By David Snowball

Dear friends,

Welcome.  Do you think it a coincidence that the holiday season occurs at the least promising time of the year?  The days are getting shorter and, for our none-too-distant ancestors, winter represented a period of virtual house arrest.  Night was a time of brigands and beasts.  Even in the largest cities, respectable folks traveled abroad after dark only with armed guard.  In villages and on farms, travel on a clouded night risked disappearance and death.  The homes of all but the richest citizens were, contrary to your mental fantasy of roaring hearths and plentiful candles, often a single room that could boast a single flickering rushlight.  The hungry months of late winter were ahead.

And so they did what any sensible group would do.  They partied.  One day’s worth of oil became eight nights’ worth of light; Jewish friends gathered, ate and gifted.  Bacchus reigned from our Thanksgiving to the Winter Solstice, and the Romans drank straight through it.  The Kalash people of Pakistan sang, danced, lit bonfires and feasted on goat tripe “and other delicacies” (oh, yum!).  Chinese and Korean families gathered and celebrated with balls of glutinous rice (more yum!).  Welsh friends dressed up like wrens (yuh), and marched from home to home, singing and snacking.  Romans in the third century CE celebrated Dies Natalis Solis Invicti (festival of the birth of the Unconquered Sun) on December 25^th, a date later borrowed by Christians for their own mid-winter celebration.  Some enterprising soul, having consumed most of the brandy, inexplicably mashed together figs, stale bread and the rest of the brandy.  Figgy pudding was born and revelers refused to go until they got some (along with a glass of good cheer).

Few of these celebrations recognized a single day, they brought instead Seasons Greetings.  Fewer still celebrated individual success or personal enrichment, they instead brought to the surface the simple truth that we often bury through the rest of the year: we are infinitely poorer alone in our palaces than we are together in our villages.

Season’s greetings, dear friends.

But curb yer enthusiasm

Small investors and great institutions alike are partaking in one of the market’s perennial ceremonies: placing your investments atop an ever-taller pile of dried kindling and split logs.  All of the folks who hated stocks when they were cheap are desperate to buy them now that they’re expensive.

We have one word for you: Don’t.

Or, at the very least, don’t buy them until you’re clear why they weren’t attractive to you five years ago but are calling so loudly to you now.  We’re not financial planners, much like market visionaries, but some very careful folks forecast disappointment for starry-eyed stock investors in the years ahead.

Sam Lee, editor of Morningstar ETFInvestor, warned investors to “Expect Below-Average Stock Returns Ahead” based on his reading of the market’s cyclically-adjusted price/earnings ratio.  He wrote, on November 21, that:

The Shiller P/E recently hit 25. When you invert that you get is another measure that I like: the cyclically adjusted earnings yield. The inverse of the Shiller P/E, 1 divided by 25 is about 0.04, or 4%. And this is the smooth earnings yield of the market. This is actually, I think, a reasonable forecast for what the market can be expected to return during the next 10, 20 years. And a 4% real expected return is well below the historical average of 6.5%. 

The Shiller P/E is saying that the market is overvalued relative to history, that you can expect about 2 percentage points less per year over a long period of time. .. if you believe that the market is mean reverting to its historical Shiller P/E, and that the past is a reasonable guide to the future, then you can expect lower returns than the naive 4% forecast return that I provided.

The institutional investors at Grantham, Mayo, van Otterloo (GMO) believe in the same tendency of markets to revert to their mean valuations and profits to revert to their mean levels (that is, firms can’t achieve record profit levels forever – some combination of worker demands to share the wealth and predatory competitors drawn by the prospect of huge profits, will drive them back down).  After three years of research on their market projection models, GMO added some factors that slightly increased their estimate of the market’s fair value and still came away from the projection that US stocks are poised to trail inflation for the rest of this decade.  Ben Inker writes:

In a number of ways it is a “clean sheet of paper” look at forecasting equities, and we have broadened our valuation approach from looking at valuations through the lens of sales to incorporating several other methods. It results in about a 0.7%/year increase in our forecast for the S&P 500 relative to the old model. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation.

On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. For those interested in the broader U.S. stock market, our forecast for the Wilshire 5000 is a bit worse, at -2.0%, due to the fact that small cap valuations are even more elevated than those for large caps.

In 2013, the average equity investor made inflation plus about 28%.  Through the remainder of the decade, optimists might give you inflation plus 2, 3 or 4%.  Bearish realists are thinking inflation minus 1 or 2%.

The Leuthold Group, looking at the market’s current valuation, is at most masochistically optimistic: they project that a “normal” bear market, starting now, would probably not trim much more than 25% off your portfolio.

What to do?  Diversify, keep expenses aligned with the value added by your managers, seek some income from equities and take time now – before you forget and before some market event makes you want to look away forever – to review your portfolio for balance and performance.  As an essential first step, remember the motto:

Off with their heads!

As the Thanksgiving holiday passes and you begin year-end financial planning, we say it’s time to toss out the turkeys.  There are some funds that we’re not impressed with but which have the sole virtue that they’re not rolling disasters. You know: the overpriced, bloated index-huggers that seemed like the “safe” choice long ago. And now, like mold or lichen, they’ve sort of grown on you.

Fine. Keep ‘em if you must. But at least get rid of the rolling disasters you’ve inherited. There are a bunch of funds whose occasional flashes of adequacy and earnest talk of new paradigms, great rotations, sea changes, and contrarian independence simply can’t mask the fact that they suck. A lot. For a long time.

It’s time to work through your portfolio, fund by fund, and answer the simple question: “if I didn’t already own this fund, is there any chance on earth I’d buy it?” If the answer is “no,” sell.

Mutual Fund Observer is an outgrowth of FundAlarm, whose iconic Three Alarm Funds list continually identified the worst of the worst in the fund industry. For the last several years we’ve published our own Roll Call of the Wretched, an elite list of funds whose ineptitude stretches over a decade or more. In response to requests that arrive every month, we’re happy to announce the re-introduction of the Three Alarm Funds list which will remain an ongoing service of the Observer. So here we go!

The Observer’s Annual “Roll Call of the Wretched”

If you’re resident in one of the two dozen states served by Amazon’s wine delivery service, you might want to buck up your courage with a nice 2007 Domaine Gerard Charvin Chateauneuf du Pape Rhône Valley Red before you settle in to enjoy the Observer’s annual review of the industry’s Most Regrettable funds. Just as last year, we looked at funds that have finished in the bottom one-fourth of their peer groups for the year so far. And for the preceding 12 months, three years, five years and ten years. These aren’t merely “below average.” They’re so far below average they can hardly see “mediocre” from where they are.

When we ran the screen in 2011, there were 151 consistently awful funds, the median size for which is $70 million. In 2012 there were . . . 151 consistently awful funds, the median size for which is $77 million. And now? 152 consistently awful funds (I love consistency), the median size of which is $91 million.

Since managers love to brag about the consistency of their performance, here are the most consistently awful funds that have over a billion in assets. Funds repeating from last year are flagged in red.

Some funds did manage to escape this year’s Largest Wretched Funds list, though the strategies vary: some went extinct, some took on new names, one simply shrank below our threshold and a few rose all the way to mediocrity. Let’s look:

While most Roll Call funds are small enough that they’re unlikely to trouble you, there are 50 more funds with assets between $100 million and a billion. Check to see if any of these wee beasties are lurking around your portfolio:

Morningstar maintains a favorable analyst opinion on three Wretched funds, is Neutral on three (Brandywine BRWIX, Fidelity Freedom 2000 FFFMX and Pioneer PIODX) and Negative on just four (Hussman Strategic Growth HSGFX, Oppenheimer Flexible Strategies QVOPX and two State Farm LifePath funds). The medalist trio are:

And now (drum roll, please), it’s the return of a much-loved classic …

Three Alarm Funds Redux

Roy Weitz first published the legacy Three Alarm fund list in 1996. He wanted to help investors decide when to sell mutual funds. Being on the list was not an automatic sell, but a warning signal to look further and see why.

“I liken the list to the tired old analogy of the smoke detector. If it goes off, your house could be on fire. But it could also be cobwebs in the smoke detector, in which case you just change the batteries and go back to sleep,” he explained in a 2002 interview.

Funds made the list if they trailed their benchmarks for the past 1, 3, and 5 year periods. At the time, he grouped funds into only five equity (large-cap, mid-cap, small-cap, balanced, and international) and six specialty “benchmark categories.” Instead of pure indices, he used actual funds, like Vanguard 500 Index Fund VFINX, as benchmarks. Occasionally, the list would catch some heat because “mis-categorization” resulted in an “unfair” rating. Some things never change.

At the end of the day, however, Mr. Weitz wanted “to highlight the most serious underperformers.” In that spirit, MFO will resurrect the Three Alarm fund list, which will be updated quarterly along with the Great Owl ratings. Like the original methodology, inclusion on the list will be based entirely on absolute, not risk-adjusted, returns over the past 1, 3, and 5 year periods.

Since 1996, many more fund categories exist. Today Morningstar assigns over 90 categories across more than 7500 unique funds, excluding money market, bear, trading, volatility, and specialized commodity. MFO will rate the new Three Alarm funds using the Morningstar categories. We acknowledge that “mis-categorization” may occasionally skew the ratings, but probably much less than if we tried to distill all rated funds into just 11 or so categories.

For more than two-thirds of the categories, one can easily identify a reasonable “benchmark” or reference fund, thanks in part to the proliferation of ETFs. Below is a sample of these funds, sorted first by broad investment Type (FI – Fixed Income, AA – Asset Allocation, EQ – Equity), then Category:

Values in the table include the 3-year annualized standard deviation percentage (STDEV), as well as annualized return percentages (APR) for the past 1, 3, and 5 year periods.

A Return Rating is assigned based how well a fund performs against other funds in the same category during the same time periods. Following the original Three Alarm nomenclature, best performing funds rate a “2” (highlighted in blue) and the worst rate a “-2” (red).

As expected, most of the reference funds rate mid range “0” or slightly better. None produce top or bottom tier returns across all evaluation periods. The same is true for all 60 plus category reference funds. Selecting reference funds in the other 30 categories remains difficult because of their diversity.

To “keep it simple” MFO will include funds on the Three Alarm list if they have the worst returns in their categories across all three evaluation periods. More precisely, Three Alarm Funds have absolute returns in the bottom quintile of their categories during the past 1, 3, and 5 years. Most likely, these funds have also under-performed their “benchmarks” over the same three periods.

There are currently 316 funds on the list, or fewer than 6% of all funds rated. Here are the Three Alarm Funds in the balanced category, sorted by 3 year annualized return:

Like in the original Three Alarm list, a fund’s Risk Rating is assigned based a “potential bad year” relative to other funds in the same category. A Risk Rating of “2” (highlighted in red) goes to the highest risk funds, while “-2” (blue) goes to the lowest risk funds. (Caution: This rating measures a fund’s risk relative to other funds in same category, so a fund in a high volatility category like energy can have high absolute risk relative to market, even if it has a low risk rating in its category.)

“Risk” in this case is based on the 3 year standard deviation and return values. Specifically, two standard deviations are subtracted from the return value. The result is then compared with other funds in the category to assign a rating. The rating is a little more sensitive to downside than the original measure as investors have experienced two 50% drawdowns since the Three Alarm system was first published.

While never quite as popular as the Three Alarm list, Mr. Weitz also published an Honor Roll list. In the redux system, Honor Roll funds have returns in the top quintile of their categories in the past 1, 3, and 5 years. There are currently 339 such funds.

The Three Alarm, Honor Roll, and Reference funds can all be found in a down-loadable *.pdf version.

06Nov2013/Charles

Funds that are hard to love

Not all regrettable funds are defined by incompetent management. Far from it. Some have records good enough that we really, really wish that they weren’t so hard to love (or easy to despise). High on our list:

Oceanstone Fund (OSFDX)

Why would we like to love it? Five-star rating from Morningstar. Small asset base. Flexible mandate. Same manager since launch. Top 1% returns over the past five years.

What makes it hard to love? The fund is entirely opaque and the manager entirely autocratic. Take, for example, this sentence from the Statement of Additional Information:

Ownership of Securities: As of June 30, 2013, the dollar range of shares in the Fund beneficially owned by James J. Wang and Yajun Zheng is $500,001-$1,000,000.

Mr. Wang manages the fund. Ms. Zheng does not. Nor is she a director or board member; she is listed nowhere else in the prospectus or the SAI as having a role in the fund. Except this: she’s married to Mr. Wang. Which is grand. But why is she appearing in the section of the manager’s share ownership?

Mr. Wang was the only manager to refuse to show up to receive a Lipper mutual fund award. He’s also refused all media attempts to arrange an interview and even the chairman of his board of trustees sounds modestly intimidated by him. His explanation of his investment strategy is nonsense. He keeps repeating the magic formula: IV = IV divided by E, times E. No more than a high school grasp of algebra tells you that this formula tells you nothing. I shared it with two professors of mathematics, who both gave it the technical term “vacuous.” It works for any two numbers (4 = 4 divided by 2, times 2) but it doesn’t allow you to derive one value from the other.

The fund’s portfolio turns over at triple the average rate, consists of just five stocks and a 70% cash stake.

Value Line Asset Allocation Fund (VLAAX)

Why would we like to love it? Five-star rating from Morningstar. Consistency below-average to low risk. Small asset base. Same manager for 20 years. Top tier returns over the past decade.

What makes it hard to love? Putting aside the fact that the advisory firm’s name is “value” spelled backward (“Eulav”? Really guys?), it’s this sentence:

Ownership of Securities. None of the portfolio managers of the Value Line Asset Allocation Fund own shares of the Fund. The portfolio manager of the Value Line Small Cap Opportunities Fund similarly does not own shares of that Fund.

It’s also the fact that I’ve tried, on three occasions, to reach out to the fund’s advisor to ask why no manager ever puts a penny alongside his shareholders but they’ve never responded to any of the queries.

But wait! There’s 

Four things strike us as quite good:

1. You probably aren’t invested in any of the really rotten funds!
2. Even if you are, you know they’re rotten and you can easily get out.
3. There are better funds – ones more appropriate to your needs and personality – available.
4. We can help you find them!

Accipiter, Charles and Chip have been working hard to make it easier for you to find funds you’ll be comfortable with. We’d like to share two and have a third almost ready, but we need to be sure that our server can handle the load (we might a tiny bit have precipitated a server crash in November and so we’re being cautious until we can arrange a server upgrade).

The Risk Profile Search is designed to help you understand the different measures of a fund’s risk profile. Most fund profiles reduce a fund’s risks to a single label (“above average”) or a single stat (standard deviation = 17.63). Unfortunately, no one measure of risk captures the full picture and most measures of risk are not self-explanatory (how would you do on a pop quiz over the Martin Ratio?). Our Risk Profile Reporter allows you to enter a single ticker symbol for any fund and it will generate a short, clear report, in simple, conversational English, that walks you through the various means of risk and returns and will provide you with the profiles for a whole range of possible benchmarks. Alternatively, entering multiple ticker symbols will return a tabular results page, making side-by-side comparisons more convenient.

The Great Owl Search Engine allows you to screen our Great Owl Funds – those which have top tier performance in every trailing period of three years or more – by category or profile. We know that past performance should never be the primary driver of your decision-making, but working from a pool of consistently superior performers and learning more about their risk-return profile strikes us as a sensible place to start.

Our Fund Dashboard. a snapshot of all of the funds we’ve profiled, is updated quarterly and is available both as a .pdf and searchable, sortable search.

Accipiter’s Miraculous Multi-Search will, God and server willing, launch by mid-December and we’ll highlight its functions for you in our New Year’s edition.

Touchstone Funds: Setting a high standard on analysis

On November 13, Morningstar published an essay entitled “A Measure of Active Management.” Authored by Touchstone Investments, it’s entirely worth your consideration as one of the most readable walk-throughs available of the literature on active management and portfolio outperformance.

We all know that most actively managed funds underperform their benchmarks, often by more than the amount of their expense ratios. That is, even accounting for an index fund’s low-expense advantage, the average manager seems to actively detract value. Literally, many investors would be better off if their managers were turned to stone (“calling Madam Medusa, fund manager in Aisle Four”), the portfolio frozen and the manager never replaced.

Some managers, however, do consistently earn their keep. While they might or might not produce raw returns greater than those in an index fund, they can fine-tune strategies, moderate risks and keep investors calm and focused.

Touchstone’s essay at Morningstar makes two powerful contributions. First, the Touchstone folks make the criteria for success – small funds, active and focused portfolios, aligned interests – really accessible. Second, they document the horrifying reality of the fund industry: that a greater and greater fraction of all investments are going into funds that profess active management but are barely distinguishable from their benchmarks.

Here’s a piece of their essay:

A surprising take away from the Active Share studies was the clear trend away from higher Active Share (Exhibit 5). The percentage of assets in U.S. equity funds with Active Share less than 60% went from 1.5% in 1980 to 50.2% in 2009. Clearly indexing has had an impact on these results.

Yet mutual funds with assets under management with an Active Share between 20% and 60% (the closet indexers) saw their assets grow from 1.1% in 1980 to 31% in 2009, meaning that closet index funds have seen the greatest proportion of asset growth. Assets in funds managed with a high Active Share, (over 80%), have dropped precipitously from 60% in 1980 to just 19% in 2009.

While the 2009 data is likely exaggerated — as Active Share tends to come down in periods of high market volatility —the longer term trend is away from high Active Share.

 

Cremers and Petajisto speculate that asset growth of many funds may be one of the reasons for the trend toward lower Active Share. They note that the data reveals an inverse relationship between assets in a fund and Active Share. As assets grow, managers may have a tougher time maintaining high Active Share. As the saying goes “nothing fails like success,” and quite often asset growth can lead to a more narrow opportunity set due to liquidity constraints that prevent managers from allocating new assets to their best ideas, they then add more liquid benchmark holdings. Cremers states in his study: “What I say is, if you have skill, why not apply that skill to your whole portfolio? And if your fund is too large to do that, why not close your portfolio?”

In an essentially unprecedented disclosure, Touchstone then published the concentration and Active Share statistics for their entire lineup of funds:

While it’s clear that Touchstone has some great funds and some modest ones, they really deserve attention and praise for sharing important, rarely-disclosed information with all of their investors and with the public at large. We’d be much better served if other fund companies had the same degree of confidence and transparency.

Touchstone is also consolidating four funds into two, effective March 2014. Steve Owen, one of their Managing Directors and head of International Business Development, explains:

With regard to small value, we are consolidating two funds, both subadvised by the same subadvisor, DePrince, Race & Zollo. Touchstone Small Cap Value Fund (TVOAX) was a legacy fund and that will be the receiving fund. Touchstone Small Company Value Fund (FTVAX), the one that is going away, is a fund that was adopted last year when we bought the Fifth Third Fund Family and we replaced the subadvisor at that time with DePrince Race & Zollo. Same investment mandate, same subadvisor, so it was time to consolidate the two funds.

The Mid Value Opportunities Fund (TMOAX)was adopted last year from the Old Mutual Fund Family and will be merged into Touchstone Mid Cap Value Fund (TCVAX). Consolidating the lineup, eliminating the adopted fund in favor of our incumbent from four years ago.

In preparation for the merger, Lee Munder Capital Group has been given manager responsibilities for both mid-cap funds. Neither of the surviving funds is a stand-out performer but bear watching.

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.

Aegis Value (AVALX): There are a few funds that promise to pursue the most inefficient, potentially most profitable corner of the domestic equity mark, ultra-small deep value stocks. Of the handful that pursue it, only one other microcap value fund even comes close to Aegis’s long-term record.

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously. Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds. So far, so good!

Elevator Talk

Elevator Talks are a short feature which offer the opportunity for the managers of interesting funds which we are not yet ready to profile, to speak directly to you. The basic strategy is for the Observer to lay out three paragraphs of introduction and then to give the manager 200 unedited words – about what he’d have time for in an elevator ride with a prospective investors – to lay out his case for the fund.

