Monthly Archives: September 2016

September 1, 2016

By David Snowball

Dear friends,

It’s fall. We made it!

The leaves are still green and there are still tomatoes to be canned (yes, I do) but I saw one of my students pull on a sweater today. The Steelers announce their final roster this weekend. The sidewalks are littered with acorns. It’s 6:00 p.m. and the sun outside my window is noticeably low in the sky. I hear the distant song of ripening apples.

Life is good, if only you’ll take time to notice it.

We could spend time this month fretting about the obvious:

A variety of stock indexes are at all-time highs and traders are placing bets that it will hit new highs
By one measure, stock overvaluation is worse than in 1999; currently every S&P industry category is richly valued while three or four industries, left behind by the mad tech rush of the late 1990s, were substantially undervalued at the turn of the century (The Leuthold Group, Perception for the Professional, August 2016)
A more freakish analysis suggest that the bond market valuations might be at a 5,000 year high
The number of investors describing themselves as “bullish” is climbing while the number of bullish strategists is falling, and
Investors as a group have become complacent; August was the least volatile month in 20 years.

But we won’t. (The paragraph above was brought to you by the rhetoric trope named paralipsis, the tactic of telling you things by telling you that we’re not going to tell you.) But that will wait. The Fed will keep its head down until after the election and 99% of politicians are anxiously trying to avoid generating headlines. I will, instead, celebrate the season by unveiling our all new Certificate in ETF Punditry.

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.

Mairs and Power Small Cap (MSCFX): Mairs and Power Small Cap has a surprising number of things in common with Seafarer Overseas Growth & Income. Both are consistently excellent funds with consistent, risk-conscious disciplines. Both have smart, experienced, self-effacing managers. Neither is a household name. And both are closing on September 30. We offer this updated profile for those who are considering their small cap exposure.

Updates

We noted in last month’s issue that Morningstar’s definition of “new” and “small,” when it comes to funds, is inching toward our definition of “old” and “bloated.” That is, funds with five year records and billions in assets still get described as “off the radar.” In “5 more under-the-radar and up-and-coming funds” (8/30/2016), Dan Culloton does a nice job of highlighting a handful of actually new-and-small funds that are either dirt cheap or whose management teams have long records of sustained success with the fund’s strategy. Those five are:

Vanguard Core Bond (VCORX) launched in March 2016. It falls into the not-very-actively managed camp; it targets high-quality bonds, makes modest bets and counts on the compounding advantage of a 0.25% expense ratio.

Hood River Small-Cap Growth (HRSRX) is a small-growth fund that we should have written about a year ago. A couple readers have called it to our attention, but it kept falling through the cracks. Apologies for that. Hood River is run by the former Columbia Small Cap Growth team and operated under the Roxbury name into the team spun themselves off as an independent adviser. It has about $150 million in assets and has been, over most trailing periods, modestly superior to its peers.

Mar Vista Strategic Growth (RMSIX) is a conservative large-growth fund, formerly in the Roxbury family. It invests in a reasonably compact portfolio of “wide moat” firms. As you might imagine, that means it’s okay in up-markets and strong in down ones. The team has been managing the strategy for more than 10 years.

Mondrian International Equity (DPIEX) is a defensive equity strategy that used to be called Delaware Pooled Trust International Equity. They were rebranded in March 2016. Morningstar reports that about 40% of the portfolio construction is driven by macro-economic calls, 60% by stock-specific stuff. The discipline focuses on avoiding big losses which has given them top quartile returns with below-average volatility.

WCM Focused International Growth (WCMRX) invests in a focused (30-35 stock) portfolio of high-quality firms. “Quality” is measured by factors like net margin and return on equity. Strong long-term returns, muted volatility.

Whistlerblower rewards: I have deeply mixed feelings about the SEC’s celebration of reaching the $100 million mark in payouts to whistleblowers, including individual awards of $22 million and $30 million. On the one hand it’s nice to have an incentive to root out large scale corruption. On the other hand, it’s appalling that there’s so much to be rooted.

In Closing . . .

The good folks at Amazon have been poring over the data, trying to discern what books might most interest you. From some combination of stuff that other readers have purchased and … you know, Big Data, they offer up the following reading recommendations:


Boomerang: Travels in the New Third World	Liar’s Poker: Rising Through the Wreckage on Wall Street	The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It

Thanks, as ever to Greg and to Deb. And, this month, thanks also to Brett from Cincinnati and Richard from the state of Washington. We appreciate your generosity.

Our colleague Charles Boccadoro will be attending Morningstar’s ETF Conference on our behalf this month. If you’ll be there and want to chat, please do let him know.

We’ll look for you.

Certificate in ETF Punditry

By David Snowball

The latest vogue in higher education, an industry rife with voguishness, is stackable certificates. Stackable certificates are academic credentials certifying your ability to complete some specific task. Some of the certifications (Craft Brewing) seem modestly more concrete than others (Dream Tending). Since they’re relatively easy to obtain in relatively short periods, students can accumulate a bunch of them while still earning a conventional degree. That’s the “stackable” part.

In order to shore up the Observer’s finances, we’ve decided to capitalize on the trend and launch our new Certificate in E.T.F. Punditry program. In order to become a certified ETFP, you need to be able to demonstrate your ability to execute seven specific tasks. They are:

Befriend irrelevant numbers
Remember that only a small percentage of active managers beat “the market” over a five-year period. That fact that “beating the market” is irrelevant gamesmanship, unrelated to an investor’s ultimate goals, shouldn’t bother you. Likewise, the fact that every index fund trails the market every year needn’t come up.
Report on arbitrary periods
Quick question: why does anyone care about five-year performance? Is it because we’re investing for goals in five-year increment, rather like the old Soviet five-year plans? Or perhaps because “five years” captures some meaningful rhythm in the life of the stock market?

Quick answer: nope. Investors need far longer time frames and stock market cycles are more typically seven to nine year affairs. Actually, we focus on five year increments only because we have five fingers; if we had six fingers, the most natural period in the world would be six years.

If you can combine irrelevant numbers with arbitrary periods, you get extra credit: “only 7.33% of domestic equity funds that were in the top quartile of performance in March 2014 were still there two years later” (“Why you should steer clear of actively-managed funds,” Reuters, 8/25/2016).
Quote only true believers
Larry Swedroe is a quotable favorite, but it’s always good to check in with index providers (the folks at S&P Dow Jones Indices get quoted a lot), ETF sponsors and ETF-dependent websites. Try to avoid Jack Bogle at all costs. Console yourself with the thought that declarations like “ETFs have become the new way to speculate … There’s a lot of junk out there” (“Bogle: Trump is wrong, ETFs are bogus and foreign investing is useless,” 10/16/2015) are just the ramblings of an elderly gentleman who long since lost his way. Or you could join the chorus of true believers who denounced his comments as “confused,” “misplaced,” “self-serving” and “utter nonsense.” (“John Bogle’s stance on ETFs branded ‘utter nonsense’” Financial Times, 3/22/2015).

You will lose certificate points if you snicker when you quote an unnamed ETF industry insider denouncing other people’s statements as “self-serving.”
Avoid uncomfortable questions with no easy answers
Exchange traded funds are designed to be traded. But we know that trading is the enemy of all investors; professional or amateur, the more you trade, the more you lose. The fact that the average holding period for the S&P 500 EFT is 41 days (and the S&P 500 index fund is closer to 41 months), shouldn’t worry you. After all, regular people aren’t trading their ETF shares, right? All of that trading volume is made up of bad people trading a thousand times a second. All the good people bought a trading vehicle without ever intending to trade it.
Don’t confuse yourself
Professorial pointy-heads spend excessive time asking confusing questions, like “how do we best assess the risk required to achieve those rewards?” That leads them to long boring formulas and dry boring statistics like Sharpe ratios, Information ratios, Sortino Ratios, Martin Ratios, Ulcer Indexes and probably Radio Ratios. If you try to sort that out your head will hurt and you’ll find yourself looking at unpleasant numbers.

For example, ETFs reign supreme in the domestic large-cap core space, right? Home of the S&P 500. Highly efficient. No chance for puny humans. Unless, of course, you ask confusing questions like “over the past full market cycle (bad! Market cycles are meaningful periods that encompass the combined rhythm of a bull and a bear phase. Avoid talking about them), how many of the top ten large-cap core funds, defined as funds with the best risk-adjusted returns (bad! You’re getting dangerously close to numbers that might have meaning. Don’t do it.) are passive funds?”

Answer: none of the top ten funds are passive. Also none of the top 15 funds are passive. Only one of the top 20 funds. Apparently it’s a bad thing that when there’s a cliff ahead, cap-weighted index funds pretty much hit the gas and fly over the edge.

Ick! 95% of the best performing funds, using a meaningful measure over a meaningful period, are actively managed? That’s so confusing. Pretend it ain’t so and move on.

