Barefoot Investor: Beware the big fat cat funds

Fat cat funds have been licking the cream off investors’ returns for years and the average young worker who has their super with one of the big five could find themselves $200,000 worse off when they retire, writes the Barefoot Investor.

I copped an elbow to the head.

“Your turn,” grumbled my sleep-deprived wife.

I stumbled into the nursery, where our daughter was wailing.

Cutting teeth is a tough game and we’re right in the middle of it.

Still, it allows me to catch up on my 3am iPhone reading.

So I read the Stockspot Fat Cat Funds Report, which names and shames the worst-performing super funds in Australia.

Now, I may be a little delirious as I type this, but this report reminded me of a book I was reading to our daughter earlier in the evening: Hairy Maclary from Donaldson’s Dairy.

It’s a super simple set-up: Hairy Maclary and his doggie mates (all with cute rhyming names) are on the hunt for a bone (a high-returning super fund), while at the same time trying to avoid their arch-nemesis Scarface Claw — “the toughest tom in town!” (the Fat Cat super funds).

Scarface Claw is, in this instance, OnePath/ANZ (now IOOF), AMP, Perpetual, MLC and Zurich.

These five financial outfits have 30 of the 40 worst-performing super funds.

What does that mean?

Well, according to Stockspot, the average young worker who has their super with one of these funds could find themselves $200,000 worse off when they retire, compared to choosing a low-cost fund. Hercules Morse, as big as a horse!

Yet, with the greatest of respect to Stockspot, this ain’t groundbreaking research.

This is not a test of investment skill, but of investment costs. These Fat Cat funds all have one thing in common: they charge way too much (average 2 per cent per annum).

Now, if this was a children’s book, old Scarface Claw would understand the gig was up and scamper away.

Yet this ain’t no fairytale.

The 40 Fat Cat funds have been licking the cream off investors’ returns for years. Collectively, they are siphoning off $150 million a year in fees, according to Stockspot.

In other words, they’re making out like Muffin McLay — like a bundle of hay!

Tread Your Own Path!

The 40 Fat Cat funds have been licking the cream off investors’ returns for years.

Q&As

ARE INDEX FUNDS IN A BUBBLE?

STEVE ASKS: The financial guru from the movie The Big Short, Michael Burry, who made a fortune betting against the US housing collapse, is saying that the next big bubble is index funds and exchange traded funds (ETFs), and that things will get really ugly should the share market crash.

Aren’t index funds what Barefoot recommends? How do you respond?

BAREFOOT REPLIES: After the 1987 crash, governments around the world held at least six inquiries to work out what caused it.

There was no conclusive answer.

My guess is that investors were driven by their emotions: First, by greed as they watched stocks going up (buy, buy, buy!), and then quickly by fear (sell, sell, sell!).

And, given human emotions don’t change, this behaviour will be what causes the next crash.

Faced with all this erratic decision-making, wouldn’t it be good to have a mechanical, unemotional, by-the-numbers way of investing?

Enter index funds (and exchange traded (index) funds (ETFs).

They are simple to understand: you own, for example, a share in the 300 largest businesses on the ASX. They have transparent investing rules: twice a year they rebalance the portfolio so it matches with the index (the market).

And, as a result, they have low turnover, low taxes and low fees.

In other words, they are the exact opposite of those actively managed funds that try and pick market swings and roundabouts.

In fact, we know that, over the long term, investors in these actively managed funds will end up with less money than they would if they’d invested in a simple index fund. (And repeated studies show that even those actively managed funds that do well in the short term often do so by luck rather than skill.)

Now, to your question: will things get ugly for index funds if there’s a share market crash?

Yes.

Yet it will be ugly for every investor, whether they’re in index funds or not. However, I still can’t see how owning a collection of the largest stocks on the market would put you at a greater disadvantage than other investors.

Steve, if you’re lying awake at night worrying whether you’ll be able to sell your investments in the event of a once-in-a-lifetime crash — rather than, I don’t know, making love to your wife — you really need to check yourself before you wreck yourself.

Besides, history tells us that the day a market crashes is the worst time to be selling.

WEAPONS OF MASS DESTRUCTION

SAM ASKS: I am just about to finish my uni degree and have landed myself a full-time job at a small accounting firm.

Before I plough into the life of debits and credits, I want to make sure I join the best super fund in the market.

I have looked at various funds that use indexing and have low fees.

However, I have read that they use “derivatives” in their portfolio. Have you looked into the portfolio breakdown of these funds? Derivatives have resulted in a lot of mess in the past for a lot of people.

BAREFOOT REPLIES: You’re asking all the right questions.

Stockspot found that index super funds beat 90 per cent of all other super funds — both retail and industry — over five years.

However, not all index funds are created equal.

For example: REST super use Macquarie Bank’s True Index fund, which charges no fees.

What’s the catch?

Well, Macquarie True Index uses “derivatives”, which essentially means that it isn’t required to invest in the actual shares that make up the index, only to guarantee to provide the returns the index makes.

But what happens if Macquarie doesn’t come good on their promise?

Well, that is the risk you’re taking. REST say they’ve done their due diligence and are comfortable with the risk.

I agree with them. However, personally, I want my index funds to actually own the underlying shares.

If you can stick to something for 10 long years, the next 10 years are going to be really exciting for you.

WE ARE DEBT-FREE THANKS TO YOU

DOM WRITES: Ten years ago, my wife and I were drowning in debt, with a big mortgage and maxed-out credit cards.

I came across a copy of your (first) Barefoot Investor book and vowed to change our circumstances and write to you once we were debt free.

Well, this week, 10 years on, in our early 40s, we paid the final instalment on our home loan. We have also built a healthy share portfolio and have not used a credit card in 10 years. It is the most amazing feeling to get there. We are debt-free, and we sincerely thank you.

BAREFOOT REPLIES: That has made my week.

But let me tell you: it has nothing to do with me (well, apart from a little at the start).

It’s you who did it, internalised it, lived it. You are freaking amazing.

Most people don’t stick to anything, ever. The fact that you were able to do this for 10 years … that’s incredible.

You pulled yourself out of a pit for 10 years!

Now, here is my prediction: if you can stick to something for 10 long years, the next 10 years are going to be really exciting for you. Because, if you continue doing what you’re doing, you’re going to build serious wealth for yourselves (rather than the bank).

With the dedication you’ve shown, I want you to email me in another 10 years’ time and tell me you’re millionaires. You deserve all the success in the world. I’m really proud of you.

If you have a burning money question, go to barefootinvestor.com and #askbarefoot

The Barefoot Investor holds an Australian Financial Services Licence (302081). This is general advice only. It should not replace individual, independent, personal financial advice.

The Barefoot Investor for Families: The Only Kids’ Money Guide You’ll Ever Need (HarperCollins)RRP $29.99

Originally published as Barefoot Investor: Beware the big fat cat funds