Our planned Elevator Talk for December didn’t come to fruition, but we’ll keep working with the managers to see if we can get things lined up for January.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.
10. November 2013: Jeffrey Ringdahl of American Beacon Flexible Bond (AFXAX) gives teams from Brandywine Global, GAM and PIMCO incredible leeway wth which to pursue “positive total return regardless of market conditions.” Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Conference Call Highlights: John Park and Greg Jackson, Oakseed Opportunity

If I had to suggest what characteristics gave an investor the greater prospects for success, I suggest looking for demonstrably successful managers who viscerally disliked the prospect of careless risk and whose interests were visibly, substantially and consistently aligned with yours.

The evidence increasingly suggests that Oakseed Opportunity matches those criteria. On November 18^th, Messrs Jackson and Park joined me and three dozen Observer readers for an hour-long conversation about the fund and their approach to it.

I was struck, particularly, that their singular focus in talking about the fund is “complete alignment of interests.” A few claims particularly stood out:

1. their every investable penny in is in the fund.
2. they intend their personal gains to be driven by the fund’s performance and not by the acquisition of assets and fees
3. they’ll never manage separate accounts or a second fund
4. they created an “Institutional” class as a way of giving shareholders a choice between buying the fund NTF with a marketing fee or paying a transaction fee but not having the ongoing expense; originally they had a $1 million institutional minimum because they thought institutional shares had to be that pricey. Having discovered that there’s no logical requirement for that, they dropped the institutional minimum by 99%.
5. they’ll close on the day they come across an idea they love but can’t invest in
6. they’ll close if the fund becomes big enough that they have to hire somebody to help with it (no analysts, no marketers, no administrators – just the two of them)

Highlights on the investing front were two-fold:

first, they don’t intend to be “active investors” in the sense of buying into companies with defective managements and then trying to force management to act responsibly. Their time in the private equity/venture capital world taught them that that’s neither their particular strength nor their passion.

second, they have the ability to short stocks but they’ll only do so for offensive – rather than defensive – purposes. They imagine shorting as an alpha-generating tool, rather than a beta-managing one. But it sounds a lot like they’ll not short, given the magnitude of the losses that a mistaken short might trigger, unless there’s evidence of near-criminal negligence (or near-Congressional idiocy) on the part of a firm’s management. They do maintain a small short position on the Russell 2000 because the Russell is trading at an unprecedented high relative to the S&P and attempts to justify its valuations require what is, to their minds, laughable contortions (e.g., that the growth rate of Russell stocks will rise 33% in 2014 relative to where they are now.

Their reflections of 2013 performance were both wry and relevant. The fund is up 21% YTD, which trails the S&P500 by about 6.5%. Greg started by imagining what John’s reaction might have been if Greg said, a year ago, “hey, JP, our fund will finish its first year up more than 20%.” His guess was “gleeful” because neither of them could imagine the S&P500 up 27%. While trailing their benchmark is substantially annoying, they made these points about performance:

• beating an index during a sharp market rally is not their goal, outperforming across a complete cycle is.
• the fund’s cash stake – about 16% – and the small short position on the Russell 2000 doubtless hurt returns.
• nonetheless, they’re very satisfied with the portfolio and its positioning – they believe they offer “substantial downside protection,” that they’ve crafted a “sleep well at night” portfolio, and that they’ve especially cognizant of the fact that they’ve put their friends’, families’ and former investors’ money at risk – and they want to be sure that they’re being well-rewarded for the risks they’re taking.

John described their approach as “inherently conservative” and Greg invoked advice given to him by a former employer and brilliant manager, Don Yacktman: “always practice defense, Greg.”

When, at the close, I asked them what one thing they thought a potential investor in the fund most needed to understand in order to know whether they were a good “fit” for the fund, Greg Jackson volunteered the observation “we’re the most competitive people alive, we want great returns but we want them in the most risk-responsible way we can generate them.” John Park allowed “we’re not easy to categorize, we don’t adhere to stylebox purity and so we’re not going to fit into the plans of investors who invest by type.”

They announced that they should be NTF at Fidelity within a week. Their contracts with distributors such as Schwab give those platforms latitude to set the minimums, and so some platforms reflect the $10,000 institutional minimum, some picked $100,000 and others maintain the original $1M. It’s beyond the guys’ control.

Finally, they anticipate a small distribution this year, perhaps $0.04-0.05/share. That reflects two factors. They manage their positions to minimize tax burdens whenever that’s possible and the steadily growing number of investors in the fund diminishes the taxable gain attributed to any of them.

If you’re interested in the fund, you might benefit from reviewing the vigorous debate on the discussion board that followed the call. Our colleague Charles, who joined in on the call, looked at the managers’ previous funds. He writes: “OK, quick look back at LTFAX and OAKGX from circa 2000 through 2004. Ted, even you should be impressed…mitigated drawdown, superior absolute returns, and high risk adjusted returns.”

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.

The SEEDX Conference Call

As with all of these funds, we’ve created a new featured funds page for Oakseed Opportunity Fund, pulling together all of the best resources we have for the fund.

December Conference Call: David Sherman, RiverPark Strategic Income

We’d be delighted if you’d join us on Monday, December 9^th, for a conversation with David Sherman of Cohanzick Asset Management and Morty Schaja, president of the RiverPark funds. On September 30, 2013, Cohanzick and Riverpark collaborated on the launch of their second fund together, RiverPark Strategic Income (RSIVX). Two months later, the fund has drawn nearly $90 million into a limited capacity strategy that sort of straddles the short- to intermediate-term border.

David describes this as a conservatively managed fund that focuses on reasonable returns with maximum downside protection. With both this fund and RiverPark Short-Term High-Yield (RPHYX, closed to new investors), David was comfortable having his mom invest in the fund and is also comfortable that if he gets, say, abducted by aliens, the fund could simply and profitably hold all of its bonds to redemption without putting her security as risk. Indeed, one hallmark of his strategy is its willingness to buy and hold to redemption rather than trading on the secondary market.

President Schaja writes, “In terms of a teaser….

• Sherman and his team are hoping for returns in the 6-8% range while managing a portfolio of “Money Good” securities with an average duration of less than 5 years.  Thereby, getting paid handsomely for the risk of rising rates.
• By being small and nimble Sherman and his team believe they can purchase “Money Good” securities with above average market yields with limited risk if held to maturity.
• The fund will be able to take advantage of some of the same securities in the 1-3 year maturity range that are in the short term high yield fund.
• There are “dented Credits” where credit stress is likely, however because of the seniority of the security the Fund will purchase, capital loss is deemed unlikely.

David has the fund positioned as the next step out from RPHYX on the risk-return spectrum and he thinks the new fund will about double the returns on its sibling. So far, so good:

Since I’m not a fan of wild rivers in a fixed-income portfolio, I really appreciate the total return line for the two RiverPark funds. Here’s Strategic Income against its multisector bond peer group:

Well, yes, I know that’s just two months. By way of context, here’s the three year comparison of RPHYX with its wildly-inappropriate Morningstar peer group (high yield bonds, orange), its plausible peer group (short-term bonds, green) and its functional peer, Vanguard’s Prime Money Market (VMMXX, hmmm…goldenrod?):

Our conference call will be Monday, December 9, from 7:00 – 8:00 Eastern. It’s free. It’s a phone call.

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WOULD AN ADDITIONAL HEADS UP HELP?

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Launch Alert: Kopernik Global All-Cap Fund (KGGAX and KGGIX)

It’s rare that the departure of a manager triggers that collapse of an empire, but that’s pretty much what happened when David Iben left his Nuveen Tradewinds Global All-Cap Fund (NWGAX) in June 2012. From inception through his departure, a $10,000 investment in NWGAX would have grown by $3750. An investment made in his average peer would have grown by $90.

Iben was hired away from Tradewinds by Jeff Vinik, the former Fidelity Magellan manager who’d left that fund in 1996 to establish his hedge fund firm, Vinik Asset Management. Iben moved with four analysts to Vinik and became head of a 20-person value investing team.

In the six months following his announced intention to depart, Tradewinds lost nearly 75% of its total assets under management. Not 75% of his funds’ assets. 75% of the entire firm’s assets, about $28 billion between investor exits and market declines.

In May 2013, Vinik announced the closure of his firm “citing poor performance over a 10-month period” (Tampa Bay Business Journal, May 3 2013). You’ll have to give me a second to let my eyes return to normal; the thought of closing a firm because of a ten month bad stretch made them roll.  Mr. Iben promptly launched his own firm, backed by a $20 million investment (a/k/a pocket change) by Mr. Vinik.

On November 1, 2013, Kopernik Global Investors launched launched Kopernik Global All-Cap Fund (Class A: KGGAX; Class I: KGGIX) which they hope will become their flagship. By month’s end, the fund had nearly $120 million in assets.

If we base an estimate of Kopernik Global on the biases evident in Nuveen Tradewinds Global, you might expect:

A frequently out-of-step portfolio, which reflects Mr. Iben’s value orientation, disdain for most investors’ moves and affinity for market volatility. They describe the outcome this way:

This investment philosophy implies ongoing contrarian asset positioning, which in turn implies that the performance of Kopernik holdings are less reliant on the prevailing sentiment of market investors. As one would expect with such asset positioning, the performance of Kopernik strategies tend to have little correlation to common benchmarks.

A substantial overweight in energy and basic materials, which Mr. Iben overweighted almost 2:1 relative to his peers. He had a particular affinity for gold-miners.

The potential for a substantial overweight in emerging markets, which Mr. Iben overweighted almost 2:1 relative to his peers.

A slight overweight in international stocks, which were 60% of the Tradewinds’ portfolio but a bit more than 50% of its peers.

The themes of independence, lack of correlation with other investments, and the exploitation of market anomalies recur throughout Kopernik’s website. If you’re even vaguely interested in exploring this fund, you’d better take those disclosures very seriously. Mr. Iben had brilliant performance in his first four years at Tradewinds, and then badly trailed his peers in five of his last six quarters. While we do not know how his strategy performed at Vinik, we do know that 10 months after his arrival, the firm closed for poor performance.

Extended periods of poor performance are one of the hallmarks of independent, contrarian, visionary investors. It’s also one of the hallmarks of self-prepossessed monomaniacs.  Sometimes the latter look like the former. Often enough, the former are the latter.

The first month of Kopernik’s performance (in blue) looks like this:

Mr. Iben is clearly not following the pack. You’d want to be comfortable with where he is leading the caravan before joining.

“A” shares carry a 5.75% load, capped 1.35% expenses and $3000 minimum. Institutional shares are no-load with expenses of 1.10% and a $1 million minimum. The fund is not (yet) available for sale at Schwab or the other major platforms and a Schwab rep says he does not see any evidence of active negotiation with Kopernik but recommends that interested parties check in occasionally at the Kopernik Global All-Cap page at Schwab. The “availability” tab will let you know if it has become available.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves. This month he tracked down 15 no-load retail funds in registration, which represents our core interest. That number is down from what we’d normally see because these funds won’t launch until February 2014; whenever possible, firms prefer to launch by December 30^th and so force a lot of funds into the pipeline in October.

Interesting entries this month include:

American Beacon Global Evolution Frontier Markets Income Fund will be the first frontier market bond fund, focusing on sovereign debt. It will be managed by a team from Global Evolution USA, LLC, a subsidiary of Global Evolution Fondsmæglerselskab A/S. But you already knew that, right?

PIMCO Balanced Income Fund primarily pursues income and will invest globally, both very much unlike the average balanced fund. They’ll invest globally in dividend-paying common and preferred stocks and all flavors of fixed- and floating-rate instruments. The prospectus is still in the early stages of development, so there’s no named manager or expense ratio. This might be good news for Sextant Global High Income (SGHIX), which tries to pursue the same distinctive strategy but has had trouble explaining itself to investors.

SPDR Floating Rate Treasury ETF and WisdomTree Floating Rate Treasury Fund will track index of the as-yet unissued floating rate Treasury notes, the first small auction of which will occur January 29, 2014.

Manager Changes

On a related note, we also tracked down 58 fund manager changes.

Updates: the reorganization of Aegis Value, take two

Last month we noted, with unwarranted snarkiness, the reorganization of Aegis Value Fund (AVALX).  We have now had a chance to further review the preliminary prospectus and a 73-page proxy filing. The reorganization had two aspects, one of which would be immediately visible to investors and the other of which may be significant behind the scenes.

The visible change: before reorganization AVALX operates as a no-load retail fund with one share class and a $10,000 investment minimum.  According to the filings, after reorganization, Aegis is expected to have two share classes.  In the reorganization, a new, front-loaded, retail A-share class would be introduced with a maximum 3.75% sales load but also a series of breakpoint reductions.  There would also be a two-year, 1% redemption fee on some A-share purchases with value in excess of $1 million. There would also be a no-load institutional share class with a published $1,000,000 minimum.  However, current AVALX shareholders would become holders of grandfathered institutional shares not subject to the $1 million investment minimum.

Does this mean that new retail investors get stuck paying a sales load?  No, not necessarily. While the institutional class of Aegis High Yield has the same nominal million dollar minimum as Aegis Value will, it’s currently available through many fund supermarkets with the same $10,000 minimum investment as the retail shares of Aegis Value now have. We suspect that Aegis Value shareholders may benefit from the same sort of arrangement.

Does this mean that retail investors get stuck paying a 1% redemption fee on shares sold early? Again, not necessarily. As best I understand it, the redemption fee applies only to broker-sold A-shares sold in denominations greater than $1 million where the advisor pays a commission to the broker if the shares are then redeemed within two years of purchase.  So folks buying no-load institutional shares or buying “A” shares and actually paying the sales load are expected to be exempt.

The visible changes appear designed to make the fund more attractive in the market and especially to the advisor market, though it remains an open question whether “A” shares are the package most attractive to such folks.  Despite competitive returns over the past five years, the fund’s AUM remains far below its peak so we believe there’s room and management ability for substantially more assets.

The invisible change: two existing legal structures interfere with the advisor’s smooth and efficient organization.  They have two funds (Aegis High Yield AHYAX/AHYFX is the other) with different legal structures (one Delaware Trust, one Maryland Corporation) and different fiscal year ends. That means two sets of bookkeeping and two sets of reports; the reorganization is expected to consolidate the two and streamline the process.  We estimate the clean-up might save the advisor a little bit in administrative expenses.  In the reorganization, AVALX is also eliminating some legacy investment restrictions.  For example, AVALX is currently restricted from holding more than 10% of the publicly-available shares of any company.  The reorganization would lift these restrictions.  While the Fund has in the past only rarely held positions approaching the 10 percent ownership threshold, lifting these kinds of restrictions may provide management with more investment flexibility in the future.

Briefly Noted . . .

In a surprising announcement, Forward Funds removed a four-person team from Cedar Ridge Partners as the sub-advisers responsible for Forward Credit Analysis Long/Short Fund (FLSLX).  The fund was built around Cedar Ridge’s expertise in muni bond investing and the team had managed the fund from inception.  Considered as a “non-traditional bond” fund by Morningstar, FLSLX absolutely clubbed their peers in 2009, 2011, and 2012 while trailing a bit in 2010.  Then this in 2013:

Over the past six months, FLSLX dropped about 14% in value while its peers drifted down less than 2%.

We spoke with CEO Alan Reid in mid-November about the change.  While he praised the Cedar Ridge team for their work, he noted that their strategy seemed to work best when credit spreads were compressed and poorly when they widened.  Bernanke’s May 22 Congressional testimony concerning “tapering” roiled the credit markets, but appears to have gobsmacked the Cedar Ridge team: that’s the cliff you see them falling off.  Forward asked them to “de-risk” the portfolio and shortly afterward asked them to do it again.  As he monitored the fund’s evolution, Mr. Reid faced the question “would I put my money in this fund for the next three to five years?”   When he realized the answer was “no,” he moved to change management.

The new management team, Joseph Deane and David Hammer, comes from PIMCO.  Both are muni bond managers, though neither has run a fund or – so far as I can tell – a long/short portfolio.  Nonetheless they’re back by an enormous analyst corps.  That means they’re likely to have access to stronger research which would lead to better security selection.  Mr. Reid points to three other distinctions:

There is likely to be less exposure to low-quality issues, but more exposure to other parts of the fixed-income market.  The revised prospectus points to “municipal bonds, corporate bonds, notes and other debentures, U.S. Treasury and Agency securities, sovereign debt, emerging markets debt, variable rate demand notes, floating rate or zero coupon securities and nonconvertible preferred securities.”

There is likely to be a more conservative hedging strategy, focused on the use of credit default swaps and futures rather than shorting Treasury bonds.

The fund’s expenses have been materially reduced.  Cedar Ridge’s management fee had already been cut from 1.5% to 1.2% and the new PIMCO team is under contract for 1.0%.

It would be wise to approach with care, since the team is promising but untested and the strategy is new.  That said, Forward has been acting quickly and decisively in their shareholders’ interests and they have arranged an awfully attractive partnership with PIMCO.

Wow.  In mid-November T. Rowe Price’s board decided to merge the T. Rowe Price Global Infrastructure Fund (TRGFX) into T. Rowe Price Real Assets Fund (PRAFX).  Equity CIO John Linehan talked with us in late November about the move.  The short version is this: Global Infrastructure found very little market appeal because the vogue for infrastructure investing is in private equity rather than stocks.  That is, investors would rather own the lease on a toll road than own stock in a company which owns, among other things, the lease on a toll road. Since the fund’s investment rationale – providing a hedge against inflation – can be addressed well in the Real Assets funds, it made business sense to merge Infrastructure away.

Taken as a global stock fund, Infrastructure was small and mediocre. (We warned that “[t]he case for a dedicated infrastructure fund, and this fund in particular, is still unproven.”) Taken as a global stock fund, Real Assets is large and rotten. The key is that “real assets” funds are largely an inflation-hedge, investing in firms that control “stuff in the ground.”  With inflation dauntingly low, all funds with this focus (AllianceBernstein, Cohen & Steers, Cornerstone, Harford, Principal and others offer them) has looked somewhere between “punky” and “putrid.”  In the interim, Price has replaced Infrastructure’s manager (Kes Visuvalingam has replaced Susanta Mazumdar) and suspended its redemption fee, for the convenience of those who would like out early. 

Our Real Assets profile highlights the fact that this portfolio might be used as a small hedge in a diversified portfolio; perhaps 3-5%, which reflects its weight in Price’s asset allocation portfolios.  Mr. Lee warns that the fund, with its huge sector bets on energy and real estate, will underperform in a low-inflation environment and would have no structural advantage even in a moderate rate one. Investors should probably celebrate PRAFX’s underperformance as a sign that the chief scourge of their savings and investments – inflation – is so thoroughly suppressed.

FundX Tactical Total Return Fund (TOTLX) Effective January 31, 2014, the investment objective of the FundX Tactical Total Return Fund is revised to read:  “The Fund seeks long term capital appreciation with less volatility than the broad equity market; capital preservation is a secondary consideration.”

SMALL WINS FOR INVESTORS

CAN SLIM® Select Growth Fund (CANGX) On Monday, November 11, 2013, the Board of Trustees of Professionally Managed Portfolios approved the following change to the Fund’s Summary Prospectus, Prospectus and Statement of Additional Information: The Fund’s Expense Cap has been reduced from 1.70% to 1.39%.

The expense ratio on nine of Guggenheim’s S&P500 Equal Weight sector ETFS (Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Materials, Technology and Utilities) have dropped from 0.50% to 0.40%.

Effective November 15^th, REMS Real Estate Income 50/50 (RREFX) eliminated its sales load and reduced its 12(b)1 fee from 0.35% to 0.25%.  The new investment minimum is $2,500, up from its previous $1,000.  The 50/50 refers to the fund’s target allocation: 50% in the common stock of REITs, 50% in their preferred securities.

Effective mid-November, the Meridian Funds activated Advisor and Institutional share classes.

