By David Snowball

Dear friends,

It’s not a question of whether it’s coming.  It’s just a question of whether you’ve been preparing intelligently.

There’s an old joke about the farmer with the leaky roof that never gets fixed.  When the sun’s out, he never thinks about the leak and when it’s raining, he can’t get up there to fix it anyway.  And so the leak continues.

Our investments likewise: people who are kicking themselves for not having 100% equity exposure in March 2009 and 200% exposure in January 2013 have been pulling money steadily from boring investments and adding them to stocks.  The domestic stock market has seen its 13^th consecutive month of inflows and the S&P 500 closed February at its highest nominal level ever.

I mention this now because the sun has been shining so brightly.  March 9, 2014 marches the five-year anniversary of the current bull market.  In those five years, a $10,000 investment in the S&P500 would have grown to $30,400.  The same amount invested in the NASDAQ on March 9 would have grown to $35,900. The last remnants of the ferocious bear markets of 2000-02 and 2007-09 have faded from the ratings.  And investors really want a do-over.  All the folks hiding under their beds in 2009 and still peering out from under the blankies in 2011 feel cheated and they want in on the action, and they want it now.

Hence inflows into an overpriced market.

Our general suggestion is to learn from the past, but not to live there.  Nothing we do today can capture the returns of the past five years for us.  Sadly, we still can damage the next five.  To help build a strong prospects for our future, we’re spending a bit of time this month talking about hedging strategies – ways to get into a pricey market without quite so much heartache – and cool funds that might be better positioned for the next five than you’d otherwise find.

And, too, we get to celebrate the onset of spring!

The search for active share

It’s much easier to lose in investing than to win.  Sometimes we lose because we’re offered poor choices and sometimes we lose because we make poor ones.  Frankly, it doesn’t take many poor choices to trash the best laid plans.

Winning requires doing a lot of things right.  One of those things is deciding whether – or to what extent – your portfolio should rely on actively and passively managed funds.  A lot of actively managed funds are dismal but so too are a lot of passive products: poorly constructed indexes, trendy themes, disciplines driven by marketing, and high fees plague the index and EFT crowd.

If you are going to opt for active management, you need to be sure that it’s active in more than name alone.  As we’ve shown before, many active managers – especially those trying to deploy billions in capital – offer no advantage over a broad market index, and a lot of disadvantages. 

One tool for measuring the degree to which your manager is active is called, appropriately enough, “active share.”  Active share measures the degree to which your fund’s holdings differ from its benchmark’s.  The logic is simple: you can’t beat an index by replicating it and if you can’t beat it, you should simply buy it.

The study “How Active Is Your Manager” (2009) by Cremers and Petajitso concluded that “Funds with high active share actually do outperform their benchmarks.” The researchers originally looked at an ocean of data covering the period from 1990 to 2003, then updated it through 2009.  They found that funds with active share of at least 90% outperformed their benchmarks by 1.13% (113 basis points per year) after fees. Funds with active share below 60% consistently underperformed by 1.42 percentage points a year, after accounting for fees.

Some researchers have suggested that the threshold for active share needs to be adjusted to account for differences in the fund’s investment universe: a fund that invests in large to mega-cap names should have an active share north of 70%, midcaps should be above 80% and small caps above 90%. 

So far, we’ve only seen research validating the 60% and 90% thresholds though the logic of the step system is appealing; of the 5008 publicly-traded US stocks, there are just a few hundred large caps but several thousand small and micro-caps.

There are three problems with the active share data.  We’d like to begin addressing one of them and warn you of the other two.

Problem One: It’s not available.  Morningstar has the data but does not release it, except in occasional essays. Fund companies may or may not have it, but almost none of them share it with investors. And journalists occasionally publish pieces that include an active share chart but those tend to be an idiosyncratic, one-time shot of a few funds. Nuts.

Problem Two: Active share is only as valid as the benchmark used. The calculation of active share is simply a comparison between a fund’s portfolio and the holdings in some index. Pick a bad index and you get a bad answer. By way of simple illustration, the S&P500 stock index has an active share of 100 (woo hoo!) if you benchmark it against the MSCI Emerging Markets Index.

Fund companies might have the same incentive and the same leverage with active share providers that the buyers of bond ratings did: bond issuers could approach three ratings agencies and say “tell me how you’ll rate my bond and I’ll tell you whether we’re paying for your rating.” A fund company looking for a higher active share might simply try several indexes until they find the one that makes them look good. Here’s the warning: make sure you know what benchmark was used and make sure it makes sense.

Problem Three: You can compare active share between two funds only if they’ve chosen to use the same benchmark. One large cap might have an active share of 70 against the Mergent Dividend Achievers Index while another has a 75 against the Russell 1000 Value Index. There’s no way, from that data, to know whether one fund is actually more active than the other. So, look for comparables.

To help you make better decisions, we’ve begun gathering publicly-available active share data released by fund companies.  Because we know that compact portfolios are also correlated to higher degrees of independence, we’ve included that information too for all of the funds we could identify.  A number of managers and advisors have provided active share data since our March 1^st launch.  Thanks!  Those newly added funds appear in italics.

Fund	Ticker	Active share	Benchmark	Stocks
Artisan Emerging Markets (Adv)	ARTZX	79.0	MSCI Emerging Markets	90
Artisan Global Equity	ARTHX	94.6	MSCI All Country World	57
Artisan Global Opportunities	ARTRX	95.3	MSCI All Country World	41
Artisan Global Value	ARTGX	90.5	MSCI All Country World	46
Artisan International	ARTIX	82.6	MSCI EAFE	68
Artisan International Small Cap	ARTJX	97.8	MSCI EAFE Small Cap	45
Artisan International Value	ARTKX	92.0	MSCI EAFE	50
Artisan Mid Cap	ARTMX	86.3	Russell Midcap Growth	65
Artisan Mid Cap Value	ARTQX	90.2	Russell Value	57
Artisan Small Cap	ARTSX	94.2	Russell 2000 Growth	68
Artisan Small Cap Value	ARTVX	91.6	Russell 2000 Value	103
Artisan Value	ARTLX	87.9	Russell 1000 Value	32
Barrow All-Cap Core Investor	BALAX	92.7	S&P 500	182
Diamond Hill Select	DHLTX	89	Russell 3000 Index	35
Diamond Hill Large Cap	DHLRX	80	Russell 1000 Index	49
Diamond Hill Small Cap	DHSIX	97	Russell 2000 Index	68
Diamond Hill Small-Mid Cap	DHMIX	97	Russell 2500 Index	62
DoubleLine Equities Growth	DLEGX	88.9	S&P 500	38
DoubleLine Equities Small Cap Growth	DLESX	92.7	Russell 2000 Growth	65
Driehaus EM Small Cap Growth	DRESX	96.4	MSCI EM Small Cap	102
FPA Capital	FPPTX	97.7	Russell 2500	28
FPA Crescent	FPACX	90.3	Barclays 60/40 Aggregate	50
FPA International Value	FPIVX	97.8	MSCI All Country World ex-US	23
FPA Perennial	FPPFX	98.9	Russell 2500	30
Guinness Atkinson Global Innovators	IWIRX	99	MSCI World	28
Guinness Atkinson Inflation Managed Dividend	GAINX	93	MSCI World	35
Linde Hansen Contrarian Value	LHVAX	87.1 *	Russell Midcap Value	23
Parnassus Equity Income	PRBLX	86.9	S&P 500	41
Parnassus Fund	PARNX	92.6	S&P 500	42
Parnassus Mid Cap	PARMX	94.9	Russell Midcap	40
Parnassus Small Cap	PARSX	98.8	Russell 2000	31
Parnassus Workplace	PARWX	88.9	S&P 500	37
Pinnacle Value	PVFIX	98.5	Russell 2000 TR	37
Touchstone Capital Growth	TSCGX	77	Russell 1000 Growth	58
Touchstone Emerging Markets Eq	TEMAX	80	MSCI Emerging Markets	68
Touchstone Focused	TFOAX	90	Russell 3000	37
Touchstone Growth Opportunities	TGVFX	78	Russell 3000 Growth	60
Touchstone Int’l Small Cap	TNSAX	97	S&P Developed ex-US Small Cap	97
Touchstone Int’l Value	FSIEX	87	MSCI EAFE	54
Touchstone Large Cap Growth	TEQAX	92	Russell 1000 Growth	42
Touchstone Mid Cap	TMAPX	96	Russell Midcap	33
Touchstone Mid Cap Growth	TEGAX	87	Russell Midcap Growth	74
Touchstone Mid Cap Value	TCVAX	87	Russell Midcap Value	80
Touchstone Midcap Value Opps	TMOAX	87	Russell Midcap Value	65
Touchstone Sands Capital Select	TSNAX	88	Russell 1000 Growth	29
Touchstone Sands Growth	CISGX	88	Russell 1000 Growth	29
Touchstone Small Cap Core	TSFAX	99	Russell 2000	35
Touchstone Small Cap Growth	MXCAX	90	Russell 2000 Growth	81
Touchstone Small Cap Value	FTVAX	94	Russell 2000 Value	75
Touchstone Small Cap Value Opps	TSOAX	94	Russell 2000 Value	87
William Blair Growth	WBGSX	83	Russell 3000 Growth	53

*        Linde Hansen notes that their active share is 98 if you count stocks and cash, 87 if you look only at the stock portion of their portfolio.  To the extent that cash is a conscious choice (i.e., “no stock in our investable universe meets our purchase standards, so we’ll buy cash”), count both makes a world of sense.  I just need to find out how other investors have handled the matter.

Who’s not on the list? 

A lot of firms, some of whose absences are in the ironic-to-hypocritical range. Firms not choosing to disclose active share include:

BlackRock – which employs Anniti Petajisto, the guy who invented active share, as a researcher and portfolio manager in their Multi-Asset Strategies group. (They do make passing reference to an “active share buyback” on the part on one of their holdings, so I guess that’s partial credit, right?)

Fidelity – whose 5 Tips to Pick a Winning Fund tells you to look for “stronger performers [which are likely to] have a high ‘active share’”.  (They do reprint a Reuters article ridiculing a competitor with a measly 56% active share, but somehow skip the 48% for Fidelity Blue Chip Growth, 47% for Growth & Income, the 37% for MegaCap Stock or the under 50% for six of their Strategic Advisers funds). (per the Wall Street Journal, Is Your Fund a Closet Index Fund, January 14, 2014).

Oakmark – which preens about “Harris Associates and Active Share” without revealing any.

Are you active?  Would you like someone to notice?

We’ve been scanning fund company sites for the past month, 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.

Does Size Matter?

By Edward Studzinski

“Convictions are more dangerous enemies of truth than lies.”

                    Nietzsche

One of the more interesting consequences of the performance of equities in 2013 is the ramp-up of the active investment management marketing machines to explain why their performance in many instances lagged that of inexpensive index funds. This has resulted in a manure storm media blitz with terms and phrases such as “stock picker’s market” or “active share” or “concentrated portfolios.” 

“Stock picker’s market” is generally a euphemism for active management. That is, why you should pay me 100 basis points for investing in a subset of the S&P 500, rather than pay Vanguard or some other index fund provider 5 basis points for their product. One of the rationales I used to regularly hear to justify active management fees was that the active manager will know when to get out of the market and when to get back in, whereas the small investor will always go in and out at the wrong time. The period of 2008-2009 puts paid to that argument when one looks at maximum drawdown numbers.  The question it raises however is whether the time horizon most investment managers and investors use is far too short. I think it clearly is and that rather than three years or three to five years, we should be thinking of ten years at a minimum.  Unfortunately, given personnel turnover in many investment organizations, it is difficult for the investing public to know or understand that the people who gave a fund its long-term performance, looking in the rear-view mirror, are not the ones doing the analysis or selecting the investments going forward. And if they are, often their time and attention is pulled in many other directions.  This is why I now, sitting on an endowment investment committee, appreciate why an integral part of the investment consultant’s report covers stability of personnel and succession planning at current firms invested in as well as firms proposed for consideration. Of course, if you are the average retail investor, you are far better off to focus on your risk tolerance, true time horizon, and asset allocation, again making use of low cost index products if you are not going to spend the time and effort to replicate the work of the consultants used by endowments and pension funds.

I am going to leave it to others to discuss “active share.”  I do think the question of “concentrated portfolios” is worth a few thoughts.  I once asked a friend of mine, at a large East Coast fund complex, how he managed to keep track of the two hundred or so stocks in his fund portfolio. His answer was illuminating.  He said that his firm had a very large research department and prided itself on its selection and training of analysts.  Politically then, over time he had to use an idea or two from everyone or every area. His preference would have been to have a much more concentrated portfolio.  I will refer to that then as the “ark” approach to investment management. Other firms, such as Longleaf, have tended from the get-go to have truly concentrated portfolios, say somewhere between twenty to twenty five stocks, given that the benefits of diversification run-out at a certain number of securities. Their rationale has been that rarely, when you are building a portfolio from the bottom up based on what are the most undervalued ideas, do ideas number thirty to forty have the same expected return potential as ideas number one to ten. (That is even more the case with the S&P 500 hitting new all time highs now).