Likewise, on expenses, keep quoting magic numbers:

(“Index funds versus mutual funds,” Fool.com, 8/27/2016)

That’s a good number to quote. It would be confusing to mention that only 10 of 1300 index funds have expenses that low and are available to retail investors (that is, folks with under $10,000 to start with). Likewise pointing out that some index funds have expense ratios of 4.46% or that 120 index funds have expense ratios over 2% just muddles things. Trading commissions: muddle. The occasional freakish bid/ask spread: muddle.
Keep it one-sided
For example, when mutual funds are liquidated, point out “the high ‘death rate’ among poorly performing active funds.” ETFs are liquidated, as illustrated by August’s partial toll:

AccuShares Spot CBOE VIX Up (VXUP)
AccuShares Spot CBOE VIX Down (VXDN)
AccuShares S&P GSCI Crude Oil Excess Return Down (OILD)
AccuShares S&P GSCI Crude Oil Excess Return Up (OILU)
SPDR MSCI EM Beyond BRIC ETF (NYSE: EMBB)
SPDR S&P BRIC 40 (ETF) (NYSE: BIK)
SPDR MSCI EM 50 ETF (SPDR Index Shares Fund) (NYSE: EMFT)
SPDR BofA Merrill Lynch EM Corp. Bond ETF (SPDR Series Trust (NYSE: EMCD)
SPDR Russell Nomura PRIME Japan (ETF) (NYSE: JPP)
SPDR Russell Nomura Small Cap Japan(ETF) (NYSE: JSC).
SPDR Barclays International High Yield Bond ETF (NYSE: IJNK)
SPDR S&P International Mid Cap (ETF) (NYSE: MDD).
SPDR Nuveen Barclays Build America (NYSE: BABS),
SPDR Nuveen Barclays Calif Muni Bond (NYSE: CXA)
SPDR Nuveen Barclays NY Muni Bond (NYSE: INY).
SPDR S&P BRIC 40 ETF
SPDR MSCI EM 50 ETF
SPDR SSGA Risk Aware ETF
WisdomTree Coal Fund (TONS)
WisdomTree Global ex-U.S. Utilities Fund (DBU)
WisdomTree Global Natural Resources Fund (GNAT)
WisdomTree Commodity Currency Strategy Fund (CCX)
WisdomTree Commodity Country Equity Fund (CCXE)
WisdomTree Japan Interest Rate Strategy Fund (JGBB)

Studiously ignore it. Certainly avoid reference to the nearly 500 moribund ETFs on this month’s ETF Deathwatch. After all, some might misinterpret having a third of all ETFs in parlous shape as being a bad thing. So hush! Better yet, celebrate it as a sign of virtue: “But don’t panic. This isn’t a sign that the ETF industry is in trouble. Rather like any business, companies need to periodically cull the herd of under-performing product to make room for new ventures.” (“Oops There Goes Another ETF,” 8/26/2016).
Go for the big finish!
“It’s another nail in the coffin of actively-managed funds.” “They’re dinosaurs.” “50% of them won’t be here in five years.” And as you write those things, try desperately to block out the fact that you’re making a living in an industry that’s imploding. Better to make pronouncements on others than to look too closely around your own space.

Remember: your job is to studiously simplify a complicated story. Don’t ask whether both sorts of investments might make sense as complements. Don’t ask whether metrics like “holding period” are more meaningful than portfolio returns. Don’t ask why almost no one studies the portfolio-level effects of using trading products; well, almost no one: the only study on the question looked at German investors and found that ETF-based portfolios, when controlled by asset allocation, consistently underperformed fund-based portfolios because those silly Germans used their trading vehicles to, well, trade.

And, in the end, you’ll be certifiably clickable.

Behind the Curtain

By Edward A. Studzinski

“Moon in a barrel: you never know just when the bottom will fall out.”

Mabutsu (19^th Century Japanese haiku poet)

So, August as usual is the period of the “dog days” of summer, usually a great opportunity to catch up on reading. A site I commend to you for all things investment is Hurricane Capital, recommended to me by my friend Michael Mauboussin, of Credit Suisse. Among other things Michael pointed out that the writer of this blog (from Sweden) had posted all of Michael’s strategy and thought pieces going back for years. A recent one, which I would suggest is worth a read is entitled, “Thirty Years – Reflections on the Ten Attributes of Great Investors.” You will discover as you look at the listed attributes, Michael’s bias, is disclosed up front: he believes in economic value which joined with constant learning and teaching, and varied inputs that, when combined with rigorous framework, can lead to insight, consistent with Charlie Munger’s faith in the “mental models” approach to investing.

I was especially struck by the tenth listed attribute – “Read (and keep an open mind)”. Mauboussin relates how yearly, Columbia Business School sends a group of students to Omaha to meet with Todd Combs and Warren Buffett. In a recent visit, Combs apparently suggested to the students that they target reading 500 pages a day. And note that we are not talking about reading in business or finance. Rather, the habit of intellectual curiosity pushes voracious readers to move into ever expanding subject areas, since good ideas may spring from multiple origins. Indeed, to be able to recognize the cusp of change requires reading primarily for education but also for entertainment. The other important thing is to not establish “safe zones” in your reading but rather, seek out things that you don’t either agree with or, that challenge your previous and comfortably held beliefs.

My point here is this – that intellectual curiosity is one of those cultural determinants that sets the tone for a successful investment research methodology. One of the first times I had a discussion at length with Robert Sanborn after I joined Harris Associates was when he was excited after reading the book Guns, Germs, and Steel: The Fate of Human Societies by Jared Diamond, which influenced his thinking on investments in a number of ways. Robert was an avid reader, always with a book on his desk that was his current read, and in diverse areas of biography, history, or science, among other things.

In 2004 and 2005, I was involved in the interviewing process for hiring analysts. A believer in the Hyman Rickover School of interviewing, I was always trying to find intellectually curious people who would not be just like everyone else at the firm. I wanted them to be inquiring about life in general, and show it both in their professional and personal interests. One of my favorite questions was what people read for fun, if anything. I will leave it to you to imagine my response when the answer I got one day was, “My reading for fun is all of the quarterly reports written by the people at Longleaf, as well as Buffett’s annual letters, and what you all write.”

There is a somewhat humorous codicil to this story. A few months later, I was having lunch with a friend in charge of an investment analysis effort at a financial research publishing firm based here in Chicago. She told me that one reason for the lunch was they wanted to pick my brain on what criteria I looked for in determining the kind of person who could become a successful investment analyst. I said I am not sure you want to do that as I am not involved in the interviewing process. She insisted that no, they were really interested in the criteria I would use for selecting people. So, over a long lunch, I gave her my thoughts. She left with a long list of notes.

About a year later, I asked how that had worked out. She said they were very pleased, and had used most of my criteria in selecting people for their analyst training program. Part of their underlying premise was that you could teach people accounting and finance, but you could not teach them to read, write, or think. Interestingly, she confirmed what I had long thought, which was that the most successful candidates generally had liberal arts degrees with an emphasis in English literature, and were very gifted and creative writers. The company involved continued to grow, had a successful IPO, and is now a public company with a market capitalization in excess of $3B. There is one piece of information I should include here, so that you don’t go off thinking that this was a rather random event. And that is that for some years before joining Harris, I had been involved in interviewing, selecting, and training individuals to become intelligence analysts. The skill sets and personality characteristics required were not that different from those that one would look for in a good business analyst (which was what I wanted). One looked at all costs to avoid group-think individuals, so as to avoid another Pearl Harbor or Yom Kippur War. Now of course, the Bloomberg terminal has doomed the investment research business in general by making it easy to rationalize never leaving one’s office. It is hard to think out of the box if you never leave the box. Garbage in, garbage out, and if it is not in Bloomberg, it is not worth knowing. What’s next – the anonymity of the blogosphere for research?

Why Is Competition Bad?

In the last few months, there have been discussions in the financial press about non-compete clauses in employment contracts. The primary focus for the discussion has been to examine how growth in the technology area has been impacted in the economy of Massachusetts, which under state law permits non-compete clauses for as long as a three-year period. At the other extreme is California, where they are illegal as contrary to public policy. It is thought, and would appear to be the case, that one result is that the number of technology start-ups in Massachusetts has been throttled by allowing enforcement of non-compete clauses. In a compromise, New York has enforced them, but generally limits the period to no more than a year (described by some as the Goldman Sachs rule).

As should not be a surprise, the clauses are also popular in the financial services industry. Three years of course is a lifetime in the investment management and investment banking industries (what have you done for me today). Being able to walk out the door and start anew of course, has given us Jeff Gundlach as well as Bill Gross in new situations. Illinois until recently allowed non-compete agreements up to a period of three years, but recent court decisions appear to have ended the concept here (sometimes the desire for job growth trumps all). After all, there has been shrinkage in the number of investment management firms and assets under management in general in Chicago. The chicken-egg question is of course whether sub-par performance has led to asset shrinkage, or whether the intellectual capital has become too genetically incestuous and not replenished by input from other parts of the country.

An interesting question, and one to which I do not have an answer, is whether one should look to invest in the products of investment management firms in jurisdictions that do not permit non-compete clauses. Said differently, should one tilt toward California-based firms, because they will always be more vital and self-renewing. After all, as we have seen in the fixed income area in particular, the talent can just go down in the elevator at night and not come back if they don’t think they are being treated fairly, or if they think the wrong things are being emphasized in the culture of the firm. Alternatively, there are firms in both Boston and Chicago which are having serious succession planning issues notwithstanding the ability to “protect” the franchise with non-compete clauses. As we watch for a number of fund shut-downs and personnel exits in coming months, it will be an interesting endeavor to piece through fact from fiction.

What to Do Now?

