Investment Environment

House for Sale US Housing prices reached their peak in July 2006, according to the S&P/Case-Shiller index of values in 20 US cities. A month before that Mark Kiesel sold his house.

Mark Kiesel is a managing director with Pacific Investment Management Co (PIMCO). An American fund manager with over $1.3 trillion under management and the largest bond investor in the world. So when PIMCO executives speak the markets usually pay attention.

Back in 2006 Kiesel had concluded that a combination of factors including excess home construction and lax lending standards set the stage for a crash. “It’s not just houses that will be for sale. You’re going to see financial assets for sale over time, and ultimately corporate bonds.”

Next weekend Kiesel moves into a house he has just purchased. On 5 May 2012 he wrote in Global Credit Perspectives published on the PIMCO website entitled "Back In" he says “I’m not sure U.S. housing prices have bottomed -- only time will tell -- but there are many more positives today than there were six years ago when I sold my house.”

A brief summary of Kiesels article can be found on Bloomberg Pimco Housing Bear Kiesel Says Its Time To Start Buying.

Click here to read the full PIMCO Global Credit Perspectives article "Back In"

Improvement in sentiment in the US housing sector is likely to stimulate the economy through:

increased economic activity - building permits were up 33% year on year to March 2012
improvement in consumer confidence which will likely lead to greater spending, and
improvements to bank balance sheets, which will likely mean they will be more willing to lend.

Improvements in the US economy is likely to benefit its trading partners, and so should eventually flow through to improvements in our economy.

Is your portfolio positioned to benefit if Mr Kiesel is right again? If not call us on 578 3863 to discuss options.

ANZ New Zealand is calling for a change to the terms and conditions that govern the default KiwiSaver provider schemes to prevent a potential $14 billion retirement savings time bomb, as savers continue to be enrolled in conservative funds through the default scheme investment options.

Research by ANZ Wealth and OnePath – the country's largest KiwiSaver funds manager¹ - estimates that under the current default settings about 191,000² New Zealanders could potentially face a shortfall of $72,000 each in their final account balance, when they turn 65. This compares with the final balance an average member could experience after 40 years with an investment strategy that changes as the circumstances of their lives change.

This "life stages" investment strategy – sometimes called the 'Lifetimes Option' (see box below) - gradually adjusts an investor's fund allocation from growth-oriented assets to income-oriented assets, based on each individual's length of time to the retirement age.

ANZ Wealth Managing Director John Body said today that this ticking time bomb inside KiwiSaver was a $14 billion shortfall for current New Zealand savers and would continue to blow out as more people enrolled in the scheme in coming years.

"Our research demonstrates that over the long term, investors are likely to be significantly better off through the life stages approach than with the current default 'conservative option'," Mr Body said.

"A life stages approach tends to lift overall performance and moves investors to more defensive investments as they get closer to retirement."

The ANZ KiwiSaver Scheme and the National Bank KiwiSaver Scheme already use the life stages investment fund selection as the default setting for people who do not select their own investment fund.

However, people who do not actively select their own scheme provider are put into one of six default schemes. Under the current terms and conditions for KiwiSaver default providers, new members are automatically defaulted into 'conservative' investment funds, if they do not choose their own investment fund.

"Over the medium to longer term – and this is what the vast majority of retirement savings plans are designed for - conservative funds can seriously disadvantage the saver."

Mr Body said this was a major problem that was missed during recent debates around retirement savings.

ANZ believed that the investment options for default KiwiSaver funds should be reset to better reflect the age and investment horizons of investors.

"We're calling for a simple adjustment to the Government prescribed default investment fund settings that are permitted under the contracts for the six government appointed default providers. If we do nothing, it will cost New Zealand billions of dollars and seriously compromise the standard of living for a generation of retirees."

He said conservative funds were more appropriate for short-term savers due to their lower risk profile.

"This is an important consideration for preserving your savings as you approach retirement and also if you have a short-term focus, such as saving for your first home.

"In these circumstances you may not want to experience the short-term fluctuations that can come with growth funds. We highly recommend that everyone in KiwiSaver receives appropriate professional advice according to their individual circumstances.

"For younger people coming into the scheme now they have a lifetime ahead of them to prepare for retirement. The small change we are proposing to the current default provider investment settings will have a major impact on this younger generation's financial well-being in retirement."

KiwiSaver case study: Conservative fund vs life stages investment funds

Jonathan is a 25 year old sales coordinator from Wellington who recently signed up for KiwiSaver and was placed into a default scheme. Jonathan earns the average wage, $36,000*, and pays the current minimum contribution of 2% of his salary until he retires, and his employer contributes 2% of his salary. In his current conservative fund, he stands to accumulate about $248,000 in his KiwiSaver account by the time he turns 65.

But if he had been placed into a life stages option, which adjusts the mix of investment allocations according to his age, he would have accumulated around $320,000 – a difference of $72,000, according to median projected returns.

Note: *based on Statistics NZ figures for average wage, calculation assumes wage increase based on inflation of 2.5% per annum over forty years and a "Wage Alpha" that increases someone's pay as their skills increase over time . The proposed increase from 2% to 3% of salary has not been taken into account in this example.