CLOSINGS (and related inconveniences)

Effective November 18, 2013, the Buffalo Emerging Opportunities Fund (BUFOX), a series of Buffalo Funds, will be closed to all new accounts, including new employer sponsored retirement plans (“ESRPs”).  The Fund will remain open to additional investments by all existing accounts

Invesco European Small Company Fund (ESMAX) will close to all investors effective the open of business on December 4, 2013. The fund has $560 million in AUM, a low turnover style and a splendid record. The long-time lead manager, Jason Holzer, manages 13 other funds, most for Invesco and most in the European and international small cap realms. That means he’s responsible for over $16 billion in assets.  He has over a million invested both here and in his International Small Company Fund (IEGAX).

Effective December 31, 2013, T. Rowe Price New Horizons Fund (PRHNX) will be closed to new investors.  This used to be one of Price’s best small cap growth funds until the weight of $14 billion in assets moved it up the scale.  Morningstar still categorizes it as “small growth” and it still has a fair chunk of its assets in small cap names, but a majority of its holdings are now mid- to large-cap stocks.

Also on December 31, 2013, the T. Rowe Price Small-Cap Stock Fund (OTCFX) will be closed to new investors.  Small Cap is smaller than New Horizons – $9 billion versus $14 billion – and maintains a far higher exposure to small cap stocks (about 70% of the portfolio).  Nonetheless it faces serious headwinds from the inevitable pressure of a rising asset base – up by $2 billion in 12 months.  There’s an interesting hint buried in the fund’s ticker symbol: it was once the Over the Counter Securities Fund.

Too late: Vulcan Value Partners Small Cap Fund (VVPSX), which we profiled as “a solid, sensible, profitable vehicle” shortly after launch, vindicated our judgment when it closed to new investors at the end of November.  The closure came with about one week’s notice, which strikes me as a responsible decision if you’re actually looking to close off new flows rather than trigger a last minute rush for the door.  The fund’s current AUM, $750 million, still gives it plenty of room to maneuver in the small cap realm. 

Effective December 31, 2013, Wells Fargo Advantage Emerging Markets Equity Fund (EMGAX) will be closed to most new investors.  Curious timing: four years in a row (2009-2012) of top decile returns, and it stayed open.  Utterly mediocre returns in 2013 (50^th percentile, slightly underwater) and it closes.

OLD WINE, NEW BOTTLES

BlackRock Emerging Market Local Debt Portfolio (BAEDX) is changing its name and oh so much more.  On New Year’s 2014, shareholders will find themselves invested in BlackRock Emerging Markets Flexible Dynamic Bond Portfolio which certainly sounds a lot more … uhh, flexible.  And dynamic!  I sometimes wonder if fund marketers have an app on their iPhones, rather like UrbanSpoon, where you hit “shake” and slot machine-like wheels start spinning.  When they stop you get some combination of Flexible, Strategic, Multi-, Asset, Manager, Strategy, Dynamic, Flexible and Tactical.

Oh, right.  Back to the fund.  The Flexible Dynamic fund will flexibly and dynamically invest in what it invests in now except they are no longer bound to keep 65% or more in local-currency bonds.

Effective March 1, 2014, BMO Government Income Fund (MRGIX) beomes BMO Mortgage Income Fund. There will be no change in strategy reflecting the fact that the government gets its income from . . . uh, mortgages?

Effective December 11, 2013 Columbia Large Cap Core Fund (NSGAX) will change to Columbia Select Large Cap Equity Fund.  The prospectus for the new version of the fund warns that it might concentrate on a single sector (they name technology) and will likely hold 45-65 stocks, which is about where they already are.  At that same time, Columbia Active Portfolios® – Diversified Equity Income Fund (INDZX) becomes Active Portfolios® Multi-Manager Value Fund and Columbia Recovery and Infrastructure (RRIAX) becomes Columbia Global Infrastructure Fund.  Morningstar rates it as a one-star fund despite high relative returns since inception, which suggests that the fund’s volatility is higher still.

Dreyfus will ask shareholders to approve a set of as-yet undescribed strategy changes which, if approved, will cause them to change the Dreyfus/Standish Intermediate Tax Exempt Bond Fund to Dreyfus Tax Sensitive Total Return Bond Fund

On February 21, 20414, Dreyfus/The Boston Company Emerging Markets Core Equity Fund will change its name to Dreyfus Diversified Emerging Markets Fund.

Effective December 23, 2013, Forward Select Income Opportunity Fund (FSONX) becomes Forward Select Opportunity Fund.  The fact that neither the fund’s webpage nor its fact sheet report any income (i.e., there’s not even a spot for 30-day SEC yield or anything like it) might be telling us why “income” is leaving the name.

Ivy Pacific Opportunities Fund (IPOAX) seems to have become Ivy Emerging Markets Equity Fund. The new fund’s prospectus shifts it from a mid-to-large cap fund to an all-cap portfolio, adds the proviso that up to 20% of the portfolio might be invested in precious metals. There’s an unclear provision about investing in a Cayman Islands subsidiary to gain commodities exposure but it’s not clear whether that’s in addition to the gold.  And, finally, Ivy Asset Strategy New Opportunities Fund (INOAX) will merge into the new fund in early 2014.  That might come as a surprise to INOAX shareholders, since their current fund is not primarily an emerging markets vehicle.

OFF TO THE DUSTBIN OF HISTORY

Corporate America CU Short Duration Fund (CASDX) liquidated at the end of November.  That’s apparently more evidence of Corporate America’s shortened time horizon.  The fund was open a bit more than a year and pulled in a bit more than $60 million in assets before the advisor thought … what?  “Oh, we’re not very good at this”?  “Oh, we’re not apt to get very good at this”?  “Oh, look!  There’s a butterfly”?

Delaware International Bond Fund (DPIFX) will be liquidated and dissolved on New Year’s Eve.  I knew several grad students who suffered a similar fate that evening.

The Equinox funds plan a wholesale liquidation: Equinox Abraham Strategy Fund (EABIX), Absolute Return Plus Strategy (EMEIX), Eclipse Strategy (EECIX), John Locke Strategy (EJILX), QCM Strategy (EQQCX) and Tiverton Strategy (EQTVX) all meet their maker on December 9^th.  The smallest of these funds has about $8500 in AUM.  Right: not enough to buy a used 2010 Toyota Corolla.  The largest has about $600,000 and, in total, they don’t reach $750,000.  All are classified as “managed futures” funds and no, I have no earthly idea why Equinox has seven such funds: the six dead funds walking and the surviving Equinox Crabel Strategy (EQCRX) which has about $15,000 in AUM.

Given that these funds have $25,000 minimums and half of them have under $25,000 in assets, the clear implications is that several of these funds have one shareholder. In no instance, however, is that one shareholder a manager of the fund since none of the five managers was silly enough to invest.

FundX ETF Upgrader Fund (REMIX) is merging into the FundX Upgrader Fund (FUNDX) and the FundX ETF Aggressive Upgrader Fund (UNBOX) goes into the FundX Aggressive Upgrader Fund (HOTFX), effective January 24, 2014.   My colleague Charles’s thoughtful and extensive analysis of their flagship FundX Upgrader Fund offers them as “a cautionary tale” for folks whose strategy is to churn their portfolios, always seeking hot funds.

An ING fund disappears: ING has designated ING Bond Portfolio (IABPX) as a “disappearing portfolio.”  They craftily plan to ask shareholders in late February to authorize the disappearance.  The largely-inoffensive ING Intermediate Bond Portfolio (IIABX) has been designated as “the Surviving Portfolio.”

But nothing will survive of ING American Funds International Growth and Income Portfolio (IAIPX) or ING American Funds Global Growth and Income Portfolio (IAGPX), both of which will be liquidated on February 7, 2014.

ING PIMCO High Yield Portfolio (IPHYX) disappears on February 14 and is replaced by ING High Yield Portfolio.  See ING decided to replace the world’s most renowned fixed income shop, which was running a four-star $900 million portfolio for them, with themselves with Rick Cumberledge and team, nice people who haven’t previously managed a mutual fund.  The investors get to celebrate a two (count ‘em: 2!) basis point fee reduction as a result.

The Board of Trustees of the JPMorgan India Fund (JIDAX) has approved the liquidation and dissolution of the Fund on or about January 10, 2014.  The fund has a six-year record that’s a bit above average but that comes out as a 17% loss since inception.  The $9.5 million there would have been, and would still be, better used in Matthews India (MINDX).  

We’d already announced the closure and impending liquidation of BlackRock India Fund (BAINX).  The closure occurred October 28 and the liquidation occurs on December 10, 2013.  BAINX – the bane of your portfolio?  due to be bain-ished from it? – is down 14% since launch, its peers are down 21% from the same date. 

The Board of Trustees of the JPMorgan U.S. Real Estate Fund (SUSIX) has approved the liquidation and dissolution of the Fund on or about December 20, 2013.  Color me clueless: it’s an unimpressive fund, but it’s not wretched and it does have $380 million dollars.

Litman Gregory Masters Focused Opportunities Fund (MSFOX) is merging into Litman Gregory Masters Equity Fund (MSENX) because, they explain, MSFOX

… has had net shareholder redemptions over the past five years, causing the asset level of the Focused Opportunities Fund to decline almost 50% over that time period.  The decline in assets has resulted in a corresponding increase in the Focused Opportunities Fund’s expense ratio, and … it is unlikely that the Focused Opportunities Fund will increase in size significantly in the foreseeable future.

The first part of that statement is a bit disingenuous.  MSFOX has $67 million at the moment.  The only time it exceeded that level was in 2007 when, at year end, it had $118 million.  It lost 60% between October 2007 and March 2009 (much more than its peers) and has never regained its place in the market. The Observer has a favorable opinion of the fund, which has earned four stars from Morningstar and five for Returns, Consistency and Preservation from Lipper but its fall does point to the fragility of survival once investors have been burned. This is the second fund to merge into MSENX, Litman Gregory Masters Value was the first, in May 2013.

The Lord hath left the building: the shareholders of Lord Abbett Classic Stock Fund (LRLCX) convened on November 7^th to ponder the future of their fund.  Fifteen days later it was gone, absorbed by Lord Abbett Calibrated Dividend Growth Fund (LAMAX).  Not to suggest that Lord Abbett was going through the motions, but they did put the LAMAX managers in charge of LRLCX back on June 11^th. 

Mercer Investment Management decided to liquidate the Mercer US Short Maturity Fixed Income Fund (MUSMX) on or about December 16, 2013

Monetta has decided to liquidate Monetta Mid-Cap Equity Fund (MMCEX), effective as of the close of business on December 20, 2013.  Robert Baccarella has been running the fund for 20 years, the last four with his son, Robert.  Despite a couple good years, the fund has resided in the 98^th or 99^th percentiles for performance for long ago.

Effective December 9, 2013, the name of the MutualHedge Frontier Legends Fund (MHFAX) changes to Equinox MutualHedge Futures Strategy Fund.  Morningstar has a Neutral rating on the fund and describes it as “good but not great yet” because of some management instability and high expenses.

Paladin Long Short Fund (PALFX) will discontinue operations on December 20, 2013.  Given the fund’s wild churning, this closure might well threaten the profitability of three or four systemically important institutions:

Why, yes, the liquidation is a taxable event for you.  Not so much for the fund’s manager, who has under $50,000 invested.  Given that the fund has, from inception in 2011 to mid-November 2013 lost money for its investors, taxes generated by churn will be particularly galling.

As noted above, T. Rowe Price Global Infrastructure Fund (TRGFX) is slated to merge into T. Rowe Price Real Assets Fund (PRAFX) in the spring of 2014.

Quaker Funds closed Quaker Akros Absolute Return Fund (AARFX) and the Quaker Small-Cap Growth Tactical Allocation Fund (QGASX) on November 5^th in anticipation of liquidating them (an action which requires shareholder approval).  I have no idea of why they’re ditching AARFX.  The fund promises “absolute returns.”  $10,000 invested at inception in 2005 would be worth $10,040 today.  Mission accomplished!

Roosevelt Strategic Income Fund (RSTIX) was liquidated on November 27, 2013.  That’s presumably a low-assets/bad marketing sort of call since the fund had top tier returns compared to its global bond peers over the two-plus years of its existence.  The manager, Arthur Sheer, continues managing Roosevelt Multi-Cap (BULLX).

The Royce Fund’s Board of Trustees approved a plan of liquidation for Royce Global Select Long/Short Fund (RSTFX), to be effective on December 2, 2013. The Fund is being liquidated primarily because it has not attracted and maintained assets at a sufficient level for it to be viable.  The decision elicited several disgusted comments on the board, directed at Royce Funds.  The tenor of the comments was this: “Royce, a Legg Mason subsidiary, has morphed from an investment manager to an asset gatherer.  It’s the Legg Mason mantra: “assets (hence revenues) über alles.”  It’s indisputably the case that Royce rolled out a bunch of funds once it became part of Mason; they ran 11 funds when they were independent, 29 today plus some Legg Mason branded funds (such as Legg Mason Royce Smaller Companies Premier, £ denominated “A” shares in Ireland) and some sub-advised ones.  And the senior Royce managers presume to oversee more funds than almost any serious peer: Charles Royce – 13 funds, Whitney George – 10 funds, David Nadel – 10 funds.

Then, too, it’s not very good. At least over the past three years, it’s badly trailed a whole variety of benchmarks.

Symetra funds has decided, for no immediately evident reason, to liquidate several successful funds (Symetra DoubleLine Total Return, Symetra DoubleLine Emerging Markets Income and Symetra Yacktman Focused).

TEAM Asset Strategy Fund (TEAMX) is liquidating, but it’s doing so with refreshing honesty: it’s “because of a decline in assets due to continued poor performance and significant redemptions.” 

Yep.  You’re reading it right: $10,000 becomes $1904.  75% YTD loss.  To which I can only response: “Go, TEAM, go!  Quickly!  Go now!”

The Board of Directors of Tributary Funds has approved liquidation of Tributary Large Cap Growth Fund (FOLCX) on or about January 29, 2014.  Since David Jordan, manager of the five-star Tributary Balanced (FOBAX) and flagship four-star Growth Opportunities (FOGRX) funds, took over in 2011, the fund has had very competitive returns but not enough to draw serious assets and move the fund toward economic viability.

Vanguard Tax-Managed International Fund (VTMGX) merges into the Vanguard Developed Markets Index Fund, which is expected to occur on or about April 4, 2014.  Finally, a $20 billion closet index fund (the r-squared against the MSCI EAFE Index was nearly 99) that just surrenders to being an index!  In a final dose of irony, VTMGX tracked its index better than does the index fund into which it’s merging.  Indeed, there are seven international large-blend index funds which track their indexes less faithfully than the supposedly-active VTMGX did. 

In Closing . . .

Thanks to all of the folks who join us each month, and thanks especially to those who support the Observer by joining our remarkably thoughtful discussion board, by sharing tips and leads with me by email, and by contributing through PayPal or via our Amazon partnership.  Your interest and engagements helps make up for a lot of late nights and the occasional withering glare as we duck away from family gatherings to write a bit more.

Our partnership with Amazon provides our steadiest income stream: if you buy a $14 book, we get about a buck. If you buy a Cuisinart Brew Central coffeemaker at $78, we get five or six.  Buy an iPad and we get bumpkus (Apple refuses to play along), but that’s okay, they’re cool anyway. There are, nonetheless, 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 if moderately pricey.  Their sweatshirts, by way of example, are $45-50 when they’re not on sale.  JCPenney claims that their sweatshirts are $48 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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VoiceBase offers cools, affordable transcription services.  We’re working with the folks at Beck, Mack & Oliver to generate a FINRA-compliant transcript of our October conference call with Zac Wydra.  Step One was to generate a raw transcript with which the compliance folks at Beck, Mack might work. Chip, our estimable technical director, sorted through a variety of sites before settling on VoiceBase.

It strikes us that their service is cool, reliable and affordable.  Here’s the process.  Set up a free account.  Upload an audio file to their site.  About 24 hours later, they’ve generate a free machine-based transcription for you.  If you need greater accuracy than the machine produces – having multiple speakers and variable audio quality wreaks havoc with the poor beastie’s circuits – they provide human transcription within two or three days.

The cool part is that they host the audio on their website in a searchable format.  Go to the audio, type “emerging markets” and the system automatically flags any uses of that phrase and allows you to listen directly to them. If you’d like to play, here is the MFO Conference Call with Zac Wydra.

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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, gave us permission to reproduce one of their images (normally the online version is watermarked):

The text reads “A time to quiet our hearts… (inside) to soften our edges, clear our minds, enjoy our world, and to share best wishes for the season. May these days and all the new year be joyful and peaceful.”  It strikes me as an entirely-worthy aspiration.

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,

Occasionally Facebook produces finds that I’m at a loss to explain.  Ecce:

(Thanks to Nina K., a really first-rate writer and first-rate property/insurance lawyer in the Bay State for sharing Mr. Takei’s post with us. Now if I could just get her to restrain the impulse to blurt out, incredulous, “you really find this stuff interesting?”)

Let’s see.  Should I be more curious about the fact that Mr. Takei (iconically Ensign Sulu on Star Trek) manages just a basso profundo “oh myyy” on his post or the fact that he was recently lounging in a waiting room at the University of Iowa Hospitals, a bit west of here?  Perhaps it would be better to let his friends weigh in?

Chip’s vote was to simply swipe her favorite image from the thread, one labeled “a real hedge fund.”

Which is to say, a market that tacks on 29% in a year makes it easy to think of investing as fun and funny again. 

Now if only that popular sentiment could be reconciled with the fact that a bunch of very disciplined, very successful managers are quietly selling down their stocks and building their cash reserves again.

Here’s today’s “know your Morningstar!” quiz.  

Here are the total return charts for two short-term bond funds.  One is the sole Morningstar Gold Medalist in the group, representing “one of the industry’s best managers, and one of the category’s best funds.”  The other is a lowly one-star fund unworthy of Morningstar’s notice 

 

Question: do you …know your Morningstar!?  Which is the golden child?  Is it blue or orange?

Would it help to know that one of these funds is managed by a multi-trillion dollar titan and the other by a small, distinctive boutique?  Or that one of the funds invests quite conventionally and fits neatly into a style-box while the other is one-of-a-kind?

If you know your Morningstar, you’ll know that “small, distinctive and hard to pigeonhole” is pretty much the kiss of death.  The orange (or gold) line represents PIMCO Low Duration, “D” shares (PLDDX).  It’s a $24 billion “juggernaut” (Morningstar’s term) that’s earned four stars and a Gold designation.  It tends to be in the top quarter of the short-term bond group, though not at its top, and is a bit riskier than average.

The blue line represents RiverPark Short Term High Yield (RPHYX), an absolutely first-rate cash management fund about which we’ve written a lot. And which Morningstar just designated as a one-star fund. Why so?  Because Morningstar classifies it as a “high yield bond” fund and benchmarks it against an investment class that has outperformed the stock market over the past 15 years but with the highest volatility in the fixed-income universe. To be clear: there is essentially no overlap between RiverPark’s portfolio and the average high-yield bond funds and they have entirely different strategies, objectives and risk profiles. Which is to say, Morningstar has managed a classic “walnuts to lug nuts” comparison.

Here’s the defense Morningstar might reasonably make: “we had to put it somewhere.  It says ‘high yield.’  We put it there.”

Here’s our response: “that’s a sad and self-damning answer.  Yes, you had to put it somewhere.  But having put it in a place that you know is wildly inappropriate, you also need to accept the responsibility – to your readers, to RiverPark’s investors and to yourselves – to address your decision.  You’ve got the world’s biggest and best supported corps of analysts in the world. Use them! Don’t ignore the funds that do well outside of the comfortable framework of style boxes, categories and corporate investing! If the algorithms produce palpably misleading ratings, speak up.”

But, of course, they didn’t.

The problem is straightforward: Morningstar’s ratings are most reliable when you least need them. For funds with conventional, straightforward, style-pure disciplines – index funds and closet index funds – the star ratings probably produce a fair snapshot across the funds. But really, how hard is it – even absent Morningstar’s imprimatur – to find the most solid offering among a gaggle of long-only, domestic large cap, growth-at-a-reasonable price funds? You’ll get 90% of the way there with three numbers: five year returns, five year volatility and expense ratio. Look for ones where the first is higher and the second two are lower.

