Question:

Why would I have to wait three years to see if my KiwiSaver cash investment is any good on a relative basis - as discussed in your column recently? Cash is generally defined as fixed-interest investments of less than 365 days and in practice many use 180 days.

If the explanation for Westpac's poor cash returns is market movement, then they had to be holding non-traditional cash assets in the portfolio.

This is another example of what is wrong with our disclosure regime. Investors should be told that, "We call this cash but it is not cash, and the returns that you get will not be cash-like, and you might even lose some money."

Answer:

Mary Holm: It all comes down to how cash in a cash fund is defined, and I must say I have a lot of sympathy with your viewpoint. I suspect most people would expect a cash fund to invest in savings accounts, short-term bank deposits and similar safe holdings.

However, BT Funds Management, which runs Westpac's KiwiSaver scheme, has a somewhat different view. "I must emphasise that this is not a bank account," says BT chief investment officer Paul Richardson. While 90 per cent of the cash fund is invested short-term, 10 per cent is invested in another BT fund whose holdings include some investments that mature in more than a year.

Richardson hastens to add that these are high-quality bonds, issued by local authorities, Fonterra and the like. Therefore, he says, there's virtually no danger of default.

However, with any longer-term bonds or similar, their value fluctuates. Let's look at what happens if a fund invests in $10,000 Nice Company bonds, which are paying 5 per cent interest, and market rates later rise so that similar bonds are paying 7 per cent.

If the fund were to sell its Nice bonds, it would have to accept less than $10,000 for them because they are paying below market interest. Even if the fund has no plans to sell the bonds, it must still record the drop in their value as a loss to the fund.

This may oversimplify it, but basically that's what has happened to Westpac's KiwiSaver cash fund. The value of its longer-term investments has fallen, explaining the fact that it was the worst performing KiwiSaver cash fund from the start of KiwiSaver, on July 1, 2007, to March 31 this year.

Since then, however, Richardson says the fund has performed well. In the most recent three months, it was fourth out of 11 KiwiSaver cash funds, and in time Richardson hopes that the longer-term investments in the cash fund will give it a superior return. The longer term is what matters, he says, given that nobody can invest in KiwiSaver for just a short period.

I buy that to some extent. Certainly nobody in KiwiSaver has been able to take out their money yet, except in cases of financial hardship, serious illness and so on.

However, once KiwiSaver has been around for a few more years, I suspect cash funds will be popular with KiwiSavers who are doing the smart thing and transferring their savings to cash in the year or two before they plan to spend the money - on either a first home or in retirement.

Sure, there will also be longer-term investors in cash funds because they are ultraconservative. But I would like to see KiwiSaver providers keeping their cash funds short-term, so that members who are using the funds as KiwiSaver exit points can't be hurt by taking their money out at a time when longer-term bonds are doing badly. Such bonds certainly have their place in KiwiSaver, but not in cash funds.

Where does this leave investors in Westpac's KiwiSaver cash fund? Since you can't take your money out for at least another year - and then only if you are buying a first home - you might want to wait and see if the fund's returns bounce back.

Or, if you really want to invest in cash, you might want to move to another provider's KiwiSaver cash fund. Check first, though, that it limits all its investments to the short term - preferably 180 days or less. Westpac isn't the only KiwiSaver cash fund with longer-term investments. No point in jumping out of the frying pan into the fire.

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.