My understanding is that over the long term, passive funds do better than the average of active funds. Is that right?
Mary Holm: That's my understanding too - from following the debate since I first learned about passive funds at the University of Chicago in the late 1970s. I invested in a passive fund then, and haven't changed my mind since.
Let me start by agreeing with one of Gaynor's main messages last week - that KiwiSavers in the scheme for many years will most likely end up with more money if they invest in riskier funds, which hold more shares and property.
But when it comes to how the funds are run, Gaynor and I part company. He prefers actively managed funds, in which the managers choose which shares - or cash, bonds or other investments - to buy and sell in the hope of performing better than the market averages.
I prefer passive funds, some of which are called index funds because they invest in the shares or bonds in a market index. Other passive funds choose a range of investments to buy and hold. The key point is that passive managers don't do ongoing research on what to buy or when to sell. They also trade much less.
For those two reasons, passive funds are much cheaper to run, and so their fees are lower - often much lower. A glance at the results on the KiwiSaver fee calculator on www.sorted.org.nz, which tells you whether a fund is active or passive, will confirm this.
Of course, lower fees aren't much help if passive funds perform worse, after fees, than active funds. Do they?
In Gaynor's column, he compares the performance of the largest KiwiSaver providers' main funds with a fund run by Smartshares, which he calls "the main provider of KiwiSaver passive funds". He notes that the performance of Smartshares' fund "has lagged well behind its competitors".
There are a couple of problems with this. First, Smartshares is hardly the main passive provider. Gaynor may not be aware that ASB Group Investment's conservative default fund - by far the largest KiwiSaver fund of all - is 100 per cent passively managed.
Secondly, guess which fund comes first equal in performance in the table with Gaynor's column - and is singled out for praise from Gaynor? ASB's conservative default fund.
ASB Group Investments - the biggest KiwiSaver provider - is, in fact, largely committed to passive management. In its default scheme all its funds are passive. The same applies to all the funds with "Tracker" in their name in ASB's FirstChoice KiwiSaver Scheme.
ASB favours passive because it enables it to keep fees low, "and it's simple to explain - we're not trying to describe market outperformance or underperformance", says head of ASB Group Investments Greg McAllister.
There are also two other providers whose management is largely passive. Civic Assurance uses passive management for all shares except 10 per cent of international shares. And SuperLife uses passive management in all their funds except Gemino.
The following also use some passive management:
* Craigs Investment Partners' kiwiSTART Defined - about 30 per cent of international shares. And in their kiwiSTART Personalised scheme you can go entirely into passive investments if you wish.
* Fidelity - all international shares.
* Grosvenor - 60 per cent of international shares.
* ING KiwiSaver - all international shares.
* Mercer KiwiSaver - for 30 per cent of the international shares in three funds, the manager uses an "enhanced index" approach.
* Mercer Super Trust - all of the funds that hold international shares have a 30 per cent "enhanced index" management component.
Because I don't see any point in poring over short-term KiwiSaver performance, I don't know how well all of these providers and funds have performed, compared with active managers. But I do know that ASB's default fund is not the only one to do well.
SuperLife's funds have performed better than almost all other similar investments, says chief executive Michael Chamberlain. "When compared to the providers who have their returns published by FundSource or Morningstar (which includes all the big providers), we have been very competitive and generally outperformed each of the alternative funds - except one of the Milford ones - largely because of our low-cost and passive approach."
Interestingly, the Milford funds are Gaynor's babies. He's an executive director of Milford Asset Management. More on that in a minute.
First, though, why has SuperLife done so well? It bases its international share investments on the MSCI world index, noting that no company makes up more than 2 per cent of that index. But for its New Zealand and Australian share investments, it doesn't use an index. This is partly because many of the indexes are dominated by one or two large companies, and if they do badly - as Telecom has done recently - that drags down the fund. Instead SuperLife uses another form of passive management.
"For the New Zealand shares, we asked [stockbrokers] Forsyth Barr to pick 20 shares, and broadly equally weight them," says Chamberlain. "For the Australian shares, they picked 25 shares, and they are also equally weighted." The funds rarely trade, except to keep the holdings roughly equal. And the strategy has worked well.
But what about Gaynor's fund, which has done even better - at least in the first 2 years of KiwiSaver? Is he outstandingly good at picking which investments to buy and sell, or has he just been lucky in a period too short to prove anything much?
Research by Lipper Analytical Services suggests that most stars in the fund performance world don't last. The study looked at two 10-year periods - long enough to be meaningful. It found that the top performing share fund in the US in 1988-1998 came 1485th out of 2322 funds in 1998-2008. Gulp!
The share funds that ranked second through 10th in 1988-1998 ranked as follows in the following decade: 1977th, 1991st, 620th, 1699th, 2066th, 1460th, 2154th, 2274th and 2123rd. Only one made it into the top half. Six were in the bottom sixth. Abysmal.
Study after study finds that funds that do well in one period frequently do badly - quite often really badly - in the next period. Passively managed funds, meanwhile, plod along, performing about as well as the whole market in each and every period. And over long periods - and if you're investing in shares it should be over a long period - they do considerably better than average, especially after fees.
There will always be a few active funds that beat passive funds in the long run. Gaynor would no doubt say his will do that. So would other active KiwiSaver managers who bring up this issue every now and then - saying the New Zealand market is different. And perhaps at least some of them will prove correct. But which ones?
I'm not prepared to risk going with a fund that might shine but might fizzle out. I'm sticking with my passive investments.
Mary Holm is the author of bestselling books on KiwiSaver and personal finance. She is also a highly praised seminar presenter. Her written advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following that advice.
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