There is another way to look at this which I think makes it more understandable for the average person.  In 2006, Huber Capital Managed LLC performed a study, looking at value-oriented investors, entitled “Limited Assets Under Management is a Competitive Advantage.”   The study assumed an equal weighted portfolio of 2.5% positions (forty stocks) to show how the investable universe of securities shrank at certain asset levels. It looked at the Russell 1000 Value Index and the Russell 2000 Value Index. The conclusion of the study was that as assets under management grew, portfolio managers faced increasingly unpleasant choices. One choice of course was to shrink the investment universe, what I have referred to in the past as the rule limiting investments to securities that can be bought or sold in five days average trading volume.

Another alternative was to increase the number of stocks held in the portfolio. You can see whether your manager has done this by going back five or ten years and looking at annual reports.  When the fund was $5B in asset size, did it own thirty stocks? Do you really believe that with the fund at $10B or $15B in asset size, that it has found another twenty or thirty undervalued stocks?  Look also to see if the number of research analysts has increased materially. Are roughly the same number of analysts covering more names? 

The third choice was to make the fund very concentrated or even non-diversified by SEC standards, with individual positions greater than five per cent. That can work, but it entails taking on career risk for the analysts and fund managers, and enterprise risk for the management company. A fund with $10B in assets under management has available only 50% of the investable set of stocks to invest in, assuming it is going to continue to focus on liquidity of the investment as an implicit criteria. That is why you see more and more pension funds, endowments, and family office managers shifting to low-cost index or ETF vehicles for their large cap investments. The incremental return is not justified by the incremental fee over the low-cost vehicle. And with a long-term time horizon, the compounding effect of that fee differential becomes truly important to returns.

My thanks to Huber Capital Manangement LLC for doing this study, and to Long Short Advisors for making me aware of it in one of their recent reports. Both firms are to be commended for their integrity and honesty. They are truly investment managers rather than asset gatherers. 

On the impact of fund categorization: Morningstar’s rejoinder

Morningstar’s esteemed John Rekenthaler replied to MFO’s February commentary on categorization, although officially “his views are his own.” His February 5 column is entitled How Morningstar Categorizes Funds.

Snowball’s gloss: John starts with a semantic quibble (Charles: “Morningstar says OSTFX is a mid-cap blend fund,” John: “Morningstar does not say what a fund is,” just what category it’s been assigned to), mischaracterizes Charles’s article as “a letter to MFO” (which I mention only because he started the quibble-business) and goes on to argue that the assignment of OSTFX to its category is about as reasonable a choice as could be made. Back to Charles:

Mr. R. uses BobC’s post to frame an explanation of what Morningstar does and does not do with respect to fund categorization. In his usual thoughtful and self-effacing manner, he defends the methodology, while admitting some difficulty in communicating. Fact is, he remains one of Morningstar’s best communicators and Rekenthaler Report is always a must read.

I actually agree with his position on Osterweis. Ditto for his position on not having an All Cap category (though I suspect I’m in the minority here and he actually admits he may be too). He did not address the (mis-)categorization of River Park Short Term High Yield Fund (RPHYX/RPHIX, closed). Perhaps because he is no longer in charge of categorization at Morningstar.

The debate on categorization is never-ending, of course, as evidenced by the responses to his report and the many threads on our own board. For the most part, the debate remains a healthy one. Important for investors to understand the context, the peer group, in which prospective funds are being rated.

In any case and as always, we very much appreciate Mr. Rekenthaler taking notice and sharing his views.

Snowball’s other gloss: geez, Charles is a lot nicer than I am. I respect John’s work but frankly I don’t really tingle at the thought that he “takes notice.” Well, except maybe for that time at the Morningstar conference when he swerved at the last minute to avoid crashing into me. I guess there was a tingle then.

Snowball’s snipe: at the sound of Morningstar’s disdain, MFWire did what MFWire does. They raised high the red-and-white banner, trumpeting John’s argument and concluding with a sharp “grow up, already!” I would have been much more impressed with them if they’d read Charles’s article beforehand. They certainly might have, but there’s no evidence in the article that they felt that need.

One of the joys of writing for the Observer is the huge range of backgrounds and perspectives that our readers bring to the discussion. A second job is the huge range of backgrounds and perspectives that my colleagues bring. Charles, in particular, can hear statistics sing. (He just spent a joyful week in conference studying discounted cash-flow models.) From time to time he tries, gently, to lift the veil of innumeracy from my eyes. The following essay flows from our extended e-mail exchanges in which I struggled to understand the vastly different judgments of particular funds implied by different ways of presenting their risk-adjusted statistics. 

We thought some of you might like to overhear that conversation.  

Morningstar’s Risk Adjusted Return Measure

Central to any fund rating system is the performance measure used to determine percentile rank order. MFO uses Martin ratio, as described Rating System Definitions. Morningstar developed its own risk adjusted return (MRAR), which Nobel Laureate William Sharpe once described as a measure that “…differs significantly from more traditional ones such as various forms of the Sharpe ratio.” While the professor referred to an earlier version of MRAR, the same holds true today.

Here is how Morningstar describes MRAR on its Data FAQ page: Morningstar adjusts for risk by calculating a risk penalty for each fund based on “expected utility theory,” a commonly used method of economic analysis. Although the math is complex, the basic concept is relatively straightforward. It assumes that investors are more concerned about a possible poor outcome than an unexpectedly good outcome and that those investors are willing to give up a small portion of an investment’s expected return in exchange for greater certainty. A “risk penalty” is subtracted from each fund’s total return, based on the variation in its month-to-month return during the rating period, with an emphasis on downward variation. The greater the variation, the larger the penalty. If two funds have the exact same return, the one with more variation in its return is given the larger risk penalty.

For the curious and mathematically inclined, the detailed equations are well documented in The Morningstar Rating Methodology. The following figure illustrates how MRAR behaves for three hypothetical funds over a 3 year period ending Dec 2013:

Each fund in the illustration delivers the same total return, but with varying levels of volatility. The higher the volatility, the lower the risk adjusted return. Fund 0 delivers consistent returns every month with zero volatility; consequently, it receives the highest MRAR, which in this case is the fund’s annualized total return minus the risk-free T-Bill (i.e., it’s the annualized “excess” return).

Morningstar computes MRAR for all funds over equivalent periods, and then percentile ranks them within their respective categories to assign appropriate levels, 1 star for those funds in the lowest group and the coveted 5 star rating for the highest.

It also computes a risk measure MRisk and performs a similar ranking to designate “low” to “high” risk funds within each category. MRisk is simply the difference between the annualized excess return of the fund and its MRAR.

The following figure provides further insight into how MRAR behaves for funds of varying volatility. This time, fund total returns have been scaled to match their category averages, again for the 3 year period ending Dec 2013. The figure includes results from several categories showing MRAR versus the tradition volatility measure, annualized standard deviation.

Once again we see that funds with higher volatility generally receive lower MRARs and that the highest possible MRAR is equal to a fund’s annualized excess return, which occurs at zero standard deviation.

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, since with the latter the benefit is “capped.”

This behavior is different from other risk adjusted return measures based on say Sharpe ratio, as can be seen in the figure below. Here the same funds from above are plotted against Sharpe, but now funds with low volatility are rewarded handsomely, even if they have below average total returns.

Revisiting the Morningstar risk measure MRisk, one finds another observation: it appears to correlate rather satisfactorily against a simple function based on standard deviation (up to about 30% for funds of positive total return without load):

Which means that Morningstar’s risk adjusted return can be estimated from the following:

This simple approximation may come in handy, like when David wonders: “Why do RPHIX and ICMYX, which have superior 3 year Sharpe ratios, rate a very inferior 1 star by Morningstar?” He can use the above calculation to better understand, as illustrated here:

While both do indeed have great 3 year Sharpe ratios – RPHIX is highest of any US fund – they both have below average total returns relative to their current peer group, as represented by say VWEHX, a moderate risk and average returning high yield bond “reference” fund.

Their low volatilities simply get no love from Morningstar’s risk adjusted return measure.

27Feb2014/Charles

Celebrating one-starness

I was having a nice back-channel conversation with a substantially frustrated fund manager this week. He read Charles’s piece on fund categorization and wrote to express his own dismay with the process. He’s running a small fund. It hit its three-year mark and earned five stars. People noticed. Then Morningstar decided to recategorize the fund (into something he thinks he isn’t). And it promptly became one star. And, again, people – potential investors – noticed, but not in a good way.

Five to one, with the stroke of a pen? It happens, but tends not to get trumpeted. After all, it rather implies negligence on Morningstar’s part if they’ve been labeling something as, say, a really good conservative allocation fund for years but then, on further reflection, conclude that it’s actually a sucky high-yield bond or preferred stock fund.

Here’s what Morningstar’s explanation for such a change looks like in practice:

Morningstar Alert

Osterweis Strategic Income Fund OSTIX

12-03-13 01:00 PM

Change in Morningstar Fund Star Rating: The Morningstar Star Rating for this fund has changed from 4 stars to 2 stars. For details, go to http://quicktake.morningstar.com/Fund/RatingsAndRisk.asp?Symbol=OSTIX.

Sadly, when you go to that page there are no details that would explain an overnight drop of that magnitude. On the “performance” page, you will find the clue:

I don’t have an opinion on the appropriateness of the category assignment but it would be an awfully nice touch, given the real financial consequences of such a redesignation, if Morningstar would take three sentences to explain their rationale at the point that they make the change.

Which got me to thinking about my own favorite one-star fund (RiverPark Short Term High Yield RPHYX and RPHIX, which is closed) and Charles’s favorite one-shot stat on a fund’s risk-adjusted returns (its Sharpe ratio).

And so, here’s the question: how many funds have a higher (i.e., better) Sharpe ratio than does RPHYX?

And, as a follow-up, how many have a Sharpe ratio even half as high as RiverPark’s?

That would be “zero” and “seven,” respectively, out of 6500 funds.

Taking up Rekenthaler’s offer

In concluding his response to Charles’s essay, John writes:

A sufficient critique is one that comes from a fund that truly does not behave like others in its category, that contains a proposal for a modification to the existing category system, that does not lead to rampant category proliferation, and that results in a significantly closer performance comparison between the fund and its new category. In such cases, Morningstar will consider the request carefully–and sometimes make the suggested change.

Ummm … short-term high-yield? In general, those are funds that are much more conservative than the high-yield group. The manager at RiverPark Short-Term High Yield (RPHYX) positions the fund as a “cash management” account. The managers at Intrepid Income (ICMYX) claim to be “absolute return” investors. Wells Fargo Advantage Short-Term High-Yield Bond (STHBX) seems similarly positioned. All are one-star funds (as of February 2014) when judged against the high-yield universe.

“Does not behave like others in its category” but “results in a significantly closer performance comparison [within] its new category.” The orange line is the high-yield category. That little cluster of parallel, often overlapping lines below it are the three funds.

“Does not lead to rampant category proliferation.” You mean, like creating a “preferred stock” category with seven funds? That sort of proliferation? If so, we’re okay – there are about twice as many short-term high-yield candidates as preferred stock ones.

I’m not sure this is a great idea. I am pretty sure that dumping a bunch of useful, creative funds into this particular box is a pretty bad one.

Next month’s unsought advice will highlight emerging markets balanced (or multi-asset) funds. We’re up to a dozen of them now and the same logic that pulled US balanced funds out of the equity category and global balanced funds out of the international equity category, seems to be operating here.

Two things you really should read

In general, most writing about funds has the same problem as most funds do: it’s shallow, unoriginal, unreflective. It contributes little except to fill space and get somebody paid (both honorable goals, by the way). Occasionally, though, there are pieces that are really worth some of our time, thought and reflection. Here are two.

I’m not a great fan of ETFs. They’ve always struck me as trading vehicles, tools for allowing hedge funds and others to “make bets” rather than to invest. Chuck Jaffe had a really solid piece entitled “The growing case against ETFs” (Feb. 23, 2014) that makes the argument that ETFs are bad for you. Why? Because the great advantage of ETFs are that you can trade them all day long. And, as it turns out, if you give someone a portfolio filled with ETFs that’s precisely – and disastrously – what they do.

