By David Snowball

Dear friends,

Dear friends,

Well, we’ve done it again. Augustana just launched its 154^th set of graduates in your direction. Personally, it’s my 29^th set of them. I think you’ll enjoy their company, if not always the quality of their prose. They’re good kids and we’ve spent an awful lot of time teaching them to ask questions more profound than “how much does it pay?” or “would you like fries with that?”  We’ve tried, with some success, to explain to them that leadership flows from service, that words count, that deeds count, and that other people count.

They are, on whole, a work well begun. The other half is up to you and to them.

As for me and my colleagues, two months to recoup and then 714 more chances to make a difference.

All the noise, noise, noise, noise!

Here’s my shameful secret: I have no idea of why global stock markets at all-time highs nor when they will cease to be there. I also don’t know quite what investors are doing or thinking, much less why. Hmmm … also pretty much confused about what actions any of it implies that I should take.

I spent much of the month of May paying attention to questions like the ones implied above and my interim conclusion is that that was not a good use of my time. There are about 300 million Americans who need to make sense out of their world and about 57,000 Americans paid to work as journalists and four times that many public relations specialists who are charged with telling them what it all means. And, sadly, there’s a news hole that can never be left unfilled; that is, if you have a 30 minute news program (22.5 minutes plus commercials), you need to find 22.5 minutes worth of something to say even when you think there’s nothing to say.

And so we’re inundated with headlines like these from the May issues of The Wall Street Journal and The New York Times (noted as NYT):

Investors Abandon Riskier Assets (WSJ, May 16, C1) “Investors stepped up their retreat from riskier assets …”   Except when they did the opposite four pages later:

Higher-Yielding Bank Debt Draws Interest (WSJ, May 16, C4) “Investors are scooping up riskier bonds sold by banks …”

Small Stocks Fuel a Run to Records (WSJ, May 13, C1) but then again Smaller Stocks Slammed in Selloff (WSJ, May 21, C1)

The success of “safe” strategies is encourage folks to pursue unsafe ones. Bonds Flip Scripts on Risk, Reward (WSJ, May 27, C1) “Bonds perceived as safe have produced better returns than riskier ones for the first time since 2010… in response, many investors are doubling down on riskier debt.”And so Riskier Fannie Bonds Are Devoured (WSJ, May 21, C1).

Market Loses Ground as Investors Seek Safety (NYT, May 14) “The stock market fell back from record levels on Wednesday as investors decided it was better to play it safe… ‘There’s some internal self-correction and rotation going on beneath the surface,’ said Jim Russell, a regional investment director at U.S. Bank.”  But apparently that internal self-correction self-corrected within nine days because Investors Show Little Fear (WSJ, May 23, C1) “Many traders say they detect little fear in the market lately.  They cite a financial outlook that is widely perceived to pose little risk of an economic or market downturn: near-record stock prices, low interest rates, steady if unspectacular U.S. growth and expansive if receding Federal Reserve support for the economy and financial markets.”

And so the fearless fearful are chucking money around:

Penny Stocks Fuel Big-Dollar Dreams (WSJ, May 23, C1) “Investors are piling into the shares of small, risky companies at the fastest clip on record, in search of investments that promise a chance of outsize returns.  Investors are buying up so-called penny stocks … at a pace that far eclipses the tech boom of the 1990s.”  The author notes that average trading volume is up 40% over last year which was, we’ll recall, a boom year for stocks.

Investors Return to Emerging World (WSJ, May 29, C1) “Investors are settling in for another ride in emerging markets … The speed with which investors appear to have forgotten losses of 30% in some markets has been startling.”

Searching for Yield, at Almost Any Price (NYT, May 1) “Fixed-income investors trying to increase their income essentially have two options. One is to extend maturities. The other is to reduce credit quality. There are risks to both. The prices of long-term bonds fall sharply when interest rates go up. Lower-quality bonds are more likely to default.  These days, lower quality, rather than longer maturities, seems to be more popular. Money has poured into mutual funds that invest in bank loans — often low-quality ones. To a lesser extent, it has also gone into high-yield mutual funds that buy bonds rated below investment grade, known as junk bonds to those who are dubious of them.”

So, all of this risk-chasing means that it’s Time to Worry About Stock Market Bubbles (NYT, May 6) “Relative to long-term corporate earnings – and more in a minute on why that measure is important – stocks have been more expensive only three times over the past century than they are today, according to data from Robert Shiller, a Nobel laureate in economics. Those other three periods are not exactly reassuring, either: the 1920s, the late 1990s and in the prelude to the 2007 financial crisis.” … Based on history, stocks look either very expensive or somewhat expensive right now. Mr. Shiller suggests that the most likely outcome may be worse returns in coming years than the market has delivered over recent decades – but still better than the returns of any other investment class.”  Great. Worst except for all the others.

Good news, though: there’s no need to worry about stock market bubbles as long as people are worrying about stock market bubbles. That courtesy of the Leuthold Group, which argues that bubbles are only dangerous once we’ve declared that there is no bubble but only a new, “permanently high plateau.”

Happily, our Republican colleagues in the House agree and seem to have decided that none of the events of 2007-08 actually occurred. Financial Crisis, Over and Already Forgotten (NYT, May 22) “Michael S. Barr, a law professor at the University of Michigan who was an assistant Treasury secretary when the financial crisis was at its worst, is working on a book titled Five Ways the Financial System Will Fail Next Time. The first of them, he says, is ‘amnesia, willful and otherwise,’ regarding the causes and consequences of the crisis. Let’s hope the others are not here yet [since a]mnesia was on full view this week.”

Wait!  Wait!  Josh Brown is pretty sure that they did occur, might well re-occur and probably still won’t get covered right:

Okay can we be honest for a second?

The similarities between now and the pre-crisis era are f**king sickening at this point.

There, I said it.  

 (After a couple paragraphs and one significant link.)

To recap – Volatility is nowhere to be found – not in currencies, in fixed income or in equities. Complacency rules the day as investors and institutions gradually add more risk, using leverage and increasingly exotic vehicles to reach for diminishing returns in an aging bull market. This as economic growth – led by housing and consumer spending – stalls out and the Fed removes stimulus that never really worked in the first place.

And once again, the media is oblivious for the most part, fixated as it is on a French economist and the valuations of text messaging startups.

(Second Verse, Same as the First, 05/29/14)

You wouldn’t imagine that those of us who try to communicate for a vocation might argue that you need to read (watch and listen) less, rather than more but that is the position that several of us tend toward.

Tadas Viskanta , proprietor of the very fine Abnormal Returns blog, calls for “a news diet” in his book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere (2012).  He argues:

A media diet, as practiced by Nassim Taleb, is a conscious effort to decrease the amount of media we consume. Most of what we consume is “empty calories.” Most of it has little information value and can only serve to crowd out other more interesting and informative sources.

That’s all consistent with Barry Ritzholz’s argument that the stuff which makes great and tingly headlines – Black Swans, imminent crashes, zombie apocalypses – aren’t what hurts the average investor most. We’re hurt most, he says during a presentation at the FPA NorCal Conference in 2014, by the slow drip, drip, drip of mistakes: high expenses, impulsive trading and performance chasing. None of which is really news.

Josh Brown, who writes under the moniker The Reformed Broker at a blog of the same name, disagrees.  One chapter of this new book The Clash of the Financial Pundits (2014)is entitled “The Myth of the Media Diet.”  Brown argues that we have no more ability to consistently abstain from news than we have to consistently abstain from sugary treats.  In his mind, the effort of suppressing the urge in the first place just leads to cheating and then a return, unreformed, to our original destructive habits: “A true media diet virtually assures an overreaction to market volatility and expert prognostication once the dieter returns to the flashing lights and headlines.”  He argues that we need to better understand the financial media in order to keep intelligently informed, rather than entirely pickled in the daily brew.

And Snowball’s take on it all?

I actually teach about this stuff for a living, from News Literacy to Communication and Emerging Technologies. My best reading of the research supports the notion that we’ve become victims of continuous partial attention. There are so many ways of reaching us and we’re so often judged by the speed of our response (my students tell me that five minutes is the longest you can wait before responding to text without giving offense), that we’re continually dividing our attention between the task at hand and a steady stream of incoming chatter. (15% of us have interrupted sex to take a cellphone call while a third text while driving.) It’s pervasive enough that there are now reports in the medical literature of sleep-texting; that is, hearing an incoming text while asleep, rousing just enough to respond and then returning to sleep without later knowing that any of this had happened. We are, in short, training ourselves to be distracted, unsure and unfocused.

Fortunately, we can also retrain ourselves to become more focused. Focus requires discipline; not “browsing” or “link-hopping,” but regular, structured attention. In general, I pay no attention to “the news” except during two narrow windows each day (roughly, the morning when I have coffee and read two newspapers and during evening commutes). During those windows, I listen to NPR News which – so far as I can determine – has the most consistently thoughtful, in-depth journalism around.

But beyond that, I do try to practice paying intense and undivided attention to the stuff that’s actually important: I neither take and make calls during my son’s ballgames, I have no browser open when my students come for advice, and I seek no distraction greater than jazz when I’m reading a book. 

It’s not smug self-indulgence, dear friends. It’s survival. I really want to embrace my life, not wander distractedly through it. For investors, that means making fewer, more thoughtful decisions and learning to trust that you’ve gotten it right rather than second-guessing yourself throughout the day and night.

How Good Is Your Fund Family?

Question: How many funds at Dodge & Cox beat their category average returns since inception?

Answer: All of them.

In the case of Dodge & Cox, “all” is five funds:  DODBX, DODFX, DODGX, DODIX, and DODWX. Since inception, or at least as far back as January 1962, through March 2014, each has beaten its category average.

Same is true for these families: First Eagle, Causeway, Marsico, and Westwood.

For purposes of this article, a “fund family” comprises five funds or more, oldest share class only, with each fund being three years or older.

Obviously, no single metric should be used or misused to select a fund. In this case, fund lifetimes are different. Funds can perform inconsistently across market cycles. Share class representing “oldest” can be different. Survivorship bias and category drift can distort findings. Funds can be mis-categorized or just hard to categorize, making comparisons less meaningful.

Finally, metrics based on historical performance may say nothing of future returns, which is why analysis houses (e.g., Morningstar) examine additional factors, like shareholder friendliness, experience, and strategy to identify “funds with the highest potential of success.”

In the case of Marsico, for example, its six funds have struggled recently. The family charges above average expense ratios, and it has lost some experienced fund managers and analysts. While Morningstar acknowledges strong fund performance within this family since inception, it gives Marsico a negative “Parent” rating.

Nonetheless, these disclaimers acknowledged, prudent investors should know, as part of their due diligence, how well a fund family has performed over the long haul.

So, question: How many funds at Pacific Life beat category average returns since inception?

Applying the same criteria as above, the sad truth is: None of them.

PL funds are managed by Pacific Life Fund Advisors LLC, a wholly owned subsidiary of Pacific Life Insurance Company of Newport Beach, CA. Here from their web-site:

Got that?

Same sad truth for these families: AdvisorOne, Praxis, Integrity, Oak Associates, Arrow Funds, Pacific Financial, and STAAR.

In the case of Oak Associates, its seven funds have underperformed against their categories by 2.4% every year for almost 15 years! (They also experience maximum drawdown of -70.0% on average, or 13.1% worse than their categories.) Yet it proudly advertises recent ranking recognition by US News and selection to Charles Schwab’s OneSource. Its motto: “A Focus on Growth.”

To be clear, my colleague Professor Snowball has written often about the difficulties of beating benchmark indices for those funds that actually try. The headwinds include expense ratios, loads, transaction fees, commissions, and redemption demands. But the lifetime over- and under-performance noted above are against category averages of total returns, which already reflect these headwinds.

Overview. Before presenting performance results for all fund families, here’s is an overall summary, which will put some of the subsequent metrics in context:

It remains discouraging to see half the families still impose front load, at least for some share classes – an indefensible and ultimately shareholder unfriendly practice. Three quarters of families still charge shareholders a 12b-1 fee. All told shareholders pay fund families $12.3 billion every year for marketing. As David likes to point out, there are more funds in the US today than there are publically traded US companies. Somebody must pay to get the word out.

Size. Fidelity has the most number of funds. iShares has the most ETFs. But Vanguard has the largest assets under management.

Expense. In last month’s MFO commentary, Edward Studzinski asked: “It Costs How Much?”

As a group, fund families charge shareholders $83.3 billion each year for management fees and operating costs, which fall under the heading “expense ratio.” ER includes marketing fees, but excludes transaction fees, loads, and redemption fees.

It turns out that no fund family with an average ER above 1.58% ranks in the top performance quintile, as defined below, and most families with an average ER above 2.00 end up in the bottom quintile.

While share class does not get written about very often, it helps reveal inequitable treatment of shareholders for investing in the same fund. Typically, different share classes charge different ERs depending on initial investment amount, load or transaction fee, or association of some form. American has the largest number of share classes per fund with nearly five times the industry average.

Rankings. The following tables summarize top and bottom performing families, based on the percentage of their funds with total returns that beat category averages since inception:

As MFO readers would expect, comparison of top and bottom quintiles reveals the following tendencies:

• Top families charge lower ER, 1.06 versus 1.45%, on average
• Fewer families in top quintile impose front loads, 21 versus 55%
• Fewer families in top quintile impose 12b-1 fees, 64 versus 88%

For this sample at least, the data also suggests:

• Top families have longer tenured managers, if slightly, 9.6 versus 8.2 years
• Top families have fewer share classes, if slightly (1.9 versus 2.3 share class ratio, after 6 sigma American is removed as an outlier; otherwise, just 2.2 versus 2.3)

The complete set of metrics, including ER, AUM, age, tenure, and rankings for each fund family, can be found in MFO Fund Family Metrics, a downloadable Google spreadsheet. (All metrics were derived from Morningstar database found in Steel Mutual Fund Expert, dated March 2014.)

A closer look at the complete fund family data also reveals the following:

Some fund families, like Oakmark and Artisan, have beaten their category averages by 3-4% every year for more than 10 years running, which seems quite extraordinary. Whether attributed to alpha, beta, process, people, stewardship, or luck…or all the above. Quite extraordinary.

While others, frankly too many others, have done just the opposite. Honestly, it’s probably not too hard to figure out why.

