KiwiSaver risk indicators

Abstract

In a recent proposal, the New Zealand Financial Markets Authority promotes the synthetic risk and reward indicator used in the European Union as a way to standardise the risk classification of KiwiSaver funds. Our study shows that KiwiSaver providers generally correctly indicate the risk category of their funds, but there are some important exceptions. We also show that historical fund volatility is the best predictor of future volatility, and propose an easy-to-understand risk indicator that outperforms the SRRI.

Keywords:

• KiwiSaver
• risk indicators
• defined contribution plan

Acknowledgements

We thank Greg Bunkall from Morningstar. We also thank the editor (Gail Pacheco) and two referees for their comments. This article is based on Randall Clement's honours thesis at the University of Auckland, which won the FMA Research Prize in 2014.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. KiwiSaver funds had $22,261 million of $96,583 million total managed fund assets as of June 2014, according to aggregate managed funds data from the Reserve Bank of New Zealand.

2. The default funds of default KiwiSaver providers are conservative risk, and are meant as a temporary means while investors actively choose a fund that best suits their risk tolerance. See https://fma.govt.nz/help-me-comply/KiwiSaver/who-needs-to-comply/default-providers/

3. The FMA provides some guidance for KiwiSaver investors on investment goals and risk tolerance at http://www.fma.govt.nz/help-me-invest/investing-basics/goals-and-risk-tolerance/

4. Details on the European Risk indicator are included in Appendix 1. Also note that we use the terms risk indicator, risk classification and risk category interchangeably.

5. We define the GFC period as the period from October 2007 to March 2011 and the post-GFC period from April 2011 to September 2014.

6. The initial sample excludes KiwiSaverfunds offered by Craig's Investment Partners, IWIinvestor, Kiwi Bank, Kiwi Wealth, and SuperLife as they had not provided Morningstar with fund data.

7. The payoff structure of these funds is designed to remove downside risk, such that the investor either receives investment returns from the fund, or they receive their original investment.

8. This removes all funds offered by BNZ and Generate. Being relatively new KiwiSaver providers, they only have 19 and 17 months of returns, respectively. We also remove the Fidelity KiwiSaver Active Class Conservative Fund, the Fidelity KiwiSaver Active Class Growth Fund, and the Milford KiwiSaver Conservative Fund as they each only have approximately 20 months of returns.

9. Specifically, the fund categories are assigned an integer number as follows: Cash = 1, Conservative = 2, Conservative-Balanced = 3, Moderate = 4, Moderate-Balanced = 5, Balanced = 6, Balanced-Growth = 7, Growth = 8, High Growth = 9, Aggressive = 10.

10. We present an overview of the funds ranked on volatility during the GFC period and post-GFC periods in Appendix 2. The results show the boundaries between fund categories become blurred as the exposure to growth assets increases, particularly between the Growth, High Growth, and Aggressive peer groups. Of potential concern is the number of Conservative, Moderate, and Balanced funds that are much riskier than their risk category indicates, in both the GFC and post-GFC sub-periods.

11. The issue of currency hedging by fund managers was highlighted recently in a Sunday Star Times article (Kloeten, 2014).

12. The Morningstar NZ Category Definitions document provides details on the Category classification system. See (Morningstar, 2014).

13. We also experimented with a risk indicator based on predicted volatility obtained from model (1), regressing the GFC period volatility of the fund on the benchmark asset allocation. However, the predicted volatility was inferior to the actual historical volatility suggesting that the residual in model (1) is not just ‘noise’, but reflects useful information about the volatility of a fund.

14. The numbers range from 1 through 10, going from cash funds to aggressive funds, respectively as per Footnote 9.

15. We perform the same tests using quarterly returns and reach the same conclusions (results are available on request). The reason we use monthly returns throughout this study is that it increases the number of observations relative to quarterly returns (84 instead of 30). Moreover, the synthetic risk and reward indicator (SRRI) proposed by the FMA uses monthly returns.

16. Document reference CESR/10-673: www.esma.europa.eu/system/files/10_673.pdf