The Observer was founded on the premise that small, independent, active funds are the only viable alternative to a low-cost indexed portfolio. As funds swell, two bad things happen: their investable universe shrinks and the cost of making a mistake skyrockets, both of which lead to bad investment choices. There’s a vibrant line of academic research on the issue. John Rekenthaler began dissecting some of that research – in particular, a recent study endorsing younger managers and funds – in a four-part series of The Rekenthaler Report. At this writing, John had posted two essays: “Are Young Managers All That?” (Feb. 27, 2014) and “Has Your Fund Become Too Large, Or Is Industry Size the Problem?” (Feb. 28, 2014).  The first essay walks carefully through the reasons why older, larger funds – even those with very talented managers – regress. To my mind, he’s making a very strong case for finding capacity-constrained strategies and managers who will close their funds tight and early. The second picks up an old argument made by Charles Ellis in his 1974 “The Loser’s Game” essay; that the growth and professionalization of the investment industry is so great that no one – certainly not someone dragging a load – can noticeably outrun the crowd. The problem is less, John argues, the bloat of a single fund as the effect of “$3 trillion in smart money chasing the same ideas.”  

Regardless of whether you disdain or adore ETFs, or find the industry’s difficulties located at the level of undisciplined funds or an unwieldy industry, you’ll come away from these essays with much to think about.

RiverPark Strategic Income: Another set of ears

I’m always amazed by the number of bright and engaging folks who’ve been drawn to the Observer, and humbled by their willingness to freely share some of their time, insights and experience with the rest of us. One of those folks is an investor and advisor named “Mark” who is responsible for extended family money, a “multi-family office” if you will. He had an opportunity to spend some time chatting with David Sherman in mid-January as he contemplated a rather sizeable investment in RiverPark Strategic Income (RSIVX) for some family members who would benefit from such a strategy. Herewith are some of the reflections he shared over the course of a series of emails with me.

Where he’s coming from

Mark wrote that to him it’s important to understand the “context” of RSIVX. Mr. Sherman manages private strategies and hedge fund monies at Cohanzick Management, LLC. He cut his teeth at Leucadia National (whose principal Ian Cumming is sometimes referred to as Canada’s Warren Buffett) and is running some sophisticated and high entry strategies that have big risks and big rewards. His shop is not as large as some, sure, but Mr. Sherman seems to prefer it that way.

Some of what Mr. Sherman does all day “informs” RSIVX. He comes across an instrument or an idea that doesn’t fit in one strategy but may in another. It has the risk/reward characteristics that he wants for a particular strategy and so he and his team perform their due diligence on it. More on that later.

Where he is

RSIVX only exists, according to Mr. Sherman, because it fills a need. The need is for an annuity like stream of income at a rate that “his mother could live off” and he did not see such a thing in the marketplace. (In 2007 you could park money at American Express Bank in a jumbo CD at 5.5%. No such luck today.) He saw many other total return products out there in the high yield space where an investor can get a bit higher returns than what he envisions. But some of those returns will be from capital appreciation, i.e., returns from in essence trading. Mr. Sherman did not want to rely on that. He wants a lower duration portfolio (3-4 years) that he can possibly but not necessarily hold to get nice, safe, relatively high coupons from. As long as his investor has that timeframe, Mr. Sherman believes he can compound the money at 6-8% annually, and the investor gets his money back plus his return.

Shorter timeframes, because of impatience or poor timing choices, carry no such assurances. It’s not a CD, it’s not a guaranteed annuity from an insurer, but it’s what is available and what he is able to get for an investor.

How? Well, one inefficiency he hopes to exploit is in the composition of SPDR Barclays High Yield Bond (JNK) and iShares High Yield Corporate Bond (HYG). He doesn’t believe they reflect the composition of high yield space accurately with their necessary emphasis on the most liquid names. He will play in a different sandbox with different toys. And he believes it’s no more risky and thinks it is less so. In addition, when the high yield market moves, especially down, those names move fast.

Mark wrote that he asked David whether the smoothness of his returns exhibited in RPHYX and presumably in RSIVX in the future was due or would be due to a laddering strategy that he employed. He said that it was not – RSIVX’s portfolio was more of a barbell presently- and he did not want to be pigeonholed into a certain formula or strategy. He would do whatever it took to produce the necessary safe returns and that may change from time to time depending upon the market.

What changing interest rates might mean

What if rates fall? If rates fall then, sure, the portfolio will have some capital appreciation. What if rates rise? Well, every day and every month, David said, the investor will grind toward the payday on the shorter duration instruments he is holding. Mark-to-market they will be “worth” less. The market will be demanding higher interest rates and what hasn’t rolled off yet will not be as competitive as the day he bought them. The investor will still be getting a relatively high 6-8% return and as opportunities present themselves and with cash from matured securities and new monies the portfolio will be repopulated over time in the new interest rate environment. Best he can do. He does not intend to play the game of hedging. 

Where he might be going

Mark said he also asked about a higher-risk follow-on to RSIVX. He said that David told him that if he doesn’t have something unique to bring that meets a need, he doesn’t want to do it. He believes RPHYX and RSIVX to be unique. He “knew” he could pull off RPHYX, that he could demonstrate its value, and then have the credibility to introduce another idea. That idea is the Strategic Income Fund.

He doesn’t see a need for him to step out on the spectrum right now. There are a hundred competitors out there and a lot of overlap. People can go get a total return fund with more risk of loss. Returns from them will vary a lot from year to year unless conditions are remarkably stable. This [strategy] almost requires a smaller, more nimble fund and manager. Here he is. Here it is. So the next step out isn’t something he is thinking [immediately] about, but he continually brings ideas to Morty.

Mark concludes: “We discussed a few of his strategies that had more risk. They are fascinating but definitely not vanilla or oatmeal and a few I had to write out by hand the mechanics afterward so I could “see” what he was doing. One of them took me about an hour to work through where the return came from and where it could go possibly wrong.

But he described it to me because working on it gave him the inspiration for a totally different situation that, if it came to pass, would be appropriate for RSIVX. It did, is much more vanilla and is in the portfolio. Very interesting and shows how he thinks. Would love to have a beer with this guy.”

Mark’s bottom line(s)

Mark wanted me to be sure to disclose that he and his family have a rather large position in RiverPark Strategic Income now, and will be holding it for an extended period assuming all goes well (years) so, yeah, he may be biased with his remarks. He says “the strategy is not to everyone’s taste or risk tolerance”. He holds it because it exactly fills a need that his family has.

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.

Driehaus Emerging Markets Small Cap Growth (DRESX): There’s a lot to be said for EM small caps. They provide powerful diversification and performance benefits for a portfolio. The knock of them is that they’re too hot to handle. Driehaus’s carefully constructed, hedged portfolio seems to have cooled the handle by a lot.

Guinness Atkinson Inflation Managed Dividend (GAINX): It’s easy to agree that owning the world’s best companies, especially if you buy them on the cheap, is a really good strategy. GAINX approaches the challenge of constructing a very compact, high quality, low cost portfolio with quantitative discipline and considerable thought.

Intrepid Income (ICMUX): What’s not to like about this conservative little short-term, high-yield fund. It’s got it all: solid returns, excellent risk management and that coveted one-star rating! Intrepid, like almost all absolute value investors, is offering an object lesson on the important of fortitude in the face of frothy markets and serial market records.

RiverPark Gargoyle Hedged Value (RGHVX): The short story is this. Gargoyle’s combination of a compact, high quality portfolio and options-based hedging strategy has, over time, beaten just about every reasonable comparison group. Unless you anticipate a series of 20 or 30% gains in the stock market over the rest of the decade, it might be time to think about protecting some of what you’ve already made.

Elevator Talk: Ted Gardner, Salient MLP & Energy Infrastructure II (SMLPX)

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.

Master limited partnerships (MLPs) are an intriguing asset class which was, until very recently, virtually absent from both open-end fund and ETF portfolios.

MLPs are a form of business organization, in the same way corporations are a form of organization. Their shares trade on US exchanges (NYSE and NASDAQ) and they meet the same SEC security registration requirements as corporations do. They were created in the 1980s primarily as a tool to encourage increased energy production in the country and the vast majority of MLPs (75% or so) are in the energy sector.

MLPs are distinct from corporations in a number of ways:

• They’re organized around two groups: the limited partners (i.e., investors) and the general partners (i.e., managers). The limited partners provide capital and receive quarterly distributions.
• MLPs are required, by contract, to pay minimum quarterly distributions to their limited partners. That means that they produce very consistent streams of income for the limited partners.
• MLPs are required, by law, to generate at least 90% of their income from “qualified sources.” Mostly that means energy production and distribution.

The coolest thing about MLPs is the way they generate their income: they operate hugely profitable, economically-insensitive monopolies whose profits are guaranteed by law. A typical midstream MLP might own a gas or oil pipeline. The MLP receives a fee for every gallon of oil or cubic foot of gas moving through the pipe. That rate is set by a federal agency and that rate rises every year by the rate of inflation plus 1.3%. It doesn’t matter whether the price of oil soars or craters; the MLP gets its toll regardless. And it doesn’t really matter whether the economy soars or craters: people still need warm homes and gas to get to work. At worst, bad recessions eliminate a year’s demand rise but haven’t yet caused a net demand decrease. As the population grows and energy consumption rises, the amount moving through the pipelines rise and so does the MLPs income.

Those profits are protected by enormously high entry barriers: building new pipelines cost billions, require endless hearings and permits, and takes years. As a result, the existing pipelines function as de facto a regional monopoly, which means that the amount of material traveling through the pipeline won’t be driven down by competition for other pipelines.

Quick highlights of the benchmark Alerian MLP index:

• From inception through early 2013, the index returned 16% annually, on average.
• For that same period, it had a 7.1% yield which grew 7% annually.
• There is a low correlation – 50 – between the stock market and the index. REITs say at around 70 and utility stocks at 25, but with dramatically lower yield and returns.

Only seven of the 17 funds with “MLP” in their names have been around long enough to quality for a Morningstar rating; all seven are four- or five-star funds, measured against an “energy equity” peer group. Here’s a quick snapshot of Salient (the blue line) against the two five-star funds (Advisory Research MLP & Energy Income INFIX and MLP & Energy Infrastructure MLPPX) and the first open-end fund to target MLPs (Oppenheimer SteelPath MLP Alpha MLPAX):

The quick conclusion is that Salient was one of the best MLP funds until autumn 2013, at which point it became the best one. I did not include the Alerian MLP index or any of the ETFs which track it because they lag so far behind the actively-managed funds. Over the past year, for example, Salient has outperformed the Alerian MLP Index – delivering 20% versus 15.5%.

High returns and substantial diversification. Sounds perfect. It isn’t, of course. Nothing is. MLP took a tremendous pounding in the 2007-09 meltdown when credit markets froze and dropped again in August 2013 during a short-lived panic over changes in MLP’s favorable tax treatment. And it’s certainly possible for individual MLPs to get bid up to fundamentally unattractive valuations.

Ted Gardner is the co‐portfolio manager for Salient’s MLP Complex, one manifestation of which is SMLPX. He oversees and coordinates all investment modeling, due diligence, company visits, and management conferences. Before joining Salient he was both Director of Research and a portfolio manager for RDG Capital and a research analyst with Raymond James. Here are his 200 words on why you should consider getting into the erl bidness:

Our portfolio management team has many years of experience with MLP investing, as managers and analysts, in private funds, CEFs and separate accounts. We considered both the state of the investment marketplace and our own experiences and thought it might translate well into an open-end product.

As far as what we saw in the marketplace, most of the funds out there exist inside a corporate wrapper. Unfortunately C-Corp funds are subject to double taxation and that can create a real draw on returns. We felt like going the traditional mutual fund, registered investment company route made a lot of sense.

We are very research-intensive, our four analysts and I all have a sell side background. We take cash flow modeling very seriously. It’s a fundamental modeling approach, modeling down to the segment levels to understand cash flows. And, historically, our analysts have done a pretty good job at it.

We think we do things a bit differently than many investors. What we like to see is visible growth, which means we’re less yield-oriented than others might be. We typically like partnerships that have a strategic asset footprint with a lot of organic growth opportunities or those with a dropdown story, where a parent company drops more assets into a partnership over time. We tend to avoid firms dependent on third-party acquisitions for growth. And we’ve liked investing in General Partners which have historically grown their dividends at approximately twice the rate of the underlying MLPs.

The fund has both institutional and retail share classes. The retail classes (SMAPX, SMPFX) nominally carry sales loads, but they’re available no-load/NTF at Schwab. The minimum for the load-waived “A” shares is $2,500. Expenses are 1.60% on about $630 million in assets. Here’s the fund’s homepage, but I’d recommend that you click through to the Literature tab to grab some of the printed documentation.

