Every year, significant amounts are invested into KiwiSaver funds with total funds under management almost NZD100 billion. However, despite this substantial capital, only a small number of these funds have engaged in direct investment including via merger and acquisition (M&A) activity.

New Zealand’s M&A market is known for its strength and vitality. Many world-class businesses have yielded substantial returns for private equity investors, showcasing the lucrative nature of this sector. However, KiwiSaver funds, despite managing billions of dollars, have largely remained on the side-lines of this vibrant market.

As of March 2023, the Reserve Bank of New Zealand) reported that a mere 0.18% of KiwiSaver funds were allocated to direct investment. By contrast, in Australia, AFSA reports that in the June 2023 quarter, for entities with more than six members, the NZD2.3 trillion in investments of entities with more than six members, was made up of 53.8% in equities (21.9% in Australian listed equities; 27.0% in international listed equities; and 4.9% in unlisted equities). Property and infrastructure accounted for a further 15.6% of total investments.

Private equity makes up approximately 4% of the New Zealand Superannuation Fund’s investment portfolio.

KiwiSaver providers have a broad discretion to invest KiwiSaver scheme assets, provided it is in accordance with the fundamental requirement to act in the best interests of investors and within any asset class or other limits they impose in their schemes’ Statements of Investment Policy and Objectives (which are publicly available documents established and maintained for each scheme containing the scheme’s investment objectives and strategies). But comparatively few are taking the step of investing in private assets.

There is a significant opportunity for KiwiSaver funds to become more active in the M&A market within existing mandates. Their continued absence not only represents a missed opportunity for KiwiSaver members, but also for New Zealand businesses seeking access to capital.

We believe that there is a significant opportunity for KiwiSaver funds to become more active in the M&A market. The continued under-investment in private assets not only represents a missed opportunity for KiwiSaver members, who could potentially invest in local businesses and reap the associated rewards, but also for New Zealand businesses seeking access to capital. The position will become starker as KiwiSaver funds undermanagement inevitably increases, and even more so should there be any changes to contribution rates (another area where New Zealand lags behind Australia).

By becoming more active in the M&A market, KiwiSaver funds could provide a valuable source of capital for local businesses, fostering growth and innovation within the New Zealand economy. At the same time, KiwiSaver members with the appropriate risk appetite could benefit from the potential high returns of M&A activity.

While there are valid reasons for the cautious approach of KiwiSaver funds, we think it is worth exploring how these funds can safely and effectively participate in the M&A and direct investment market. Doing so in the right way could unlock significant benefits for KiwiSaver members and the broader New Zealand economy.

The unique management and regulatory framework of KiwiSaver funds is typically pointed to

as the reason for their limited involvement in M&A activities. These funds are of course designed with a long-term savings goal in mind, primarily retirement savings. This, in very broad terms, may skew the incentives for a KiwiSaver manager to a conservative approach, favouring stability and consistent growth over the potential risks and opportunities tied to M&A activity. Regulatory requirements and transaction costs might also discourage KiwiSaver funds from participating in M&A. For example:

Liquidity

Direct investments by private equity investors typically anticipate a 5 to 10-year period between the investment and the realisation of returns. These investments are less liquid than more traditional investments like bonds and listed securities. This type of investment profile may not suit KiwiSaver funds designed for individuals with shorter term investment timeframes, for example, those nearing retirement or wanting to purchase a first home, who are planning to withdraw their funds in the near term. However, with appropriate liquidity risk arrangements, this should not deter funds from allocating a small portion of KiwiSaver funds to direct investment. For funds with a higher risk profile, i.e. where recommended investment horizons will likely be 7+ years, there is a real opportunity to diversify further and potentially outperform the market through direct investments.

Even where a long-term horizon is recommended, managers need to provide for the ability of members to switch between funds and between managers.

Expertise required

Direct investment (if not outsourced) requires different skills from stock selection across equities markets. This likely requires use of specialists with experience in dealing with unlisted investment opportunities and the ongoing management of businesses generally. Not all KiwiSaver providers have that expertise.

Regulation

KiwiSaver funds are regulated differently from private equity funds. They are required to allow for a member to transfer to another KiwiSaver provider within 10 working days, and they are also open to early withdrawal in other circumstances (e.g., first home withdrawals) and as a result they usually provide for daily unit pricing, to revalue their assets regularly. However, with the right mechanisms in place, and with the benefit of actuarial analysis of past investor behaviour, this should be able to be managed, to allow a greater level of private equity investment than many KiwiSaver managers currently engage in. After all, as the FMA’s KiwiSaver Annual Report 2023 points out, only about 4% of KiwiSaver investors transferred between providers in the year to 31 March 2023.

In the longer term, the challenge can be further addressed by legislative change to allow KiwiSaver members, who wish to do so, to agree to lock in their investment for longer periods. This may be particularly appropriate for those with significant balances, who are not eligible for a first home withdrawal (eg because they already have a house).

Fees

KiwiSaver managers have to ensure that their fees are not “unreasonable”. Given the relative complexity associated with the management of private assets, this may act as an inhibitor to providers investing in private equity. Further, fees may be benchmarked against the fees for investment in a highly liquid index in determining whether fees are “not unreasonable”. Such an approach may cause providers to be discouraged from private asset investment if it results in fees that are “out of step” with the market and therefore potentially vulnerable to being categorised as “unreasonable”.