Lifetimes Option information

The Lifetimes Option adjusts an investor's allocations to the five main asset classes based on his or her specific length of time to the standard New Zealand Superannuation qualification age (currently 65). By selecting the Lifetimes option, investors are automatically transitioned through the various funds as they reach pre-determined age milestones.

Investment funds for specific age groups

Age group	Allocated fund
0 - 35	Growth Fund
36 - 45	Balanced Growth Fund
46 - 55	Balanced Fund
56 - 60	Conservative Balanced Fund
61 - 64	Conservative Fund
65+	Cash Fund

¹ FundSource Wholesale and Retail Managed Funds Report, September Quarter 2011

² The basis for this figure is derived from the total number of 15-24 year olds in Statistics NZ population figures, 638,000, multiplied by the estimated 30% of current KiwiSaver members who are in conservative funds, (an approximate figure based on publicly available statistics from a variety of sources including IRD, FMA).

OCR unchanged at 2.5 percent

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 2.5 percent.

Reserve Bank Governor Alan Bollard said: "As foreshadowed in the September Statement, global conditions have deteriorated. Continuing difficulties related to sovereign and bank debt in a growing number of European economies have resulted in high levels of volatility in financial markets. There has also been a softening in international economic activity, including in the Asia-Pacific region.

"Global developments are having some negative impact on New Zealand, though to date it has been limited. Business confidence has declined and investment spending is likely to remain weak for some time. In addition, tightness in international markets means funding costs for New Zealand banks will increase to some degree over the coming year.

"There remains a high degree of uncertainty around the global outlook and, as discussed in the scenario in this Statement, there is a risk that conditions weaken further.

"Domestically, economic activity continues to expand, though at a modest pace. Although off their peaks, export commodity prices remain elevated. In addition, the depreciation of the New Zealand dollar provides some support for the tradable sector of the economy. Over time, repairs and reconstruction in Canterbury will also provide a significant boost to demand for an extended period.

"Annual headline inflation is estimated to have returned within the Bank's 1 to 3 percent target band in the December quarter. Underlying inflation continues to sit close to 2 percent. In addition, wage and price setting pressures have remained contained.

"Given the current unusual degree of uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent for now to keep the OCR on hold at 2.5 percent."

Moral Hazard

In economics Moral Hazard is a situation in which a party insulated from risk behaves differently from how it would behave if it were fully exposed to the risk. Economist Paul Krugman described moral hazard as: "...any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly."

The theory is that people behave differently if someone else bears the adverse consequences of a poor decision. The theory originated in the insurance industry where it was thought that people are likely to be less careful if they are insured against loss. So people may not be so careful to lock there house if they have insurance against being burgled.

In the finance markets the theory is that if there is a Government gaurantee or a "lender of last resort facility", lenders will take higher risks because if the worst comes to the worst someone else will bail them out.

Some economist believe that the root cause of the whole global financial crisis was caused by moral hazard as lenders became less and less careful about who they loaned money to as the lenders were always going to sell the loan to someone else.

If you want to read up more on moral hazard Wikipedia is a good place to start, click here http://en.wikipedia.org/wiki/Moral_hazard.

Europe on the Brink

The following article was written by Christian Hawkesby, Head of Fixed Income at Harbour Asset Management, drawing on his understanding of Europe from his experience at the Bank of England. An adridged version was published in the National Business Review on 7 October 2011.

New Zealand Fixed Income Monthly Commentary

6 October 2011 | This email address is being protected from spambots. You need JavaScript enabled to view it. +64 4 460 8309

The European sovereign crisis has worsened significantly in recent months. While European leaders are waiting for the July rescue package to receive parliamentary approvals, it already looks too little, too late.
The crisis is now too large for the Europeans to deal with alone: they lack the clear leadership and financial resources to put a rescue beyond doubt. But policymakers are beginning to acknowledge the enormity of the problem.
It is now in the best interests of countries outside of Europe to see the crisis resolved. The IMF is well placed to coordinate a global solution. This needs to include a Greek restructuring, support to periphery Europe, bank recapitalisations, support to funding markets, and structural reforms.
In the meantime, in fixed income markets there is ample scope for bouts of optimism and disappointment, leading to more market volatility over coming months.

Herding Cats

During my time at the Bank of England, I experienced a small window into the way that Europe works (or doesn't work).

As the Bank's representative on one of the European Central Bank (ECB)'s working groups, I travelled to Frankfurt once a month to join representatives from 25 other countries: covering euro-ins (e.g. Germany, France, Italy), EU-ins-euro-outs (e.g. UK, Sweden), and euro-accession countries (e.g. Malta, Slovenia). In many cases each country was represented by a central bank and financial regulator. (In other committees you'd add someone from the finance ministry to a make up to 75 representatives.) There were a rainbow of cultures, attitudes and personalities; far too many to agree to an agenda or action points. Indeed, delegates from the same country often struggled to agree on a common line to take. The one thing we all had in common was that we had been sent with strict instructions not to commit unconditional support to any proposal. The ECB secretariat based in Frankfurt was ambitious and enthusiastic, but outnumbered. Furthermore, there were at least two other European-wide committees chaired by other European-wide official institutions with overlapping membership and agendas, but with equal ineffectiveness.