The Community Trust sector has slammed a recent Otago University study as fundamentally flawed.
It is understood the financial regulator has also been put on watch following the publication of the University of Otago paper produced in association with Simplicity that accused 11 community trusts of collectively “[destroying] $127.9 million in value” over the three years to the end of March 2020.
According to sources familiar with the Financial Markets Authority (FMA) position, the regulator has been surprised by some of the conclusions made about the community trust study reported in the media.
Both Simplicity chief, Sam Stubbs, and the author of the paper, Helen Roberts of the University of Otago accountancy and finance school, have used the findings to call for reform of the community trusts and to criticise trustees along with investment advisers who service the sector.
In a statement, Dennis Turton, Trust Waikato chief, said: “We’re disappointed that Simplicity has used its partnership with the University to promote and market itself in this way. We do not think that this report is a responsible or relevant comparative assessment of the contribution our community trusts make.”
The 12 community trusts manage about $4 billion between them, dominated by the $1.4 billion Auckland-based Foundation North.
Prior to the publication of the paper, Ian Miller, Simplicity director of sales and strategy, emailed the community trusts stating: “Simplicity have formed a research partnership with the University of Otago to provide consistent, objective analysis on issues that matter to New Zealanders.
“The research will be updated regularly, and be freely available to the investment community, press and public.”
However, Stubbs said Simplicity has a “data sharing” arrangement with Otago University rather than a commercial relationship.
Roberts said Simplicity helped source and interpret the community trust financial information used in the study.
The research piece compared 11 of the 12 community trusts (with the TSB Community Trust excluded as a non portfolio investor) against Simplicity KiwiSaver funds over the three years ending March 31 last year.
“… our three year empirical analysis shows that the methodologies adopted by consultants have led to significant underperformance for most Community Trusts in New
Zealand, at great cost to beneficiary charities,” the paper says.
But as well as pointing out the “statistically insignificant” value of a single three-year period of performance, the community trusts – in a review of the Otago report carried out by Fidato Advisory principal, Ed Schuck – questioned the validity of the Simplicity benchmark.
“We have a number of issues with the way the report has been prepared, beginning with a fundamental disagreement that the short-term performance of Simplicity, as a passive Kiwisaver fund, is an appropriate benchmark for analysing long-term community trust outcomes,” Turton said. “… We have not received an explanation as to why Simplicity, a passive fund for retail investors, was selected as the most appropriate benchmark.”
Roberts defended Simplicity KiwiSaver as a community trust proxy because both are “not for profit, long-term investors”.
“Simplicity’s asset allocation and currency hedging is passive and benchmarked to the top 12 providers,” the Otago study says. “By using market average asset allocations, hedging, currency and duration, Simplicity were chosen as a real world passive benchmark.”
But the reasoning has astounded industry veterans including Anthony Edmonds, head of Implemented Investment Solutions.
In particular, Edmonds said the study ignores a core difference between non tax-paying entities like community trusts and taxable investments such as KiwiSaver funds.
“Every experienced investment person knows that the portfolio mix of a tax-exempt investor (like a community trust) will naturally be different than a tax-payer (like a person in KiwiSaver),” he said.
For example, Edmonds said tax-exempt investors, who cannot access imputation credits on NZ shares, generally allocate more to offshore assets than the average KiwiSaver scheme.
Over the three-year period covered by the Roberts study, he said NZ equities returned an annualised 11.9 per cent against 7.7 per cent for unhedged global shares (shrinking to 2.4 per cent on a fully hedged basis).
“Accordingly, you would naturally expect that a fund designed for tax-paying clients (like a KiwiSaver scheme) to outperform a tax-exempt investor (like a community trust), Edmonds said.
In a long list of other criticism, the Fidato review says terms used in the Otago report such as “value destroyed” and “benchmark underperformance” could have been put in “more neutral language”.
“The use of terms such as ‘incompetence’, ‘negligence’ and ‘financially illiterate’ used to describe trustee performance is unnecessarily emotive,” the Schuck report says.
“We appreciate that the way in which the paper was used was not under the control of the authors. However, the approach to the community trusts appeared to be directed to a single course of action,” the Fidato analysis says. “In fact, because of their size, many trusts have the opportunity (and many have) to gain exposure to passive funds by going direct to international fund managers, without incurring the duplication of fees involved with using a local intermediary.”
Roberts said the paper titled ‘The Relative Underperformance of Community Trust Investments in New Zealand’ is in the process of being peer-reviewed.