The FMA points out in its Value for Money (VfM) Industry Report, that value for money does not necessarily mean “cheapest”. It says that “In focusing on after-fees performance relative to a market index, however, the VfM guidance does enable scrutiny of whether active and passive funds are delivering the desired results (respectively, outperformance or close replication of market index performance after fees) and, if not, whether members of those funds are receiving value for money.”

Plainly, the VfM focus is on underperforming active managers in traded investments, not private equity investors. However, managers should be justified in charging higher fees for the management of

funds which allocate to private asset investment compared to those that do not, where the private asset investments are expected to have, or have the potential, to earn returns that warrant those extra costs. The challenge then is to identify an appropriate benchmark for fees and performance in relation to private equity investments – which should not be the same as for publicly traded investments. That is something, we expect the sector and the FMA will work together to solve for.

The small number of KiwiSaver schemes that buck that trend and allocate to private equity investments include Simplicity, Booster, Milford, KiwiWealth (now part of Fisher), Generate and Pathfinder.

It is noteworthy that, some providers (i.e. Simplicity, Booster and Milford) are actually investing while the others undertake their investments via private equity funds such as Movac.

Simplicity announced earlier in 2023 that it would be increasing its asset allocation to unlisted New Zealand investments across all its existing KiwiSaver and investment funds. This will bring its total allocation of unlisted assets from 7.5% to approximately 10% of funds under its management.

Booster undertook its first direct investment in 2017 and now allocates up to 5% of its funds across direct business investments within its Tahi fund and two listed funds which focus on productive land (NZX:PLP) and innovation (NZX:BIF). Its investments now total NZD320 million, of which NZD75 million represents investors who have specifically invested into these funds.

Booster’s Chair, Paul Foley, commented “We see direct investment as an appropriate allocation within an overall asset allocation. It involves additional work for any manager undertaking such investments, but we believe we should do this in the interests of our investors. It opens up opportunities to a much broader section of the NZ economy than is available within only listed markets. Our members also appreciate that there is a real connection between their savings and businesses operating in their communities.”

Milford has been investing in private New Zealand companies for over a decade and has raised two dedicated private equity funds totalling circa NZD300 million, which invest alongside other Milford funds such as the Active Growth Fund, to back private kiwi businesses. Milford’s KiwiSaver clients can also access these private equity activities via the Milford KiwiSaver Aggressive Fund.

Brooke Bone, Private Markets Investment Director at Milford, said “KiwiSaver is a long- term investment product which lends itself ideally to investment in alternative, long term assets such as private equity. KiwiSaver is a growing pool of funds, now around NZD100 billion, but the majority of the money is being invested offshore, so there is an opportunity to channel more of this to growing NZ companies, supporting the local economy and providing a potential pipeline of new listings for the NZX in future.”

Over the past 12 months, Generate has made three significant investments into non-listed assets.The investments include a USD25 million investment into CIM Group, a USD25 million investment into Novva Data Centres, and USD25 million into the New Zealand based Movac Growth 6 Fund.

Another KiwiSaver provider engaging in private asset investment through Movac is KiwiWealth, which in 2020 invested NZD54 million in Movac Fund 5. KiwiWealth also committed up to NZD50 million to Pioneer Capital’s latest NZD300 million private equity fund in 2021.

John Berry, CEO of Pathfinder KiwiSaver, has been quoted as saying “There’s a reason high net worth investors in large, long-term sophisticated endowment funds invest in private assets. Over the long term they pay higher returns than listed markets if managed and diversified properly”.

All in all, activity among KiwiSaver providers over the past three years has shown a slight uptick in investments in private equity (both by way of direct investment and through direct investment funds such as Movac).

This trend has likely been boosted by the potential for returns from private equity investments in comparison to equity in publicly listed companies.

There have also been calls for KiwiSaver providers to increase their direct investments for reasons other than

the possibility of higher returns. These reasons include the potential for private equity investment to support startups and local businesses, finance large-scale infrastructure projects, and target more sustainable investment opportunities.

In its UpStart Nation2023 Report, the Startup Advisors Council recommended a four-pronged approach to remove barriers to KiwiSaver funds directly investing in startups and venture funds. The recommendations were for the Government to eliminate the liquidity barrier by guaranteeing the short-term liquidity of any investments in an eligible New Zealand venture fund, to consider moving from daily liquidity to 90-day liquidity, to institute a break out fee/return reporting for KiwiSaver investments in illiquid assets, and to provide guidance on asset allocation.

Likewise, the Centre for Sustainable Finance’s 2023 publication Investing in Private Assets: Joint Paper on Key Recommendations to Reduce Barriers and Challenges for KiwiSaver Funds to invest in Private Assets sets out a series of recommendations to help facilitate the private sector’s involvement indecarbonisation investments which usually are in the form of private assets. Many of these recommendations apply equally to other forms of private investment.

With the parties making up the new Coalition Government each having views on what useful changes might be made to KiwiSaver settings, we expect that the sector will want to engage with responsible Ministers to see what useful options could be considered to encourage greater direct investment activity from KiwiSaver funds.

Superannuation funds in Australia are significant investors in infrastructure and with the recognition that the upcoming significant infrastructure investment in New Zealand needs to be funded, finding solutions to possible impediments to doing the same here should be part of the conversation.

Even without government action, the actions of those managers that have undertaken direct investment are capable of replication by others, which we believe will be of benefit to both investors and the wider economy.