Dear friends,

If you’re ever had cause to poke around MFO, perhaps “About Us” or “Support Us,” you’ll have spotted the younger me and the younger version of my son, Will. We were poking around England seven years ago, around the time we launched MFO, and we wanted to give folks a peek at the people behind the text.

I note, with pride and trepidation, that seven years have now passed. The 12,000 folks who joined us that first month have grown to 28,000 this past month, and 1,298,128 readers, interlocutors and passersby since launch.

You sort of look like this:

And Will? Will sort of looks like this:

I’m pleased and terrified to note that Will has accepted an offer of admission from the University of St. Thomas, in St. Paul. Apparently my son’s going to be a “Tommie” soon, and a data analyst. It’s an expensive proposition, no question, and something of a stretch for the family. And yet we believe, in Will, in the power of great teachers and small schools, in the future that we can yet shape together. The Lebanese-American poet Kahlil Gibran once wrote:

You are the bows from which your children
as living arrows are sent forth.
The archer sees the mark upon the path of the infinite, 
and He bends you with His might 
that His arrows may go swift and far.
Let your bending in the archer’s hand be for gladness;
For even as He loves the arrow that flies, 
so He loves also the bow that is stable.

(On Children, 1923)

Come summer, I will launch my arrow northward and report, with delight, from time to time, upon its arc.

On the limits of happiness

As happy as I am to write about funds for you, I’m not a tenth so happy as this woman is with her Fidelity investments.

Yuhh … it’s only coincidental that I’ve begun the process of moving the Fidelity portion of my 403(b) retirement account to T. Rowe Price.  I noted in my portfolio review that Augustana has frozen our access to Price and Fidelity, and substituted a small array of carefully chosen active and passive funds. It seems silly to maintain two locked sets of funds, so I resolved to transfer one to the other. Price seems to have a stronger, healthier culture, I respect their brains and their thoughtful communication with investors, and I agree with their firm-wide approach to investing. The move is a bit complicated, but it will be good to have it done.

I shudder to imagine that young woman’s expression should she choose to come along, so I think she’s safest staying with the Johnsons.

Thanks

To you all, for sharing these first seven years of MFO with us. When we launched, the average lifespan of a boutique website was barely seven weeks.

To Ed, Chip and Charles, who’ve contributed more than you could ever know. They’re amazing and I’m amazed by their support and friendship.

To the folks on MFO’s Discussion Board, which would be award-winning if only there were awards for such things. Their daily banter, always interesting and frequently good-spirited, is daily reading for me. Thanks, pointedly, to Ted the Linkster and the shadowy The Shadow, who always gets there before me.

And to Kirk, as well as our stalwart subscribers Greg, Brian, and Deb. We thank you!

The summer brings interesting stuff. Ed is off in Paris and Sam Lee is patrolling the streets of Seoul, but both will be soon back. Charles has been revamping the MFO Premium site, for the better, and has profiles coming on two funds. And Morningstar is coming in June. We’ll be there, and we’d be delighted to spend a bit of time with you while we’re at it. Just let us know.

As ever,

(with special thanks to rforno of MFO’s Discussion Board for the title)

The New York State Attorney General’s office has weighed-in on behalf of investors, and active share. Active share is a measure of the extent of the difference between what’s in fund’s portfolio and what’s in the fund’s benchmark index. If your fund holds all the same stocks in all the same percentage as its benchmark, then its active share is zero. A zero active share is good if you’ve bought – and are being charged for – an index fund. A zero active share is bad is you were sold – and are being charged for – something masquerading as an active fund.

The difference in risks and return between a fund and its benchmark are created by the active part of the fund’s portfolio. A fund that differs in composition only a tiny bit from its benchmark will likely differ in risk or return by only a tiny bit. If you’re paying substantially more for an active fund than you’d be charged for a passive one, they you have reason to expect a substantial difference from the benchmark with the prospect for substantially lower risks or higher returns.

Sadly, many funds – called “closet index funds” – charge for active management then produce index-like portfolios. In March 2018, nearly a year after alerting funds that they were under investigation for misbranding themselves, Britain’s Financial Conduct Authority forced a number of British investment firms to pay their investor £34 million for marketing 64 large funds as “active” when they were closet indexers.