31May14/Charles

Good news for Credit Suisse shareholders

CS just notified its shareholders that they won’t be sharing a cell with company officials.

On May 19, 2014, the Department of Justice nailed CS for conspiracy to commit tax fraud. At base, they allowed US citizens to evade taxes by maintaining illegal foreign accounts on their behalf. CS pled guilty to one criminal charge, which dents the otherwise universal impulse “to neither admit nor deny” wrongdoing. In consequence, they’re going to make a substantial contribution to reducing the federal budget deficit. CS certainly admits to wrong-doing, they have agreed to pay “over $1.8 billion” to the government, to ban some former officials, and to “undertake certain remedial actions.” The New York Times reports that the total settlement will end up around $2.6 billion dollars. The Economist calls it $2.8 billion.

Critics of the settlement, including Senator John McCain of Arizona, were astonished that the bank was not required to turn over the names of the tax cheats nor were “any officers, directors or key executives individually accountable for wrongdoing.” Comparable action against UBS, another Swiss bank with a presence in the US mutual fund market, in 2009 forced them to disclose the identities of 4700 account holders. The fact that CS seems intent to avoid discovering the existence of wrongdoing (the Times reports that the firm “did not retain certain documents, failed to interview potentially culpable bankers before they left the firm, and did not start an internal inquiry” for a long while after they had reason to suspect a crime), some argue that the penalties should have been more severe and more targeted at senior management.

If you want to get into the details, the Times also has a nice online archive of the legal documents in the case.

Here’s the good news part: CS reports that “The recent settlements … do not involve the Funds or Credit Suisse Asset Management, LLC, Credit Suisse Asset Management Limited or Credit Suisse Securities (USA) LLC [and] will not have any material impact on the Funds or on the ability of the CS Service Providers to perform services for the Funds.” Of course the fact that CSAM is tied to a criminal corporation would impede their ability to run US funds except for a “temporary exemptive order” from the SEC “to permit them to continue serving as investment advisers and principal underwriters for U.S.-registered investment companies, such as the Funds. Due to a provision in the law governing the operation of U.S.-registered investment companies, they would otherwise have become ineligible to perform these activities as a result of the plea in the Plea Agreement.”

If the SEC makes permanent its temporary exemptive order, then CSAM could continue to manage the funds albeit with the prospect of somewhat-heightened regulatory interest in their behavior. If the commission does not grant permanent relief, the house of cards will begin to tumble.

Which is to say, the SEC is going to play nice and grant the exemption.

One other bit of good news for CS and its shareholders: at least you’re not BNP Paribas which was hoping to get off with an $8 billion slap on the wrist but might actually be on the hook for $10 billion in connection with its assistance to tax dodgers.

Another argument for a news diet: Reuters on the end of the world

A Reuter’s story of May 28 reads, in its entirety:

BlackRock CEO says leveraged ETFs could ‘blow up’ whole industry

May 28 (Reuters) – BlackRock Inc Chief Executive Larry Fink said on Wednesday that leveraged exchange-traded funds contain structural problems that could “blow up” the whole industry one day.

Fink runs a company that oversees more than $4 trillion in client assets, including nearly $1 trillion in ETF assets.

“We’d never do one (a leveraged ETF),” Fink said at Deutsche Bank investment conference in New York. “They have a structural problem that could blow up the whole industry one day.”

Didja notice anything perhaps missing from that story?  You know, places where the gripping narrative might have gotten just a bit thin?

How about: WHAT DOES “BLOW UP” EVEN MEAN? WHAT INDUSTRY EXACTLY?  Or WHY?

Really, guy, you claim to be covering the end of the world – or of the investment industry or ETF industry or something – and the best you could manage was 75 words that skipped, oh, every essential element of the story?

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. 

Dodge & Cox Global Bond (DODLX): Dodge & Cox, which has been helping the rich stay rich since the Great Depression, is offering you access to the world’s largest asset class, international bonds.  Where their existing Income fund (DODIX) is domestic and centered on investment-grade issues, Global Bond is a converted limited partnership that can go anywhere and shows a predilection for boldness.

RiverNorth/Oaktree High Income (RNOTX): “high income” funds are often just high-yield bond funds with a handful of dividend stocks tossed in for flavor. RiverNorth and Oaktree promise a distinctive and principled take on the space: they’re allocating resources tactically between three very distinct high-income asset classes. Oaktree will pursue their specialty in senior loan and high-yield debt investing while RiverNorth continues to exploit inefficiency and volatility with their opportunistic closed-end fund strategy. They are, at base, looking for investors rational enough to profit from the irrationality of others.

Lookin’ goooood!

As you’ve noticed, the Observer’s visual style is pretty minimalist – there are no flashing lights, twirling fonts, or competing columns and there’s pretty minimal graphic embellishment.  We’re shooting for something that works well across a variety of platforms (we know that a fair chunk of you are reading this on your phone or tablet while a brave handful are relying on dial-up connections).

From time to time, fund companies commission more visually appealing versions of those reprints.  When they ask for formatted reprints, two things happen: we work with them on what are called “compliance edits” so that they don’t run afoul of FINRA regulations and, to a greater or lesser extent, our graphic design team (well, Barb Bradac is pretty much the whole team but she’s really good) works to make the profiles more visually appealing and readable.

Those generally reside on the host companies’ websites, but we thought it worthwhile to share some of the more recent reprints with folks this month.  Each of the thumbnails opens into a full .pdf file in a separate tab.

A sample of recent reprints:

Beck, Mack & Oliver	Tributary Balanced	Evermore Global Value
Intrepid Income	Guinness Atkinson Inflation Managed Dividend	RiverPark/Gargoyle Hedged Value

And what about the other hundred profiles?

We’ve profiled about a hundred funds, all of which are accessible under the Funds tab at the top of the page. Through the kind of agency of my colleague Charles, there’s also a monthly update for every profiled fund in his MFO Dashboard, which he continues to improve. If you want an easy, big picture view, check out the Dashboard – also on the Funds page. 

Elevator Talk: David Bechtel, Principal, Barrow All-Cap Core (BALAX / BALIX)

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.

Barrow All-Cap Core has the unusual distinction of sporting a top tier five year record despite being less than one year old. The secret is that the fund began life as a private partnership at the end of 2008. It was designed as a public equity vehicle run by private equity investors.

Their argument is that they understand both value and business prospects in ways that are fundamentally different than typical stock investors do. Combining both operating experience with a record of buying entire companies, they’re used to different metrics and different perspectives.

While you might be tempted to dismiss that as “big talk,” two factors might moderate your skepticism. First, their portfolio – typically about 200 names – really is way different from their competitors’. While Morningstar benchmarks them against the large-value group (a style box in which Barrow places just 5% of their money), the fund nearly reversed the size profile of its peers: it has about 20% in large caps, 30% in mid caps and 50% in small caps. Its peer group has about 80% in large caps. The entire portfolio is invested in six sectors, with effectively zero exposure to the four others (including financials and tech). By almost any measure (long-term earnings growth, level of corporate debt, free cash flow generation), their portfolio is substantially higher-quality than its peers. Second, the strategy’s performance – primarily as a private partnership, lately as a mutual fund – has been absolutely first tier: top 3% since inception 12/31/08 and in the top 20% in every calendar year since inception. Overall they’ve earned about 20% annually, better than both the S&P 500 and its large-value peers.

BALAX is managed by Nicholas Chermayeff, formerly of Morgan Stanley’s Principal Investment Group, and Robert F. Greenhill, who co-founded Barrow Street Advisors LLC, the fund’s advisor, after a stint at Goldman Sachs’ Whitehall Funds. Both are Harvard graduates (unlike some of us). The Elevator Talk itself, though, was provided by Yale graduate David Bechtel, a Principal of Barrow Street Advisors LLC, the fund’s advisor, who serves on its Investment Committee, and advises on the firm’s business development activities. He is a Founder and Managing Member of Outpost Capital Management LLC which structures and manages investments in the natural resources and financial services sectors. Mr. Bechtel offered just a bit more than 200 words to explain Barrow’s distinctiveness:

We are, first and foremost, private equity investors. Since Barrow Street was founded in 1997, we have invested and managed hundreds of millions in private market opportunities. The public equity strategy (US stocks only) used in Barrow All-Cap was funded by our own capital in 2008.

We launched this strategy and the fund to meet what we viewed as a market need. We take a private equity approach to security selection. We are not a “value” manager – selecting stocks based on low p/e, etc. – nor a pure “quality” manager – buying blue chips at any price. We look for very high quality companies whose shares are temporarily trading at a discount.

We look at value and quality the way a control investor in a business would. We emphasize cash flow, sales growth per unit of capital, operating margins, and we like companies that reinvest in their businesses. That gives us a very good feeling that not only is the management team interested in growing their business, but also that the business itself is good at generating cash.

On the valuation side, we’re looking for firms that are “momentarily” trading well-below intrinsic value. The general idea is to look at total enterprise value – equity market cap plus debt and preferred stock minus cash on the books – which controls for variations on capital structures, leverage, etc.

We’re trying to differentiate by combining our private equity approach to quality and value into one strategy at the security selection level. And, we are just as dedicated to portfolio diversification to help our investors better weather market volatility. It’s a portfolio without compromises. We think that’s very unusual in the mutual fund universe.

The fund has both institutional and retail share classes. The retail class (BALAX) has a $2500 minimum initial investment. Expenses are 1.41% with about $22 million in assets. The institutional share class (BALIX) is $250,000 and 1.16%. Here’s the fund’s homepage. The content there is modest but useful. 

Funds in Registration

Funds currently in registration with the SEC will generally be available for purchase some time in July, 2014. Our dauntless research associate David Welsch tracked down 12 new no-load funds in registration this month. While there are no immediately tantalizing registrants, there are two flexible bond funds being launched by well-respected small fund families (Weitz Core Plus Income and William Blair Bond Fund) plus the conversion of a pretty successful private options-hedged equity strategy (V2 Hedged Equity Fund, though I would prefer that we not name our investments after the Nazi “Vengeance Weapon 2”).

All of the new registrants are available on the June Funds in Registration page.

Manager Changes

The manager change story-of-the-month comes from S&P Capital IQ. While the report is not publicly available, its conclusion is widely reported: “Of 6,185 U.S. equity mutual funds tracked by Rosenbluth’s firm, more than a thousand of them, or 16.3%, have experienced a manager change since February 2011.” Oddly, the journalists reporting on the story including Brendan Conaway at Barron’s and the Mutual Fund Wire staff, don’t seem to ask the fundamental question: how often does it matter?  They do point to do instances cited by Rosenbluth (Janus Contrarian and Fidelity Growth & Income) where the manager change was worth noting, but don’t ask how typical those cases are.

A far more common pattern, however, is that what’s called a “fund manager change” is actually a partial shuffle of an existing management team. For example, our May “manager changes” feature highlighted 52 manager changes but 36 of those (70% of the total) were partial changes. Example would be New Covenant Growth Fund (NCGFX) where one of the 17 members of the management team departed, Fidelity Series Advisor Growth Opportunities Fund (FAOFX) where there’s a long-term succession strategy or a bunch of the Huntington funds where no one left but a new co-manager was added to the collection.

Speaking of manager changes, Chip this month tracked down 57 sets of them.

Updates: the Justin Frankel/Josh Brown slapfest over liquid alts

Josh Brown, the above-named “reformed broker,” ran a piece in mid-May entitled Brokers, Liquid Alts and the Fund that Never Goes Up. He discusses the fate of Andrew Lo and ASG Diversifying Strategies Fund (DSFAX):

Dr. Andrew Lo vehicle called ASG Diversifying Strategies Fund. The idea was that Dr. Lo, perhaps one of the most brilliant quantitative scientists and academicians in finance (MIT, Harvard, all kinds of awards, PhDs out the ass, etc), would be incorporating a variety of approaches to manage the fund using all asset classes, derivatives and trading methodologies that he and his team saw fit to apply.

What actually did happen was this: Andy Lo, maybe one of the smartest men in the history of finance, managed to invent a product that literally cannot make money in any environment. It’s an extraordinarily rare accomplishment; I don’t think you could go out and invent something that always loses money if you were actually attempting to.

Brown’s argument is less with liquid alts as an arena for investing, and more with the brokers who continue to push investors into a clearly failed strategy.

Justin Frankel, probably the only RiverPark manager that we haven’t spoken with and co-manager of RiverPark Structural Alpha Fund (RSAFX), quickly rushed to the barricades to defend Alt-land from the barbarian horde (and, in doing so, responded to an argument that Brown wasn’t actually making). He published his defense on, of all things, his Tumblr page:

The Wall Street machine has a long history of favoring institutions over individuals, and the ultra-high net worth over the mass affluent. After all, finance is a service industry, and it is those larger clients that pay the lion’s share of fees.

Liquid Alternatives are simply hedge fund strategies wrapped in a mutual fund format … From a practical standpoint, investors should view these strategies as a way to diversify either bond or stock holdings in order to provide non-correlated returns to their investment portfolios, cushion portfolios against downside risks, and improve risk-adjusted returns.

Individual investors have become more sophisticated consumers of financial products. Liquid Alternatives are not just a democratization of the alternative investing landscape. They represent an evolution in how investors can gain access to strategies that they could never invest in before.

Frankel’s argument is redolent of Morty Schaja’s stance, that RiverPark is bringing hedge fund strategies to the “mass affluent” though with a $1000 minimum, they’re available to the mass mass, too.

Both pieces, despite their possibly excessive fraternity, are worth reading.

Briefly Noted . . .

Manning and Napier is adding options to the funds in their Pro-Blend series. Effective on July 14, 2014, the funds will gain the option of writing (which is to say, say selling) options on securities and pursuing a managed futures (a sort of asset-class momentum) strategy. And since the Pro-Blend funds are used in Manning & Napier’s target-date retirement funds, the strategy changes ripple into them, too.

This month, most especially, I’m drawing on the great good work of The Shadow in tracking down the changes below. “Go raibh mile maith agaibh as bhur gcunamh” big guy! Thanks, too, to the folks on the discussion board for their encouragement during the disruptions caused by my house move this month.

 

SMALL WINS FOR INVESTORS

Donald P. Carson, formerly the president of an Atlanta-based investment holding company and now a principal at Ansley Securities, joined the Board of The Cook & Bynum Fund (COBYX) in April and has already made an investment in the fund in the range of $100,001 – $500,000.  Two things are quite clear from the research: (1) having directors – as distinct from managers – invested in a fund improves its risk-return profile and (2) it’s relatively rare to see substantial director investment in a fund.  The managers are deeply invested in the fund and it’s great that their directors are, too.

