KiwiSaver managers must provide value for money

Today the Financial Markets Authority (FMA) has issued final guidance on fees for managed funds and value for money. This follows a six-month consultation which began last November.

The FMA expects fund managers to regularly review and assess whether fees are reasonable and provide value for money for members.

Links to the guidance and the FMA’s media release are available here and here.

Who needs to read it?

Managers and supervisors of KiwiSaver schemes and other managed funds. While the guidance is aimed at KiwiSaver, the FMA makes clear that it expects others to take the same approach, whether the scheme is currently open or closed to new members.

What does it cover?

Principle-based reviews

The FMA’s guidance requires fund managers to conduct regular reviews of fees in order to comply with their statutory duty to act in the best interests of scheme members. Managers are expected to formally review their fees and value for money with their supervisors annually and also when there is a change materially affecting cost (such as a change to asset allocation or underlying fund managers).

Managers must conclude that their fees are reasonable and reflect value for money, or if unable to do so, outline remedial steps so that fees will provide value for money. Managers should also consider whether the fees they charge and why they are charged is transparent to investors. While the FMA has indicated they expect fees to decrease, they also encouraged managers to add value in other ways, such as providing additional services. Managers must be able to evidence that a review has taken place and are encouraged to share the results of the review with investors. The FMA has indicated that a failure to conduct regular reviews of fees and value for money will impact the FMA’s consideration of whether a fee is unreasonable under rule 2 of the KiwiSaver Rules.

Reviews should be based on the following principles:

  • Risk and return are critical – the two key indicators of value for money are how well the manager minimises the investment risk the member experiences, and the members’ return after fees.
  • The financial value of investment management must be shared – value should be appropriately shared between the manager doing the work, and the member paying the cost, providing the capital, and taking on the risk.
  • Advice and service is received, not just offered – a service or feature provided by a manger contributes to a member’s value for money if it demonstrably helps the member make better investment decisions or demonstrably benefits the member’s investment account.
  • Review yourself as you review others – when evaluating their fees and value for money to members, managers should use the same rigour they would apply to assessing the same of any underlying manager.

The guidance sets out questions under each principle that the supervisor and fund manager can ask in assessing whether their fees are reasonable and whether they are providing value for money to their investors.

Active management versus passive management

While the guidance allows for active managers to take into account a higher level of costs in running the scheme, the FMA has warned that active management alone is not enough to justify higher fees – finding that active managers typically do not outperform their market index after fees. Managers employing active strategies must justify their fees in relation to the proportion of returns earned due to active management (as opposed to passive management strategies).

Fixed membership fees

The FMA expects fund managers to stop charging fixed membership fees in certain circumstances. The FMA can find “little justification for schemes to charge both a fixed membership fee and a base management fee”. In their view, membership fees were intended to cover costs when scale was low and are no longer necessary when scale and member balances increase.

High risk of enforcement action for managers charging unreasonable fees

The guidance states that a failure to comply with the guidance may be a breach of the duty to act in the best interests of scheme participants and the duty to set reasonable fees. The guidance reminds the market that the FMA has a range of tools it can use, including:

  • Stop orders;
  • Direction orders;
  • Censures or action plans;
  • Altering, suspending or cancelling a licence; and
  • Court action.

Our view

In general, the FMA expects fees for KiwiSaver schemes to decrease. Decreasing fees benefits investors, however, provided it does not overly restrict the choices available to them. We welcome the FMA’s acknowledgement that competent managers are entitled to make a profit.

Prescriptive regulation

There are significant dangers with taking an overly prescriptive approach to the unreasonable fees obligation under the KiwiSaver Scheme rules given the wide range of investment styles in the market.

We have particular concerns with the requirement to compare fees for non-default KiwiSaver Schemes to those for a default KiwiSaver with comparable strategies and features. Fees for default funds are set directly by the Instrument of Appointment for the default Scheme. To our knowledge, none of the default fund managers take a fully active approach to both asset allocation and security selection. The current Default Provider RFP states that “Fees Proposals are sought that achieve the lowest fees for Default Members and other relevant members.” That is only likely to reinforce the passive approach to management of KiwiSaver default funds.

Competitive markets with effective disclosure

Further, members should be able to judge for themselves whether they consider the fees charged are justified by the management style and performance of the fund they have chosen. There is a highly competitive market, in which KiwiSaver members are easily able to transfer schemes or funds and information on pricing is freely available, including on the FMA and the Commission for Financial Capability’s websites. There is clear, mandated disclosure to investors on fees and investors can easily compare fee information across schemes. We consider that full and transparent disclosure of fees enhances competition, without the need for further prescription. We encourage the FMA to consider how the market already adequately regulates fees through competition.

Duty to act in member’s best interests

There are existing protections under the Financial Markets Conduct Act 2013 (FMCA) and the KiwiSaver Act 2006 (KiwiSaver Act).

The FMCA deals with fees and expenses by requiring detailed and prescriptive disclosure of fees. Further, a governing document for a registered scheme must provide adequately for the fees and expenses that can be paid out of scheme property to any manager, investment manager, administration manager, supervisor, or custodian, or the basis on which those fees and expenses are to be determined.

A manager has a duty to act in the best interests of the scheme participants “in exercising any powers or performing any duties as manager”. The duty is circumscribed by reference to the performance of the powers and duties of the manager i.e. it relates to the manner in which the manager performs its functions. It is not a general duty to prefer the interests of the scheme participants to its own, or to set a fee that is in the best interests of investors.

The KiwiSaver Act includes specific provisions regulating KiwiSaver fees. The guidance conflates those provisions with the general duty of a manager to act in the best interests of investors and includes statements that a manager of a managed investment scheme (that is not a KiwiSaver scheme) is subject to an obligation to only charge a reasonable fee.

If the Parliamentary intention had been to apply an equivalent requirement to other managed investment schemes, it would have been an easy matter to include this in the FMCA.

What next?

If you have any questions in relation to the KiwiSaver fees or are considering how the FMA guidance may affect your business, please contact one of our experts.

Who can help