Jenny Ruth: Less is more for those Fat Prophets

Given its name, the Fat Prophets Australia Fund's prospectus is surprisingly free of hype and glossy pictures.

"The company has no performance history as it is a new company," is the only remark about its potential returns.

But although it isn't discussed in the prospectus, the Fat Prophets' newsletters do have a track record dating back to October 2000 when Angus Geddes and Jason McIntosh founded the company.

The prospectus warns investors the newsletter's track record "should not be seen as being indicative as to the future performance of the company".

The fund won't be bound to replicate the newsletters' hypothetical portfolio, but it will be heavily based on it.

The all ordinaries accumulation index has produced a 9.6 per cent annualised return since October 2000 but Fat Prophets has achieved a 35.3 per cent annualised return over that period.

In 2001, the annualised return was 18 per cent while the index fell 10.1 per cent. The following year was even better with a 26.8 per cent return against an 8.1 per cent fall in the index. While the index managed a 15.9 per cent return in 2003, Fat Prophets was 43.7 per cent.

In 2004, it slightly under-performed with a 27.5 per cent return against the index's 27.6 per cent, its worst comparative performance but one investors are unlikely to complain about.

Geddes says that in preparing the prospectus, they "erred on the side of caution". "We didn't want to run the risk of the prospectus being held up by ASIC [Australian Securities and Investments Commission]."

Fat Prophets has good reason to be wary of ASIC, having already had a run-in with the corporate regulator back in October 2002.

Fat Prophets had been calculating its own returns and publishing them but had only reported on its closed-out positions - stocks it had recommended investors buy and then later sell.

ASIC's obvious concern was that this methodology could be used to make your performance look fantastic if you never sold your duds, never realised your losses.

Although Fat Prophets' publisher never admitted to any breach of the law, ASIC extracted from it an enforceable undertaking which involved engaging an independent expert to devise an appropriate way to measure the hypothetical portfolio's performance.

The company now has its performance independently verified on a monthly basis.

The company also had to publish a notice addressing ASIC's concerns and ensure it went to all past subscribers and invite complaints from anybody who believed they were misled.

Geddes said the company received few complaints although it offered full refunds to any subscriber who felt hard done by.

Using the new methodology, the hypothetical portfolio's performance was better than it had been under their old method.

The company certainly publishes information about investments which don't work out as well as about those that do.

Its investment philosophy is to buy under-valued stocks, particularly companies in some kind of distress, and await a market re-rating. It uses traditional company analysis and charting to identify prospects.

It recommended investors buy shares in the Palm Springs natural and spring water company on no less than three occasions since early 2001.

By March 2004, it was recommending that investors sell, realising a 34.2 per cent loss.

Pasminco was an even worse choice, realising a 100 per cent loss over the seven months last year since Fat Prophets recommended it.

But, given its investment style, it would be amazing if the hypothetical portfolio didn't contain a few duds and its overall record shows the company gets more right than wrong.

"We accept that losses are inevitable in the stockmarket and sometimes hard decisions need to be made. It is true also that we do not win on every recommendation. Our mission is to win more than we lose and, in doing so, come out ahead," the company says on its website.

The company's name is flamboyant and the fund is its first foray into the managed funds market which suggests some flakiness.

However, the people behind it have solid track records in the funds management industry. Geddes and McIntosh, who met when working at Bankers Trust eight years ago, have 15 and 14 years of experience respectively in the finance industry.

The independent chairman, Robert Bolton, has 20 years of experience in executive management, project management and consulting.

David Shearwood, the fund's chief executive, has 18 years of experience in funds management, investment banking and stock-broking. Companies he has worked for include Bain & Co, now Deutsche Bank, McIntosh, now Merrill Lynch, Westpac Investment Management and QBE Insurance

He is backed up by two other executives with nine and 10 years of experience working for reputable companies in the financial services industry.

The company continues the biblical theme in its name into its investment philosophy which is based on its "10 Commandments".

These include not paying "ridiculously high prices", avoiding fads, not following the crowd and being disciplined about cutting losses. The fund's management fees are in line with similar funds.

The manager will get 1.25 per cent of the net value of the portfolio - it isn't intended to gear the fund but it is allowed to gear to 30 per cent - plus a performance fee of 15 per cent of any out-performance of the S&P/ASX 300 accumulation index.

From an Australian point of view, this looks like an attractive offer.

But for all this, any New Zealand investors are starting behind the eight ball because the fund isn't at all tax efficient for them. While Australian investors will get usable franking credits, such credits will be useless to New Zealanders.

And the fund will be subject to Australia's capital gains tax, paying 30 per cent of any capital gains. New Zealanders are not entitled to a tax break on this.

Even if Fat Prophets' future performance is as good as its track record, those are huge hurdles for the New Zealand investor.

Geddes says the fund is being offered to New Zealanders because about 15 per cent of Fat Prophets' 7000 subscribers are Kiwis - he is one himself.

He says the company may look at establishing a separate fund for New Zealanders later.

In the meantime, investors would probably do better with the two local funds which listed last year, Kingfish and Salvus, both of which are tax effective, able to pass on usable franking credits and avoiding capital gains tax in New Zealand through their buy-and-hold philosophies.

Kingfish's shares and options, issued at $1 in March last year, were trading at a combined $1.424 yesterday. Salvus shares and options were trading at a combined $1.15.

Bulking up

Fat Prophets Australia Fund
Headquarters: Level 33, 2 Park St, Sydney.
Profile: The fund aims to out-perform the S&P/ASX 300 accumulation index through buying under-valued shares and benefiting from their expected recovery. It will hold between 25 and 80 securities, relying on the Fat Prophets' newsletters as a major source of investment ideas. It will be listed on the Australian Stock Exchange.
Amount to be raised: A minimum of A$16 million and up to A$40 million. The offer isn't underwritten.
Key executives: Chief executive David Shearwood, chief operating officer Drew Wilson and senior fund manager Steve OHanna.