What’s the chance that your fund is a closet index? Large funds are, on whole, less active than small funds and the industry is increasingly dominated by large funds; in consequence, the percentage of industry assets held by closet indexers has grown steadily and is now a third or more of industry assets (Jeffrey Moeller, Closet Indexing and the Concept of Active Share, 2013). Research by Matos, Cremers,  Ferreira Starks, published in 2016, sorts through 24,000 funds worldwide, and estimates that about 20% are closet indexes (Indexing and Active Fund Management: International Evidence; a readable report about the research, Active Vs. Passive Funds: The Mutual Fund Shell Game, was published in 2017). That research uses an active share cut-off of 60% to distinguish active funds from closet indexers.

The problem is that it’s damnably difficult to find out if you’re one of the people paying for one thing and getting another. Very few large fund companies have been willing to easily disclose that data.

The New York Attorney General’s action might be changing that. In April the office published Mutual Fund Fees and Active Share. The study surveys the expenses and active shares of 2700 mutual funds.

The Attorney General has three major findings.

1. Active share is relevant.
   Rather than reviewing the debate on the relevance of active share to a fund’s performance, the AG simply noted that fund firms use this data themselves in determining who to hire and fire and in assessing the performance of their funds.

2. Active share and fund expenses are weakly correlated.
   It would be nice if paying more guaranteed that you got more active management. It doesn’t. Advisers charge whatever they can get you to pay (it’s the nature of capitalism), so you see bunches of closet index funds (the dots below the 60% line, as a rough illustration) charging high fees.

3. Fund firms don’t disclosure active share to peons.
   Of 14 major firms surveyed, only one – Fidelity – makes active share information routinely available to retail investors while all 14 use it with their institutional investors. Even with Fidelity, the number is isolated and buried. Here’s their profile of Fidelity Growth Company, you’ll find active share in the right hand column just below “asset allocation.”

   Independent fund firms, such as Artisan, Touchstone and about 80% of the funds we cover, do routinely and prominently share that information.

Responding to the Attorney General’s pressure, the fund advisors have agreed to publish active share information quarterly.

Following NYOAG’s investigation, 13 of the 14 mutual fund firms surveyed agreed to publish the Active Share metric for their actively managed equity funds available to U.S. investors. The 14th firm surveyed by NYOAG – Fidelity Management & Research Company – was already publishing Active Share for its relevant funds. As a result of these actions by some of the largest mutual fund firms in the United States, all investors will now have access to additional important information about more than 400 actively managed funds.

The firms that have agreed to post Active Share information for their relevant funds on their websites on a quarterly basis are:

• AllianceBernstein
• BlackRock
• Dreyfus
• Capital Group Companies, Inc. (American Funds)
• Columbia
• Eaton Vance
• Goldman Sachs
• JP Morgan Chase
• OppenheimerFunds
• Nuveen
• Rowe Price
• USAA and
• Vanguard.

The industry’s trade group, the Investment Company Institute, promptly did what you’d expect: they denounced both state interference and the importance of relevant information for investors.

“We strongly believe state authorities should not arrogate to themselves the authority to impose inconsistent disclosure requirements,” Paul Schott Stevens, ICI’s president and chief executive, said in an e-mailed statement. “‘Active share’ is not relevant for many funds or investors.” (Rachel Evans, Picking a Mutual Fund Just Got Easier, Thanks to N.Y. Regulator, Bloomberg, 4/6/2018)

Neither the Attorney General nor Ms. Evans points investors to ActiveShare.Info, but they should. The active share site provides slightly out-of-date active share information for most domestic equity funds. The “slightly out of date” shouldn’t particularly bother you because active share tends to be stable; closet indexers tend to remain closet indexes while highly independent managers tend to remain highly independent. Here, as an illustration, is five years’ worth of data for FPA Capital.

Likewise for Fidelity Growth Company (FCGSX), which Fido reports as having an active share of 54%.

The problem with active share is that calculations are pretty much limited to pure equity funds; the data doesn’t seem to exist for multi-asset and income funds.

