By David Snowball

Dear friends,

The Christmas of the early American republic – of the half century following the Revolution – would be barely recognizable to us. It was a holiday so minor as to be virtually invisible to the average person. You’ll remember the famous Christmas of 1776 when George Washington crossed the Delaware on Christmas and surprised the Hessian troops who, one historian tells us, were “in blissful ignorance of local custom” and had supposed that there would be celebration rather than fighting on Christmas. Between the founding of the Republic and 1820, New England’s premier newspaper – The Hartford Courant – had neither a single mention of Christmas-keeping nor a single ad for holiday gifts. In Pennsylvania, the Harrisburg Chronicle – the newspaper of the state’s capital – ran only nine holiday advertisements in a quarter century, and those were for New Year’s gifts. The great Presbyterian minister and abolitionist orator Henry Ward Beecher, born in 1813, admitted that he knew virtually nothing about Christmas until he was 30: “To me,” he writes, “Christmas was a foreign day.” In 1819, Washington Irving, author of The Legend of Sleepy Hollow and Rip van Winkle, mourned the passing of Christmas. And, in 1821, the anonymous author of Christmas-keeping lamented that “In London, as in all great cities … the observances of Christmas must soon be lost.” Though, he notes, “Christmas is still a festival in some parts of America.”

Why? At base, Christmas was suppressed by the actions and beliefs of just two groups: the rich people . . . and the poor people.

The rich — the Protestant descendants of the founding Puritans, concentrated in the booming commercial and cultural centers of the Northeast – reviled Christmas as pagan and unpatriotic. About which they were at least half right: pagan certainly, unpatriotic . . . ehhh, debatable.

Here we seem to have a contradiction in terms: a pagan Christmas. To resolve the contradiction, we need to separate a religious celebration of Christ’s birth from a celebration of Christ’s birth on December 25^th. Why December 25^th? The most important piece of the puzzle is obscured by the fact that we use a different calendar system – the Gregorian – than the early Christians did. Under their calendar, December 25^th was the night of the winter solstice – the darkest day of the year but also the day on which light began to reassert itself against the darkness. It is an event so important that every ancient culture placed it as the centerpiece of their year. We have record of at least 40 holidays taking place on, or next to, the winter solstice. Our forebears rightly noted that the choice of December 25^th with a calculated marketing decision meant to draw pagans away from one celebration and into another.

So the Puritans were correct when they pointed out – and they pointed this out a lot – that Christmas was simply a pagan feast in Christian garb. Increase Mather found it nothing but “mad mirth…highly dishonorable to the name of Christ.” Cromwell’s Puritan parliament banned Christmas-keeping in the 1640s and the Massachusetts Puritans did so in the 1650s.

And while the legal bans on Christmas could not be sustained, the social ones largely were.

The rich, who didn’t party, were a problem. The poor, who did, were a far bigger one.

There was, by long European tradition, a period of wild festivity to celebrate New Year’s. Society’s lowest classes – slaves or serfs or peasants or blue collar toilers – temporarily slipped their yokes and engaged in a period of wild revelry and misrule.

In America, the parties were quite wild. Really quite wild.

Think: Young guys.

Lots of them.

With guns.

Drunk.

Ohhh . . . way drunk, lots of alcohol, to . . . uh, drive the cold winter away.

And a sense of entitlement – a sense that their social betters owed them good food, small bribes and more alcohol.

Then add lots more alcohol.

Roving gangs, called “callithumpian bands,” roamed night after night – by a contemporary account “shouting, singing, blowing trumpets and tin horns, beating on kettles, firing crackers … hurling missiles” and demanding some figgy pudding. Remember?

Oh, bring us a figgy pudding and a cup of good cheer

We won’t go until we get some;

We won’t go until we get some;

We won’t go until we get some, so bring some out here

Back then, that wasn’t a song. It was a set of non-negotiable demands.

In a perverse way, what saved Christmas was its commercialization. Beginning in New York around 1810 or 1820, merchants and civic groups began “discovering” old Dutch Christmas traditions (remember New York started as New Amsterdam) that surrounded family gatherings, communal meals and presents. Lots of presents. The commercial Christmas was a triumph of the middle class. Slowly, over a generation, they pushed aside old traditions of revelry and half-disguised violence. By creating a civic holiday which helped to bridge a centuries’ old divide between Christian denominations – the Christmas-keepers and the others – and gave people at least an opportunity to offer a fumbling apology, perhaps in the form of a Chia pet, for their idiocy in the year past and a pledge to try better in the year ahead.

I might even give it a try, minus regifting my Chia thing.

Harness the incomparable power of lethargy!

We are lazy, inconstant, wavering and inattentive. It’s time to start using it to our advantage. It’s time to set up a low minimum/low pain account with an automatic investment plan.

About a third of us have saved nothing. The reasons vary. Some of us simply can’t; about 60 million of us – the bottom 20% of the American population – are getting by (or not) on $21,000/year. Over the past 40 years, that group has actually seen their incomes decline by 1%. Folks with just high school diplomas have lost about 20% in purchasing power over that same period. NPR’s Planet Money team did a really good report on how the distribution of wealth in the US has changed over the past 40 years.

A rather larger group of us could save, or could save more, but we’re thwarted by the magnitude of the challenge. Picking funds is hard, filling out forms is scary and thinking about how far behind we are is numbing. So we sort of panic and freeze. That reaction is only so-so in possums; it pretty much reeks in financial planning.

Fortunately, you’ve got an out: low minimum accounts with automatic investment plans. That’s not the same as a low minimum mutual fund account. The difference is that low minimum accounts are a bad idea and an economic drain to all involved; when I started maintaining a list of funds for small investors in the 1990s, there were over 600 no-load options. Most of those are gone now because fund advisers discovered an ugly truth: small accounts stay small. Full of good intentions people would invest the required $250 or $500 or whatever, then bravely add $100 in the next month but find that cash was a bit tight in the next month and that the cat needed braces shortly thereafter. Fund companies ended up with thousands of accounts containing just a few hundred dollars each; those accounts might generate just $3 or 4 a year in fees, far below what it cost to keep them open. Left to its own a $250 account would take 20 years to reach $1,000, a nice amount but not a meaningful one.

But what if you could start small then determinedly add a pittance – say $50 – each month? Over that same 20 year period, your $250 account with a $50 monthly addition would grow to $29,000. Which, for most of us, is really meaningful.

Would you like to start moving in that direction? Here’s how.

If you do not have an emergency fund or if you mostly want to sleep well at night, make your first fund one that invests mostly in cash and bonds with just a dash of stocks. As we noted last month, such a stock-light portfolio has, over the past 65 years, captured 60% of the stock market’s gains with only 25% of its risks. Roughly 7% annual returns with a minimal risk of loss. That’s not world-beating but you don’t want world-beating. For a first fund or for the core of your emergency fund, you want steady, predictable and inflation-beating.

Consider one of these two:

TIAA-CREF Lifestyle Income Fund (TSILX). TIAA-CREF is primarily a retirement services provider to the non-profit world. This is a fund of other TIAA-CREF funds. About 20% of the fund is invested in dividend-paying stocks, 40% in short-term bonds and 40% in other fixed-income investments. It charges 0.83% per year in expenses. You can get started for just $100 as long as you set up an automatic investment of at least $100/month from your bank account. Here’s the link to the account application form. You’ll have to print off the pdf and mail it. Sorry that they’re being so mid-90s about it.

Manning & Napier Strategic Income, Conservative Series (MSCBX). Manning & Napier is a well-respected, cautious investment firm headquartered in Fairport, NY. Their funds are all managed by the same large team of people. Like TSILX, it’s a fund-of-funds and invests in just five of M&N’s other funds. About 30% of the fund is invested in stocks and 70% in bonds. The bond portfolio is a bit more aggressive than TSILX’s and the stock portfolio is larger, so this is a slightly more-aggressive choice. It charges 0.88% per year in expenses. You can get started for just $25 (jeez!) as long as you set up a $25 AIP. Do yourself a favor a set a noticeably higher bar than that, please. Here’s the direct link to the fund application form. Admittedly it’s a poorly designed one, where they stretch two pages of information they need over about eight pages of noise. Be patient with them and with yourself, it’s just not that hard to complete and you do get to fill it out online.

Where do you build from there? The number of advisers offering low or waived minimums continues to shrink, though once you’re through the door you’re usually safe even if the firm ups their requirement for newcomers.

Here’s a quick warning: Almost all of the online lists of funds with waived or reduced minimum contain a lot of mistakes. Morningstar, for instance, misreports the results for Artisan (which does waive its minimum) as well as for DoubleLine, Driehaus, TCW and Vanguard (which don’t). Others are a lot worse, so you really want to follow the “trust but verify” dictum.

Here are some of your best options for adding funds to your monthly investing portfolio:

Family	AIP minimum	Notes
Amana	$250	The Amana minimum does not require an automatic investment plan; a one-time $250 investment gets you in. Very solid, very risk-conscious.
Ariel	50	Six value-oriented, low turnover equity funds.
Artisan	50	Artisan has four Great Owl funds (Global Equity, Global Opportunities, Global Value, and International Value) but the whole collection is risk-conscious and disciplined.
Azzad	300	Two socially-responsible funds, one midcap and one focused on short-term fixed-income investments.
Buffalo	100	Ten funds across a range of equity and stock styles. Consistently above average with reasonable expenses. Look at Buffalo Flexible Income (BUFBX) which would qualify as a Great Owl except for a rocky stretch well more than a decade ago under different managers.
FPA Funds	100	These guys are first-rate, absolute return value investors. Translation: if nothing is worth buying, they’ll buy nothing. The funds have great long term records but lag in frothy markets. All are now no-load for the first time.
Gabelli	0	On AAA shares, anyway. Gabelli’s famous, he knows it and he overcharges. That said, he has a few solid funds including their one Great Owl, Gabelli ABC. It’s a market neutral fund with badly goofed up performance reporting from Morningstar.
Guinness Atkinson	100	Guinness offers nine funds, all of which fit into unique niches – Renminbi Yuan & Bond Fund (a Great Owl) or Inflation-Managed Dividend Fund, for instances
Heartland	0	Four value-oriented small to mid-cap funds, from a scandal-touched firm. Solid to really good.
Hennessy	100	Hennesy has a surprisingly large collection of Great Owls: Equity & Income, Focus, Gas Utility Index, Japan and Japan Small Cap.
Homestead	0	Seven funds (stock, bond, international), solid to really good performance (including the Great Owls: Short Term Bond and Small Company Stock), very fair expenses.
Icon	100	17 funds whose “I” or “S” class shares are no-load. These are sector or sector-rotation funds, a sort of odd bunch.
James	50	Four very solid funds, the most notable of which is James Balanced: Golden Rainbow (GLRBX), a quant-driven fund that keeps a smallish slice in stocks
Laudus Mondrian	100	An “institutional managers brought to the masses” bunch with links to Schwab.
Manning & Napier	25	The best fund company that you’ve never heard of. Thirty four diverse funds, including many mixed-asset funds, all managed by the same team. Their sole Great Owl is Target Income.
Northern Trust	250	One of the world’s largest advisers for the ultra-wealthy, Northern offers an outstanding array of low expense, low minimum funds – stock and bond, active and passive, individual and funds of funds. Their conservatism holds back performance but Equity Income is a Great Owl.
Oberweis	100	International Opportunities is both a Great Owl and was profiled by the Observer.
Permanent Portfolio	100	A spectacularly quirky bunch, the Permanent Portfolio family draws inspiration from the writings of libertarian Harry Browne who was looking to create a portfolio that even government ineptitude couldn’t screw up.
Scout	100	By far the most compelling options here are the fixed-income funds run by Reams Asset Management, a finalist for Morningstar’s fixed-income manager of the year award (2012).
Steward Capital	100	A small firm with a couple splendid funds, including Steward Capital Mid Cap, which we’ve profiled.
TETON Westwood	0	Formerly called GAMCO (for Gabelli Asset Management Co) Westwood, these are rebranded in 2013 but are the same funds that have been around for years.
TIAA-CREF	100	Their whole Lifecycle Index lineup of target-date funds has earned Great Owl designation.
Tributary	100	Four solid little funds, including Tributary Balanced (FOBAX) which we’ve profiled several times.
USAA	500	USAA primarily provides financial services for members of the U.S. military and their families. Their funds are available to anyone but you need to join USAA (it’s free) in order to learn anything about them. That said, 26 funds, some quite good. Ultra-Short Term Bond is a Great Owl.

Do you have a fund family that really should be on this list but we missed? Sorry ‘bout that! But we’ll fix it if only you’ll let us know!

Correcting our misreport of FPA Paramount’s (FPRAX) expense ratio

In our November profile of FPRAX, we substantially misreported FPRAX’s expense ratio. The fund charges 1.26%, not 0.92% as we reported. . Morningstar, which had been reporting the 0.92% charge until late November, now reports a new figure. The annual report is the source for the 1.06% number, the prospectus gives 1.26%.  The difference is that one is backward-looking, the other forward looking.

Where did the error originate? Before the fall of 2013, Paramount operated as a domestic small- to mid-cap fund which focused on high quality stocks. At that point the expense ratio was 0.92%. That fall FPA changed its mandate so that it now focuses on a global, absolute value portfolio.  Attendant to that change, FPA raised the fund’s expense ratio from 0.92 to 1.26%. We didn’t catch it. Apologies for the error.

The next question: why did FPA decide to charge Paramount’s shareholders an extra 37%? I’ve had the opportunity to chat at some length with folks from FPA, including Greg Herr, who serves as one of the managers for Paramount. The shortest version of the explanation came in an email:

… the main reasons we sought a change in fees was because [of] the increased scope of the mandate and comparable fees charged by other world stocks funds.

FPA notes that the fund’s shareholders voted overwhelmingly to raise their fees. The proxy statement adds a bit of further detail:

FPA believes that the proposed fee would be competitive with other global funds, consistent with fees charged by FPA to other FPA Funds (and thus designed to create a proper alignment of internal incentives for the portfolio management team), and would allow FPA to attract and retain high quality investment and trading personnel to successfully manage the Fund into the future.

Based on our conversations and the proxy text, here’s my best summary of the arguments in favor of a higher expense ratio:

• It’s competitive with what other companies charge
• The fund has higher costs now
• The fund may have higher costs in the future, for example higher salaries and larger analyst teams
• FPA wants to charge the same fee to all of our shareholders

Given the fund’s current size ($304 million), the additional 34 bps translates to an additional $1.03 million/year transferred from shareholders to the adviser.

Let’s start with the easy part. Even after the repricing, Paramount remains competitively priced. We screened for all retail, no-load global funds with between $100-500 million in their portfolios, and then made sure to add the few other global funds that the Observer already profiled. There are 35 such funds. Twelve are cheaper than Paramount, 21 are more expensive. Great Owls appear in highlighted blue rows, while profiled funds have links to their MFO profiles.

		Expense ratio	Size (million)
Vanguard Global Minimum Volatility	VMVFX	0.30	475
Guinness Atkinson Inflation Managed Dividend	GAINX	0.68	5
T. Rowe Price Global Stock	PRGSX	0.91	488
Polaris Global Value	PGVFX	0.99	289
Dreyfus Global Equity Income I	DQEIX	1.06	299
Deutsche World Dividend S	SCGEX	1.09	362
Voya Global Equity Dividend W	IGEWX	1.11	108
Invesco Global Growth Y	AGGYX	1.18	359
PIMCO EqS® Dividend D	PQDDX	1.19	166
Deutsche CROCI Sector Opps S	DSOSX	1.20	152
Hartford Global Equity Income	HLEJX	1.20	288
Deutsche Global Small Cap S	SGSCX	1.25	499
FPA Paramount	FPRAX	1.26	276
First Investors Global	FIITX	1.27	430
Invesco Global Low Volatility	GTNYX	1.29	206
Perkins Global Value S	JPPSX	1.29	285
Cambiar Aggressive Value	CAMAX	1.35	165
Motley Fool Independence	FOOLX	1.36	427
Artisan Global Value	ARTGX	1.37	1800
Portfolio 21 Global Equity R	PORTX	1.42	494
Columbia Global Equity W	CGEWX	1.45	391
Guinness Atkinson Global Innovators	IWIRX	1.46	147
Artisan Global Equity	ARTHX	1.50	247
Artisan Global Small Cap	ARTWX	1.50	169
BBH Global Core Select	BBGRX	1.50	130
William Blair Global Leaders N	WGGNX	1.50	162
Grandeur Peak Global Reach	GPROX	1.60	324
AllianzGI Global Small-Cap D	DGSNX	1.61	209
Evermore Global Value A	EVGBX	1.62	249
Grandeur Peak Global Opportunities	GPGOX	1.68	709
Royce Global Value	RIVFX	1.69	154
Wasatch World Innovators	WAGTX	1.77	237
Wasatch Global Opportunities	WAGOX	1.80	195
	average	1.32%	$325M

Unfortunately other people’s expenses are a pretty poor explanation for FPA’s prices.

There are two ways of reading FPA’s decision:

1. We’re going to charge what the market will bear. Welcome to capitalism. The cynical reading starts with the suspicion that the fund’s expenses haven’t risen by a million dollars. While FPA cites research, trading, settlement and compliance expenses that are higher in a global fund than in a domestic fund, the fact that every international stock in Paramount’s portfolio was already in International Value’s means that the change required no additional analysts, no additional research trips, no additional registrations, certifications or subscriptions. While Paramount’s shareholders might need to share the cost of those reports with International Value’s (which lowers the cost of running International Value), at best it’s a wash: International Value’s expenses should fall as Paramount’s rise.
2. We need to raise fees a lot in the short term to be sure we can do right by our shareholders in the long term. There are increased expenses, they were fully disclosed to the fund’s board, and that the board acted thoughtfully and in good faith in deciding to propose a higher expense ratio. They also argue that it makes sense that Paramount and International Value’s shareholders should pay the same rate for their manager’s services, the so-called management fee, since they’ve got the same managers and objectives. Before the change, FPIVX shareholders paid 1% and FPRAX shareholders paid 0.65%. The complete list of FPA management fees:
   

   FPA New Income	Non-traditional bond	0.50
   FPA Capital	Mid-cap value	0.65
   FPA Perennial	Mid-cap growth	0.65
   FPA Crescent	Free-range chicken	1.00
   FPA International Value	International all-cap	1.00
   FPA Paramount	Global	1.00

   Finally, the new expenses create a sort of war-chest or contingency fund which will give the adviser the resources to address opportunities that are not yet manifest.

So what do we make of all this? I don’t know. I respect and admire FPA but this decision is disquieting and opaque. I’m short on evidence, which is frustrating.

That, sadly, is where we need to leave it.

Whitney George and the Royce Funds part ways

We report each month on manager changes, primarily at equity and balanced funds. All told, nearly 700 funds have reported changes so far in 2014. Most of those changes have a pretty marginal effect. Of the 68 manager changes we reported in our November issue, only 12 represented house cleanings. The remainder were simply adding a new member to an existing team (20 instances) or replacing part of an existing team (36 funds).

Occasionally, though, manager departures are legitimate news and serious business, both for a fund’s shareholders and the larger investing community.

And so it is with the departure of Whitney George from Royce Funds.

Mr. George has been with Royce Funds for 23 years, both as portfolio manager and with founder Charles Royce, co-Chief Investment Officer. He manages the $65 million Royce Privet hedge fund (‘cause “privet” is a kind of hedge, you see) and the $170 million Royce Focus Trust (FUND), an all-cap, closed-end fund. On November 10, Royce announced that Mr. George was leaving to join Toronto-based Sprott Asset Management and that, pending shareholder approval, Privet and Focus were going with him. At the same time he stepped aside from the management (sole, co- or assistant) of five open-end funds: Royce Global Value (RIVFX), Low-Priced Stock (RYLPX), Premier (RPFFX), SMid-Cap Value (RMVSX) and Value (RYVFX). They are all, by Morningstar’s reckoning, one- or two-star funds. As of May 2014, Mr. George was connected with the management of more than $15 billion in assets.

Why? The firm’s leadership was contemplating long term succession planning for Chuck and decided on an executive transition that did not include Whitney. The position of president went to Chris Clark. Sometime thereafter, he concluded that his greatest contributions and greatest natural strengths lay in managing investments for Canadians and began negotiating a separation. He’ll remain with Royce through the end of the first quarter of 2015, and will remain domiciled in New York City rather than moving to Toronto and feigning an interest in the Maple Leafs, Blue Jays, Rock, Raptors or round bacon.

What’s worth knowing?

