NZ Herald 13 February 2010

AIndeed it does. If we look back on any period, the “right” active funds will have done better than index funds — which perform at the average market level. And the “wrong” ones will have performed worse.

The trick is to know in advance which active funds are going to outperform. If I knew that, I wouldn’t be sitting here typing this column — for all that I love doing it! And if you knew that, you probably wouldn’t bother to read this column.

It’s no good assuming that the funds that did well in the last period will continue to do so. We’ve just seen a classic example of how fund performance can seesaw, with the two of the three top performing KiwiSaver funds over the last two years coming last in their sectors in the last quarter of 2009, and the other coming second to last, according to FundSource.

Meanwhile, the best performing growth fund over that quarter came bottom over the two years. And the quarter’s top conservative and balanced funds also performed badly over the longer period. Investment history is full of such switches.

Because of this, I prefer not to choose an active fund in the hope that it will be a winner. Instead, I go for the average performance of index funds, knowing they won’t do worse than the market. They charge lower fees than active funds, so over the long term they are a better bet.

Which brings me to your point about the dismal performance of share markets over the last decade. It was certainly disappointing, especially for those who bought all their shares in 1999 or 2000. But those of us who have dripfed money into shares over a long period had seen really big gains in the late 1990s and took the noughties in our stride.

What of the future? Perhaps you didn’t notice a certain paragraph in Brent Sheather’s January 30 column, which reads: “On the bright side, the poor performance of the stockmarket over the past 10 years means valuations are now far more reasonable than they were in 2000, and thus the outlook for equities (a.k.a. shares) in the next 10 years is materially better than it was back then.”

Sheather goes on to note that nothing is certain. But sharemarkets, too, quite often seesaw. Here’s hoping the markets will head upwards this decade. I’m in for the ride — in my index funds.

ASorry, but I’m going to sound like Mother here. I’m not going to tell you, because it could do you more harm than good.

Chasing the best KiwiSaver returns can be bad for your wealth. And it’s too easy to do.

No KiwiSaver provider charges an entry fee, and only a few — Gareth Morgan, Grosvenor and Staples Rodway — charge exit fees in some circumstances. And it’s simple to switch providers. You just contact the new one and they get your money from the old one and update Inland Revenue.

I’m not saying people shouldn’t switch. But you, and I suspect many others, are doing it for the wrong reasons.

For one thing, not all schemes report their results in exactly the same way, so they are not directly comparable — although I hope that will change in the next couple of years.

For another, the types of assets in different funds vary. For example, Fund A holding 25 per cent shares and 75 per cent bonds is likely to be compared to Fund B, which holds 20 per cent shares and 80 per cent bonds. If shares are having a good year, A will probably do better, even if it’s not necessarily better managed. It’s an apples and oranges problem.

But most importantly, as stated in the Q&A above, last year’s — or last quarter’s or last decade’s — winner won’t necessarily do well this time around.

In fact, research shows there can be a tendency for former winners to perform dismally, perhaps because they are higher-risk funds, which are more likely to come either top or bottom. Studies have found that people who chase winners frequently end up worse off than those who don’t.

That’s not to say that performance doesn’t matter. In the end, performance after fees is really all that does matter. It’s just that there’s no way of telling who will perform well in future.

So how should you pick a provider? It’s a question that more people will ask as their KiwiSaver balances grow to considerable amounts. But it’s not easy to answer.

Two of the most important issues are fees and communication.

Fees can make a big difference over the long term. I suggest you use the KiwiSaver Fees Calculator on the Retirement Commission’s www.sorted.org.nz.

And good communication is crucial. You must understand what is happening to your account, and the commentaries and options your provider offers.

To get a feel for that, check out a provider’s website, and ring and ask them to mail information to you — noting, among other things, how well they treat you on the phone. Perhaps ask them to send you a sample statement, to see if you can follow what’s on it.

But there’s more to it than that. In my book “The Complete KiwiSaver”, I include a step by step guide to choosing the best provider for you. It includes looking for a provider that:

• Offers a fund with the right mix of investments for you. Some providers have a limited range.
• Offers special features you might want, such as: automatic risk reduction as you get closer to retirement; active or passive management; or a fund that invests in a single sector, such as shares or commercial property.
• Permits the contribution amount and pattern that suits you if you are a non-employee, such as quarterly or annual contributions.
• Lets you invest in more than one of its funds — an issue that will become more important as KiwiSaver balances grow.
• Offers an ethical investment fund — which typically invests only in “good” companies or avoids “bad” companies, with somewhat varying definitions of good and bad.
• Lets you pick the exact mix of assets you want, or select the individual shares in your KiwiSaver account.
• Includes more exotic investments, such as options, gold or forestry.
• Offers advice on how you should invest, or helps with the transition into retirement.
• Offers rewards.
• Is New Zealand-owned, or on the other hand owned by a big overseas company that may provide good resources.
• States that the chief executive invests in their scheme.

And so on. My book lists which providers do what in all these areas and more — some of which will matter to you, while you won’t care about others.

I apologise if I seem to be pushing the book. Of course I would love you to buy it, but that’s not the point here. I don’t know any other way you can get independent guidance in choosing a provider.

If readers know of other independent sources — which consider all providers and not just those that have paid to be included in the comparison, or those that will pay the source a commission — let’s hear about them.

AThanks for that.

AFair point. I must say if I were an adviser I would hate to face clients who didn’t fully understand the risks they were taking and were angry with me when their investments lost value.

The only thing I disagree with is your saying that “higher risk investments are just as likely to lead to lower asset values and fees”. Higher risk investments, on average over long periods, grow faster than lower risk investments.

If they didn’t, nobody would be willing to take on the extra risk. This lack of demand would push down their prices, which would raise their potential returns until they were, indeed, higher than on less risky investments. That’s how markets work.