The Osterweis funds (Osterweis, Strategic Income, Strategic Investment and Institutional Equity) will all, effective June 30 2014 drop their 30-day, 2.0% redemption fees.  I’m always ambivalent about eliminating such fees, since they discourage folks from trading in and out of funds, but most folks cheer the flexibility so we’re willing to declare it “a small win.”  

Effective May 16, 2014, the minimum initial investment on the institutional class of the RiverPark funds (Large Growth, RiverPark/Wedgewood Fund, Short Term High Yield, Long/Short Opportunity, RiverPark/Gargoyle Hedged Value, Structural Alpha Fund and Strategic Income) were all reduced from $1,000,000 to $100,000.   Of greater significance to many of us, the expense ratios were reduced for Short Term High Yield (from 1.25% to 1.17% on RPHYX and from 1.00% to 0.91% on RPHIX) and RiverPark/Wedgewood (from 1.25% to 1.05% on RPCFX and from 1.00% to 0.88% on RWGIX).

CLOSINGS (and related inconveniences)

Effective on July 8, 2014, Franklin Biotechnology Discovery Fund (FBDIX) will close to new investors. It’s a fund for thrill seekers – it invests in very, very growth-y midcap biotech firms which are (ready for this?) really volatile. The fund’s returns have averaged about 12% over the past decade – 115 bps better than its peers – but the cost has been high: a beta of 1.77 and a standard deviation nearly 50% about the Specialty-Health group norm. That hasn’t been enough to determine $1.3 billion in investment from flowing in.

Morningstar’s been having real problems with their website this month.  During the last week of the month, some fund profiles were completely unavailable while, in other cases, clicking on the link to one fund would take you to the profile of another. I assume something similar is going on here, since the MPT data for this biotech stock fund benchmarks it against “BofAML Convertible Bonds All Qualities.”

Update: One of the Corporate Communication folks at Morningstar reached out in response to my comment on their site stability which itself was triggered mostly by the vigorous thread on the point. Ms. Spelhaug writes: “Hope you’re well. I saw your column mentioning issues you’ve experienced with the Quote pages on Morningstar.com. I wanted to let you know that we’re aware that there have been some issues and have been in the process of retiring the system that’s causing the problems.”

Effective as of May 30, 2014, the investor class of Samson STRONG Nations Currency Fund (SCRFX) closed its “Investor” class to new investors. On that same day, those shares were re-designated as Institutional Class shares. Given the fund’s parlous performance (down about 8% since inception compared to a peer group that’s down about 0.25%), the closure might be prelude to …. uhhh, further action.

T. Rowe Price Capital Appreciation (PRWCX) will close to new investors on June 30, 2014. Traditionally famous for holding convertible securities, the fund’s fixed-income exposure is almost entirely bonds now with a tiny sliver of convertibles. That reflects the manager’s judgment that converts are way overpriced. The equity part of the portfolio targets blue chips, though the orientation has slowly but surely shifted toward growthier stocks over the years.

The fund is bloated at over $20 billion in assets but it’s sure hard to criticize. It’s posted peer-beating returns in 11 of the past 12 years, including all five years since crossing the $10 billion in AUM threshold. It’s particularly impressive that the fund has outperformed Prospector Capital Appreciation (PCAFX), which is run by Richard Howard, PRWCX’s long-time manager, over the past seven years. While I’m generally reluctant to recommend large funds, much less large funds that are about to close, this one really does warrant a bit of attention on your part.

All classes of the Wells Fargo Advantage Discovery Fund (WFDAX) are closed to new investors. The $3.2 billion fund has posted pretty consistently above average returns, but also consistently above average risks.

OLD WINE, NEW BOTTLES

Effective July 1, 2014, the AllianzGI Structured Alpha Fund (AZIAX) will change its name to the AllianzGI Structured Return Fund. Its investment objective, principal investment strategies, management fee and operating expenses change as well. The plan is to write exchange-traded call options or FLEX call options (i.e. listed options that are traded on an exchange, but with customized strike prices and expiration dates) to generate income and some downside protection. The choice strikes me as technical rather than fundamental, since the portfolio is already comprised of 280 puts and calls. The most significant change is a vast decrease in the fund’s expense ratio, from 1.90% for “A” shares down to 1.15%.

Crow Point Hedged Global Equity Income Fund (CGHAX) has been rechristened Crow Point Defined Risk Global Equity Income Fund. The Fund’s investment objective, policies and strategies remain unchanged.

Hansberger International Growth (HIGGX/HITGX) is in the process of becoming one of the Madison (formerly Mosaic) Funds. I seem to have misread the SEC filing last month and reported that they’re becoming part of the Madison Fund (singular) rather than Madison Funds (plural). The management team is responsible for about $4 billion in mostly institutional assets. They’re located in, and will remain in, Toronto. This will be Madison’s second international fund, beside Madison NorthRoad International (NRIEX) whose managers finish their third solid year at the helm on June 30^th.

Effective June 4 2014, the Sustainable Opportunities (SOPNX) fund gets renamed the Even Keel Multi-Asset Managed Risk Fund. The Fund’s investment objective, policies and strategies remain unchanged. Given the fund’s modest success over its first two years, I suppose there are investors who might have preferred keeping the name and shifting the strategy.

The Munder Funds are in the process of becoming Victory funds. Munder Capital Management, Munder’s advisor, got bought by Victory Capital Management, so the transition is sensible and inevitable. Victory will create a series of “shell” funds which are “substantially similar, if not identical” to existing Munder funds, then merge the Munder funds into them. This is all pending shareholder approval.

Touchstone Core Bond Fund has been renamed Touchstone Active Bond Fund (TOBAX). The numbers on the fund are a bit hard to decipher – by some measures, lots of alpha, by others

Effective on or about July 1, 2014, Transamerica Diversified Equity (TADAX) will be renamed Transamerica US Growth and the principal investment strategy will be tweaked to require 80% U.S. holdings. Roughly speaking, TADAX trailed 90% of its peers during manager Paul Marrkand’s first calendar year. The next year it trailed 80%, then 70% and so far in 2014, 60%.  Based on that performance, I’d put it on your buy list for 2019.

OFF TO THE DUSTBIN OF HISTORY

On May 29, 2014 (happy birthday to me, happy birthday to me …), the tiny and turbulent long/short AllianzGI Redwood Fund (ARRAX) was liquidated and dissolved.

The Giralda Fund (GDAIX) liquidates its “I” shares on June 27, 2014 but promises that you can swap them for “I” shares of Giralda Risk-Managed Growth Fund (GRGIX) if you’d really like.

Harbor Target Retirement 2010 Fund (HARFX) has changed its asset allocation over time in accordance with its glide path and its allocation is now substantially similar to that of Harbor Target Retirement Income Fund, and so 2010 is merging into Retirement Income on Halloween.  Happily, the merger will not trigger a tax bill.

In mid-May, 2014, Huntington suspended sales of the “A” and institutional shares of its Fixed Income Securities, Intermediate Government Income, Mortgage Securities, Ohio Tax-Free, and Short/Intermediate Fixed Income Securities funds.

On May 16, 2014, the Board of Trustees of Oppenheimer Currency Opportunities Fund (OCOAX) approved a plan to liquidate the Fund on or about August 1, 2014.  Since inception, the fund offered its investors the opportunity to turn $100 into $98.50 which a fair number of them inexplicably accepted.

At the recommendation of LSV Asset Management, the LSV Conservative Core Equity Fund (LSVPX) will cease operations and liquidate on or about June 13, 2014. Morningstar has it rated as a four-star fund and its returns have been in the top decile of its large-value peer group over the past five years, which doesn’t usually presage elimination. As the discussion board’s senior member Ted puts it, “With only $15 Million in AUM, and a minimum investment of $100,000 hard to get off the ground in spite of decent performance.”

Turner All Cap Growth Fund (TBTBX) is slated to merge into Turner Midcap Growth Fund (TMGFX) some time in the fall of 2014. Since I’ve never seen the appeal of Turner’s consistently high-volatility funds, I mostly judge nod and mumble about tweedle-dum and …

Wilmington’s small, expensive, risky, underperforming Large-Cap Growth Fund (VLCPX) and regrettably similar Large-Cap Value Fund (VEINX) have each been closed to new investors and are both being liquidated around June 20th.

In Closing . . .

The Morningstar Investment Conference will be one of the highlights of June for us. A number of folks responded to our offer to meet and chat while we’re there, and we’re certainly amenable to the idea of seeing a lot more folks while we’re there.

I don’t tweet (despite Daisy Maxey’s heartfelt injunction to “build my personal brand”) but I do post a series of reports to our discussion board after each day at the conference. If you’re curious and can’t be in Chicago, please to feel free to look in on the board.

Finally, thanks to all those who continue to support the Observer – with their ideas and patience, as much as with their contributions and purchases. It’s been a head-spinning time and I’m grateful to all of you as we work through it.

Just a quick reminder that we’re going to clean our email list. We’ve got two targets, addresses that make absolutely no sense and folks who haven’t opened one of our emails in a year or more.

We’ll talk soon!

By David Snowball

Dear friends,

It’s been that kind of month. Oh so very much that kind of month. In addition to teaching four classes and cheering Will on through 11 baseball games, I’ve spent much of the past six weeks buying a new (smaller, older but immaculate) house and beginning to set up a new household. It was a surprisingly draining experience, physically, psychologically and mentally. Happily I had the guidance and support of family and friends throughout, and I celebrated the end of April with 26 signatures, eight sets of initials, two attorneys, one large and one moderately-large check, and the arrival of a new set of keys and a new garage door clicker. All of which slightly derailed my focus on the world of funds. Fortunately the indefatigable Charles came to the rescue with …

The Existential Pleasures of Engineering Beta

Mebane Faber is a quant.

He is a student of financial markets, investor behavior, trend-following, and market bubbles. He pursues absolute return, value, and momentum strategies. And, he likes companies that deliver cash to shareholders.

He recognizes alpha is elusive, so instead focuses on engineering beta, which promises a more pragmatic and enduring reward.

In a field full of business majors and MBAs, he holds degrees in engineering and biology.

He distills a wealth of financial literature, research, and conditions into concise and actionable investing advice, shared through books, his blog, and lectures.

Given low-cost ETFs and mutual funds available today, he thinks people generally should no longer need to hire advisors, or “brokers back in the day,” at 1-2% fees to tell them how to allocate buy-and-hold portfolios. “It kind of borderlines on criminal,” he tells Michael Covel in a recent interview, since such advisors “do not do enough to justify their fees.”

He is a portfolio manager and CIO of Cambria Investment Management, L.P., which he co-founded along with Eric Richardson in 2006. It is located in El Segundo, CA.

His down-to-earth demeanor is at once confident and refreshingly approachable. He cites philosopher Henry David Thoreau: “There is no more fatal blunderer than he who consumes the greater part of his life getting his living.”

The Paper. Mebane (pronounced “meb-inn”) started his career as biotech equity analyst during the genome revolution and internet bubble. While at University of Virginia, he attended an advanced seminar in security analysis taught by the renowned hedge fund manager John Griffin of Blue Ridge Capital. In fulfillment of the Chartered Market Technician program, Mebane drafted a paper that became the basis for “A Quantitative Approach To Tactical Asset Allocation,” published in the Journal of Wealth Management in 2007.

The paper originally included the words “market timing,” but he soon discovered that to a lot of people, the phrase comes with “enormous emotional baggage” and “can immediately shut-down all synapses in their brains.” Similar to Ed Thorp’s experience with his first academic paper on winning at blackjack, Mebane had to change the title to get it published. (It continues to stimulate synapses, as discussed in David’s July 2013 commentary, “Timing Method Performance Over Ten Decades” and periodically on the MFO discussion board.)

He attributes the paper’s ultimate popularity to 1) its simple presentation and explanation of the compelling results, and 2) the fortuitous timing of the publication itself – just before the financial meltdown of 2008/9. Practitioners of the method during that period were rewarded with a maximum drawdown of only -2% through versus -51% for the S&P 500.

The Books. There are three. All insightful, concise, and well-received:

• The first published by Wiley in 2009, entitled “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.”
• The second, self-published in 2013, entitled “Shareholder Yield: A Better Approach to Dividend Investing.”
• The third, also self-published and just released, “Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market.”

As summarized above, each contains straight-forward strategies that investors can follow on their own using publically available information. That said, each also forms the basis of ETFs launched by Cambria Investment Management.

The First Fund. Last December, Mebane tweeted “Diversification was deworseification in 2013.” To understand what he meant, just compare US stock return against just about all other asset classes – it trounced them. Several all-asset strategies have underperformed during the current bull market, as seen in the comparison below, including AdvisorShares Cambria Global Tactical ETF Fund (GTAA). GTAA was Cambria’s first ETF, launched in November 2010, as a sub-advisor through ETF house AdvisorShares, and based on the strategy outlined in “The Ivy Portfolio.”

If it helps, Mebane is in good company. Rob Arnott’s all asset and John Hussman’s total return strategies have not received much love lately either. In fact, since GTAA’s inception, the “generic” all-asset allocation of US stocks, foreign stocks, bonds, REITs, and broad commodities has underperformed US equity index by 40% and traditional 60/40 balanced index by 15%.

GTAA’s actual portfolio currently shows more than 50 holdings, virtually all ETFs. Looking back, the fund has held substantial cash at times, approaching 40% in mid-2013…”assuming a defensive posture and utilizing cash as an alternative to its long positions.”

Market volatility has likely hurt GTAA as well. Its timing strategy, shown to thrive in trending markets, can struggle with short-term gyrations, which have been present in commodity, foreign equity, and real estate markets during this time. Finally, AdvisorShares’ high expense ratio, even after waivers, only adds to the headwind. At the 3.5-year mark, GTAA remains at $36M assets under management (AUM).