• The media got it wrong. In 2009, Mr. George was named co-chief investment officer along with Chuck Royce. At the time Royce was clear that this was not succession planning (this was “not in preparation for Mr. Royce retiring at some point”); which is to say, Mr. George was not being named heir apparent. Outsiders knew better: “The succession plan has become clearer recently: Whitney George was promoted to co-chief investment officer in 2009, and for now he serves alongside Chuck Royce” Karen Anderson, Morningstar, 12/01/10.
• Succession is clearer now. Royce’s David Gruber allowed that the 2009 move was contingency planning, not succession planning. There now are succession plans: the firm has created a management committee to help Mr. Royce, who is 75, run the firm. While Mr. Royce has no plans on retiring, they “would rather make these decisions now than when Chuck is 85” and imagine that “Chris Clark will become CEO in the next several years.” Mr. Clark has been with Royce for over seven years, has been a manager for them and used to be a hedge fund manager. He’s now their co-CIO.
• The change will make a difference in the funds. David Nadel, an international equity specialist for them, will take over the international sleeve of Global Value. Mr. Royce assumes the lead on Premier, his 13^th Most significantly, James Stoeffel intends to reorient the Low-Priced Stock portfolio toward, well, low-priced stocks. The argument is that low-priced stocks are inefficiently priced stocks. They have limited interest to institutions for some reason, especially those priced below $10. Stocks priced below $5 cannot be purchased on margin, which further limits their market. Mr. Stoeffel intends to look more closely now at stocks priced near $10 rather than those in the upper end of the allowable range ($25). Up until the last three years, RLPSX has stayed step-for-step with Joel Tillinghast and the remarkable Fidelity Low-Priced Stock Fund (FLPSX). If they can regain that traction, it would be a powerful addition to Royce’s lagging lineup.
• Royce is making interesting decisions. Messrs. George and Royce served as co-CIOs from 2009 to the end of 2013. At that point, the firm appointed Chris Clark and Francis Gannon to the role. The argument strikes me as interesting: Royce does not want their senior portfolio managers serving as CIOs (or, for that matter, as CEO). They believe that the CIO should complement the portfolio managers, rather than just being managers. The vision is that Clark and Gannon function as the firm’s lead risk managers, trying to understand the bigger picture of threats and challenges and working with a new risk management committee to find ways around them. And the CEO should have demonstrated business management skills, rather than demonstrated investment management ones. That’s rather at odds with the prevailing “great man” ideology. And, frankly, being at odds with the prevailing ideology strikes me as fundamentally healthy.

Succession is an iffy business, especially when a firm’s founder was a titanic personality. We learned that in the barely civil transition from Jack Bogle to John Brennan and some fear that we’re seeing it as Marty Whitman becomes marginalized at Third Avenue. We’ll follow-up on the Third Avenue transition in our January issue and, for now, continue to watch Royce Funds to see if they’re able to regain their footing in the year ahead.

Top developments in fund industry litigation – November 2014

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before.

“We built Fundfox from the ground up for mutual fund insiders,” says attorney-founder David M. Smith. “Directors and advisory personnel now have easier and more affordable access to industry-specific litigation intelligence than even most law firms had before.”

The core offering is a database of case information and primary court documents for hundreds of industry cases filed in federal courts from 2005 through the present. A Premium Subscription also includes robust database searching—by fund family, subject matter, claim, and more.

Orders

• In a win for Fidelity, the U.S. Supreme Court denied a certiorari petition in an ERISA class action regarding the float income generated by transactions in plan accounts. (Tussey v. ABB Inc.)
• Extending the fund industry’s losing streak, the court denied Harbor’s motion to dismiss excessive fee litigation regarding the subadvised International Fund: “Although it is far from clear that Zehrer [the plaintiff-shareholder] will be able to meet the high standard for liability under § 36(b), he has alleged sufficient facts specific to the fees paid to Harbor Capital to survive a motion to dismiss.” (Zehrer v. Harbor Capital Advisors, Inc.)
• The court dismissed Nuveen from an ERISA class action regarding services rendered by FAF Advisors, holding that the contract for Nuveen’s purchase of FAF “unambiguously indicates that Nuveen did not assume any liability that FAF may have had” with respect to the plan at issue. (Adedipe v. U.S. Bank, N.A.)

Briefs

• Genworth filed a motion for summary judgment in the class action alleging that defendants misrepresented the role that Robert Brinker played in the management of the BJ Group Services portfolio. (Goodman v. Genworth Fin. Wealth Mgmt., Inc.)
• SEI Investments filed a motion to dismiss an amended complaint challenging advisory and transfer agent fees for five funds. (Curd v. SEI Invs. Mgmt. Corp.)
• In the ERISA class action regarding TIAA-CREF’s account closing procedures, defendants filed a motion seeking dismissal of interrelated state-law claims as preempted by ERISA. (Cummings v. TIAA-CREF.)

Amended Complaint

• Plaintiffs filed an amended complaint in a consolidated class action regarding an alleged Ponzi scheme related to “TelexFree Memberships.” Defendants include a number of investment service providers, including Waddell & Reed. (Abdelgadir v. TelexElectric, LLLP.)

Supplemental Complaint

• In the class action regarding Northern Trust’s securities lending program, a pension fund’s board of trustees filed a supplemental complaint asserting individual non-class claims. (La. Firefighters’ Ret. Sys. v. N. Trust Invs., N.A.)

The Alt Perspective: Commentary and news from DailyAlts.

Brian Haskin publishes and edits the DailyAlts site, which is devoted to the fastest-growing segment of the fund universe, liquid alternative investments. Here’s his quick take on the DailyAlts mission:

Our aim is to provide our readers (investment advisors, family offices, institutional investors, investment consultants and other industry professionals) with a centralized source for high quality news, research and other information on one of the most dynamic and fastest growing segments of the investment industry: liquid alternative investments.

Brian offers this as his take on the month just past.

NO PLACE TO HIDE

Asset flows into and out of mutual funds and ETFs provide the market with insights about investor behavior, and in this past month it was clear that investors were not happy about active management and underperformance. While the data is lagged a month (October flow data becomes available in November, for instance), asset flows out of alternative mutual funds and ETFs exceeded inflows for the first time in…. well quite a while.

As noted in the table below, alternatives suffered $2.8 billion in outflows across both active and passive strategies. This is a stark change from previous months whereby the category generated consistent positive inflows. Of the $2.8 billion in outflows however, the MainStay Marketfield Fund, a long/short equity fund, contributed $2.2 billion. Market neutral funds also suffered outflows, while managed futures, multi-alternative and commodity funds all saw reasonable inflows.

However, alternatives were not the only category hit in October. Actively managed funds were hit to the tune of $31 billion in outflows, while passive funds recorded $54 billion in inflows. Definitely a shift in investor preferences as active funds in general struggle to keep up with their passive counterparts.

NEW FUND LAUNCHES IN NOVEMBER

Year to date, we have seen 80 new alternative funds hit the market, and six of those were launched in November (this may be revised upward in the next few days; see List of New Funds for more information). Both the global macro and managed futures categories had two new entrants, while other new funds fell into the long/short equity and mutli-alternative categories. Two notable new funds are as follows:

• Neuberger Berman Global Long Short Fund – There are not many pure global long/short funds, yet a larger opportunity set creates more potential for value added. The portfolio manager is new to Neuberger Berman, but not new to global investing. With its global mandate, this fund has the potential to work well alongside a US focused long/short fund.
• Eaton Vance Global Macro Capital Opportunities Fund – This fund is also global but looks for opportunities across multiple asset classes including equity and fixed income securities. The fund carries a moderate fee relative to other multi-alternative funds, and Eaton Vance has had longer-term success with other global macro funds.

FUND REGISTRATIONS IN NOVEMBER

October was the final month to register a fund and still get it launched in 2014, and as a result, November only saw eight new alternative funds enter the registration process, all of which fall into the alternative fixed income or multi-alternative categories. Two of these that look promising are:

• Franklin Mutual Recovery Fund – If you like distressed fixed income, then keep an eye out for the launch of this fund. This fund goes beyond junk and looks for bonds and other fixed income securities of distressed or bankrupt companies.
• Collins Long/Short Credit Fund – If interest rates ever rise, long/short credit funds can help get out of the way of volatile fixed income markets. The sub-advisor of this new fund has a record of delivering fairly steady returns over past several years while beating the Barclays Aggregate Bond Index.

NOVEMBER’S TOP RESEARCH / EDUCATIONAL ARTICLES

Education is critical when it comes to newer and more complex investment approaches, and liquid alternatives fit that description. The good news is that asset managers, investment consultants and other thought leaders in the industry publish a wide range of research papers that are available to the public. At DailyAlts, we provide summaries of these papers, along with links to the full versions. The top three research related articles in November were:

• The Sharpe Ratio is Not the Best Metric for Maximizing Portfolio Efficiency
• MLP Investment Guide for Taxable and Non-Taxable Investors
• The Free Lunch Effect: The Value of Decoupling Diversification and Risk

OTHER NEWS

Probably the most interesting news during the month was the SEC’s approval of Eaton Vance’s proposal to launch Exchange Traded Managed Funds, which essentially combines the intra-day trading, brokerage account availability and lower operating costs of exchange traded funds (ETFs) with the less frequent transparency (at least quarterly disclosure of holdings) of mutual funds. Think of actively managed mutual funds in an ETF wrapper.

Why is this significant? The ETF market is growing at a much faster rate than the mutual fund market, and so far most of the flows into ETFs have been into indexed ETFs. Now the door is open for actively managed ETFs with less transparency than a typical ETF, so expect to see over the next few years a long line of active fund management companies shift gears away from mutual funds and prepping new ETMF structures on the heels of Eaton Vance’s approval from the SEC. Many active fund managers that have wanted to tap the growth of the ETF market now have a mechanism to do so, assuming they can either create their own structure without violating patents held by Eaton Vance, or license the technology directly from Eaton Vance.

Visit us at DailyAlts.com for ongoing news and information about liquid alternatives.

Dodging the tax bullet

We’re entering capital gains season, a time when funds make the distributions that will come back to bite you around April 15^th. Because funds operate as pass-through vehicles for tax purposes, investors can end up paying taxes in two annoying circumstances: when they haven’t sold a single share of a fund and when the fund is losing money. The sooner you know about a potential hit, the better you’re able to work on offsetting strategies. We’re offering two short-term resources to help you sort through.

Our colleague The Shadow, one of our discussion board’s most vigilant members, has assembled links to the announced distributions for over 160 fund families. If you want to go directly there, let your mouse hover over the Resources tab at the top of this page and the link will appear.

Beyond that, Mark Wilson has launched Cap Gains Valet to help you. In addition to being Chief Valet, Mark is chief investment officer for The Tarbox Group in Newport Beach, CA. He is, they report, “one of only four people in the nation that has both the Certified Financial Planner® and Accredited Pension Administrator (APA) designations.” Mark’s site, which is also free and public, offers a nice search engine, interpretive articles and a list of funds with the most horrifyingly large distributions. Here’s a friendly suggestion to any of you invested in the Turner Funds: go now! There’s a good chance that you’re going to say something that rhymes with “oh spit.”

We asked Mark what advice he could offer to avoid taking another hit next year. Here’s his year-end planning list for you:

Keeping More of What You Make

Between holiday shopping, decorating and goodie eating there is more than enough going on this time of year without worrying about the tax consequences from mutual fund capital gain distributions.

I have already counted over 450 funds that will distribute more than 10% of their net asset value (NAV) this year, and 50 of these are expected to distribute in excess of 20%! Mutual fund information providers, fund marketers, and most fund managers focus on total investment returns, so they do not care much about taxable distributions. Of course, total returns are very important, but it is not what you make, it is what you keep! After-tax returns are what are most important for the taxable investor.

You can keep more of what you make by considering these factors before you make your investment:

• Use funds with embedded losses or low potential capital gains exposures. Are there really quality funds that have little/no gains? Yes, and Mutual Fund Observer (MFO) is a great site to find these opportunities. The most likely situations are when an experienced manager opens his/her own shop or when one takes over a failing fund and makes it their own.
• Use funds with low turnover and with a long-term investment philosophy. Paying taxes on annual long-term capital gains is not pleasant; however, it is the short-term gains that are the real killer. Short-term gains are taxed at your ordinary income tax rates. Worse yet, short-term capital gains distributions are not offset by other types of capital losses, as these are reported on a completely different tax schedule. Fund managers who trade frequently might have attractive returns, but their returns have to be substantially higher than tax-efficient managers to offset the higher tax bite they are generating.
• Think about asset location. Putting your most tax-inefficient holdings in your tax-deferred accounts will help you avoid these issues. Funds that typically have significant taxable income, high turnover, or mostly short-term gains should be placed in your IRA, Roth IRA, etc. High yield funds, REIT funds and many alternative strategies are usually ideal funds to place in tax-deferred accounts.
• Use index funds or broad based indexed ETFs. I know MFO is not an index fund site, but it is clear that it is not easy to choose funds that beat comparable broad based, low cost index funds or ETFs. When taxes are added to the equation, the hurdle gets even higher. Using index-based holdings in taxable accounts and active fund managers in tax-deferred accounts can make for a great compromise.

I hope considering these strategies will leave you with a little more to spend on the holidays in 2015. Mark.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Polaris Global Value (PGVFX) Polaris sports one of the longer records among global stock funds, low expenses, excellent tax efficiency, dogged independence and excellent long term returns. Well, no wonder they have such a small fund!

RiverPark Structural Alpha (RSAFX) Structural Alpha starts with a simple premise: people are consistently willing to overpay in order to hedge their risks. That makes the business of selling insurance to them consistently profitable if you know what you’re doing and don’t get greedy. Justin and Jeremy have proven over the course of years that (1) they do and (2) they don’t, much to their investors’ gain. For folks disgusted with bonds and overexposed to stocks, it’s an interesting alternative.

ValueShares US Quantitative Value (QVAL) We don’t typically profile ETFs, but our colleague Charles Boccadoro has been in an extended conversation with Wesley Gray, chief architect of Alpha Architect, and he offers an extended profile with a wealth of unusual detail for this quant’s take on buying “the cheapest, highest quality value stocks.”

Conference call with Mitch Rubin, CIO and PM, RiverPark Large Growth Fund, December 17th, 7:00 Eastern

We’d be delighted if you’d join us on Wednesday, December 17^th, for a conversation with Mitch Rubin, chief investment officer for the RiverPark Funds. Over the past several years, the Observer has hosted a series of hour-long conference calls between remarkable investors and, well, you. The format’s always the same: you register to join the call. We share an 800-number with you and send you an emailed reminder on the day of the call. We divide our hour together roughly in thirds: in the first third, our guest talks with us, generally about his or her fund’s genesis and strategy. In the middle third I pose a series of questions, often those raised by readers. Here’s the cool part, in the final third you get to ask questions directly to our guest; none of this wimpy-wompy “you submit a written question in advance, which a fund rep rewords and reads blankly.” Nay nay. It’s your question, you ask it.

The stability of the Chinese economy has been on a lot of minds lately. Between the perennial risks of the unregulated shadow banking sector and speculation fueled by central bank policies to the prospect of a sudden crackdown on whatever the bureaucrats designate as “corruption,” the world’s second largest stock market – and second largest economy – has been excessively interesting.

Mr. Rubin and his fund have a fair amount of exposure to China. In the second week of December, he and his team will embark on a research trip to the region. They’ve agreed to speak with us about the trip and the positioning of his fund almost immediately after the jet lag has passed.

RiverPark’s president Morty Schaja is coordinating the call and offers this explanation from why you might want to join it.

Given the planned openings of new casinos and the expected completion of the bridge from Hong Kong to Macau, Mitch and his team believe that the current stock weakness presents an unusual opportunity for investors.

Generally speaking Mitch is excited about the opportunity for the Fund post a period of relative underperformance. This year many of the fund’s positions – relative to both the market and, more importantly, to their expected growth – are now as inexpensive as they have been in some time. The Fund is trading at a weighted average price-earnings ratio (PE) of about 13x 2016 earnings, a discount to the market as a whole. This valuation is, in Mitch’s view, especially compelling given that their holdings have demonstrated substantially faster earnings growth of 15-20% or more as compared with the 7% historical earnings growth for the market. Given these valuations and the team’s continued confidence in the long-term earnings growth of the companies, they believe the Fund is especially well positioned going into year end.

It will be an interesting opportunity to talk with Mitch about how he thinks about the vicissitudes of “relative performance” (three excellent years are being followed by one poor one) and shareholder twitchiness.

HOW CAN YOU JOIN IN?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over two hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Funds in registration

There were remarkably few funds in registration with the SEC this month, just four and a half. That reflects, in part, the fact that advisers wanted to get new funds launched by December 30^th and the funds in registration now won’t be available until February. It might also reflect a loss of confidence within the fund industry, since it’s the lowest total we’ve recorded in nine years. That said, several of the new registrations will end up being solid and useful offerings: T. Rowe Price is launching a global high income bond fund and a global unconstrained bond fund while Vanguard will offer an ultra-short bond fund for the ultra-nervous. They’re all detailed on the Funds in Registration page.

Manager changes

This month also saw a modest level of manager turnover; 53 funds reported changes, the most immediately noticeable of which was Mr. George’s departure from various Royce funds. More-intriguing changes include the appointment of former Janus manager and founding partner of Arrowpoint Minyoung Sohn to manage Meridian Equity Income (MEIFX). At about the same time, Bernard Horn and Polaris Capital were appointed to manage Pear Tree Columbia Small Cap Fund (USBNX) which I assume will become Pear Tree Polaris Small Cap Fund on January 1. Polaris already subadvises Pear Tree Polaris Foreign Value Small Cap Fund (QUSOX / QUSIX) which has earned both five stars from Morningstar and a Great Owl designation from the Observer.

We know you’re communicating in new ways …

But why don’t you communicate in simple ones? It turns out that fund firms are, with varying degrees of conviction, invading the world of cat videos. A group called Corporate Insights maintains a series of Mutual Fund Monitor reports, the most recent of which is “Fund Films Go Viral: The Diverse Strategies of Fund Firms on YouTube.” They were kind enough to share a copy and a quick reading suggests that firms have a long way to go if they intend to use sites like YouTube to reach younger prospective investors. We’ll talk with the report’s authors in December and pass along what we learn.

In the meanwhile: all fund firms have immediate access to a simple technology that could dramatically increase the number of people noticing what you’ve written and published. And you’re not using it. Why is that?

Chip, our technical director and founding partner, has been looking at the possibility of aggregating interesting content from fund advisers and making it widely available.  The technology to acquire that content is called Real Simple Syndication, or RSS for short. At base the technology simply pushes your new content out to folks who’ve already expressed an interest in it; the Observer, for example, subscribes to the New York Times RSS feed for mutual funds. When they write it there, it pops up here.

Journalists, analysts, investors and advisers could all receive your analyses automatically, without needing to remember to visit your site, in their inboxes. And yet, Chip discovered, almost no one uses the feed (or, in at least one case, made a simple coding mistake that made their feed ineffective).

If you work with or for a fund company, would you let us know why? And if you don’t know, would you ask someone in web services?  In either case, drop Chip a note to let her know what’s up. We’d be happy to foster the common good by getting more people to notice high-quality independent shops, but we’d need your help. Thanks!

Briefly noted . . .

If you ever wondered I look like, you’re in luck. The Wall Street Journal ran a nice interview with me, entitled, “Mutual Funds’ Professor Can Flunk Them.” Embarrassed that the only professional pictures of me were from my high school graduation, I duped a very talented colleague into taking a new set, one of which appears in the Journal article. Pieces of the article, though not the radiant portrait, were picked up by Ben Carlson, at A Wealth of Common Sense; Cullen Roche, at Pragmatic Capitalism; and Joshua Brown, at The Reformed Broker.

A reader has requested that we share word of Seafarer‘s upcoming conference call. Here it is:

SMALL WINS FOR INVESTORS

DuPont Capital Emerging Markets Fund (DCMEX) reopened to new investors on December 1, 2014. It sports a $1 million minimum, $348 million portfolio and record that trails 96% of its peers over the past three years. On the upside, the fund appointed two additional managers in mid-October.

Guggenheim Alpha Opportunity Fund (SAOAX) reopens to new and existing investors on January 28^th. At the same time they’ll get a new long/short strategy and management team. Okay, I’m baffled. Here’s the fund’s performance under its current strategy and managers (blue line) versus long/short benchmark (orange line):

If you’d invested $10,000 in the average long/short fund on the day the SAOAX team came on board, your account would have grown by 25%. If you’d given your money to the SAOAX team, it would have grown by 122%. That’s rarely grounds for kicking the scoundrels out. Admittedly the fund has a minuscule asset base ($11 million after 11 years) but that seems like a reason to change the marketing team, doesn’t it?

As a guy who likes redemption fees since they benefit long-term fund holders at the expense of traders, I’m never sure of whether their elimination qualifies as a “small win” or a “small loss.” In the holiday spirit, we’ll classify the elimination of those fees from four Guinness Atkinson funds (Inflation-Managed Dividend, Global Innovators, Alternative Energy, Global Energy and Alternative Energy) as “wins.” After the New Year, though, we’re back to calling them losses.