When funds try not to follow the herd, when the manager appears to have a brain and to be using it to pursue different possibilities, is when the ratings system is most prone to misleading readers. That’s when you need to hear an expert’s analysis. 

So why, then, deploy your analysts to write endless prose about domestic large cap funds? Because that’s where the money is.

Morningstar ETF Invest: Rather less useful content than I’d imagined

Morningstar hosted their ETF-focused conference in Chicago at the beginning of October.  The folks report that the gathering has tripled in size over the last couple years, turned away potential registrants and will soon need to move to a new space.  After three days there, though, I came away with few strong reactions.  I was struck by the decision of one keynote speaker to refer to active fixed-income managers as “the enemy” (no, dude, check the mirror) and the apparent anxiety around Fidelity’s decision to enter the ETF market (“Fidelity is coming.  We know they’re coming.  It’s only a matter of time,” warned one).

My greatest bewilderment was at the industry’s apparent insistence on damaging themselves as quickly and thoroughly as possible.  ETFs really have, at most, three advantages: they’re cheap, transparent and liquid.  The vogue seems to be for frittering that away.  More and more advisors are being persuaded to purchase the services of managed portfolio advisors who, for a fee, promise to custom-package (and trade) dozens of ETFs.  I spoke with representatives of a couple index providers, including FTSE, who corroborated Morningstar’s assertion that there are likely two million separate security indexes in operation with more being created daily. And many of the exchange-traded products rely in derivatives to try to capture the movements of those 2,000,000.  On whole, it feels like a systematic attempt to capture the most troubling features of the mutual fund industry – all while preening about your Olympian superiority to the mutual fund industry.

Odd.

The most interesting presentation at the conference was made by Austan Goolsbee, a University of Chicago economist and former chief of the President’s Council of Economic Advisers, who addressed a luncheon crowd. It was a thoroughly unexpected performance: there’s a strong overtone of Jon Stewart from The Daily Show, an almost antic energy. The presentation was one-third Goolsbee family anecdotes (“when I’d complain about a problem, gramma would say ‘80% of us don’t care. . . and the other 20% are glad about it'”), one-third White House anecdotes and one-third economic arguments.

The short version:

• The next 12-18 months will be tough because the old drivers of recovery aren’t available this time. Over the last century, house prices appreciated by 40 basis points annually for the first 90 years. From 2000-08, it appreciated 1350 bps annually. In the future, 40 bps is likely about right which means that a recovery in the housing industry won’t be lifting all boats any time soon.
• We’ll know the economy is recovering when 25 year olds start moving out of their parents’ basements, renting little apartments, buying futons and cheap pots and pans. (Technically, an uptick in household formation. Since the beginning of the recession, the US population has grown by 10 million but the number of households has remained flat.) One optimistic measure that Goolsbee did not mention but which seems comparable: the number of Americans choosing to quit their jobs (presumably for something better) is rising.
• The shutdown is probably a good thing, since it will derail efforts to create an unnecessary crisis around the debt ceiling.
• In the longer term, the US will recover and grow at 3.5% annually, driven by a population that’s growing (we’ll likely peak around 400 million while Japan, Western Europe and Russia contract), the world’s most productive workforce and relatively light taxation. While Social Security faces challenges, they’re manageable. Given the slow rolling crisis in higher education and the near collapse of new business launches over the past decade, I’m actually somewhere between skeptical and queasy on this one.
• The Chinese economic numbers can’t be trusted at all. The US reports quarterly economic data after a 30 day lag and frequently revises the numbers 30 days after that. China reports their quarterly numbers one day after the end of the quarter and has never revised any of the numbers. A better measure of Chinese activity is derivable from FedEx volume (it’s way down) since China is so export driven.

One highlight was his report of a headline from The Onion: “recession-plagued nation demands a new bubble to invest in … so we can get the economy going again. We need a concrete way to create illusory wealth in the near future.”

One of the great things about having Messrs Studzinski and Boccadoro contributing to the Observer is that they’re keen, experienced observers and very good writers.  The other great thing about it is that I no longer have to bear the label, “the cranky one.” In the following essay, Ed Studzinkski takes on one of the beloved touchstones of shareholder-friendly management: “skin in the game.”  Further down, Charles Boccadoro casts a skeptical eye, in a data-rich piece, on the likelihood that an investor’s going to avoid permanent loss of capital.

 

Skin in the Game, Part Two

The trouble with our times is that the future is not what it used to be.

Paul Valery

Nassim Nicholas Taleb, the author of The Black Swan as well as Antifragile: Things That Gain from Disorder, has recently been giving a series of interviews in which he argues that current investment industry compensation practices lead to subtle conflicts of interest, that end up inuring to the disadvantage of individual investors. Nowhere is this more apparent than when one looks at the mutual fund complexes that have become asset gatherers rather than investment managers.

By way of full disclosure I have to tell you that I am an admirer of Mr. Taleb’s. I was not always the most popular boy in the classroom as I was always worrying about the need to consider the potential for “Black Swan” or outlier events. Unfortunately all one has to have is one investment massacre like the 2008-2009 period. This gave investors a lost decade of investment returns and a potentially permanent loss of capital if they panicked and liquidated their investments. To have a more in-depth appreciation of the concept and its implications, I commend those of you with the time to a careful study of the data that the Mutual Fund Observer has compiled and begun releasing regularly. You should pay particular attention to a number called the “Maximum Drawdown.” There you will see that as a result of that dark period, looking back five years it is a rarity to find a domestic fund manager who did not lose 35-50% of his or her investors’ money. The same is to be said for global and international fund managers who likewise did not distinguish themselves, losing 50-65% of investors’ capital, assuming the investors panicked and liquidated their investments, and many did.

A number of investment managers that I know are not fans of Mr. Taleb’s work, primarily because he has a habit of bringing attention to inconvenient truths. In Fooled by Randomness, he made the case that given the large number of people who had come into the investment management business in recent years, there were a number who had to have generated good records randomly. They were what he calls “spurious winners.” I would argue that the maximum drawdown numbers referred to above confirm that thesis.

How then to avoid the spurious winner? Taleb argues that the hedge fund industry serves as a model, by truly having managers with “skin in the game.” In his experience a hedge fund manager typically has twenty to fifty times the exposure of his next biggest client. That of necessity makes them both more careful and as well as aware of the consequences if they have underinvested in the necessary talent to remain competitive. Taleb quite definitively states, “You don’t get that with fund managers.”

I suspect the counterargument I am going to hear is that fund managers are now required to disclose, by means of reporting within various ranges, the amount of money they have invested in the fund they are managing. Just go to the Statement of Additional Information, which is usually found on a fund website. And if the SAI shows that the manager has more than $1 million invested in his or her fund, then that is supposed to be a good sign concerning alignment of interests. Like the old Hertz commercial, the real rather than apparent answer is “not exactly.”

The gold standard in this regard has been set by Longleaf Partners with their funds. Their employees are required to limit their publicly offered equity investments to funds advised by Southeastern Asset Management, Longleaf’s advisor, unless granted a compliance exception. Their trustees also must obtain permission before making a publicly offered equity investment. That is rather unique in the fund industry, since what you usually see in the marketing brochures or periodic fund reports is something like “the employees and families of blah-blah have more than $X million invested in our funds.” If you are lucky this may work out to be one percent of assets under management in the firm, hardly hedge-fund like metrics. At the same time, you often find trustees of the fund with de minimis investments.

The comparison becomes worse when you look at a fund with $9 billion in assets and the “normal” one percent investment management fee, which generates $90 million in revenue. The fund manager may tell you that his largest equity investment is in the fund and is more than $1 million. But if his annual compensation runs somewhere between $1million and $10 million, and this is Taleb’s strongest point, the fund manager does not have a true disincentive for losing money. The situation becomes even more blurred where compliance policy allows investment in ETF’s or open-ended mutual funds, which in today’s world will often allow a fund manager to construct his own personal market neutral or hedged portfolio, to offset his investment in the fund he is managing.

Is there a solution? Yes, a fairly easy one – adopt as an industry standard through government regulation the requirement that all employees in the investment firm are required to limit their publicly offered equity investments to the funds in the complex. To give credit where credit is due, just as we have a Volcker rule, we can call it the “Southeastern Asset Management” rule. If that should prove too restrictive, I would suggest as an alternative that the SEC add another band of investment ranges above the current $1 million limit, at perhaps $5 million. That at least would give a truer picture for the investor, especially given the money flows now gushing into a number of firms, which often make a $1 million investment not material to the fund manager. Such disclosure will do a better job of attuning investment professionals to what should be their real concern – managing risk with a view towards the potential downside, rather than ignoring risk with other people’s money.

Postscript:

What does it say when such well known value managers as Tweedy, Browne and First Pacific Advisors are letting cash positions rise in their portfolios as they sell and don’t replace securities that have reached their target valuations? Probably the same thing as when one of the people I consider to be one of the outstanding money managers of our time, Seth Klarman at Baupost Partners, announces that he will be returning some capital to his partnership investors at year end. Stay tuned.

So, if it’s “the best,” why can’t people just agree on what it is?

Last month David pointed out how little overlap he found between three popular mutual fund lists: Kiplinger 25, Money 70, and Morningstar’s Fantastic 51. David mused: “You’d think that if all of these publications shared the same sensible goal – good risk-adjusted returns and shareholder-friendly practices – they’d also be stumbling across the same funds. You’d be wrong.”

He found only one fund, Dodge & Cox International Fund DODFX, on all three lists. Just one! Although just one is a statistically better outcome than randomly picking three such lists from the 6600 or so mutual funds and 1000 ETFs, it does seem surprisingly small. 

Opening up the field a little, by replacing the Fantastic 51 with a list of 232 funds formed from Morningstar’s current “Gold-Rated Funds” and “Favorite ETFs,” the overlap does not improve much. Just two funds appear in all three publications: DODFX and Habor Bond Institutional HABDX. Just two!

While perhaps not directly comparable, the table below provides a quick summary of the criteria used by each publication. Money 70 criteria actually include Morningstar’s so-called stewardship grade, which must be one of the least maintained measures. For example, Morningstar awarded Bruce Berkowitz Fund Manager of the Decade, but it never published a stewardship grade for Fairholme.

Overall, however, the criteria seem quite similar, or as David described “good risk-adjusted returns and shareholder-friendly practices.”  Add in experienced managers for good measure and one would expect the lists to overlap pretty well. But again, they don’t.

How do the “forward-looking” recommendations in each of these lists fare against Morningstar’s purely quantitative “backward-looking” performance rating system? Not as well as you might think. There are just seven 5-star funds on Money’s list, or 1-in-10. Kiplinger does the best with six, from a percentage perspective, or almost 1-in-4. (They must have peeked.) Morningstar’s own list includes 44 5-star funds, or about 1-in-5. So, as well intentioned and “forward looking” as these analysts certainly try to be, only a small minority of their “best funds” have delivered top-tier returns.

On the other hand, they each do better than picking funds arbitrarily, if not unwittingly, since Morningstar assigns 5 stars to only about 1-in-17 funds. Neither of the two over-lapping funds that appear on all three lists, DODFX and HABDX, have 5 stars. But both have a commendable 4 stars, and certainly, that’s good enough.

Lowering expectations a bit, how many funds appear on at least two of these lists? The answer: 38, excluding the two trifectas. Vanguard dominates with 14. T. Rowe Price and American Funds each have 4. Fidelity has just one. Most have 4 stars, a few have 3, like SLASX, probably the scariest.

But there is no Artisan. There is no Tweedy. There is no Matthews. There is no TCW or Doubleline. There are no PIMCO bond funds. (Can you believe?) There is no Yacktman. Or Arke. Or Sequoia. There are no funds less than five years old. In short, there’s a lot missing.

There are, however, nine 5-star funds among the 38, or just about 1-in-4. That’s not bad. Interestingly, not one is a fixed income fund, which is probably a sign of the times. Here’s how they stack-up in MFO’s own “backward looking” ratings system, updated through September:

Four are moderate allocation funds: FPACX, PRWCX, VWELX, and TRRBX. Three are Vanguard funds: VWELX, VDIGX, and VASVX. One FMI fund FMIHX and one Oakmark fund OAKIX. Hard to argue with any of these funds, especially the three Great Owls: PRWCX, VWELX, and OAKIX.

These lists of “best funds” are probably not a bad place to start, especially for those new to mutual funds. They tend to expose investors to many perfectly acceptable, if more mainstream, funds with desirable characteristics: lower fees, experienced teams, defensible, if not superior, past performance.

They probably do not stress downside potential enough, so any selection needs to also take risk tolerance and investment time-frame into account. And, incredulously, Morningstar continues to give Gold ratings to loaded funds, about 1-in-7 actually.

The lists produce surprisingly little overlap, perhaps simply because there are a lot of funds available that satisfy the broad screening criteria. But within the little bit of overlap, one can find some very satisfying funds.

Money 70 and Kiplinger 25 are free and online. Morningstar’s rated funds are available for a premium subscription. (Cheapest path may be to subscribe for just one month each year at $22 while performing an annual portfolio review.)

As for a list of smaller, less well known mutual funds with great managers and intriguing strategies? Well, of course, that’s the niche MFO aspires to cover.

23Oct2013/Charles

The Great Owl search engine has arrived

Great Owls are the designation that my colleague Charles Boccadoro gives to those funds which are first in the top 20% of their peer group for every trailing period of three years or more. Because we know that “risk” is often more durable and a better predictor of investor actions than “return” is, we’ve compiled a wide variety of risk measures for each of the Great Owl funds.

Up until now, we’ve been limited to publishing the Great Owls as a .pdf while working on a search engine for them. We’re pleased to announce the launch of the Great Owl Search, 1.0. We expect in the months ahead to widen the engine’s function and to better integrate it into the site. We hope you like it.

For JJ and other fans of FundAlarm’s Three-Alarm and Most Alarming fund lists, we’re working to create a predefined search that will allow you to quickly and reliable identify the most gruesome investments in the fund world. More soon!

Who do you trust for fund information?

The short answer is: not fund companies.  On October 22, the WSJ’s Karen Damato hosted an online poll entitled Poll: The Best Source of Mutual-Fund Information? 

Representing, as I do, Column Three, I should be cheered.  Teaching, as I do, Journalism 215: News Literacy, I felt compelled to admit that the results were somewhere between empty (the margin of error is 10.89, so it’s “somewhere between 16% and 38% think it’s the fund company’s website and marketing materials”) and discouraging (the country’s leading financial newspaper managed to engage the interest of precisely 81 of its readers on this question).

Nina Eisenman, President of Eisenman Associates which oversees strategic communications for corporations, and sometime contributor to the Observer

Asking which of the 3 choices individual investors find “most useful” generates data that creates an impression that they don’t use the other two at all when, in fact, they may use all 3 to varying degrees. It’s also a broad question. Are investors responding based on what’s most useful to them in conducting their initial research or due diligence? For example, I may read about a fund in the Mutual Fund Observer (“other website”) and decide to check it out but I would (hopefully) look at the fund’s website, read the manager’s letters and the fund prospectus before I actually put money in.

When I surveyed financial advisors and RIAs on the same topic, but gave them an option to rate the importance of various sources of information they use, the vast majority used mutual funds’ own websites to some extent as part of their due diligence research. [especially for] fund-specific information (including the fund prospectus which is generally available on the website) that can help investors make educated investment decisions.

Both Nina’s own research and the results of a comparable Advisor Perspectives poll can be found at FundSites, her portal for addressing the challenges and practices of small- to medium sizes fund company websites.

The difference between “departures” and “succession planning”

Three firms this month announced the decisions of superb managers to move on. Happily for their investors, the departures are long-dated and seem to be surrounded by a careful succession planning process.

Mitch Milias will be retiring at the end of 2013

Primecap Management was founded by three American Funds veterans. That generation is passing. Howard Schow has passed away at age 84 in April 2012. Vanguard observer Dan Weiner wrote at the time that “To say that he was one of the best, and least-known investors would be a vast understatement.”  The second of the triumvirate, Mitch Milias, retires in two months at 71.  That leaves Theo Kolokotrones who, at 68, is likely in the latter half of his investing career.  Milias has served as comanager of four Gold-rated funds: Vanguard Primecap  (VPMCX) Vanguard Primecap Core (VPCCX), Primecap Odyssey Growth (POGRX), and  Primecap Odyssey Stock (POSKX).

Neil Woodford will depart Invesco in April, 2014

British fund manager Neil Woodford is leaving after 25 years of managing Invesco Perpetual High Income Fund and the Invesco Perpetual Income Fund. Mr. Woodford apparently is the best known manager in England and described as a “hero” in the media for his resolute style.  He’s decided to set up his own English fund company.  In making the move he reports:

My decision to leave is a personal one based on my views about where I see long-term opportunities in the fund management industry.  My intention is to establish a new fund management business serving institutional and retail clients as soon as possible after 29th April 2014.

His investors seem somehow less sanguine: they pulled over £1 billion in the two weeks after his announcement.  Invesco’s British president describes that reaction as “calm.”

Given Mr. Woodford’s reputation and the global nature of the securities market, I would surely flag 1 May 2014 as a day to peer across the Atlantic to see what “long-term opportunities” he’s pursuing.

Scott Satterwhite will be retiring at the end of September, 2016

Scott Satterwhite joined Artisan from Wachovia Securities in 1997 and was the sole manager of Artisan Small Cap Value (ARTVX) from its launch. ARTVX is also the longest-tenured fund in my non-retirement portfolio; I moved my Artisan Small Cap (ARTSX) investment into Satterwhite’s fund almost as soon as it launched and I’ve never had reason to question that decision.  Mr. Satterwhite then extended his discipline into Artisan Mid Cap Value (ARTQX) and the large cap Artisan Value (ARTLX).  All are, as is typical of Artisan, superb.

Artisan has a really strong internal culture and focus on creating coherent, self-sustaining investment teams.  Three years after launch, Satterwhite’s long-time analyst Jim Kieffer became a co-manager.  George Sertl was added six years after that and Dan Kane six years later.  Mr. Kane is now described as “the informal lead manager” with Satterwhite on ARTVX.  This is probably one of the two most significant manager changes in Artisan’s history (the retirement of its founder was the other) but the firm seems exceptionally well-positioned both to attract additional talent and to manage the required three year transition.

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. 

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously.  Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds.  So far, so good!

Oops! The fund profile is slightly delayed. Please check back tomorrow.

Elevator Talk: Jeffrey K. Ringdahl of American Beacon Flexible Bond (AFXAX)

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.

In a fundamentally hostile environment, investors need to have a flexible approach to income investing. Some funds express that flexibility by investing in emerging market bonds, financial derivatives such as options, or illiquid securities (think: “lease payments from the apartment complex we just bought”).

American Beacon’s decision was to target “positive total return regardless of market conditions” in their version.  Beacon, like Harbor, positions itself as “a manager of managers” and assembles teams of institutional sub-advisors to manage the actual portfolio.  In this case, they’ve paired Brandywine Global, GAM and PIMCO and have given the managers extraordinarily leeway in pursuing the fund’s objective.  One measure of that flexibility is the fund’s duration, a measure of interest rate sensitivity.  They project a duration of anything from negative five years (effectively shorting the market) to plus eight years (generally the preferred spot for long-term owners of bond funds).  Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Jeff Ringdahl is American Beacon’s Chief Operating Officer and one of the primary architects of the Flexible Bond Strategy. He’s worked with a bunch of “A” tier management firms including Touchstone Investments, Fidelity and State Street Global Advisors.   Here are his 245 words (I know, he overshot) on why you should consider a flexible bond strategy:

In building an alternative to a traditional bond fund, our goal was to stay true to what we consider the three tenets of traditional bond investing: current income, principal preservation and equity diversification.  However, we also sought to protect against unstable interest rates and credit spreads.