The New Funds. Cambria has since launched three other ETFs, based on the strategies outlined in Mebane’s two new books, but this time the funds were kept in-house to have “control over the process and charge reasonable fees.” Each fund invests in some 100 companies with capitalizations over $200M. And, each has quickly attracted AUM, rather remarkably given the proliferation of ETFs today. They are:

GVAL is the newest and actually tracks to a Cambria-developed index, maintained daily. It focuses on companies that trade 1) below their assessed intrinsic value, and 2) in countries with the most undervalued markets determined by parameters like CAPE, as depicted in earlier figure. These days, Mebane believes that means outside the US. “We certainly don’t think the [US] market is in a bubble, rather, valuations will be a headwind. There are much better opportunities abroad.”

SYLD is actively managed and focuses primarily on US companies that exhibit strong characteristics of returning free cash flow to their shareholders; specifically, “shareholder yield,” which comprises dividend payments, share buybacks, and debt pay-down. FYLD seeks the same types of companies, but in developed foreign countries and it passively tracks to Cambria’s FYLD index.

Mebane believes that these are the first ETFs to incorporate the shareholder yield strategy. And, based on their reception in the crowded ETF market, he seems pretty pleased: “I certainly think alpha is possible…lots of jargon across smart beta, alpha, etc., but beating a market cap index is a great first step.” Morningstar’s Samuel Lee noted them among best new ETFs of 2013. Approaching its first year, SYLD is certainly off to a strong start:

Interestingly, none of these three ETFs employ explicit draw-down control or trend-following, like GTAA, although GVAL does “start moving to cash if markets don’t pass an absolute valuation filter … no sense in buying what is cheapest when everything is expensive,” Mebane explains. SYLD too has the discretion to take the entire portfolio to “Temporary Defensive Positions.”

When asked if his approach to risk management is changing, given the incorporation of more traditional strategies, he asserts that he’s “still a firm believer in trend-following and future funds will have trend components.” (Other funds in pipeline at Cambria include Global Momentum ETF and Value and Momentum ETF).

Mebane remains one of the largest shareholders on record among the portfolio managers at AdvisorShares. His overall skin-in-the-game? “100% of my investable net worth is in our funds and strategies.”

The Blog. mebfaber.com (aka “World Beta”) started in November 2006. It is a pleasant blend of perspective, opinion, results from his and other’s research – quantitative and factual, images, and references. He shares generously on both personal and professional levels, like in the recent posts “My Investing Mentor” and “How to Start an ETF.”

There is a great reading list and blogroll. There are sources for data, references, and research papers. It’s free, with occasional plugs, but no annoying pop-ups. For the more serious investors, fund managers, and institutions, he offers a premium subscription to “The Idea Farm.”

He once wrote actively for SeekingAlpha, but stopped in 2010, explaining: “I find the quality control of the site is poor, and the respect for authors to be low. Also, [it] becomes a compliance risk and headache.”

He strikes me as having the enviable ability to absorb enormous about of information, from past lessons to today’s water-hose of publications, blogs, tweets, and op-eds, then distill it all down to chart a way forward. Asked whether this comes naturally or does he use a process, he laughs: “I would say it comes unnaturally and painfully!”

29Apr14/Charles

It Costs How Much?

by Edward Studzinski

A democracy is a government in the hands of men of low birth, no property, and vulgar entitlements.

Aristotle

One of the responses I received to last month’s diatribe about mutual fund fees was that the average mutual fund investor did not object to them because they were unseen. They painlessly and invisibly disappeared every quarter. The person who pointed this out noted that lawyers charged a bill for services rendered, as did accountants. Why then, should not a quarterly mutual fund statement show the gross amount invested at the beginning of the period, the investment appreciation or depreciation, and then the deduction of fees to arrive at a net amount invested at the end of the period ? Not a bad idea. But one that has been resisted (or gutted) at every turn by the industry and one that the regulators have never felt strongly enough to move forward on.

But do clients truly understand what they are giving up or what they are actually paying? Charlie Ellis, in an article in the current issue of the Financial Analysts Journal would argue that they do not. He goes on to make the case that the enormity of the fees as a percentage makes the 2% and 20% that many hedge funds charge seem reasonable in comparison. His rationale is thus. Assume an S&P 500 Index Fund achieves in a year a total return of 36% and charges investment management fees of 5 basis points (0.05%). Assume your other investment is Mick the Bookie’s Select Investment Fund which had a total return of 41% over the same period and charges 85 basis points (0.85%). Your incremental return is 500 basis points (5%) for which you paid an extra 80 basis points (0.80%). Ellis would argue, and I believe correctly so, that your incremental fee for achieving that excess return was SIXTEEN PER CENT. And don’t forget that the money that went into the account to begin with was already your money that you had earned.

So, one question that I hear coming is – the outside trustees or directors have to approve fees annually and they wouldn’t do it if it was not fair and reasonable, especially given the returns. Answer #1 – eighty per cent of the time the active manager does not beat the benchmark and achieve an excess return. Answer #2 – the 20% of the time when the active manager beats the return, it is not on a sustainable basis, but rather almost random. Answer #3 – rarely does the investor actually get a benchmark beating return because he or she moves their investments too frequently to even achieve the performance numbers advertised by the investment management firm. Answer #4 – all too rarely do the outside trustees or directors have an aligned vested interest in the fee question (a) because in most instances they have at best a de minimis investment in the fund or funds that they are overseeing and (b) oddly enough the outside trustees or directors often have more of a vested interest in the success of the investment management company. Growth and profitability there will lead to increases in their fees.

So you say, I must be getting something of value for the incremental fees at those times when the investment returns don’t justify the added expense? Well, sadly, if recent history is any guide, the kinds of things you have gotten for such excess incremental fees include things like vicarious interests in yachts and sports cars; race horses in Lexington, Kentucky; and multiple homes and pent houses on the lake front in the greater Chicago area. I could go on and on in a similar vein. Rather than outperforming benchmarks or making money for investors, the primary goal has morphed to the creation and accumulation of substantial personal wealth, often to the tune of hundreds of millions of dollars.

To paraphrase Don Corleone in that scene in New York City where he says to the heads of the Five Families, “How did we let things go so far?” I don’t have a good answer for that. I suspect that the painlessness of fee extraction explains part of it. Having had the present administration in Washington serving in the role of defender of Middle Class America, one has to wonder why they have allowed the savings and investments of the Middle Class to effectively be clipped by dollars and cents every month. What has happened is one of the great hidden wealth transfers in our society, similar to what happens when hackers get into a bank computer and start skimming fractions of cents from millions of transactions. It is not solely the administration’s fault however, as neither the regulators nor the courts have wanted to clean up the fee mess. Everyone really wants to believe that there is a Santa Claus, or more appropriately, a Horatio Alger ending to the story.

One might hope that financial publications such as Morningstar, would through their media outlets as well as their conferences, address the subject of fees and their excessive nature. Certainly when they first started with their primary conference at the Grand Hyatt at Illinois Center in Chicago, there was a decided tilt to the content and substance that favored and indeed championed the small investor. However, since then in terms of content the current big Morningstar conference here has taken on more of an industry tilt or bias.

Why do I keep harping on this subject? For this reason – mutual fund investors cannot negotiate their own fees. Institutional investors can, and corporate and endowment investors do just that, every day. And often, their fee agreements with the investment manager will have a “most favored nation” clause, which means if someone else in the institutional world with a similar amount of assets negotiates a lower fee agreement with that investment firm the existing clients get the benefit of it. If you sit in enough presentations from fund managers, it becomes obvious that, public industry statements notwithstanding, in many instances the mutual fund business (and the small investor) is being used as the cash cow that subsidizes the institutional business.

Remember, expenses matter as they lessen the compounding ability of your investment. That in turn keeps the investment from growing as much as it should have over a period of time. With interest rates and tax rates where they are, it is hard enough to compound at a required rate to meet future accumulation targets without having even further degradation occur from the impact of high fees. Rule Number One of investing is “Don’t lose money” and Rule Number Two is “Don’t forget Rule Number One.” However, Rule Number Three is “Keep the expenses low to maximize the compounding effect.”

From Russia, with Love

While journalist Brett Arends bravely offered to explain “Why I’m going to invest in the Russian stock market” – roughly, Russian stocks are cheap and Putin couldn’t be that crazy, right? – a whole series of Russia-oriented funds have amended their statements of principal risks to include potential financial warfare:

SSgA Emerging Markets (SSEMX)

In response to recent political and military actions undertaken by Russia, the United States and European Union have instituted numerous sanctions against certain Russian officials and Bank Rossiya. These sanctions, and other intergovernmental actions that may be undertaken against Russia in the future, may result in the devaluation of Russian currency, a downgrade in the country’s credit rating, and a decline in the value and liquidity of Russian stocks. These sanctions could result in the immediate freeze of Russian securities, impairing the ability of the Fund to buy, sell, receive or deliver those securities. Retaliatory action by the Russian government could involve the seizure of U.S. and/or European residents’ assets and any such actions are likely to impair the value and liquidity of such assets. Any or all of these potential results could push Russia’s economy into a recession. These sanctions, and the continued disruption of the Russian economy, could have a negative effect on the performance of funds that have significant exposure to Russia, including the Fund.

SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (EMCD) uses the same language, apparently someone was sharing drafts.

iShares MSCI Russia Capped ETF (ERUS) posits similar concerns:

The United States and the European Union have imposed economic sanctions on certain Russian individuals and a financial institution. The United States or the European Union could also institute broader sanctions on Russia. These sanctions, or even the threat of further sanctions, may result in the decline of the value and liquidity of Russian securities, a weakening of the ruble or other adverse consequences to the Russian economy. These sanctions could also result in the immediate freeze of Russian securities, impairing the ability of the Fund to buy, sell, receive or deliver those securities. Sanctions could also result in Russia taking counter measures or retaliatory actions which may further impair the value and liquidity of Russian securities.

ING Russia Fund (LETRX) adds the prospect that they might not be able to honor redemption requests:

… the sanctions may require the Fund to freeze its existing investments in Russian companies, prohibiting the Fund from selling or otherwise transacting in these investments. This could impact the Fund’s ability to sell securities or other financial instruments as needed to meet shareholder redemptions. The Fund could seek to suspend redemptions in the event that an emergency exists in which it is not reasonably practicable for the Fund to dispose of its securities or to determine the value of its net assets.

I’ve continued my regular investments in two diversified emerging markets funds whose managers have earned my trust: Andrew Foster at Seafarer Overseas Growth & Income (SFGIX) and Robert Gardiner at Grandeur Peak Emerging Markets Opportunities (GPEOX). I don’t think I have nearly the expertise needed to run toward that particular fire, nor to know when it’s gotten too hot. I wish Mr. Arends well, but would advise others to consider finding a manager whose experience and judgment is tested and true.

Here’s my rule of thumb: Avoid rules of thumb at all costs

The folks on our discussion board have posted links to two “rule of thumb” articles about investing. Just a quick word on why they’re horrifying.

Rule One: You need to invest $82.28 a day! 

The story comes from USA Today, by way of Lifehacker. “Want to live well in old age? You’d better get cracking: $82.28 a day to be exact.”

That’s $29,000 a year. Cool! That’s just $1000 more than the average per capita income in the US! In fairness, though, it’s just 54% of the median family income: $53,046. So here’s the advice: if you’re living paycheck-to-paycheck, remember to set aside 54% of your income. BankRate.com, by the way, advises you to invest 10%. Why 10%? Presumably because it’s a nice round number.

Rule Two: Your age should be your bond allocation!

More of the same: where to put it? Your bond allocation should be equal to your age, which Lifehacker shares from Bankrate.com. But why is this a good rule of thumb? Like “remember to drink eight glasses of water each day,” it’s catchy and memorable but I’ve seen no research that validates it.

Forbes magazine places it #1 on its list of “10 Terrible Pieces of Investment Advice.” Fund companies flatly reject it in their own retirement planning products. The target-date 2030 funds are designed for folks about 50; that is, people who might retire in 15 years or so. If this advice were sound, some or all of those funds would have 50% in bonds. They don’t. T. Rowe Price Retirement 2030 is 16% bonds, American Funds is 10%, Fidelity is 12%, TIAA-CREF is 21% and Vanguard 20%. JPMorgan (23%) and BlackRock (30-33%) seem to represent the high end.

Especially at the end of a three decade bull market in bonds, we owe it to ourselves and our readers to be particularly thoughtful about quick ‘n’ easy advice.

I’m sorry, they paid Gabelli what?

The folks are MFWire did a nice, nearly snarky story on The Mario’s most recent payday. (I’m Sorry, They Paid Gabelli What?). I’ll share the intro and suggest that you read one of the two linked stories:

Mario Gabelli made $85 million in salary in 2013.

That’s one eighth the global domestic product of Somoa.

According to USA Today, the GAMCO founder, chief executive and investment officer was paid not only $85 million last year, but his three-year total compensation came to over $215 million.

No wonder he looks like that.

Morningstar Goes on Autopilot

On April 23^rd, Morningstar’s Five-Star Investor feature trumpeted “9 Core Funds That Beat the Market,” which they might reasonably have subtitled “Small funds need not apply.”

Morningstar highlights nine funds in the article, with assets up to $101 billion. Those are drawn from a list of 28 that made the cut. Of those 28, one has under a billion in assets.

The key to making the cut: Morningstar must designate it a “core” fund, a category for which there are no hard-and-fast rules. They’re generally large cap and generally diversified, but also fairly large. There’s only one free-standing fund with under $250 million in assets that they think of as “core.”

There are a lot of “core” funds under $250 million but that occurs only when they’re part of a target-date suite: Fidelity Retirement 2090 might have only $12 in it but it becomes “core” because the whole Fido series is core.

Morningstar’s implied judgments (“we don’t trust anyone over 30 or with under a billion in assets”) might be fair, but would be fairer if more explicit.

They followed that up with a list of 4 Medalist Ideas for Long-Short Strategies.”Some of the funds we like in this area are Robeco Boston Partners Long/Short Equity, Robeco Boston Partners Research Fund, MainStay Marketfield, and Wasatch Long/Short.”

I’d describe those as Long-Closed, Recently-Closed, Bloated (they had $1 billion three years ago and $21 billion today; trailing 12 month performance is exactly mediocre which might be a blip or might be the effects of the $11 billion they picked up last year) and Very Solid, respectively.

Russel Kinnel finished the month by asking “How Bloated is your Fund?” He calculates a “bloat ratio” which “tries to find out how much a fund trades and how liquid its holdings are. It multiplies turnover by the average day’s trading volume of a fund’s holdings (asset-weighted).” At base, Russel’s assumption is that the only cost of bloat is a loss of the ability to trade quickly in and out of stocks.