Invesco European Small Company Fund (ESMAX) has reopened to existing investors though it remains closed to new ones. It’s the best open-end fund in its space, but then it’s almost the only open-end mutual fund in its space. Its two competitors are Royce European Smaller-Companies (RESNX) and DFA Continental Small Company (DFCSX). ESMAX handily outperforms either. There are a couple ETF alternatives to it, the best being WisdomTree Europe SmallCap Dividend ETF (DFE). DFE’s a bit more volatile but a lot cheaper (58 bps versus 146), available and has posted near-identical returns over the past five years.

Loomis Sayles gives new meaning to “grandfathered-in.” While several Loomis Sayles funds (notably Small Cap Growth and Small Cap Value) remain closed to new investors, as of November 19, 2014 they became available to Natixis employees … and to their grandparents. Also grandkids. Had I mentioned mothers-in-law? The institutional share classes of a half dozen funds are available to family members without a minimum investment requirement. Yes, indeed, if your wretched son-in-law (really, none of us have any idea of what your daughter saw in that ne’er do well) works for Natixis you can at least comfort yourself with your newly gained access to first-rate investment management.

Market Vectors lowered the expense cap on Market Vectors Investment Grade Floating Rate ETF (NYSE Arca: FLTR) from 0.19% to 0.14%. As the release discusses, FLTR is an interesting option for income investors looking to decrease interest rate sensitivity in their portfolios. The fund was recently recognized by Morningstar at the end of September with a 5-star overall rating. 

CLOSINGS (and related inconveniences)

None that I could find. I’m not sure what to make of the fact that the Dow has had 29 record closes through late November, and still advisers aren’t finding cause to close any funds. It might be that stock market records aren’t translating to fund flows, or it might be that advisers are seeing flows but are loathe to close the doors.

OLD WINE, NEW BOTTLES

Effective January 28, 2015, AQR is renaming … well, pretty much everything.

Current Name	New Name
AQR Core Equity	AQR Large Cap Multi-Style
AQR Small Cap Core Equity	AQR Small Cap Multi-Style
AQR International Core Equity	AQR International Multi-Style
AQR Emerging Core Equity	AQR Emerging Multi-Style
AQR Momentum	AQR Large Cap Momentum Style
AQR Small Cap Momentum	AQR Small Cap Momentum Style
AQR International Momentum	AQR International Momentum Style
AQR Emerging Momentum	AQR Emerging Momentum Style
AQR Tax-Managed Momentum	AQR TM Large Cap Momentum Style
AQR Tax-Managed Small Cap Momentum	AQR TM Small Cap Momentum Style
AQR Tax-Managed International Momentum	AQR TM International Momentum Style
AQR U.S. Defensive Equity	AQR Large Cap Defensive Style
AQR International Defensive Equity	AQR International Defensive Style
AQR Emerging Defensive Equity	AQR Emerging Defensive Style

The ticker symbols remain the same.

Effective December 19, 2014, a handful of BMO funds add the trendy “allocation” moniker to their names:

Current Name	Revised Name
BMO Diversified Income Fund	BMO Conservative Allocation Fund
BMO Moderate Balanced Fund	BMO Moderate Allocation Fund
BMO Growth Balanced Fund	BMO Balanced Allocation Fund
BMO Aggressive Allocation Fund	BMO Growth Allocation Fund

On January 14, 2015, Cloud Capital Strategic Large Cap Fund (CCILX) is becoming Cloud Capital Strategic All Cap Fund. It will be as strategic as ever, but now will be able to ply that strategy on firms with capitalizations down to $169 million.

Effective December 30, 2014, the name of the CMG Managed High Yield Fund (CHYOX) will be changed to CMG Tactical Bond Fund. And “high yield bond” will disappear from the mandate. Additionally, effective January 28, 2015, the Fund will no longer have a non-fundamental policy of investing at least 80% of its assets in fixed income securities.

Crystal Strategy Leveraged Alternative Fund has become the Crystal Strategy Absolute Return Plus Fund (CSLFX). That change occurred less than a year after launch but that fund has attracted only $5 million, which might be linked to high expenses (2.3%), a high sales load and losing money while their multi-alternative peers were making it. It’s another instance where “change the name” doesn’t seem to be the greatest imperative.

Deutsche International Fund (SUIAX) has changed its name to Deutsche CROCI® International Fund and Deutsche Equity Dividend (KDHAX) has become Deutsche CROCI® Equity Dividend Fund. Oddly the name change does not appear to be accompanied by any explanation of what’s up with the CROCI (cash return on capital invested??) thing. CROCI was part of Deutsche Bank’s research operation until late 2013.

Effective December 8, 2014, Guinness Atkinson Asia Pacific Dividend Fund (GAADX) will be renamed Guinness Atkinson Asia Pacific Dividend Builder Fund with this strategy clarification:

The Advisor uses fundamental analysis to assess a company’s ability to maintain consistent, real (after inflation) dividend growth. The Advisor seeks to invest in companies that have returned a real cash flow return on investment of at least 8% for each of the last eight years, and, in the opinion of the Advisor, are likely to grow their dividend over time.

At the same time, Guinness Atkinson Inflation Managed Dividend Fund (GAINX) becomes Guinness Atkinson Inflation Managed Dividend Builder Fund.

RESQ Absolute Income Fund has become the RESQ Strategic Income Fund (RQIAX). It now “seeks income with an emphasis on total return and capital preservation as a secondary objective.” “Capital appreciation” is out; “total return” is in. And again, the fund has been around for less than a year so changing the name and strategy doesn’t seem like evidence of patience and planning. Oh, too, RESQ Absolute Equity Fund is now RESQ Dynamic Allocation Fund (RQEAX). It appears to be heightening the visibility of international equities in the investment plan and adding popular words to the name.

Orion/Monetta Intermediate Bond Fund is now Varsity/Monetta Intermediate Bond Fund (MIBFX). Sorry, Orion, you’ve been chopped!

Effective November 12, 2014, Virtus Mid-Cap Value Fund became Virtus Contrarian Value Fund (FMIVX). By the end of January 2015, the principle investment strategy be tweaked but in reading the old and new text side-by-side, I couldn’t quite figure out what was changing. A performance chart of the fund suggests that it’s pretty much a mid-cap value index fund with slightly elevated volatility and noticeably elevated expenses.

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Global Select Opportunities Fund (BJGQX), formerly Artio Select Opportunities, formerly Artio Global Equity, formerly Julius Baer Global Equity Fund, is disappearing. Either shareholders will approve a merger with Aberdeen Global Equity Fund or the trustees will liquidate it. Note from the Observer: vote for the merger. Global Equity has been a dramatically better fund.

AIS Tactical Asset Allocation Portfolio (TAPAX) has closed and will liquidate by December 15, 2014.

AllianceBernstein Global Value Fund (ABAGX) will liquidate and dissolve around January 16, 2015. Not to be picking on the decedent, but don’t “liquidate” and “dissolve” conjure the exact same image, sort of what happened to the witch in The Wizard of Oz?

In distinction to most such actions, the Board of Trustees of the ALPS ETF Trust ordered “an orderly liquidation” of the VelocityShares Emerging Markets DR ETF, VelocityShares Russia Select DR ETF and VelocityShares Emerging Asia DR ETF. All are now “former options.”

BMO Pyrford Global Strategic Return Fund (BPGAX) and BMO Global Natural Resources Fund (BAGNX) are both scheduled to be liquidated on December 23, 2014, perhaps part of an early Christmas present to their investors. BAGNX has, in six short months of existence, parlayed a $1,000 investment into an $820 portfolio, rather more dismal than even its average peer.

BTS Bond Asset Allocation Fund (BTSAX) will be merging into the BTS Tactical Fixed Income Fund (BTFAX) on December 12, 2014.

DSM Small-Mid Cap Growth Fund (DSMQX) will liquidate on December 2, 2014.

Eaton Vance Asian Small Companies Fund (EVASX) bites the dust on or about January 23, 2015. Despite the addition of How Teng Chiou as a co-manager in March (I’m fascinated by that name), the fund has drawn neither assets nor kudos.

Huntington Income Generation Fund (HIGAX) is another victim of poor planning, impatience and the redundant “dissolve and liquidate” fate. The fund launched in January 2014, performed miserably, for which reason the D&L is scheduled for December 19, 2014.

MassMutual Premier Focused International Fund was dissolved, liquidated and terminated, all on November 14^th. We’re not sure of the order of occurrence.

The 20 year old, $150 million Victory Special Value Fund (SSVSX) has merged into the two year old, $8 million Victory Dividend Growth Fund (VDGAX). Cynics would suggest an attempt to bury Special Value’s record of trailing 85% of its peers by merging into a tiny fund run by the same manager. We wouldn’t, of course. Only cynics would say that.

Virginia Equity Fund decided to liquidate before it launched. Here’s the official word: “the Fund’s investment adviser, recommended to the Board to approve the Plan based on the inability to raise sufficient capital necessary to commence operations. As a result, the Board of Trustees has concluded that it is in the best interest of the sole shareholder to liquidate the Fund.”

Wright Total Return Bond Fund (WTRBX) disappears at the same moment that 2014 does.

In Closing . . .

In November we picked up about 1500 new registrants for our monthly email notification. Greetings to you all and, especially, to the nice folks at Smart Chicken. Love your work! Welcome to one and all.

A number of readers deserve thanks for their support in the month just passed. And so to the amazing Madame Nadler: “thanks! We’re not going anywhere.” To the folks at Gaia Capital: cool logo, though I’m still not sure that “proactive” is a word. To Jason, Matt and Tyler: “thanks” are in the mail! (Soon, anyway.) For Jason and our other British readers, by the way, we are trying to extend the Amazon partnership to Amazon UK. Finally thanks, as always, to our two stalwart subscribers, Deb and Greg. Do let us know how we can make the beta version of the premium site better.

November also saw us pass the 30,000 “unique visitors” threshold for the first time. Thanks to you all, but dropping by and imagining possibilities smarter and better than behemoth funds and treacherous, trendy trading products.

Finally, I promise I won’t mention this again (in 2014): Frankly it would help a lot if folks who haven’t already done so would take a moment to bookmark our Amazon link. Our traffic has grown by almost 80% in the past 12 months and that extra traffic increases our operating expenses by a fair bit. At the same time our Amazon revenue for November grew by (get ready!) $1.48 from last year, a full one-third of one percent. While we’re grateful for the extra $1.48, it doesn’t quite cover the added hosting and mail expenses.

The Amazon thing is remarkably quick, painless and helpful. The short story is that Amazon will rebate to us an amount equivalent to about 6% of whatever you purchase through our Associates link. It costs you nothing, since it’s built into Amazon’s marketing budget. It adds no steps to your shopping. And it doesn’t require that you come to the Observer to use it. Just set it as a bookmark, use it as your homepage or use it as one of the opening tabs in your browser. Okay, here’s our link. Click on it then click on the star on the address bar of your browser – they all use the same symbol now to signal “make a bookmark!” If you want to Amazon as your homepage or use it as one of your opening tabs but don’t know how, just drop me a note with your browser’s name and we’ll send off a paragraph.

There are, in addition, way cool smaller retailers that we’ve come across but that you might not have heard of. The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

Some guys wear ties rarely enough that they need to keep that little “how to tie a tie” diagram taped to their bathroom mirrors. Other guys really wish that they had a job where they wore ties rarely enough that they needed to keep that little “how to tie a tie” diagram taped up.

Duluth sells clothes, and accessories, for them. I own rather a lot of it. Their stuff is remarkably well-made and, more importantly, thoughtfully made. Their clothes are designed, for example, to allow a great deal of freedom of motion; they accomplish that by adding panels where other folks just have seams. Admittedly they cost more than department store stuff. Their sweatshirts, by way of example, are $45-50 when they’re not on sale. JCPenney claims that their sweatshirts are $55 but on perma-sale for $20 or so. The difference is that Duluth’s are substantially better: thicker fabric, longer cut, with thoughtful touches like expandable/stretchy side panels.

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QuoteArts.com is a small shop that consistently offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen. Steve Metivier, who runs the site, shared one of his favorites:

The text reads “’tis not too late to seek a newer world.” The original cards are, of course, sharper and don’t have the copyright watermark. Steve writes that “we’ve found that a number of advisors and other professionals buy our cards to keep in touch with their clients throughout the year. So, we offer a volume discount of 100 or more cards. The details can be found on our specials page.”

We hope it’s a joyful holiday season for you all, and we look forward to seeing you in the New Year.

 

By David Snowball

Dear friends,

In a college with more trees than students, autumn is stunning. Around the campus pond and along wooded paths, trees begin to erupt in glorious color. At first the change is slow, more teasing than apparent. But then we always have a glorious reign of color … followed by a glorious rain of leaves. It’s more apparent then than ever why Augustana was recognized as having one of America’s 25 most beautiful campuses.

Every morning, teaching schedule permitting, I park my car near Old Main then conspire to find the longest possible route into the building. Instead of the simple one block walk east, I head west, uphill and through the residential neighborhoods or south, behind the natural sciences building and up a wooded hillside. I generally walk unencumbered by technology, purpose or companions. 

Kicking the leaves is not optional.

I listen to the crunching of acorns underfoot and to the anxious scouring of black squirrels. I look at the architecture of the houses, some well more than a century old but still sound and beautiful. I breathe, sniffing for the hint of a hardwood fire. And I left my mind wander where it wants to, too.  Why are some houses enduringly beautiful, while others are painful before they’re even complete?  How might more volatile weather reshape the landscape? Are my students even curious about anything? Would dipping their phones in epoxy make a difference? Maybe investors don’t want to know what their managers actually do? Where would we be if folks actually did spend less? Heck, most of them have already been forced to. I wonder if folks whose incomes and wealth are rapidly rising even think about the implications of stagnation for the rest of us? Why aren’t there any good donut shops anymore?  (Nuts.)

You might think of my walks as a luxury or a harmless indulgence by a middle-aged academic. You’d be wrong. Very wrong.

The world has conspired to heap so many demands upon our attention than we can barely focus long enough to button our shirts. Our attention is fragmented, our time is lost (go on, try to remember what you actually did Friday) and our thinking extends no further than the next interruption. It makes us sloppy, unhappy and unimaginative.

Have you ever thought about including those characteristics in a job description: “We’re hoping to find sloppy, unhappy and unimaginative individuals to take us to the next level!  If you have the potential to become so distracted by minutiae and incessant interruption that you can’t even remember any other way, we have the position for you.”

Go take a walk, dear friends. Go take a dozen. Take them with someone who makes you want to hold a hand rather than a tablet. The leaves beckon and you’ll be better for it. 

On the discreet charm of a stock light portfolio

All the signs point to stocks. The best time of the year to buy stocks is right after Halloween. The best time in the four year presidential cycle to be in stocks is just after the midterm elections. Bonds are poised for a bear market. Markets are steadying. Stocks are plowing ahead; the Total Stock Market Index posted gains of 9.8% through the first 10 months of 2014.

And yet, I’m not plowing into stocks. That’s not a tactical allocation decision, it’s strategic. My non-retirement portfolio, everything outside the 403(b), is always the same: 50% equity, 50% income. Equity is 50% here, 50% there, as well as 50% large and 50% small. Income tends to be the same: 50% short duration/cash-like substances, 50% riskier assets, 50% domestic, 50% international. It is, as a strategy, designed to plod steadily.

My asset allocation has some similarities to Morningstar’s “conservative retirement saver” portfolio, which they gear “toward still-working individuals who expect to retire in 2020 or thereabouts.”  Both portfolios are about 50% in equities and both have a medium term time horizon of around 7-10 years.  On whole, though, I appear to be both more aggressive and more conservative than Morningstar’s model.  I’ve got a lot more exposure to international and, particularly, emerging markets stocks (through Seafarer, Grandeur Peak and Matthews) and bonds (through Matthews and Price) than they do.  I favor managers who have the freedom to move opportunistically between asset classes (FPA Crescent is the show piece, but managers at eight of my 10 funds have more than one asset class at their disposal).  At the same time, I’ve got a lot more exposure to short-term and cash-management strategies (through Price and two fine RiverPark funds).  My funds are cheaper than average (I’m not cheap, I’m rationally cost-conscious) though pricier than Morningstar’s, which reflects their preference for large (no, I didn’t called them “bloated”) funds.

You might benefit from thinking about whether a more diversified stock-light portfolio might help you better balance your personal goals (sleeping well) with your financial ones (eating well). There’s good evidence to guide us.

T. Rowe Price is one of my favorite fund companies, in part because they treat their investors with unusual respect. Price’s publications depart from the normal marketing fluff and generally provide useful, occasionally fascinating, information.

I found two Price studies, in 2004 and again in 2010, particularly provocative. Price constructed a series of portfolios representing different levels of stock exposure and looked at how the various portfolios would have played out over the past 50-60 years.

The original study looked at portfolios with 20, 40, 60, 80 and 100% stocks. The update dropped the 20% portfolio and looked at 0, 40, 60, 80, and 100%. Price updated their research for us and allowed us to release it here.

Performance of Various Portfolio Strategies
December 31, 1949 to December 31, 2013
	S&P 500 USD	80 Stocks 20 Bonds 0 Short	60 Stocks 30 Bonds 10 Short	40 Stocks 40 Bonds 20 Short	20 Stocks 50 Bonds 30 Short
Return for Best Year	52.6	41.3	30.5	22.5	22.0
Return for Worst Year	-37.0	-28.7	-20.4	-11.5	-1.9
Average Annual Nominal Return	11.3	10.5	9.3	8.1	6.8
Number of Down Years	14	14	12	11	4
Average Loss (in Down Years)	-12.5	-8.8	-6.4	-3.0	-0.9
Annualized Standard Deviation	17.6	14.0	10.5	7.3	4.8
Average Annual Real (Inflation-Adjusted) Return	7.7	6.8	5.7	4.5	3.2

T. Rowe Price, October 30 2014. Used with permission.

Over the last 65 years, periods which included devastating bear markets for both stocks and bonds, a stock-light portfolio returned 6.8% annually. That translates to receiving about 60% of the returns of an all-equity portfolio with about 25% of the volatility. Going from 20% stocks to 100% increases the chance of having a losing year by 350%, increases the average loss in down years by 1400% and nearly quadruples volatility.

On face, that’s not a compelling case for a huge slug of equities. The findings of behavioral finance research nibbles away at the return advantage of a stock-heavy portfolio by demonstrating that, on average, we’re not capable of holding assets which are so volatile. We run at the wrong time and hide too long. Morningstar’s “Mind the Gap 2014” research suggests that equity investors lose about 166 basis points a year to their ill-timed decisions. Over the past 15 years, S&P 500 investors have lost nearly 200 basis points a year.

Here’s the argument: you might be better with slow and steady, even if that means saving a bit more or expecting a bit less. For visual learners, here’s a picture of what the result might look like:

The blue line represents the performance, since January 2000, of T. Rowe Price Spectrum Income (RPSIX) which holds 80% or so in a broadly diversified income portfolio and 20% or so in dividend-paying stocks. The orange line is Vanguard 500 Index (VFINX). I’m happy to admit that maxing-out the graph, charting the funds for 25 years rather than 14, gives a major advantage to the 500 Index. But, as we’re already noted, investors don’t act based on a 25 year horizon.

I know what you’re going to say: (1) we need stocks for the long-run and (2) the bear is about to maul the bond world. Both are true, in a limited sort of way.

First, the mantra “stocks for the long-term” doesn’t say “how much stock” nor does it argue for stocks at any particular juncture; that is, it doesn’t justify stocks now. I’m profoundly sympathetic to the absolute value investors’ argument that you’re actually being paid very poorly for the risks you’re taking. GMO’s latest asset class projections have the broad US market with negative real returns over the next seven years.

Second, a bear market in bonds doesn’t look like a bear market in stocks. A bear market in stocks looks like 25 or 35 or 45% down. Bonds, not so much. A bear market in bonds is generally triggered by rising interest rates. When rates rise, two things happen: the market value of existing low-rate bonds falls while the payouts available from newly issued bonds rises.

The folks at Legg Mason looked at 90 years of bond market returns and graphed them against changes in interest rates. The results were published in Rate-Driven Bond Bear Markets (2013) and they look like this:

The vertical axis is you, gaining or losing money. The horizontal axis measures rising or falling rates. In the 41 years in which rates have risen, the bond index fell on only nine occasions (the lower right quandrant). In 34 other years, rising rates were accompanied by positive returns, fed by the income payouts of the newly-issued bonds. And even when bonds fall, they typically lose 2-3%. Only 1994 registered a hefty 9% loss.