Bottom Line: Being active is not the same thing as being good. A manager who wanders off and buys Venezuelan cryptocurrencies and pink-sheet stocks is being active, and actively stupid. That said, managers who are simultaneously active, patient and focused tend to outperform others (Cremers, Active Share and the Three Pillars of Active Management: Skill, Conviction and Opportunity, 2017). Managers who are inactive and expensive represent about the worst possible deal for investors. You owe it to yourself, if nothing else, to find out whether your fate is tethered to such a creature.

Morningstar’s plan to roll out their own family of mutual funds, for use with their managed portfolio service, is becoming more concrete. In an April 23, 2018 filing with the SEC, Morningstar notes that they’re in “the quiet period” required by the SEC; nonetheless their filing says a lot.

Morningstar will offer nine funds to their Morningstar Managed Portfolio clients. That’s a booming niche for them:

… for the full year ended Dec. 31, 2017 … Assets under management and advisement in Managed Portfolios increased 31.8% to $39.8 billion. (Morningstar, Inc. Reports Fourth-Quarter, Full-Year 2017 Financial Results, 2/20/2018)

In each case, Morningstar will select the manager or managers responsible for selecting the fund’s securities: “the portfolios will invest in Morningstar Funds which, in turn, will invest their assets in individual stocks, bonds, and other securities that have been selected by third-party managers.”

The managers for the new funds are listed separately in the new prospectus. We originally reported that the manager names were not public. We were wrong and we regret it. Thanks to Sarah Wirth, who handles media relations with Morningstar, for helping straighten that out. Here’s the short roster with just the names of the advisory firms.

We also know that some of the current managers will not be investing on Morningstar’s behalf in the future.

Some of the managers whose mutual funds are currently used in your managed portfolios were not named as subadvisers to Morningstar Funds. Why?

Although the trust will provide a discussion of the factors the trustees considered in approving the subadvisers in a future shareholder report, we won’t otherwise comment on why we selected or rejected individual managers. 

One possibility is that Morningstar saw virtue in streamlining the management structure, another is that some of the managers declined the opportunity to take a pay cut (Morningstar estimates they’ll be able to lower fund expenses by 20% using the new funds, presumably some of that attributable to lower management fees) to continuing working on Morningstar’s behalf, but that’s not documented.

The most curious question and answer in their FAQ involves their decision not to make their funds available to the public.

Why aren’t you making Morningstar Funds available directly to the investing public?

Our focus is on delivering cost savings to clients in our Morningstar Managed Portfolios. The impetus for launching the Morningstar Funds is to lower the overall fees that these clients pay. Thus, the funds are intended to be used exclusively in the portfolios we offer these clients, not as standalone offerings. We don’t currently have plans to make the funds available to the general investing public.

The answer feels, at the very least, incomplete. If the goal is “delivering cost savings” to their current investors, they could achieve the goal more easily by including more (outside) investors. Other possible, though unconfirmed, explanations might be (1) they don’t want to directly challenge Vanguard, T. Rowe Price and others who themselves support Morningstar and (2) they might anticipate problems attracting top-tier “third party managers” if the Morningstar products threaten to cannibalize those managers’ business.

The comparable question about offering Morningstar Funds to non-U.S. investors adds in interesting gloss.

Does Morningstar Investment Management plan to offer Morningstar Funds to investors outside the U.S.?

We don’t currently have plans to do so but are continuously evaluating ways we can bring low-cost options to our managed portfolios globally. Morningstar Investment Management Australia already offers multimanager funds.

Most of the Morningstar Australia retail funds seem to be objective-focused (Morningstar High Growth) and high-performing (High Growth is five stars in each measurement period), though it’s impossible to make a confident assessment of the fund without understanding its competition.

Bottom Line: I hope the Morningstar funds do brilliantly well. They represent an interesting experiment and the financial security of a lot of people rest on them. They seem thoughtfully designed and their emphasis on cost minimization likely serves their investors’ interests. Nonetheless, the “sleeves for star managers” strategy is hard, as illustrated by the manager turnover at, and occasional liquidations of, the Litman Gregory Masters funds.  The “masters” at their Smaller Companies fund, for instance, tend to fall from favor pretty quickly; the fund has had 20 masters since launch in 2003, with some teams out within three years.

