Interest rate rises could hurt conservative KiwiSavers

Wednesday, 18 July 2018

Conservative funds have their money in cash and fixed interest products.

KiwiSaver members who are in conservative default funds could get a nasty shock when interest rates start to rise – because it will mean their balances will probably fall.

A group of financial advisers wrote to the Financial Markets Authority and the Reserve Bank this week, asking for a change to the rules so that members were not left in conservative default funds.

The advisers suggested they be moved on after a year, even if they had not made an active fund choice.

Conservative funds are inappropriate for most KiwiSaver members because they deliver lower returns over the long term than a fund with more exposure to growth assets, such as shares and property. If people do not need their money within the next few years, they should take more risk than a conservative fund gives them.

* Protest over the $1 billion cost of KiwiSaver default funds**

But one of the advisers who signed the letter, Alistair Bean, said there was another issue on the horizon.

While conservative funds are less risky than those invested in the stock market, investors can still see their balances fall.

Interest rates are largely on hold, but it is expected that within the next couple of years they will start to rise again.

While the cash proportion of a conservative fund would benefit from that interest rate rise, the portion that was in bonds – up to 80 per cent of the fund - would not.

That is because bonds have a resale value in a portfolio, as well as the interest income they deliver.

If you have a bond with an interest rate of 4 per cent and then market rates jump to 5 per cent overnight, the bonds held in the portfolio lose capital value because the only way they could be sold to anyone else would be to offer them at 3 per cent.

'You've just lost 25 per cent of the value of your investment,' Bean said.

That would leave many KiwiSaver members who had not switched out of default funds asking why they had been left exposed, he said.

Bean said while it took 'forever' for interest rates to come down, once they started to rise it tended to happen quickly.

'They might take 10 years to come down then be two or three years at a lower rate then historically when the world panics the interest rates don't go up by 25 basis points each time, they go up by 100 or 150.'

He said when interest rates were high and declining a conservative investment might do well but in a slump when rates were increasing, investors could get burnt and see significant falls.

David Beattie, chief investment officer of KiwiSaver provider Booster said, if interest rates rose, that would probably be due to tighter central bank policies in reaction to higher inflation.

'In that scenario, equity markets will probably be rising and for default schemes, sufficiently to offset the losses on the bonds. Overall, balances wouldn't really drop much if at all in that scenario. So while they would underperform funds with higher equity weightings, this is no different a situation than what has already been the case over the last seven years.'

The country's largest KiwiSaver provider, ANZ, supported the call for a change to default funds.

'We calculated the average KiwiSaver will miss out on $88,000 over the course of their working life if they leave their money in a conservative fund,' said Ana-Marie Lockyer, ANZ general manager wealth products.

'A conservative fund should be a pit stop, not a long-term stay. In some circumstances, such as when the investor is planning to buy a house, a conservative fund is the best place to be.

'But for most people, a fund that's more focused on growth will potentially deliver them a greater return in their retirement – and that's what KiwiSaver is all about.'