Price’s research makes things even a bit more positive. They argue that simply using a monolithic measure (intermediate Treasuries, the BarCap aggregate or whatever) underestimates the potential of diversifying within fixed income. Their most recent work suggests that a globally diversified portfolio, even without resort to intricate derivative strategies or illiquid investments, might boost the annual returns of a 60/40 portfolio. A diversified 60/40 portfolio, they find, would have beaten a vanilla one by 130 basis points or so this century. (See “Diversification’s Long-Term Benefits,” 2013.)

This is not an argument against owning stocks or stock funds. Goodness, some of my best friends (the poor dears) own them or manage them. The argument is simpler: fix the roof when it’s not raining. Think now about what’s in your long-term best interest rather than waiting for a sickened panic to make the decision for you. One of the peculiar signs of my portfolio’s success is this: I have no earthly idea of how it’s doing this year.  While I do read my managers’ letters eagerly and even talk with them on occasion, I neither know nor care about the performance over the course of a few months of a portfolio designed to serve me over the course of many years. 

And as you think about your portfolio’s shape for the year ahead or reflect on Charles’ and Ed’s essays below, you might find the Price data useful. The original 2004 and 2010 studies are available at the T. Rowe Price website.

Mediocrity and frustration

I’ve been fully invested in the market for the past 14 years with little to show for it, except frustration and proclamations of even more frustration ahead. During this time, basically since start of 21st century, my portfolio has returned only 3.9% per year, substantially below historical return of the last century, which includes among many other things The Great Depression.

I’ve suffered two monster drawdowns, each halving my balance. I’ve spent 65 months looking at monthly statements showing retractions of at least 20%. And, each time I seem to climb-out, I’m greeted with headlines telling me the next big drop is just around the corner (e.g., “How to Prepare for the Coming Bear Market,” and “Are You Prepared for a Stock Selloff ?“)

I have one Nobel Prize winner telling me the market is still overpriced, seeming every chance he gets. And another telling me that there is nothing I can do about it…that no amount of research will help me improve my portfolio’s performance.

Welcome to US stock market investing in the new century…in the new millennium.

The chart below depicts S&P 500 total return, which includes reinvested dividends, since December 1968, basically during the past 46 years. It uses month-ending returns, so intra-day and intra-month fluctuations are not reflected, as was done in a similar chart presented in Ten Market Cycles. The less frequent perspective discounts, for example, bear sightings from bear markets.

The period holds five market cycles, the last still in progress, each cycle comprising a bear and bull market, defined as a 20% move opposite preceding peak or trough, respectively. The last two cycles account for the mediocre annualized returns of 3.9%, across 14-years, or more precisely 169 months through September 2014.

Journalist hyperbole about how “share prices have almost tripled since the March 2009 low” refers to the performance of the current bull market, which indeed accounts for a great 21.9% annualized return over the past 67 months. Somehow this performance gets decoupled from the preceding -51% return of the financial crisis bear. Cycle 4 holds a similar story, only investors had to suffer 40 months of protracted 20% declines during the tech bubble bear before finally eking out a 2% annualized return across its 7-year full cycle.

Despite advances reflected in the current bull run, 14-year annualized returns (plotted against the secondary axis on the chart above) are among the lowest they been for the S&P 500 since September 1944, when returns reflected impacts of The Great Depression and World War II.

Makes you wonder why anybody invests in the stock market.

I suspect all one needs to do is see the significant potential for upside, as witnessed in Cycles 2-3. Our current bull pales in comparison to the truly remarkable advances of the two bull runs of 1970-80s and 1990s. An investment of $10,000 in October 1974, the trough of 1973-74, resulted in a balance of $610,017 by August 2000 – a 6000% return, or 17.2% for nearly 26 years, which includes the brief bear of 1987 and its coincident Black Monday.

Here’s a summary of results presented in the above graph, showing the dramatic differences between the two great bull markets at the end of the last century with the first two of the new century, so far:

But how many funds were around to take advantage 40 years ago? Answer: Not many. Here’s a count of today’s funds that also existed at the start of the last five bull markets:

Makes you wonder whether the current mediocrity is simply due to too many people and perhaps too much money chasing too few good ideas?

The long-term annualized absolute return for the S&P 500 is 10%, dating back to January 1926 through September 2014, about 89 years (using database derived from Goyal and Shiller websites). But the position held currently by many value oriented investors, money-managers, and CAPE Crusaders is that we will have to suffer mediocre returns for the foreseeable future…at some level to make-up for excessive valuations at the end of the last century. Paying it seems for sins of our fathers.

Of course, high valuation isn’t the only concern expressed about the US stock market. Others believe that the economy will face significant headwinds, making it hard to repeat higher market returns of years past. Rob Arnott describes the “3-D Hurricane Force Headwind” caused by waves of Deficit spending, which artificially props-up GDP, higher than published Debt, and aging Demographics.

Expectations for US stocks for the next ten years is very low, as depicted in the new risk and return tool on Research Affiliates’ website (thanks to Meb Faber for heads-up here). Forecast for large US equities? Just 0.7% total return per year. And small caps? Zero.

Good grief.

What about bonds?

Plotted also on the first chart presented above is 10-year average T-Bill interest rate. While it has trended down since the early 1980’s, if there is a correlation between it and stock performance, it is not obvious. What is obvious is that since interest rates peaked in 1981, US aggregate bonds have been hands-down superior to US stocks for healthy, stable, risk-adjusted returns, as summarized below:

Sure, stocks still triumphed on absolute return, but who would not take 8.7% annually with such low volatility? Based on comparisons of absolute return and Ulcer Index, bonds returned more than 70% of the gain with just 10% of the pain.

With underlining factors like 33 years of declining interest rates, it is no wonder that bond funds proliferated during this period and perhaps why some conservative allocation funds, like the MFO Great Owl and Morningstar Gold Metal Vanguard Wellesley Income Fund (VWINX), performed so well. But will they be as attractive the next 33 years, or when interest rates rise?

As Morningstar’s Kevin McDevitt points out in his assessment of VWINX, “the fund lagged its average peer…from July 1, 1970, through July 1, 1980, a period of generally rising interest rates.” That said, it still captured 85% of the S&P500 return over that period and 76% during the Cycle 2 bull market from October 1974 through August 1987.

Of course, predicting interest rates will rise and interest rates actually rising are two different animals, as evidenced in bond returns YTD. In fact, our colleague Ed Studzinski recently pointed out the long term bonds have done exceptionally well this year (e.g., Vanguard Extended Duration Treasury ETF up 26.3% through September). Who would have figured?

I’m reminded of the pop quiz Greg Ip presents in his opening chapter of “Little Book of Economics”: The year is 1990. Which of the following countries has the brighter future…Japan or US? In 1990, many economists and investors picked Japan. Accurately predicting macroeconomics it seems is very hard to do. Some say it is simply not possible.

Similarly, the difficulty mutual funds have to consistently achieve top-quintile performance, either across fixed time periods or market cycles, or using absolute or risk-adjusted measures, is well documented (e.g., The Persistence Scorecard – June 2014, Persistence is a Killer, In Search of Persistence, and Ten Market Cycles). It does not happen. Due to the many underlying technical and psychological variables of the market place, if not the shear randomness of events.

In his great book “The Most Important Thing,” Howard Marks describes the skillful defensive investor as someone who does not lose much when the market goes down, but gains a fair amount when the market goes up. But this too appears very hard to do consistently.

Vanguard’s Convertible Securities Fund (VCVSX), sub-advised by OakTree Capital Management, appears to exhibit this quality to some degree, typically capturing 70-100% of upside with 70-80% of downside across the last three market cycles.

Since bull markets tend to last much longer than bear markets and produce returns well above the average, capturing a “fair amount” does not need to be that high. Examining funds that have been around for at least 1.5 cycles (since October 2002, oldest share class only), the following delivered 50% or more total return during bull markets, while limiting drawdowns to 50% during bear markets, each relative to S&P 500. Given the 3500 funds evaluated, the final list is pretty short.

VWINX is the oldest, along with Lord Abbett Bond-Debenture Fund (LBNDX) . Both achieved this result across the last four full cycles. As a check against performance missing the 50% threshold during out-of-cycle or partial-cycle periods, all funds on this list achieved the same result over their lifetimes.

For moderately conservative investors, these funds have not been mediocre or frustrating at all, quite the contrary. For those with an appetite for higher returns and possess the attendant temperament and investing horizon, here is a link to similar funds with higher thresholds: MFO Pain-To-Gain Funds.

We can only hope to have it so good going forward.

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I fear that Charles and I may have driven poor Ed over the edge.  After decades of outstanding work as an investment professional, this month he’s been driven to ask …

Investing – Why?

By Edward Studzinski

“The most costly of all follies is to believe passionately in the palpably not true.  It is the chief occupation of mankind.”

          H.L. Mencken

I will apologize in advance, for this may end up sounding like the anti-mutual fund essay. Why do people invest, and specifically, why do they invest in mutual funds?  The short answer is to make money. The longer answer is hopefully more complex and covers a multitude of rationales. Some invest for retirement to maintain a standard of living when one is no longer working full-time, expecting to achieve returns through diversified portfolios and professional management above and beyond what they could achieve by investing on their own. Others invest to meet a specific goal along the path of life – purchase a home, pay for college for the children, be able to retire early. Rarely does one hear that the goal of mutual fund investing is to become wealthy. In fact, I can’t think of any time I have ever had anyone tell me they were investing in mutual funds to become rich. Indeed if you want to become wealthy, your goal should be to manage a mutual fund rather than invest in one. 

How has most of the great wealth been created in this country? It has been created by people who started and built businesses, and poured themselves (and their assets) into a single-minded effort to make those businesses succeed, in many instances beyond anyone’s wildest expectations. And at some point, the wealth created became solidified as it were by either selling the business (as the great philanthropist Irving Harris did with his firm, Toni Home Permanents) or taking it public (think Bill Gates or Jeff Bezos with Microsoft and Amazon). And if one goes further back in time, the example of John D. Rockefeller with the various Standard Oil companies would loom large (and now of course, we have reunited two of those companies, Standard Oil Company of New Jersey aka Exxon and Standard Oil Company of New York aka Mobil as Exxon-Mobil, but I digress).

So, this begs the question, can one become wealthy by investing in a professionally-managed portfolio of securities, aka a mutual fund? The answer is – it depends. If one wants above-average returns and wealth creation, one usually has to concentrate one’s investments. In the mutual fund world you do this by investing in a concentrated or non-diversified fund. The conflict comes when the non-diversified fund grows beyond a certain size of assets under management and number of investments.  It then morphs from an opportunistic investment pool into a large or mega cap investment pool. The other problem arises with the unlimited duration of a mutual fund. Daily fund pricing and daily fund flows and redemptions do have a cost. For those looking for a real life example (I suspect I know the answer but I will defer to Charles to provide the numbers in next month’s MFO), contrast the performance over time of the closed-end fund, Source Capital (SOR) run by one of the best value investment firms, First Pacific Advisors with the performance over time of the mutual funds run by the same firm, some with the same portfolio managers and strategy. 

The point of this is that having a fixed capital structure lessens the number of issues with which an investment manager has to deal (focus on the investment, not what to do with new money or what to sell to meet redemptions). If you want a different real life example, take a look at the long-term performance of one of the best investment managers to come out of Harris Associates, whom most of you have never heard of, Peter B. Foreman, and his partnership Hesperus Partners, Ltd.

Now the point of this is not to say that you cannot make money by investing in a mutual fund or a pool of mutual funds. Rather, as you introduce more variables such as asset in-flows, out-flows, pools of analysts dedicated to an entire fund group rather than one investment product, and compensation incentives or disincentives, it becomes harder to generate consistent outperformance. And if you are an individual investor who keeps increasing the number of mutual funds that he or she has invested in (think Noah and the Ark School of Personal Investment), it becomes even more difficult

A few weeks ago it struck me that in the early 1980’s, when I figured out that I was a part of the sub-species of investor called value investor (not “value-oriented investor” which is a term invented by securities lawyers for securities lawyers), I made my first investment in Berkshire Hathaway, Warren Buffett’s company. That was a relatively easy decision to make back then. I recently asked my friend Greg Jackson if he could think of a handful of investments, stocks like Berkshire (which has in effect been a closed-end investment portfolio) that today one could invest in that were one-decision investments. Both of us are still thinking about the answer to that question. 

Has something changed in the world in investing in the last fifteen or twenty years? Yes, it is a different world, in terms of information flows, in terms of types of investments, in terms of derivatives, in terms of a variety of things. What it also is is a different world in terms of time horizons and patience.  There is a tremendous amount of slippage that can eat into investment returns today in terms of trading costs and taxes (even at capital gains rates). And as a professional investment manager you have lots of white noise to deal with – consultants, peer pressure both internal and external, and the overwhelming flow of information that streams by every second on the internet. Even sitting in Omaha, the net of modern communications still drops over everything. 

So, how does one improve the odds of superior long-term performance? One has to be prepared to step back and stand apart. And that is increasingly a difficult proposition. But the hardest thing to do as an investment manager, or in dealing with one’s own personal portfolio, is to sometimes just do nothing. And yes, Pascal the French philosopher was right when he said that most of men’s follies come from not being able to sit quietly in one room. Even more does that lesson apply to one’s investment portfolio. More in this vein at some future date, but those are the things that I am musing about now.

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“ … if you want to become wealthy, your goal should be to manage a mutual fund rather than invest in one.”  It’s actually fairer to say, “manage a large firm’s mutual fund” since many of the managers of smaller, independent funds are actually paying for the privilege of investing your money: their personal wealth underwrites some of the fund’s operations while they wait for performance to draw enough assets to cross the financial sustainability threshold.  One remarkably successful manager of a small fund joked that “you and I are both running non-profits.  The difference is that I hadn’t intended to.”

In the Courts: Top Developments in Fund Industry Litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before.

“We built Fundfox from the ground up for mutual fund insiders,” says attorney-founder David M. Smith. “Directors and advisory personnel now have easier and more affordable access to industry-specific litigation intelligence than even most law firms had before.”

The core offering is a database of case information and primary court documents for hundreds of industry cases filed in federal courts from 2005 through the present. A Premium Subscription also includes robust database searching—by fund family, subject matter, claim, and more.

Settlement

• Fidelity settled a six-year old whistleblower case that had been green-lighted by the U.S. Supreme Court earlier this year. (Zang v. Fid. Mgmt. & Research Co.)

Briefs

• American Century defendants filed their opening appellate brief (under seal) in a derivate action regarding the Ultra Fund’s investments in gambling-related securities. Defendants include independent directors. (Seidl v. Am. Century Cos.)
• Fidelity filed a motion to dismiss a consolidated ERISA class action that challenges Fidelity’s practices with respect to “redemption float” (i.e., the cash held to pay checks sent to 401(k) plan participants who have withdrawn funds from their 401(k) accounts). (In re Fid. ERISA Float Litig.)
• First Eagle filed a reply brief in support of its motion to dismiss fee litigation regarding two international equity funds: “Plaintiffs have not identified a single case in which a court allowed a § 36(b) claim to proceed based solely on a comparison of the adviser’s fee to a single, unknown fee that the adviser receives for providing sub-advisory services to another client.” (Lynn M. Kennis Trust v. First Eagle Inv. Mgmt., LLC.)

Amended Complaints

• Plaintiffs filed an amended complaint in the excessive-fee litigation regarding five SEI funds, adding a new claim regarding the level of transfer agent fees. (Curd v. SEI Invs. Mgmt. Corp.)
• ERISA class-action plaintiffs filed an amended complaint alleging that TIAA-CREF failed to honor customer requests to pay out funds in a timely fashion. (Cummings v. TIAA-CREF.)

Answer

Having lost its motion to dismiss, Principal filed an answer in excessive-fee litigation regarding six of its LifeTime Funds. (Am. Chems. & Equip., Inc. 401(k) Ret. Plan v. Principal.

For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

The Alt Perspective:  Commentary and News from DailyAlts.

PREPARE FOR VOLATILITY

The markets delivered investors both tricks and treats in October. Underlying the modestly positive top-line U.S. equity and bond market returns for the month was a 64% rise, and subsequent decline, in the CBOE Volatility Index, otherwise known as VIX. This dramatic rise in the VIX coincided with a sharp, mid-month decline in equity markets. But with Halloween looming, the market goblins wanted to deliver some treats, and in fact did so as they pushed the VIX down to end the month 12.3% lower than it started. In turn, the equity markets rallied to close the month at all-time highs on Halloween day.

But as volatility creeps back into the markets, opportunities arise. Investment strategies that rely on different segments of the market behaving differently, such as managed futures and global macro, can thrive as global central bank policies diverge. And indeed they have. The top three managed futures funds have returned an average of 14.7% year-to-date through Oct. 31, according to data from Morningstar.

Other strategies that rely heavily on greater dispersion of returns, such as equity market neutral strategies, are also doing well this year. Whereas managed futures and global macro strategies take advantage of diverging prices at a macro level (U.S equities vs. Japanese equities, or Australian dollar vs. the Euro), market neutral funds take advantage of differences in individual stock price performance. And many of these funds have done just that this year. Through October 31, the three best performing equity market neutral funds have an average return of 11.9% year-to-date, according to data from Morningstar.

All three of these strategies generate returns by investing both long and short, generally in equal amounts, and maintain low levels of net exposure to individual markets. As a result, they can be used to effectively diversify portfolios away from stocks and bonds. And as volatility picks up, these funds have a greater opportunity to add value.  

NEW FUND LAUNCHES IN OCTOBER

As of this writing, seven new alternative funds have been launched in October, and like last month when four new funds launched on the last day of the month, we expect to add a few more to the October count. Five of the new funds are packaged as mutual funds, and two are ETFs, while five are multi-strategy funds, one is long/short, one is managed futures and one is market neutral. Two notable launches that dovetail on the discussion above are as follows:

• ProShares Managed Futures Strategy Fund (FUTS) – This is a low cost, systematic managed futures fund that invests across multiple asset classes.
• AQR Equity Market Neutral Fund (QMNIX) – This is a pure equity market neutral fund that will target a beta of 0 relative to the US equity markets.

NEW FUNDS REGISTERED IN OCTOBER

October saw 13 new alternative funds register with the S.E.C. covering a wide swath of strategies including multi-strategy, long/short equity, arbitrage, global macro and managed futures. Two notable funds are:

• Balter Discretionary Global Macro Fund – This is the second mutual fund from Balter Liquid Alternatives and will provide investors with exposure to Willowbridge Associates, a discretionary global macro manager that was formed in 1988.
• PIMCO Multi-Strategy Alternative Fund – This fund will be sub-advised by Research Affiliates and will invest in a range of alternative mutual funds and ETFs managed and offered by PIMCO.

OTHER NOTABLE NEWS

• The SEC rejected two proposals for non-transparent ETFs (exchange traded funds that don’t have to disclose their holdings on a daily basis). This is a setback for this new product structure that may ultimately bring more alternative strategies to the ETF marketplace.
• Education continues to be a hot topic among advisors and other investors looking to use alternative mutual funds and ETFs. The two most viewed articles on DailyAlts in October had to do with investor education and related research articles: AllianceBernstein Provides Thought Leadership on Liquid Alts and Neuberger Berman Calls Alts ‘The New Traditionals’.
• The S.E.C. continues to examine liquid alternative funds, and potentially has an issue with some fund disclosures. Norm Champ, the S.E.C. director leading the investigations, spoke recently at an industry event and noted that there appears to be some discrepancies between what funds are permitted to do per their prospectuses, and what is actually being done in the funds. Interestingly, he noted that prospectuses sometimes disclose more strategies than are actually being used in the funds.

Have a joyful Thanksgiving, and feel free to stop by DailyAlts.com for more updates on the liquid alternatives market.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

FPA Paramount (FPRAX): Paramount has just completed Year One under its new global, absolute value discipline.  If it weren’t for those danged emerging markets (non) consumers and anti-corruption drives, the short term results would likely have been as bright as the long-term promise.

Launch Alert: US Quantitative Value (QVAL)

My colleague Charles Boccadoro has been in conversation with Wesley Gray and the folks at Alpha Architect.  While ETFs are not our traditional interest, the rise of actively managed ETFs and the recently thwarted prospect for non-transparent, actively managed ETFs, substantially blurs the line between them and open-end mutual funds.  When we encounter particularly intriguing active ETF options, we’re predisposed to share them with you. Based on the investing approach detailed in his highly praised 2013 book Quantitative Value, this fund qualifies. Wesley Gray launched the U.S. Quantitative Value ETF (QVAL) on 22 October 2014.

Dr. Gray gave an excellent talk at the recent Morningstar conference with a somewhat self-effacing title borrowed from Warren Buffet: Beware of Geeks Bearing Formulas. His background includes serving as a US Marine Corps intelligence officer and completing both an MBA and a PhD from the University of Chicago’s Booth School of Business. He appears well prepared to understand and ultimately exploit financial opportunities created by behavioral biases and inefficiencies in the market.