There have been many changes for me since August 31, 2017.  On that day, I officially retired as partner and Chief Compliance Officer of PDS Planning, Inc. in Columbus.  Having worked for a total of almost 50 years (five of those while I was in college), there was more than a bit of trepidation as I neared retirement.  Would I really fill my time?  Would I find myself longing to be at work again, missing the daily interactions with colleagues and meetings with clients? Would I be able to sit back and not be on top of the financial markets?  These were just a few of the thoughts running through my 67 year-old brain as I cleaned out my desk and office.

Notice that I did include the future of the company I helped build in my concerns.  Its success was a foregone conclusion, with second and third-generation owners already continuing the commitment to exceptional service established at the beginning. Multi-generations of clients shared our values of hard work, responsibility, kindness, and joy. It was not a drudge to come to work early in the morning with that kind of atmosphere. I knew PDS would thrive without me, as much as that caused my ego a bit of chagrin.

The first three months of retirement were taken up by a lot of travel, which allowed me to think about something besides being retired from my long career.  A river cruise in Portugal, visiting friends in Tucson, a visit with my brother in Florida, and a surprise trip for my wife to New York City in early December kept me occupied.  (An aside…if you haven’t been to NYC during the holiday season, it really is wonderful.) Then there was the cleaning out and redecorating of my home office – my goodness, I had accumulated stuff.  Add my continuing and growing work time as a musician, time with friends, and other projects, and I was indeed filling my time.

I had expected to work one or two days a week, perhaps at a local wine shop.  Fortunately I do not have to work (and I realize many retirees do not have this option).  I am still waiting for a part-time, day-time option.  In the meantime, I have been able to increase my volunteer work with a local food pantry, collecting meat donations from Kroger and delivering 200-400 pounds of meat to the pantry each week. And I remain on the board of trustees for the Columbus Symphony Orchestra.

My wife and I recently joined a health club no more than one minute from our home.  Run by one of the area’s largest healthcare corporations, it has marvelous facilities and more options than we can possibly explore.  Some former clients are also members. The annual cost is an investment in our health, somewhat neglected over the last few years.  I still have some weight to lose, but I am determined to live as long a life as I am able.

With spring finally coming after a very long, cold, and dreary winter here in Ohio, I am eager to be outside, preparing our gardens and yard for summer.  As some readers already know, my wife and I have a national display garden for the American Daylily Society, with thousands of blooms during peak visitor season in late June through early August.  That means lots of intense, almost-daily exercise – hauling heavy bags of mulch and compost, moving huge ceramic container pots, digging and dividing plants, mowing, trimming, stooping, kneeling, sweating – it is hard but very fulfilling work.

One confession is that I have spent very little time thus far on the MFO Discussion Board, and I have rarely looked at the value of my portfolio. I hope to contribute more to the Discussion Board, but I doubt I will increase the time spent watching my investments. My allocation has remained the same despite the ups and downs of the last seven months. I open my Schwab statements each month and find the value is almost unchanged since the end of 2017. I will rely on the investment team at PDS to notify me of any real concerns. In the meantime, I have found being disconnected from the daily thrashings of the financial world reduces my stress levels considerably. I still wonder why so many retirees who have investment portfolios spend so many anxious hours worrying, especially those individuals who do not need to take distributions. As I suggested for years, find an allocation that lets you sleep at night, and back away. So far, at least, I have been able to do that.

Perhaps the biggest change personally has been my sleep pattern. I used to get up around 5 AM and was in the office shortly after 6 each morning. I cannot tell you how much sleep I got the first few months of retirement. Retired friends told me I would find out how physically and mentally tired I really was, and they were right.