River Park/Gargoyle Hedged Value Conference Call Highlights

On February 12th we spoke for an hour with Alan Salzbank and Josh Parker, both of the Gargoyle Group, and Morty Schaja, CEO of RiverPark Funds. Here’s a brief recap of the highlights:

Alan handles the long portfolio. Josh, a securities lawyer by training, handles the options portfolio. He’s also an internationally competitive bridge player (Gates, Buffett, Parker…) and there’s some reason to believe that the habits of mind that make for successful bridge play also makes for successful options trading. They have 35 and 25 years of experience, respectively, and all of the investment folks who support them at Gargoyle have at least 20 years of experience in the industry. Morty has been investigating buy-write strategies since the mid-1980s and he described the Gargoyle guys as “the team I’ve been looking for for 25 years.”

The fund combines an unleveraged long portfolio and a 50% short portfolio, for a steady market exposure of 50%. The portfolio rebalances between those strategies monthly, but monitors and trades its options portfolio “in real time” throughout the month.

The long portfolio is 80-120 stocks, and stock selection is algorithmic. They screen the 1000 largest US stocks on four valuation criteria (P/B, P/E, P/CF, P/S) and then assign a “J score” to each stock based on how its current valuation compares with (1) its historic valuation and (2) its industry peers’ valuation. They then buy the 100 more undervalued stocks, but maintain sector weightings that are close to the S&P 500’s.

The options portfolio is a collection of index call options. At base, they’re selling insurance policies to nervous investors. Those policies pay an average premium of 2% per month and rise in value as the market falls. That 2% is a long-term average, during the market panic in the fall of 2008, their options were generating 8% per month in premiums.

Why index calls? Two reasons: (1) they are systematically mispriced, and so they always generate more profit than they theoretically should. In particular, they are overpriced by about 35 basis points/month 88% of the time. For sellers, that means something like a 35 bps free lunch. And (2) selling calls on their individual stocks – that is, betting that the stocks in their long portfolio will fall – would reduce returns. They believe that their long portfolio is a collection of stocks superior to any index and so they don’t want to hedge away any of their upside.

And it works. Their long portfolio has outperformed the S&P 500 by an average of 5% per year for 15 years. The entire strategy has outperformed the S&P in the long-term and has matched its returns, with less volatility, in the shorter term. Throughout, it has sort of clubbed its actively-managed long-short peers. It also anticipates clubbing the emerging bevy of buy-write ETFs.

The guys identify two structural advantages they have over an ETF: (1) they buy stocks superior to those in broad indexes and (2) they manage their options portfolio moment by moment, while the ETF just sits and takes hits for 29 out of 30 days each month.

There’s evidence that they’re right. The ETFs are largely based on the CBOE S&P Buy-Write Index (BXM). Between 2000-12, the S&P 500 returned 24% and the BXM returned 52%; the options portion of the Gargoyle portfolio returned 110% while the long portfolio crushed the S&P.

Except not so much in 2008. The fund’s maximum drawdown was 48%, between 10/07 and 03/08. The guys attributed that loss to the nature of the fund’s long portfolio: it buys stocks in badly dented companies when the price of the stock is even lower than the company’s dents would warrant. Unfortunately in the meltdown, those were the stocks people least wanted to own so they got killed. The fund’s discipline kept them from wavering: they stayed 100% invested and rebalanced monthly to buy more of the stocks that were cratering. The payback comes in 2009 when they posted a 42% return against the S&P’s 26% and again in 2010 when they made 18% to the index’s 15%.

The managers believe that ’08 was exceptional, and note that the strategy actually made money from 2000-02 when the market suffered from the bursting of the dot-com bubble.

In general, the strategy fares poorest when the market has wild swings. It fares best in gently rising markets, since both the long and options portfolios can make money if the market rises but less than the strike price of the options – they can earn 2% a month on an option that’s triggered if the market rises by more than 1%. If the market rises but by less than 1%, they pay out nothing, pocket the 2% and pocket the capital appreciation from their long portfolio.

What’s the role of the fund in a portfolio? They view it as a substitute for a large-cap value investment; so if your asset allocation plan is 20% LCV, then you could profitably invest up to 20% of your portfolio in Gargoyle. For the guys, it’s 100% of their US equity exposure.

Morty Speaks!  The rationale for hedging a long-term portfolio.

The Gargoyle call sparked – here’s a surprise – considerable commentary on our discussion board. Some were impressed with Josh and Alan’s fortitude in maintaining their market exposure during the 2007-09 meltdown but others had a more quizzical response. “Expatsp” captured it this way: “Though this seems the best of the long/short bunch, I just don’t see the appeal of long/short funds for anyone who has a long-term horizon.”

There’s a great scene in Big Bang Theory where the brilliant but socially-inept Sheldon clears up a misunderstanding surrounding a comment he made about his roommate: “Ah, I understand the confusion. Uh, I have never said that you are not good at what you do. It’s just that what you do is not worth doing.” Same theme.

Morty Schaja, RiverPark’s president, is in an interesting position to comment on the question. His firm not only advises a pure long/short fund (RiverPark Long/Short Opportunity RLSFX) and a long hedged with options fund (RiverPark Gargoyle), but it also runs a very successful long-only fund (RiverPark Large Cap Growth RPXFX, which he describes as “our five-star secret weapon”).

With the obvious disclaimer that Morty has a stake in the success of all of the RiverPark funds (and the less-obvious note that he has invested deeply in each), we asked him the obvious question: Is it worth doing?

 

Since RiverPark is one of the very few investment advisors to offer the whole range of hedged funds, I asked Morty to share a quick snapshot of each to illustrate how the different strategies are likely to play out in various sets of market conditions.

Let’s start with the RiverPark Long/Short Opportunity Fund.

 

How does this compare with the RiverPark/Gargoyle Hedged Value Fund?

 

And finally, tell us about the new Structural Alpha Fund.

 

Is the Structural Alpha Fund an absolute return strategy?

Conference Call Upcoming

We haven’t scheduled a call for March. We only schedule calls when we can offer you the opportunity to speak with someone really interesting and articulate.  No one has reached that threshold this month, but we’ll keep looking on your behalf.

Conference call junkies might want to listen in on the next RiverNorth call, which focuses on the RiverNorth Managed Volatility Fund (RNBWX). Managed Volatility started life as RiverNorth Dynamic Buy-Write Fund. Long/short funds comes in three very distinct flavors, but are all lumped in the same performance category. For now, that works to the detriment of funds like Managed Volatility that rely on an options-based hedging strategy. The fund trails the long/short peer group since inception but has performed slightly better than the $8 billion Gateway Fund (GATEX). If you’re interested in the potential of an options-hedged portfolio, you’ll find the sign-up link on RiverNorth’s Events page.  The webcast takes place March 13, 2014 at 3:15 Central.

Launch Alert: Conestoga SMid Cap (CCSMX)

On February 28, 2014, Conestoga Mid Cap (CCMGX) ceased to be. Its liquidation was occasioned by negative assessments of its “asset size, strategic importance, current expenses and historical performance.” It trailed its peers in all seven calendar quarters since inception, in both rising and falling periods. With under $2 million in assets, its disappearance is not surprising.

Two things are surprising, however. First, its poor relative performance is surprising given the success of its sibling, Conestoga Small Cap (CCASX). CCASX is a four-star fund that received a “Silver” designation from Morningstar’s analysts. Morningstar lauds the stable management team, top-tier long-term returns, low volatility (its less volatile than 90% of its peers) and disciplined focus on high quality firms. And, in general, small cap teams have had little problem in applying their discipline successfully to slightly-larger firms.

Second, Conestoga’s decision to launch (on January 21, 2014) a new fund – SMid Cap – in virtually the same space is surprising, given their ability simply to tweak the existing fund. It smacks of an attempt to bury a bad record.

My conclusion after speaking with Mark Clewett, one of the Managing Directors at Conestoga: yeah, pretty much. But honorably.

Mark made two arguments.

1. Conestoga fundamentally mis-fit its comparison group. Conestoga targeted stocks in the $2 – 10 billion market cap range. Both its Morningstar peers and its Russell Midcap Growth benchmark have substantial investments in stocks up to $20 billion. The substantial exposure to those large cap names in a mid-cap wrapper drove its peer’s performance.

   The evidence is consistent with that explanation. It’s clear from the portfolio data that Conestoga was a much purer mid-cap play that either its benchmark or its peer group.

   Portfolio	Conestoga Mid Cap	Russell Mid-cap Growth	Mid-cap Growth Peers
   % large to mega cap	0	35	23
   % mid cap	86	63	63
   % small to micro cap	14	2	14
   Average market cap	5.1M	10.4M	8.4M

    By 2013, over 48% of the Russell index was stocks with market caps above $10 billion.

   Mark was able to pull the attribution data for Conestoga’s mid-cap composite, which this fund reflects. The performance picture is mixed: the composite outperformed its benchmark in 2010 and 2011, then trailed in 2013 and 2013. The fund’s holdings in the $2-5 billion and $5–10 billion bands sometimes outperformed their peers and sometimes trailed badly.

2. Tweaking the old fund would not be in the shareholders’ best interest.  The changes would be expensive and time-consuming. They would, at the same time, leave the new fund with the old fund’s record; that would inevitably cause some hesitance on the part of prospective investors, which meant it would be longer before the fund reached an economically viable size.

The hope is that with a new and more appropriate benchmark, a stable management team, sensible discipline and clean slate, the fund will achieve some of the success that Small Cap’s enjoyed.  I’m hopeful but, for now, we’ll maintain a watchful, sympathetic silence.

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 April or early May 2014 and some of the prospectuses do highlight that date.

This month David Welsch battled through wicked viruses and wicked snowstorms to track down eight funds in registration, one of the lowest totals since we launched three years ago.

The clear standout in the group is Dodge & Cox Global Bond, which the Dodge & Cox folks ran as “a private fund” since the end of December 2012.  It did really well in its one full year of operation – it gained 2.6% while its benchmark lost the same amount – and it comes with D&C’s signature low minimum, low expenses, low drama, team management.

Three other income funds are at least mildly interesting: Lazard Emerging Markets Income, Payden Strategic Income and Whitebox Unconstrained Income.

Manager Changes

On a related note, we also tracked down 50 sets of fund manager changes. The most intriguing of those include fallout from the pissing match at Pimco as Marc Seidner, an El-Erian ally, leaves to become GMO’s head of fixed-income operations.

Updates: The Observer here and there

I had a long conversation with a WSJ reporter which led to a short quotation in “Infrastructure funds are intriguing, but ….” The Wall Street Journal, Feb. 4 2014.  My bottom line was “infrastructure funds appear to be an incoherent mish-mash, with no two funds even agreeing on what sectors are worth including much less what stocks.  I don’t see any evidence of them adding value to a portfolio,” an observation prompted in part by T. Rowe Price’s decision to close their own Global Infrastructure fund. The writer, Lisa Ward, delicately quotes me as saying “you probably already own these same stocks in your other funds.” 

I was quoted as endorsing Artisan Global Small Cap (ARTWX) in Six promising new funds (though the subtitle might have been: “five of which I wouldn’t go near”), Kiplinger’s, Feb. 12 2014.  ARTWX draws on one of the most storied international management teams around, led by Mark Yockey.  The other funds profiled include three mutual funds and two ETFs.  The funds are Miller Income Opportunity (I’ve written elsewhere that “The whole enterprise leaves me feeling a little queasy since it looks either like Miller’s late-career attempt to prove that he’s not a dinosaur or Legg’s post-divorce sop to him”), Fidelity Event-Driven (FARNX: no record that Fido can actually execute with new funds anymore, much less with niche funds and untested managers), and Vanguard Global Minimum Volatility (VMVFX: meh – they work backward from a target risk level to see what returns they can generate).  The ETFs are two of the “smart beta” sorts of products, iShares MSCI USA Quality Factor (QUAL) and Schwab Fundamental U.S. Broad Market (FNDB). 

Finally, there was a very short piece entitled “Actively managed funds with low volatility,” in Bottom Line, Feb. 15 2014.  The publication is not online, at least not in an accessible form.  The editors were looking for funds with fairly well-established track records that have a tradition of low volatility.  I offered up Cook & Bynum Fund (COBYX, I’ve linked to our 2013 profile of them), FPA Crescent (FPACX, in which I’m invested) and Osterweis Fund (OSTWX).

Updates: Forbes discovers Beck, Mack & Oliver Partners (BMPEX)

Forbes rank a nice article on BMPEX, “Swinging at Strikes,” in their February 10, 2014 issue. Despite the lunacy of describing a $175 million fund as “puny” and “tiny,” the author turns up some fun facts to know and tell (the manager, Zac Wydra, was a premed student until he discovered that the sight of blood made him queasy) and gets the fund’s basic discipline right. Zac offers some fairly lively commentary in his Q4 shareholder letter, including a nice swipe at British haughtiness and a reflection on the fact that the S&P 500 is at an all-time high at the same time that the number of S&P 500 firms issuing negative guidance is near an all-time high.