The fund employs a Benjamin Graham value philosophy, which Dr. Gray has been studying since his 12th birthday, when his late grandmother gave him a copy of The Intelligent Investor. In quant-fashion, the fund attempts to implement the value strategy in systematic fashion to help protect against behavioral errors. Behaviors, for example, that led to the worst investor returns for the past decade’s best performing fund – CGM Focus Fund (2000-09). “We are each our own worst enemy,” Dr. Gray writes.

The fund uses academically-based and empirically-validated approaches to identify quality and price. In this way, Dr. Gray has actually challenged a similar strategy, called “The Magic Formula,” made popular by Joel Greenblatt’s book The Little Book That Beats the Market. The issue appears to be that The Magic Formula systematically forces investors to pay too high for quality. Dr. Gray argues that price is actually a bigger determinant of ultimate return than quality.

QVAL currently holds 40 stocks so we classify it as a concentrated portfolio, though not technically non-diversified. Its expense ratio is 0.79%, substantially less than the former Formula Investing funds (now replaced by even more expensive Gotham funds). The fund has quickly collected $8M in AUM. An international version (IVAL) is pending. We plan to do an in-depth profile of QVAL soon.

Alpha Shares maintains separate sites for its Alpha Shares advisory business and its Value Shares active ETFs.  Folks trying to understand the evidence behind the strategy would be well-advised to start with the QVAL factsheet, which provides the five cent tour of the strategy, then look at the research in-depth on the “Our Ideas” tab on the advisor’s homepage

Funds in Registration

The intrepid David Welsch, spelunker in the SEC database, tracked down 23 new no-load, retail funds in registration this month. In general, these funds will be available for purchase at the very end of December.  Advisors really want to have a fund live by December 30^th or reporting services won’t credit it with “year to date” results for all of 2015. A number of the prospectuses are incredibly incomplete (not listing, for example, a fund manager, minimums, expenses or strategies) which suggests that they’re panicked about having something on file.

Highlights among the registrants:

• Arbitrage Tactical Equity Fund will inexplicably do complicated things in pursuit of capital appreciation. Given that all of the Arbitrage funds could be described in the same way, and all of them are in the solid-to-excellent range, that’s apparently not a bad thing. 
• Greenhouse MicroCap Discovery Fund will pursue long-term capital appreciation by investing in 50-100 microcaps “run by disciplined management teams possessing clear strategies for growth that … trade at a discount to intrinsic value.” The fund intrigues me because Joseph Milano is one of its two managers. Milano managed T. Rowe Price New America Growth Fund (PRWAX) quite successfully from 2002-2013. PRWAX is a large growth fund but a manager’s disciplines often seem transferable across size ranges.
• Intrepid International Fund will seek long-term capital appreciation by investing in foreign stocks but it is, by prospectus, bound to invest only 40% of its portfolio overseas. Curious. The Intrepid funds are all built around absolute value disciplines: if the case for risky assets isn’t compelling, they won’t buy them.  That’s led to some pretty strong records across full market cycles, and pretty disappointing ones if you look only at little slices of time.  One of the managers of Intrepid Income was handle the reins here.

Manager Changes

This month saw 67 manager changes including the departures of several high profile professionals, including Abhay Deshpande of the First Eagle Funds.

Updates

PIMCO has been punted from management of Forward Investment Grade Fixed-Income Fund (AITIX) and Principal Global Multi-Strategy Fund (PMSAX). I’m afraid that the folks at the erstwhile “happiest place on earth” must be a bit shell-shocked. Since Mr. Gross stomped off, they’ve lost contracts – involving either the Total Return Fund or all of their services – with the state retirement systems in New Hampshire and Florida, the teachers’ retirement system in Arkansas, Ford Motor’s 401(k), Advanced Series Trust, Massachusetts Mutual Life Insurance Co., Alabama’s and California’s 529 College Savings accounts, Russell Investments, British wealth manager St. James Place, Schwab’s Target Date funds and a slug of city retirement plans. Consultant DiMeo Schneider & Associates, whose clients have about a billion in PIMCO Total Return, has issued “a universal sell recommendation” on PIMCO and Schwab reportedly is saying something comparable to its private clients.

Three short reactions:

The folks firing PIMCO are irresponsible.  The time to dump PIMCO would have been during the period that Gross was publicly unraveling. Leaving after you replace the erratic titan with a solid, professional team suggests either they weren’t being diligent or they’re grabbing for headlines or both.

PIMCO crisis management appears inept. “We are PIMCO (dot com)!” Really? I don’t tweet but enormous numbers of folks do and PIMCO’s Twitter feed is lame. One measure of impact is retweeting and only three of the past 20 tweets have been retweeted 10 or more times. There appears to be no coherent focus or intensity, just clutter and business-as-usual as the wobble gets worse.

Financial writers should be ashamed. In the months leading up to Gross’s departure, I found just three or four people willing to state the obvious. Now many stories, if not virtually every story, about PIMCO being sacked pontificates about the corrosive effect of months of increasingly erratic behavior. Where we these folks when their readers needed them? Oh right, hiding behind “the need to maintain access.”

By the way, the actual Pontiff seems to be doing a remarkably good job of pontificating. He seems an interesting guy. It will be curious to see whether his efforts are more than just a passing ripple on a pond, since the Vatican specializes in enduring, absorbing then forgetting reformist popes.

Grandeur Peak Global Opportunities (GPGOX) and Grandeur Peak International Opportunities (GPIOX) have now changed their designation from “non-diversified” to “diversified” portfolios. Given that they hold more than 200 stocks each, that seems justified.

Briefly Noted . . .

Kent Gasaway has resigned as president of the Buffalo Funds, though he’ll continue to co-manage Buffalo Small Cap Fund (BUFSX) and the Buffalo Mid Cap Fund (BUFMX).

At about the same time, Abhay Deshpande has resigned as manager of the First Eagle Global (SGENX), Overseas (SGOVX) and US Value (FEVAX) funds. It’s curious that his departure, described as “amicable,” has drawn essentially no notice given his distinguished record and former partnership with Jean-Marie Eveillard.

Chou America makes it definite. According to their most recent SEC filing, the unexplained changes that might happen on December 6 now definitely will happen on December 6:

Robeco Boston Partners Long/Short Research Fund (BPRRX) is closed to new investors, which is neither news (it happened in spring) nor striking (Robeco has a long record of shuttering funds). What is striking is their willingness to announce the trigger that will lead them to reopen the fund:

Robeco reserves the right to reopen the Fund to new investments from time to time at its discretion, should the assets of the Fund decline by more than 5% from the date of the last closing of the Fund. In addition, if Robeco reopens the Fund, Robeco has discretion to close the Fund thereafter should the assets of the Fund increase by more than 5% from the date of the last reopening of the Fund.

Portfolio 21 Global Equity Fund (PORTX) “is excited to announce” that it’s likely to be merge with Trillium Asset Management and that its president, John Streur, has resigned.

Wasatch Funds announced the election of Kristin Fletcher to their board of trustees. I love it when funds have small, highly qualified boards. Ms. Fletcher surely qualifies, with over 35 years in the industry including a stint as the Chairman and CEO of ABN AMRO, and time at First Interstate Bank, Standard Chartered Bank, Export-Import Bank of the U.S., and Wells Fargo Bank.

SMALL WINS FOR INVESTORS

Aristotle International Equity (ARSFX) and Aristotle/Saul Global Opportunities Fund (ARSOX) have reduced their initial purchase minimum from $25,000 to $2,500 and their subsequent investment minimum to $100. Both funds have been cellar-dwellers over their short lives; presumably rich folks have enough wretched opportunities in hedge funds and so weren’t drawn here.

Effective November 1, Forward trimmed five basis points of the management fee for the various classes of Forward Emerging Markets Fund (PGERX). The fund is tiny, mediocre and running at a loss of .68%, so this is a marketing move rather than an adjustment to the economies of scale.

The trustees for O’Shaughnessy Enhanced Dividend (OFDAX/OFDCX) and O’Shaughnessy Small/Mid Cap Growth Fund (OFMAX) voted to eliminate the fund’s “A” and “C” share classes and transitioning those investors into the lower-cost Institutional share class. Neither makes a compelling case for itself.

On October 9, 2014, the Board of Trustees of Philadelphia Investment Partners New Generation Fund (PIPGX) voted to remove the fund’s sales charge. The fund has earned just under 5% per year for the past three years, handily trailing its long-short peer group.

Break out the bubbly! PSP Multi-Manager Fund (CEFFX/CEFIX) has slashed its expenses – exclusive of a long list of exceptions – from 3.0% to 2.64%. The fund inherits its predecessor Congressional Effect Fund’s dismal record, so don’t hold bad long-term returns against the current team. They’ve only been on-board since late August 2014. If you’d like, you’re more than welcome to hold a 2.64% e.r. against them instead.

Hartford Total Return Bond Fund (HABDX) has dropped its management fee by 12 basis points. I’m not certain that the reduction is related to the departure of the $200 Million Man, manager Bill Gross, but the timing is striking.

As of October 1, 2014, the investment advisory fee paid to Charles Schwab for the Laudus Mondrian International Equity Fund (LIEQX) was dropped by 10 basis points to 0.75%.

Each of the Litman Gregory Masters Fund’s Investor Class shares is eliminating its redemption fee.

PIMCO Emerging Markets Bond Fund (PAEMX) has dropped its management charge by 5 basis points to 50 basis points.

Similarly, RBC Global Asset Management will see its fees reduced by 10 basis points for the RBC BlueBay Emerging Market Corporate Bond Fund (RECAX) and by 5 basis points for the RBC BlueBay Emerging Market Select Bond Fund (RESAX), RBC BlueBay Global High Yield Bond Fund (RHYAX) and RBC BlueBay Global Convertible Bond Fund.

CLOSINGS (and related inconveniences)

The American Beacon International Equity Index Fund (AIIIX) will close to new investors on December 31, 2014. Uhhh … why? It’s an index fund tracking the largest international index.

Effective December 1, 2014, American Century One Choice 2015 Portfolio (ARFAX) will be closed to new investors. One presumes that the fund is in the process of liquidating as it reaches its target date, which its assets transferring to a retirement income fund.

OLD WINE, NEW BOTTLES

Just before Christmas, the AllianzGI Wellness Fund (RAGHX) will change its name to the AllianzGI Health Sciences Fund and it will begin investing in, well, health sciences-related companies. Currently it also invests in “wellness companies,” those promoting a healthy lifestyle. Not to dismiss the change, but pretty much all of the top 25 holdings are health-sciences companies already and Morningstar places 98% of its holdings in the healthcare field.

Effective January 15, 2015, Calvert High Yield Bond Fund (CYBAX) will shift its principal investment strategy from investing in bonds with intermediate durations to those “with varying durations,” with the note that “duration and maturity will be managed tactically.” At the same time Calvert Global Alternative Energy Fund (CGAEX) will be renamed Calvert Global Energy Solutions Fund, presumably because “alternative energy” is “so Obama.” I’ll note in passing that I really like the clarity of Calvert’s filings; they make it ridiculously easy to understand exactly what they do now and what they’ll be doing in the future. Thanks for that.

Effective December 30, 2014, CMG Managed High Yield Fund (CHYOX) will be renamed CMG Tactical Bond Fund. It appears as if the fund’s adviser decided to change its name and principal strategy within two weeks of its initial launch. They had filed to launch this fund in April 2013, appeared to have delayed for nearly 20 months, launched it and then immediately questioned the decision. Why am I not finding this reassuring?

Equinox EquityHedge U.S. Strategy Fund is chucking its “let’s hire lots of star sub-advisers” strategy in favor of investing in derivatives and ETFs on their own. Following the change, the investment advisory fee drops from 1.95% to 0.95% but “the Board also approved a decrease in the fee waiver and expense reimbursement arrangements with the Adviser to correspond with the decreased advisory fee.” The new system caps “A” share expenses at 1.45% except for a long list of uncapped items which might push the total substantially higher.

First Pacific Low Volatility Fund (LOVIX) has been renamed Lee Financial Tactical Fund. Headquartered in Honolulu. I feel a field trip coming on.

On October 1, Forward announced plans to reposition Forward Global Dividend Fund (FFLRX) as Forward Foreign Equity Fund on December 1. The new investment strategy statement is unremarkable, except for the absence of the word “dividend” anywhere in it. Two weeks later Forward filed an indefinite suspension of the change, so FFLRX lives on but conceivably on borrowed time.

Goldman Sachs Municipal Income Fund becomes Goldman Sachs Strategic Municipal Income Fund in December. The strategy in question involves permitting investments in high yield munis and in a 2-8 year duration band.

Effective December 17, Janus’s INTECH subsidiary will be “applying a managed volatility approach” to four of INTECH’s funds, at which point their names will change:

Current Name	New Name
INTECH Global Dividend Fund	INTECH Global Income Managed Volatility Fund
INTECH International Fund	INTECH International Managed Volatility Fund
INTECH U.S. Growth Fund	INTECH U.S. Managed Volatility Fund II
INTECH U.S. Value Fund	INTECH U.S. Managed Volatility Fund

 

Laudus Mondrian Institutional Emerging Markets (LIEMX) and Laudus Mondrian Institutional International Equity (LIIEX) funds are pursuing one of those changes that make sense primarily to the fund’s accountants and lawyers. Instead of being the Institutional EM Fund, it will become the Institutional share class Laudus Mondrian Emerging Markets (LEMIX). Likewise with International Equity.

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Global Select Opportunities Fund (BJGQX) is going to merge into the Aberdeen Global Equity Fund (GLLAX) following what the adviser refers to as “the completion of certain conditions” a/k/a approval by shareholders. Neither fund is particularly good and they have overlapping management teams, but Select is microscopic and pretty much doomed.

Boston Advisors Broad Allocation Strategy Fund (BABAX) will be liquidated come December 18, 2014. It’s a small, overpriced fund-of-funds that’s managed to lag in both up markets and down markets over its short life.

HNP Growth and Preservation Fund (HNPKX) is slated for liquidation in mid-November. It was a reasonably conservative managed futures fund that was hampered by modest returns and high expenses. We wrote a short profile of it a while ago.

iShares isn’t exactly cleaning house, but they did bump off 18 ETFs in late October. The descendants include their entire Target Date lineup plus a couple real estate, emerging market sector and financial ETFs. The full list is:

• iShares Global Nuclear Energy ETF (NUCL)
• iShares Industrial/Office Real Estate Capped ETF (FNIO)
• iShares MSCI Emerging Markets Financials ETF (EMFN)
• iShares MSCI Emerging Markets Materials ETF (EMMT)
• iShares MSCI Far East Financials ETF (FEFN)
• iShares NYSE 100 ETF (NY)
• iShares NYSE Composite ETF (NYC)
• iShares Retail Real Estate Capped ETF (RTL)
• iShares Target Date Retirement Income ETF (TGR)
• iShares Target Date 2010 ETF (TZD)
• iShares Target Date 2015 ETF (TZE)
• iShares Target Date 2020 ETF (TZG)
• iShares Target Date 2025 ETF (TZI)
• iShares Target Date 2030 ETF (TZL)
• iShares Target Date 2035 ETF (TZO)
• iShares Target Date 2040 ETF (TZV)
• iShares Target Date 2045 ETF (TZW)
• iShares Target Date 2050 ETF (TZY)

Lifetime Achievement Fund (LFTAX) “has concluded that it is in the best interests of the Fund and its shareholders that the Fund cease operations.” The orderly dissolution of the fund will take until March 31, 2015.

Effective October 13, 2014, the Nationwide Enhanced Income Fund and the Nationwide Short Duration Bond Fund were reorganized into the Nationwide HighMark Short Term Bond Fund (NWJSX).

QS LEGG MASON TARGET RETIREMENT 2015,

Speaking of mass liquidations, Legg Mason decided to bump off its entirely target-date lineup, except for Target Retirement 2015 (LMFAX), effective mid-November.

• QS Legg Mason Target Retirement 2020,
• QS Legg Mason Target Retirement 2025,
• QS Legg Mason Target Retirement 2030,
• QS Legg Mason Target Retirement 2035,
• QS Legg Mason Target Retirement 2040,
• QS Legg Mason Target Retirement 2045,
• QS Legg Mason Target Retirement 2050
• QS Legg Mason Target Retirement Fund.

Robeco Boston Partners International Equity Fund merged into John Hancock Disciplined Value International Fund (JDIBX) on September 26, 2014.

Symons Small Cap Institutional Fund (SSMIX) has decided to liquidate, done in by “the Fund’s small asset size and the increasing regulatory and operating costs borne by the adviser.” Trailing 98-99% of its peers over the past 1, 3 and 5 year periods probably didn’t help its case.

Effective immediately, the USFS Funds Limited Duration Government Fund (USLDX) is closed to new purchases, its manager has left and all references to him in the Fund’s Summary Prospectus, Prospectus and SAI have been “deleted in their entirety.” Given that the fund is small and sad, and the adviser’s website doesn’t even admit it exists, I’m thinking the “closed to new investors and the manager’s out the door” might be a prelude to a watery grave.

The Japan Fund (SJPNX) just became The Former Japan Fund as it ended a long and rambling career by being absorbed into the Matthews Japan Fund (MJFOX, as in Michael J. Fox). The Japan Fund, launched in the late 1980s as Scudder Japan, was one of the first funds to target Japan – at just about the time Japan’s market peaked.

Effective October 20, 2014, three Virtus Insight money market funds (Government Money Market, Money Market and Tax-Exempt Money Market) were liquidated.

Bon Voya-age: Voya Global Natural Resources Fund (LEXMX – another of the old Lexington funds, along with our long-time favorite Lexington Corporate Leaders LEXCX) is merging in Voya International Value Equity (NAWGX). LEXMX has led its peers in four of the past five years but seems not to have drawn enough assets to satisfy the adviser’s needs. In the interim, International Value will be rechristened Voya Global Value Advantage.

 

In Closing . . .

One of our greatest challenges each month is balancing the needs and interests of our regular readers with those of the folks who are encountering us for the first time. Of the 25,000 folks who’ve read the Observer in the past 30 days, 40% ~ say, 10,000 ~ were first-time visitors. That latter group might reasonably be wondering things like “who on earth are these people?” and “where are the ads?” The following is for them and for anyone who’s still wondering “what’s up here?”

Who is the Observer?

The Mutual Fund Observer operates as a public service, a place for individuals to interact, grow, learn and gain confidence. It is a free, independent, non-commercial site, financially supported by folks who value its services. We write for intellectually curious, serious investors – managers, advisers, and individuals – who need to get beyond marketing fluff and computer-generated recommendations.

We have about 25,000 readers, 95% of whom are resident in the US.

The Observer is published by David Snowball, a Professor of Communication Studies and former Director of Debate at Augustana College in Rock Island, Illinois. While I might be the “face” of the Observer, I’m also only one piece of it. The strength of the Observer is the strength of the people it has drawn. There is a community of folks, fantastically successful in their own rights, who provide us with an incredibly powerful advantage. Some (Charles and Edward, as preeminent examples) write for us, some write to us (mostly in private emails) and some (David Smith at Fundfox and Brian Haskin at DailyAlts) share their words and expertise with us. They all share a common passion: to teach and hence to learn. Their presence, and yours, makes this infinitely more than Snowball 24/7.

What’s our mission?

We’ll begin with the obvious: about 80% of all mutual funds could shut their doors today and not be missed.  If I had to describe them, I’d use words like

• Large
• Unimaginative
• Undistinguished
• Asset sponges

They thrive by never being bad enough to dump and so, year after year, their numbers swell. By one estimate, 30% of all mutual fund money is invested in closet index funds – nominally active funds whose strategy and portfolio is barely distinguishable from an index. One of Russel Kinnel’s sharper lines of late was, “New funds tend to be mediocre because fund companies make them that way” (“New Funds Generate More Excitement Than Results,” 10/16/14). Add “larger” in front of “fund companies” and I’d nod happily. The situation is worse in ETF-land where the disappearance of 90% of offerings would likely improve the performance of 99% of investor portfolios.

Sadly those are the funds that win analyst coverage and investor attention.  The structure of the investment company industry is such that the funds you should consider most seriously are the ones about which you hear the least: small, nimble, independent entities with skilled managers who – in many cases – have left major firms in disgust at the realization that the corporation’s needs were going to trump their investors’ needs. Where the mantra at large companies is “let’s not do anything weird,” the mantra at smaller firms seems to be “let’s do the right thing for our investors.”

That’s who we write about, convinced that there are opportunities there that you really should recognize and consider with all seriousness.

How can you best use it?

Give yourself time and go beyond the obvious.

We tend to publish longer pieces that most sites and many of those essays assume that you’re smart, interested and thoughtful. We don’t do fluff though we celebrate quirky. The essays that Charles posts tend to be incredibly data-rich. Ed’s essays tend to be driven by a sharply trained, deeply inquisitive mind and decades of experience; he understands more about what’s going on just under the surface or behind closed doors than most of us could ever aspire to. They bear re-reading.