I am regularly asked, as recently as this week, by various individuals and entities, the question of where I would put funds/new moneys now in terms of investments. At this point, I have to confess that I really have no good ideas. Nothing looks undervalued. Bonds look quite overvalued. In terms of real estate, the idea that class A office properties are changing hands at capitalization rates of 4 times or less (income multiples of 25X or greater) is truly off the charts, driven by a desire for income without an appreciation of the risk attendant. And that is before we think about change as represented by the Millennials. An experienced developer said to me today, an office for a Millennial is a cubicle with a chair and a place to plug in a headset (and not interact with others). Retail real estate is dying a slow, or perhaps not so slow, death. Equities as a class don’t look undervalued. While I feel that now is the time for active value managers to outshine and outperform the passive players, too many of them have compromised the discipline by investing based on metrics. Their analysts have gotten used to a form of pandering rather than looking for truly undervalued or misclassified situations, where the market inefficiencies still exist relative to the business value. My answer for the moment, which few will like, is that cash is the undervalued asset. It also has the lowest opportunity costs attached to it, since one year insured certificates of deposit are increasingly available in the marketplace yielding a 1% APR.

The Diversified Portfolio of Less Correlated Asset Classes

By Charles Boccadoro

“… over the long term the benefits offered by diversifying a portfolio of less correlated asset classes can be significant … investing in a diversified portfolio across equity and fixed income is the best option for most individuals,” wrote Jeremy Simpson in 2015, then director of Morningstar Investment Management in the article The Benefits of Diversification.

In Mebane Faber’s classic The Ivy Portfolio, he cites multiple sources on the benefits of diversification:

Harry Markowitz’s seminal 1952 paper “Portfolio Selection” explained the benefits of portfolio diversification. In addition to earning Markowitz a Nobel Prize in Economics, this Modern Portfolio Theory enabled managers to quantify with mathematics the benefits of not putting all of your eggs in one basket.

The Yale portfolio is constructed based on academic theory-namely namely a framework known as mean-variance analysis. The technique was originally developed by Harry Markowitz in concert with David Swensen’s mentor James Tobin, and eventually earned Markowitz a Nobel Prize in 1990 … You can put together a bunch of risky assets (stocks, real estate, commodities) and as long as they don’t all move together in a correlated fashion, the combined portfolio is less risky than the individual parts.

The most powerful tool an investor has working for him or her is diversification. True diversification allows you to build portfolios with higher returns for the same risk. Most investors, institutional and individual, are far less diversified than they should be.

Recently, in the piece On Financial Planners, I wrote of a family friend whose “certified financial planner” had him in 34 funds across five tax deferred accounts. Adjusting for different share classes, he owned eight unique funds, which turned-out to be not all that unique. Amazon was held in six different funds. Ditto for Phillip Morris, Amgen, UnitedHealth Group, Home Depot, Broadcom, Microsoft, etc.

Below is the correlation matrix for the eight funds. (Click on image to enlarge.) Most are more than 90% correlated, while none are less than 80% correlated. In short, they are all strongly correlated! Why would a financial planner construct this portfolio?

While such a correlation matrix has its limitations, it remains a helpful tool for assessing portfolio concentration and diversification. It comprises correlation coefficients, often denoted “r”, which attempt to measure the tendency of two funds (their monthly total returns) to move together.

Values of r can range from -1.00 to 1.00. The closer to 1.00, the more two funds have behaved similarly. The closer to -1.00, the more two funds have behaved opposite to each other. Values closer to 0.00 mean the funds are uncorrelated and have behaved independent of each other. A more detailed description can be found here and here.

One of the simplest ways to be diversified is through Vanguard Balanced Index Fund (VBINX). Here is the correlation matrix for its basic components, essentially the Total Stock and Bond Index Funds (VTMSX and VBMFX).

One of the shortcomings of correlation is that it is backward looking. Future correlation can change. While certain fund metrics, like volatility and even correlation, tend to be more persistent than say absolute return performance, correlation can change too with evaluation period, especially when markets dislocate. Even so, during the financial crisis bear market, VTMSX and VBMFX remained much more dissimilar than other asset pairs.

Here is the attendant performance comparison over the current market cycle (click on image to enlarge):

Another way to easily get diversification is through some of the so-called Target Date funds. Vanguard, for example, adds global exposure in its Target Retirement Series. Here is the correlation matrix of the underlying funds:

Finally, below find the correlation matrix for several ETFs representing various asset classes, including VTI, VEU, IEF, VNQ, DBC – the five comprising Faber’s “Ivy Portfolio … it is very simple but still reflects the general allocations of the top endowments without hedge funds and private equity.”

The MultiSearch Correlation Matrix can now be obtained for up to 12 funds across seven evaluation periods on the MFO Premium site. Just click “Correlate” button on the MultiSearch Results page.

Woe! We’re Halfway There

By Leigh Walzer

Over the past eight years the US mutual fund industry has witnessed a massive shift from active to passive management. In the Trapezoid universe, 35% of equity funds are now passively managed compared with 28% a year ago. This figure is AUM weighted, includes exchange-traded and closed-end funds, captures flows through July. The fixed income universe gets less attention but we observe 12% of AUM are now passively managed.

How far this trend will extend is up for debate. But the penetration rate actually steepened this year. The new DOL fiduciary rules, which take full effect at the end of 2017, may be a catalyst. If you believe in the classic S curve from Marketing 101, we are (to paraphrase Bon Jovi) only half way there.

Trapezoid believes fewer than 10% of actively managed funds justify their expense ratio. Readers unfamiliar with Trapezoid and FundAttribution can visit the methodology page on our website. Readers can register for a no-obligation demo on the site. So while a small number of managers give us statistical evidence that they can beat the market and justify

How we arrive at the $70 billion figure: We look at every mutual fund in our universe, considering the AUM, the average expense ratio across classes, and what we think a passive alternative would cost. We ignore funds domiciled outside the US, municipal funds, and separate accounts.

next year’s fees, most of that $70 billion outlay is unjustified. A lot of money is at stake. US mutual and closed-end fund investors are paying over $70 billion per year for active management. Considering all investment vehicles and looking more globally the impact is several times greater.

Who is the beneficiary of all that largesse? Seventy percent of the fees are going to active equity funds, by our reckoning, with fixed income and target date funds accounting for most of the balance. Capital Group, Fidelity, and T. Rowe represent about 30% of the pot. Franklin Resources, BlackRock, Invesco, Allianz, Natixis, JPMorgan, Sun Life, Mass Mutual, and Principal comprise another 20%. The rest is spread widely. The asset managers share their wealth with a number of service providers, distributors, and subadvisors. Without more transparency, we must make some educated guesses.

If we are really only “halfway there” – in other words passive and rules-based funds will end up with 60+ % of the market, the economics of the industry will come under heavy pressure and will have to manage expenses tightly.

A number of these players are publicly traded. To gauge where the industry is headed, it might be useful to look at the stock prices of the asset managers, particularly those with a high dependence on actively managed funds. Exhibit II shows that the past 24 months have not been kind to this group. Still, some have held up much better than others. Of the larger players, T Rowe Price Group Inc. (TROW) is down 15% while Legg Mason Inc. (LM) is down 30%. Among the hardest hit are Waddell & Reed (WDR), Calamos (CLMS), and Virtus (VRTS) The basket of stocks in Exhibit II trade at 13.7x 2017 earnings. This compare with 17x for the S&P500. The market is discounting stormy weather, but not an avalanche.

Credit: Yahoo Finance

Without commenting too much on individual securities, we can make some general observations. The market seems to believe fixed income is relatively immune; fund groups with a high concentration do better. Some companies benefit from sticky products or distribution. Others have benefitted from acquisitions. Many are now on the passive bandwagon. The hardest hit stocks are relatively concentrated in active equity mutual funds.

A lot of money is at stake. US mutual and closed-end fund investors are paying over $70 billion per year for active management. . most is unjustified

Sell-side analysts on the whole seem selective, looking for companies with defensive qualities. They anxiously monitor retail outflows. Although liquid alts have registered disappointing performance (see our July article “Liquid Alts; The Thrill is Gone” ) and outflows, some still view it as a source of growth.The performance of a firm’s investment products matters greatly. WDR (which markets funds under the Waddell & Reed and Ivy monikers) delivered a stunningly bad sS of -3.4 for the 12 months ending July 2016. (Recall sS is skill from Security Selection. This doesn’t even factor the expenses associated with active fund management) Our skill estimate is based on a bottoms-up analysis of 43 funds with AUM totaling $65 billion; these funds comprise ¾ of the firm’s overall assets. As a result, the firm’s AUM have dropped by 1/3 and the stock price has fallen by half over the past year. One bright spot for the new CEO is strong performance from small-cap strategies.

Playing Defense

No mutual fund executive wants their company to be the next Waddell & Reed. Mutual fund executives must be tempted to ask their successful fund managers with well-established track records to protect the franchise by tamping down on risk and not straying too far from the benchmarks.

Conversely, investors in actively managed funds must do their homework to ferret out elite managers who continue to justify their higher costs. Funds with low active share are sometimes called closet indexers. The term refers to a fund which bills itself as an active fund, charges like an active fund, but performs very much like an index fund. Generally, these funds track their benchmarks closely. Investors who are paying the added freight of an active fund demand a differentiated portfolio. As you would expect, closet index funds score poorly at FundAttribution.com because they deliver no value-added and thus are almost certain to underperform after fees.

