InvestNow Foundation Series vs Simplicity funds – Tax leakage an issue?

In this article we’ll be exploring two managed fund offerings – Simplicty’s funds versus the InvestNow Foundation Series funds. They’re both diversified fund offerings, providing investors with a well-rounded investment containing a mix of local and international shares and bonds, all with very competitive fees. While Simplicity has been very successful, accumulating over $4 billion in funds under management, InvestNow’s Foundation Series funds provide a near like-for-like alternative. With Simplicity’s newly announced foray into Build-to-Rent housing and the topic of tax leakage in the mix, could the Foundation Series funds be the superior option?

This article covers:
1. What’s on offer?
2. Fund composition
3. Fee comparison
4. Tax leakage

Update (1 December 2021) – Simplicity no longer charges a $20 annual membership fee.

1. What’s on offer?

Simplicity

Simplicity offer the following diversified funds:

  • Growth
  • Balanced
  • Conservative

They’re available as KiwiSaver funds, or in non-KiwiSaver form which requires a minimum investment of $1,000.

Simplicity also offer a NZ Share and NZ Bond fund, but these are single-sector funds which won’t be covered in this article.

InvestNow Foundation Series

The InvestNow Foundation Series funds are issued by IIS, InvestNow’s parent company. They offer two funds under this brand:

  • Growth
  • Balanced

These funds were formerly known as the Hunter Growth and Hunter Balanced funds, but were recently rebranded in late September 2021. They were originally created as an alternative to the successful Simplicity funds:

We saw that Simplicity funds have been hugely popular with Kiwi investors, so we wanted to offer similar funds to the Simplicity ones within InvestNow. Since they would not let us use their funds, we built our own.

IIS

These funds are available through InvestNow, either as part of their KiwiSaver scheme, or outside of KiwiSaver (where the minimum lump sum investment is $250).

Further Reading:
InvestNow review – The most efficient way to invest?

2. Fund composition

Let’s compare what each of Simplicity’s and InvestNow’s Foundation Series Growth and Balanced funds invest in (unfortunately InvestNow doesn’t have a Conservative fund we can compare against):

Growth

The Growth funds are mostly invested into shares, which will better suit those investing for longer timeframes:

Asset classSimplicityInvestNow FS
Cash2%2%
NZ Bonds7.5%3%
International Bonds12.5%15%
Total income assets22%20%
NZ Shares18%26%
Australian Shares8.5%0%
International Shares48.5%54%
Unlisted NZ Property3%0%
Total growth assets78%80%

Notes:

  • Simplicity’s investment in NZ Bonds includes a maximum 2% allocation towards mortgage lending.
  • Simplicity’s investment in NZ Shares includes a maximum 2.5% allocation towards unlisted companies (private equity).
  • Simplicity’s 3% investment in Unlisted NZ Property relates to their new Build-to-Rent Housing business. Previously this 3% was allocated to NZ shares.
  • InvestNow’s allocation to bonds is actively managed by AMP and PIMCO, while all other allocations are passively managed.

Balanced

The Balanced funds have more weighting towards bonds, which will suit those wanting a less volatile investment, or those with slightly shorter investment timeframes:

Asset classSimplicityInvestNow FS
Cash2%2%
NZ Bonds16.5%12%
International Bonds25.5%26%
Total income assets44%40%
NZ Shares13%20%
Australian Shares6%0%
International Shares35%40%
Unlisted NZ Property2%0%
Total growth assets56%60%

Notes:

  • Simplicity’s investment in NZ Bonds includes a maximum 5.5% allocation towards mortgage lending.
  • Simplicity’s 2% investment in Unlisted NZ Property relates to their new Build-to-Rent Housing business.
  • InvestNow’s allocation to bonds is actively managed by AMP and PIMCO, while all other allocations are passively managed.

Overall the two providers’ funds are largely similar, with small differences in asset allocation here and there. But there’s a few other differences worth looking at in more detail:

Simplicity’s alternative assets

Simplicity has an allocation of up to 7.5% towards alternative assets outside of traditional bonds and shares:

We’ve seen mixed feelings towards these alternative investments. On one hand, these investments provide Simplicity with a point of difference to other funds. Their view is that most KiwiSaver money is invested long-term, so would benefit by having a small allocation to illiquid and higher risk, but potentially higher return assets. And it’s a clever use of their constant inflows of KiwiSaver contributions to fund initiatives that do good to society, like providing affordable housing and low-cost mortgages.

