A key aspect of saving and investing is the regulatory environment and its disclosure requirements. The Retirement Commissioner’s 2016Review(accessible here) made no reference to the major changes that have been made to the disclosure regime as it affects collective investment vehicles (CIVs) and the impact on investors’ outcomes.
The regime today is based on a product disclosure statement (PDS), a published statement of investment policies and objectives (SIPO), quarterly fund updates (Fund Updates) and for KiwiSaver, annual statements. For KiwiSaver, the annual statements now require disclosure of the total fees in dollar amounts that were paid by the investor over the previous year. The annual statements for KiwiSaver will shortly also require disclosure of the expected balance at retirement and the expected income that the balance will provide throughout retirement.
Over the three years to December 2016, New Zealand moved from a prospectus/investment statement regime to a licensed adviser, licensed manager, licensed supervisor and standardised disclosure documents regime.
The objectives of the new regime were to create fair and efficient markets and to put the interests of the investor first. The disclosure documents were meant to make investment products more standardised and therefore more comparable and easier to understand.
The PDS regime: A PDS has size requirements in that there are limits on the number of pages and the number of words used (no more than 12 pages for a ‘collective investment vehicle’ or managed fund or no more than 6,000 words[1]). Also, many of the words are prescriptive with issuers having limited opportunities to tailor the disclosure documents to their requirements. The content is prescribed and, therefore, rules-based and not principles-based. There is no logical benefit in reading the same prescribed words in all PDSs; for example, the explanation of the risk indicator. Such standardised prescriptions, if they are deemed important, would be better published on the FMA’s website to free up more space in the PDS itself for the things that really matter or even to shorten the PDS.
Few would dispute that the old disclosure documents (prospectus and investment statements) were not read by investors, even many ‘professional’ investors. Even if they were read, the level of understanding was probably limited.
We suggest that the new, shorter PDSs are also generally unread[2]. Likewise, even if read, it is highly unlikely that an investor can gain a complete picture of the investment on offer and the true risks they will be exposed to.
One goal of the new regime was to make it easier to compare products and, to an extent, it achieves that. It is easier to compare fees and some features, such as contributions, withdrawal provisions etc. However, it does not make it easy to understand investment strategy and philosophy, except at a high level and in some cases, not even at a high level.
To take two KiwiSaver schemes as examples:
Simplicity’s KiwiSaver Scheme’s PDS (as of 3 May 2019; accessible here) does not tell an investor that (s)he can invest in only one of the four investment funds at a time. So an investor doesn’t know that (s)he can’t have some savings in the ‘Balanced Fund’ and some in the ‘Conservative Fund’. This is an important omission for an investor approaching retirement. They probably will not want to switch from 60% in shares (Balanced Fund) to 30% in shares (Conservative Fund) in one transaction. They should probably want to do that over time or with new savings. While we think that this is a design flaw in the Simplicity KiwiSaver Scheme, what is more important is that potential investors are not told about it in the PDS.
SuperLife’s KiwiSaver scheme’s PDS (as of 29 March 2019; accessible here) does not explain that an investor can have the interest and dividend income from bonds and shares automatically reinvested in bonds and shares, or paid to the ‘NZ Cash Fund’ – this is particularly useful for those in retirement looking to draw down on their balance. There is provision on the application form but no explanation and only if you have not chosen one of the standard options.
Under the legislative framework, each investment product has a “Supervisor”. The Supervisor’s role is to make sure that the manager does what it is meant to do and what it says it will do. We should therefore expect that the Supervisors would have picked up the deficiencies in the PDSs and encouraged managers to improve their disclosure. However, in the same way they did not prevent the failure of many of the finance companies at the time of the global financial crisis, Supervisors generally have not yet worked out what an investor’s interests look like and what is important to an investor. It would be good if the 2019 Review captured evidence of whether or not the new disclosure regime was working.
Investment categories: A PDS must disclose investment categories but these are artificially constrained, presumably to simplify the PDS. Two examples illustrate the problem with this kind of ‘simplification’:
A New Zealand share fund must be disclosed as part of ‘Australasian shares’ rather than separately by each country. So, the PDS for two separate CIVs might each disclose that, say, 20% of the portfolio is in ‘Australasian shares’ but one has all of that in Australian shares while the other has it all in New Zealand. Neither has to disclose that difference nor to explain whether the portfolio can move from one to the other if, indeed, that might happen.
An ‘emerging markets’ fund must be disclosed as ‘international shares’ but there is a world of investment difference between a fund that invests solely in, say, East Asia compared with one that invests in a fund that tracks the S&P 500 Index.
On these issues, the prescribed PDS disclosure illustrates the dangers of ‘simplification’ – what looks like ‘simple’ has become ‘simplistic’ and has actually got in the way of relevant communication.