These musings are not meant to be a prescribed retirement life for others. Everyone brings different lifestyle decisions, financial security, personal health status, and time constraints into their retirement reality. This is simply how my life has evolved in recent months. No doubt there will be changes, probably some significant changes. When I decided on a retirement date last spring, it seemed a long ways off. But as most retirees have found, time does indeed seem to move faster the older we get. Fortunately, planning for my retirement (including writing about my thoughts, expectations, and plans) was a wise decision. It forced me to consider many aspects of retirement life. Financially, the biggest relief is not having a mortgage payment. This single-biggest expense for most people is not a factor for us, and I am really glad we made the decision to convert to a 15-year mortgage years ago. As I wrote in my blogs last year, the timing seemed right. It was.

There have been some surprising aspects of retirement, too, and I will comment on those in future articles. 

Not the stock market. I have no earthly clue about what it’s going to do, when, or why. I mean the headlines.

On April 24, the Dow dropped by 425 points. That’s 1.7%, which isn’t large and isn’t saying “the market” dropped by 1.7%. The Dow is a narrow and quirky construct. The broader market is reflected in the performance of the Vanguard Total Stock Market Index Fund (VTSMX), which declined by 1.2%.

On whole, I would prefer that my portfolio not decline. It did decline that day, by 0.41%. In reaction to the drop, Chip and I had a nice dinner (she provided the wine, I roasted a chicken with some root vegetables) and read for a while.

People whose job it is to scare the bejeebers out of you, though, couldn’t take the evening off. Here’s a quick synopsis of stories that crossed my desk in the past 24 hours:

Here’s where the markets stand after Tuesday’s beating (TheStreet) – 1.2%. Not a “beating.” I would allow you “a kerfuffle.”

Can’t blame 3% yield for this stock rout (Bloomberg) – I wasn’t blamed anyone. And it wasn’t a “rout,” either.

Stocks try to rebound following Tuesday’s plunge (Fox News) – 1.2%. No, not a “plunge.” Keep your rhetorical powder dry, dude. I sat through a day in which the Dow dropped twenty-times that much; what are you going to use for descriptors in a real decline if you use up all your terror-words on market stumbles?

America’s confidence in the stock market is crumbling (CNN Money) – my confidence remains unshaken; I’m very confident that, over short periods, the stock market moves with the predictability and speed of an armed lunatic

Yet another ‘outside day’ in stocks is an ominous sign (MarketWatch)

and

Financial markets are at an inflection point (Seeking Alpha) – my general view is that this sort of thing is just marketing talk; “trust me, I see that shadow of the iron cordon is soon to pass over the shire.”

S&P 500’s last line of defense holds firm (Bloomberg) – “last line of defense”? It’s not a war, it’s attention-deficient traders passing slips of paper back and forth as fast as they can.

 ‘Just around the bend.’ This is when the stock market will crash according to 5 famous investors (Money) – David Stockman, who isn’t typically described as a ‘famous investor,’ thinks there’s “a doozy just around the corner.”

The Dow rose modestly on April 25 and 26 and, suddenly, all of these headlines disappeared, replaced by knowing talk about earnings that are (or aren’t) “baked in” to equity prices, a trillion dollars in buybacks and dividends, and the unbearable attractiveness of gold. (Ed Studzinksi reported, back in March, that wine has been a vastly better investment than gold. Charles raised a glass of an approachable and unprepossessing Central Coast vintage in affirmation.)

I don’t blame writers for writing, nor headline writers for writing headlines. It’s how they feed their families. That does not change the fact that it’s hysterical, misleading and driven by the simple need to make you look. (The absence of links to any of those articles is intentional.) Even in the best of times, financial journalists were derided as purveyors of financial pornography, writing salacious tales of the acts of prostitutes.

That world where the beautiful and wondrous act of romance and procreation is to reduced to one pitiful act. A sham ritual in which the customer’s appetite for lies is equaled by the prostitute’s willingness to tell those lies in whatever detail he is ready to pay for. The tones of lies are vulgar facts. But they are not noble sounds.

Stanley Crouch, “Premature Autopsies” from The Majesty of the Blues (1989)

This, sadly, is not the best of times.

What’s a body to do? Our suggestion is, protect yourself.