Morningstar estimates that 15-20% of funds (by assets) are closet indexers. Professor Thomas Howard of the University of Colorado believes 70% of funds fall into this category. He evidently includes funds whose results match the benchmarks, even if the manager tried to differentiate the holdings.

How to tell if your fund is a closet indexer? One strategy in vogue is to seek funds with high active share. These are funds whose managers make a concerted effort to differ their portfolio from the indices. WSJ subscribers can refer to this list published several years ago.

We combed our universe for “Closet Passives”. In some ways our definition is a little more expansive because we include funds which track a blend of several indices. We allow that blend to vary over time based on a formula (think of a target fund) or at the discretion of the manager (i.e., a fund of closet index funds). In other respects, our definition is narrower. Closet Passives must track their indices over time, and must be fairly consistent over their lifetimes. We exclude funds which market themselves as index funds as well as those with low expense ratios.

Here are some representative funds we found. These are not true passives. The portfolio holdings will not resemble their benchmarks. Performance will deviate a bit from year to year due to security selection. But the funds gross returns stay ~98% correlated to the Trapezoid “replication portfolio” at all times.

For a more complete list of Closet Passives, the FundAttribution.com website shows an R-squared for every fund in our universe. (Register for the free demo and navigate to the Fund Analysis/Details page.) An R-squared close to 100 means we can replicate it almost exactly.

Interestingly, the funds in Exhibit III do show a modicum of sS skill, roughly +0.3 over both the most recent one year and three year periods. (That level of skill is not statistically significant and could be explained by survivorship bias.)

A lot of offerings from insurance companies seem geared to stay fairly close to the benchmarks but are priced like active funds. And many target date funds look a lot like cocktails blending equity and bond indices; the bartender gets a healthy markup for stirring the drink.

What if you find you are holding a closet passive with lots of capital gains? I put this question to Sam Lee, fellow contributor and principal of Severian Asset Management. Assuming the fund is in a taxable portfolio, Sam advises you should generally not rush to dump the fund unless the fund is very expensive and/or will distribute lots of capital gains anyway. With some patience, there is usually a future opportunity to get rid of the fund with a smaller tax hit, usually due to some combination of losses in the fund and harvestable losses elsewhere in the portfolio.

Unfortunately, avoiding Closet Passives isn’t good enough. Out of the $70 billion in excess fees cited above, avoiding them will ameliorate only 5% of the problem. But it is a good place to start.

What’s the Trapezoid story? Leigh Walzer has over 25 years of experience in the investment management industry as a portfolio manager and investment analyst. He’s worked with and for some frighteningly good folks. He holds an A.B. in Statistics from Princeton University and an M.B.A. from Harvard University. Leigh is the CEO and founder of Trapezoid, LLC, as well as the creator of the Orthogonal Attribution Engine. The Orthogonal Attribution Engine isolates the skill delivered by fund managers in excess of what is available through investable passive alternatives and other indices. The system aspires to, and already shows encouraging signs of, a fair degree of predictive validity.

The stuff Leigh shares here reflects the richness of the analytics available on his site and through Trapezoid’s services. If you’re an independent RIA or an individual investor who need serious data to make serious decisions, Leigh offers something no one else comes close to. More complete information can be found at www.fundattribution.com. MFO readers can sign up for a free demo.

Mairs and Power Small Cap Fund (MSCFX), September 2016

By David Snowball

Objective and strategy

The fund seeks “above-average” long-term capital appreciation by investing in 40-45 small cap stocks. For their purposes, “small caps” have a market capitalization under $3.4 billion at the time of purchase. The manager is authorized to invest up to 25% of the portfolio in foreign stocks and to invest, without limit, in convertible securities (but he plans to do neither). Across all their portfolios, Mairs & Power invests in “carefully selected, quality growth stocks” purchased “at reasonable valuation levels.”

Adviser

Mairs & Power, Inc. Mairs and Power, headquartered in Minneapolis and chartered in 1931, manages approximately $8.5 billion in assets. The firm provides investment services to individuals, employee benefit plans, endowments, foundations and over 50,000 accounts in three no-load mutual funds (Growth, Balanced and Small Cap).

Manager

Andrew Adams and Allen Steinkopf. Mr. Adams joined Mairs & Power in 2006 and has managed Small Cap from its inception. From August 2004 to March 2007, he helped manage Nuveen Small Cap Select (EMGRX). Before that he was the co-manager of the large cap growth portfolio at Knelman Asset Management Group in Minneapolis. Mr. Steinkopf joined Mairs & Power in 2013 after co-managing Nuveen Small Cap Select for 10 years. He was appointed as co-manager on this fund in 2015.

Allen D. Steinkopf has passed away at the age of 61. Otherwise it’s a three-person team: Andrew R. Adams, Christopher D. Strom, and Michael C. Marzolf.

Strategy capacity and closure

The fund will close to new investors on September 30, 2016.

Management’s stake in the fund

The fund was launched with $2 million in seed money that Mr. Adams garnered by, as he put it, “passing the hat” at a staff meeting. Insiders continue to have substantial financial commitments to the fund. Mr. Adams has between $500,000 – $1,000,000 invested in the fund. Mr. Steinkopf has between $10,000 – 50,000. Each of the fund’s six trustees has over $100,000 invested in it.

Opening date

August 11, 2011.

Minimum investment

$2500, reduced to $1000 for various tax-sheltered accounts.

Expense ratio

0.92% on assets of $345.2 million, as of July 17, 2023.

Comments

We underestimated Mairs & Power Small Cap. Shortly after launch we warned investors, “If you’re looking for excitement, look elsewhere. If you want the next small cap star, go away. It’s not here.” Based on Mairs & Power’s discipline, manifested in two other funds, we suggested “Small Cap will, almost certainly, grow into a solidly above-average performer that lags a bit in frothy markets, leads in soft ones and avoids making silly mistakes.”

It has been all that and more.

There is a rare degree of unanimity surrounding Mairs & Power Small Cap. Morningstar’s analysts recognize it as a Silver medalist and its rating system gives it five stars. Lipper designates it as a Lipper Lead for both total return and consistency of returns. The Observer endorsed it at launch and it has earned the Great Owl designation for its consistent outperformance.

A quick review of its performance from inception through July 2016 substantiates the case:

Here’s how to read that table: since August 2011, Small Cap has generated 6% greater annual returns that its Lipper peers while exposing shareholders to less risk. Its maximum drawdown was significantly smaller, its downside volatility was lower, its performance in bear market months was better and the length and magnitude of its losses (which is what the Ulcer Index measures) was less. It follows then that all of the measures of risk-adjusted returns (the Sharpe, Sortino and Martin ratios) are higher. It’s particularly noteworthy that the measures which are most sensitive to downside risk (Sortino and Martin) show greater advantage than does the standard Sharpe ratio.

Three factors contribute to that strong showing:

They like buying good quality, but they’re not willing to overpay.
They like buying what they know best. About 90% of the Small Cap portfolio are companies based in the upper Midwest, 50% in the State of Minnesota alone. They are unapologetic about their affinity for Midwestern firms: “we believe there are an unusually large number of attractive companies in this region that we have been following for many years. While the Funds have a national charter, their success is largely due to our focused, regional approach.”
And once they’ve bought, they keep it. Turnover over the past five years has averaged 17%, far below the 63% typical of small cap funds. That’s consistent with the record at Growth (10%) and Balanced (16%, with most of their bonds held all the way to maturity).

Messrs. Adams and Steinkopf embody the corporate ethos: they are looking for consistent performers, won’t sacrifice quality to get growth and won’t let “investment decisions [be] based on day-to-day news,” whether Brexit, Yellen or elections.

Bottom Line

There are few investment firms with this combination of quiet focus and discipline. Much was made of the fact that this is Mairs and Power’s first new fund in 50 years. Less has been said about the fact that this fund had been under consideration for more than five years before they felt comfortable launching it. This is not a firm that rushes into anything. While I wouldn’t normally suggest that investors rush into anything, the fund’s imminent closure means that folks considering the future of their small cap exposure need to move it to the top of their due diligence agenda.

Fans of passive investing might benchmark the fund against iShares Core S&P Small-Cap ETF (IJR), over which Mairs & Power maintains a small but consistent advantage in risk-adjusted performance.

Fund website

Mairs and Power Small Cap

What if…

By Robert Cochran

Investors with any experience at all can recite the long-term results: the U.S. stock market has averaged about 9-10% total returns over the last 30 years and about 6% the last 15 years. The bond market has averaged about 5%. In truth, the average stock market investor has gained only about 3.5%, on average over the last 15 years, and the average bond investor only 3.8%. The lower investor returns are due to the inability of people to stay in the markets during turbulent time periods, when they cash out near market lows and then miss out on corresponding gains. All kinds of studies have shown that staying invested pays off, but when risk becomes reality, investors become their own worst enemies, seemingly embracing the “sell low, buy high” concept they are trying to avoid. Bond investors have realized gains that are almost 25% lower than average, for the very same reasons.

This topic is surely worthy of a long discussion, but there is another, darker aspect of this investor tendency that has even worse long-term implications. There are a number of very intelligent researchers, analysts, and long-term thinkers, who are suggesting that, going forward, both stock and bond returns will be quite muted. They suggest investors should expect no more than 4-5% for stocks, and that bonds (in a period of rising rates) will barely break even. We all know predictions and estimates are just that. But there are compelling reasons why this could indeed happen.