With due respect, that seems silly. As assets grow, fund managers necessarily target the sorts of stocks that they can trade and begin avoiding the ones that they can’t. If your fund’s size constrains you to invest mostly in stocks worth $10 billion or more (the upper end of the mid-cap range), your investable universe is just 420 stocks. You may trade those 420 effectively, but you’re not longer capable of benefiting from the 6360 stocks at below $10 billion.

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.

Martin Focused Value (MFVRX): it’s easy for us to get stodgy as we age; to become sure that whatever we did back then is quite exactly what we should be doing today. Frank Martin, who has been doing this stuff for 40 years, could certainly be excused if he did stick with the tried and true. But he hasn’t. There’s clear evidence that this absolute value equity investor has been grappling with new ideas and new evidence, and they’ve led him to construct his portfolio around the notion of “an antifragile dumbbell” (with insights credited to Nassim Talib). His argument, as much as his fund, are worth your attention.

Conference Call Upcoming

We’re toying with the possibility of talking with Dr. Ian Mortimer (Oxford, no less) and Matt Page of Guinness Atkinson Global Innovators (IWIRX), which targets investments in firms that are demonstrably engaged in creative thinking and are demonstrably beginning from it. They appear to be the single best performer in Lipper’s global growth category and we know from our work on Guinness Atkinson Inflation-Managed Dividend (GAINX) that they’re awfully bright and articulate. Both of their funds have small asset bases, distinctive and rigorous disciplines and splendid performance. The hang-up is the time difference between here and London; our normal nighttime slot (7:00 Eastern) would be midnight for them. Hmmm … we’ll work on it.

Launch Alert

It says something regrettable about the industry that Morningstar reports 156 new funds since mid-March, of which 153 are new share classes of older funds, one is Artisan Global High Income (ARTFX) and two aren’t terribly interesting. We’ll keep looking… Found another worth noting, just launched 4/28: Whitebox Tactical Income (WBIVX/WBINX).

Funds in Registration

Funds currently in registration with the SEC will generally be available for purchase around the end of June, 2014. Our dauntless research associate David Welsch tracked down 17 new no-load funds in registration this month. There are several intriguing possibilities:

Catalyst added substantially to their collection of quirky funds (uhhh … Small Cap Insider Buying (CTVAX) might be a decent example) with the registration of five more funds, of which three (Catalyst Absolute Total Return, Catalyst/Stone Beach Income Opportunity and Catalyst/Groesbeck Aggressive Growth Funds) will be sub-advised by folks with strong documented performance records.

LSV GLOBAL Managed Volatility Fund will follow the recent vogue for investing in low-volatility stocks. The fund gains credibility from the pedigree of its managers (“L” is a particularly renowned academic who was one of the path-breaking researchers in behavioral finance) and by the strength of the other four LSV funds (all three of the rated funds have earned four stars, though tend toward high volatility).

North Star Bond Fund will invest primarily in the bonds, convertible securities and (potentially) equities issued by small cap companies. I’m not sure that I know of any other fund with that specialization. The management team includes North Star’s microcap and opportunistic equity managers. Their equity funds have had very solid performance in not-quite three years of operation (though I’m a bit puzzled by Morningstar’s assignment of the North Star Opportunity fund to the “aggressive allocation” category given its high stock exposure). In any case, this strikes me as an interesting idea and we’re apt to follow up in the months after launch.

All of the new registrants are available on the May Funds in Registration page.

Manager Changes

On a related note, we also tracked down 52 sets of fund manager changes. The most intriguing of those include the exit of Stephen and Samuel Lieber, Alpine Woods founders and Alpine Small Cap’s founding managers, from Alpine Small Cap (ADIAX) and Chuck McQuaid’s long-anticipated departure from Columbia Acorn (ACRNX).

Active share updates

“Active share” is a measure of the degree to which a fund’s portfolio differs from what’s in its benchmark index. Researchers have found that active share is an important predictor of a fund’s future performance. Highly active fund are more like to outperform their benchmarks than are index funds (which should never outperform the index itself) or “closet index” funds which charge for active management but really only play around the edges of an indexed portfolio.

In March, we began publishing a list of active share data for as many funds as we could. And the same time, we asked folks to share data for any funds that we’d missed. We’re maintaining a master list of all funds, which you can get to by clicking on our Resources tab:

Each month we try to update our list with new funds submitted by our readers. This month folks shared seven more data reports:

Fund	Ticker	Active share	Benchmark	Stocks
LG Masters International	MSILX	89.9	MSCI EAFE	90
LG Masters Smaller Companies	MSSFX	98.2	Russell 2000	52
LG Masters Equity	MSEFX	84.2%	Russell 3000	85
Third Avenue Value	TAVFX	98.1	MSCI World	37
Third Avenue International Value	TAVIX	97.0	MSCI World ex US	34
Third Avenue Small Cap Value	TASCX	94.3	Russell 2000 Value	37
Third Avenue Real Estate	TAREX	91.1	FTSE EPRA/NAREIT Developed	31

Thanks to jlev, one of the members of the Observer’s discussion community and Mike P from Litman Gregory for sharing these leads with us. Couldn’t do it without you!

The return of Jonathan Clements

Jonathan Clements had an interesting valedictory column when he left The Wall Street Journal. He said he had about three messages for his readers and he’d repackaged them into 1008 columns: “Forget spending more money at the mall — and instead spend more time with friends. Your bank account may still be skimpy, but your life will be far, far richer.”

Apparently he’s found either a fourth message to share, or renewed passion for the first three, because he returned to the Journal in April. Oddly, his work appears only on Sundays and only online; he doesn’t even use a Dow Jones email address. When I asked him about the plan, he noted:

I didn’t want a fulltime position with the WSJ again, at least not at this juncture. The column gives a little variety to my week. But most of my time is currently devoted to a new personal-finance book. The book is a huge undertaking, and it wouldn’t be possible if I was fulltime at the WSJ.

He’s written several really solid columns (on the importance of saving even in a zero-interest environment and on the role of dividend funds in a retirement portfolio) and has a useful website that shares personal finance resources and works to dispel the rumor that he’s an accomplished writer of erotica. (Really.)

On whole, I’m glad he’s back.

MFO in the news!

Indeed

The English-language version of the article by Javier Espinosa, “Travel Guide: Do Acronyms Aid ‘Emerging’ Investing?” ran on April 7^th but lacked the panache of the Malay version.

MFO on the road

For those of you interested in dropping by and saying “hi,” we’ll be present at a couple conferences this summer.

 

I’ve been asked to provide the keynote address at the Cohen Client Conference, August 20 – 21, 2014. The conference, in Milwaukee, is run by Cohen Fund Audit Services. This will be Cohen’s third annual client conference. Last year’s version, in Cleveland OH, drew about 100 clients from 23 states.

Cohen offers the conference as a way of helping fund professionals – directors, compliance officers, tax and accounting guys, operating officers and the occasional curious hedge fund manager –develop both professional competence and connections within the fund community. Which is to say, the Cohen folks promised that there would be both serious engagement – staff presentations, panels by industry experts, audience interaction – and opportunities for fellowshipping. (My first, unworthy impulse is to drive a bunch of compliance officers over to Horny Goat Brewing, buy a round or two, then get them to admit that they’re making stuff up as they go.)

The good and serious folks at Cohen want to offer fund professionals help with fund operations, accounting, governance, tax, legal and compliance updates, and sales, marketing and distribution best practices.

And they want me to say something interesting and useful for 45 minutes or so. Hmmm … so here’s a request for assistance. Many of you folks work in the industry (I don’t) and all of you know the sorts of stuff I talk about. What do you think I could say that would most help someone trying to be a good fund trustee or operations professional? Drop me a line through this link, please!

For more information about the conference itself, you can contact

Chris Bellamy, 216-649-1701 or [email protected] or

Megan Howell, 216-774-1145 or [email protected].

They’d love to hear from you. So would I.

We’ll also spend three full days in and around the Morningstar Investment Conference, June 18 – 20, in Chicago. We try to divide our time there into thirds: interviewing fund managers and talking to fund reps, listening to presentations by famous guys, and building our network of connections by spending time with readers, friends and colleagues. If you’d like to connect with us somewhere in the bowels of McCormick Place, just let me know.

Briefly Noted . . .

Interesting developments in the neighborhood of Gator Focus Fund and Gator Opportunities Fund. At the end of February, Brad W. Olecki and Michael Parks resigned from their positions as Trustees of the Trust. No new Trustees have been appointed. On the same date Andres Sandate resigned from his position as President, Secretary and Treasurer of the Trust.

Do recall that, for reasons that continue to elude me, ING Funds have been rebranded as Voya Funds.

LS Opportunity Fund (LSOFX) just reclassified itself from “diversified” to “non-diversified.” It’s not clear why or what effect that will have on its 100 stock portfolio.

SMALL WINS FOR INVESTORS

IMS Capital Management is reorganizing three of its funds (IMS Capital Value,Strategic Income Fund, and Dividend Growth funds) into a new series of the 360 funds. I’m guessing they’ll be rebranded and the advisor is guessing that the reorganization will result in lower administration, fund accounting and transfer agency costs.” With luck, those savings will be passed along to investors.

Effective immediately, the Leader Total Return Fund (LCTRX) has discontinued the redemption fee.

Vanguard has decreased, generally by one basis point, the expense ratios on seven of its ETFs include Vanguard Total Bond Market ETF (BND), Vanguard FTSE Developed Markets ETF (VEA), Vanguard Value ETF (VTV), Vanguard Growth ETF (VUG), Vanguard Small-Cap ETF (VB) and a couple others

CLOSINGS (and related inconveniences)

First Eagle Overseas Fund (SGOVX) will close to new investors on May 9, 2014. Good fund but with $15 billion in AUM, its best days might be in the past.

Grandeur Peak Global Reach (GPROX) closed on April 30^th. That closure was the subject of our first mid-month alert to readers, which we sent to 4800 of you about 10 days before the closure was effective. We heard back from four readers who said that the information was useful to them. My hope is that we didn’t overly annoy the other 99.9% of recipients.

On May 9, 2014, the Wasatch Frontier Emerging Small Countries Fund (WAFMX) will close to new investors. Wasatch avers that it “takes fund capacity very seriously. We monitor assets in each of our funds carefully and commit to shareholders to close funds before asset levels rise to a point that would alter our intended investment strategy.” At $1.2 billion with investments in Nigeria, Kuwait and Kenya, it seems like a prudent move for a fund with top decile returns. (Thanks to JimJ on the Observer’s discussion board for timely notice of the closing.)

OLD WINE, NEW BOTTLES

Bridgehampton Value Strategies Fund (BVSFX) is being rebranded as the Tocqueville Alternative Strategies Fund. Same management and a “substantially similar” strategy but lower expenses for investors. The change becomes effective on June 27, 2014. Looks like a pretty decent fund.

The Board of John Hancock Rainier Growth Fund decided to axe Rainier and hire Baillie Gifford to manage it. As of mid-April, it was rechristened as JHancock Select Growth Fund (RGROX).

 Neuberger Berman Dynamic Real Return Fund (NDRAX) becomes Neuberger Berman Inflation Navigator Fund on June 2.

Hansberger International Growth Fund is being reorganized into the Madison Fund.

On June 2, 2014, Neuberger Berman International Select Fund changed its name from Neuberger Berman International Large Cap Fund. Two year record, slightly below-average returns and absolutely no investor interest.

Neuberger Berman Emerging Markets Income Fund’s name has changed to Neuberger Berman Emerging Markets Debt Fund.

Effective on May 1, 2014, Parnassus Equity Income Fund (PRBLX) became Parnassus Core Equity Fund while Parnassus Workplace Fund (PARWX) became Parnassus Endeavor. There were no changes to management, strategy or fees.

Effective December 29, 2014, the T. Rowe Price Retirement Income Fund (TRRIX) will change its name to the T. Rowe Price Retirement Balanced Fund. It’s a really solid fund but with 40% of its portfolio in equities, it’s probably not what most folks think of as a “retirement income” fund.

OFF TO THE DUSTBIN OF HISTORY

Ever wonder why it’s “The Dustbin of History”? It’s Leon Trotsky’s dismissal of the Menshevik revolutionaries, who he saw as failed agents: “You are pitiful, isolated individuals. You are bankrupts; your role is played out. Go where you belong from now on – in the dustbin of history!” It was in Russian, of course, so translations vary (occasional “the trash heap of history”) but the spirit is there.

CMG SR Tactical Bond Fund (CMGTX/CMGOX) liquidated on April 29, 2014. Nope, I’d never heard of it either.

The Board of Directors of Nomura Partners Funds approved the merger of The Japan Fund (NPJAX) into Matthews Japan (MJFOX), effective in late July, 2014. Japan Fund has sort of bounced from adviser to adviser over the years and is more the victim of Nomura’s decision to get out of the U.S. fund business than of crippling incompetence. The investors are getting a stronger fund with lower expenses, with the merger boosting MJFOX’s size by about 30%.

Morgan Stanley Institutional Total Emerging Markets Portfolio (MTEPX) will liquidate on May 30, 2014.

Principal intends to merge Principal Large Cap Value Fund I (PVUAX) into the Large Cap Value Fund III (PESAX). Shareholders are scheduled to rubbersta vote on the proposal at the end of May. Neither fund is particularly attractive, but the dying fund actually has the stronger record of the two.

On April 17, 2014, Turner’s Board of Trustees decided ed to close and liquidate the Turner Market Neutral Fund (TMNFX) on or about June 1, 2014. Three stars but also $3 million in assets. Sadly the performance was decent and steadily improving.

Vanguard continues with its surprising shakeup. It has decided to merge Vanguard Tax-Managed Growth and Income Fund (VTMIX) into Vanguard 500 Index Fund (VFISX) on about May 16, 2014. Why surprising? VTMIX has over $3 billion in assets, 0.08% expenses, a “Gold” analyst rating and four stars, which are not usually characteristics associated with descendent funds. Vanguard is looking to lower investor expenses (by about three basis points in this case) and simplify their line-up. On an after-tax basis, it looks like investors will gain two basis points in returns.