Risk indicators: The PDS must show a ‘risk indicator’ for each of the funds on offer (as an example, see here for the BNZ KiwiSaver Scheme’s PDS at page 2). The government forces providers to identify the ‘risk’ of a product and capture that in a single number (from 1 ‘lower risk’ to 7 ‘higher risk’).
We think the ‘Risk indicator’ is misleading and unhelpful and should be eliminated. It assumes that the saver’s relevant investment timeframe is 12 months (almost never the actual case). It also uses investment returns, to calculate the risk indicator, that are different from those advised to savers in their fund updates. Finally, it is based solely on recent historical volatility and is unrelated to the actual returns earned by the fund. The risk indicator tries to simplify the issue but ends up as a simplistic label.
Effective communication? The Retirement Commissioner’s 2016 Review did not look at the question of how well members were served by the new regime nor whether it had improved the managers’ practices. It also did not look at the additional compliance costs imposed on the industry but that are ultimately passed through to the investor.
Research indicates that different people learn and comprehend information in different ways. Logic suggests therefore that having a single, prescriptive disclosure regime targets, at most, only one part of the community. A better alternative would be a principles-based regime where providers of services or the sellers of products are required to achieve ‘understanding’ outcomes. This would require the regime to identify:
What investors (the ultimate consumers) need to know– this will not be the same for all investors at all stages in their investing lives. Identifying those various categories of requirement should be the first task.
What investors are being told now.
We suggest that it is really unhelpful for the Financial Markets Authority to say “Ask questions and make sure you understand the product before you invest”. That may have satisfied the old disclosure regime[3]but it adds nothing to the new. It’s one of those ‘comfort’ statements that reads well but makes no practical difference to a saver’s information needs, information gathering or eventual decisions.
The FMA has launched its ‘Investor Capability Strategy for 2017-2020’ (see here). It’s definition of ‘investor capability’ is:
“Investor capability is the ability to make informed judgments [sic] and effective decisions regarding investments. It is about having the knowledge, understanding, confidence and motivation to make and implement investment strategies and decisions.”
…which we think is ‘all very well’ but the announcement again seems to be ‘top down’ – telling savers what the FMA thinks savers need to know/do. We think it should be focussed on what savers actually know and what they are actually doing. Armed with that information, the FMA should be in a position to build a picture of current shortcomings and possible improvements.
The ‘Disclose Register’ – a step in the right direction
The government has established the ‘Disclose Register’ (here) that gathers in one searchable spot all the official documents of every CIV. These include PDSs, financial statements, the providers’ constitutional documents and the descriptions of key contracts; also, each CIV’s ‘Statement of Investment Performance and Objectives’. Providers are legally obliged to keep this information up-to-date.
We think this is a constructive step and suggest that it be extended to cover investment returns and fees in a single place.
The role of the Supervisor
Initially, the regulatory regime required KiwiSaver schemes to have a Supervisor. That requirement was extended by the Financial Markets Conduct Act 2013 to all collective investment vehicles from 30 November 2016 at the latest. There is a limited number of Supervisors. Of the six licensed Supervisors, four have a licence to supervise KiwiSaver schemes and similar CIVs. Of these, two are owned by Perpetual Guardian so there are effectively only three independent Supervisors.
The Supervisor’s role is to be the first line regulator and the FMA then regulates the Supervisors. We think the 2019 Review should look at the role Supervisors have played and determine whether or not the regime is improving the investment disclosure, improving the behaviour of managers and improving the outcome for the investors or whether, as we suspect, it has just increased compliance costs.
We suspect that there is no evidence that the Supervisor regime has improved the position of investors, but we should find out.
Projected income from KiwiSaver
In future, KiwiSaver providers will be required to disclose to investors their expected balance at retirement and the retirement income that the balance will support, made up of investment returns and the expenditure of capital. The projections will be on a defined set of assumptions (nothing to do with the provider’s own performance) and use a defined formula. The return assumptions will vary by investment strategy calculated on a broad-brush basis (conservative, balanced and growth) and providers will choose which of the three strategies is closest to that of the individual over the full saving period to retirement. After retirement the expected return will be prescribed for all providers equal to the conservative strategy’s expected return.
We do not expect the projected income requirement for KiwiSaver schemes to improve savers’ preparedness for retirement. It will simply give them four more numbers to be confused about (projected balance, both at retirement and in today’s money; projected income, both at the point of retirement and in today’s money). However, the more important issue is how will the government and the Retirement Commissioner determine whether the new requirement will be successful. We think that the basis for the projections and nature of the disclosure are likely to be confusing and will probably encourage savers to make decisions based on poor information and based on expected average returns without due regard for risk.