The 30-year bond bull market, when interest rates on 30-year U.S. Treasuries declined from more than 20% to the current 2.3%, is over. Short-term bonds have been at or near 0% for several years now. Whether it is later this year, or next year, or the year after that, it is pretty clear that the Fed will be pushing rates higher over the next few years. Most bond experts say investors should be happy to net their bond coupons and hope the face values do not decline. That could mean average real returns (net of inflation) in the 0-2% range.

If stocks follow a reversion to the mean, we might see average total returns in the low-to-mid single digits, meaning 4-5%. This would be an average, of course, with riskier asset classes perhaps doing better. And why should we expect overall investor behavior (buy high, sell low) to change? Add this to the mix, and you can quickly have net negative returns.

If these return expectations turn out to be correct, what does this do to retirement planning scenarios that have plugged in annual returns of 6%, 7% or higher? The quick answer is that it will blow many retirement cash flow plans out of the water. Even a half-percent change in long-term planning assumptions can be huge, so you can imagine what would happen to investment portfolios when expected 7% returns are reduced to 4% or even 3%. We have been using 4-5% for years with our clients, but we are now considering using 3-4% as a “what-if” scenario.

Retirement cash flow spending becomes critical, of course. But even more importance might be unloading debt prior to retirement – no ongoing credit card debt, no mortgage debt, and no other outstanding loans. Mortgage payments are likely our biggest monthly expense, with credit card payments a close second. The average household’s debt-to-income ratio is more than 45%. Getting debt paid (or at least lowered) before retirement means much less pressure on the investment portfolio, and could be the difference between running out of money and having money left over when you die.

There are other factors, of course, such as life expectancy (individual and family health history), but we urge clients to use a very conservative number for investment returns, assume inflation at 2-3%, and annual increases for Social Security of 1%. Run the projections with these inputs, and see what you get. Any reduction in cash flow needs will only improve the picture. Do your own “what if”.

Seafarer Overseas Growth & Income closing

By David Snowball

Seafarer Overseas Growth & Income (SFGIX/SIGIX) closing to new investors

On August 31, 2016, Seafarer announced the imminent closure of its flagship Seafarer Overseas Growth & Income fund. The closure is set to become effective on September 30, 2016.

Highlights of the announcement:

The fund will soft-close on September 30, so that existing investors will still be able to add to their accounts. There are the usual exceptions to the closure.

The strategy capacity is currently estimated to be around $4 billion. As the fund approaches that threshold, Seafarer will pursue strategies to control inflows from existing shareholders. A capacity constraint is, in Mr. Foster’s judgment, “a real and material constraint for an investment strategy, much the way a wall is real and material constraint to a car.” The plan is to slow the metaphorical car down now, through a soft closure, in hopes to avoid running into the wall and being forced to hard-close the fund later.
The minimum initial investment for Seafarer’s lower cost institutional shares has been reduced from $100,000 to $25,000. That applies to both this fund and their new Seafarer Overseas Value Fund (SIVLX).
As part of their ongoing commitment to pass economies of scale along to their investors, Seafarer is reducing their management fee on assets of about $1.5 billion from 0.75% to 0.70%.

The change in institutional minimum will allow Investor Class shareholders with more than $25,000 but less than $100,000 in their accounts to move into the lower-cost shares. In addition, folks who invest directly with Seafarer can gain access to the low-cost Institutional share class (which Mr. Foster would prefer to designate as the Universal Share Class) by investing at least $1500 and signing up for an automatic investing plan through their Institutional Class Waiver Program.

For those unfamiliar with the fund, Seafarer is a four year old diversified emerging markets fund; its manager, Andrew Foster, has a long and distinguished track record as manager and is incessantly committed to helping his shareholders. He’s been evangelical about lowering expenses whenever conditions permit and his shareholder communications are singularly clear and thoughtful. He believes that emerging market economies are characterized by unreliable capital markets; that is, firms cannot count on being able to raise capital quickly and efficiently when they need it. As a result, one of his strong preferences is for firms that generate sufficient free cash flow to cover their capital needs internally.

The fund has had strong returns and muted volatility, relative to its EM peers. Morningstar recognizes it as a Bronze medalist with a five-star rating. The Observer has repeatedly profiled the fund, most recently in 2015. Additional resources about the fund are on Seafarer’s Featured Fund page. The indefatigable Ted, Linkster and senior member of our discussion board, also points folks to Chuck Jaffe’s August 2016 interview with Mr. Foster.

For those asking “if not Seafarer, who?” I used at the multi-search tool at MFO Premium to generate a list of the E.M. funds with the highest Sharpe ratios, a measure of risk-adjusted returns, over the past three years. Seafarer was fifth on that list. We then used our new fund correlation matrix generator to look at the relationship between the different top-ranked funds.

The list below excludes one fund, a China-India index, because it struck us as too narrow and quirky to offer a meaningful comparison. In each case the results are for the fund’s oldest share class, which often means the Institutional share class.

A couple things stand out:

The funds with the highest and lowest correlations to Seafarer are both “Emerging Asia” funds, Fidelity and Matthews, respectively.
Seafarer acts rather more like a “balanced” fund than most, that’s reflected in its high correlation with the EM balanced funds from Fidelity and Alliance Bernstein (AB). We’ve argued before that more EM equity investors should look closely at the option of balanced or hedged EM exposure.

With regard to the list in general:

The William Blair fund is also closed to new investors
The City National Rochdale fund is a bit pricey (1.61%) and a bit tough to access; Scottrade, for example, has it as a transaction-fee only fund.
The AllianceBernstein and Rational Risk (formerly Huntington) funds carry sales loads
Baron E.M., managed by Michael Kass, has about $2.3 billion in assets and charges about 30 basis points more than does Seafarer. It is, otherwise, a very solid fund with a very experienced manager.

I don’t want to complicate Mr. Foster’s task by encouraging inappropriate inflows, neither “hot money” nor folks who don’t understand what he’s up to and what they’d be investing in. That said, he’s given potential investors the gift of a month’s time to consider their options. I’d use it.

Elevator Talk: Michael Willis, Index Funds S&P 500 Equal Weight (INDEX)

By David Snowball

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.

INDEX, the fund, and Index Funds, the company, are the product of 20 years of failing to beat the S&P 500. Michael Willis worked for years as an active manager, most recently as a Senior Vice President at UBS Financial, trying to beat the S&P 500. Despite consistent, concerted effort, he couldn’t consistently achieve that goal.

Mr. Willis ultimately reached two sets of conclusions.

First, the S&P 500 contains intrinsic strengths that make it nearly impossible to beat. Its constituent firms are generally pretty solid. It buys and holds. It doesn’t get distracted. And it’s cheap.

Second, the S&P 500 contains intrinsic weaknesses that make it possible to beat. The weighting of any stock in the index is dependent on its market capitalization; the greater a stock’s market cap, the larger its position in the index. And a stock’s market cap reflects the madness of crowds. Market cap-weighted indexes are driven by, and are drivers of, the market’s momentum. Investors get excited about the newest iSomething from Apple (AAPL) and rush to snatch up its stock. The price goes up and passive indexes allocate more of their money to the stock, which causes the price to go up. Because the attention of crowds is limited, they tend to bid up a relatively limited set of stocks which means that the index becomes more and more concentrated in those few. The inadvertent result is that the index has biases toward growth, large caps, concentration and momentum. Those are not universally desirable qualities.

Mr. Willis became intrigued by an alternative approach: investing in the same 500 stocks but weighting your investment equally, rather than weighting it based on a stock’s market cap. In such a system, Apple would constitute 0.2% of the fund, the same as Diamond Offshore Drilling (DO). The FANG stocks, whose collective weighting in the S&P 500 doubled from 3% in 2013 to 6% in 2015, would remain a consistent 0.8% in the equal-weight index. That gives an equal-weight version of the index three distinctive characteristics:

The equal-weight S&P 500 is more value-conscious. In its quarterly rebalancing, it automatically sells whatever has been bid up and buys more of whatever has been left behind. Currently, the equal-weigh index is cheaper than its sibling whether measured by lower price/earnings, price/sales, price/book or price/cash flow.
The equal-weight S&P 500 has more exposure to mid-cap stocks. The average market cap of the equal-weight 500 is $20 billion, about one-quarter of the market cap of the cap-weighted version. Neither version offers meaningful exposure to small cap stocks (about 2% in the equal weight version and 0.15% in the other) but the equal-weight version offers vastly greater exposure to mid-cap stocks (47% versus 13%).
The equal-weight S&P 500 is less prone to inadvertent concentration. If a sector or stock becomes popular, its weight in the cap weighted index automatically grows even if its business prospects or fundamental attractiveness do not. Currently, for example, the cap-weighted S&P 500 has a 50% greater weighting in tech (18% versus 12%) than does the equal-weight version.

In the long-term, biases toward value, smallness and diversification pay off handsomely. One attempt to calculate the returns of the equal-weight and cap-weight versions of the S&P 500 back to 1926 estimate that the equal-weight version returns outperforms the cap weighted version by 281 basis points – that is 2.8% – per year. Over the study’s 90 year horizon, that compounded into a ten-fold difference in returns in favor of the equal-weight index. Standard and Poor’s own researchers place the advantage around 180 basis points per year. The performance of the oldest extant equal-weight index fund (Invesco Equally-Weighted S&P 500 Fund VADAX) shows a 190 basis point advantage over 15 years.