World Commodity Fund (WCOMX) has closed and will liquidate on May 26, 2014. It’s got rather less than a million in the portfolio and has, over the course of its seven-and-a-half year life, managed to turn a $10,000 initial investment into $10,120 which averages out to rather less than 0.10% per year. That saddest part? That’s not nearly the worst record, at least over the past five years, in either the “natural resources equity” or “broad commodities” groups.

 

In Closing . . .

Thanks to folks who’ve been supporting MFO financially, with a special tip of the cap to Capt. Neel (thank you, sir) and the Right Reverend Rick (I’m guided here by Luke: “In every way and everywhere we accept this with all gratitude”).

Especially for the benefit of the 6000 first-time readers we see each month, if you’re inclined to support the Observer, the easiest way is to use the Observer’s Amazon link. The system is simple, automatic, and painless. We receive an amount equivalent to about 7% of the value of almost anything you purchase through our Amazon link (used books, Kindle downloads, groceries, sunscreen, power tools, pool toys …). You might choose to set it as a bookmark or, in my case, you might choose to have one of your tabs open in Amazon whenever you launch your browser. Some purchases generate a dime, some generate $10-12 and all help keep the lights on!

June: the month for income. With the return of summer turbulence and Janet Yellen’s insistent dovishness about rates, we thought we’d take some time to look at four new funds that promise high income and managed volatility:

Artisan High Income (ARTFX) run by former Ivy High Income manager Bryan Krug. The fund has drawn $76 million in its first six weeks.

Dodge & Cox Global Bond, which went live on May 1.

RiverNorth Oaktree High Income (RNOTX), which combines RiverNorth’s distinctive CEF strategy with Oaktree’s first-rate institutional income one.

(maybe) West Shore Real Asset Income (AWSFX) which combines an equity-oriented income strategy with substantial exposure to alternative investments. We’ve had a couple readers ask, and we’ve been trying to learn enough to earn an opinion but it’s a bit challenging.

We’ve also scheduled a conversation with the folks at Arrowpoint, adviser to the new Meridian Small Cap Growth Fund (MSGAX) which is run by former Janus Triton managers Brian Schaub and Chad Meade.

As ever.

By David Snowball

Dear friends,

I love language, in both its ability to clarify and to mystify.

Take the phrase “think outside the box.”  You’ve heard it more times than you’d care to count but have you ever stopped to wonder: what box are they talking about?  Maybe someone invented it for good reason, so perhaps you should avoid breaking the box?

In point of fact, it’s this box:

Here’s the challenge that lies behind the aphorism: link all nine dots using four straight lines or fewer, without lifting the pen and without tracing the same line more than once.  There are only two ways to accomplish the feat: (1) rearrange the dots, which is obviously cheating, and (2) work outside the box.  For example:

As we interviewed managers this month, Ed Studzinski, they and I got to talking about investors’ perspectives on the future.  In one camp there are the “glass half-full” guys. Dale Harvey of Poplar Forest Partners Fund (PFPFX) allowed, for example, that there may come a time to panic about the stock market, but it’s not now. He looks at three indicators and finds them all pretty green:

1. His ability to find good investment ideas.  He’s still finding opportunities to add positions to the fund.
2. What’s going on with the Fed? “Don’t fight the Fed” is an axiom for good reason, he notes.  They’ve just slowing the rate of stimulus, not slowing the economy.  You get plenty of advance notice when they really want to start applying the brakes.
3. What’s going on with investor attitudes?  Folks aren’t all whipped-up about stocks, though there are isolated “story” stocks that folks are irrational over.

Against those folks are the “glass half-empty” guys.  Some of those guys are calling the alarm; others stoically endure that leaden feeling in the pit of their stomachs that comes from knowing they’ve seen this show before and it never ends well. By way of illustration:

1. The Leuthold Group believes that large cap stocks are more than 25% overvalued, small caps much more than that, that there could be a substantial correction and that corrections overshoot, so a 40% drop is not inconceivable.
2. Jeremy Grantham of GMO places the market at 65% overvalued. Fortunately, according to a Barron’s interview, it won’t become “a true bubble” until it inflates 30% more and individual investors, still skittish, become “gung-ho.”
3. Mark Hulbert notes that “true insider” stock sales have reached their highest level in a quarter century.  Hulbert notes that insider selling isn’t usually predictive because the term “insider” encompasses both true insiders (directors, presidents, founders, operating officers) and legal insides (any investor who controls more than 5% of the stock).  It turns out that “true” insider selling is predictive of a stock market fall a couple quarters later.  He makes his argument in two similar, but not quite identical, articles in Barron’s and MarketWatch.  (Go read them.)

And me, you ask?  I guess I’m neither quite a glass half full nor a glass half empty sort of investor.  I’m closer to a “don’t drop the glass!” guy.  My non-retirement portfolio remains about where it always is (25% US stocks with a value bias, 25% international stocks with a small/emerging bias, 50% income) and it’s all funded on auto-pilot.  I didn’t lose a mint in ’08, I didn’t make a mint in ’13 and I spend more time thinking about my son’s average (the season starts in the first week of April and he’ll either be on the mound or at second) than about the Dow’s.

“Judge Our Performance Over a Full Market Cycle”

Uh huh! Be careful of what you wish for, Bub. Charles did just check your performance across full market cycles, and it’s not as pretty as you’d like. Here are his data-rich findings:

Ten Market Cycles

In response to the article In Search of Persistence, published in our January commentary, NumbersGirl posted the following on the MFO board:

I am not enamored of using rolling 3-year returns to assess persistence.

A 3-year time period will often be all up or all down. If a fund manager has an investing personality or philosophy then I would expect strong relative performance in a rising market to be negatively correlated with poor relative performance in a falling market, etc.

It seems to me that the best way to measure persistence is over 1 (or better yet more) market cycles.

There followed good discussion about pros and cons of such an assessment, including lack of consistent definition of what constitutes a market cycle.

Echoing her suggestion, fund managers also often ask to be judged “over full cycle” when comparing performance against their peers.

A quick search of literature (eg., Standard & Poor’s Surviving a Bear Market and Doug Short’s Bear Markets in the S&P since 1950) shows that bear markets are generally “defined as a drop of 20% or more from the market’s previous high.” Here’s how the folks at Steele Mutual Fund Expert define a cycle:

Full-Cycle Return: A full cycle return includes a consecutive bull and bear market return cycle.

Up-Market Return (Bull Market): A Bull market in stocks is defined as a 20% rise in the S&P 500 Index from its previous trough, ending when the index reaches its peak and subsequently declines by 20%.

Down-Market Return (Bear Market): A Bear market in stocks is defined as a 20% decline in the S&P 500 Index from its previous peak, and ends when the index reaches its trough and subsequently rises by 20%.

Applying this definition to the SP500 intraday price index indicates there have indeed been ten such cycles, including the current one still in process, since 1956:

The returns shown are based on price only, so exclude dividends. Note that the average duration seems to match-up pretty well with so-called “short term debt cycle” (aka business cycle) described by Bridgewater’s Ray Dalio in the charming How the Economic Machine Works – In 30 Minutes video.

Here’s break-out of bear and bull markets:

The graph below depicts the ten cycles. To provide some historic context, various events are time-lined – some good, but more bad. Return is on left axis, measured from start of cycle, so each builds where previous left off. Short-term interest rate is on right axis.

Note that each cycle resulted in a new all-time market high, which seems rather extraordinary. There were spectacular gains for the 1980 and 1990 bull markets, the latter being 427% trough-to-peak! (And folks worry lately that they may have missed-out on the current bull with its 177% gain.) Seeing the resiliency of the US market, it’s no wonder people like Warren Buffett advocate a buy-and-hold approach to investing, despite the painful -50% or more drawdowns, which have occurred three times over the period shown.

Having now defined the market cycles, which for this assessment applies principally to US stocks, we can revisit the question of mutual fund persistence (or lack of) across them.

Based on the same methodology used to determine MFO rankings, the chart below depicts results across nine cycles since 1962:

Blue indicates top quintile performance, while red indicates bottom quintile. The rankings are based on risk adjusted return, specifically Martin ratio, over each full cycle. Funds are compared against all other funds in the peer group. The number of funds was rather small back in 1962, but in the later cycles, these same funds are competing against literally hundreds of peers.

(Couple qualifiers: The mural does not account for survivorship-bias or style drift. Cycle performance is determined using monthly total returns, including any loads, between the peak-to-peak dates listed above, with one exception…our database starts Jan 62 and not Dec 61.)

Not unexpectedly, the result is similar to previous studies (eg., S&P Persistence Scorecard) showing persistence is elusive at best in the mutual fund business. None of the 45 original funds in four categories delivered top-peer performance across all cycles – none even came close.

Looking at the cycles from 1973, a time when several now well know funds became established, reveals a similar lack of persistence – although one or two come close to breaking the norm. Here is a look at some of the top performing names:

MFO Great Owls Mairs & Powers Balanced (MAPOX) and Vanguard Wellington (VWELX) have enjoyed superior returns the last three cycles, but not so much in the first. The reverse is true for legendary Fidelity Magellan (FMAGX).

Even a fund that comes about as close to perfection as possible, Sequoia (SEQUX), swooned in the late ‘90s relative to other growth funds, like Fidelity Contrafund (FCNTX), resulting in underperformance for the cycle. The table below details the risk and return metrics across each cycle for SEQUX, showing the -30% drawdown in early 2000, which marked the beginning of the tech bubble. In the next couple years, many other growth funds would do much worse.

So, while each cycle may rhyme, they are different, and even the best managed funds will inevitably spend some time in the barrel, if not fall from favor forever.

We will look to incorporate full-cycle performance data in the single-ticker MFO Risk Profile search tool. As suggested by NumbersGirl, it’s an important piece of due diligence and risk cognizance for all mutual fund investors.

26Mar14/Charles

Celebrating one-star funds, part 2!

Morningstar faithfully describes their iconic star ratings as a starting place for additional research, not as a one-stop judgment of a funds merit.  As a practical matter investors do use those star ratings as part of a two-step research process:

Step One: Eliminate those one- and two-star losers

Step Two: Browse the rest

In general, there are worse strategies you could follow. Nonetheless, the star ratings can seriously misrepresent the merits of individual funds.  If a fund is fundamentally misfit to its category (in March we highlighted the plight of short-term high income funds within the high-yield peer group) or if a fund is highly risk averse, there’s an unusually large chance that its star rating will conceal more than it will reveal.  After a long statistical analysis, my colleague Charles concluded in last month’s issue that:

 A consequence of Morningstar’s methodology is that low volatility funds with below average returns can quite possibly be out-ranked by average volatility funds with average returns. Put another way, the methodology generally penalizes funds with high volatility more so than it rewards funds with low volatility.

The Observer categorizes funds differently: our Great Owl funds are those whose risk-adjusted returns are in the top 20% of their peer group for every measurement period longer than one year.  Our risk-adjustment is based on a fund’s Martin ratio which “excels at identifying funds that have delivered superior returns while mitigating drawdowns.”  At base, we’ve made the judgment that investors are more sensitive to the size of a fund’s drawdown – its maximum peak to trough loss – than to the background noise of day-to-day volatility.  As a result, we reward funds that provide good returns while avoiding disastrous losses.

For those interested in a second opinion, here’s the list of all one-star Great Owl funds:

• American Century One Choice 2035 A (ARYAX)
• Aquila Three Peaks High Income A (ATPAX)
• ASTON/River Road Independent Value (ARIVX)
• BlackRock Allocation Target Shares (BRASX)
• Dividend Plus Income (MAIPX)
• Fidelity Freedom Index 2000 (FGIFX)
• Intrepid Income (ICMUX)
• Invesco Balanced-Risk Retire 2030 (TNAAX)
• Invesco Balanced-Risk Retire 2040 (TNDAX)
• Invesco Balanced-Risk Retire 2050 (TNEAX)
• PIMCO 7-15 Year U.S. Treasury Index ETF (TENZ)
• PIMCO Broad U.S. Treasury Index ETF (TRSY)
• RiverPark Short Term High Yield (RPHYX)
• Schwab Monthly Income Max Payout (SWLRX)
• SEI New Jersey Municipal Bond A (SENJX)
• SPDR Nuveen S&P VRDO Municipal Bond (VRD)
• Symons Value (SAVIX)
• Weitz Nebraska Tax-Free Income (WNTFX)
• Wells Fargo Advantage Dow Jones Target 2015 (WFQEX)
• Wells Fargo Advantage Short Term High-Yield Bond (STHBX)

Are we arguing that the Great Owl metric is intrinsically better than Morningstar’s?

Nope.  We do want to point out that every rating system contains biases, although we somehow pretend that they’re “purely objective.”  You need to understand that the fact that a fund’s biases don’t align with a rater’s preferences is not an indictment of the fund (any more than a five-star rating should be taken as an automatic endorsement of it).

Still waiting by the phone

Last month’s celebration of one-star funds took up John Rekenthaler’s challenge to propose new fund categories which were more sensible than the existing assignments and which didn’t cause “category bloat.”

Amiably enough, we suggested short-term high yield as an eminently sensible possibility.  It contains rather more than a dozen funds that act much more like aggressive short-term bond funds than like traditional high-yield bond funds, a category dominated by high-return, high-volatility funds with much longer durations.

So far, no calls of thanks and praise from the good folks in Chicago.  (sigh)

How about another try: emerging markets allocation, balanced or hybrid?  Morningstar’s own discipline is to separate pure stock funds (global or domestic) from stock-bond hybrid funds, except in the emerging markets.  Almost all of the dozen or so emerging markets hybrid funds are categorized as, and benchmarked against, pure equity funds.  Whether that advantages or disadvantages a hybrid fund at any given point isn’t the key; the question is whether it allows investors to accurately assess them.  The hybrid category is well worth a test.

Who’s watching the watchers?

Presidio Multi-Strategy Fund (PMSFX) will “discontinue operations” on April 10, 2014.  It’s a weird little fund with a portfolio about the size of my retirement account.  This isn’t the first time we’ve written about Presidio.  Presidio shared a board with Caritas All-Cap Growth (CTSAX, now Goodwood SMIDcap Discovery).   In July 2013, the Board decided to liquidate Caritas.  In August they reconsidered and turned both funds’ management over to Brenda Smith.  At that time, I expressed annoyance with their limited sense of responsibility:

The alternative? Hire Brenda A. Smith, founder of CV Investment Advisors, LLC, to manage the fund. A quick scan of SEC ADV filings shows that Ms. Smith is the principal in a two person firm with 10 or fewer clients and $5,000 in regulated AUM.