We have a lot of resources not immediately evident in the monthly update you’ve just read. I’ll highlight four and suggest you click around a bit on the top menu bar.

1. We share content from, and link to, people who impress us. David Smith and FundFox do an exceptional job of following and organizing the industry’s legal travails; it strikes me as an indispensable tool for trustees, reporters and folks whose names are followed by the letters J and D.  Brian Haskin and the folks are DailyAlts are dedicated to comprehensive tracking of the industry’s fastest growing, most complex corner.  Both offer resources well beyond our capacity and strike us as really worth following.
2. We offer tools that do cool things. Want detailed, current, credible risk measures for any fund? Risk Profile Search. A searchable list of every fund whose risk-adjusted returns beat its peers in every trailing period?  Great Owls.  A quick way to generate lists of candidates for a portfolio?  Miraculous Multi-Search.  Every manager change at an equity, balanced or alts fund over the past three years.  Got it.  Chip’s Manager Changes master list. Most of them are under the Search Tools tab, but the Navigator – which links you directly to any specified fund’s page on a dozen credible news and rating sites – is a Resource. 
3. We have profiles of over 100 funds, generally small, new and distinctive. Charles’s downloadable dashboard gives you quick access to updated risk and return information on each. There are archived audio interviews with the managers of some of the most intriguing of them. We present the active share calculations for every fund we profile and host one of the web’s largest collections of current active share data.
4. We have searchable editorial and analytic content back to our inception. Curious about everything we’ve reported on Seafarer Growth & Income (SFGIX) since its inception?  It’s there.  Our discussion of the fall o’ Fidelity funds? 

Quite independent of which (fiercely independent of which, I dare say) is the Observer’s mutual fund discussion board, which has had 1600 users and 65,000 posts.

We also answer our mail.

How do we pay for it?

Because the folks most in need of a quiet corner and reasonable people are those least able to pay a subscription, we’ve never charged one. When readers wish to support the Observer, they have four pretty simple, entirely voluntary channels:

1. They can use our Amazon.com link for their online shopping. On average, Amazon rebates to us an amount equivalent to about 7% of your purchase. Hint! Hint! There are holidays coming. If you’re one of those people who participate in “holiday shopping”, use this link. It costs you nothing. There really are no strings attached.
2. They can contribute directly through PayPal.
3. They can become de facto subscribers through an automatic monthly contribution through PayPal.
4. They can send a check. Or cash. Heck, we’d take fruitcakes and would delight in good chocolates.

All of that is laid out on our Support Us page.

Our goal each month is not to be great. It’s to be a bit better than we were last month. Frankly, the more you help – with ideas, encouragement, criticism and support – the likelier that is to occur.

Speaking of de facto subscribers, the number has doubled in the last month. Thanks Greg, Deb appreciates the company!  Charles is developing a remarkably sophisticated fund search function; in thanks and in hopes of getting feedback, we’ve extended access to our subscribers. If our recent rate of subscriber growth (i.e., doubling monthly) keeps up, we’ll crack 8200 in a year and I think we’d hit 16,777,216 by the end of the following year. Charles, the energetic one among us, has promised to greet each of you at the door.

I’m sure by now that you’ve set your clocks back.  But what about your other fall chores?  Change the batteries in your smoke detectors.  If you don’t have spare batteries on hand, leave a big Post-It note on the door to the garage so you remember to buy some.  If your detector predates the Obama administration, it’s time for a change.  And when was the last time you called your mom, changed your furnace filters or unwrapped that mysterious aluminum foil clad nodule in the freezer?  Time to get to it, friends!

For December, we’ll profile three new funds and think with you about the results of our latest research project focusing on the extent to which fund trustees are willing to entrust their own money to the funds they oversee.  We’ve completed reviews of 80 of our target 100 funds and, so far, 515 trustees might have a bit of explaining to do. 

Also coming in December, our pilot episode of the soon-to-be-hit reality TV show: So you think you can be an equity fund manager!  It’ll be hosted by some cheeky chick from Poughkeepsie who sports a faux British accent.

It looks so easy.  And so profitable.  Our British confreres boiled the attraction down in a single three minute video.

Wealth Management Parody from SCM on Vimeo. Thanks to Ted, one of the discussion board’s senior members, for bringing it to our attention.

In December we’ll look at Motif, a service mentioned to us by actual fund managers who are intrigued by it and which would let you run your own mutual fund (or six), in real time with real money.

Your money.

See you then!

 

By David Snowball

Dear friends,

If it weren’t for everything else I’ve read in the news this week (a “blood feud” between DoubleLine and Morningstar? Blood feud? Really? “Pa! Grab your shotgun. Ah dun seen one a them filthy Mansuetos down by the crik!”), the silliest story of the week would be the transformation of candidate’s mutual fund portfolios into attack fodder. And not even attacks for the right reasons!

Republican U.S. Senate candidate Terri Lynn Land attacked her opponent for owning shares of the French firm Total SA. Three weeks later Democrat Gary Peters struck back after discovering that Land (the wretch!) owned “C” shares of Well Fargo Absolute Return (WARCX)and WARCX in turn owns GMO Benchmark-Free Allocation which owns five other GMO funds, one of which has 3% of its portfolio invested in Total SA stock. “She got her hand caught in the cookie jar,” quoth the Democrat.

Land’s total profit from WARCX was between $200-1000. Total SA represented 4% of a fund that was itself 14% of another fund. Hmmm … maybe 0.5% of her perhaps $200 windfall was Total SA so, yup, the issue came down to $1 worth of cookie.

Of course, it wasn’t about the money. It was about the principle. As politics so often are.

Also in Michigan Democrat Mark Schauer attacked the Republican governor’s tax break which benefited companies “even if they send jobs overseas.” The Republican struck back after discovering that Schauer owned shares of Growth Fund of America (AGTHX) which “has a portfolio of companies that make goods overseas, such as Apple.” Here in the Quad Cities, the Democrat candidate for Congress has been attacked for her investment in Janus Overseas (JAOSX), whose 7% holding in Li and Fung Enterprises raised Republican hackles. Congressional candidate Martha Robertson was attacked for owning stock in the treacherous, border-jumping, tax-inverting Burger King – which turns out to be held in the portfolio of a mutual fund she bought 36 years ago. Minnesota senator Al Franken was found to own Lazard, the parent company of a somehow objectionable company, via shares in a socially responsible mutual fund.

Yup. That sure would have been the craziest story of the month except for …

Notes on The Greatest (ill-timed mutual fund manager transition) Story Ever Told

Bill Gross arriving at Janus

Making sense of Mr. Gross’s departure from PIMCO is the very epitome of an “above my pay grade and outside my circle of competence” story. I don’t know why he left. I don’t know whether PIMCO has a toxic environment or, if so, whether he was the source or the firewall. And I certainly don’t know who, among the many partisans furiously spinning their stories, is even vaguely close to speaking the truth.

Here are, however, seven things that I do believe to be true.

If your adviser has recommended moving out of PIMCO funds, you should fire him. If your endowment consultant has advised moving out of PIMCO funds, fire them. If your newsletter editor has rushed out a special bulletin urging you to run, cancel your subscription, demand a refund and send the money to us. (We’ll buy chocolate.) If your spouse is planning on selling PIMCO shares, fir … distract him with pie and that adorable story about a firefighter giving oxygen to baby hamsters. (Also switch him to decaf and consider changing the password on your brokerage account.)

At base, Mr. Gross made some contribution to his core fund’s long-term outperformance, which is in the range of 100-200 basis points/year. In the long term, say over the course of decades, that’s huge. For the immediate future, it’s utterly trivial and irrelevant.

Note to PIMCO (from academe): Thank you! Thank you! Thank you! On behalf of all of us who teach Crisis Communications, Strategic Comm, Media Relations or Public Relations, thanks. Your handling of the story has been manna and will be the source of case studies for years.

For those of you without the time to take a crisis communications course, let me share the five word version of it: Get ahead of the story. Play it, don’t let it play you. Mr. Gross’s departure was absolutely predictable, even if the precise timing wasn’t. The probability of his unhappy departure was exceedingly high, even if the precise trigger was unknown. The firm’s strategists have either known it, or had a responsibility to know it, for the past six months. You could have been planning positive takes. You could have been helping journalists, long in advance, imagine positive frames for the story.

As is, you appeared to be somewhere between scrambling and flailing. About the most positive coverage you could generate was a whiny headline, “Bill Gross relied on us,” and a former employee’s human interest assessment, “El-Erian: PIMCO’s new CIO is one of the most considerate and decent people I know.”

We’d been living off BP’s mishandling of the Gulf oil disaster for years, but it was endless and getting stale. Roger Goodell has certainly offered himself up (latest: he’s got bodyguards and they assault photographers) but it’s great to have a Menu of Misses and Messes to work with.

Note (1) to Janus: You don’t have a Global Unconstrained Bond Fund. Or didn’t at the point that you announced that Mr. Gross was running it:

You might blame the “Global” slip-up on your IT team. It turns out that it’s not just the low-level gnomes. Janus president Richard Weil also invoked the non-existent Global Unconstrained Fund:

Morningstar echoed the confusion:

I called a Janus phone rep, who affirmed that of course they had a Global Unconstrained Fund, followed by a bunch of tapping, a “that’s odd,” an “uh-oh” and a “I’ll have to refer this up the line.” Two hours later Janus filed the name change announcement with the SEC.

Dudes: you were at the top of the news cycle. Everyone was looking. This was just chance to prove to everyone that you were relevant. Why deflect the story with careless goofs? You could have filed a two sentence SEC notice, with no mention of Mr. Gross, the week before. You didn’t. Why, too, does the fund have an eight page summary prospectus with five pages of text, two pages labeled “Intentionally Blank” and another page also blank (even blanker than the two preceding pages with writing on them), but apparently unintentionally so?

Note (2) to Janus: That’s the best picture of Mr. Gross that you could find? Really? Uhhh … that’s not a fund manager. That’s the Grinch.

Note to the ETF zealots, dancing around a bonfire and attempting to howl like wolves: Stop it, you’re embarrassing.

If you actually believed the credo that you so piously pronounce, there’d be about three ETFs in existence, each with a trillion in assets. They’d be overseen by a nonprofit corporation (hi, Jack!) which would charge one basis point. All the rest of you would be off somewhere, hawking nutraceuticals and testosterone supplements for a living. We’ll get to you later.

Note to pundits tossing around 12 figure guesstimates about PIMCO outflows: Stop it, you’re not helping anyone. I know you want to get headlines and build your personal brand. That’s fine, go date a Kardashian. There are a bunch of them available and apparently their standards are pretty … uhhh, flexible. Making up scary pronouncements with blue sky numbers (“we anticipate as much as $400 billion in outflows…”) does nothing more than encourage people to act poorly.

Note to our readers and other PIMCO investors: this is likely the best news you’ve had in a year. PIMCO has been twisting itself in knots over this issue. It’s been a daily distraction and a source of incredible tension and anxiety for dozens upon dozens of management and investment professionals. The situation had been steadily worsening. And now it’s done.

We don’t much cover PIMCO funds. Like the American Funds, they’re way too big to be healthy or interesting. That said, PIMCO has launched innovative and successful new funds over the past five years. Their collective Morningstar performance ratings (4.4 stars for the average domestic equity fund, 3.8 stars for taxable bond funds, 3.6 for international stocks and 1.9 for muni bonds) are well above average.

There is, I suspect, a real prospect of very healthy outcomes for PIMCO and their investors from all this. I suspect that a lot of people may start to look forward to coming to work again. That it will be a lot easier to attract and retain talent. And that a lot of folks will hear the call to step up and take up the slack. You might want to give them to chance to do just that.

Ever wonder what Mr. Gross did when he wasn’t prognosticating?

When I explained to Chip, overseer of our manager changes data, that Mr. Gross was moving on and that his departure affected a six page, single-spaced list of funds (accounting for all of the share classes and versions), she threatened to go all Air France on us and institute a work stoppage. Shuddering, I promised to share the master list of Gross changes with you in the cover essay.  The manager changes page will reflect just some of the higher-profile funds in his portfolio.

Here’s a partial list, courtesy of Morningstar, of the funds he was responsible for:

• PIMCO Total Return, the quarter trillion dollar beast he was famous for

And the other 34:

• MassMutual Select PIMCO Total Return
• PIMCO Emerging Markets Fundamental IndexPLUS Absolute Return Strategy
• JHFunds2 Total Return
• Target Total Return Bond
• AMG Managers Total Return Bond
• PIMCO GIS Total Return Bond
• PIMCO Worldwide Fundamental Advantage Absolute Return Strategy, the fund with the highest buzzwords-to-content ratio of any.
• Transamerica Total Return
• 37 iterations of PIMCO GIS Unconstrained Bond
• Consulting Group Core Fixed-Income
• Harbor Unconstrained Bond
• PIMCO Unconstrained Bond
• PIMCO Total Return IV
• Principal Core Plus Bond
• PL Managed Bond
• PIMCO Fundamental Advantage Absolute Return Strategy
• VY PIMCO Bond
• PIMCO International StocksPLUS® Absolute Return Strategy
• PIMCO Small Cap StocksPLUS® Absolute Return Strategy
• PIMCO Fundamental IndexPLUS Absolute Return
• PIMCO StocksPLUS Absolute RETURN Short Strategy
• PIMCO GIS Low Average Duration
• PIMCO StocksPLUS Absolute Return
• Old Mutual Total Return
• PIMCO GIS StocksPlus
• PIMCO Moderate Duration
• PIMCO StocksPLUS
• PIMCO Low Duration III
• PIMCO Total Return II
• PIMCO Low Duration II
• PIMCO Total Return III
• Harbor Bond
• PIMCO Low Duration
• Prudential Income Builder

As we note with PIMCO GIS Unconstrained (the GIS standing for “global investor series”), there can be literally dozens of manifestations of the same portfolio, denominated in different currencies and hedged and unhedged forms, offers to investors in a dozen different nations.

Morningstar ETF Conference Notes

By Charles Boccadoro

The pre-autumnal weather was perfect. Blue skies. Warm days. Cool nights. Vibrant city scene. New construction. Breath-taking architecture. Diverse eateries, like Lou Malnati’s deep dish pizza. Stylist bars and coffee shops. Colorful flower boxes on The River Walk. Shopping galore. An enlightened public metro system that enables you to arrival at O’Hare and 45 minutes later be at Clark/Lake in the heart of downtown. If you have not visited The Windy City since say when the Sears Tower was renamed the Willis Tower, you owe yourself a walk down The Magnificent Mile.

At the opening keynote, Ben Johnson, Morningstar’s director responsible for coverage of exchange traded funds (ETFs) and conference host, noted that ETFs today hold $1.9T in assets versus just $700M only five years ago, during the first such conference. He explained that 72% is new money, not just appreciation.

The conference had a total of 671 attendees, including 470 registered attendees (mostly financial advisors, but this number also includes PR people and individual attendees), 123 sponsor attendees, 43 speakers, and 35 journalists, but not counting a very helpful M* staff and walk-ins. Five years ago? Just shy of 300 attendees.

The Dirty Words of Finance

AQR’s Ronen Israel spoke of Style Premia, which refers to source of compelling returns generated by certain investment vehicle styles, specifically Value, Momentum, Carry (the tendency for higher-yielding assets to provide higher returns than lower-yielding assets), and Defensive (the tendency for lower-risk and higher-quality assets to generate higher risk-adjusted returns). He argues that these excess returns are backed by both theory, be it efficient market or behavioral science, and “decades of data across geographies and asset groups.”

He presented further data that indicate these four styles have historically had low correlation. He believes that by constructing a portfolio using these styles across multiple asset classes investors will yield more consistent returns versus say the tradition 60/40 stocks/bond balanced portfolio. Add in LSD, which stands for leverage, shorting and derivatives, or what Mr. Israel jokingly calls “the dirty word of finance,” and you have the basic recipe for one of AQR’s newest fund offerings: Style Premia Alternative (QSPNX). The fund seeks long-term absolute (positive) returns.

Shorting is used to neutralize market risk, while exposing the Style Premia. Leverage is used to amplify absolute returns at defined portfolio volatility. Derivatives provide most efficient vehicles for exposure to alternative classes, like interest rates, currencies, and commodities.

When asked if using LSD flirted with disaster, Mr. Israel answered it could be managed, alluding to drawdown controls, liquidity, and transparency.

(My own experience with a somewhat similar strategy at AQR, known as Risk Parity, proved to be highly correlated and anything but transparent. When bonds, commodities, and EM equities sank rapidly from May through June 2013, AQR’s strategy sank with them. Its risk parity flagship AQRNX drew down 18.1% in 31 trading days…and the fund house stopped publishing its monthly commentary.)

When asked about the size style, he explained that their research showed size not to be that robust, unless you factored in liquidity and quality, alluding to a future paper called “Size Matters If You Control Your Junk.”

When asked if his presentation was available on-line or in-print, he answered no. His good paper “Understanding Style Premia” was available in the media room and is available at Institutional Investor Journals, registration required.

Launched in October 2013, the young fund has generated nearly $300M in AUM while slightly underperforming Vanguard’s Balanced Index Fund VBINX, but outperforming the rather diverse multi-alternative category.

QSPNX er is 2.36% after waivers and 1.75% after cap (through April 2015). Like all AQR funds, it carries high minimums and caters to the exclusivity of institutional investors and advisors, which strikes me as being shareholder unfriendly. Today, AQR offers 27 funds, 17 launched in the past three years. They offer no ETFs.

In The Shadow of Giants

PIMCO’s Jerome Schneider took over the short-term and funding desk from legendary Paul McCulley in 2010. Two years before, he was at Bear Stearns. Today, think popular active ETF MINT. Think PAIUX.

During his briefing, he touched on 2% being real expected growth rate. Of new liquidly requirements for money market funds, which could bring potential for redemption gates and fees, providing more motivation to look at low duration bonds as an alternative to cash. He spoke of 14 year old cars that needed to be replaced and expected US housing recovery.

He anticipates capital expenditure will continue to improve, people will get wealthier, and for US to provide a better investment outlook than rest of world, which was a somewhat contrarian view at the conference. He mentioned global debt overhang, mostly in the public sector. Of working age population declining. And, of geopolitical instability. He believes bonds still play a role in one’s portfolio, because historically they have drawn down much less than equities.

It was all rather disjointed.

Mostly, he talked about the extraordinary culture of active management at PIMCO. With time tested investment practices. Liquidity sensitivity. Risk management. Credit research capability, including 45 analysts across the globe that he begins calling at 03:45…the start of his work day. He touted PIMCO’s understanding of tools of the trade and trading acumen. “Even Bill Gross still trades.” He displayed a picture of himself that folks often mistook for a young Paul McCulley.

Cannot help but think what an awkward time it must be for the good folks at PIMCO. And be reminded of another giant’s quote: “Only when the tide goes out do you discover who’s been swimming naked.”

Youthful Hosts

Surely, it is my own graying hair, wrinkled bags, muddled thought processes, and inarticulate mannerisms that makes me notice something extraordinary about the people hosting and leading the conference’s many panels, workshops, luncheons, keynotes, receptions, and sidebars. They all look very young! In addition to being clear thinkers, articulate public speakers, helpful and gracious hosts.

It would not be too much of a stretch to say that the combined ages of M*’s Ben Johnson, Ling-Wei Hew, and Samuel Lee together add up to one Eugene Fama. Indeed, when Mr. Johnson sat across from Nobel laureate Professor Fama, during a charming lunch time keynote/interview, he could have easily been an undergraduate from University of Chicago.

Is it because the ETF industry itself is young? Or, is it as a colleague explains: “Morningstar has hard time holding on to good talent because it is a stepping stone to higher paying jobs at places like BlackRock.”

Whatever the reason, if we were all as knowledgeable about investing as Mr. Lee and the rest of the youthful staff, the world of investing would be a much better place.

Damp & Disappointing

That’s how JP Morgan’s Dr. David Kelly, Chief Global Strategist, describes our current recovery. While I did not agree with everything, it was hands-down the best talk of the conference. At one point he said that he wished he could speak for another hour. I wished he could have too.

“Damp and disappointing, like an Irish summer,” he explained.

Short term US prospects are good, but long term not good. “In the short run, it’s all about demand. But in the long run, it’s all about supply, which will be adversely impacted by labor and productivity.” The labor force is not growing. Baby boomers are retiring en masse. He also showed data that productivity was likely not growing, blaming lack of capital expenditure. (Hard to believe since we seem to work 24/7 these days thanks to amazing improvements communications, computing, information access, manufacturing technology, etc. All the while, living longer.)

Dr. Kelly offered up fixes: 1) corporate tax reform, including 10% flat rate, and 2) immigration reform, that allows the world’s best, brightest, and hardest working continued entry to the US. But since congress only acts in crisis, he concedes his forecast prepares for slowing US growth longer term.