The word “unconstrained” is often used to describe similar strategies, but we believe “flexible” is a better descriptor for our approach. Many investors associate the word “unconstrained” with higher risk.  We implemented important risk constraints which help to create a lower risk profile. Our multi-manager structure is a key distinguishing characteristic because of its built-in risk management. Unconstrained or flexible bond funds feature a great degree of investment flexibility. While investment managers may deliver compelling risk-adjusted performance by using this enhanced flexibility, there may be an increased possibility of underperformance because there are fewer risk controls imposed by many of our peer funds. In our opinion, if you would ever want to diversify your managers you would do so where the manager had the greatest latitude. We think that this product style is uniquely designed for multi-manager diversification.

Flexible bond investing allows asset managers the ability to invest long and short across the global bond and currency markets to capitalize on opportunities in the broad areas of credit, currencies and yield curve strategies. We think focusing on the three Cs: Credit, Currency and Curve gives us an advantage in seeking to deliver positive returns over a complete market cycle.

The fund has five share classes. The minimum initial investment for the no-load Investor class is $2,500.   Expenses are 1.27% on about $300 million in assets.

The fund’s website is functional but spare.  You get the essential information, but there’s no particular wealth of insight or commentary on this strategy (and there is one odd picture of a bunch of sailboats barely able to get out of one another’s way).

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.

Conference Call Highlights: Zac Wydra of Beck, Mack & Oliver Partners

In mid-October we spoke for about an hour with Zac Wydra of Beck, Mack & Oliver Partners Fund (BMPEX). There were about 30 other participants on the call. I’ve elsewhere analogized Beck, Mack to Dodge & Cox: an old money, white shoe firm whose core business is helping the rich stay rich. In general, you need a $3 million minimum investment to engage with them. Partners was created in 1991 as a limited partnership to accommodate the grandkids or staff of their clients, folks who might only have a few hundred thousand to commit. (Insert about here: “Snowball gulps”) The “limited” in limited partnership signals a maximum number of investors, 100. The partnership filled up and prospered. When the managing partner retired, Zac made a pitch to convert the partnership to a ’40 fund and make it more widely available. He argued that he thought there was a wider audience for a disciplined, concentrated fund.

He was made the fund’s inaugural manager. He’s 41 and anticipates running BMPEX for about the next quarter century, at which point he’ll be required – as all partners are – to move into retirement and undertake a phased five year divestment of his economic stake in the firm. His then-former ownership stake will be available to help attract and retain the best cadre of younger professionals that they can find. Between now and retirement he will (1) not run any other pooled investment vehicle, (2) not allow BMPEX to get noticeably bigger than $1.5 billion – he’ll return capital to investors first – and (3) will, over a period of years, train and oversee a potential successor.

In the interim, the discipline is simple:

1. never hold more than 30 securities – he can hold bonds but hasn’t found any that offer a better risk/return profile than the stocks he’s found.
2. only invest in firms with great management teams, a criterion that’s met when the team demonstrates superior capital allocation decisions over a period of years
3. invest only in firms whose cash flows are consistent and predictable. Some fine firms come with high variable flows and some are in industries whose drivers are particularly hard to decipher; he avoids those altogether.
4. only buy when stocks sell at a sufficient discount to fair value that you’ve got a margin of safety, a patience that was illustrated by his decision to watch Bed, Bath & Beyond for over two and a half years before a short-term stumble triggered a panicky price drop and he could move in. In general, he is targeting stocks which have the prospect of gaining at least 50% over the next three years and which will not lose value over that time.
5. ignore the question of whether it’s a “high turnover” or “low turnover” strategy. His argument is that the market determines the turnover rate. If his holdings become overpriced, he’ll sell them quickly. If the market collapses, he’ll look for stocks with even better risk/return profiles than those currently in the portfolio. In general, it would be common for him to turn over three to five names in the portfolio each year, though occasionally that’s just recycling: he’ll sell a good firm whose stock becomes overvalued then buy it back again once it becomes undervalued.

Two listener questions, in particular, stood out:

Kevin asked what Zac’s “edge” was. A focus on cash, rather than earnings, seemed to be the core of it. Businesses exist to generate cash, not earnings, and so BM&O’s valuations were driven by discounted cash flow models. Those models were meaningful only if it were possible to calculate the durability of cash flows over 5 years. In industries where cash flows have volatile, it’s hard to assign a meaningful multiple and so he avoids them.

Seth asked what mistakes have you made and what did you learn from them? Zac hearkened back to the days when the fund was still a private partnership. They’d invested in AIG which subsequently turned into a bloody mess. Ummm, “not an enjoyable experience” was his phrase. He learned from that that “independent” was not always the same as “contrary.” AIG was selling at what appeared to be a lunatic discount, so BM&O bought in a contrarian move. Out of the resulting debacle, Zac learned a bit more respect for the market’s occasionally unexplainable pricings of an asset. At base, if the market says a stock is worth twenty cents a share, you’d better than remarkably strong evidence in order to act on an internal valuation of twenty dollars a share.

Bottom Line: On whole, it strikes me as a remarkable strategy: simple, high return, low excitement, repeatable, sustained for near a quarter century and sustainable for another.

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.

The BMPEX Conference Call

As with all of these funds, we’ve created a new featured funds page for Beck, Mack & Oliver Partners Fund, pulling together all of the best resources we have for the fund, including a brand new audio profile in .mp3 format.

When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded. If the file downloads, instead, you may have to double-click to play it.

As promised, my colleague Charles Boccadoro weighs in on your almost-magical ability to turn a temporary loss of principal into a …

Permanent Loss of Capital

The father of value investing, Benjamin Graham, employed the concept of “Margin of Safety” to minimize risk of permanent loss. His great student, Warren Buffett, puts it like this: “Rule No. 1: never lose money; rule No. 2: don’t forget rule No. 1.”

Zachary Wydra, portfolio manager of the 5-star Beck Mack & Oliver Partners (BMPEX) fund, actually cited Mr. Buffett’s quote during the recent MFO conference call.

But a look at Berkshire Hathaway, one of the great stocks of all time, shows it dropped 46% between December 2007 and February of 2009. And, further back, it dropped about the same between June 1998 and February 2002. So, is Mr. Buffett not following his own rule? Similarly, a look at BMPEX shows an even steeper decline in 2009 at -54%, slightly worse than the SP500.

The distinction, of course, is that drawdown does not necessarily mean loss, unless one sells at what is only a temporary loss in valuation – as opposed to an unrecoverable loss, like experienced by Enron shareholders. Since its 2009 drawdown, BMPEX is in fact up an enviable 161%, beating the SP500 by 9%.

Robert Arnott, founder of Research Associates, summarizes as follows: “Temporary losses of value are frequent; at times they can become so frightening that they become permanent—for those that sell.” Distinguishing between temporary drawdown and permanent loss of capital (aka “the ultimate risk”) is singularly the most important, if unnerving, aspect of successful value investing.

Mr. Wydra explains his strategy is to target stocks that have an upside potential over the next three years of at least 50% and will not lose value over that time. Translation: “loss,” as far as BMPEX is concerned, equates to no drawdown over a three year period. A very practical goal indeed, since any longer period would likely not be tolerated by risk averse investors.

And yet, it is very, very hard to do, perhaps even impossible for any fund that is primarily long equities.

Here is downside SP500 total return performance looking back about 52 years:

It says that 3-year returns fall below zero over nearly 30% of the time and the SP500 shows a loss of 20% or more in 15% of 3-year returns. If we compare returns against consumer price index (CPI), the result is even worse. But for simplicity (and Pete’s) sake, we will not. Fact is, over this time frame, one would need to have invested in the SP500 for nearly 12 years continuously to guarantee a positive return. 12 years!

How many equity or asset allocation funds have not experienced a drawdown over any three year period? Very few. In the last 20 years, only four, or about 1-in-1000. Gabelli ABC (GABCX) and Merger (MERFX), both in the market neutral category and both focused on merger arbitrage strategies. Along with Permanent Portfolio (PRPFX) and Midas Perpetual Portfolio (MPREX), both in the conservative allocation category and both with large a percentage of their portfolios in gold. None of these four beat the SP500. (Although three beat bonds and GABCX did so with especially low volatility.)

So, while delivering equity-like returns without incurring a “loss” over a three year period may simply prove too high a goal to come true, it is what we wish was true.

29Oct2013/Charles

Conference Call Upcoming: John Park and Greg Jackson, Oakseed Opportunity, November 18, 7:00 – 8:00 Eastern

On November 18, Observer readers will have the opportunity to hear from, and speak to John Park and Greg Jackson, co-managers of Oakseed Opportunity Fund (SEEDX and SEDEX). John managed Columbia Acorn Select for five and a half years and, at his 2004 departure, Morningstar announced “we are troubled by his departure: Park had run this fund since its inception and was a big driver behind its great long-term record. He was also the firm’s primary health-care analyst.” Greg co-managed Oakmark Global (OAKGX) for over four years and his departure in 2003 prompted an Eeyore-ish, “It’s never good news when a talented manager leaves.”

The guys moved to Blum Capital, a venture capital firm.  They did well, made money but had less fun than they’d like so they decided to return to managing a distinctly low-profile mutual fund.

Oakseed is designed to be an opportunistic equity fund.  Its managers are expected to be able to look broadly and go boldly, wherever the greatest opportunities present themselves.  It’s limited by neither geography, market cap nor stylebox.   John Park laid out its mission succinctly: “we pursue the maximum returns in the safest way possible.”

I asked John where he thought they’d focus their opening comments.  Here’s his reply:

We would like to talk about the structure of our firm and how it relates to the fund at the outset of the call.  I think people should know we’re not the usual fund management company most people think of when investing in a fund. We discussed this in our first letter to shareholders, but I think it’s worthwhile for our prospective and current investors to know that Oakseed is the only client we have, primarily because we want complete alignment with our clients from not only a mutual investment perspective (“skin in the game”), but also that all of our time is spent on this one entity. In addition, being founders of our firm and this fund, with no intentions of ever starting and managing a new fund, there is much less risk to our investors that one or both of us would ever leave. I think having that assurance is important.

Our conference call will be Monday, November 18, from 7:00 – 8:00 Eastern.  It’s free.  It’s a phone call.

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?

Nearly 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.

Conference Call Queue: David Sherman, RiverPark Strategic Income, December 9, 7:00 – 8:00 Eastern

On Monday, December 9, from 7:00 – 8:00 Eastern, you’ll have a chance to meet David Sherman, manager of RiverPark Short Term High Yield (RPHYX) and the newly-launched RiverPark Strategic Income Fund (RSIVX). David positions RSIVX as the next step out on the risk-return ladder from RPHYX: capable of doubling its sibling’s returns with entirely manageable risk.  If you’d like to get ahead of the curve, you can register for the call with David though I will highlight his call in next month’s issue.

Launch Alert: DoubleLine Shiller Enhanced CAPE

On October 29, DoubleLine Shiller Enhanced CAPE (DSEEX and DSENX) launched. The fund will use derivatives to try to outperform the Shiller Barclays CAPE US Sector Total Return Index.  CAPE is an acronym for “cyclically-adjusted price/earnings.”  The measure was propounded by Nobel Prize winning economist Robert Shiller as a way of taking some of the hocus-pocus out of the calculation of price/earnings ratios.  At base, it divides today’s stock price by the average, inflation-adjusted earnings from the past decade.  Shiller argues that current earnings are often deceptive since profit margins tend over time to regress to the mean and many firms earnings run on three to five year cycles.  As a result, the market might look dirt cheap (high profit margins plus high cyclical earnings = low conventional P/E) when it’s actually poised for a fall.  Looking at prices relative to longer-term earnings gives you a better chance of getting sucked into a value trap.

The fund will be managed by The Gundlach and Jeffrey Sherman. Messrs Gundlach and Sherman also work together on the distinctly disappointing Multi-Asset Growth fund (DMLAX), so the combination of these guys and an interesting idea doesn’t translate immediately into a desirable product.  The fact that it, like many PIMCO funds, is complicated and derivatives-driven counsels for due caution in one’s due diligence. The “N” share class has a $2000 minimum initial investment and 0.91% expense ratio.  The institutional shares are about one-third cheaper.

Those interested in a nice introduction to the CAPE research might look at Samuel Lee’s 2012 CAPE Crusader essay at Morningstar. There’s a fact sheet and a little other information on the fund’s homepage.

Funds in Registration (The New Year’s Edition)

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves.  This month he tracked down 24 no-load retail funds in registration, which represents our core interest.  But if you expand that to include ETFs, institutional funds, reorganized funds and load-bearing funds, you find nearly 120 new vehicles scheduled for Christmas delivery.

Close readers might find the answers to four funds in reg quiz questions:

1. Which manager of a newly-registered fund had the schmanciest high society wedding this year?
2. Which fund in registration gave Snowball, by far, the biggest headache as he tried to translate their prose to English?
3. Which hedge fund manager decided that the perfect time to launch a mutual fund was after getting bludgeoned on returns for two consecutive years?
4. Which managers seem most attuned to young investors, skippering craft that might be described as Clifford the Big Red Mutual Fund and the Spongebob Fund?

Manager Changes

On a related note, we also tracked down 51 fund manager changes.

Updates

One of the characteristics of good managers is their ability to think clearly and one of the best clues to the existence of clear thinking is clear writing. Here’s a decent rule: if they can’t write a grocery list without babbling, you should avoid them. Contrarily, clear, graceful writing often reflects clear thinking.

Many managers update their commentaries and fund materials quarterly and we want to guide you to the most recent discussions and data possible for the funds we’ve written about. The indefatigable Mr. Welsch has checked (and updated) every link and linked document for every fund we’ve profiled in 2013 and for most of 2012. Here’s David’s summary table, which will allow you to click through to a variety of updated documents.

Advisory Research Strategic Income	Q3 Report Manager Commentary Fact Sheet
Artisan Global Equity Fund	Q3 Report
Artisan Global Value Fund	Q3 Report
Beck, Mack & Oliver Partners Fund	Fact Sheet
Bretton Fund	Q3 Report Fund Fact Page
Bridgeway Managed Volatility	Q3 Report Fact Sheet
FPA International Value	Q3 Report and Commentary Fact Sheet
FPA Paramount	Q3 Report and Commentary Fact Sheet
Frank Value	Fact Sheet Q3 Report and Commentary
FundX Upgrader Fund	Fact Sheet
Grandeur Peak Global Opportunities	Q3 Report Commentary
Grandeur Peak Global Reach	Q3 Report Commentary
LS Opportunity Fund	Q3 Report
Matthews Asia Strategic Income	Commentary Q3 Report
Oakseed Opportunity Fund	Fact Sheet
Oberweis International Opportunities	Q3 Report
Payden Global Low Duration Fund	Q3 Report Commentary
PIMCO Short Asset Investment Fund “D” shares	Q3 Report
RiverPark/Gargoyle Hedge Value	Q3 Report
Scout Low Duration Bond Fund	Q3 Report Commentary
Sextant Global High Income	Q3 Report
Smead Value Fund	Q3 Report Fact Sheet
The Cook and Bynum Fund	Fact Sheet
Tributary Balanced	Q3 Report Fact Sheet
Whitebox Long Short Equity Investor Class	Fact Sheet

Briefly Noted 

A big ol’ “uhhh” to Advisory Research Emerging Markets All Cap Value Fund (the “Fund”) which has changed both manager (“Effective immediately, Brien M. O’Brien is no longer a portfolio manager of the Fund”) and name (it will be Advisory Research Emerging Markets Opportunities Fund), both before the fund even launched.  A few days after that announcement, AR also decided that Matthew Dougherty would be removed as a manager of the still-unlaunched fund.  On the bright side, it didn’t close to new investors before launch, so that’s good.  Launch date is November 1, 2013.

In a singularly dark day, Mr. O’Brien was also removed as manager of Advisory Research Small Micro Cap Value Fund, which has also not launched and has changed its name: Advisory Research Small Company Opportunities Fund.”

A Centaur arises!  The Tilson funds used to be a two-fund family: the one that Mr. Tilson ran and the one that was really good. After years of returns that never quite matched the hype, Mr. Tilson liquidated his Tilson Focus (TILFX) fund in June 2013.  That left behind the Tilson-less Tilson Dividend Fund (TILDX) which we described as “an awfully compelling little fund.”

Effective November 1, Tilson Dividend became Centaur Total Return Fund (TILDX), named after its long-time sub-adviser, Centaur Capital Partners.  Rick Schumacher, the operations guy at the Centaur funds, elaborates:

Since Tilson is no longer involved in the mutual fund whatsoever, and since the Dividend Fund has historically generated as much (if not more) income from covered call premiums rather than pure dividends, we felt that it was a good time to rebrand the fund.  So, effective today, our fund is now named the Centaur Total Return Fund.  We have kept the ticker (TILDX), as nothing’s really changed as far as the investment objective or strategy of the fund, and besides, we like our track record.  But, we’re very excited about our new Centaur Mutual Funds brand, as it will provide us with potential opportunities to launch other strategies under this platform in the future.

They’ve just launched a clean and appropriate dignified website that both represents the new fund and archives the analytic materials relevant to its old designation.  The fund sits at $65 million in assets with cash occupying about a quarter of its portfolio.  All cap, four stars, low risk. It’s worth considering, which we’ll do again in our December issue.

Laudus Growth Investors U.S. Large Cap Growth Fund is having almost as much fun.  On September 24, its Board booted UBS Global Asset Management as the managers of the fund in favor of BlackRock.  They then changed the name (to Laudus U.S. Large Cap Growth Fund) and, generously, slashed the fund’s expense ratio by an entire basis point from 0.78% to 0.77%.

But no joy in Mudville: the shareholder meeting being held to vote on the merger of  Lord Abbett Classic Stock Fund (LRLCX) into Lord Abbett Calibrated Dividend Growth Fund (LAMAX) has been adjourned until November 7, 2013 for lack of a quorum.

Scout Funds are sporting a redesigned website. Despite the fact that our profiles of Scout Unconstrained Bond and Scout Low Duration don’t qualify as “news” for the purposes of their media list (sniffles), I agree with reader Dennis Green’s celebration of the fact the new site is “thoughtful, with a classy layout, and—are you sitting down?— their data are no longer stale and are readily accessible!”  Thanks to Dennis for the heads-up.

Snowball’s portfolio: in September, I noted that two funds were on the watchlist for my own, non-retirement portfolio.  They were Aston River Road Long Short (ARLSX) and RiverPark Strategic Income (RSIVX). I’ve now opened a small exploratory position in Aston (I pay much more attention to a fund when I have actual money at risk) as I continue to explore the possibility of transferring my Northern Global Tactical Asset Allocation (BBALX) investment there.  The Strategic Income position is small but permanent and linked to a monthly automatic investment plan.

For those interested, John Waggoner of USA Today talked with me for a long while about the industry and interesting new funds.  Part of that conversation contributed to his October 17 article, “New Funds Worth Mentioning.”

SMALL WINS FOR INVESTORS

Eaton Vance Asian Small Companies Fund (EVASX) will eliminate its danged annoying “B” share class on November 4, 2013. It’s still trying to catch up from having lost 70% in the 2007-09 meltdown. 

Green Owl Intrinsic Value Fund (GOWLX) substantially reduced its expense cap from 1.40% to 1.10%. It’s been a very solid little large cap fund since its launch in early 2012.

Invesco Balanced-Risk Commodity Strategy Fund (BRCAX) will reopen to new investors on November 8, 2013. The fund has three quarters of a billion in assets despite trailing its peers and losing money in two of its first three years of existence.

As of December, Vanguard Dividend Appreciation Index (VDAIX) will have new Admiral shares with a 0.10% expense ratio and a $10,000 minimum investment. That’s a welcome savings on a fund currently charging 0.20% for the Investor share class.

At eight funds, Vanguard will rename Signal shares as Admiral shares and will lower the minimum investment to $10,000 from $100,000.

Zeo Strategic Income Fund (ZEOIX) dropped its “institutional” minimum to $5,000.  I will say this for Zeo: it’s very steady.