Briefly Noted . . .

BlackRock has added the BlackRock Emerging Markets Long/Short Equity Fund (BLSAX) and the BlackRock Global Long/Short Equity Fund (BDMAX) as part of the constituent fund lineup in its Aggressive Growth, Conservative , Growth and Moderate Prepared Portfolios, and its Lifepath Active-Date series. Global has actually made some money for its investors, which EM has pretty much flatlined while the emerging markets have risen over its lifetime.  No word on a target allocation for either.

Effective May 1, Chou Income (CHOIX) will add preferred stocks to the list of their principal investments: “fixed-income securities, financial instruments that provide exposure to fixed-income securities, and preferred stocks.” Morningstar categorizes CHOIX as a World Bond fund despite the fact that bonds are less than 20% of its current portfolio and non-U.S. bonds are less than 3% of it.

Rydex executed reverse share splits on 13 of its funds in February. Investors received one new share for between three and seven old shares, depending on the fund.

Direxion will follow the same path on March 14, 2014 with five of their funds. They’re executing reverse splits on three bear funds and splits on two bulls.  They are: 

 

 SMALL WINS FOR INVESTORS

Auxier Focus (AUXIX) is reducing the minimum initial investment for their Institutional shares from $250,000 to $100,000. Investor and “A” shares remain at $5,000. The institutional shares cost 25 basis points less than the others.

TFS Market Neutral Fund (TFSMX) reopened to new investors on March 1, 2014.

At the end of January, Whitebox eliminated its Advisor share class and dropped the sales load on Whitebox Tactical. Their explanation: “The elimination of the Advisor share class was basically to streamline share classes … eliminating the front load was in the best interest of our clients.” The first makes sense; the second is a bit disingenuous. I’m doubtful that Whitebox imposed a sales load because it was “in the best interest of our clients” and I likewise doubt that’s the reason for its elimination.

CLOSINGS (and related inconveniences)

Artisan Global Value (ARTGX) closed on Valentine’s Day.

Grandeur Peak will soft close the Emerging Markets Opportunities (GPEOX) and hard close the Global Opportunities (GPGOX) and International Opportunities (GPIOX) strategies on March 5, 2014.

 Effective March 5, 2014, Invesco Select Companies Fund (ATIAX) will close to all investors.

Vanguard Admiral Treasury Money Market Fund (VUSSX) is really, really closed.  It will “no longer accept additional investments from any financial advisor, intermediary, or institutional accounts, including those of defined contribution plans. Furthermore, the Fund is no longer available as an investment option for defined contribution plans. The Fund is closed to new accounts and will remain closed until further notice.”  So there.

OLD WINE, NEW BOTTLES

Effective as of March 21, 2014, Brown Advisory Emerging Markets Fund (BIAQX) is being changed to the Brown Advisory – Somerset Emerging Markets Fund. The investment objective and the investment strategies of the Fund are not being changed in connection with the name change for the Fund and the current portfolio managers will continue. At the same time, Brown Advisory Strategic European Equity Fund (BIAHX) becomes Brown Advisory -WMC Strategic European Equity Fund.

Burnham Financial Industries Fund has been renamed Burnham Financial Long/Short Fund (BURFX).  It’s a tiny fund (with a sales load and high expenses) that’s been around for a decade.  It’s hard to know what to make of it since “long/short financial” is a pretty small niche with few other players.

Caritas All-Cap Growth Fund has become Goodwood SMID Cap Discovery Fund (GAMAX), a name that my 13-year-old keeps snickering at.  It’s been a pretty mediocre fund which gained new managers in October.

Compass EMP Commodity Long/Short Strategies Fund (CCNAX) is slated to become Compass EMP Commodity Strategies Enhanced Volatility Weighted Fund in May. Its objective will change to “match the performance of the CEMP Commodity Long/Cash Volatility Weighted Index.”  It’s not easily searchable by name at Morningstar because they’ve changed the name in their index but not on the fund’s profile.

Eaton Vance Institutional Emerging Markets Local Debt Fund (EELDX) has been renamed Eaton Vance Institutional Emerging Markets Debt Fund and is now a bit less local.

Frost Diversified Strategies and Strategic Balanced are hitting the “reset” button in a major way. On March 31, 2014, they change name, objective and strategy. Frost Diversified Strategies (FDSFX) becomes Frost Conservative Allocation while Strategic Balanced (FASTX) becomes Moderate Allocation. Both become funds-of-funds and discover a newfound delight in “total return consistent with their allocation strategy.” Diversified currently is a sort of long/short, ETFs, funds and stocks, options mess … $4 million in assets, high expense, high turnover, indifferent returns, limited protection. Strategic Balanced, with a relatively high downside capture, is a bit bigger and a bit calmer but ….

Effective on or about May 30, 2014, Hartford Balanced Allocation Fund (HBAAX) will be changed to Hartford Moderate Allocation Fund.

At the same time, Hartford Global Research Fund (HLEAX) becomes Hartford Global Equity Income Fund, with a so far unexplained “change to the Fund’s investment goal.” 

Effective March 31, 2014, MFS High Yield Opportunities Fund (MHOAX) will change its name to MFS Global High Yield Fund.

In mid-February, Northern Enhanced Large Cap Fund (NOLCX) became Northern Large Cap Core Fund though, at last check, Morningstar hadn’t noticed. Nice little fund, by the way.

Speaking of not noticing, the folks at Whitebox have accused of us ignoring “one of the most important changes we made, which is Whitebox Long Short Equity Fund is now the Whitebox Market Neutral Equity Fund.” We look alternately chastened by our negligence and excited to report such consequential news.

OFF TO THE DUSTBIN OF HISTORY

BCM Decathlon Conservative Portfolio, BCM Decathlon Moderate Portfolio and BCM Decathlon Aggressive Portfolio have decided that they can best serve their shareholders by liquidating.  The event is scheduled for April 14, 2014.

BlackRock International Bond Portfolio (BIIAX) has closed and will liquidate on March 14, 2014.  A good move given the fund’s dismal record, though you’d imagine that a firm with BlackRock’s footprint would want a fund of this name.

Pending shareholder approval, City National Rochdale Diversified Equity Fund (AHDEX) will merge into City National Rochdale U.S. Core Equity Fund (CNRVX) of the Trust. I rather like the honesty of their explanation to shareholders:

This reorganization is being proposed, among other reasons, to reduce the annual operating expenses borne by shareholders of the Diversified Fund. CNR does not expect significant future in-flows to the Diversified Fund and anticipates the assets of the Diversified Fund may continue to decrease in the future. The Core Fund has significantly more assets [and] … a significantly lower annual expense ratio.

Goldman Sachs Income Strategies Portfolio merged “with and into” the Goldman Sachs Satellite Strategies Portfolio (GXSAX) and Goldman Sachs China Equity Fund with and into the Goldman Sachs Asia Equity Fund (GSAGX) in mid-February.

Huntington Rotating Markets Fund (HRIAX) has closed and will liquidate by March 28, 2014.

Shareholders of Ivy Asset Strategy New Opportunities Fund (INOAX) have been urged to approve the merger of their fund into Ivy Emerging Markets Equity Fund (IPOAX).  The disappearing fund is badly awful but the merger is curious because INOAX is not primarily an emerging markets fund; its current portfolio is split between developed and developing.

The Board of Trustees of the JPMorgan Ex-G4 Currency Strategies Fund (EXGAX) has approved the liquidation and dissolution of the Fund on or about March 10, 2014.  The “strategies” in question appear to involve thrashing around without appreciable gain.

After an entire year of operation (!), the KKR Board of Trustees of the Fund approved a Plan of Liquidation with respect to KKR Alternative Corporate Opportunities Fund (XKCPX) and KKR Alternative High Yield Fund (KHYZX). Accordingly, the Fund will be liquidated in accordance with the Plan on or about March 31, 2014 or as soon as practicable thereafter. 

Loomis Sayles Mid Cap Growth Fund (LAGRX) will be liquidated on March 14^th, a surprisingly fast execution given that the Board approved the action just the month before.

On February 13, 2014, the shareholders of the Quaker Small Cap Growth Tactical Allocation Fund (QGASX) approved the liquidation and dissolution of the Fund. 

In Closing . . .

We asked you folks, in January, what made the Observer worthwhile.  That is, what did we offer that brought you back each month?  We poured your answers into a Wordle in hopes of capturing the spirit of the 300 or so responses.

Three themes recurred:  (1) the Observer is independent. We’re not trying to sell you anything.  We’re not trying to please advertisers. We’re not desperate to write inflated drivel in order to maximize clicks. We don’t have a hidden agenda. 

(2) We talk about things that other folks do not. There’s a lot of appreciation for our willingness to ferret out smaller, emerging managers and to bring them to you in a variety of formats. There’s also some appreciate of our willingness to step back from the fray and try to talk about important long-term issues rather than sexy short-term ones.

(3) We’re funny. Or weird. Perhaps snarky, opinionated, cranky and, on a good day, curmudgeonly.

And that helps us a lot.  As we plan for the future of the Observer, we’re thinking through two big questions: where should we be going and how can we get there? We’ll write a bit next time about your answer to the final question: what should we be doing that we aren’t (yet)?

We’ve made a couple changes under the hood to make the Observer stronger and more reliable.  We’ve completed our migration to a new virtual private server at Green Geeks, which should help with reliability and allow us to handle a lot more traffic.  (We hit records again in January and February.)  We also upgraded the software that runs our discussion board.  It gives the board better security and a fresher look.  If you’ve got a bookmarked link to the discussion board, we need you to reset your link to http://www.mutualfundobserver.com/discuss/discussions.  If you use your old bookmark you’ll just end up on a redirect page.  

In April we celebrate our third anniversary. Old, for a website nowadays, and so we thought we’d solicit the insights of some of the Grand Old Men of the industry: well-seasoned, sometimes storied managers who struck out on their own after long careers in large firms. We’re trying hard to wheedle our colleague Ed, who left Oakmark full of years and honors, to lead the effort. While he’s at that, we’re planning to look again at the emerging markets and the almost laughable frenzy of commentary on “the bloodbath in the emerging markets.”  (Uhh … Vanguard’s Emerging Market Index has dropped 8% in a year. That’s not a bloodbath. It’s not even a correction. It’s a damned annoyance. And, too, talking about “the emerging markets” makes about as much analytic sense as talking about “the white people.”  It’s not one big undifferentiated mass).  We’ve been looking at fund flow data and Morningstar’s “buy the unloved” strategy.  Mr. Studzinski has become curious, a bit, about Martin Focused Value (MFVRX) and the arguments that have led them to a 90% cash stake. We’ll look into it.

Please do bookmark our Amazon link.  Every bit helps! 

 As ever,

By David Snowball

Dear friends,

Given the intensity of the headlines, you’d think that Black Monday had revisited us weekly or, perhaps, that Smaug had settled his scaly bulk firmly atop our portfolios.  But no, the market wandered down a few percent for the month.  I have the same reaction to the near-hysterical headlines about the emerging markets (“rout,” “panic” and “sell-off” are popular headline terms). From the headlines, you’d think the emerging markets had lost a quarter of their value and that their governments were back to defaulting on debts and privatizing companies. They haven’t and they aren’t.  It makes you wonder how ready we are for the inevitable sharp correction that many are predicting and few are expecting.

Where are the customers’ yachts: The power of asking the wrong question

In 1940, Fred Schwed penned one of the most caustic and widely-read finance books of its time.  Where Are the Customers’ Yachts, now in its sixth edition, opens with an anecdote reportedly set in 1900 and popular on Wall Street in the 1920s.

An out-of-town visitor was shown the wonders of the New York financial district. When the party arrived at the Battery, one of his guides indicated some of the handsome ships riding at anchor. He said, “Look, those are the bankers’ and the brokers’ yachts.” The naïve visitor asked, “Where are the customer’s yachts?”

 

 

That’s an almost irresistibly attractive tale since it so quickly captures the essence of what we all suspect: finance is a game rigged to benefit the financiers, a sort of reverse Robin Hood scheme in which we eagerly participate. Disclosure of rampant manipulation of the London currency exchanges is just the most recent round in the game.

As charming as it is, it’s also fundamentally the wrong question.  Why?  Because “buying a yacht” was not the goal for the vast majority of those customers.  Presumably their goals were things like “buying a house” or “having a rainy day cushion,” which means the right question would have been “where are the customer’s houses?”

We commit the same fallacy today when we ask, “can your fund beat the market?”  It’s the question that drives hundreds of articles about the failure of active management and of financial advisors more generally.  But it’s the wrong question.  Our financial goals aren’t expressed relative to the market; they’re expressed in terms of life goals and objectives to which our investments might contribute.