Greater opportunity for long term growth is overseas. Manufacturing momentum is gaining around world. Cyclical growth will be higher than US while valuations remain lower and work force is younger. Simply put, they have more room to grow. Unfortunately, US media bias “always gives impression that the rest of the world is in flames…it shows only bad news.”

JP Morgan remains underweight fixed income, since monetary policy remains abnormal, and cautiously over weight US equities. The thing about Irish summers is…everything is green. Low interest rates. Higher corporate margins. Normal valuation. Although he takes issue with the phrase “All the easy money has been made in equities.” He asks “When was it ever easy?”

Alpha Architect

Dr. Wesley Gray is a former US Marine Captain, a former assistant and now adjunct professor at Drexel University, co-author of Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and founder of AlphaArchitect, LLC.

He earned his MBA and Finance PhD from University of Chicago, where Professor Fama was on his doctoral committee. He offers a fresh perspective in the investment community. Straight talking and no holds barred. My first impression – a kind of amped-up, in-your-face Mebane Faber. (They are friends.)

In fact, he starts his presentation with an overview of Mr. Faber’s book “The Ivy Portfolio,” which at its simplest form represents an equal allocation strategy across multiple and somewhat uncorrelated investment vehicles, like US stocks, world stocks, bonds, REITS, and commodities.

Dr. Gray argues that simple, equal allocation remains tough to beat. No model works all the time; in fact, the simple equal allocation strategy has under-performed the past four years, but precisely because forces driving markets are unstable, the strategy will reward investors with satisfactory returns over the long run. “Complexity does not add value.”

He seems equally comfortable talking efficient market theory and how to maximize a portfolio’s Sharpe ratio as he does explaining why the phycology of dynamic loss aversion creates opportunities in the market.

When Professor Fama earlier in the day dismissed a question about trend-following, answering “No evidence that this works,” Dr. Gray wished he would have asked about the so-called “Prime anomaly…momentum. Momentum is pervasive.”

When Dr. Gray was asked, “Will your presentation would be made available on-line?” He answered “Absolutely.” Here is link to Beware of Geeks Bearing Formulas.

His firm’s web site is interesting, including a new tools page, free with an easy registration. They launch their first ETF aptly called Alpha Architect’s Quantitative Value (QVAL) on 20 October, which will follow the strategy outlined in the book. Basically, buy cheap high-quality stocks that Wall Street hates using systematic decision making in a transparent fashion. Definitively a candidate MFO fund profile.

Trends Shaping The ETF Market

Ben Johnson hosted an excellent overview ETF trends. The overall briefings included Strategic Beta, Active ETFs (like BOND and MINT), and ETF Managed Portfolios.

Points made by Mr. Johnson:

1. Active vs passive is a false premise. Today’s ETFs represent a cross-section of both approaches.

2. “More assets are flowing into passive investment vehicles that are increasingly active in their nature and implementation.”

3. Smart beta is a loaded term. “They will not look smart all the time” and investors need to set expectations accordingly.

4. M* assigns the term “Strategic Beta” to a growing category of indexes and exchange traded products (ETPs) that track them. “These indexes seek to enhance returns or minimize risk relative to traditional market cap weighted benchmarks.” They often have tilts, like low volatility value, and are consistently rules-based, transparent, and relatively low-cost.

5. Strategic Beta subset of ETPs has been explosive in recent years with 374 listed in US as of 2Q14 or 1/4 of all ETPs, while amassing $360M, or 1/5th of ETP AUM. Perhaps more telling is that 31% of new cash flows for ETPs in 2013 went into Strategic Beta products.

6. Reduction or fees and a general disillusionment with active managers are two of several reasons behind the growth in these ETFs.  These quasi active funds charge a fraction of traditional fees. A disillusionment with active managers is evidenced in recent surveys made by Northern Trust and PowerShares.

M* is attempting to bring more neutral attention to these ETFs, which up to now has been driven by product providers. In doing so, M* hopes to help set expectation management, or ground rules if you will, to better compare these investment alternatives. With ground rules set, they seek to highlight winners and call out losers. And, at the end of the day, help investors “navigate this increasingly complex landscape.”

They’ve started to develop the following taxonomy that is complementary to (but not in place of) existing M* categories.

Honestly, I think their coverage of this area is M* at its best.

Welcomed Moderation

Mr. Koesterich gave the conference opening keynote. He is chief investment strategist for BlackRock. The briefing room was packed. Several hundred people. Many standing along wall. The reception afterward was just madness. His briefing was entitled “2014 Mid-Year Update – What to Know / What to Do.”

He threaded a somewhat cautiously reassuring middle ground. Things aren’t great. But, they aren’t terrible either. They are just different. Different, perhaps, because the fed experiment is untested. No one really knows how QE will turn out. But in mean time, it’s keeping things together.

Different, perhaps, because this is first time in 30-some years where investors are facing a rising interest rate environment. Not expected to be rapid. But rather certain. So bonds no longer seem as safe and certainly not as high yield as in recent decades.

To get to the punch-line, his advice is: 1) rethink bonds – seek adaptive strategies, look to EM, switch to terms less interest rate sensitive, like HY, avoiding 2-5 year maturities, look into muni’s on taxable accounts, 2) generate income, but don’t overreach – look for flexible approaches, proxies to HY, like dividend equities, and 3) seek growth, but manage volatility – diversify to unconstrained strategies

More generally, he thinks we are in a cyclical upswing, but slower than normal. Does not expect US to achieve 3.5% annual GDP growth (post WWII normal) for next decade. Reasons: high debt, aging demographics, and wage stagnation (similar to Rob Arnott’s 3D cautions).

He cited stats that non-financial debt has actually increased 20-30%, not decreased, since financial crisis. US population growth last year was zero. Overall wages, adjusted for inflation, same as late ’90s. But for men, same as mid ‘70s. (The latter wage impact has been masked by more credit availability, more women working, and lower savings.) All indicative of slower growth in US for foreseeable future, despite increases in productivity.

Lack of volatility is due to fed, keeping interest rates low, and high liquidity. Expects volatility to increase next year as rates start to rise. He believes that lower interest rates so far is one of year’s biggest surprises. Explains it due to pension funds shifting out of equities and into bonds and that US 10 year is pretty good relative to Japan and Europe.

On inflation, he believes tech and aging demographics tend to keep inflation in check.

BlackRock continues to like large cap over small cap. Latter will be more sensitive to interest rate increases.

Anything cheap? Stocks remain cheaper than bonds, because of extensive fed purchases during QE. Nothing cheap on absolute basis, only on relative basis. “All asset classes above long term averages, except a couple niche areas.”

“Should we all move to cash?” Mr. Koesterich answers no. Just moderate our expectations going forward. Equities are perhaps 10-15% above long term averages. But not expensive compared to prices before previous drops.

One reason is company margins remain high. For couple of same reasons: low credit interest and low wages. Plus higher productivity, which later appeared contrary to JP Morgan’s perspective.

He advises investors be selective in equities. Look for value. Like large over small. More cyclical companies. He likes tech, energy, manufacturing, financials going forward. This past year, folks have driven up valuations of “safe” equities like utilities, staples, REITS. But those investments tend to work well in recessions…not so much in rising interest rate environment. EM relatively inexpensive, but fears they are cheap for reason. Lots of divided arguments here at BlackRock. Japan likely good trade for next couple years due to Japanese pension funds shifting to organic assets.

He closed by stating that only New Zealand is offering a 10 year sovereign return above 4%. Which means, bond holders must take on higher risk. He suggests three places to look: HY, EM, muni’s.

Again, a moderate presentation and perhaps not much new here. While I personally remain more cautiously optimistic about US economy, compared to mounting predictions of another big pull-back, it was a welcomed perspective.

Beta Central

I’m hard-pressed to think of someone who has done more to enlighten investors about the benefits of ETF vehicles and opportunities beyond buy-and-hold US market cap than Mebane Faber. At this conference especially, he represents a central figure helping shape investment opportunities and strategies today.

He was kind enough to spend a few minutes before his panel on dividend investing and ETFs, which he held with Morningstar’s Josh Peters and Samuel Lee.

He shared that Cambria recently completed a funding campaign to expand its internal operations using the increasingly popular “Crowd Funding” approach. They did not use one of the established shops, like EquityNet, simply because of cost.  A couple hundred “accredited investors” quickly responded to Cambria’s request to raise $1-2M. The investors now have a private stake in the company. Mebane says they plan to use the funds to increase staff, both research and marketing. Indeed, he’s hiring: “If you are an A+ candidate, incredibly sharp, gritty, and super hungry, come join us!”

The new ETF Global Momentum (GMOM), which we mentioned in the July commentary, is due out soon, he thinks this month. Several others are in pipeline: Global Income and Currency Strategies ETF (FXFX), Emerging Shareholder Yield ETF (EYLD), Sovereign High Yield Bond ETF (SOVB), and Value and Momentum ETF (VAMO), which will make for a total of eight Cambria ETFs. The initial three ETFs (SYLD, FYLD, and GVAL) have attracted $365M in their young lives.

He admitted being surprised that Mark Yusko of Morgan Creek Funds agreed to take over AdvisorShares Global Tactical ETF GTAA, which now has just $20M AUM.

He was also surprised and disappointed to read about the SEC’s probe in F2 Investments, which alleges overstated performance results. F2 specializes in strategies “designed to protect investors from severe losses in down markets while providing quality participation in rising markets” and they sub-advise several Virtus ETFs. When WSJ reported that F2 received a so-called Wells notice, which portends a civil case against the company, Mebane posted “first requirement for anyone allocating to separate account investment advisor – GIPS audit. None? Move on.” I asked, “What’s GIPS?” He explains it stands for Global Investment Performance Standards and was created by the CFA Institute.

Mebane continues to write, has three books in work, including one on top hedge funds. Speaking of insight into hedge funds, subscribers joining his The Idea Farm after 31 December will pay a much elevated $499 annually.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

This month’s funds call into two broad categories: The Fallen Titans Funds and Stealthy Funds from “A” Tier Teams.

Le roi est mort, vive le roi’s new fund

Janus Unconstrained Bond (JUCAX) On October 6, Bill Gross, The Bond King, completes the transition from running 34 funds and $1.8 trillion in assets to managing a single $13 million portfolio. Like a Walmart at dawn on Black Friday, the fund is sure is see a huge crush of anxious, half-unhinged shoppers jammed against the doors.

Miller Income Opportunity (LMCJX) On February 26, Bill Miller, The Guy Who Bested the S&P 15 Years in a Row, partnered with his son to manage a new fund with a slightly misleading name (the portfolio produces little income) and hedge fund like freedom (and fees).

Quiet funds from “A” tier teams

Meridian Small Cap Growth (MSAGX) Small growth stocks have been described as “a failed asset class” because of the inability of most professional investors to control the sector’s downside well enough to benefit from its upside. Fortunately Chad Meade and Brian Schaub didn’t know that it was impossible to profit handsomely by limiting a small growth portfolio’s downside and so, for the past seven years, they’ve been doing exactly that. After moving from Janus to Meridian, they get to do it with a small, nimble fund.

Sarofim Equity (SRFMX) Have you ever looked at a large fund with a sensible strategy, solid management team and fine long-term record and thought to yourself “sure wish they were running a small, new fund doing the exact same thing for noticeably less money”? If so, the management team behind Dreyfus Appreciation has an opportunity for you to consider.

Elevator Talk: Justin Frankel, RiverPark Structural Alpha (RSAFX/RSAIX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Justin Frankel (presumably not the JF described as “the world’s most dangerous geek”) co-manages Structural Alpha with his colleague Jeremy Berman. RiverPark launched the fund in June 2013, but the strategy’s public record is considerably longer. It began life in September 2008 as Wavecrest Partners Fund, LP which the guys ran alongside separate accounts for rich folks. Justin and I spent some time discussing the fund over warm drinks in lovely Milwaukee this August.

Structural Alpha embodies an options-based strategy. Every time I write that, my head begins to hurt because I struggle to explain them even to myself. Investors use options as a sort of portfolio insurance. The managers here sell options because those options are structurally overpriced; that is, there’s a predictable excess profit for the sellers built into the market just as you pay more for your insurance policies than you’ll ever get out of them.

The portfolio has four components – long-dated options which tend to move in the direction of the stock market, short-dated options which tend to be market independent, a permanent hedge which buffers the long options’ downside risk and a huge amount of cash which serves as collateral on the options they’ve sold. The guys invest that cash in short-term securities which produce income for the fund. As market conditions change, the managers adjust the size of the options components to keep the fund’s risk exposure within predetermined limits. That is, there are times when their market indicators show that the long-dated portion is carrying the potential for too much downside and so they’ll dial back that component.

Here’s what that performance looks like, including the strategy’s time as a hedge fund. RiverPark is the blue line, its painfully inept peer group is on the orange line and the S&P 500 is green.

Over the better part of a full market cycle, the Structural Alpha strategy captured the 80% of the stock index’s returns – the strategy gained about 70% while the S&P rose 87% – while largely sidestepping any sustained losses. On average, it captures about 20% of the market’s down market performance and 40% of its up market. The magic of compounding then works in their favor – by minimizing their losses in falling markets, they have little ground to make up when markets rally and so, little by little, they catch up with a pure equity portfolio.

It’s clear that they might substantially lag in sustained, low volatility rallies but it’s also clear that they’ll make money for their investors even then.

Here are Justin’s 200 words on how you might buy some insurance:

The RiverPark Structural Alpha Fund is a market-neutral, hedged equity strategy. Our goal is to generate equity-like returns with fixed-income like volatility. We use a consistent and systematic investment process that focuses first on the management of risk, and then on the management of return.

The core of our investment philosophy is that excessive returns are rarely realized, and therefore should be traded for the opportunity to generate more stable returns, protect against some market declines, and reduce overall portfolio volatility. Secondarily, we believe that index options are overpriced, and by systematically selling these options we can generate positive returns without market exposure. This is why we use the term Structural Alpha in the fund’s name.

Jeremy Berman

Importantly, we have no view of the market and do not change our holdings or market exposure based on market conditions. Specifically, we use options to set zones of protection and to allow the fund to perform in up markets while maintaining a constant hedge to help protect the fund in down markets. The non-linear profile of options makes them ideally suited to implement our philosophy. Our portfolio naturally gets more exposed to the market as it declines (which means that we are constantly buying lower), and gets less exposed to the market when it rises (which means we are constantly selling higher).

Over the long run, the fund is slightly long-biased. Therefore, we believe it should perform better in rising markets. In our opinion, small and consistent gains over time, when compounded, will yield above average risk-adjusted returns for our shareholders. We believe our structural approach to investing gives the strategy a high probability for success across a range of different market environments.

RiverPark Structural Alpha has a $1000 minimum initial investment. Expenses are capped at 2.0% on the investor shares and the fund has about gathered about $7 million in assets since its June 2013 launch. Here’s the fund’s homepage, which has a funny video of the guys talking through the strategy. It’s a sort of homemade ten minute video and has much of the unprepossessing charm of Sheldon Cooper’s “Fun with flags” videos on The Big Bang Theory. Spoiler alert: the first two minutes are the managers sharing their biographies and the last seven minutes are soundless images of slides and disclaimers (I feel the compliance group’s hand here). If you’d like to listen to a précis of the strategy, start listening at about the 4:00 minute mark through to about 6:50. They make a complex strategy about as clear as anyone I’ve yet heard.

Launch Alert: T. Rowe Price International Concentrated Equity (PRCNX)

It’s rare that a newly launched fund receives both a “Great Owl” (top quintile risk-adjusted returns in all trailing periods longer than a year) and Morningstar five star rating, but Price’s International Concentrated Equity Fund (PRCNX) managed the trick. On August 22, 2014, T. Rowe released a retail version of its outstanding Institutional International Concentrated Equity Fund (RPICX). That fund launched in July 2010. Federico Santilli, who has managed the RPICX since inception, will manage the new fund. He claims to be style, sector and region-agnostic, willing to go wherever the values are best. He targets “companies that have solid positions in attractive industries, have an ability to generate visible and durable free cash flow, and can create shareholder value over time.”

The portfolio holds 60 large cap names, weighting them equally but turning them over with alarming speed, about 150% per year. The portfolio offers little direct exposure to the emerging markets but the multinationals that dominate the portfolio (Royal Bank of Scotland, Sony, drug maker Glaxo, Honda) derive much of their earnings from consumers in those newer markets.

The fund has performed well. It has been in or near the top 10% of foreign large blend funds each year. $10,000 invested there at inception would have grown to $15,700 (as of late September, 2014) while its average peer would have generated $13,700 with noticeably higher volatility. It has been the second-strongest performer among all the T. Rowe Price international funds, trailing only International Discovery (PRIDX), whose lead is tiny.

PRCNX is not merely a share class of RPICX. It is a separate fund, managed by the same guy using the same discipline. Nonetheless, the portfolios may show significant differences depending on what names are attractive when money flows into each fund.

The expense ratio is capped at 0.90%, barely higher than the Institutional fund’s 0.75%, under February 2017. The minimum initial investment is $2500, reduced to $1000 for IRAs. The fund’s homepage is here but the institutional fund’s homepage has a far greater array of information and strategy detail. Price would urge me to remind you that the information about the institutional fund is designed to inform qualified investors and analysts and it’s not aimed to persuading you to buy the retail fund.

Funds in Registration

Our colleague David Welsch tracked down 12 new no-load, retail funds in registration this month. In general, these funds will be available for purchase by late November. A number of the prospectuses are incredibly incomplete (not listing, for example, a fund manager) which suggests that they’re just gearing up for the traditional year-end rush to launch new funds. Highlights among the registrants:

• 361 Global Long/Short Equity Fund, which will feature a global long/short portfolio. Its most notable for its cast of managers, including Blaine Rollins from 361 Capitals and Harindra de Silva from Analytic Investors. Mr. Rollins ran Janus Fund at the height of its popularity (sadly, that would be around the year 2000), left investing in 2006 but has since returned to cofound 361, a liquid alts firm that’s dedicated to trying to prevent the sorts of losses the Janus funds suffered. Mr. Silva has roots going back to the PBHG Funds in the 1990s. The fund is no-load with a $2500 minimum, but we don’t yet know the expenses.
• American Century Multi-Asset Income Fund, which will primarily seek income with a conservative balanced portfolio. You might anticipate 40% dividend-paying stocks and 60% bonds. It will be team-managed with a reasonable 0.91% e.r. and $2,000 minimum.
• DoubleLine Long Duration Total Return Bond Fund, which will sport an effective average duration of 10 years or more. That’s a fascinating launch since long duration funds are highly interest rate sensitive and most observers anticipate rising rates (eventually). The Other Bond King and Vitaliy Liberman will manage the fund. The expenses aren’t yet set. The minimum initial investment will be $2,000 for “N” shares.

Manager Changes

Yikes.  This month saw 93 manager changes without accounting for the full extent of the turmoil caused by Mr. Gross’s change of employment. 

Top Developments in Fund Industry Litigation – September 2014

Fundfox is the only intelligence service to focus exclusively on litigation involving U.S.-registered investment companies, their directors and advisers. Each month editor David Smith shares word of the month’s litigation-related highlights. Folks whose livelihood ride on such matters need to visit FundFox and chat a bit with David about the service.

New Lawsuit

• Harbor was hit with new excessive-fee litigation, alleging that it charges advisory fees to its International and High-Yield Bond Funds that include a mark-up of more than 80% over the fees paid by Harbor to unaffiliated subadvisers who do most of the work. (Tumpowsky v. Harbor Capital Advisors, Inc.)

Orders

• The court consolidated a pair of fee lawsuits regarding the Davis N.Y. Venture Fund. (In re Davis N.Y. Venture Fund Fee Litig.)
• In a pair of ERISA lawsuits regarding a J.P. Morgan pooled stable value investment fund, the court transferred venue to the S.D.N.Y. (Adams v. J.P. Morgan Ret. Plan Servs., LLC; Ashurst v. J.P. Morgan Ret. Plan Servs. LLC.)
• The court denied defendants’ motion to dismiss excessive-fee litigation regarding six Principal LifeTime funds: “[W]hile Plaintiff has included some generalized statements regarding the mutual fund industry in its complaint, Plaintiff is not relying solely on speculation and has included some specific factual allegations regarding Defendants and their practices.” (Am. Chems. & Equip., Inc. 401(k) Ret. Plan v. Principal Mgmt. Corp.)
• The court gave its final approval to a $19.5 million settlement of an ERISA class action regarding TIAA-CREF‘s procedures for closing retirement plan accounts. (Bauer-Ramazani v. TIAA-CREF.)

Brief

• The plaintiff filed her opening brief in an appeal concerning American Century‘s liability for the Ultra Fund’s investments in off-shore Internet gambling businesses. Defendants include independent directors. (Seidl v. Am. Century Cos.)