Rather than the new rules-based, deterministic approach, we think a principles-based approach designed to be helpful would be less misleading and more helpful for savers. In fact, logic suggests that a better approach would have been for the Commission for Financial Capability:
to develop a software application that helps savers understand their position and that
lets savers vary the assumptions, and then
require all providers to provide monthly APIs to the centrally administered tool so that the projections could be personalised to each KiwiSaver scheme for each KiwiSaver member and updated with the latest information.
In summary
We think that the overall process started by the FMA eight years ago is just a step and the FMA probably accepts there is a long road still to travel on disclosure issues. The old regime was founded principally on legally protecting providers from savers rather than helping savers to make appropriate decisions. The new regime is better in some respects but worse in others. It is still not member-centric.
Terms of reference for 2019 Review
There was no mention in the Terms of Reference for the Retirement Commissioner’s 2019 Review of the issues associated with the disclosure regime for retirement saving schemes. The only indirect reference was to the “public’s perception and understanding” of:
(a) Fees charged by KiwiSaver schemes – we also have more to say in the next Section 19;
(b) So-called ‘ethical’ investments by KiwiSaver schemes.
We have covered those issues in our commentary on the 2019 Terms of Reference in the Introduction to this report.
Of greater significance are the following questions that will need to be addressed.
Questions New Zealand needs to discuss on disclosure issues:
Do savers read the PDS and do they understand the key components of the CIV covered by the PDS?
Does the PDS contain the important information that an investor should consider?
Has the PDS improved the quality of disclosure and access by ordinary savers?
What are the key things an investor should know about a provider and do all these have to be in a single document? What is the likely pattern of returns in terms of income and market movements?
What do savers actually know and what do they need to know about the collective investment products they already use? Where is the evidence?
Where precisely can the average saver get the help they need to understand the products they need to use? Saying they should seek advice from an ‘Authorised Financial Adviser’[4], a ‘Registered Financial Adviser’[5]or a ‘Qualifying Financial Entity’ adviser[6](see here) is unhelpful.
Does the FMA know what savers need to know and how is the FMA finding out whether providers of managed funds are delivering that information? For example, has the FMA run ‘mystery shopper’ programmes with providers? Has it benchmarked service standards for common transactions (joining, changing details, changing contributions, changing investment strategy etc)?[7]
What are savers currently receiving on a regular basis? What is current ‘best practice’? How much do savers understand about the things they are being told? How can savers be helped in this communication process? Again, where is the evidence?
What are the current costs of compliance (initial and on-going)? Given that members ultimately pay for these, how can the regulatory regime work to reduce these? How can technology help? In other words, why must the key messages be reduced to a single, written document?
Why not increase the scope of the current ‘Disclose Register’ to include other key information about each CIV like investment returns and fees?
Has the latest requirement for the disclosure of KiwiSaver fees on the annual statement improved an investor’s understanding of fees and improved returns or reduced risk?
Will the new projection requirements lead to better decisions and allow savers to be better prepared for retirement?
How will we capture data to assess the value of the fees’ disclosure and the projected income disclosure to determine whether they have achieved their goals?
Has the Supervisor regime improved the position for investors?
[1]See here for a consumer-oriented explanation of the PDS from the Financial Markets Authority.
[2]For example, just to pick two KiwiSaver providers: for BNZ, the PDS has a very low priority on the main BNZ KiwiSaver web page (here), being buried as a link in a ‘Small print’ section at the bottom of the page; the same applies to the ANZ (see here). In other words, the PDS seems to be a compliance document rather than a primary piece of communication.
[3]One of the required statements in the old ‘Investment Statements’ was “Investment decisions are very important. They often have long-term consequences. Read all documents carefully. Ask questions. Seek advice before committing yourself.” There is no evidence that prospective investors did any of those things.
[4]As of 1 May 2017, there were only 1,995 with an AFA qualification in the whole of New Zealand (see here for the list).
[5]An RFA is allowed to give advice on simpler financial services such as mortgages and insurance services and so they are not relevant to retirement saving issues.
[6]A QFE is employed by the financial service provider and is only allowed to talk to customers about the provider’s own products.
[7]The closest we were able to get on these kinds of questions was the FMA’s Statement of performance expectations 2017-2018 (accessible here). The FMA cited survey results that 63% investors of all kinds (not just managed funds) were “confident in the quality of regulation of New Zealand’s financial markets.” (at page 6). That was up from 46% in 2014/15 (see hereat page 3). That doesn’t come close to what we think is needed. There were, however, eight pages devoted in the Statement of performance expectations to the FMA’s own ‘Forecast financial statements’.