That’s a pretty neat idea from the Simplicity team to leverage the funds that are sitting in KiwiSaver to help solve the housing crisis. 

Reddit commenter

On the other hand these investments can be considered a bit of a gimmick, and detract from the ethos of low-cost, passive investing which Simplicity is best known for. Your Money Blueprint has a great article arguing that their mortgage lending adds risk to their funds, while not moving the dial much in terms of returns.

This is another reason why I’m personally moving away from the Simplicity Growth Fund. I don’t want any more exposure to this crazy NZ property market and I’m after a passive fund – not one that is dabbling in mortgages and direct ownership in property.

Reddit commenter

Their new BTR initiative gives their funds greater exposure to real estate, but initially comes at the expense of exposure to NZ shares. This move could deliver strong one-off returns as they realise a targeted 12.5% gain on the completion of individual housing projects, but may sacrifice long-term gains as residential property is lower yielding than shares (especially when leverage isn’t in the mix). However, they intend to reallocate some of their NZ bonds exposure to BTR when the portfolio becomes more mature – here it’s envisaged that the rental income will be higher yielding than the bonds they replace.

Overall we feel their alternative investments result in a confusing mashup of a predominantly passively managed fund dabbling in various side initiatives. But ultimately it’s up to you, the investor, to decide whether you prefer a more traditional managed fund like the InvestNow Foundation Series, or a fund that’s been tinkered with to invest in special initiatives.

Ethical considerations

Simplicity market their funds as ethical and excludes investments into companies involved with fossil fuels, alcohol, tobacco, gambling, military weapons, civilian firearms, nuclear power, and adult entertainment, as well companies that have been involved in corruption or human rights breaches. However, there’s a couple of aspects of Simplicity’s ethical considerations that we find confusing:

  • The NZ Shares portion of their funds contains 37 NZX listed companies. This understandably excludes SKYCITY (for gambling), but it’s unclear why they’ve excluded companies like Stride Property and Heartland Group, while including much smaller companies outside the NZX 50 like The Warehouse and Briscoes.
  • Simplicity’s founder Sam Stubbs argues that cryptocurrency is unethical, yet their Growth fund invests in cryptocurrency retailer Easy Crypto via an Icehouse Ventures private equity fund. Sounds a bit hypocritical to us, calling themselves an ethical fund, but investing in an industry they openly call unethical.

The InvestNow Foundation Series funds aren’t marketed as ethical, nor do they exclude any companies for ethical reasons.

Currency hedging

Currency Hedging is used by many fund managers to remove the impact of exchange rate fluctuations on international investments. Hedging is standard on bonds, given their aim is to provide a low volatility anchor for a fund, but the merits of hedging on shares are debatable, given the extra cost and their long-term investment timeframe in which exchange rate volatility should even out. The hedging strategies for each fund manager are:

  • Simplicity – Australian and International shares are 65% hedged. International bonds are 100% hedged.
  • InvestNow Foundation Series – International shares are unhedged. International bonds are 100% hedged.

Performance

There’s not enough performance data to make a meaningful comparison between the two providers, given the InvestNow Foundation Series funds haven’t been around for long. But here’s the limited performance data we do have (after fees and before tax, and as at 30 September 2021):

1 month3 months1 year
Simplicity Growth-1.96%1.55%15.75%
InvestNow Foundation Series Growth-0.92%2.67%17.10%
Simplicity Balanced-1.71%0.96%9.98%
InvestNow Foundation Series Balanced-0.93%1.86%11.79%

3. Fee comparison

Here’s a summary of the fees you’ll pay for each fund:

SimplicityInvestNow FS
Management fee0.31%*0.37%
Buy spread0.00%^0.08% (Balanced)
0.10% (Growth)
Sell spread0.00%^0.11%

Notes:

  • *Simplicity donates 15% of management fees to charity via the Simplicity Charitable Trust.
  • ^While Simplicity doesn’t charge spreads upfront for transacting in and out of their funds, the funds’ transactions costs will be borne by the investors in the fund, resulting in a drag in performance.

