It would be up to the police to decide whether KiwiSaver schemes, or other NZ investors, are breaking the law by investing in pooled global equity funds that have exposure to cluster munitions manufacturers, according to Commerce Minister Paul Goldsmith.
As well as the Cluster Munitions Prohibition Act 2009, NZ investors could face similar problematic breaches of the: New Zealand Nuclear Free Zone, Disarmament, and Arms Control Act 1987; Anti-Personnel Mines Prohibition Act 1998; Chemical Weapons (Prohibition) Act 1996; Driftnet Prohibition Act 1991; and, UN resolutions banning investments that support nuclear weapons in Iran or the Democratic People’s Republic of Korea.
“The Police are responsible for investigations in respect of these laws,” Goldsmith told Investment News NZ (IN NZ) in a statement. “As the Minister, it is not my role to assess compliance by individual companies.”
While the Minister declined to offer a definitive government legal position on the status of pooled global share funds – including unlisted passive products and exchange-traded funds (ETFs) – vis-à-vis the cluster munitions law in particular, it is understood a Crown Law interpretation of the Act has found investors in such collective investment vehicles would not be running afoul of the legislation.
An industry legal opinion sighted by IN NZ also concludes that “merely holding shares in companies that make cluster munitions is not a breach of the Act, particularly where the fund has bought the shares on market and/or the holding is through another underlying fund”.
However, legal questions aside, the recently publicity around potential exposure to cluster munitions via index funds has sparked a moral panic in the mainstream press, particularly in regards to KiwiSaver default funds.
In the wake of the media noise, Goldsmith wrote to all nine KiwiSaver default providers “to reinforce [the] expectation” that they “comply with the law” – although IN NZ understands the letter doesn’t specify which law.
Interestingly, default providers face the most intense scrutiny on fees, driving them almost inevitably to seek passive solutions, especially for global exposures.
A number of default providers, including Westpac, subsequently announced they were reviewing investment policies while Grosvenor (soon to be rebranded as Booster) revealed it would switch global equity providers immediately.
Notably, the Grosvenor global equity fund transfer (from the Vanguard International Share Index Funds into the UBS MSCI World SRI Index ETF) applies only to the group’s default fund, according to CEO, David Beattie.
The approximately $20 million Grosvenor KiwiSaver default fund has about 12 per cent, or roughly $2.5 million, invested in the Vanguard global equity products. While Grosvenor does invest via the UBS product for its SRI funds (which constitute a tiny proportion of overall funds), Beattie said it would remain invested in Vanguard international share products across the rest of its $1 billion or so KiwiSaver scheme.
For example, the $320 million Grosvenor balanced fund invests about 25 per cent – or $80 million – in Vanguard global equity products.
Beattie said Grosvenor was negotiating with Vanguard to produce an international shares fund that excluded the handful of problematic companies identified in the cluster bomb furore.
“Vanguard would have about $2 billion from NZ investors [in global shares],” he said. “That should give them the scale to do something reasonably quickly.”
Any change may still come at a cost, however. For instance, the UBS SRI product charges underlying fees of 0.38 per cent compared to about 0.18 per cent for the Vanguard global shares products.
According to analysis by Pathfinder Asset Management director, John Berry, standard global ETFs are substantially cheaper (five or six-times less expensive in some cases) than those with ethical or SRI screens while also providing a “massive liquidity advantage”.
“For US share ETFs, choosing the ethical option can be between four to 10 times more expensive in terms of management fees,” Berry said.
Beattie acknowledges cost would put a constraint on moving KiwiSaver funds holus-bolus to products excluding stocks allegedly associated with cluster munitions production.
But he said if providers do nothing they could face reputational risks at least.
“We made the decision [to drop Vanguard global shares from the default fund] because we wanted to be seen as a responsive and transparent provider,” Beattie said. “It wasn’t a legal decision. We haven’t sought any legal advice on it.”
Meanwhile, the exclusion policy of the New Zealand Superannuation Fund (NZS) has been held up as a model for other investors. The most recent NZS exclusion list includes about 170 companies, eight of which are linked with cluster munitions.
A spokesperson for NZS said the fund applies the exclusion list both in its direct and passive holdings (which make up about 80 per cent of the $30 billion plus fund).
“We use a number of mechanisms to ensure that we can apply our exclusion list, including using segregated mandates,” the NZS spokesperson said. “We also use Investment Management Agreements where the manager acts on our directions so we can apply our exclusion list. This is the approach we have used with our passive global equity and fixed income mandates.”
But whether the wider, fragmented NZ fund industry can match the NZS approach remains moot. The NZS itself admits that screening pooled funds for excluded securities is a difficult task.
“We endeavour to apply exclusions to Collective Investment Vehicles (CIVs), to the extent this is feasible and commercially prudent. CIVs are evaluated on a case-by-case basis,” the NZS website says. “The potential for indirect exposure to excluded securities through CIVs is factored into the selection of access points.”
Other investors also dispute the relevance of the NZS list. For example, General Dynamics – on the NZS exclusion list – is “now the largest cluster munitions disposal facility in the world”, according to its website.
Global SRI research firm, Sustainalytics, which recently partnered with Morningstar in Australasia, also notes that “there is no longer evidence of General Dynamic’s involvement in these types of weapons”.
“You could infer that not investing in General Dynamics would prevent them from cleaning up the issue of cluster bombs,” one manager told IN NZ.
Regardless, if allegations that default providers are breaking the law by investing in underlying funds with exposure to companies associated with cluster munitions manufacturer are substantiated, the issue goes much wider than KiwiSaver.
For example, any NZ investor in the increasingly popular ETFs offered by Vanguard, State Street or iShares etc could also be affected by the legislation.
Goldsmith has deferred the matter to the investment industry.
“If investors are not happy about the information they are getting from their provider, or the kinds of investments that they’re making, I’d encourage them to take a look at the other options out there,” he said.
The industry itself is yet to provide a collective response. Owen Gill, head of the peak NZ investment bodies – Workplace Savings NZ and the Financial Services Council – did not provide comment prior to deadline.