In short, the right question is “why does investing in this fund give me a better chance of achieving my goals than I would have otherwise?”  That might redirect our attention to questions far more important than whether Fund X lags or leads the S&P500 by 50 bps a year.  Those fractions of a percent are not driving your investment performance nearly as much as other ill-considered decisions are.  The impulse to jump in and out of emerging markets funds (or bond funds or U.S. small caps) based on wildly overheated headlines are far more destructive than any other factor.

Morningstar calculates “investor returns” for hundreds of funds. Investor returns are an attempt to answer the question, “did the investors show up after the party was over and leave as things got dicey?”  That is, did investors buy into something they didn’t understand and weren’t prepared to stick with? The gap between what an investor could have made – the fund’s long-term returns – and what the average investor actually seems to have made – the investor returns – can be appalling.  T. Rowe Price Emerging Market Stock (PRMSX) made 9% over the past decade, its average investor made 4%. Over a 15 year horizon the disparity is worse: the fund earned 10.7% while investors were around for 4.3% gains.  The gap for Dodge & Cox Stock (DODGX) is smaller but palpable: 9.2% for the fund over 15 years but 7.0% for its well-heeled investors. 

My colleague Charles has urged me to submit a manuscript on mutual fund investing to John Wiley’s Little Book series, along with such classics as The Little Book That Makes You Rich and The Little Book That Beats the Market. I might. But if I do, it will be The Little Book That Doesn’t Beat the Market: And Why That’s Just Fine. Its core message will be this:

If you spend less time researching your investments than you spend researching a new kitchen blender, you’re screwed.  If you base your investments on a belief in magical outcomes, you’re screwed.  And if you think that 9% returns will flow to you with the smooth, stately grace of a Rolls Royce on a country road, you’re screwed.

But if you take the time to understand yourself and you take the time to understand the strategies that will be used by the people you’re hiring to provide for your future, you’ve got a chance.

And a good, actively managed mutual fund can make a difference but only if you look for the things that make a difference.  I’ll suggest four:

Understanding: do you know what your manager plans to do?  Here’s a test: you can explain it to your utterly uninterested spouse and then have him or her correctly explain it back?  Does your manager write in a way that draws you closer to understanding, or are you seeing impenetrable prose or marketing babble?  When you have a question, can you call or write and actually receive an intelligible answer?

Alignment: is your manager’s personal best interests directly tied to your success?  Has he limited himself to his best ideas, or does he own a bit of everything, everywhere?  Has he committed his own personal fortune to the fund?  Have his Board of Directors?  Is he capable of telling you the limits of his strategy; that is, how much money he can handle without diluting performance? And is he committed to closing the fund long before you reach that sad point?

Independence: does your fund have a reason to exist? Is there any reason to believe that you couldn’t substitute any one of a hundred other strategies and get the same results? Does your fund publish its active share; that is, the amount of difference between it and an index? Does it publish its r-squared value; that is, the degree to which it merely imitates the performance of its peer group? 

Volatility: does your manager admit to how bad it could get? Not just the fund’s standard deviation, which is a pretty dilute measure of risk. No, do they provide their maximum drawdown for you; that is, the worst hit they ever took from peak to trough.  Are the willing to share and explain their Sharpe and Sortino ratios, key measures of whether you’re getting reasonably compensated for the hits you’ll inevitable take?  Are they willing to talk with you in sharply rising markets about how to prepare for the sharply falling ones?

The research is clear: there are structural and psychological factors that make a difference in your prospects for success.  Neither breathless headlines nor raw performance numbers are among them.

Then again, there’s a real question of whether it could ever compete for total sales with my first book, Continuity and Change in the Rhetoric of the Moral Majority (total 20-year sales: 650 copies).

Absolute value’s sudden charm

Jeremy Grantham often speaks of “career risk” as one of the great impediments to investment success. The fact that managers know they’re apt to be fired for doing the right thing at the wrong time is a powerful deterrent to them. For a great many, “the right thing” is refusing to buy overvalued stocks. Nonetheless, when confronted by a sharply rising market and investor ebullience, most conclude that it’s “the wrong time” to act on principle. In short, they buy when they know  they probably shouldn’t.

A handful of brave souls have refused to succumb to the pressure. In general, they’re described as “absolute value” investors. That is, they’ll only buy stocks that are selling at a substantial discount to their underlying value; the mere fact that they’re “the best of a bad lot” isn’t enough to tempt them.

And, in general, they got killed – at least in relative terms – in 2013. We thought it would be interesting to look at the flip side, the performance of those same funds during January 2014 when the equity indexes dropped 3.5 – 4%.  While the period is too brief to offer any major insights, it gives you a sense of how dramatically fortunes can reverse.

THE ABSOLUTE VALUE GUYS

	Cash	Relative 2013 return	Relative 2014 return
ASTON River Road Independent Value ARIVX	67%	bottom 1%	top 1%
Beck, Mack & Oliver Partners BMPEX	18	bottom 3%	bottom 17%
Cook & Bynum COBYX	44	bottom 1%	top 8%
FPA Crescent FPACX *	35	top 5%	top 30%
FPA International Value FPIVX	40	bottom 20%	bottom 30%
Longleaf Partners Small-Cap LLSCX	45	bottom 23%	top 10%
Oakseed SEEDX	21	bottom 8%	top 5%
Pinnacle Value PVFIX	44	bottom 2%	top 3%
Yacktman YACKX	22	bottom 17%	top 27%

Motion, not progress

Cynic, n.  A blackguard whose faulty vision sees things as they are, not as they ought to be.

                                                                                                         Ambrose Bierce

One of the joys of having entered the investment business in the 1980’s is that you came in at a time when the profession was still populated by some really nice and thoughtful people, well-read and curious about the world around them.  They were and are generally willing to share their thoughts and ideas without hesitation. They were the kind of people that you hoped you could keep as friends for life.  One such person is my friend, Bruce, who had a thirty-year career on the “buy side” as both an analyst and a director of research at several well-known money management firms. He retired in 2008 and divides his time between homes in western Connecticut and Costa Rica.

Here in Chicago in January, with snow falling again and the wind chill taking the temperature below zero, I see that Bruce, sitting now in Costa Rica, is the smart one.  Then I reflected on a lunch we had on a warm summer day last August near the Mohawk Trail in western Massachusetts.  We stay in touch regularly but this was the first time the two of us had gotten together in several years. 

The first thing I asked Bruce was what he missed most about no longer being active in the business.  Without hesitation he said that it was the people. For most of his career he had interacted daily with other smart investors as well as company management teams.  You learned how they thought, what kind of people they were, whether they loved their businesses or were just doing it to make money, and how they treated their shareholders and investors. Some of his best memories were of one-on-one meetings or small group dinners.  These were events that companies used to hold for their institutional shareholders.  That ended with the implementation of Regulation FD (full disclosure), the purpose of which was to eliminate the so-called whisper number that used to be “leaked” to certain brokerage firm analysts ahead of earnings reporting dates. This would allow those analysts to tip-off favored clients, giving them an edge in buying or selling a position. Companies now deal with this issue by keeping tight control on investor meetings and what can be said in them, tending to favor multi-media analyst days (timed, choreographed, scripted, and rehearsed events where you find yourself one of three hundred in a room being spoon-fed drivel), and earnings conference calls (timed, choreographed, scripted, and rehearsed events where you find yourself one of a faceless mass listening to reporting without seeing any body language).  Companies will still visit current and potential investors by means of “road shows” run by a friendly brokerage firm coincidentally looking for investment banking business.  But the exchange of information can be less than free-flowing, especially if the brokerage analyst sits in on the meeting.  And, to prevent accidental disclosure, the event is still heavily scripted.  It has however created a new sideline business for brokerage firms in these days of declining commission rates.  Even if you are a large existing institutional shareholder, the broker/investment bankers think you should pay them $10,000 – $15,000 in commissions for the privilege of seeing the management of a company you already own.  This is apparently illegal in the United Kingdom, and referred to as “pay to play” there.  Here, neither the SEC nor the compliance officers have tumbled to it as an apparent fiduciary violation.

Next I asked him what had been most frustrating in his final years. Again without hesitation he said that it was difficult to feel that you were actually able to add value in evaluating large cap companies, given how the regulatory environment had changed. I mentioned to him that everyone seemed to be trying to replace the on-site leg work part of fundamental analysis with screening and extensive earnings modeling, going out multiple years. Unfortunately many of those using such approaches appear to have not learned the law of significant numbers in high school chemistry. They seek exactitude while in reality adding complexity.  At the same time, the subjective value of sitting in a company headquarters waiting room and seeing how customers, visitors, and employees are treated is no longer appreciated.

Bruce, like many value investors, favors private market value as the best underpinning for security valuation. That is, based on recent transactions to acquire a comparable business, what was this one worth? But you need an active merger & acquisition market for the valuation not to be tied to stale inputs. He mentioned that he had observed the increased use of dividend discount models to complement other valuation work. However, he thought that there was a danger in a low interest-rate environment that a dividend discount model could produce absurd results. One analyst had brought him a valuation write-up supported by a dividend discount model. Most of the business value ended up being in the terminal segment, requiring a 15 or 16X EBITDA multiple to make the numbers work.  Who in the real world pays that for a business?  I mentioned that Luther King, a distinguished investment manager in Texas with an excellent long-term record, insisted on meeting as many company managements as he could, even in his seventies, as part of his firm’s ongoing due diligence. He did not want his investors to think that their investments were being followed and analyzed by “three guys and a Bloomberg terminal.”  And in reality, one cannot learn an industry and company solely through a Bloomberg terminal, webcasts, and conference calls. 

Bruce then mentioned another potentially corrupting factor. His experience was that investment firms compensate analysts based on idea generation, performance of the idea, and the investment dollars committed to the idea. This can lead to gamesmanship as you get to the end of the measurement period for compensation. E.g., we tell corporate managements they shouldn’t act as if they were winding up and liquidating their business at the end of a quarter or year. Yet, we incent analysts to act that way (and lock in a profitable bonus) by recommending sale of an idea much too early. Or at the other extreme, they may not want to recommend sale of the idea when they should. I mentioned that one solution was to eliminate such compensation performance assessments as one large West Coast firm is reputed to have done after the disastrous 2008 meltdown. They were trying to restore a culture that for eighty years had been geared to producing the best long-term compounding investment ideas for the clients. However, they also had the luxury of being independent.      

Finally I asked Bruce what tipped him over the edge into retirement. He said he got tired of discussions about “scalability.” A brief explanation is in order. After the dot-com disaster at the beginning of the decade, followed by the debacle years of 2008-2009, many investment firms put into place an implicit policy. For an idea to be added to the investment universe, a full investment position had to be capable of being acquired in five days average trading volume for that issue. Likewise, one had to also be able to exit the position in five days average trading volume. If it could not pass those hurdles, it was not a suitable investment. This cuts out small cap and most mid-cap ideas, as well as a number of large cap ideas where there is limited investment float. While the benchmark universe might be the S&P 500, in actuality it ends up being something very different. Rather than investing in the best ideas for clients, one ends up investing in the best liquid ideas for clients (I will save for another day the discussion about illiquid investments consistently producing higher returns long-term, albeit with greater volatility). 

From Bruce’s perspective, too much money is chasing too few good ideas. This has resulted in what we call “style drift”.  Firms that had made their mark as small cap or mid cap investors didn’t want to kill the goose laying the golden eggs by shutting off new money, so they evolved to become large cap investors. But ultimately that is self-defeating, for as the assets come in, you either have to shut down the flows or change your style by adding more and larger positions, which ultimately leads to under-performance.

I mentioned to Bruce that the other problem of too much money chasing too few good new ideas was that it tended to encourage “smart guy investing,” a term coined by a mutual friend of ours in Chicago. The perfect example of this was Dell. When it first appeared in the portfolios of Southeastern Asset Management, I was surprised. Over the next year, the idea made its way in to many more portfolios at other firms. Why? Because originally Southeastern had made it a very large position, which indicated they were convinced of its investment merits. The outsider take was “they are smart guys – they must have done the work.” And so, at the end of the day after making their own assessments, a number of other smart guys followed. In retrospect it appears that the really smart guy was Michael Dell.

A month ago I was reading a summary of the 2013 annual investment retreat of a family office investment firm with an excellent reputation located in Vermont. A conclusion reached was that the incremental value being provided by many large cap active managers was not justified by the fees being charged. Therefore, they determined that that part of an asset allocation mix should make use of low cost index funds. That is a growing trend. Something else that I think is happening now in the industry is that investment firms that are not independent are increasingly being run for short-term profitability as the competition and fee pressures from products like exchange traded funds increases. Mike Royko, the Chicago newspaper columnist once said that the unofficial motto of Chicago is “Ubi est meum?” or “Where’s mine?” Segments of the investment management business seemed to have adopted it as well. As a long-term value investor in New York recently said to me, short-termism is now the thing. 