Skeptics of the approach, including our colleague Sam Lee, point out that “there’s no such thing as a free lunch.” The higher returns come at the price of higher volatility, higher taxes as a result of more frequent portfolio rebalancing and the prospect of lagging badly during periods where mega-caps soar. All of which is true, though the magnitude of those downsides seem manageable.

Here, in any case, are Michael Willis’s 300 (admittedly somewhat overwrought) words on why his INDEX fund deserves your attention:

Why buy INDEX over the other guys?

We created a Fund and gave it a profoundly simple ticker to give every investor our story in one word, INDEX.

We created INDEX because we see a trillion-dollar tsunami coming. A wave of RIAs and investors just like us (and Warren Buffett) who realize the S&P 500 Index is an investment best to own rather than to fight.

We created INDEX because we discovered that the best way to beat the S&P500 Index is to own it, equally.

We created INDEX because we believe the equal-weight methodology corrects an intrinsic “buy-high-sell-low” trading flaw imbedded in the market-cap methodology.

We created INDEX because we want to help people get in on the ground floor of the next Wall Street before everyone else does.

We created INDEX because we see the entire investment process transitioning into a simple, performance-driven, low-cost model.

We created INDEX because we see a global realignment coming and believe a flight to quality is only in its early stages and that the constituents of the S&P 500 Index will be big benefactors.

We created INDEX as a no-load mutual fund instead of an ETF because we believe most investors are not day traders nor do they want their nest eggs more vulnerable to intraday algorithms and short sellers.

We created INDEX because we envision a day when low cost investing and transparency reigns on Wall Street.

We created INDEX because we want to create a Mutual Fund Company that grows organically from the investor up, instead of backed by the institutions of Wall Street.

We are headquartered in Colorado because sometimes the crisp clean air of the Rocky Mountains can give you clarity you cannot get in the city.

If you share our values, then we invite you to join our story and help us change the way Wall Street invests.

The minimum initial investment in INDEX is $1,000 and the expense ratio is 30 basis points. From the outset, Mr. Willis has made it a priority to remain one of the lowest cost options of this equal-weight strategy. The fund’s website is organized around a long scrolling homepage, with links to a half dozen articles on their “In the News” page.

Funds in Registration, September 2016

By David Snowball

It’s been a quiet month for new registrants. There’s the usual collection of trendy ETFs (e.g., Pacer US Cash Cows 100 ETF) and Mr. Greenblatt is launching more Gorham-branded institutional funds (Gotham Neutral 500 at 1.4%, Defensive Long at 2.15%, and Defensive Long 500 at 1.65%). Other than that, we found just four new no-load, retail funds. Folks interested in social impact investing might want to put Gerstein Fisher Municipal CRA Qualified Investment Fund on their radar. Low minimum, relatively low expense, it provides individual investors a tool to support affordable housing and community development. Otherwise, the new options peaked out at “meh.”

American Beacon Numeric Integrated Alpha Fund

American Beacon Numeric Integrated Alpha Fund will pursue long-term capital appreciation.. The plan is to invest, long and short, in a global equity portfolio. In addition to looking at valuations, they seek to exploit “price trends and patterns, such as momentum, valuation and seasonality.” Happily, Numeric’s approach is “highly-detailed and systematic.” The fund will be managed by Paul Pflugfelder and Bingcheng Yan of Numeric Investors. Messrs. Pflugfelder and Yan are Co-Heads of Hedge Fund Strategies at Numeric and formerly ran a market-neutral strategy for Barclays Global Investors. The initial expense ratio is 6.46%, after waivers, on Investor shares. The minimum initial investment is $2,500.

Gerstein Fisher Municipal CRA Qualified Investment Fund

Gerstein Fisher Municipal CRA Qualified Investment will seek to provide “current income consistent with preservation of capital with investments that will be deemed qualified under the Community Reinvestment Act.” The plan is to invest in CRA-qualified securities; at base, bonds and other instruments which help fund supporting affordable housing and community development. The fund will be managed by Gregg S. Fisher, founder of Gerstein Fisher. The initial expense ratio is capped at 0.99%. The minimum initial investment is $250.

HCM Income Plus Fund (HCMGX/HCMDX)

HCM Income Plus Fund (HCMGX/HCMDX) will pursue total return by investing in equity and fixed-income ETFs. The plan is to use a quant model to find the hottest sector(s) and position the fund there. The prospectus implies that the portfolio might shift weekly. The fund will be managed by Vance Howard, the firm’s president, CEO and the fund’s manager since 2014. Uhhh … that’s a curious statement for a fund that doesn’t yet exist. The initial expense ratio is not yet set. The minimum initial investment is $2,500, reduced to $1,000 for IRAs.

Rareview Longevity Income Generation Fund

Rareview Longevity Income Generation Fund will pursue long-term capital appreciation and income. The plan is to invest in closed-end funds whose portfolios mostly reflect single, broad asset classes (“an MLP fund,” for instance). Generally, the plan would be to invest in CEFs selling at a discount to their net asset value and short CEFs selling at a premium. The fund will be managed by Neil Azous, Chief Investment Officer of Rareview Capital LLC. The initial expense ratio is not yet set. The minimum initial investment is $2,500.

Manager changes, August 2016

By Chip

In memoriam

With great sadness, we note the passing of two members of the investing community.

Albert “Ab” Nicholas, philanthropist and founder of the Nicholas Funds, died August 4, 2016, full of years and honors, at age 85. He earned his bachelor’s degree, in the early 1950s, from the University of Wisconsin-Madison. He was deeply grateful for the scholarship that made it possible for a poor kid from Rockford, Illinois, to attend college and he repaid that kindness a thousand times over through his gifts to the university.

Drafted by the NBA, he chose instead to serve in the Army. Drafted again by the NBA after his discharge, he chose instead to attend graduate school where he studied investment and finance.

He died peacefully in his sleep in bucolic Door County, Wisconsin, and is survived by his wife of 64 years and a large and loving family.

Bonnie Baha, director of global credit at the DoubleLine funds, died August 22, 2016, at age 56. Her family was in Charlotteville, Virginia, dropped her son off at the University of Virginia when she, her husband Mustapha and their daughter were struck by a car. Her husband and daughter were both treated for non-life-threatening injuries.

Ms. Baha studied political science at UC-Irvine before earning her MBA at USC, where she met her future husband. She worked for 17 years at TCW before joining Jeffrey Gundlach at DoubleLine. She recalls the early days when things were so tenuous there that Mr. Gundlach had to make a teary-eyed promise that he’d find a way to make sure each of them got paid. She was also capable of asking Mr. Gundlach why he was such a “f*****g a*****e.” Her colleagues describe her as “generous and gracious … incredibly strong and hilarious.” In announcing her death, the folks at her mosque ask “God to abundantly bless her soul, multiply the good deeds she has left in this world, and enter her into the highest levels of paradise. We pray God envelopes Mrs. Baha’s family with mercy and comfort in this difficult period in their lives.”

This month’s list of manager changes was extensive – nearly 60 full or partial shifts – but largely overshadowed by the lives lost, which we memorialize above. There are a handful of solid folks who’ve moved on, but no immediately blockbuster shifts.

Because bond fund managers, traditionally, had made relatively modest impacts of their funds’ absolute returns, Manager Changes typically highlights changes in equity and hybrid funds.