Where a fund doesn’t have spreads, then underlying transaction costs as a result of investor cashflows will have a drag on performance.

Anthony Edmonds, InvestNow

Both funds are among the lowest-cost options in the diversified funds category with BNZ‘s (0.45% fee) and SuperLife‘s (up to 0.63% fee) funds being the closest competitors.

4. Tax leakage

The above fees don’t tell the whole story. Recently there’s been increasing awareness over a hidden fee on Simplicity’s funds thanks to a tax leakage issue. This is primarily due to a key difference in the way their funds get exposure to international shares:

  • Simplicity – Invests in international shares via Australian Unit Trusts (AUTs) managed by Vanguard (the Vanguard Ethically Conscious International Shares Index Fund).
  • InvestNow Foundation Series – Invest in international shares via a locally domiciled PIE fund managed by AMP (the AMP Wholesale Unit Trust MSCI Global Index Shares Fund).

So how does the tax leakage issue come about due to this difference in structure? Simply put:

  • When the underlying companies in each fund pays dividends, the fund has to pay tax on those dividends. This includes a 15% withholding tax that goes to the foreign government of where the dividend paying company is domiciled.
  • Usually this 15% withholding tax can be claimed as a tax credit to reduce the amount of tax payable to our own NZ government (otherwise we’d be double taxed on the dividend).
  • The above is not an issue for InvestNow, as the locally domiciled PIE fund it invests in has the ability to claim the above tax credits.
  • But for Simplicity, Vanguard’s fund is problematic, due to their status as an Australian domiciled unit trust. Only Aussie investors would be able to claim the 15%, while NZ investors (in this case Simplicity) forfeits that tax credit.

IIS estimate this situation adds an effective 0.15% fee on top of the headline 0.31% fee Simplicity advertise (though the tax leakage will be smaller for their Balanced and Conservative funds due to the lower allocation towards international shares). But there are also a couple of other sources of tax leakage on Simplicity’s funds:

  • While most Australian shares are exempt from the FIF tax regime, Simplicity also use AUTs to get exposure to Aussie shares (via the Vanguard Ethically Conscious Australian Shares Fund). These AUTs are treated as FIFs so are taxed unfavourably compared to direct investment into ASX shares.
  • The management fees a fund incurs are usually tax deductible, ultimately reducing the tax liability passed onto investors. However, the management fees incurred on AUTs (which Simplicity uses) are not tax deductible.

We won’t dig into the topic further as Reddit user u/chemikills already has an excellent comment providing a comprehensive analysis, which estimates total tax leakage of up to 0.264% for an overall effective fee of up to 0.574% on Simplicity’s Growth Fund! The 0.37% fee on InvestNow’s Foundation Series funds now look more attractive, given they don’t face the same tax leakage issues.

Conclusion

Both funds are excellent products, with great fees, and provide an incredibly simple way to invest your money whether it’s inside or outside of KiwiSaver. You can chuck your money into one of their funds and instantly have a diversified portfolio of domestic and international shares and bonds. They save you from having to pick individual companies to invest in, or agonise over your portfolio’s asset allocation.

But we think the InvestNow Foundation Series is the new king of low-cost diversified funds. Their asset allocation provides a near like-for-like alternative to Simplicity’s funds, and despite the higher headline management fee, their fund structure is more efficient. They also have a lower minimum investment.

Simplicity has always been a popular choice, but their current fund structure leads to tax leakage, effectively a hidden fee resulting in poorer performance. But they still offer a few unique features that many people will like. Their funds have ethical exclusions, they cleverly allocate money towards initiatives like BTR housing, and they operate as not-for-profit, donating money to charity in the process. However, not everyone will be a fan of their pivot away from their core role as a simple and passive fund manager, to a scheme which dabbles in housing development and mortgage funding.

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Disclaimer

The content of this article is based on Money King NZ’s opinion and should not be considered financial advice. The information should never be used without first assessing your own personal and financial situation, and conducting your own research. You may wish to consult with an authorised financial adviser before making any investment decisions.