New Zealand equity active managers have a much more optimistic view of capacity limits than their Australian counterparts, according a Russell Investments report released last week.
The Russell study, which explores the potential effects of KiwiSaver flows for local equity investors, estimates the average active NZ manager capacity limit stood at about 1.7 per cent of market capitalisation – close to double the standard Australian level.
Generally, Australian “broad market equity managers” limit funds under management between 0.75 to 1 per cent of market cap “in order to avoid undue negative impact on performance”, the report says.
“Australian Small Cap managers tend to limit their exposure to around 0.5%—0.75% of the Small Ordinaries index,” the Russell study says. “… In summary, New Zealand managers are expecting to manage a greater proportion of a more concentrated market which has lower overall turnover than their Australian peers.”
The report says some NZ managers would justify the higher capacity limits “based on their ability to benefit from poor trading practices and implementation inefficiencies shown by offshore investors”.
Historically, NZ active equity managers have outperformed the index. Last year a Mercer study confirmed most local equities fund managers have consistently beat their respective NZX benchmarks over most time periods.
However, the Mercer research – published last February – noted most managers at the time were reviewing capacity assumptions.
The new Russell study confirms that, even with higher capacity expectations, many NZ active managers are now butting up against the limit.
Overall, the Russell study estimates the NZ active funds industry has filled up 90 per cent of an aggregate $10 billion capacity.
The report says the growth of KiwiSaver – now at more than $35 billion – has undoubtedly accelerated the race to capacity for NZ active managers.
“… the growth in KiwiSaver assets has certainly contributed and will continue to put pressure on these managers,” the Russell study says. “It is informative though to consider that institutional New Zealand listed equity assets equate to approximately 11% of the S&P/NZX 50 market capitalisation.”
According to the report, as at this June KiwiSaver funds own about 3.4 per cent of the S&P/NZX 50, equating to $2.4 billion. By comparison, Russell estimates Australian super funds have invested about A$467 billion in the ASX 300 – or about a third of that index.
The average KiwiSaver fund allocation to NZ equities is about 7 per cent, the study says, while Australian super funds typically allocate 23 per cent to domestic shares.
“If KiwiSaver assets were to continue to trend toward this [Australian] level, we believe it would have significant implications for active management in the New Zealand listed equity market,” the Russell report says.
The paper argues KiwiSaver effect on local active managers could be managed if: more listings appear on the NZX at a faster rate; new active managers appear; KiwiSaver schemes reduce exposure to NZ shares; and, investors move to “passive of semi-passive” local equities exposure.
While the Russell research, authored by Sam Faulkner, notes some KiwiSaver providers have downsized their NZ shares allocation, little progress has been achieved in the other three areas it highlights.
In the interim, the study says as local managers approach capacity in “the highly concentrated New Zealand equity market” they may “need to explore stock ideas elsewhere” to keep an edge.
Melville Jessup Weaver (MJW) noted similar concerns in a NZ manager capacity review last year. The MJW report found many NZ equity managers facing local capacity constraints looked across the Tasman to absorb excess.
“This development almost takes us back to the question of whether a portfolio ought to include separate allocations to NZ and Australian shares and the question of how good the NZ manager is at investing in the Australian market,” the MJW study says.
According to the latest MJW investment survey, the median NZ manager has outperformed the index over the 10-, five- and three-year periods but sits slightly behind benchmark over the 12 months to June 30, 2016.