Protect yourself from the noise. If you use social media, remember to use it for socializing. It’s a great way to keep up with friends from high school; a wretched way to make sense of the worlds of politics and finance. If you don’t use social media, good but don’t get all self-righteous or people will mistake you for a Prius owner. Support good journalism. It’s out there. In print and online, The Wall Street Journal and the Financial Times are consistently first-rate and consistently sober. In audio, there are few better sources than Marketplace which works hard to make things sensible and not scary. Planet Money, from NPR, is solid and informative (Chip and I were just discussing their piece on “brushing,” a scam by which online sellers generate the illusion of good reviews) though less extensive. Both are available, free, as podcasts.

Unless you’re in the financial services industry, you don’t need a daily dose of noise. Keep informed, keep calm and keep centered on what actually brings you joy.

Protect yourself from the market.  More correctly, “protect yourself from your own reactions to the market.” At some point, perhaps sooner than later, the market is going to do something really horrifying. At some other point, perhaps sooner than later, the market is going to do something really horrifying and extended. It happens.

You’re got four options. Pick the one that works for you.

1. Completely ignore it all. Period. Chuck Jaffe once shared the finding that the best-performing brokerage accounts are those that have been forgotten or belong to the dead. MFO noted that one of the best performing funds in history, Voya Corporate Leaders (LEXCX), is a ghost ship that has sailed without a manager or a change of portfolio since 1933. If you’re in your 30s or 40s, do ye likewise: set up a sensible investment portfolio, fund it automatically each month, and give it nary a thought.
2. Do something simple. Simply put, hold a part of your portfolio in cash instead of in risk assets. While you can actively manage your portfolio (that is, fund a strategic cash alternative such as RPHYX or ZEOIX until the equity prices are amazingly cheap), most of us shouldn’t because (a) we’re amateurs and (b) it requires paying a lot of attention to the market. A better move is to entrust part of your portfolio to absolute value managers who will hold cash when stocks are expensive and move in when to stock when stocks are bloodied and everyone else is running away. Trust the folks at FPA, Intrepid, River Road or a fund like Centaur Total Return (TILDX) or Pinnacle Value (PVFIX). The upside of “simple” is that it’s a cheap and reliable strategy. The downside is that it is a pure beta strategy; it reduces volatility but does not add to short-term returns.
3. Do something complicated. Find a good long-short, market-neutral or event-arbitrage manager to handle part of your portfolio. Most of the funds in these categories are overpriced, complicated messes. Still, there are some gems. We’re written about RiverPark Long-Short Opportunity (RLSFX), LS Opportunity (LSOFX), and AMG River Road Long-Short (ARLSX). We’ll soon write about Camelot Event-Arbitrage née Pennsylvania Avenue Event-Arbitrage and might soon profile 361 Global Long/Short Equity (AGAQX). The upside of “complicated” is that it adds alpha; that is, these guys are trying to drive returns up. The downside is that it tends to be expensive and, like equity, works in fits and starts.
4. Wait until the moment comes, then panic and ruin both your finances and your health. It’s a surprisingly common strategy, though one that continues to mystify me.

Bottom line: the mere fact that it’s not the best of times does not mean you’re powerless. It means that circumstances seem to be conspiring against you. It happens. Fortunately, you’re strong. Stronger than you’ll admit. And we’re here. We’ll help.

Some people might ask, “What is this man doing talking about nobility? Doesn’t he know that this is a dragon-spawned and blood-encrusted century? Doesn’t he know that the dragon breath of our time is breathing down the neck of the year 2000? Doesn’t he know that this is the era of flash and cash?” … But I will answer them also by saying that nobility is always born somewhere out there in the world, and when you live in a democratic nation you have to face the mysterious fact that nobility has no permanent address, you have to face the fact that nobody has nobility’s private phone number. Nobility is not listed in the phone book. Nobility is not listed in the society column, nobility shows up where it feels like showing up, and where it feels like showing up might be just about anywhere. If it could rise like a mighty light from among the human livestock of the plantation, you know it can come from anywhere it wants to. You see, nobility is listed though. Yes, it is listed. Nobility lists itself in the human spirit, and its purpose is to enlist the ears of the listeners in the bittersweet song of spiritual concerns.

Stanley Crouch, “Premature Autopsies” from The Majesty of the Blues (1989)