At almost the same moment, the same Board gave Ms. Smith charge of the failing Presidio Multi-Strategy Fund (PMSFX), an overpriced long/short fund that executes its strategy through ETFs.

I wish Ms. Smith and her new investors all the luck in the world, but it’s hard to see how a Board of Trustees could, with a straight face, decide to hand over one fund and resuscitate another with huge structural impediments on the promise of handing it off to a rookie manager and declare that both moves are in the best interests of long-suffering shareholders.

By October, she was gone from Caritas but she’s stayed with Presidio to the bitter end which looks something like this:

This isn’t just a note about a tiny, failed fund.  It’s a note about the Trustees of your fund boards.  Your representatives.  Your voice.  Their failures become your failures.  Their failures cause your failures.

Presidio was overseen by a rent-a-board (more politely called “a turnkey board”); a group of guys who nominally oversee dozens of unrelated funds but who have stakes in none of them.  Here’s a quick snapshot of this particular board:

First Name	Qualification	Aggregate investment in the 23 funds overseen
Jack	Retired president of Brinson Chevrolet, Tarboro NC	$0
Michael	President, Commercial Real Estate Services, Rocky Mount, NC	0
Theo	Senior Partner, Community Financial Institutions Consulting, a sole proprietorship in Rocky Mount, NC	0
James	President, North Carolina Mutual Life Insurance, “the diversity partner of choice for Fortune 500 companies”	0
J Buckley	President, Standard Insurance and Realty, Rocky Mount NC	0

The Board members are paid $2,000 per fund overseen and meet seven times a year.  The manager received rather more: “For the fiscal year ended May 31, 2013, Presidio Capital Investments, LLC received fees for its services to the Fund in the amount of $101,510,” for managing a $500,000 portfolio.

What other funds do they guide?  There are 22 of them:

• CV Asset Allocation Fund (CVASX);
• Arin Large Cap Theta Fund (AVOAX) managed by Arin Risk Advisors, LLC;
• Crescent Large Cap Macro, Mid Cap Macro and Strategic Income Funds managed by Greenwood Capital Associates, LLC;
• Horizons West Multi-Strategy Hedged Income Fund (HWCVX, formerly known as the Prophecy Alpha Trading Fund);
• Matisse Discounted Closed-End Fund Strategy (MDCAX) managed by Deschutes Portfolio Strategies;
• Roumell Opportunistic Value Fund (RAMVX) managed by Roumell Asset Management, LLC;
• The 11 RX funds (Dynamic Growth, Dynamic Total Return, Non Traditional, High Income, Traditional Equity, Traditional Fixed Income, Tactical Rotation, Tax Advantaged, Dividend Income, and Premier Managers);
• SCS Tactical Allocation Fund (SCSGX) managed by Sentinel Capital Solutions, Inc.;
• Sector Rotation Fund (NAVFX) managed by Navigator Money Management, Inc.; and
• Thornhill Strategic Equity Fund (TSEQX) managed by Thornhill Securities, Inc.

Oh, wait.  Not quite.  Crescent Mid Cap Macro (GCMIX) is “inactive.”  Thornhill Strategic Equity (TSEQX)?  No, that doesn’t seem to be trading either. Can’t find evidence that CV Asset Allocation ever launched. Right, right: the manager of Sector Rotation Fund (NAVFX) is under SEC sanction for “numerous misleading claims,” including reporting on the performance of the fund for periods in which the fund didn’t exist.

The bottom line: directors matter. Good directors can offer a manager access to skills, perspectives and networks that are far beyond his or her native abilities.  And good directors can put their collective foot down on matters of fees, bloat and lackluster performance.

Every one of your funds has a board of directors and you really need to ask just three questions about these guys:

1. What evidence is there that the directors are bringing a meaningful skill set to their post?
2. What evidence is there that the directors have executed serious oversight of the management team?
3. What evidence is there that the directors have aligned their interests with yours?

You need to look at two documents to answer those questions.  The first is the Statement of Additional Information (SAI) which is updated every time the prospectus is.  The SAI lists the board members’ qualifications, compensation, the number of funds each director oversees and the director’s investment in each of them. Here’s a general rule: if they’re overseeing dozens of funds and investing in none of them, back away.  There are some very good funds that use what I refer to as rent-a-boards as a matter of administrative convenience and financial efficiency, but the use of such boards weakens a critical safeguard.  If the board isn’t deeply invested, you need to see that the management team is.

The second document is called the Renewal of Investment Advisory Contract.  Boards are legally required to document their due diligence and to explain to you, the folks who elected them, exactly what they looked at and what they concluded.  These are sometimes freestanding documents but they’re more likely included as a section of the fund’s annual report. Look for errant nonsense, rationalizations and wishful thinking.  If you find it, run away!  Here’s an example of the discussion of fees charged by a one-star fund that trails 96-98% of its peers but charges a mint:

Fee Rate and Profitability – The Trustees considered that the Fund’s advisory fee is the highest in its peer group, while its expense ratio is the second highest. The Trustees considered [the manager’s] explanation that several funds included in the Fund’s peer group are passive index funds, which have extremely low fees because, unlike the Fund, they are not actively managed. The Trustees also considered [the] explanation that the growth strategy it uses to manage the Fund is extremely expensive and labor intensive because it involves reviewing and evaluating 8,000+ stocks four times a year.

Here’s the argument that the board bought: the fund has some of the highest fees in its industry but that’s okay because (1) you can’t expect us to be as cheap as an index fund and (2) we work hard, apparently unlike the 98% of funds that outperform us or charge less.

If you had an employee who was paid more and produced less than anyone else, what would you do?  Then ask: “and why didn’t my board do likewise?”

It’s The Money, Stupid!

By Edward Studzinski

“To be clever enough to get a great deal of money, one must be stupid enough to want it.”

G.K. Chesterton

There is a repetitive scene in the movie “Shakespeare in Love” – an actor and a director are reading through one of young Master Shakespeare’s newest plays, with the ink still drying.  The actor asks how a particular transition is to be made from one scene to the next.  The answer given is, “I don’t know – it’s a mystery.”  Much the same might be said for the process of setting and then regularly reviewing, mutual fund fees. One of my friends made the Long March with Morningstar’s Joe Mansueto from a cave deep in western China to what should now be known now as Morningstar Abbey in Chicago. She used to opine about how for commodity products like equity mutual funds, in a world of perfect competition if one believed economic theory as taught at the University of Chicago, it was rather odd that the clearing price for management fees, rather than continually coming down, seemed mired at one per cent. That comment was made almost twenty years ago. The fees still seem mired there.

One argument might be that you get what you pay for. Unfortunately many actively-managed equity funds that charge that approximately one per cent management fee lag their benchmarks. This presents the conundrum of how index funds charging five basis points (which Seth Klarman used to refer to as “mindless investing”) often regularly outperform the smart guys charging much more. The public airing of personality clashes at bond manager PIMCO makes for interesting reading in this area, but is not necessarily illuminating. For instance, allegedly the annual compensation for Bill Gross is $200M a year. However, much of that is arguably for his role in management at PIMCO, as co-chief investment officer. Some of it is for serving on a daily basis as the portfolio manager for however many funds his name is on as portfolio manager. Another piece of it might be tied to his ownership interest in the business.

The issue becomes even more confusing when you have similar, nay even almost identical, funds being managed by the same investment firm but coming through different channels, with different fees. The example to contrast here again is PIMCO and their funds with multiple share classes and different fees, and Harbor, a number of whose fixed income products are sub-advised by PIMCO and have lower fees for what appear, to the unvarnished eye, to be very similar products often managed by the same portfolio manager. A further variation on this theme can be seen when you have an equity manager running his own firm’s proprietary mutual fund for which he is charging ninety basis points in management fees while his firm is running a sleeve of another equity mutual fund for Vanguard, for which the firm is being paid a management fee somewhere between twenty and thirty basis points, usually with incentives tied to performance. And while the argument is often made that the funds may have different investment philosophies and strategies and a different portfolio manager, there is often a lot of overlap in the securities owned (using  the same research process and analysts).

So, let’s assume that active equity management fees are initially set by charging what everyone else is charging for similar products. One can see by looking at a prospectus, what a competitor is charging. And I can assure you that most investment managers have a pretty good idea as to who their competitors are, even if they may think they really do not have competitors. How do the fees stay at the same level, especially as, when assets under management grow there should be economies of scale?

Ah ha!  Now we reach a matter that is within the purview of the Board of Trustees for a fund or fund group. They must look at the reasonableness of the fees being charged in light of a number of variables, including investment philosophy and strategy, size of assets under management, performance, etc., etc., etc.  And perhaps a principal underpinning driving that annual review and sign-off is the peer list of funds for comparison.

Probably one of the most important assignments for a mutual fund executive, usually a chief financial officer, is (a) making sure that the right consulting firm is hired to put together the peer list of similar mutual funds and (b) confirming that the consulting firm understands their assignment. To use another movie analogy, there is a scene early on in “Animal House” where during pledge week, two of the main characters visit a fraternity house and upon entering, are immediately sent to sit on a couch off in a corner with what are clearly a small group of social outliers. Peer group identification often seems to involve finding a similar group of outliers on the equivalent of that couch.

Given the large number of funds out there, one identifies a similar universe with similar investment strategies, similar in size, but mirabile dictu, the group somehow manages to have similar or inferior performance with similar or higher fees and expenses. What to do, what to do?  Well of course, you fiddle with the break points so that above a certain size of assets under management in the fund, the fees are reduced. And you never have to deal with the issue that the real money is not in the break points but in fees that are too high to begin with. Perish the thought that one should use common sense and look at what Vanguard or Dodge and Cox are charging for base fees for similar products.

There is another lesson to be gained from the PIMCO story, and that is the issue of ownership structure. Here, you have an offshore owner like Allianz taking a hands-off attitude towards their investment in PIMCO, other than getting whatever revenue or income split it is they are getting. It would be an interesting analysis to see what the return on investment to Allianz has been for their original investment. It would also be interesting to see what the payback period was for earning back that original investment. And where lies the fiduciary obligation, especially to PIMCO clients and fund investors, in addition to Allianz shareholders?  But that is a story for another time.

How is any of this to be of use to mutual fund investors and readers of the Observer. I am showing my age, but Vice President Hubert Humphrey used to be nick-named the “Happy Warrior.” One of the things that has become clear to me recently as David and I interview managers who have set up their own firms after leaving the Dark Side, LOOK FOR THE HAPPY WARRIORS. For them, it is not the process of making money. They don’t need the money. Rather they are doing it for the love of investing.  And if nobody comes, they will still do it to manage their own money.  Avoid the ones for whom the money has become an addiction, a way of keeping score. For supplementary reading, I commend to all an article that appeared in the New York Sunday Times on January 19, 2014 entitled “For the Love of Money” by Sam Polk. As with many of my comments, I am giving all of you more work to do in the research process for managing your money. But you need to do it if you serious about investing.  And remember, character and integrity always show through.

And those who can’t teach, teach gym (part 2)

Beginning in 1997, the iconically odd-looking Jim Jubak wrote the wildly-popular “Jubak’s Picks” column for MSN Money.  In 2010, he apparently decided that investment management looked awfully easy and so launched his own fund.

Which stunk.  Over the three years of its existence, it’s trailed 99% of its peers.   And so the Board of Trustees of the Trust has approved a Plan of Liquidation which authorizes the termination, liquidation and dissolution of the Jubak Global Equity Fund (JUBAX). The Fund will be T, L, and D’d on or about May 29, 2014. (It’s my birthday!)

Here’s the picture of futility, with Mr. Jubak on the blue line and mediocrity represented by the orange one:

Yup, $16 million in assets – none of it representing capital gains.

Mr. Jubak joins a long list of pundits, seers, columnists, prognosticators and financial porn journalists who have discovered that a facility for writing about investments is an entirely separate matter from any ability to actually make money.

Among his confreres:

Robert C. Auer, founder of SBAuer Funds, LLC, was from 1996 to 2004, the lead stock market columnist for the Indianapolis Business Journal “Bulls & Bears” weekly column, authoring over 400 columns, which discussed a wide range of investment topics.  As manager of Auer Growth (AUERX), he’s turned a $10,000 investment into $8500 over the course of six years.

Jonathan Clements left a high visibility post at The Wall Street Journal to become Director of Financial Education, Citi Personal Wealth Management.  Sounds fancy.  Frankly, it looks like was relegated to “blogger.”  Mr. Clements recently announced his return to journalism, and the launch of a weekly column in the WSJ.

John Dorfman, a Bloomberg and Wall Street Journal columnist, launched Dorfman Value Fund which finally became Thunderstorm Value Fund (THUNX). Having concluded that low returns, high expenses, a one-star rating, and poor marketing aren’t the road to riches, the advisor recommended that the Board close (on January 17, 2012) and liquidate (on February 29, 2012) the fund.

Ron Insana, who left CNBC in 2006 to form a hedge fund and returned to part-time punditry three years later.  He’s currently (March 28, 2014) prognosticating “a very nasty pullback” in the stock market.

Scott Martin, a contributor to FOX Business Network and a former columnist with TheStreet.com, co-managed Astor Long/Short ETF Fund (ASTLX) for one undistinguished year before moving on.

Steven J. Milloy, “lawyer, consultant, columnist, adjunct scholar,” managed the somewhat looney Free Enterprise Action Fund which merged with the somewhat looney $12 million Congressional Effect Fund (CEFFX), which never hired Mr. Milloy and just fired Congressional Effect Management.

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.

During March, Bro. Studzinski and I contacted a quartet of distinguished managers whose careers were marked by at least two phases: successfully managing large funds within a fund complex and then walking away to launch their own independent firms.  We wanted to talk with them both about their investing disciplines and current funds and about their bigger picture view of the world of independent managers.

Our lead story in May carries the working title, “Letter to a Young Fund Manager.”  We are hoping to share some insight into what it takes to succeed as a boutique manager running your own firm.  Our hope is that the story will be as useful for folks trying to assess the role of small funds in their portfolio as it will be to the (admittedly few) folks looking to launch such funds.

As a preview, we’d like to introduce the four managers and profile their funds:

Evermore Global Value (EVGBX): David Marcus was trained by Michael Price, managed Mutual European and co-managed two other Mutual Series funds, then spent time investing in Europe before returning to launch this remarkably independent “special situations” fund.