Ticker	Fund	Out with the old	In with the new	Dt
GASAX	Aberdeen Diversified Alternatives Fund	Michael Turner is no longer listed as a portfolio manager for the fund.	Robert Minter is joined by Russell Barlow, Kevin Lyons, and Darren Wolf.	8/16
GMAAX	Aberdeen Diversified Income Fund	Sean Phayre is no longer listed as a portfolio manager for the fund.	Robert Minter and Michael Turner are joined by Russell Barlow, Kevin Lyons, and Darren Wolf.	8/16
GMMAX	Aberdeen Dynamic Allocation Fund	Sean Phayre is no longer listed as a portfolio manager for the fund.	Robert Minter and Michael Turner are joined by Russell Barlow, Kevin Lyons, and Darren Wolf.	8/16
NRFAX	AEW Real Estate Fund	Roman Ranocha, co-portfolio manager of the fund, recently passed away unexpectedly.	Matthew Troxell, John Garofalo and J. Hall Jones, Jr. will continue to manage the fund.	8/16
CANTX	Alpha Risk Hedged Dividend Equity Fund	Scott Chaisson and Tim Shanahan are no longer listed as portfolio managers for the fund.	Timothy Dolan, Warren Mulhern and Charles Petrie will manage the fund.	8/16
ATVAX	Athena Value Fund	Greg Anderson and John Sabre are no longer listed as portfolio managers for the fund.	Andrew Howard and C. Thomas Howard will now manage the fund	8/16
WISEX	Azzad Wise Capital Fund	Ruggero de’Rossi no longer serves as portfolio manager.	Jamal Elbarmil, John Polinski and Ihab Salib continue to manage the fund	8/16
CDVDX	Cavalier Dividend Income Fund	Scott Chaisson and Tim Shanahan are no longer listed as portfolio managers for the fund.	Scott Wetherington will manage the fund.	8/16
CDYGX	Cavalier Dynamic Growth Fund	Scott Chaisson and Tim Shanahan are no longer listed as portfolio managers for the fund.	William Mann and Mark Scalzo will manage the fund.	8/16
CATEX	Cavalier Global Opportunities	Scott Chaisson and Tim Shanahan are no longer listed as portfolio managers for the fund.	David Haviland will manage the fund.	8/16
CMSFX	Cavalier Multi Strategist Fund	Scott Chaisson and Tim Shanahan are no longer listed as portfolio managers for the fund.	The new team is Lee Calfo, Gavan Duemke, Joy Gruber, Henry Ma, Brian Shevland, Josheph Styrna, Scott Wetherington, Sean Wright and Alexis Zemaitis.	8/16
CTROX	Cavalier Tactical Rotation Fund	Scott Chaisson and Tim Shanahan are no longer listed as portfolio managers for the fund.	David Haviland will manage the fund.	8/16
CHNAX	Clough China Fund	No one, but …	Brian Chen has joined the portfolio management team of Eric Brock and Francoise Vappereau	8/16
CAFRX	Commonwealth Africa Fund	Ronald Manning no longer serves as part of the portfolio management team for the fund.	Robert Scharar and Wesley Yuhnke will continue to manage the fund.	8/16
CNZLX	Commonwealth Australia/New Zealand Fund	Ronald Manning no longer serves as part of the portfolio management team for the fund.	Robert Scharar and Wesley Yuhnke will continue to manage the fund.	8/16
CNGLX	Commonwealth Global Fund	Ronald Manning no longer serves as part of the portfolio management team for the fund.	Robert Scharar and Wesley Yuhnke will continue to manage the fund.	8/16
CNJFX	Commonwealth Japan Fund	Ronald Manning no longer serves as part of the portfolio management team for the fund.	Robert Scharar and Wesley Yuhnke will continue to manage the fund.	8/16
CNREX	Commonwealth Real Estate Securities Fund	Ronald Manning no longer serves as part of the portfolio management team for the fund.	Robert Scharar and Wesley Yuhnke will continue to manage the fund.	8/16
KDCAX	Deutsche Large Cap Value Fund	Deepak Khanna is no longer listed as a portfolio manager for the fund.	Walter Holman and Brendan O’Neill are now managing the fund.	8/16
SSETX	Dreyfus/The Boston Company Small Cap Growth Fund	David Borah is no longer listed as a portfolio manager for the fund.	Todd Wakefield and Robert Zeuthen will continue to manage the fund.	8/16
EAALX	Eaton Vance Atlanta Capital Focused Growth Fund	Richard England will retire on October 31, 2016.	The rest of the team remains	8/16
ETGIX	Eaton Vance Greater India Fund	LGM Investments Limited has been terminated as a subadvisor and Rishikesh Patel will no longer serve as a portfolio manager for the fund.	Goldman Sachs will be subadvisor for the fund, with Prashant Khemka managing the fund.	8/16
IHIAX	Federated Emerging Market Debt Fund	Ruggero de’Rossi no longer serves as portfolio manager for the fund.	Ihab Salib will continue to manage the fund	8/16
MXGMX	Great-West U.S. Government Mortgage Securities Fund	Nick Yu is no longer a portfolio manager for the fund.	Catherine Tocher, Sam Moyn, Kiva Patten, Nate Simons and Jack Brown will continue to manage the fund.	8/16
HSQAX	Henderson International Select Equity Fund	Sanjeev Lakhani is no longer listed as a portfolio manager for the fund.	Matthew Beesley will continue to manage the fund.	8/16
GRRAX	James Alpha Macro Portfolio	Tim Alford and John Brynjolfsson are no longer listed as portfolio managers for the fund.	The team of Akos Beleznay, Kevin Greene, Michael Montague and James Vitalie will now manage the fund.	8/16
MSAKX	MainStay Absolute Return Multi-Strategy Fund	Taylor Wagenseil will no longer serve as portfolio manager, but will “provide non-discretionary advisory support to the Fund’s portfolio management team as a Senior Advisor” until August 2017.	The rest of the extensive team remains.	8/16
KLGAX	MainStay Cornerstone Growth Fund	Thomas Kamp is no longer listed as a portfolio manager for the fund.	Migene Kim and Andrew Ver Planck will now manage the fund.	8/16
MYHAX	MainStay High Yield Opportunities Fund	Taylor Wagenseil will no longer serve as portfolio manager, but will “provide non-discretionary advisory support to the Fund’s portfolio management team as a Senior Advisor” until August 2017.	Dan Roberts, Louis Cohen and Michael Kimble will continue to manage the fund.	8/16
MTRAX	MainStay Income Builder Fund	Taylor Wagenseil will no longer serve as portfolio manager, but will “provide non-discretionary advisory support to the Fund’s portfolio management team as a Senior Advisor” until August 2017.	Michael Kimble, William Priest, Dan Roberts, Eric Sappenfield, Michael Welhoelter, Louis Cohen, John Tobin and Kera Van Valen will continue to manage the fund.	8/16
MASAX	MainStay Unconstrained Bond Fund	Taylor Wagenseil will no longer serve as portfolio manager, but will “provide non-discretionary advisory support to the Fund’s portfolio management team as a Senior Advisor” until August 2017.	Dan Roberts, Louis Cohen and Michael Kimble will continue to manage the fund.	8/16
NSEIX	Nicholas Equity Income Fund	Mr. Albert O. Nicholas passed away on August 4, 2016. He was described as very hard working, diligent, humble, and generous.	David Nicholas and Michael Shelton will manage the fund.	8/16
NCINX	Nicholas High Income Fund	Mr. Albert O. Nicholas passed away on August 4, 2016. He was described as very hard working, diligent, humble, and generous.	Lawrence Pavelec will manage the fund.	8/16
NCTWX	Nicholas II	Mr. Albert O. Nicholas passed away on August 4, 2016. He was described as very hard working, diligent, humble, and generous.	David Nicholas will manage the fund.	8/16
NCLEX	Nicholas Limited Edition	Mr. Albert O. Nicholas passed away on August 4, 2016. He was described as very hard working, diligent, humble, and generous.	David Nicholas will manage the fund.	8/16
NICSX	Nicolas	Mr. Albert O. Nicholas passed away on August 4, 2016. He was described as very hard working, diligent, humble, and generous.	David Nicholas and Michael Shelton will manage the fund.	8/16
NWGAX	Nuveen Tradewinds Global All Cap Fund	Emily Alejos and Andrew Thelen are no longer listed as portfolio managers for the fund.	Thomas Ray and James Stephenson will now manage the fund.	8/16
OWSMX	Old Westbury Small & Mid Cap Fund	No one, but …	Samuel Nathans, William Jacques and James Eysenbach join Michael Morrisroe, Henry Gray, Ormala Krishnan, Jed Fogdall, Joseph Chi, Arun Keswani, Scott Brayman and John Hall.	8/16
OWSOX	Old Westbury Strategic Opportunities Fund	TPH Asset Management LLC will no longer act as a sub-adviser for a portion of the fund’s portfolio.	Bessemer Investment Management LLC will assume the day-to-day investment management responsibility for the portion of the fund’s assets managed by TPH.	8/16
QFFOX	Pear Tree PanAgora Emerging Markets Fund	George Mussalli, Joel Feinberg and Dmitri Kantsyrev are no longer listed as portfolio managers for the fund.	Nocholas Alonso, Mark Barnes and Edward Qian will manage the fund.	8/16
RHYAX	RBC BlueBay Global High Yield Bond Fund	Anthony Robertson will no longer serve as a portfolio manager for the fund.	Justin Jewell and Thomas Kreuzer assume the role of co-portfolio managers of the fund.	8/16
SMSNX	Schroder Emerging Markets Multi-Sector Bond Fund	Denis Parisien will no longer serve as a portfolio manager for the fund, but he will remain with the firm.	James Barrineau and Fernando Grisales are joined by Michael O’Brien.	8/16
SMLNX	Schroder Emerging Markets Small Cap Fund	Allan Conway is no longer listed as a portfolio manager for the fund. He lasted for exactly one year.	Tom Wilson joins Richard Sennitt, James Gotto, and Matthew Dobbs in managing the fund.	8/16
SMLNX	Schroder Emerging Markets Small Cap Fund	Allan Conway is no longer listed as a portfolio manager for the fund. He lasted for exactly one year.	Tom Wilson joins Richard Sennitt, James Gotto, and Matthew Dobbs in managing the fund.	8/16
SGBNX	Schroder Global Strategic Bond Fund	Gareth Isaac has resigned his portfolio manager position.	Robert Jolly and Paul Grainger remain to manage the fund.	8/16
SIDNX	Schroder International Multi-Cap Value Fund	Ben Corris is no longer listed as a portfolio manager for the fund.	Michael O’Brien joins Justin Abercrombie and Stephen Langford.	8/16
SIDNX	Schroder International Multi-Cap Value Fund	Ben Corris is no longer listed as a portfolio manager for the fund.	Justin Abercrombie and Stephen Langford will continue to manage the fund.	8/16
SNAEX	Schroder North American Equity Fund	Ben Corris is no longer listed as a portfolio manager for the fund.	Justin Abercrombie and Stephen Langford will continue to manage the fund.	8/16
SEBLX	Sentinel Balanced Fund	Daniel Manion has announced his intention to retire in 2Q17.	Jason Doiron will continue to manage the fund	8/16
SENCX	Sentinel Common Stock Fund	Daniel Manion has announced his intention to retire in 2Q17.	Hilary Roper will continue to manage the fund	8/16
CBON	VanEck Vectors ChinaAMC China Bond ETF	David Lai will no longer serve as a portfolio manager for the fund.	Charlie Hu joins Eric Isenberg and Francis Rodilosso.	8/16
WALTX	Wells Fargo Alternative Strategies Fund	James Clark and Lucy DeStafano are no longer listed as portfolio managers for the fund.	Brian Zied and Joseph Bishop join the rest of the team.	8/16
WBSNX	William Blair Small Cap Growth Fund	No one, but …	Karl Brewer and Michael Balkin are joined by Ward Sexton in managing the fund.	8/16

Briefly Noted . . .

