2019 Fat Cat Funds Report

How super funds play the ratings game

We look at how funds manipulate their inclusion into the categories set by the ratings agencies.

It’s that time of the year again when super funds release their annual performance. This article looks at how the funds twist their performance relative to other funds and indexing.

The funds’ PR is parroted by the ratings agencies whose tables and good news story are accepted at face value by the media.

Firstly, we look at how funds manipulate their inclusion into the categories set by the ratings agencies.

Defensive assets

ASIC defines defensive assets as cash or government bonds.

Cash is defensive because when market fall it holds its value.

High grade bonds can do one better and rise when share markets fall. History backs this up too; in each of the 6 times Australian shares had a down year in the past 20, bonds rose to cushion the impact.

Australian shares and bonds annual return %
Australian shares and bonds annual return %

Can other assets be defensive?

This very much depends on the opinion of the fund manager and there is strong history to demonstrate why their opinions might not end up as fact.

High income stream and low growth assets

Just because an asset delivers a big income stream does not make it defensive. Take Telstra. Most of Telstra’s returns come from regular fully franked dividend income but its share price has dropped 35% since 2015.

Infrastructure and property assets

Much infrastructure and property is held in unlisted vehicles which raises 3 concerns:

  • The value of the investment is the opinion of the fund manager and there is no way of knowing whether that value is credible given that there is no open market for the asset.
  • The financial structure may see a return of capital reported as an income distribution.
  • The investment is very illiquid and a sale is often extremely constrained by agreements with co-investors, including first right of refusal and so-called ‘tag-and-drag’ conditions. One critical characteristic of a defensive asset is to be able to sell it in a deep and open market.

The inherently risky nature of these investments is usually exposed towards the end of each market cycle when too much debt is loaded in to beef up returns.

In 2008 the Real Estate Investment Trust (REIT) sector fell by a whopping 75% globally because these funds had created income which couldn’t be sustained under high debts and falling prices.

During the Financial Crisis some super funds stopped members from transferring money out because they were unable to sell illiquid unlisted assets.

One fund, MTAA super, lost $1.6 billion due to poor hedging of unlisted assets. MTAA super lost its spot as one of the best performing funds in 2008 to become the second worst according to Super Ratings.

Creative definitions of defensive assets

In recent times many super funds have invented their own definition of a defensive asset which has helped to push them up the ratings.

Let’s look at this year’s top performing fund over the last 5 years according to Super Ratings, the Hostplus default balanced fund which claims a 25% allocation to defensive assets.

The Hostplus website explains that in addition to cash and fixed income “some asset classes, such as infrastructure, property and alternatives may have growth and defensive characteristics”.

Their self-defined defensive assets include infrastructure, credit, property and alternatives. These make up all of the portfolio allocation to defensive assets. Government bonds and cash make up 0% of the fund!


Hostplus Default Balanced Fund

Defensive AssetPortfolio Allocation
Infrastructure6%
Property9%
Alternatives5%
Credit5%
Fixed Income0%
Cash0%
Total25%
Source: Hostplus


This has enabled Hostplus to claim top gong in its chosen category.

Hostplus isn’t the only one. Many of the top funds on this list have counted some other assets as defensive to make the Balanced fund weigh-in including Sunsuper, CareSuper, Mercy Super and Media Super.

Top 10 performing balanced funds

This prompted me to ask Hostplus CIO Sam Sicilia the following question last year:

Hostplus: how do they determine a defensive asset?

The Productivity Commission got a similar response from many super funds when asking about returns for individual assets. Only 5 of 208 funds were prepared to disclose them!

Unfortunately, super funds aren’t required to disclose how they classify their investments on their website or to anyone. Not to members, to the Australian Prudential Regulation Authority (APRA) or ASIC.

They also aren’t required to share how each asset has performed or even what it is. This allows funds to play the ratings game without anyone holding them to account.

By all means Hostplus and other funds should be free to invest in illiquid unlisted infrastructure, alternatives and property assets.

Just don’t call them defensive!

How Hostplus sells the ‘success’ of its balanced default fund

Hostplus chief executive David Elia puts the performance down to active management: 

“Over the past three years our balanced option did 10.16 per cent, while the index balanced option did 7.29 per cent, so that’s almost a three percentage point differential. The [active] balanced option has outperformed across every time horizon”

It’s absurd that Hostplus compares its indexed balanced option which has 25% cash and bonds to its default balanced option with 0%.

It would be fairer to compare it to an index fund with a similar amount of risk. For example, the Vanguard High Growth Fund has a 10% allocation to cash and bonds and generated the following returns over 1, 5 and 10 years after fees and taxes.


Return PeriodHostplus BalancedVanguard High Growth
1 Year6.80%9.59%
5 Years (p.a.)9.65%9.70%
10 years (p.a.)9.67% 10.81%
Performance is net of investment fees and tax. Vanguard returns are for a super fund paying tax in accumulation stage. Source: Chant West, Vanguard


When comparing much more similar funds, Hostplus performed below an index fund over 1, 5 and 10 years.

How ratings agencies support the misleading self-reporting

The ratings agencies don’t properly query the allocations reported by the funds. This provides no check as to the real risk of the self-reported defensive assets.

In addition, the ratings agencies have a few additional problems of integrity which we discussed in what fund ratings won’t tell you. To recap:

  • Most ratings businesses only publicly announce the top performers and not the worst. This is because they are typically paid by the funds who they rate. Anyone who has seen The Big Short would understand how problematic this conflict of interest is. It’s why we publish the Fat Cat Funds Report to shed a light on the best and worst funds.

Active or indexed super?

By our analysis over 90% of active super funds underperformed an index fund of similar risk over 5 years after fees and taxes.

Expensive fees for active management is precisely what causes most super funds to underperform. For every active winner there has to be an active loser and management fees drag down net returns.

There are always going to be a small number of funds who beat the index but that group is always changing. Many funds in the top lists this year have also spent time near the bottom when markets weren’t as kind to them.

Winners always change. Fees are with you every year.

How to pick the right super fund

For those looking for a super fund with a low allocation to defensive assets, Hostplus might be one to consider. Let’s be clear, Hostplus and other Industry funds are making some good investments including into venture capital and infrastructure projects that will benefit Australia.

However what shouldn’t be making headlines and driving members to switch is how the fund performed compared to lower risk options in a rising market.

Chasing the latest returns harms investors

Over the last 5 years Hostplus has been one of the very few funds to almost generate enough extra returns to match an index fund of similar risk. Vanguard’s high growth fund still beat it after fees and taxes over 5 years.

Compared to the disastrous bank owned retail super products, industry funds consistently come out ahead. However that doesn’t mean some stakeholders aren’t massaging the truth about what drives returns and therefore what’s in the best interest of members.

Will Hostplus be able to keep up with an index fund over the next 10 years? Maybe, maybe not. Based on history, the odds of a fund that charges 1.45% per year beating a low cost index fund across the market cycle is not high.

Warren Buffett proved this when he recently won a 10 year bet that a Vanguard index fund would beat 5 expert-selected active fund managers.

Buffett backed the index fund which won by a massive 77%.

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Founder and CEO

Chris has been vocal in calling out the industry 'Fat Cats' and is known for telling it as it is. He sits on two Advisory Committees for the industry regulator ASIC, and was previously a fund manager at UBS. He holds a Bachelor of Commerce (Accounting/Finance Co-op Scholarship) from UNSW.

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