Huber Equity Income (HULIX): Joe Huber designed and implemented a state of the art research program at Hotchkis and Wiley and managed their Value Opportunities fund for five years before striking out to launch his own firm and, coincidentally, launched two of the most successful funds in existence.

Poplar Forest Partners (PFPFX): Dale Harvey is both common and rare.  He was a very successful manager for five American Funds who was disturbed by their size.  That’s common.  So he left, which is incredibly rare.  One of the only other managers to follow that path was Howard Schow, founder of the PrimeCap funds.

Walthausen Select Value (WSVRX): John Walthausen piloted both Paradigm Value and Paradigm Select to peer-stomping returns.  He left in 2007 to create his own firm which advises two funds that have posted, well, peer stomping returns.

Launch Alert: Artisan High Income (ARTFX)

On March 19^th, Artisan launched their first fixed-income fund.  The plan is for the manager to purchase a combination of high-yield bonds and other stuff (technically: “secured and unsecured loans, including, without limitation, senior and subordinated loans, delayed funding loans and revolving credit facilities, and loan participations and assignments”). There’s careful attention given to the quality and financial strength of the bond issuer and to the magnitude of the downside risks. The fund might invest globally.

The Fund is managed by Bryan C. Krug.  For the past seven years, Mr. Krug has managed Ivy High Income (WHIAX).  His record there was distinguished, especially for his ability to maneuver through – and profit from – a variety of market conditions.  A 2013 Morningstar discussion of the fund observes, in part:

[T]he fund’s 26% allocation to bonds rated CCC and below … is well above the 15% of its typical high-yield bond peer. Recently, though, Krug has been taking a somewhat defensive stance; he increased the amount of bank loans to nearly 34% as of the end of 2012, well above the fund’s 15% target allocation … Those kinds of calls have allowed the fund to mitigate losses well–performance in 2011’s third quarter and May 2012 are ready examples–as well as to deliver strong results in a variety of other environments. That record and relatively low expenses make for a compelling case here.

$10,000 invested at the beginning of Mr. Krug’s tenure would have grown to $20,700 by the time of his departure versus $16,700 at his average peer. The Ivy fund was growing by $3 – 4 billion a year, with no evident plans for closure.  While there’s no evidence that asset bloat is what convinced Mr. Krug to look for new opportunities, indeed the fund continued to perform splendidly even at $11 billion, a number of other managers have shifted jobs for that very reason.

The minimum initial investment is $1000 for the Investor class and $250,000 for Advisor shares.  Expenses for both the Investor and Advisor classes are capped at 1.25%.

Artisan’s hiring standard has remained unchanged for decades: they interview dozens of management teams each year but hire only when they think they’ve found “category killers.” With 10 of their 12 rated funds earning four- or five-stars, they seem to achieve that goal.  Investors seeking a cautious but opportunistic take on high income investing really ought to look closer.

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.

Funds in registration this month are eligible to launch in late May or early June 2014 and some of the prospectuses do highlight that date.

This month David Welsch tracked down five funds in registration, the lowest totals since we launched three years ago.  Curious.

Manager Changes

On a related note, we also tracked down 43 sets of fund manager changes. The most intriguing of those include Amit Wadhwaney’s retirement from managing Third Avenue International Value (TAVIX) and Jim Moffett’s phased withdrawal from Scout International (UMBWX).

Updates

Our friends at RiverRoad Asset Management report that they have entered a “strategic partnership” with Affiliated Managers Group, Inc.  RiverRoad becomes AMG’s 30^th partner. The roster also includes AQR, Third Avenue and Yacktman.  As part of this agreement, AMG will purchase River Road from Aviva Investors.  Additionally, River Road’s employees will acquire a substantial portion of the equity of the business. The senior professionals at RiverRoad have signed new 10-year employment agreements.  They’re good people and we wish them well.

Even more active share.

Last month we shared a list of about 50 funds who were willing to report heir current active share, a useful measure that allows investors to see how independent their funds are of the index.  We offered folks the chance to be added to the list. A dozen joined the list, including folks from Barrow, Conestoga, Diamond Hill, DoubleLine, Evermore, LindeHanson, Pinnacle, and Poplar Forest. We’ve given our active share table a new home.

ARE YOU ACTIVE?  WOULD YOU LIKE SOMEONE TO NOTICE?

We’ve been scanning fund company sites, looking for active share reports. If we’ve missed you, we’re sorry. Help us correct the oversight  by sending us the link to where you report your active share stats. We’d be more than happy to offer a permanent home for the web’s largest open collection of active share data.

Briefly Noted . . .

For reasons unexplained, GMO has added a “purchase premium” (uhhh… sales load?) and redemption fee of between 8 and 10 basis points to three of its funds: GMO Strategic Fixed Income Fund (GMFIX), GMO Global Developed Equity Allocation Fund (GWOAX) and GMO International Developed Equity Allocation Fund (GIOTX).  Depending on the share class, the GMO funds have investment minimums in the $10 million – $300 million range.  At the lower end, that would translate to an $8,000 purchase premium.  At the high end, it might be $100,000.

Effective April 1, 2014, the principal investment strategy of the Green Century Equity Fund (GCEQX) will be revised to change the index tracked by the Fund, so as to exclude the stocks of companies that explore for, process, refine or distribute coal, oil or gas.

SMALL WINS FOR INVESTORS

The Board of Mainstay Marketfield Fund (MFLDX) has voted to slash the management fee (slash it, I say!) by one basis point! So, in compensation for a sales load (5.75% for “A” shares), asset bloat (at $21 billion, the fund has put on nearly $17 billion since being acquired by New York Life) and sagging performance (it still leads its long/short peer group, but by a slim margin), you save $1 – every year – for every $10,000 you invest.  Yay!!!!!

CLOSINGS (and related inconveniences)

Robeco Boston Partners Long/Short Research Fund (BPRRX)  closed on a day’s notice at the end of March, 2014 because of “a concern that a significant increase in the size of the Fund may adversely affect the implementation of the Fund’s strategy.”  The advisor long-ago closed its flagship Robeco Boston Partners Long/Short Equity (BPLEX) fund.  At the beginning of January 2014 they launched a third offering, Robeco Boston Partners Global Long/Short (BGLSX) which is only available to institutional investors.

Effective as of the close of business on March 28, 2014, Perritt Ultra MicroCap Fund (PREOX) closed to new investors.

OLD WINE, NEW BOTTLES

On March 31, Alpine Innovators Fund (ADIAX) became Alpine Small Cap Fund.  It also ceased to be an all-cap growth fund oriented toward stocks benefiting from the “innovative nature of each company’s products, technology or business model.”  It was actually a pretty reasonable fund, not earth-shattering but decent.  Sadly, no one cared.  It’s not entirely clear that they’re going to swarm on yet another small-blend fund.  The upside is that the new managers have a stint with Lord Abbett Small Cap Blend Fund

Effective on or about April 28, 2014, BNY Mellon Small/Mid Cap Fund‘s (MMCIX) name will be changed to BNY Mellon Small/Mid Cap Multi-Strategy Fund and they’ll go all multi-manager on you.

Effective March 21, 2014, the ticker for the Giant 5 Total Investment System changed from FIVEX to CASHX. Cute.  The board had previously approved replacement of the phrase “Giant 5” with “Index Funds” (no, really), but that hasn’t happened yet.

At the end of April, 2014, Goldman Sachs has consented to modestly shorten the names of some of their funds.

They still don’t fit on one line.

Johnson Disciplined Mid-Cap Fund (JMDIX) is slated to become Johnson Opportunity on May 1, 2014.  At that point, it won’t be restricted to investing in mid-cap stocks anymore.  Good thing, too, since they’re only … how to say this? Intermittently excellent at that discipline.

On May 5, Laudus Mondrian Global Fixed Income Fund (LMGDX) becomes Laudus Mondrian Global Government Fixed Income Fund.  It’s already 90% in government bonds, so the change is mostly symbolic.  At the same time, Laudus Mondrian International Fixed Income Fund (LIFNX) becomes Laudus Mondrian International Government Fixed Income Fund.  It, too, invests now in government bonds.

Effective March 17, 2014, Mariner Hyman Beck Fund (MHBAX) was renamed the Mariner Managed Futures Strategy Fund.

OFF TO THE DUSTBIN OF HISTORY

Effective on or about May 16, 2014, AllianzGI Disciplined Equity Fund (ARDAX) and AllianzGI Dynamic Emerging Multi-Asset Fund (ADYAX) will be liquidated and dissolved. The former is tiny and mediocre, the latter tinier and worse.  Hasta!

Avatar Capital Preservation Fund (ZZZNX), Avatar Tactical Multi-Asset Income Fund (TAZNX), Avatar Absolute Return Fund (ARZNX) and Avatar Global Opportunities Fund (GOWNX) – pricey funds-of-ETFs – ceased operations on March 28, 2014.

Epiphany FFV Global Ecologic Fund (EPEAX) has closed to investors and will be liquidated on April 28, 2014.

Goldman Sachs China Equity Fund (GNIAX) is being merged “with and into” the Goldman Sachs Asia Equity Fund (GSAGX). The SEC filing mumbled indistinctly about “the second quarter of 2014” as a target date.

The $200 million Huntington Fixed Income Securities Fund (HFIIX) will be absorbed by the $5.6 billion Federated Total Return Bond Fund (TLRAX), sometime during the second quarter of 2014.  The Federated fund is pretty consistently mediocre, and still the better of the two.

On March 17, 2014, Ivy Asset Strategy New Opportunities Fund merged into Ivy Emerging Markets Equity Fund (IPOAX, formerly Ivy Pacific Opportunities Fund). On the same day, Ivy Managed European/Pacific Fund merged into Ivy Managed International Opportunities Fund (IVTAX).  (Run away!  Go buy a nice index fund!)

The $2 billion, four-star Morgan Stanley Focus Growth Fund (OMOAX) is merging with $1.3 billion, four-star Morgan Stanley Institutional Growth (MSEGX) at the beginning of April, 2014.  They are, roughly speaking, the same fund.

Parametric Currency Fund (EAPSX), $4 million in assets, volatile and unprofitable after two and a half years – closed on March 25, 2014 and was liquidated a week later.

Pax World Global Women’s Equality Fund (PXWEX) is slated to merged into a newly-formed Pax Global Women’s Index Fund.

On February 25, 2014, the Board of Trustees of Templeton Global Investment Trust on behalf of Templeton Asian Growth Fund approved a proposal to terminate and liquidate Templeton Asian Growth Fund (FASQX). The liquidation is anticipated to occur on or about May 20, 2014. I’m not sure of the story.  It’s a Mark Mobius production and he’s been running offshore versions of this fund since the early 1990s.  This creature, launched about four years ago, has been sucky performance and negligible assets.

Turner Emerging Markets Fund (TFEMX) is being liquidated on or about April 15, 2014.  Why? “This decision was made after careful consideration of the Fund’s asset size, strategic importance, current expenses and historical performance.”  Historical performance?  What historical performance?  Turner launched this fund in August of 2013.  Right.  After six months Turner pulled the plug.  Got long-term planning there, guys!

In Closing . . .

Happy anniversary to us all.  With this issue, the Observer celebrates its third anniversary.  In truth, we had no idea of what we were getting into but we knew we had a worthwhile mission and the support of good people.

We started with a fairly simple, research-based conviction: bloated funds are not good investments.  As funds swells, their investible universes contract, their internal incentives switch from investment excellence to avoiding headline risk, and their reward systems shift to reward asset growth and retention.  They become timid, sclerotic and unrewarding.

To be clear, we know of no reason which supports the proposition that bigger is better, most especially in the case of funds that place some or all of their portfolios in stocks.  And yet the industry is organized, almost exclusively, to facilitate such beasts.  Independent managers find it hard to get attention, are disadvantaged when it comes to distribution networks, and have almost no chance of receiving analyst coverage.

We’ve tried to be a voice for the little guy.  We’ve tried to speak clearly and honestly about the silly things that you’re tempted into doing and the opportunities that you’re likely overlooking.  So far we’ve reached over 300,000 readers who’ve dropped by for well over a million visits.  Which is pretty good for a site with neither commercial endorsements or pictures of celebrities in their swimwear.

In the year ahead, we’ll try to do better.  We’re taking seriously our readers’ recommendation.  One recommendation was to increase the number of fund profiles (done!) and to spend more time revisiting some of the funds we’ve previously written about (done!).  As we reviewed your responses to “what one change could we make to better serve you” question, several answers occurred over and over:

1. People would like more help in assembling portfolios, perhaps in form of model portfolios or portfolio templates.  A major goal for 2014, then, is working more with our friends in the industry to identify useful strategies for allowing folks to identify their own risk/return preferences and matching those to compatible funds.  We need to be careful since we’re not trained as financial advisors, so we want to offer models and illustrations rather than pretend to individual advice.
2. People would like more guidance on the resources already on-site.  We’ve done a poor job in accommodating the fact that we see about 10,000 first-time visitors each month.  As a result, people aren’t aware that we do maintain an archive of every audio-recording of our conference calls (check the Funds tab, then Featured Funds), and do have lists of recommended books (Resources -> Books!) and news sources (Best of the Web).  And so one of our goals for the year ahead is to make the Observer more transparent and more easily navigable.
3. Many people have asked about mid-month updates, at least in the case of closures or other developments which come with clear deadlines.  We might well be able to arrange to send a simple email, rarely more than once a month, if something compelling breaks.
4. Finally, many people asked for guidance for new investors.

Those are all wonderfully sensible suggestions and we take them very seriously.  Our immediate task is to begin inventorying our resources and capabilities; we need to ask “what’s the best we can do with what we’ve got today?” And “how can we work to strengthen our organizational foundation, so that we can help more?”

Those are great questions and we very much hope you join us as we shape the answers in the year ahead.

Finally, I’ll note that I’m shamefully far behind in extending thanks to the folks who’ve contributed to the Observer – by check or PayPal – in the past month.  I’ve launched on a new (and terrifying) adventure in home ownership; I spent much of the past month looking at houses in Davenport with the hopes of having a place by May 1.  I’m about 250 sets of signatures and initials into the process, with just one or two additional pallets of scary-looking forms to go!  Pray for me.

And thanks to you all.