CLOSINGS (and related inconveniences)

The Brown Capital Management Small Company Fund (BCSIX) closed to new investors on October 18, 2013.

Buffalo Emerging Opportunities Fund (BUFOX) formally announced its intention to close to new investors when the fund’s assets under management reach $475 million. At last check, they’re at $420 million.  Five star fund with consistently top 1% returns.  If you’re curious, check quick!

GW&K Small Cap Equity Fund (GWETX) is slated to close to new investors on November 1, 2013.

Matthews Pacific Tiger Fund (MAPTX) closed to new investors on October 25, 2013.

Oakmark International (OAKIX) closed to most new investors as of the close of business on October 4, 2013

Templeton Foreign Smaller Companies (FINEX) will close to new investors on December 10^th.  I have no idea of why: it’s a small fund with an undistinguished but not awful record. Liquidation seems unlikely but I can’t imagine that much hot money has been burning a hole in the managers’ pockets.

Touchstone Merger Arbitrage Fund (TMGAX), already mostly closed, will limit access a bit more on November 11, 2013.  That means closing the fund to new financial advisors.

OLD WINE, NEW BOTTLES

Advisory Research Emerging Markets All Cap Value Fund has renamed itself, before launch, as Advisory Research Emerging Markets Opportunities Fund.

Aegis Value Fund (AVALX) has been reorganized as … Aegis Value Fund (AVALX), except with a sales load (see story above).

DundeeWealth US, LP (the “Adviser”) has also changed its name to “Scotia Institutional Investments US, LP” effective November 1, 2013.

The Hatteras suite of alternative strategy funds (Hatteras Alpha Hedged Strategies, Hedged Strategies Fund, Long/Short Debt Fund, Long/Short Equity Fund and Managed Futures Strategies Fund) have been sold to RCS Capital Corporation and Scotland Acquisition, LLC.  We know this because the SEC filing avers the “Purchaser will purchase from the Sellers and the Sellers will sell to the Purchaser, substantially all the assets related to the business and operations of the Sellers and … the “Hatteras Funds Group.” Morningstar has a “negative” analyst rating on the group but I cannot find a discussion of that judgment.

Ladenburg Thalmann Alternative Strategies Fund (LTAFX) have been boldly renamed (wait for it) Alternative Strategies Fund.  It appears to be another in the expanding array of “interval” funds, whose shares are illiquid and partially redeemable just once a quarter. Its performance since October 2010 launch has been substantially better than its open-ended peers.

Effective October 7, 2013, the WisdomTree Global ex-US Growth Fund (DNL) became WisdomTree Global ex-US Dividend Growth Fund.

U.S. Global Investors MegaTrends Fund (MEGAX) will, on December 20, become Holmes Growth Fund

OFF TO THE DUSTBIN OF HISTORY

On-going thanks to The Shadow for help in tracking the consequences of “the perennial gale of creative destruction” blowing through the industry.  Shadow, a member of the Observer’s discussion community, has an uncanny talent for identifying and posting fund liquidations (and occasionally) launches to our discussion board about, oh, 30 seconds after the SEC first learns of the change.  Rather more than three dozen of the changes noted here and elsewhere in Briefly Noted were flagged by The Shadow.  While my daily reading of SEC 497 filings identified most of the them, his work really does contribute a lot. 

And so, thanks, big guy!

On October 16, 2013, the Board of Trustees of the Trust approved a Plan of Liquidation, which authorizes the termination, liquidation and dissolution of the 361 Absolute Alpha Fund. In order to effect such liquidation, the Fund is closed to all new investment. Shareholders may redeem their shares until the date of liquidation. The Fund will be liquidated on or about October 30, 2013.

City National Rochdale Diversified Equity Fund (the “Diversified Fund”) has merged into City National Rochdale U.S. Core Equity Fund while City National Rochdale Full Maturity Fixed Income Fund was absorbed by City National Rochdale Intermediate Fixed Income Fund

Great-West Ariel Small Cap Value Fund (MXSCX) will merge into Great-West Ariel Mid Cap Value Fund (MXMCX) around Christmas, 2013.  That’s probably a win for shareholders, since SCV has been mired in the muck while MCV has posted top 1% returns over the past five years.

As we suspected, Fidelity Europe Capital Appreciation Fund (FECAX) is merging into Fidelity Europe Fund (FIEUX). FECAX was supposed to be the aggressive growth version of FIEUX but the funds have operated as virtually clones for the past five years.  And neither has particularly justified its existence: average risk, average return, high r-squared despite the advantages of low expenses and a large analyst pool.

The Board of the Hansberger funds seems concerned that you don’t quite understand the implications of having a fund liquidated.  And so, in the announcement of the October 18 liquidation of Hansberger International Fund they helpfully explain: “The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase.”

Highland Alpha Trend Strategies Fund (HATAX), formerly Pyxis Alpha Trend Strategies Fund, will close on November 20, 2013.  With assets not much greater than my retirement account (and performance vastly below it), I’m not sure that even the manager will notice the disappearance.

Huntington Income Equity (HUINX) will merge into Huntington Dividend Capture Fund (HDCAX) at the end of the first week of December.  It’s never a good sign when the winning fund – the more attractive of the two – trails 80% of its peers.

The JPMorgan Global Opportunities Fund was liquidated and dissolved on or about October 25, 2013. Given that they’re speaking in the past tense, don’t you think that they’d know whether it was “on” or “about”?

Update on the JPMorgan Value Opportunities Fund: an attempt to merge the fund out of existence in September failed because the Board couldn’t get enough shareholders to vote one way or the other.  On October 10, though, they reached a critical mass and folded the fund into JPMorgan Large Cap Value Fund (OLVAX) on October 18^th.

So long to LONGX! Longview Tactical Allocation Fund (LONGX) has closed and will liquidate on November 15, 2013.  700% turnover which might well have led to a joke about their ability to take the long view except for the fact that they’ve joined the zombie legion of walking dead funds.

In a determinedly “WTF?” move, the Mitchell Capital’s Board of Trustees has determined to liquidate the Mitchell Capital All-Cap Growth Fund (MCAEX) “due to the adviser’s business decision that it no longer is economically viable to continue managing the Fund because of the Fund’s small size, the increasing costs associated with managing the Fund, and the difficulty encountered in distributing the Fund’s shares.”  Huh?  “No longer economically viable”?  They only launched this sucker on March 1, 2013.  Seven months, guys?  You hung on seven months and that’s it?  What sort of analytic abilities are on display here, do you suppose?

On October 15, Nomura Partners Funds closed all of its remaining five mutual funds to purchases and exchanges.  They are The Japan Fund (NPJAX), Nomura Partners High Yield (NPHAX), Nomura Partners Asia Pacific Ex Japan (NPAAX), Nomura Partners Global Equity Income (NPWAX), and Nomura Partners Global Emerging Markets (NPEAX).  Here’s a sentence you should take seriously: “The Board will consider the best interests of the investors in each of the Funds and may decide to liquidate, merge, assign the advisory contract or to take another course of action for one or more of the Funds.”  The NPJAX board has acted boldly in the past.  In 2002, it fired the fund’s long-standing adviser, Scudder,Stevens, and turned the fund over to Fidelity to manage.  Then, in 2008, they moved it again from Fidelity to Nomura.  No telling what they might do next.

The firm also announced that it, like DundeeWealth, is planning to get out of the US retail fund business.

The liquidations of Nuveen Tradewinds Global Resources Fund and Nuveen Tradewinds Small-Cap Opportunities Fund are complete.  It’s an ill wind that blows …

Oppenheimer SteelPath MLP and Infrastructure Debt Fund went the way of the wild goose on October 4.

Transamerica is bumping off two sub-advised funds in mid-December: Transamerica International Bond (TABAX), subadvised by J.P. Morgan, and Transamerica International Value Opportunities Fund, subadvised by Thornburg but only available to other Transamerica fund managers.

UBS Global Frontier Fund became UBS Asset Growth Fund (BGFAX) on October 28.  Uhhh … doesn’t “Asset Growth” strike you as pretty much “Asset Gathering”?  Under the assumption that “incredibly complicated” is the magic strategy, the fund will adopt a managed volatility objective that tries to capture all of the upside of the MSCI World Free Index with a standard deviation of no more than 15.  On the portfolio’s horizon: indirect real estate securities, index funds, options and derivatives with leverage of up to 75%. They lose a couple managers and gain a couple in the process.

U.S. Global Investors Global Emerging Markets Fund closed on October 1 and liquidated on Halloween.  If you were an investor in the fund, I’m hopeful that you’d already noticed.  And considered Seafarer as an alternative.

Vanguard plans to merge two of its tax-managed funds into very similar index funds.  Vanguard Tax-Managed International (VTMNX) is merging into Vanguard Developed Markets Index (VDMIX) and Vanguard Tax-Managed Growth & Income (VTMIX) will merge into Vanguard 500 Index (VFINX). Since these were closet index funds to begin with – they have R-squared values of 98.5 and 100(!) – the merger mostly serves to raise the expenses borne by VTMNX investors from 10 basis points to 20 for the index fund.

Vanguard Growth Equity (VGEQX) is being absorbed by Vanguard US Growth (VWUSX). Baillie Gifford, managers of Growth Equity, will be added as another team for US Growth.

Vanguard Managed Payout Distribution Focus (VPDFX) and Vanguard Managed Payout Growth Focus (VPGFX) are slated to merge to create a new fund, Vanguard Managed Payout Fund. At that time, the payout in question will decrease to 4% from 5%.

WHV Emerging Markets Equity Fund (WHEAX) is suffering “final liquidation”  on or about December 20, 2013.  Okay returns, $5 million in assets.

In Closing . . .

As Chip reviewed how folks use our email notification (do they open it?  Do they click through to MFO?), she discovered 33 clicks from folks in Toyko (youkoso!), 21 in the U.K. (uhhh … pip pip?), 13 in the United Arab Emirates (keep cool, guys!) and 10 scattered about India (Namaste!).  Welcome to all.

Thanks to the kind folks who contributed to the Observer this month.  I never second guess folks’ decision to contribute, directly or through PayPal, but I am sometimes humbled by their generosity and years of support.  And so thanks, especially, to the Right Reverend Rick – a friend of many years – and to Andrew, Bradford, Matt, James (uhh… Jimmy?) and you all.  You make it all possible.

Thanks to all of the folks who bookmarked or clicked on our Amazon link.   Here’s the reminder of the easiest way to support the Observer: just use our Amazon link whenever you’d normally be doing your shopping, holiday or other, on Amazon anyway.  They contribute an amount equal to about 7% of the value of all stuff purchased through the link.  It costs you nothing (the cost is already built into their marketing budget) and is invisible.  If you’re interested in the details, feel free to look at the Amazon section under “Support.”  

Remember to join us, if you can, for our upcoming conversations with John, Greg and David.  Regardless, enjoy the quiet descent of fall and its seasonal reminder to slow down a bit and remember all the things you have to be grateful for rather than fretting about the ones you don’t have (and, really, likely don’t need and wouldn’t enjoy).

Cheers!

By David Snowball

Welcome to October, the time of pumpkins.

October’s a month of surprises, from the first morning that you see frost on the grass to the appearance of ghosts and ghouls at month’s end.  It’s a month famous of market crashes – 1929, 1987, 2008 – and for being the least hospitable to stocks. And now it promises to be a month famous for government showdowns and shutdowns, when the sales of scary Halloween masks (Barackula, anyone?) take off.

It’s the month of golden leaves, apple cider, backyard fires and weekend football.  (Except possibly back home in Pittsburgh, where some suspect a zombie takeover of the beloved Steelers backfield.)  It’s the month that the danged lawnmower gets put away but the snowblower doesn’t need to be dragged out.

It’s the month where we discover the Octoberfest actually takes place in September, and we’ve missed it. 

In short, it’s a good month to be alive and to share with you.

Better make that “The Fantastic 48,” Russ

Russel Kinnel, Morningstar’s chief fund guy, sent out an email on September 16^th, touting his “Fantastic 51,” described as “51 Funds You Should Know About.”  And if you’ll just pony up the $125 for a Fund Investor subscription, it’s yours!

 Uhhh … might have to pare that back to the Fantastic 48, Russ.  It turns out that a couple of the funds hyped in the email underwent critical changes between the time Mr. Kinnel published that article in May and the time Morningstar’s marketers began pushing it in September.

Let’s start by looking at Mr. K’s criteria, then talking about the flubbed funds and finish by figuring out what we might learn from the list as a whole.

Here are the criteria for being Fantastic this year:

Last year I shared the “Fantastic 46” with you. This year I raised the bar on my tests and still reached 51 funds. Here’s what I want:

1. A fund with expenses in the cheapest quintile
2. Returns that beat the benchmark over the course of the manager’s tenure (minimum five years)
3. Manager investment of at least $500,000
4. A Positive Parent rating
5. A medalist Morningstar Analyst Rating

Sub-text: Fantastic funds are large or come from large fund complexes.  Of the 1150 medalist funds, only 53 have assets under $100 million.  Of those 53, only five or six are the products of independent or boutique firms.  The others are from Fido, MFS, PIMCO or another large firm.  Typically an entire target-date series gets medalized, including the Retirement 2075 fund with $500,003 in it.  By way of comparison, there are 2433 funds with under $100 million in assets.

And it’s certainly the case that the Fantastic 51 is The Corporate Collection: 10 American Funds, 10 Price and nine Vanguard.  Russel holds out the LKCM funds as examples of off-the-radar families, which would be more credible if LKCM Small Cap Equity (LKSCX) didn’t already have $1.1 billion in assets.

And what about the funds touted in the promotional email.  Two stand out: FPA Paramount and Janus Triton.

Morningstar’s take on FPA Paramount

The Mutual Fund Observer’s reply:

Great recommendation, except that the managers you’re touting left the fund and its strategy has substantially changed.  Eric and Steve’s unnamed and unrecognized co-managers are now in charge of the fund and are working to transition it from a quality-growth to an absolute-value portfolio.  Both of those took place in August 2013. 

The MFO recommendation: if you like Eric and Steve’s work, invest in FPA Perennial (FPPFX) which is a fund they actually run, using the strategy that Mr. Kinnel celebrates.

Morningstar’s take on Janus Triton

The Observer’s reply:

Uhhh … a bigger worry here is that Chad and Brian left in early May, 2013. The new manager’s tenure is 14 weeks.  Morningstar’s analysts promptly downgraded the fund to “neutral.” And Greg Carlson fretted that the “manager change leaves Janus Triton with uncertain prospects” because Mr. Coleman has not done a consistently excellent job in his other charges. That would be four months before the distribution of this email promo.

The MFO recommendation: if you’re impressed by Chad and Brian’s work (an entirely reasonable conclusion) check Meridian Growth Legacy Fund (MERDX), or wait until November and invest in their new Meridian Small Cap Growth Fund.

The email did not highlight, but the Fantastic 51 does include, T. Rowe Price New America Growth (PRWAX), whose manager resigned in May 2013.   Presumably these funds ended up in the letter because, contrary to appearances, Mr. Kinnel neither wrote, read nor approved its content (his smiling face and first-personal singular style notwithstanding).  That work was likely all done by a marketer who wouldn’t know Triton from Trident.

The bigger picture should give you pause about the value of such lists.   Twenty-six percent of the funds that were “fantastic” last year are absent this year, including the entire contingent of Fidelity funds.  Thirty-three percent of the currently fantastic funds were not so distinguished twelve months ago.  If you systematically exclude large chunks of the fund universe from consideration (those not medalized) and have a list that’s both prosaic (“tape the names of all of the Price funds to the wall, throw a dart, find your fantasy fund!”) and unstable, you wonder how much insight you’re being offered.

Interested parties might choose to compare last year’s Fantastic 46 list with 2013’s new and improved Fantastic 51. 

About the lack of index funds in the Fantastic 51

Good index funds – ones with little tracking error – can’t beat their benchmarks over time because their return is the benchmark minus expenses.  A few bad index funds – ones with high tracking error, so they’re sometimes out of step with their benchmark – might beat it from time to time, and Gus Sauter was pretty sure that microscopic expenses and canny trade execution might allow him to eke out the occasional win.  But the current 51 has no passive funds.

The authors of S&P Indices Versus Active Funds (SPIVA®) Scorecard would argue that’s a foolish bias.  They track the percentage of funds in each equity category which manage to outperform their benchmark, controlling for survivorship bias.  The results aren’t pretty.  In 17 of 17 domestic equity categories they analyzed, active funds trailed passive.  Not just “most active funds.”  No, no.  The vast majority of active funds.  Over the past five years, 64.08% of large value funds trailed their benchmark and that’s the best performance by any of the 17 groups.  Overall, 72.01% trailed.  Your poorest odds came in the large cap growth, midcap growth and multicap growth categories, where 88% of funds lagged. 

In general, active funds lag passive ones by 150-200 basis points year.  That’s a problem, since that loss is greater than what the fund’s expense ratios could explain.  Put another way: even if actively managed funds had an expense ratio of zero, they’d still modestly trail their passive peers.

There is one and only one bright spot in the picture for active managers: international small cap funds, nearly 90% of which outperform a comparable index. Which international small caps qualify as Fantastic you might ask? That would be, none.

If you were looking for great prospects in the international small cap arena, the Observer recommends that you check Grandeur Peak Global Reach (GPROX) or wait for the launch of one of their next generation of purely international funds. Oberweis International Opportunities (OBIOX), profiled this month, would surely be on the list. Fans of thrill rides might consider Driehaus International Small Cap Growth (DRIOX). Those more interested in restrained, high-probability bets might look at the new Artisan Global Small Cap Fund (ARTWX), a profile of which is forthcoming.

How much can you actually gain by picking a good manager?

It’s hard to find a good manager. It takes time and effort and it would be nice to believe that you might receive a reward commensurate with all your hard work. That is, spending dozens of hours in research makes a lot more sense if a good pick actually has a noticeably pay-off. One way of measuring that pay-off is by looking at the performance difference between purely average managers and those who are well above average. 

The chart below, derived from data in the S&P 2013 SPIVA analysis shows how much additional reward a manager in the top 25% of funds provides compared to a purely average manager.

Category	Average five-year return	Excess return earned by a top quartile manager, In basis points per year
Small-Cap Growth	8.16	231
Small-Cap Value	10.89	228
Small-Cap Core	8.23	210
Mid-Cap Value	7.89	198
Multi-Cap Core	5.22	185
Emerging Market Equity	(0.81)	173
Mid-Cap Growth	6.37	166
Multi-Cap Growth	5.37	153
Real Estate	5.74	151
Global Equity	3.57	151
Diversified International	(0.43)	135
Mid-Cap Core	7.01	129
International Small-Cap	3.10	129
Large-Cap Core	5.67	128
Large-Cap Growth Funds	5.66	125
Multi-Cap Value	6.23	120
Large-Cap Value	6.47	102

What might this suggest about where to put your energy?  First and foremost, a good emerging markets manager makes a real difference – the average manager lost money for you, the top tier of guys kept you in the black. Likewise with diversified international funds.  The poorest investment of your time might be in looking for a large cap and especially large cap value manager. Not only do they rarely beat an index fund when they do, the margin of victory is slim. 

The group where good active manager appears to have the biggest payoff – small caps across the board –  is muddied a bit by the fact that the average return was so high to begin with. The seemingly huge 231 bps advantage held by top managers represents just a 28% premium over the work of mediocre managers. In international small caps, the good-manager premium is far higher at 41%.  Likewise, top global managers returned about 42% more than average ones.

The bottom line: invest your intellectual resources where your likeliest to see the greatest reward.  In particular, managers who invest largely or exclusively overseas seem to have the prospect of making a substantial difference in your returns and probably warrant the most careful selection.  Managers in what’s traditionally the safest corner of the equity style box – large core, large  value, midcap value – don’t have a huge capacity to outperform either indexes or peers.  In those areas, cheap and simple might be your mantra.