By David Snowball

New questions to ask your potential fund manager: “so, how did your high school lacrosse team do? And how was the cuisine in the cafeteria?” If the answers were anything close to “great” and “scrumptious,” run away! Run away! As it turns out, new research shows that managers who come from relatively modest, perhaps even challenged, backgrounds tend to surpass their J. Crew wearing peers. So if you can find a kid whose forebears were, say, poor Tennessee farmers, he probably deserves your money. (Especially if his fund is closing to new investors, say, at the end of September.) Thanks to Ira Artman, longtime reader and friend of the Observer, for the heads-up!

After 35 years with Legg Mason, Bill Miller bought himself and his funds free of them. Mr. Miller manages two funds, Miller Income Opportunity Trust (LMCJX) and Legg Mason Opportunity (LGOAX), through a firm that was 50% owned by Legg Mason. By the end of 2016, “subject to certain conditions,” Legg will have sold its stake to Mr. Miller. We were pretty skeptical when Legg gave Mr. Miller and his son the reins of a new fund bearing the Miller, rather than Legg Mason, name. We likened it to a retirement present from the firm to an old, beloved employee who was being shown the door. Its performance since them has not materially softened our skepticism:

SMALL WINS FOR INVESTORS

Effective September 1, 2016, T. Rowe Price Health Sciences Fund (PRHSX) reopened to new investors. Price concluded that it was in the shareholders’ best interests to reopen the fund. The $2 billion in outflows that coincided with the announcement of a manager change may have entered into the equation.

Wells Fargo Discovery Fund (WFDAX) reopens on September 12, 2016, about two weeks after its long-time manager, Tom Pence, retires. Coincidence? Brownie points to anyone who remembers that this fund started life as Strong Mid Cap. Strong had the industry’s most spectacular flameout: founder Dick Strong got named for improper trading, had to admit to wrongdoing, was banned for life from the securities industry, had to sell his firm and fork over $140 million in fines. In the decade since it’s been a very consistently strong performer.

The $4.8 billion Sequoia Fund (SEQUX) has reopened. There was a time when that would have been joyful news to potential investors. Now we’re stuck looking at the rubble and wondering what they’ll be able to rebuild.

Oakmark International Small Cap Fund (OAKEX), Oakmark International Fund (OAKIX) and Oakmark Global Fund (OAKGX) have all reopened to new investors. Small Cap and Global each have about $2.5 billion in assets; International is about ten times as large. All have had a rocky run over the past three or four years. All have seen some outflows, though I wouldn’t describe them as “crippling” or any such. Two of the funds have Morningstar’s “Gold” rating while the third, OAKEX, is “Bronze.”

CLOSINGS (and related inconveniences)

Mairs & Power Small Cap Fund (MSCFX) will close on September 30, 2016. It’s a five-star fund with nearly $300 million in assets. Mairs & Power point to the desire for “a more stable asset base and the continued efficient management of the Fund” as their rationale for closing it.

OLD WINE, NEW BOTTLES

Effective August 15, 2016, the Aberdeen Global Fixed Income Fund (CUGAX) changed its name to the Aberdeen Global Unconstrained Fixed Income Fund. For whatever reason, Morningstar’s system hasn’t yet picked up the change.

Nuveen NWQ Global Equity Fund (NGEAX) has become Nuveen NWQ Global All-Cap Fund. (Shhhh …. As of 8/30/2016, Morningstar doesn’t know.)

Altegris/AACA Real Estate Long Short Fund (RAAAX) has been renamed Altegris/AACA Opportunistic Real Estate Fund with no change of strategy.

SPDR Russell Small Cap Completeness ETF (RSCO), a singularly dumb name which reflected its former index, the Russell Small Cap Completeness Index, has become SPDR S&P^® 1000 ETF (SMD).

Effective August 12, 2016, WHV International Equity Fund became Shelton International Select Equity Fund (WHVAX) while WHV/Acuity Tactical Credit Long/Short Fund was renamed Shelton Tactical Credit Fund (WHAAX).

OFF TO THE DUSTBIN OF HISTORY

Thanks, as ever, to TheShadow who knows not only what evil lurks in the hearts of men but also what news lurks in the darkness of the SEC daily filings. His vigilance, and willingness to share timely finds on our discussion board, make this portion of our monthly issue easier for me to produce and more complete for our readers.

“Considering the small size of the [fund] and other relevant considerations” [hmmm … the effect of a 23% short position against an insistently rising market?], its Board has decided to liquidate Aberdeen Multi-Manager Alternative Strategies Fund II (ARDWX) on or about October 14, 2016.

Aberdeen Emerging Markets Debt Local Currency Fund disappeared into the Aberdeen Emerging Markets Debt Fund (AKFAX) on August 15, 2016.

Also on August 15, 2016, Aberdeen Asia-Pacific Smaller Companies Fund, Aberdeen Ultra-Short Duration Bond Fund, Aberdeen European Equity Fund and Aberdeen Latin American Equity Fund were liquidated. Columbia Global Unconstrained Bond Fund (CLUAX) became all too constrained at the end of August, 2016 and is no longer with us.

Consilium Emerging Market Small Cap Fund (CEMSX) will be liquidating its assets at the close of business on November 23, 2016.

Croft Focus Fund (CIFVX/CRFVX), contrarily, liquidated at the end of August solely “due to the relatively small size of the Fund.”

Cupps All Cap Growth Fund (CUPAX) and Cupps Mid Cap Growth Fund were both liquidated on August 31, 2016.

Even Keel Multi-Asset Managed Risk Fund (EKMAX) will liquidate on September 16, 2016. It’s a curious decision since even though the fund was a weak performer it still had nearly $120 million in assets. No word in the filings about what drove the decision.

First Trust High Income ETF (FTHI) is absorbing First Trust Dividend and Income Fund (FAV), a closed-end fund. That’s the first CEF to ETF merger I recall.

The $11 million Hartford Duration-Hedged Strategic Income Fund (HABEX) will disappear on or about October 21, 2016. It’s probably for the best, the fund has underperformed just about every benchmark (from short-term bonds to multi-sector bonds) that I checked for it.

Good Harbor Tactical Core Developed Markets Fund GHDAX and Good Harbor Tactical Core Emerging Markets Fund GHEAX both head to that great good harbor in the sky on September 29, 2016.

Neuberger Berman Flexible Select Fund (NFLAX) will liquidate on October 3, 2016. It’s another fund damned by not standing out; it wasn’t great, it wasn’t awful, it wasn’t dirt cheap and it wasn’t ridiculously expensive. In the end, it simply wasn’t compelling.

Oaktree Emerging Markets Equity Fund (OEEDX) will liquidate on September 30, 2016. They should be embarrassed by their decision. The fund is under two years old and there’s no compelling reason why they should be so quickly pulling the rug out from under their investors. The firm manages nearly $100 billion and might reasonably be expected to put some considerable time and energy into resuscitating a new fund in an area outside of their traditional strengths. Instead, without a word of explanation, they’re turning off the lights and walking away.

The Profit Fund (PVALX) has closed to new investors and will liquidate on September 28, 2016. The “Profit” in the name is, of course, Eugene Profit who has managed the fund since the heady days of the late 1990s. Thomas Heath wrote an interesting profile of Mr. Profit, a former cornerback for the Patriots and Redskins. The article reports that Mr. Profit’s firm was managing $1.8 billion in 2012. It looks, from the most recent Form ADV, like that figure is down to $325 million. The Profit Fund, a reasonably strong performer until mid-2015, accounts for just $5 million of that total.

On August 23, 2016, the Board of Trustees of PNC Funds approved plans of liquidation for each of PNC Small Cap Index Fund (PESCX), PNC Mid Cap Index Fund (PMCEX) and PNC Mid Cap Fund (PMCAX). The funds have about $25 million between them. PNC Mid Cap Fund will be the first to go, on or about October 31, 2016, then its siblings follow on December 31, 2016.

NYSE regulators have informed the advisers to QuantShares U.S. Market Neutral Size Fund (SIZ) that they are “not in compliance with NYSE Arca Inc.’s continued listing standards with respect to the number of record or beneficial holders.”

Stone Ridge Reinsurance Risk Premium Fund (SREIX) is being “reorganized” with and into Stone Ridge High Yield Reinsurance Risk Premium Fund (SHRIX).

Victory RS Focused Growth Opportunity Fund and Victory RS Focused Opportunity Fund both liquidated on August 26, 2016.

USA Mutuals Takeover Targets Fund (TOTNX) and USA Mutuals Beating Beta Fund (BEATX) are taken over and beaten by beta, on or about September 29, 2016.

Witherspoon Managed Futures Strategy Fund (CTAAX) will close down on September 23, 2016.