good start because I don't think there would be anything worse than seeing KiwiSaver across the board failing to deliver for its first five year. In general most fund managers have delivered good results over that time.

Q) What kind of research does Milford do into the companies it invest in?

A) We have a policy of seeing 500 companies a year. We are well on track and I think we'll do 550 this year. We don't just invest in the larger companies, we invest in the medium and small sized companies in both New Zealand and Australia. They are higher risk these companies. During good markets they tend to perform much better. So when you are investing in higher risk companies you have to go and see them regularly. Most of those that we invest in we see them a minimum of four times a year. Other major companies we'll see twice. Even other companies that we don't invest in we'll go see them. Why? One of the areas we've done quite well in is placements. That's where all of a sudden a placement occurs when someone wants to sell a large block of shares and you've got to make you mind up in an hour or two. If you don't know the company and haven't visited them, it's very difficult to do that. We've taken placements in companies like Turner's Auction and EBOS. Both of them have done quite well.

Q) Fund managers in growth funds rationalise their higher fees because of this leg work. In general terms do you think fees in KiwiSaver are fair?

A) I think they are for the most part they are particularly in the beginning. Most KiwiSaver funds are very small and therefore the economics of it aren't great. For example for the month of October we'll have 14 different visits to Australia. All those costs are incurred by us, not the fund. Yes we pay it out of the fees  but I think the end result is that investors have done quite well out of investments in Australia. It is quite expensive. It's hard to do it a day so you'll have to overnight.

Interestingly enough, the worst performing KiwiSaver fund over five years has been the one with the lowest fees. That's Smartshares Growth. (According to Morningstar KiwiSaver report Sept quarter 2012 the fund, over five years, has returned -5% per annum.) They have the lowest fees but they don't do any research, it's an index based fund. Investors haven't done well out of the fund with the lowest fees. We're not the highest but we're in the top end of the fee structure but we've performed quite well. I guess the argument is that if you want a Rolls Royce you have to pay for it, if you want the Lada it comes cheaper but it's often not as good.

Q) KiwiSaver has more than 2 million members now and has started to plateau in terms of enrolment. Some are predicting consolidation in the industry. Any plans to grow your business through acquisition?

A) We have a strong philosophy of organic growth. We want to stick with the client base we have. I do think there will be rationalisation. If you haven't got to a certain size after five years you make a decision that this isn't the business you want to be in. I'm aware of three or four business that are up for sale but I can't say officially. We can look at the funds under management and know that they haven't quite got to the size that makes them economically viable. The other thing is that if you are a KiwiSaver provider you have to lodge your accounts with the Companies Office. This is something reasonably new in New Zealand. So we can see from our competitors accounts how they are doing. There's a lot of transparency that haven't been available in the past.

Q) You are in growth mode by virtue of adding to your team. Why's that?

A) We believe that as you grow you have to invest in your personnel. To keep your performance up you need good people to do the analysis for you. You need back ups as well. You need some depth in your team in case something happens to someone key or someone leaves or has ill health. So we've invested heavily in the personnel. We have eight full time investment staff. Well over half of them have worked offshore and have at least five to six years experience. In fact, two of them have never been in NZ before. We believe people who have worked offshore had a decided advantage over those who have only worked in domestic markets, so we have a strong emphasis on finding people with international experience.

Q) Do you have an exit strategy and is it on the radar?

A) It's not in my thoughts right now but I am giving more responsibility to some of the younger people. I think there is no use in employing younger people without giving them responsibility. So I'm giving them more of that. It doesn't seem that I have less to do quite the opposite. We have clear responsibilities over funds. We make sure that the people who are responsible for the funds are well identified. I have one fund but I have two people working full time with me on it.

I'm a believer that when you are doing well you tend to get more money from people and your responsibilities increase rather than decrease. So it's not a matter of resting on your laurels you've got to keep going.

Q) You have a rare bullish view about the next six to 12 months. Why?

A) I think the current low growth environment with low interest rates is good for equities markets. There's not a lot of demand for new funds because when things really get going you find there is a demand for new funds. If there isn't a demand for new funds any money that will go into the share market goes into existing shares so it pushes up the price of those shares. Interest rates are low elsewhere. Also, there is a huge amount of corporate bonds maturing in NZ over the next three months. A massive amount. As those mature, people will be wondering where to invest. They were on 8.5%-9% and (by putting them in terms deposits) they'll only get 4-5% so they'll consider the share market. Also corporate balance sheets are quite strong. It's individuals and governments who have bad balance sheets but the corporate sector is in good shape. It's quite a surprise that when companies go wrong the banks pull the plug very quickly and put them under but they keep individuals and government going as long as possible because they always reckon they'll get their money back.

So what we've seen during the global financial crisis is that companies who had stretched balanced sheets have either repaired them through capital raisings or else gone under. So the corporate sector is actually in great shape. I'm not saying all our problems are over because you have to keep an eye out for any further problems that will arise but I'm more optimistic about the New  Zealand share market than I have been in some time.

Q) Mighty River Power looks to be going ahead finally in March 2013. Will the partial privatisation of NZ's state owned enterprises have an impact on your KiwiSaver funds?

A) We'll invest in them but they'll have a bigger influence on the sharemarket. This will be the first time that we will have a share float where the Prime Minister is the main supporter of them. We've had things like Telecom and Auckland International Airport in the past but the government never got involved. With MRP, John Key is going to be a cheerleader. The biggest float we had in New Zealand previously was Contact Energy. We had 228,000 shareholders. I imagine this will be in excess of that. I'd be prepared to say over 250,000 maybe 300,000. That will create a lot of interest. And if the company performs well, that will really create some interest in the sharemarket. It's a unique opportunity and it should be very popular because we've never had a Prime Minister as the No.1 cheerleader.