The one consensus pick: Dodge & Cox International (DODFX)

There are three lists of “best funds” in wide circulation now: the Kiplinger 25, the Fantastic 51, and the Money 70.  You’d think that if all of these publications shared the same sensible goal – good risk-adjusted returns and shareholder-friendly practices – they’d also be stumbling across the same funds.

You’d be wrong. There’s actually just one fund that they all agree on: Dodge & Cox International (DODFX). The fund is managed by the same team that handles all of Dodge & Cox. It’s dragging around $45 billion in assets but, despite consistently elevated volatility, it’s done beautifully. It has trailed its peers only twice in the past decade, including 2008 when all of the D&C funds made a mistimed bet that the market couldn’t get much cheaper.  They were wrong, by about six months and 25% of their assets.

The fund has 94% of its assets in large cap stocks, but a surprisingly high exposure to the emerging markets – 17% to its peers 7%.

My colleague Charles is, even as you read this, analyzing the overlap – and lack of overlap – between such “best funds” lists.  He’ll share his findings with us in November.

Tealeaf Long/Short Deep Value Fund?

Really guys?

Really?

You’ve got a business model that’s predicated upon being ridiculed before you even launch?

The fate of the Palantir (“mystical far-seeing eye”) Fund (PALIX) didn’t raise a red flag?  Nor the Oracle Fund (ORGAX – the jokes there were too dangerous), or the Eye of Zohar Fund (okay, I made that one up)?  It’s hard to imagine investment advisors wanting to deal with their clients’ incredulity at being placed in a fund that sounds like a parody, and it’s harder to imagine that folks like Chuck Jaffe (and, well, me) won’t be waiting for you to do something ridiculous.

In any case, the fund’s in registration now and will eventually ask you for 2.62 – 3.62% of your money each year.

The art of reading tea leaves is referred to as tasseography.  Thought you’d like to know.

A new Fidelity fund is doing okay!

Yeah, I’m surprised to hear me saying that, too.  It’s a rarity.  Still FidelityTotal Emerging Markets (FTEMX) has made a really solid start.  FTEMX is one of the new generation of emerging markets balanced or hybrid funds.  It launched on November 1, 2011 and is managed by a seven-person team.  The team is led by John Carlson, who has been running Fidelity New Markets Income (FNMIX), an emerging markets bond fund, since 1995.  Mr. Carlson’s co-managers in general are young managers with only one other fund responsibility (for most, Fidelity Series Emerging Markets, a fund open only to other Fidelity funds).

The fund has allocated between 60-73% of its portfolio to equities and its equity allocation is currently at a historic high.

Since there’s no “emerging markets balanced” peer group or benchmark, the best we can do is compare it to the handful of other comparable funds we could find.  Below we report the fund’s expense ratios and the amount of money you’d have in September 2013 if you’d invested $10,000 in each on the day that FTEMX launched.

	Growth of $10k	Expense ratio
Fidelity Total Emerging Markets	$11,067	1.38%
First Trust Aberdeen Emerging Opp (FEO)	11,163	1.70 adj.
Lazard E.M. Multi-Strategy (EMMOX)	10,363	1.60
PIMCO Emerging Multi-Asset (PEAAX)	10,140	1.71
Templeton E.M. Balanced (TAEMX)	10,110	1.44
AllianceBernstein E.M. Multi-Asset (ABAEX)	9,929	1.65

The only fund with even modestly better returns is the closed-end First Trust Aberdeen Emerging Opportunities, about which we wrote a short, positive profile.  That fund’s shares are selling, as of October 1, at a 9.2% discount to its actual net asset value which is a bit more than its 8.9% average discount over the past five years and substantially more than its 7.4% discount over the past three.

Microscopic by Fidelity standard, the fund has just $80 million in assets.  The minimum initial investment is $2500, reduced to $500 for IRAs.

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.

Frank Value Fund (FRNKX) is not “that other Frank Fund” (John Buckingham’s Al Frank fund VALUX). It’s a concentrated, all-cap value fund that’s approaching its 10^th anniversary. It’s entirely plausible that it will celebrate its 10^thanniversary with returns in the top 10% of its peer group.

Oberweis International Opportunities (OBIOX) brings a unique strategy grounded in the tenets of behavioral finance to the world of international small- and mid-cap growth investing.  The results (top decile returns in three of the past four years) and the firm’s increasingly sophisticated approach to risk management are both striking.

Elevator Talk #9: Bashar Qasem of Wise Capital (WISEX)

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.

Wise Capital (WISEX) provides investors with an opportunity for diversification in a fund category (short term bonds) mostly distinguished by bland uniformity: 10% cash, one equity security thrown in for its thrill-value, about 90% of the bond portfolio would be US with a dribble of Canadian and British issues, 90% A-AAA rated and little distance between the fund and its peers. 

We began searching, late last year, from short-term income funds that offered some prospect of offering atypical returns in a bad environment: negative real short-term rates for now and the prospect of a market overreaction when US rates finally began to rise.  Our touchstones were stable management, a distinctive strategy, and a record of success.  A tiny handful of funds survived the cull.  Among them, PIMCO Short Asset (PAUIX ), Payden Global Low Duration (PYGSX), RiverPark Short Term High Yield (RPHYX), Scout Low Duration (SCLDX) … and Azzad Wise Capital.

WISEX draws on a fundamentally different asset set than any other US fixed-income fund.  Much of the fund’s portfolio is invested in the Islamic world, in a special class of bank deposits and bond-equivalents called Sukuks.  The fund is not constrained to invest solely in either asset class, but its investments are ethically-screened, Shariah-compliant and offers ethical exposure to emerging markets such as Turkey, Indonesia, Malaysia and the Gulf.

Azzad was founded in 1997 by Bashar Qasem, a computer engineer who immigrated to the United States from Jordan at the age of 23.  Here’s Mr. Qasem’s 200 words making his case:

I started Azzad Asset Management back 1997 because I was disappointed with the lack of investment options that aligned with my socially responsible worldview. For similar reasons, I traveled across the globe to consult with scholars and earned licenses to teach and consult on compliance with Islamic finance. I later trained and became licensed to work in the investment industry.

We launched the Azzad Wise Capital Fund in 2010 as a response to calls from clients asking for a fund that respects the Islamic prohibition on interest but still offers a revenue stream and risk/return profile similar to a short-term bond fund. WISEX invests in a variety of Sukuk (Islamic bonds) and Islamic bank deposits involved in overseas development projects. Of course, it’s SEC-registered and governed by the Investment Company Act of 1940. Although it doesn’t deal with debt instruments created from interest-based lending, WISEX shares in the profits from its ventures.

And I’m particularly pleased that it appeals to conservative, income-oriented investors of all backgrounds, Muslim or not. We hear from financial advisors and individual shareholders of all stripes who own WISEX for exposure to countries like Turkey, Malaysia, and Indonesia, as well as access to an alternative asset class like Sukuk.

The fund has a single share class. The minimum initial investment is $4,000, reduced to $300 for accounts established with an automatic investing plan (always a good idea with cash management accounts). Expenses are capped at 1.49% through December, 2018.

For those unfamiliar with the risk/return profile of these sorts of investments, Azzad offers two resources.  First, on the Azzad Funds website, they’ve got an okay (not but great) white paper on Sukuks.  It’s under Investor Education, then White Papers.  Second, on October 23^rd, Mr. Quesam and portfolio manager Jamal Elbarmil will host a free webinar on Fed Tapering and Sukuk Investing.  Azzad shared the announcement with us but I can’t, for the life of me, find it on either of their websites so here’s a .pdf explaining the call.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund (VCMRX), a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies. We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility

During the summer hiatus on Observer conference calls, my colleague Charles Boccadoro and I have been listening-in on calls sponsored by some of the more interesting fund companies.  We report this month on the highlights of the calls concerning the reopening of RiverNorth/DoubleLine Strategic Income (David) and the evolution of the intriguing Whitebox Tactical Opportunities (Charles) funds.

Conference Call Highlights: RiverNorth/DoubleLine Strategic Income (RNDLX)

Strategic Income was launched on December 30, 2010 and our profile of the fund described it as “compelling.”  We speculated that if an investor were planning to hold only three funds over the long haul, “given its reasonable expenses, the managers’ sustained successes, innovative design and risk-consciousness, this might well be one of those three.”  Both popular ($1.1 billion in the portfolio) and successful (it has outperformed its “multisector bond” peers since inception and in seven of 10 quarters), the fund closed to new investors at the end of March. 2012.  Faced with a substantial expansion in their opportunity set, RiverNorth decided to reopen the fund to new investors 17 months later, at the end of August 2013, with the understanding that it was subject to re-closure if there was a pressing mismatch between the fund’s resources and the opportunities available.

On September 18, 2013, co-managers Jeffrey Gundlach of DoubleLine and Patrick Galley of RiverNorth spoke with interested parties about their decision to re-open the fund and its likely evolution.

By happenstance, the call coincided with the fed’s announcement that they’d put plans to reduce stimulus on hold, an event which led Mr. Gundlach to describe it as “a pivotal day for investor attitudes.” The call addressed three issues:

• The fund’s strategy and positioning.  The fund was launched as an answer to the question, how do income-oriented investors manage in a zero-rate environment?  The answer was, by taking an eclectic and opportunistic approach to exploiting income-producing investments.  The portfolio has three sleeves: core income, modeled after Doubleline’s Core Income Fund, opportunistic income, a mortgage-backed securities strategy which is Doubleline’s signature strength, and RiverNorth’s tactical closed-end income sleeve which seeks to profit from both tactical asset choices and the opportunities for arbitrage gains when the discounts on CEFs become unsustainably large.

  The original allocation was 50% core, 25% opportunistic and 25% tactical CEF.  RiverNorth’s strategy is to change weightings between the sleeves to help the portfolio manage changes in interest rates and volatility; in a highly volatile market, they might reallocate toward the more conservative core strategy while a rising interest rate regime might move them toward their opportunistic and tactical sleeves.  Before closing, much of the tactical CEF money was held in cash because opportunities were so few. 

• The rationale for reopening. Asset prices often bear some vague relation to reality.  But not always.  Opportunistic investors look to exploit other investors’ irrationality.  In 2009, people loathed many asset classes and in 2010 they loathed them more selectively.  As the memory of the crash faded, greed began to supplant fear and CEFs began selling at historic premiums to their NAVs.  That is, investors were willing to pay $110 for the privilege of owning $100 in equities.  Mr. Galley reported that 60% of CEFs sold at a premium to their NAVs in 2012.  2013 brought renewed anxiety, an anxious departure from the bond market by many and the replacement of historic premiums on CEFs with substantial discounts.  As of mid-September, 60% of CEFs were selling at discounts of 5% or more.  That is, investors were willing to sell $100 worth of securities for $95.

  As a whole, CEFs were selling at a 6.5% discount to NAV.  That compared to a premium the year before, an average 1% discount over the preceding three years and an average 3% discount over the preceding decade.

  

  The lack of opportunities in the fixed-income CEF space, a relatively small place, forced the fund’s closure.  The dramatic expansion of those opportunities justified its reopening.  The strategy might be able to accommodate as much as $1.5 billion in assets, but the question of re-closing the fund would arise well before then.

• Listener concerns.  Listeners were able to submit questions electronically to a RiverNorth moderator, an approach rather more cautious than the Observer’s strategy of having callers speak directly to the managers.  Some of the questions submitted were categorized as “repetitive or not worth answering” (yikes), but three issues did make it through. CEFs are traded using an algorithmic trading system developed by RiverNorth. It is not a black box, but rather a proprietary execution system used to efficiently trade closed-end funds based off of discount, instead of price. The size of the fund’s investable CEF universe is about 300 funds, out of 400 extant closed-end fixed-income funds. The extent of leverage in the portfolio’s CEFs was about 20%.

Bottom Line: the record of the managers and the fund deserves considerable respect, as does the advisor’s clear commitment to closing funds when doing so is in their investors’ best interest. The available data clearly supports the conclusion that, even with dislocations in the CEF space in 2013, active management has added considerable value here. 

The data-rich slides are already available by contacting RiverNorth. A transcript of the broadcast will be available on the RiverNorthFunds.com website sometime in October. 

Update: The webcast is now available at https://event.webcasts.com/viewer/event.jsp?ei=1021309 You will be required to register, but you’ll gain access immediately.

Conference Call Highlights: Whitebox Tactical Opportunities Fund (WBMAX and WBMIX)

Portfolio managers Andrew Redleaf and Dr. Jason Cross, along with Whitebox Funds’ President Bruce Nordin, hosted the 2^nd quarter conference call for their Tactical Opportunities Fund (WBMIX) on September 10. Robert Vogel, the fund’s third manager, did not participate. The call provided an opportunity to take a closer look at the fund, which is becoming hard to ignore.

Background

WBMIX is the more directionally oriented sibling of Whitebox’s market-neutral Long Short Equity Fund (WBLFX), which David profiled in April. Whitebox is preparing to launch a third mutual fund, named Enhanced Convertible Fund (WBNIX), although no target date has been established.

Whitebox Advisors, founded by Mr. Redleaf in 1999, manages its mutual funds with similar staff and strategies as its hedge funds. Mr. Redleaf is a deep contrarian of efficient market theory. He works to exploit market irrationalities and inefficiencies, like “mispriced securities that have a relationship to each other.” He received considerable attention for successfully betting against mortgages in 2008.

The Tactical Opportunities Fund seeks to provide “a combination of capital appreciation and income that is consistent with prudent investment management.” It employs the full spectrum of security classes, including stocks, bonds, and options. Its managers reject the notion that investors are rewarded for accepting more risk. “We believe risk does not create wealth, it destroys wealth.” Instead, they identify salient risks and adjust their portfolio “to perform at least tolerably well in multiple likely scenarios.”

The fund has attracted $205M AUM since its inception in December 2011 ­– on the day of the conference call, Morningstar showed AUM at $171M, an increase of $34M in less than three weeks. All three managers are also partners and owners in the firm, which manages about $2.4B in various types of investment accounts, but the SAI filed February 2013 showed none invested in the fund proper. Since this filing, Whitebox reports Mr. Redleaf has become a “significant owner” and that most of its partners and employees are invested in its funds through the company’s 401k program.

Morningstar recently re-categorized WBMIX from aggressive allocation to long-short after Whitebox management successfully appealed to the editorial board. While long-short is currently more appropriate, the fund’s versatility makes it an awkward fit in any category. It maintains two disparate benchmarks, S&P 500 Price Index SPX (excludes dividends) and Barclay’s Aggregate U.S. Bond Total Return Index. Going forward, Whitebox reports it will add S&P 500 Total Return Index as a benchmark.

Ideally, Mr. Redleaf would prefer the fund’s performance be measured against the nation’s best endowment funds, like Yale’s or Havard’s. He received multiple degrees from Yale in 1978. Dr. Cross holds an MBA from University of Chicago and a Ph.D. in Statistics from Yale.

Call Highlights

Most of its portfolio themes were positive or flat for the quarter, resulting in a 1.3% gain versus 2.9% for SP500 Total Return, 2.4% SP500 Price Return, 0.7% for Vanguard’s Balanced Index , and -2.3% for US Aggregate Bonds. In short, WBMIX had a good quarter.

Short Bonds. Whitebox has been sounding warning bells for sometime about overbought fixed income markets. Consequently, it has been shorting 20+ year Treasuries and high-yield bond ETFs, while being long blue-chip equities. If 1Q was “status quo” for investors, 2Q saw more of an orderly rotation out of low yielding bonds and into quality stocks. WBMIX was positioned to take advantage.

Worst-Case Hedge. It continues to hold out-of-money option straddles, which hedge against sudden moves up or down, in addition to its bond shorts. Both plays help in the less probable scenario that “credit markets crack” due to total loss of confidence in bonds, rapid rate increase and mass exodus, taking equities down with them.

Bullish Industrials. Dr. Cross explained that in 2Q they remained bullish on industrials and automakers. After healthy appreciation, they pared back on airlines and large financials, focusing instead on smaller banks, life insurers, and specialty financials. They’ve also been shorting lower yielding apartment REITS, but are beginning to see dislocations in higher yielding REITs and CEFs.

Gold Miner Value. Their one misstep was gold miners, at just under 5% of portfolio; it detracted 150 basis points from 2Q returns. Long a proxy for gold, miners have been displaced by gold ETFs and will no longer be able to mask poor business performance with commodity pricing. Mr. Redleaf believes increased scrutiny on these miners will lead to improved operations and a closure in the spread, reaping significant upside. He cited that six CEOs have retired or been replaced recently. This play is signature Whitebox. The portfolio managers do not see similar inefficiencies in base metal miners.

Large vs Small. Like its miss with gold miners, its large cap versus small cap play has yet to pan-out. It believes small caps are systematically overpriced, so they have been long on large caps while short on small caps. Again, “value arbitrage” Whitebox. The market agreed last quarter, but this theme has worked against the fund since 2Q12.

Heading into 3Q, Whitebox believes equities are becoming overbought, if temporarily, given their extended ascent since 2009. Consequently, WBMIX beta was cut to 0.35 from 0.70. This move appears more tactical than strategic, as they remain bullish on industrials longer term. Mr. Redleaf explains that this is a “game with no called strikes…you never have to swing.” Better instead to wait for your pitch, like winners of baseball’s Home Run Derby invariably do.

Whitebox has been considering an increase to European exposure, if it can find special situations, but during the call Mr. Redleaf stated that “emerging markets is a bit out of our comfort zone.”

Performance To-Date

The table below summaries WBMIX’s return/risk metrics over its 20-month lifetime. The comparative funds were suggested by MFO reader and prolific board contributor “Scott.” (He also brought WBMIX to community attention with his post back in August 2012, entitled “Somewhat Interesting Tiny Fund.”) Most if not all of the funds listed here, at some point and level (except VBINX), tout the ability to deliver balanced-like returns with less risk than the 60/40 fixed balanced portfolio.

While Whitebox has delivered superior returns (besting VBINX, Mr. Aronstein’s Marketfield and Mr. Romick’s Crescent, while trouncing Mr. Arnott’s All Asset and AQR’s Risk Parity), it’s generally done so with higher volatility. But the S&P 500 has had few drawdowns and low downside over this period, so it’s difficult to conclude if the fund is managing risk more effectively. That said, it has certainly played bonds correctly.

Other Considerations

When asked about the fund’s quickly increasing AUM, Dr. Cross stated that their portfolio contains large sector plays, so liquidity is not an issue. He believes that the fund’s capacity is “immense.”

Whitebox provides timely and thoughtful quarterly commentaries, both macro and security specific, both qualitative and quantitative. These commentaries reflect well on the firm, whose very name was selected to highlight a “culture of transparency and integrity.” Whitebox also sponsors an annual award for best financial research. The $25K prize this year went to authors of the paper “Time Series Momentum,” published in the Journal of Financial Economics.

Whitebox Mutual Funds offers Tactical Opportunities in three share classes. (This unfortunate practice is embraced by some houses, like American Funds and PIMCO, but not others, like Dodge & Cox and FPA.) Investor shares carry an indefensible front-load for purchases below $1M. Both Investor and Advisor shares carry a 12b-1 fee. Some brokerages, like Fidelity and Schwab, offer Advisor shares with No Transaction Fee. (As is common in the fund industry, but not well publicized, Whitebox pays these brokerages to do so – an expensive borne by the Advisor and not fund shareholders.) Its Institutional shares WBMIX are competitive currently at 1.35 ER, if not inexpensive, and are available at some brokerages for accounts with $100,000 minimum.

During the call, Mr. Redleaf stated that its mutual funds are cheaper than its hedge funds, but the latter “can hold illiquid and obscure securities, so it kind of balances out.” Perhaps so, but as Whitebox Mutual Funds continues to grow through thoughtful risk and portfolio management, it should adopt a simpler and less expensive fee structure: single share class, no loads or 12b-1 fees, reasonable minimums, and lowest ER possible. That would make this already promising fund impossible to ignore.

Bottom Line

At the end of the day, continued success with the fund will depend on whether investors believe its portfolio managers “have behaved reasonably in preparing for the good and bad possibilities in the current environment.” The fund proper is still young and yet to be truly tested, but it has the potential to be one of an elite group of funds that moderate investors could consider holding singularly – on the short list, if you will, for those who simply want to hold one all-weather fund.