The ultimate lesson is the basic David Snowball raison d’etre for the Mutual Fund Observer. Find yourself funds that are relatively small and independent, with a clearly articulated philosophy and strategy. Look to see, by reading the reports and looking at the lists of holdings, that they are actually doing what they say they are doing, and that their interests are aligned with yours. Look at their active share, the extent to which the holdings do not mimic their benchmark index. And if you cannot be bothered to do the work, put your investments in low cost index vehicles and focus on asset allocation.  Otherwise, as Mr. Buffet once said, if you are seated at the table to play cards and don’t identify the “mark” you should leave, as you are it.

Edward Studzinski    

Impact of Category on Fund Ratings

The results for MFO’s fund ratings through quarter ending December 2013, which include the latest Great Owl and Three Alarm funds, can be found on the Search Tools page. The ratings are across 92 fund categories, defined by Morningstar, and include three newly created categories:

Corporate Bond. “The corporate bond category was created to cull funds from the intermediate-term and long-term bond categories that focused on corporate bonds,” reports Cara Esser.  Examples are Vanguard Interm-Term Invmt-Grade Inv (VFICX) and T. Rowe Price Corporate Income (PRPIX).

Preferred Stock. “The preferred stock category includes funds with a majority of assets invested in preferred stock over a three-year period. Previously, most preferred share funds were lumped in with long-term bond funds because of their historically high sensitivity to long-term yields.” An example is iShares US Preferred Stock (PFF).

Tactical Allocation. “Tactical Allocation portfolios seek to provide capital appreciation and income by actively shifting allocations between asset classes. These portfolios have material shifts across equity regions and bond sectors on a frequent basis.” Examples here are PIMCO All Asset All Authority Inst (PAUIX) and AQR Risk Parity (AQRIX).

An “all cap” or “all style” category is still not included in the category definitions, as explained by John Rekenthaler in Why Morningstar Lacks an All-Cap Fund Category. The omission frustrates many, including BobC, a seasoned contributor to the MFO board:

Osterweis (OSTFX) is a mid-cap blend fund, according to M*. But don’t say that to John Osterweis. Even looking at the style map, you can see the fund covers all of the style boxes, and it has about 20% in foreign stocks, with 8% in emerging countries. John would tell you that he has never managed the fund to a style box. In truth he is style box agnostic. He is looking for great companies to buy at a discount. Yet M* compares the fund with others that are VERY different.

In fairness, according to the methodology, “for multiple-share-class funds, each share class is rated separately and counted as a fraction of a fund within this scale, which may cause slight variations in the distribution percentages.” Truth is, fund managers or certainly their marketing departments are sensitive to what category their fund lands-in, as it can impact relative ratings for return, risk, and price.

As reported in David’s October commentary, we learned that Whitebox Funds appealed to the Morningstar editorial board to have its Tactical Opportunities Fund (WBMIX) changed from aggressive allocation to long/short equity. WBMIX certainly has the latitude to practice long/short; in fact, the strategy is helping the fund better negotiate the market’s rough start in 2014. But its ratings are higher and price is lower, relatively, in the new category.

One hotly debated fund on the MFO board, ASTON/River Road Independent Small Value (ARIVX), managed by Eric Cinnamond, would also benefit from a category change. As a small cap, the fund rates a 1 (bottom quintile) for 2013 in the MFO ratings system, but when viewed as a conservative or tactical allocation fund – because of significant shifts to cash – the ratings improve. Here is impact on return group rank for a couple alternative categories:

Of course, a conservative tactical allocation category would be a perfect antidote here (just kidding).

Getting It Wrong. David has commented more than once about the “wildly inappropriate” mis-categorization of Riverpark Short Term High Yield Fund (RPHIX), managed by David Sherman, which debuted with just a single star after its first three years of operation. The MFO community considers the closed fund more of a cash alternative, suited best to the short- or even ultrashort-term bond categories, but Morningstar placed it in the high yield bond category.

Exacerbating the issue is that the star system appears to rank returns after deducting for a so-called “risk penalty,” based on the variation in month-to-month return during the rating period. This is good. But it also means that funds like RPHIX, which have lower absolute returns with little or no downside, do not get credit for their very high risk-adjusted return ratios, like Sharpe, Sortino, or Martin.

Below is the impact of categorization, as well as return metrics, on its performance ranking. The sweet irony is that its absolute return even beat the US bond aggregate index!

RPHIX is a top tier fund by just about any measure when placed in a more appropriate bond category or when examined with risk-adjusted return ratios. (Even Modigliani’s M2, a genuinely risk-adjusted return, not a ratio, that is often used to compare portfolios with different levels of risk, reinforces that RPHIX should still be top tier even in the high yield bond category.) Since Morningstar states its categorizations are “based strictly on portfolio statistics,” and not fund names, hopefully the editorial board will have opportunity to make things right for this fund at the bi-annual review in May.

A Broader View. Interestingly, prior to July 2002, Morningstar rated funds using just four broad asset-class-based groups: US stock, international stock, taxable bond, and municipal bonds. It switched to (smaller) categories to neutralize market tends or “tailwinds,” which would cause, for example, persistent outperformance by funds with value strategies.

A consequence of rating funds within smaller categories, however, is more attention goes to more funds, including higher risk funds, even if they have underperformed the broader market on a risk-adjusted basis. And in other cases, the system calls less attention to funds that have outperformed the broader market, but lost an occasional joust in their peer group, resulting in a lower rating.

Running the MFO ratings using only the four board legacy categories reveals just how much categorization can alter the ratings. For example, the resulting “US stock” 20-year Great Owl funds are dominated by allocation funds, along with a high number of sector equity funds, particularly health. But rate the same funds with the current categories (Great Owl Funds – 4Q2013), and we find more funds across the 3 x 3 style box, plus some higher risk sector funds, but the absence of health funds.

Fortunately, some funds are such strong performers that they appear to transcend categorization. The eighteen funds listed below have consistently delivered high excess return while avoiding large drawdown and end-up in the top return quintile over the past 20, 10, 5, and 3 year evaluation periods using either categorization approach:

 Roy Weitz grouped funds into only five equity and six specialty “benchmark categories” when he established the legacy Three Alarm Funds list. Similarly, when Accipiter created the MFO Miraculous Multi-Search tool, he organized the 92 categories used in the MFO rating system into 11 groups…not too many, not too few. Running the ratings for these groupings provides some satisfying results:

A more radical approach may be to replace traditional style categories altogether! For example, instead of looking for best performing small-cap value funds, one would look for the best performing funds based on a risk level consistent with an investor’s temperament. Implementing this approach, using Risk Group (as defined in ratings system) for category, identifies the following 20-year Great Owls:

Bottom Line. Category placement can be as important to a fund’s commercial success as its people, process, performance, price and parent. Many more categories exist today on which peer groups are established and ratings performed, causing us to pay more attention to more funds. And perhaps that is the point. Like all chambers of commerce, Morningstar is as much a promoter of the fund industry, as it is a provider of helpful information to investors. No one envies the enormous task of defining, maintaining, and defending the rationale for several dozen and ever-evolving fund categories. Investors should be wary, however, that the proliferation may provide a better view of the grove than the forest.

28Jan2014/Charles

Our readers speak!

And we’re grateful for it. Last month we gave folks an opportunity to weigh-in on their assessment of how we’re doing and what we should do differently. Nearly 350 of you shared your reactions during the first week of the New Year. That represents a tiny fraction of the 27,000 unique readers who came by in January, so we’re not going to put as much weight on the statistical results as on the thoughts you shared.

We thought we’d share what we heard. This month we’ll highlight the statistical results.  In March we’ll share some of your written comments (they run over 30 pages) and our understanding of them.

Who are you?

80% identified themselves as private investors, 18% worked in the financial services industry and 2% were journalists, bloggers and analysts.

How often do you read the Observer?

The most common answer is “I just drop by at the start of the month” (36%). That combines with “I drop by once every month, but not necessarily at the start”) (14%) to explain about half of the results. At the same time, a quarter of you visit four or more times every month. (And thanks for it!)

Which features are most (or least) interesting to you?

By far, the greatest number of “great, do more!” responses came under “individual fund profiles.” A very distant second and third were the longer pieces in the monthly commentary (such as Motion, Not Progress and Impact of Category on Fund Ratings) and the shorter pieces (on fund liquidations and such) in the commentary. Folks had the least interest in our conference calls and funds in registration.

Hmmm … we’re entirely sympathetic to the desire for more fund profiles. Morningstar has an effective monopoly in the area and their institutional biases are clear: of the last 100 fund analyses posted, only 13 featured funds with under one billion in assets. Only one fund launched since January 2010 was profiled. In response, we’re going to try to increase the number of profiles each month to at least four with a goal of hitting five or six. 

We’re not terribly concerned about the tepid response to the conference calls since they’re useful in writing our profiles and the audience for them continues to grow. If you haven’t tried one, perhaps it might be worthwhile this month?

And so, in response to your suggestion, here’s the freshly expanded …

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. 

ASTON/River Road Long Short (ARLSX): measured in the cold light of risk-return statistics, ARLSX is as good as it gets. We’d recommend that interested parties look at both this profile and at the conference call highlights, below.

Artisan Global Small Cap (ARTWX): what part of “phenomenally talented, enormously experienced management team now offers access to a poorly-explored asset class” isn’t interesting to you?

Grandeur Peak Emerging Opportunities (GPEOX): ditto!

RiverNorth Equity Opportunity (RNEOX): ditto! Equity Opportunity is a redesigned and greatly strengthened version of an earlier fund.  This new edition is all RiverNorth and that is, for folks looking for buffered equity exposure, a really interesting option.

We try to think strategically about which funds to profile. Part of the strategy is to highlight funds that might do you well in the immediate market environment, as well as others that are likely to be distinctly out of step with today’s market but very strong additions in the long-run. We reached out in January to the managers of two funds in the latter category: the newly-launched Meridian Small Cap Growth (MSGAX) and William Blair Emerging Markets Small Cap (WESNX). Neither has responded to a request for information (we were curious about strategy capacity, for instance, and risk-management protocols). We’ll continue reaching out; if we don’t hear back, we’ll profile the funds in March with a small caution flag attached.

RiverNorth conference call, February 25 2014

RiverNorth’s opportunistic CEF strategy strikes us as distinctive, profitable and very crafty. We’ve tried to explain it in profiles of RNCOX and RNEOX. Investors who are intrigued by the opportunity to invest with RiverNorth should sign up for their upcoming webcast entitled RiverNorth Closed-End Fund Strategies: Capitalizing on Discount Volatility. While this is not an Observer event, we’ve spoken with Mr. Galley a lot and are impressed with his insights and his ability to help folks make sense of what the strategy can and cannot do.

Navigate over to http://www.rivernorthfunds.com/events/ for free registration.

Conference Call Highlights:  ASTON River Road Long/Short (ARLSX)

We spoke with Daniel Johnson and Matt Moran, managers for the River Road Long-Short Equity strategy which is incorporated in Aston River Road Long-Short Fund (ARLSX). Mike Mayhew, one of the Partners at Aston Asset, was also in on the call to answer questions about the fund’s mechanics. About 60 people joined in.

The highlights, for me, were:

the fund’s strategy is sensible and straightforward, which means there aren’t a lot of moving parts and there’s not a lot of conceptual complexity. The fund’s stock market exposure can run from 10 – 90% long, with an average in the 50-70% range. The guys measure their portfolio’s discount to fair value; if their favorite stocks sell at a less than 80% of fair value, they increase exposure. The long portfolio is compact (15-30), driven by an absolute value discipline, and emphasizes high quality firms that they can hold for the long term. The short portfolio (20-40 names) is stocked with poorly managed firms with a combination of a bad business model and a dying industry whose stock is overpriced and does not show positive price momentum. That is, they “get out of the way of moving trains” and won’t short stocks that show positive price movements.

the fund grew from $8M to $207M in a year, with a strategy capacity in the $1B – 1.5B range. They anticipate substantial additional growth, which should lower expenses a little (and might improve tax efficiency – my note, not theirs). Because they started the year with such a small asset base, the expense numbers are exaggerated; expenses might have been 5% of assets back when they were tiny, but that’s no longer the case. 

shorting expenses were boosted by the vogue for dividend-paying stocks, which  drove valuations of some otherwise sucky stocks sharply higher; that increases the fund’s expenses because they’ve got to repay those dividends but the managers believe that the shorts will turn out to be profitable even so.

the guys have no client other than the fund, don’t expect ever to have one, hope to manage the fund until they retire and they have 100% of their liquid net worth in it.

their target is “sleep-at-night equity exposure,” which translates to a maximum drawdown (their worst-case market event) of no more than 10-15%. They’ve been particularly appalled by long/short funds that suffered drawdowns in the 20-25% range which is, they say, not consistent with why folks buy such funds.

they’ve got the highest Sharpe ratio of any long-short fund, their longs beat the market by 900 bps, their shorts beat the inverse of the market by 1100 bps and they’ve kept volatility to about 40% of the market’s while capturing 70% of its total returns.

