Veteran NZ investment manager, Tony Hildyard, is calling for better disclosure of ‘hidden’ tax leakage through offshore-domiciled funds that unnecessarily short-changes local investors.
Hildyard, head of the almost $900 million Hunter Investment Management, said while tax slippage through overseas-based funds – such as Australian unit trusts (AUTs) – was a well-known industry issue, most end investors had no idea that inefficient product design imposed significant costs, akin to a hidden fee.
For example, he said if the Hunter Growth Fund had invested in the passive global equity Vanguard AUTs used by Simplicity and other KiwiSaver providers, it would be losing 0.15 per cent or more each year in un-claimable tax paid to foreign governments like the US, according to a Hunter analysis, compared to investing in the same shares through a NZ-based portfolio investment entity (PIE).
“Incurring an extra 0.15% per annum in tax slippage due to poor product design is just the same as paying 0.15% per annum extra in management fees,” Hildyard said in a release.
“Losing 0.15% each year through shoddy product structuring has a significant impact on long-term returns for investors – and that should be disclosed. KiwiSaver providers who promote low management fees but gloss over tax inefficiencies are essentially misleading their members.”
Hunter has just launched a new suite of funds designed to eliminate the tax plumbing issue associated with AUTs while still providing NZ investors low-cost exposure to diversified assets. The Hunter growth and balanced funds invest into underlying active fixed income and index equities PIEs for an all-in cost of 0.37 per cent – available through the InvestNow KiwiSaver scheme and as stand-alone products.
While the Hunter management fee is slightly above the Simplicity Growth Fund sticker price of 0.31 per cent, Hildyard said accounting for the cost of tax leakage would add about 50 per cent to the Simplicity headline fee.
According to a back-of-the-envelope calculation by Hunter, in real terms the Simplicity KiwiSaver scheme had indicative, and undisclosed, tax losses of about $1.3 million – based on June 30 numbers – compared to total management fees for the year to March 31 of $2.5 million.
However, Sam Stubbs, Simplicity chief, said while the scheme would move to a tax-efficient PIE structure in time, the problem was more one of “theory” than practice.
Stubbs said Simplicity’s wholesale deal with Vanguard meant investors experienced better after-fees returns despite the acknowledged tax inefficiencies.
He said the costs of establishing a PIE vehicle for Simplicity’s global assets outweighed the economic benefits for investors at current funds under management.
“We’ve had a look [at building PIE fund] but you need critical mass and we’re not there yet – and we won’t be for a while,” he said.
Simplicity currently has about $2.25 billion under management, Stubbs said, with roughly $1.5 billion in offshore assets. He said the scheme would likely need to be in the order of $4 billion to justify a structural change.
But Hildyard said managers should wear the upfront costs of establishing tax efficient vehicles through their margins for the long-term benefit of investors – or else fully-disclose the tax leakage costs.
He said, for instance, tax leakage of 0.3 per cent on a passive pure global equities fund priced at 0.3 per cent would have a significant effect on KiwiSaver members facing 40 years or more of investing.
“If you include the tax slippage on top of passive management fees, you could get tax-efficient active management for the same price,” Hildyard said.
While the tax-cost of offshore-based funds was a big deal for institutional investors, Stubbs said consultants make more of the issue than it deserves.
“Investment consultants like to talk about [tax slippage] to provide added value,” he said. “But there’s little evidence that tax-efficient schemes make members more money.”
Noah Schiltknecht, founder of consultancy firm Makao Investments, however, said tax-efficiency was a “material matter, especially for passive funds”.
Schiltknecht said Makao included tax costs as an intrinsic part of its manager assessment process.
“Tax is something that needs to be considered along with fees and inflation – and we’ve fully integrated it into our asset allocation models,” he said.
And as the focus on fees and costs ramp up in a potentially low-return environment, the impact of tax-loss to foreign governments is likely to emerge from the shadows in NZ.
Auckland-based consultancy firm, MyFiduciary, for example, is working on a fund tax efficiency paper.
As usual with tax, the topic is a complex, many-layered one in the fund world, too. But for NZ investors, withholding tax on income (including dividends and coupon yields) collected in the fund’s legal jurisdiction is the most problematic.
For instance, AUTs that invest in global shares incur 15 per cent non-resident withholding tax on dividends that Australian-based investors can claim back but New Zealanders have to suck up.