A transcript of the 2Q call should be posted shortly at Whitebox Tactical Opportunities Fund.

27Sept2013/Charles

Conference Call Upcoming: Zachary Wydra, Beck, Mack & Oliver Partners (BMPEX), October 16, 7:00 – 8:00 Eastern

On October 16, Observer readers will have the opportunity to hear from, and speak to Zachary Wydra, manager of Beck, Mack & Oliver Partners (BMPEX).  After review of a lot of written materials on the fund and its investment discipline, we were impressed and intrigued.  After a long conversation with Zac, we were delighted.  Not to put pressure on the poor guy, but he came across as smart, insightful, reflective, animated and funny, often in a self-deprecating way.  We were more delighted when he agreed to spend an hour talking with our readers and other folks interested in the fund.

Mr. Wydra will celebrate having survived both the sojourn to Nebraska and participation in The Last Blast Triathlon by opening with a discussion of the  structure, portfolio management approach and stock selection criteria that distinguish BMPEX from the run-of-the-mill large cap fund, and then we’ll settle in to questions (yours and mine).

Our conference call will be Wednesday, October 16, from 7:00 – 8:00 Eastern.  It’s free.  It’s a phone call.

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?

Nearly 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.

The Conference Call Queue

We have two other calls on tap.  On Monday, November 18, from 7:00 – 8:00 Eastern, you’ll have a chance to meet John Park and Greg Jackson, co-managers of Oakseed Opportunity (SEEDX and SEDEX).  John and Greg have really first-rate experience as mutual fund managers and in private equity, as well.  Oakseed is a focused equity fund that invests in high quality businesses whose managers interests are aligned with their shareholders.  As we note in the Updates section below, they’re beginning to draw both high-quality investors and a greater range of media attention.  If you’d like to get ahead of the curve, you can register for the call with John and Greg though I will highlight their call in next month’s issue.

In early December we’ll give you a chance to speak with the inimitable duo of Sherman and Schaja on the genesis and early performance of RiverPark Strategic Income, the focus of this month’s Launch Alert.

Launch Alert: RiverPark Strategic Income (RSIVX, RSIIX)

There are two things particularly worth knowing about RiverPark Short-Term High Yield (RPHYX): (1) it’s splendid and (2) it’s closed.  Tragically mischaracterized as a high-yield bond fund by Morningstar, it’s actually a cash management fund that has posted 3-4% annual returns and negligible volatility, which eventually drew almost a billion to the fund and triggered its soft close in June.  Two weeks later, RiverPark placed its sibling in registration. That fund went live on September 30, 2013.

Strategic Income will be managed by David Sherman of Cohanzick Management, LLC.  David spent ten years at Leucadia National Corporation where he was actively involved high yield and distressed securities and rose to the rank of vice president.  He founded Cohanzick in 1996 and Leucadia became his first client.  Cohanzick is now a $1.3 billion dollar investment adviser to high net worth individuals and corporations.   

Ed Studzinski and I had a chance to talk with Mr. Sherman and Morty Schaja, RiverPark’s president, for an hour on September 18^th.  We wanted to pursue three topics: the relation of the new fund to the older one, his portfolio strategy, and how much risk he was willing to court. 

RPHYX represented the strategies that Cohanzick uses for dealing with in-house cash.  It targets returns of 3-4% with negligible volatility.  RSIVX represents the next step out on the risk-return continuum.  David believes that this strategy might be reasonably expected to double the returns of RPHYX.  While volatility will be higher, David is absolutely adamant about risk-management.  He intends this to be a “sleep well at night” fund in which his mother will be invested.  He refuses to be driven by the temptation to shoot for “the best” total returns; he would far rather sacrifice returns to protect against loss of principal.  Morty Schaja affirms the commitment to “a very conservative credit posture.”

The strategy snapshot is this.  He will use the same security selection discipline here that he uses at RPHYX, but will apply that discipline to a wider opportunity set.  Broadly speaking, the fund’s investments fall into a half dozen categories:

1. RPHYX overlap holdings – some of the longer-dated securities (1-3 year maturities) in the RPHYX portfolio will appear here and might make up 20-40% of the portfolio.
2. Buy and hold securities – money good bonds that he’s prepared to hold to maturity. 
3. Priority-based debt – which he describes as “above the fray securities of [firms with] dented credit.”  These are firms that “have issue” but are unlikely to file for bankruptcy any time soon.  David will buy higher-order debt “if it’s cheap enough,” confident that even in bankruptcy or reorganization the margin of safety provided by buying debt at the right price at the peak of the creditor priority pyramid should be money good.
4. Off-the-beaten-path debt – issues with limited markets and limited liquidity, possibly small issues of high quality credits or the debt of firms that has solid business prospects but only modestly-talented management teams.  As raters like S&P contract their coverage universe, it’s likely that more folks are off the major firm’s radar.
5. Interest rate resets – uhhh … my ears started ringing during this part of the interview; I had one of those “Charlie Brown’s teacher” moments.  I’m confident that the “cushion bonds” of the RPHYX portfolio, where the coupon rate is greater than the yield-to maturity, would fall into this category.  Beyond that, you’re going to need to call and see if you’re better at following the explanation than I was.
6. And other stuff – always my favorite category.  He’s found some interesting asset-backed securities, fixed income issues with equity-like characteristics and distressed securities, which end up in the “miscellaneous” basket.

Mr. Sherman reiterates that he’s not looking for the highest possible return here; he wants a reasonable, safe return.  As such, he anticipates underperforming in silly markets and outperforming in normal ones.

The minimum initial investment in the retail class is $1,000.  The expense ratio is capped at 1.25%.  The fund is available today at TD and Fidelity and is expected to be available within the next few days at Schwab. More information is available at RiverPark’s website.  As I noted in September’s review of my portfolio, this is one of two funds that I’m almost certain to purchase before year’s end.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.

Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves.  This month he tracked down 10 no-load funds in registration, one of the lowest levels in a year (compare it to 26 last month), but it does contain three offerings from first-rate, veteran teams:

361 Multi-Strategy Fund, 361’s fourth alternatives fund, guided by Brian Cunningham (a hedge fund guy), Thomas Florence (ex-Morningstar Investment Management), Blaine Rollins (ex-Janus) and Jeremy Frank.

Croft Focus, which transplants the discipline that’s guided Croft Value for 18 years into a far more concentrated global portfolio.

RSQ International Equity, which marks the re-emergence of Rudolph Riad-Younes and Richard Pell from the ashes of the Artio International crash.

In addition, two first-tier firms (Brookfield and First Eagle) have new funds managed by experienced teams.

Funds in registration this month won’t be available for sale until, typically, the end of November or early December 2013.

Manager Changes

On a related note, we also tracked down 39 fund manager changes.

Updates

The good folks at Oakseed Opportunity (SEEDX and SEDEX) are getting their share of favorable notice.  The folks at Bloomberg featured them in A Fund’s Value: Having Skin in the Game (Sept 6, 2013) while, something called Institutional Imperative made them one of Two Funds on which to Build a Portfolio (Sept 10, 2013).  At last report, they were holding more cash, more international exposure and smaller firms than their peers, none of which has been positive in this year’s market. Somehow the fact that the managers have $10 million of their own money in the fund, and that two phenomenally talented international investors (David Herro of Oakmark and David Samra of Artisan) are also invested in the fund does rather make “weak relative returns in 2013” sound rather like background noise.  Thanks to the indefatigable Denny Baran for sharing both of those links and do consider the opportunity to speak with the Oakseed managers during our November conference call.

Morningstar declared Poplar Forest Partners Fund (PFPFX and IPFPX) to be an Undiscovered Manager (uhhh … okay) and featured them in a Morningstar Advisor Magazine article, “Greener Pastures” (August/September, 2013).  Rob Wherry makes the argument that manager Dale Harvey walked away from managing a $20 billion fund because it was – for reasons he couldn’t control – a $20 billion fund.  “I had to put the money to work. I was managing $20 billion, but I didn’t have $20 billion [worth of] good ideas . . . I had 80 investments, but I only wanted 30.”  It’s a good piece.

Briefly Noted . . .

Since DundeeWealth US, LP, has opted to get out of the US mutual fund business they’re looking for a buyer for their Dynamic Energy Income Fund (DWEIX/DWEJX/DWEKX), Dynamic U.S. Growth Fund (DWUGX/DWUHX/DWUIX) and Mount Lucas U.S. Focused Equity Fund (BMLEX) funds. Failing that, they’re likely to liquidate them. My suggestion for eBaying them was not received warmly (hey, it worked for William Shatner’s $25,000 kidney stone!). If you’re looking for a handful of $50 million funds – one of which, US Growth, is remarkably good – you might give them a call.

Fidelity Global Balanced Fund (FGBLX) manager Ruben Calderon has taken a leave of absence for an unspecified reason.  His co-manager, Geoff Stein, will take sole control.   A chunk of my retirement accounts are, and have for a long time been, invested in the fund and I wish Mr. Calderon all the best with whatever has called him away.

JPMorgan Value Opportunities Fund (JVOAX) isn’t dead yet.  The Board is appalled.  The Board convened a meeting on September 10, 2013, for the purpose of merged Value Opps into JPMorgan Large Cap Value.  Unfortunately, they have not received enough ballots to meet their quorum requirement and the meeting dissolved.  They’ve resolved to try again with the following stern warning to non-voting shareholders:

However, recognizing that it is neither feasible nor legally permitted for the Value Opportunities Fund to conduct a proxy solicitation indefinitely, the Board approved in principle the liquidation of the Value Opportunities Fund if shareholders do not approve the merger when the Meeting is reconvened on October 10, 2013. If the Value Opportunities Fund is liquidated, the Fund’s liquidation may be taxable to a shareholder depending on the shareholder’s tax situation; as a result, the tax-free nature of the merger may be more beneficial to shareholders.

Translation: (a) vote (b) the way we want you to, or we’ll liquidate your fund and jack up your taxes.

Litman Gregory giveth and Litman Gregory taketh away.  The firm has eliminated the redemption fee on its Institutional Class shares, but then increased the minimum investment for Institutional shares of their Equity (MSEFX) and International (MSILX) funds from $10,000 to $100,000.

Vanguard 500 Index Fund ETF Shares (VOO) has announced an odd reverse share split.  As of October 24, 2013, the fund will issue one new share for every two current ones.  Good news: Vanguard expects somewhat lower transaction costs as a result, savings which they’ll pass along to investors.  Bad news: “As a result of the split, VOO shareholders could potentially hold fractional shares. These will be redeemed for cash and sent to the broker of record, which may result in the realization of modest taxable gains or deductible losses for some shareholders.”

Virtus Dynamic AlphaSector Fund (EMNAX), on the other hand, mostly taketh away.  Virtus discontinued the voluntary limit on “Other Expenses” of the fund.  The fund, categorized as a long/short fund though it currently has no reported short positions, charges a lot for modest achievement: Class A Shares, 2.56%; Class B Shares, 3.31%; Class C Shares, 3.31%; and Class I Shares, 2.31%.   Virtus may also recapture fees previously waived. 

SMALL WINS FOR INVESTORS

The Board for Altegris Equity Long Short Fund (ELSAX) voted to reduce Altegris’s management fee from 2.75% to 2.25% of assets.   This qualifies as a small win since that’s still about 50% higher than reasonable.  Aston River Road Long/Short (ARLSX) investors, for example, pays a management fee of 1.20% for considerably stronger performance.  Wasatch Long/Short (FMLSX) investors pay 1.10%.

Altegris Futures Evolution Strategy Fund  (EVOAX) has capped its management fee at 1.50%.

Calamos Convertible Fund (CCVIX) reopened to new investors on September 6^th.

CSC Small Cap Value Fund (CSCSX) has been renamed Cove Street Capital Small Cap Value Fund.  They’ve eliminated their sales loads and reduced the minimum initial investment to $1,000 for Investor class shares and $10,000 for Institutional class shares.   The manager here was part of the team that had fair success at the former CNI Charter RCB Small Cap Value Fund.

CLOSINGS (and related inconveniences)

ASTON/Fairpointe Mid Cap Fund (ABMIX) is set to close on October 18, 2013.  About $5 billion in assets.  Consistently solid performance.  I’m still not a fan of announcing a closing four weeks ahead of the actual event, as happened here.

BMO Small-Cap Growth Fund (MRSCX) is closing effective November 1, 2013.  The closure represents an interesting reminder of the role of invisible assets in capacity limits.  The fund has $795 million in it, but the advisor reports that assets in the small-cap growth strategy as a whole are approaching approximately $1.5 billion.

Invesco European Small Company Fund (ESMAX) closes to new investors on October 4, 2013.  Invesco’s to be complimented on their decision to close the fund while it was still small, under a half billion in assets.

Touchstone Sands Capital Select Growth Fund (TSNAX) instituted a soft-close on April 8, 2013.  That barely slowed the inrush of money and the fund is now up to $5.5 billion in assets.  In response, the advisor will institute additional restrictions on October 21, 2013. In particular, existing RIA’s already using the fund can continue to use the fund for both new and existing clients.  They will not be able to accept any new RIA’s after that date.

Virtus Emerging Markets Opportunities Fund (HEMZX), a four-star medalist run by Morningstar’s International Stock Fund Manager of the Year Rajiv Jain, has closed to new investors.

OLD WINE, NEW BOTTLES

FMI Focus (FMIOX) will reorganize itself into Broadview Opportunity Fund in November.  It’s an exceedingly solid small-cap fund (four stars, “silver” rated, nearly a billion in assets) that’s being sold to its managers.

Invesco Disciplined Equity Fund (AWEIX) will, pending shareholder approval on October 17, become AT Disciplined Equity Fund.

Meridian Value (MVALX) is Meridian Contrarian Fund.  Same investment objective, policies, strategies and team. 

Oppenheimer Capital Income Fund (OPPEX) has gained a little flexibility; it can now invest 40% in junk bonds rather than 25%.  The fund was crushed during the meltdown in 2007-09.  Immediately thereafter its managers were discharged and it has been pretty solid since then.

Effective October 1, 2013, Reaves Select Research Fund (RSRAX) became Reaves Utilities and Energy Infrastructure Fund, with all of the predictable fallout in its listed investment strategies and risks.

Smith Group Large Cap Core Growth Fund (BSLGX) will, pending shareholder approval, be reorganized into an identical fund of the same name in early 2014. 

Tilson Dividend Fund (TILDX) has been sold to its long-time subadviser, Centaur Capital Partners, LP, presumably as part of the unwinding of the other Tilson fund.

U.S. Global Investors Government Securities Savings Fund (UGSCX) is being converted from a money market fund to an ultra-short bond fund, right around Christmas.

OFF TO THE DUSTBIN OF HISTORY

American Century announced that it will merge American Century Vista Fund (TWVAX) into American Century Heritage (ATHAX).  Both are multibillion dollar midcap growth funds, with Heritage being far the stronger. The merger will take place Dec. 6, 2013.

EGA Emerging Global ordered the liquidation of a dozen of emerging markets sector funds, all effective October 4, 2013.  The dearly departed:

• EGShares GEMS Composite ETF (AGEM)
• EGShares Basic Materials GEMS ETF (LGEM)
• EGShares Consumer Goods GEMS ETF (GGEM)
• EGShares Consumer Services GEMS ETF (VGEM)
• EGShares Energy GEMS ETF (OGEM)
• EGShares Financials GEMS ETF (FGEM)
• EGShares Health Care GEMS ETF (HGEM)
• EGShares Industrials GEMS ETF (IGEM)
• EGShares Technology GEMS ETF (QGEM)
• EGShares Telecom GEMS ETF (TGEM)
• EGShares Utilities GEMS ETF (UGEM)
• EGShares Emerging Markets Metals & Mining ETF (EMT)

FCI Value Equity Fund (FCIEX) closed September 27, on its way to liquidation.  The Board cited “the Fund’s small size and the increasing costs associated with advising a registered investment company” but might have cited, too, the fact that it trails 97% of its peers over the past five years and tended to post two awful years for every decent one.

Natixis Hansberger International Fund (NEFDX) will liquidate on October 18, 2013, a victim of bad returns, high risk, high expenses, wretched tax efficiency … all your basic causes.

Loomis Sayles Multi-Asset Real Return Fund (MARAX) liquidates at the end of October, 2013.  The fund drew about  $25 million in assets and was in existence for fewer than three years.  “Real return” funds are designed to thrive in a relatively high or rising inflation rate environment.  Pretty much any fund bearing the name has been thwarted by the consistent economic weakness that’s been suppressing prices.

I really like Manning & Napier.  They are killing off three funds that were never a good match for the firm’s core strengths.  Manning & Napier Small Cap (MNSMX), Life Sciences (EXLSX), and Technology (EXTCX) will all cease to exist on or about January 24, 2014.  My affection for them comes to mind because these funds, unlike the vast majority that end up in the trash heap, were all economically viable.  Between them they have over $600 million in assets and were producing $7 million/year in revenue for M&N.  The firm’s great strength is risk-conscious, low-cost, team-managed diversified funds.  Other than a real estate fund, they offer almost no niche products really.  Heck, the tech fund even had a great 10-year record and was no worse than mediocre in shorter time periods.  But, it seems, they didn’t make sense given M&N’s focus. 

Metzler/Payden European Emerging Markets Fund (MPYMX) closed on September 30, 2013.  It actually outperformed the average European equity fund over the past decade but suffered two cataclysm losses – 74% from June 2008 to March 2009 and 33% in 2011 – that surely sealed its fate.  We reviewed the fund favorably as a fascinating Eurozone play about seven years ago. 

Nuveen International (FAIAX) is slated to merge into Nuveen International Select (ISACX), which is a case of a poor fund with few assets joining an almost-as-poor fund with more assets (and, not coincidentally, the same managers). 

PIA Moderate Duration Bond Fund (PIATX) “will be liquidating its assets on October 31, 2013.  You are welcome, however, to redeem your shares before that date.”  As $30 million in assets, it appears that most investors didn’t require the board’s urging before getting out.

U.S. Global Investors Tax Free Fund (USUTX) will merge with a far better fund, Near-Term Tax Free (NEARX) on or about December 13, 2013.

U.S. Global Investors Treasury Securities Cash (USTXX) vanishes on December 27, 2013.

Victoria 1522 Fund (VMDAX) has closed and will liquidate on October 10, 2013.  Nice people, high fees, weak performance, no assets. 

Westcore Small-Cap Opportunity Fund (WTSCX) merges into the Westcore Small-Cap Value Dividend Fund (WTSVX) on or about November 14, 2013.  It’s hard to make a case for the surviving fund (it pays almost no dividend and trails 90% of its peers) except to say it’s better than WTSCX.  Vanguard has an undistinguished SCV index fund that would be a better choice than either.

In Closing . . .

At the beginning of October, we’ll be attending Morningstar’s ETF Invest Conference in Chicago, our first tentative inquiry, made in hopes of understanding better the prospects of actively-managed ETFs.  I don’t tweet (I will never tweet) but I will try to share daily updates and insights on our discussion board.  We’ll offer highlights of the conference presentations in our November issue.

Thanks to all of the folks who bookmarked or clicked on our Amazon link.  There was a gratifyingly sustained uptick in credit from Amazon, on the order of a 7-8% rise from our 2013 average.  Thanks especially to those who’ve supported the Observer directly (Hi, Joe!  It’s a tough balance each month: we try to be enjoyable without being fluffy, informative without being plodding.  Glad you think we make it.) or via our PayPal link (Thanks, Ken!  Thanks, Michelle.  Sorry I didn’t extend thanks sooner.  And thanks, especially, to Deb.  You make a difference).  It does make a difference.

We’ll see you just after Halloween.  If you have little kids who enjoy playing on line, one of Chip’s staff made a little free website that lets kids decorate jack-o-lanterns.  It’s been very popular with the seven-and-under set. 

Take care!

 

David