Amended Complaint

• After surviving a motion to dismiss, a plaintiff filed an amended complaint alleging Securities Act violations in connection with four closed-end Morgan Keegan bond funds (n/k/a Helios funds). (Small v. RMK High Income Fund, Inc.)

For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

 

Liquid Alternative Observations

Brian Haskin publishes and edits the DailyAlts site, which is devoted to the fastest-growing segment of the fund universe, liquid alternative investments. Here’s his quick take on the DailyAlts mission:

Our aim is to provide our readers (investment advisors, family offices, institutional investors, investment consultants and other industry professionals) with a centralized source for high quality news, research and other information on one of the most dynamic and fastest growing segments of the investment industry: liquid alternative investments.

I like the site for a couple reasons. The writing is clean, the stories are fresh and the content seems thoughtful. Beyond that, one of the ways that the Observer tries to help folks is by linking them to the resources they need. There are really important areas that are outside our circle of competence and beyond our resources, and we’re deeply grateful for folks like David Smith at FundFox and Brian for their generous willingness to share leads and insights.

Brian offers this as his take on the month just past.

A Key Turning Point

September 2014 may be a month to remember – jot it down in the depths of your memory as it may be a useful data point some time down the road. Why? Because it was the point at which the largest pension fund in the United States, the California Public Employee Retirement System (CalPERS), decided not to push forward with a larger allocation to hedge funds, and instead reversed course and cut their allocation to zero.

Citing costs and complexity, it is easy to see why the prior would be a problem for the taxpayer funded pension system. As James B. Stewart stated in his article for The New York Times, “the fees CalPERS paid [to hedge funds] would have soared to $1.35 billion” if they increased their hedge fund program to a meaningful allocation of their portfolio (~10-15%).

That’s clearly not a number that would make any investment committee member comfortable. The “CalPERS Decision” may be the real turning point for liquid alternatives, which are essentially hedge funds without performance fees wrapped in mutual fund or exchange traded fund wrappers.

By eliminating the performance fee, which generally is equal to 20% of annual returns, investors will reap the short- and long-term benefit of substantially lower costs. This lower cost will be attractive not only to individual investors and their advisors, but also to a much broader universe of investors that includes family offices, endowments, foundations and pension funds. Hedge funds are a key source of diversification for many of these investors already, and as more high quality mutual fund and ETF choices become available, investors will shift assets from higher cost hedge funds to lower cost liquid alternative vehicles.

It should be noted that most, but not all, alternative mutual funds do not incur a performance fee similar to a hedge fund performance fee. However, certain structures within mutual funds do allow for the mutual fund to indirectly purchase limited partnerships (i.e. hedge funds) that charge traditional hedge fund fees, including a performance fee.

New Fund Launches

As of this writing, September saw only six new alternative fund launches, with five of those being mutual funds. Additional launches often occur on the last day of the month, so others may be near, including a long/short equity fund from Goldman Sachs and a multi-alternative fund from Lazard. Two notable new funds that have launched are as follows:

• AQR Style Premia Alternative LV Fund (QSLIX) – this is a low volatility version of an existing AQR fund, but is interesting because it takes a leveraged market neutral approach to investing across multiple asset classes using a factor based investment approach. With a targeted volatility level similar to intermediate term bonds, this fund could be a good substitute for long-only fixed income if rates start to rise.
• Eaton Vance Richard Bernstein Market Opportunities Fund (ERMIX) – this new global macro fund is managed by the former Chief Investment Strategist at Merrill Lynch and the fund’s namesake, Richard Bernstein. The market environment is getting better for global macro funds as the Fed eases up on QE and more natural market trends re-emerge. Keep an eye on this one.

A full list of new funds can be found on the DailyAlts’ New Fund Listing.

New Fund Registrations

We tracked ten new alternative mutual fund filings in September, which means that the end of the year will be flush with new funds. Four of the filings are for long/short equity, which has been a recipient of significant inflows over the past year. Two of the notable filings outside of long/short equity include the following:

o  State Street Global Macro Absolute Return Fund – another go-anywhere global macro fund that will invest across global markets and asset classes. As with the new Eaton Vance fund above, the timing could be good and the universe for global macro funds is relatively small.

o   Palmer Square Long Short Credit Fund – just in time for rising interest rates, this new fund comes from a boutique asset management firm with a highly experienced fixed income team. The fund has a wide range of credit oriented securities that it can use on both a long and short basis to generate absolute (positive) returns over full market cycles.

Other Items of Interest

• On the ETF front, First Trust launched an actively managed long/short equity ETF. We’ll keep an eye on this low cost vehicle to see how well a long/short strategy can do in an ETF wrapper.
• HedgeCo launched HedgeCoVest, a managed accounts platform available to individual investors for as little as $30,000. Investors can get a hedge fund managed in their own brokerage account with full liquidity and transparency. This could be a real market disruptor.
• TFS marked the 10-year anniversary of their TFS Market Neutral Fund (TFSMX). Quite an accomplishment, especially when (in hindsight) being “market neutral” over the past five years has not been a desirable bet. But as we know, the next five years won’t be like the past five years. Congrats to TFS.

We look forward to bringing readers of the Mutual Fund Observer monthly insights on the evolving market for alternative mutual funds.

Meh. Just meh.

From time to time, I come across what strikes me as an extraordinarily cool website or online retailer. In the past those have included the DailyAlts site and the Duluth Trading Company. When that happens, I’m predisposed to share word about the site with you, for your sake and for theirs.

I still remember a sign in the hot dog shop’s window from when I was in grad school: “eat here or we’ll both go hungry.” It’s sort of like that.

I have lately been delighted with the little online shop, meh. If we were Vikings, that would be “meh son of woot” or “meh wootson.” Woot was an online shop launched in 2004. The founders worked as wholesalers and looked at the challenge of selling what I think of as “orphan goods.” That is, stuff where the quantity available is substantial but too small to be profitably distributed through a mainline retailer. Woot was distinguished by two characteristics: (1) a one-deal-one-day business model in which shoppers were offered one deeply discounted item each day and at the day’s end, the item vanished. And (2) a snarky dismissiveness of their own offerings.

It was sufficiently cool that Amazon.com bought it in 2010 and messed it up by, oh, 2011. Instead of advertising one great deal, Amazon thought they should offer one deal in each of ten categories, plus Side Deals and Woot!Plus deals and miscellaneous sale items from Amazon’s own site and goodness knows what else.

Woot’s founders decided to try again (presumably after the expiration of non-compete agreements) and, with the help of Kickstarter funding, launched meh. Like the original Woot!, meh offers precisely one deal for no more than 24 hours. The site is tantalizing for two reasons: (1) the stuff is always cheap and sometimes outstanding and (2) checking each day takes me about 30 seconds since there’s, well, just one thing.

What sort of “one thing”? 40 AA Panasonic batteries for $5. Two refurbished 39” Emerson LCD TVs for $300 (not $300 each, $300 for the pair). A Phillips Blu-ray player for $15. Down alternative comforters for $18-20. (I bought two for my son’s bed, under the assumption that 14-year-olds will eventually spot, stain or shred pretty much anything within reach.) A padded laptop, a refurbished Dyson DC41 vacuum, Bluetooth keyboards for your tablet. Stuff.

It’s a small operation. Shipping tends to be slow. They charge $5 per item to ship unless you join their Very Mediocre Person service where you get unlimited free shipping for $5/month. A lot, but not all, of the stuff is refurbished. Neither bells nor whistles are in evidence. On whole they are, I guess, sort of “meh.”

That said, they’re also worth visiting. (And no, we have no relationship of any sort with them. You’re so suspicious.) meh.

Briefly Noted . . .

Effective November 1, 2014, Catalyst/Lyons Hedged Premium Return Fund (CLPAX/ CLPFX) will pursue “long-term capital appreciation and income with less downside volatility than the equity market.” That’s a bold departure from the current promise to seek “long-term capital appreciation and income with low volatility and low correlation to the equity market.”

On October 1^st, FTSE and Research Affiliates rolled out a new set of low-volatility indexes. As with many RAFI products, the stocks in the index are weighted using fundamental factors, as opposed to market capitalization. Jason Hsu, one of the RA co-founders, describes it as “a next generation approach that produces a low volatility core universe which is valuation-aware, without uncomfortable country or sector active bets.” Given that there’s $60 billion in funds, ETFs and separate accounts benchmarked against the existing FTSE RAFI indexes, you might reasonably expect the product launches to commence in the near future.

Matthews raised the expense ratio on Matthews China Fund (MCHFX) by one basis point at the end of September, netting them a cool $110,000 on a $1.1 billion fund. MCHFX and Matthews Asia Dividend have both qualified for access to Chinese “A” shares, expenses relating to which apparently triggered the one bp bump.

In another odd development, the Board of Trustees of the Value Line Core Bond Fund (VAGIX) approved a 3:1 reverse stock split on or about October 17, 2014. It’s incredibly rare for a fund to execute a split or a reverse split because the fund’s NAV has absolutely no relevance to its operation. With stocks, share prices that are too low might trigger a delisting alert and shares prices that are too high (think Berkshire Hathaway Cl A shares) might impede trading. Funds have no such excuse. When I spoke with a fund rep, she dutifully read Value Line’s one-sentence rationale to me: “It will realign our fund’s NAV with their peers’ and daily performance would be more appropriately reported.” Neither she nor I nor why the former was important or how the latter occurred, so I rack it up to “it’s Value Line. They do that sort of thing.”

Seafarer adds capacity

As Seafarer Overseas Growth & Income (SFGIX) grows steadily in size, it’s now over $117 million, and approaches its third anniversary, Andrew Foster has taken the opportunity to add to his analyst corps.  The estimable Kate Jacquet (Morningstar keeps misspelling her name as “Jacque”) is joined by Paul Espinosa and Sameer Agarwal.   Paul was a London-based analyst who has worked for Legg Mason, JP Morgan, Citigroup and Salomon Brothers.  He’s got some interesting experience in small cap and market neutral strategies.  Sameer grew up in India and worked for an India-based mutual fund before joining Royal Bank of Scotland and later Cartica Management, LLC.  Cartica is a sort of liquid alts manager focusing on the emerging markets.  I’ll ask Andrew in the month ahead how the guys’ work with what appear to be hedged products might contribute to Seafarer’s famously risk-conscious approach.

Seafarer reduced its expenses again, to 1.25% for Investor shares, though Morningstar continues to report a higher cost. 

SMALL WINS FOR INVESTORS

Appleseed (APPLX/APPIX) is lowering their expenses for both investor and institutional classes. Manager Joshua Strauss writes: “As we begin a new fiscal year Oct. 1, we will be trimming four basis points off Appleseed Fund Investor shares, resulting in a 1.20% net expense ratio. At the same time, we will be lowering the net expense ratio on Institutional shares by four basis points, to 0.95%.” It’s a risk-conscious, go-anywhere sort of fund that Morningstar has recognized as one of the few smaller funds that’s impressed them.

CLOSINGS (and related inconveniences)

Grandeur Peak Global Reach (GPROX), which was already soft closed to new investors, imposed a hard close on virtually all investors on September 30^th.

“Effective immediately, and until further notice” Guggenheim Alpha Opportunity Fund (SAOAX) has closed to all investors. That’s odd. It’s an exceedingly solid long/short fund with negligible assets. There’s been some administrative reshuffling going on but no clear indication of the fund’s future.

OLD WINE, NEW BOTTLES

The Absolute Opportunities Fund has been renamed the Absolute Credit Opportunities Fund (AOFOX). Its prospectus is being revised to reflect a focus on credit-related strategies. At the same time, the fund’s expense ratio is dropping from a usurious 2.75% down to a high 1.60%.

Chilton Realty Income & Growth Fund (REIAX) has become West Loop Realty Fund.

Effective on September 2, 2014, Dreyfus Select Managers Long/Short Equity Fund (DBNAX) became Dreyfus Select Managers Long/Short Fund (DBNAX). Dropping the word “equity” from the name allows the managers to invest more than 20% of the portfolio in non-equity securities but it’s not clear that any great change is in the works. The new prospectus still relegates non-equity securities to one line at the end of paragraph four: “The fund may invest, to a limited extent, in bonds and other fixed-income securities.”

Effective October 1, 2014, Mellon Capital Management Corporation replaced PVG Asset Management Corporation as sub-adviser to the Dunham Loss Averse Equity Income Fund (DAAVX),which was then re-named the Dunham Dynamic Macro Fund.

John Hancock China Emerging Leaders Fund (JCHLX) is rethinking the whole “China” thing and has become just the John Hancock Emerging Leaders Fund. The change allows them to invest across the emerging markets. DFA will still manage the fund.

Effective at the close of business on October 15, 2014, Loomis Sayles Capital Income Fund (LSCAX) becomes Loomis Sayles Dividend Income Fund. The investment strategies change to stipulate the fact that they’ll be investing, mostly, in equities.

Effective September 16, 2014, Market Vectors Wide Moat ETF (MOAT) became Market Vectors Morningstar Wide Moat ETF.

Pioneer is planning to find Solutions for you. Effective mid November, all of the Pioneer Ibbotson Allocation funds will jettison Ibbotson and gain Solutions. So, for example, Pioneer Ibbotson Growth Allocation Fund (GRAAX) will be Pioneer Solutions: Growth Fund. Moderate Allocation (PIALX) will become Solutions: Balanced and Conservative Allocation (PIAVX) will become Solutions: Conservative. Some as-yet undisclosed strategy and manager changes will accompany the name changes.

In that same “let’s add the name of someone well-known to our fund’s name” vein, what was Ramius Trading Strategies Managed Futures Fund (RTSRX) is now State Street/Ramius Managed Futures Strategy Fund. SSgA replaced Horizon Cash Management LLC as manager.

OFF TO THE DUSTBIN OF HISTORY

Dreyfus Emerging Asia Fund (DEAAX) becomes Dreyfus Submerging Asia Fund on or about October 30, 2014. The decision to liquidate caps a sorry seven year run for the tiny, volatile fund which made a ton of money for investors in 2009 (130%) but was unrelievedly bad the rest of the time.

Driehaus Global Growth Fund (DRGGX)is slated to liquidate on October 20, 2014. Cycling through a half dozen managers in a half dozen years certainly didn’t solve the fund’s performance problems and might well have deepened them.

Forward Managed Futures Strategy Fund (FUTRX) no longer has a future, a fact which will be formalized with the fund’s liquidation on October 31, 2014. The fund has lost about 12% since launch in 2012. The whole managed futures universe has performed so abysmally that you have to wonder if regression to the mean is about to rescue some of the surviving funds.

Huntington International Equity Fund (HIEAX) is merging into Huntington Global Select Markets Fund (HGSAX). Effectively both funds are being liquidated. HEIAX disappears entirely and HGSAX transforms from an underperforming equity markets stock fund to a global balanced fund with no particular tilt toward the Ems. The same management team that struggled with these as international equity funds will be entrusted with the new incarnation of Global Select. The best news is a new expense cap of 1.21% on Select. The worst news is that much of the combined portfolio might have to be liquidated to complete the transition.

Morgan Stanley Global Infrastructure Fund (UTLAX)will be absorbed by its institutional sibling, MSIF Select Global Infrastructure (MTIPX). They’re essentially the same fund, except for the fact that the surviving fund is much smaller and charges more. And, too, they’re both really good funds.

Nationwide International Value Fund (NWVAX)will be liquidated on December 19^th for all the usual reasons.

Effective November 14, 2014, Northern Large Cap Growth Fund (NOEQX) will merge into Northern Large Cap Core Fund (NOLCX). The Growth Fund shareholders get a major win out of the deal, since they’re joining a far stronger, larger, cheaper fund. The reorganization does not require a shareholder vote.

Perimeter Small Cap Growth Fund (PSCGX/PSIGX) has closed to new investors in anticipation of being liquidated on Halloween. The fund’s redemption fee has been waived, just in case you want to get out early.

On or about November 14, 2014, Pioneer Ibbotson Aggressive Allocation Fund (PIAAX) merges into Pioneer Ibbotson Growth Allocation Fund (GRAAX) At the same time, Growth Allocation changes its name to Pioneer Solutions – Growth Fund.

This is kind of boring, but here’s word that PNC Pennsylvania Tax Exempt Money Market Fund and PNC Ohio Municipal Money Market Fund both liquidate in early October.

QuantShares U.S. Market Neutral Momentum Fund (MOM) and QuantShares U.S. Market Neutral Size Fund (SIZ) are under threat of delisting. “The staff of NYSE Regulation, Inc. recently advised the Trust that the Funds’ shares currently are not in compliance with NYSE Arca, Inc.’s continued listing standards with respect to the number of record or beneficial holders. Therefore, commencing on or about September 16, 2014, NYSE Arca will attach a “below compliance” (.BC) indicator to each Fund’s ticker symbol … Should the Staff determine to delist a Fund, or should the Adviser conclude that a Fund cannot be brought into compliance with NYSE Arca’s continued listing standards, the Adviser will recommend the Fund’s liquidation to the Fund’s Board of Trustees and attempt to provide shareholders with advance notice of the liquidation.”

Pending shareholder approval, Sentinel Capital Growth Fund (BRGRX – it’d read as “Boogers” if it were a license plate) and Sentinel Growth Leaders Fund (BRFOX) will merge into Sentinel Common Stock Fund (SENCX). The shareholder meeting will nominally occur in lovely Montpelier, Vermont, on November 14^th. It wouldn’t be unusual for the merger to then occur by year’s end.

TCW Growth Fund (TGGYX) will liquidate around Halloween, 2014.

Turner Large Growth Fund (TCGFX) will soon merge into Turner Midcap Growth Fund (TMGFX), pending shareholder approval. I’ve never really gotten the Turner Funds. They always feel like holdovers from the run and gun ‘90s to me. The fact that Midcap Growth suffered a 56% drawdown during the financial crisis and is routinely a third more volatile than its peers fits with that impression.

Wade Tactical L/S Fund (WADEX) plans to cease and desist around the middle of October.

The Board of Directors for Western Asset Global Multi-Sector Fund (WALAX)has determined that “it is in the best interests of the fund and its shareholders to terminate the fund.” It seemed they long ago also determined it was in shareholders’ best interest not to invest in the fund:

The fund is expected to cease operations on or about November 14, 2014.

On January 30, 2015, Wilmington Short Duration Government Bond Fund (ASTTX) will be merged into the Wilmington Short-Term Corporate Bond Fund (MVSAX). Likewise the Wilmington Maryland Municipal Bond Fund (ARMRX) will be merged into the Wilmington Municipal Bond Fund (WTABX). The latter, muni into muni, makes more sense on face than the former.

The WY Core Fund (SGBFX/SGBYX) disappeared on September 30^th, just in case you were wondering why there’s an empty seat at the table.

In Closing . . .

As I sat in my study, 11:30 p.m. CDT on the last day of September, finishing this essay, my internet connection disappeared.  Then the lights flickered, flashed then failed.  Nuts.  The MidAmerican Energy outage map shows that I was one of precisely two customers to lose power.  This is the second time since moving to my new home in May that the power disappeared just as we were trying to finishing an update.  The first time it happened we were in a world of hurt, both having lost a bunch of writing and having the rest of the new issue trapped inside an inert machine.

This time we were irked and modestly inconvenienced. The difference is that after the first major outage, Chip identified and I bought a really good uninterruptible power supply (UPS) for us. While it’s not an industrial grade unit, it allowed me to save everything, move it for safekeeping to an external solid-state drive and finish the story I was working on before shutting the system down. We resumed work a bit before dawn and finished everything roughly on time.

All of which is to say thank you! to all the folks who’ve supported the Observer.  I was deeply grateful that we had the resources at hand to react, quickly and frugally, to resolve the problems caused by the first outage.  Thanks to all the folks who use our Amazon link (feel free to share it!), to Joe and Bladen (cool old English name, linked to a village in Oxfordshire) who contributed to our resources this month but most especially to Deb who, in an odd sense, is the Observer’s only subscriber.  Deb arranged a monthly auto-transfer from her PayPal account which provides us with a modest, very welcome stipend at the beginning of each month.

The other project that you helped support this month was the first ever face-to-face meeting of the folks who write for you each month.  Charles, Chip, Ed and I gathered in Chicago in the immediate aftermath of the Morningstar ETF Conference to discuss (some would say “plot”) the Observer’s future.  Among our first priorities coming out of the meeting is to formalize the Observer as a legal enterprise: incorporation, pursue of 501(c)3 tax-exempt organization status, better liability and intellectual property protection and so on.  None of that will immediately change the Observer but it all lays the foundation for a more sustainable future.  So thanks for your help in covering the expenses there, too.

Take care and enjoy October.  It tends to be a rough and tumble month in the markets, but a fine time for visiting orchards with your family and starting the holiday fruitcakes.

As ever,