A lot of the Q&A focused on the fund’s short portfolio and a little on the current state of the market. The guys note that they tend to generate ideas (they keep a watchlist of no more than 40 names) by paging through Value Line. They focus on fundamentals (let’s call it “reality”) rather than just valuation numbers in assembling their portfolio. They point out that sometimes fundamentally rotten firms manage to make their numbers (e.g., dividend yield or cash flow) look good but, at the same time, the reality is that it’s a poorly managed firm in a failing industry. On the flip side, sometimes firms in special situations (spinoffs or those emerging from bankruptcy) will have little analyst coverage and odd numbers but still be fundamentally great bargains. The fact that they need to find two or three new ideas, rather than thirty or sixty, allows them to look more carefully and think more broadly. That turns out to be profitable.

Bottom Line: this is not an all-offense all the time fund, a stance paradoxically taken by some of its long-short peers.  Neither is it a timid little “let’s short an ETF or two and hope” offering.”  It has a clear value discipline and even clearer risk controls.  For a conservative equity investor like me, that’s been a compelling combination.

Folks unable to make the call but interested in it can download or listen to the .mp3 of the call, which will open in a separate window.

As with all of these funds, we have a featured funds page for ARLSX which provides a permanent home for the mp3 and highlights, and pulls together all of the best resources we have for the fund.

Would An Additional Heads Up Help?

Over 220 readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Conference Call Upcoming:  Joshua B. Parker and Alan Salzbank, RiverPark / Gargoyle Hedged Value

Josh Parker and Alan Salzbank, Co-Portfolio Managers of the RiverPark/Gargoyle Hedged Value Fund (RGHVX) and Morty Schaja, RiverPark’s CEO; are pleased to join us for a conference call scheduled for Wednesday, February 12 from 7:00 – 8:00 PM Eastern. We profiled the fund in June 2013, but haven’t spoken with the managers before.  

Why speak with them now?  Three reasons.  First, you really need to have a strategy in place for hedging the substantial gains booked by the stock market since its March 2009 low. There are three broad strategies for doing that: an absolute value strategy which will hold cash rather than overpriced equities, a long-short equity strategy and an options-based strategy. Since you’ve had a chance to hear from folks representing the first two, it seems wise to give you access to the third. Second, RiverPark has gotten it consistently right when it comes to both managers and strategies. I respect their ability and their record in bringing interesting strategies to “the mass affluent” (and me). Finally, RiverPark/Gargoyle Hedged Value Fund ranks as a top performing fund within the Morningstar Long/Short category since its inception 14 years ago. The Fund underwent a conversion from its former partnership hedge fund structure in April 2012 and is managed using the same approach by the same investment team, but now offers daily liquidity, low  minimums and a substantially lower fee structure for shareholders.

I asked Alan what he’d like folks to know ahead of the call. Here’s what he shared:

Alan and Josh have spent the last twenty-five years as traders and managers of options-based investment strategies beginning their careers as market makers on the option floor in the 1980’s. The Gargoyle strategy involves using a disciplined quantitative approach to find and purchase what they believe to be undervalued stocks. They have a unique approach to managing volatility through the sale of relatively overpriced index call options to hedge the portfolio. Their strategy is similar to traditional buy/write option strategies that offer reduced volatility and some downside protection, but gains an advantage by selling index rather single stock options. This allows them to benefit from both the systemic overpricing of index options while not sacrificing the alpha they hope to realize on their bottom-up stock picking, 

The Fund targets a 50% net market exposure and manages the option portfolio such that market exposure stays within the range of 35% to 65%. Notably, using this conservative approach, the Fund has still managed to outperform the S&P 500 over the last five years. Josh and Alan believe that over the long term shareholders can continue to realize returns greater than the market with less risk. Gargoyle’s website features an eight minute video “The Options Advantage” describing the investment process and the key differences between their strategy and a typical single stock buy-write (click here to watch video).

That call is scheduled for Wednesday, February 12, from 7:00 – 8:00 Eastern. We’ll provide additional details in our February issue.  

HOW CAN YOU JOIN IN?

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

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 March or early April 2014, and some of the prospectuses do highlight that date.

This month David Welsch celebrated a newly-earned degree from SUNY-Sullivan and still tracked down 18 no-load retail funds in registration, which represents our core interest.

Four sets of filings caught our attention. First, DoubleLine is launching two new and slightly edgy funds (the “wherever I want to go” Flexible Income Fund managed by Mr. Gundlach and an emerging markets short-term bond fund). Second, three focused value funds from Pzena, a well-respected institutional manager. Third, Scout Equity Opportunity Fund which will be managed by Brent Olson, a former Aquila Three Peaks Opportunity Growth Fund (ATGAX) manager. While I can’t prove a cause-and-effect relationship, ATGAX vastly underperformed its mid-cap growth peers for the decade prior to Mr. Olson’s arrival and substantially outperformed them during his tenure. 

Finally, Victory Emerging Markets Small Cap Fund will join the small pool of EM small cap funds. I’d normally be a bit less interested, but their EM small cap separate accounts have substantially outperformed their benchmark with relatively low volatility over the past five years. The initial expense ratio will be 1.50% and the minimum initial investment is $2500, reduced to $1000 for IRAs.

Manager Changes

On a related note, we also tracked down 39 sets of fund manager changes. The most intriguing of those include what appears to be the surprising outflow of managers from T. Rowe Price, Alpine’s decision to replace its lead managers with an outsider and entirely rechristen one of their funds, and Bill McVail’s departure after 15 years at Turner Small Cap Growth.

Updates

We noted a couple months ago that DundeeWealth was looking to exit the U.S. fund market and sell their funds. Through legal maneuvers too complicated for me to follow, the very solid Dynamic U.S. Growth Fund (Class II, DWUHX) has undergone the necessary reorganization and will continue to function as Dynamic U.S. Growth Fund with Noah Blackstein, its founding manager, still at the helm. 

Briefly Noted . . .

Effective March 31 2014, Alpine Innovators Fund (ADIAX) transforms into Alpine Small Cap Fund.  Following the move, it will be repositioned as a domestic small cap core fund, with up to 30% international.  Both of Innovator’s managers, the Liebers, are being replaced by Michael T. Smith, long-time manager of Lord Abbett Small-Cap Blend Fund (LSBAX).  Smith’s fund had a very weak record over its last five years and was merged out of existence in July, 2013; Smith left Lord Abbett in February of that year.

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. 

The Oppenheimer Steelpath funds have decided to resort to English. It’s kinda refreshing. The funds’ current investment Objectives read like this:

The investment objective of Oppenheimer SteelPath MLP Alpha Fund (the “Fund” or “Alpha Fund”) is to provide investors with a concentrated portfolio of energy infrastructure Master Limited Partnerships (“MLPs”) which the Advisor believes will provide substantial long-term capital appreciation through distribution growth and an attractive level of current income.

As of February 28, it becomes:

The Fund seeks total return.

SMALL WINS FOR INVESTORS

The Board of Trustees of the Fund has approved an increase in the Congressional Effect Fund’s (CEFFX) expense cap from 1.50% to 3.00%. Since I think their core strategy – “go to cash whenever Congress is in session” – is not sensible, a suspicion supported by their 0.95% annual returns over the past five years, becoming less attractive to investors is probably a net good.

Driehaus Mutual Funds’ Board approved reductions in the management fees for the Driehaus International Discovery Fund (DRIDX) and the Driehaus Global Growth Fund (DRGGX) which became effective January 1, 2014.  At base, it’s a 10-15 bps drop. 

Effective February 3, 2014, Virtus Emerging Markets Opportunities Fund (HEMZX) will be open to new investors. Low risk, above average returns but over $7 billion in the portfolio. Technically that’s capped at “two cheers.”

CLOSINGS (and related inconveniences)

Effective February 14, 2014, American Beacon Stephens Small Cap Growth Fund (STSGX) will act to limit inflows by stopping new retirement and benefit plans from opening accounts with the fund.

Artisan Global Value Fund (ARTGX) will soft-close on February 14, 2014.  Its managers were just recognized as Morningstar’s international-stock fund managers of the year for 2013. We’ve written about the fund four times since 2008, each time ending with the same note: “there are few better offerings in the global fund realm.”

As of the close of business on January 28, 2014, the GL Macro Performance Fund (GLMPX) will close to new investments. They don’t say that the fund is going to disappear, but that’s the clear implication of closing an underperforming, $5 million fund even to folks with automatic investment plans.

Effective January 31, the Wasatch International Growth Fund (WAIGX) closed to new investors.

OLD WINE, NEW BOTTLES

Effective February 1, 2014, the name of the CMG Tactical Equity Strategy Fund (SCOTX) will be changed to CMG Tactical Futures Strategy Fund.

Effective March 3, 2014, the name of the Mariner Hyman Beck Portfolio (MHBAX) has been changed to Mariner Managed Futures Strategy Portfolio.

OFF TO THE DUSTBIN OF HISTORY

On January 24, 2014, the Board of Trustees approved the closing and subsequent liquidation of the Fusion Fund (AFFSX, AFFAX).

ING will ask shareholders in June 2014 to approve the merger of five externally sub-advised funds into three ING funds.   

Disappearing Portfolio	Surviving Portfolio
ING BlackRock Health Sciences Opportunities Portfolio	ING Large Cap Growth Portfolio
ING BlackRock Large Cap Growth Portfolio	ING Large Cap Growth Portfolio
ING Marsico Growth Portfolio	ING Large Cap Growth Portfolio
ING MFS Total Return Portfolio	ING Invesco Equity and Income Portfolio
ING MFS Utilities Portfolio	ING Large Cap Value Portfolio

 

The Board of Trustees of iShares voted to close and liquidate ten international sector ETFs, effective March 26, 2014.  The decedents are:  

• iShares MSCI ACWI ex U.S. Consumer Discretionary ETF (AXDI)
• iShares MSCI ACWI ex U.S. Consumer Staples ETF (AXSL)
• iShares MSCI ACWI ex U.S. Energy ETF (AXEN)
• iShares MSCI ACWI ex U.S. Financials ETF (AXFN)
• iShares MSCI ACWI ex U.S. Healthcare ETF (AXHE)
• iShares MSCI ACWI ex U.S. Industrials ETF (AXID)
• iShares MSCI ACWI ex U.S. Information Technology ETF (AXIT)
• iShares MSCI ACWI ex U.S. Materials ETF (AXMT)
• iShares MSCI ACWI ex U.S. Telecommunication Services ETF (AXTE) and
• iShares MSCI ACWI ex U.S. Utilities ETF (AXUT)

The Nomura Funds board has authorized the liquidation of their three funds:

• Nomura Asia Pacific ex Japan Fund (NPAAX)
• Nomura Global Emerging Markets Fund (NPEAX)
• Nomura Global Equity Income Fund (NPWAX)

The liquidations will occur on or about March 19, 2014.

On January 30, 2014, the shareholders of the Quaker Akros Absolute Return Fund (AARFX) approved the liquidation of the Fund which has banked five-year returns of (0.13%) annually. 

The Vanguard Growth Equity Fund (VGEQX)is to be reorganized into the Vanguard U.S. Growth Fund (VWUSX) on or about February 21, 2014. The Trustees helpfully note: “The reorganization does not require shareholder approval, and you are not being asked to vote.”

Virtus Greater Asia ex Japan Opportunities Fund (VGAAX) is closing on February 21, 2014, and will be liquidated shortly thereafter.  Old story: decent but not stellar returns, no assets.

In Closing . . .

Thanks a hundred times over for your continued support of the Observer, whether through direct contributions or using our Amazon link.  I’m a little concerned about Amazon’s squishy financial results and the risk that they’re going to go looking for ways to pinch pennies. Your continued use of that program provides us with about 80% of our monthly revenue.  Thanks, especially, to the folks at Evergreen Asset Management and Gardey Financial Advisors, who have been very generous over the years; while the money means a lot, the knowledge that we’re actually making a difference for folks means even more.

The next month will see our migration to a new, more reliable server, a long talk with the folks at Gargoyle and profiles of four intriguing small funds.  Since you make it all possible, I hope you join us for it all.

As ever,