Dear friends,

Stand back!

Be ready!

Augustana just launched another flight of cheerful, broadly-educated graduates in your direction. Don’t worry too much: it’s the 158^th time we’ve done it.

They’re good kids, smart, ambitious, generous and worldly in ways I surely was not. On several occasions they’ve set aside their cellphones and, on many, they listened. I taught a fair number of them, but wish that I’d had more of a chance just to talk with them.

Our commencement speaker withdrew, for reasons both valid and sad, at the last minute. Our president tried valiantly to fill in for her but, well, he’s trained as an accountant and a lawyer; his celebratory oratory sounds a lot like what you’d hear from a lawyerly accountant. As he spoke, I drifted and imagined what I might say had I been pressed into service.

Hi, guys!

You made it.

We knew you could. We watched you grow.

And, we must watch you go. It’s our fate.

Your fate is to enter a world sorely tested, if not quite broken. It’s a parlous place. One by one, civilized nations have surrendered to leadership the like of which we haven’t seen since the desperate years of the Great Depression.  We’ve somehow convinced ourselves that the one valid response to ideas you don’t like is loathing the people who hold them. The safety of two dozen schools has been shattered by gunfire already this year. Our green home is wrought with increasingly violent weather that the fools deny and the humble say, “but what can you do?”

I am a historian by training, an optimist by nature and a conservative by inclination. Together, those lead me to share two happier thoughts with you. First, it has always been so. Any reasonably vigilant person, at any point in the past 3000 years, could easily surrender to the impulse to declare, “it was the worst of times, it was the worst of times.” Rampaging dinosaurs, rampaging Huns, rampaging Vikings, the Black Death, the 40,000,000 deaths in the 1918 influenza epidemic, Hitler, Stalin, Mao, the designated hitter rule … the world always seems one small step from the abyss. Second, you have more allies than you can imagine. It is our nature to notice the noisy few who would divide us, the shriekers spewing their vitriol. It is rather harder to notice the rest of us. We are not nearly as sure of anything as they are of everything but still we try to do right. We welcome our neighbors, more than fear them. We know the climate is changing, look for ways to be good stewards of the land, and good members of the community. We agree on a surprising lot of things – the protection of Dreamers, the value of immigration, the rejection of extremism, respect for all people – but somehow we don’t get around to comparing our views. We’re puzzled by some of our friends’ weird beliefs, but we have them over for hot dogs and beer anyway.

And now, it’s time for you to go.

Go happily, for you are loved.

Go bravely, you carry our hopes with you.

Go boldly, you carry the future of us all with you.

At the very least, it’s just 394 words long. A commencement speech, done in under four minutes. I rock!

Thanks, as ever, for your support.

I’d like to urge you to consider a tax-deductible contribution of the Observer. If you choose to contribute $100 or more, you’ll gain access to MFO Premium. That does two things: (1) it keeps the lights on here and (2) it gives you access to about $10,000 worth of tools and data. You can contribute either through PayPal (that’s the link over on the right side of this page) or you can go directly to MFO Premium. If you’d like to gain MFO Premium access, please use the MFO Premium link rather than PayPal. The reason’s simple: the process of getting you access to MFO Premium is much swifter and more automated if you use that link. Either way works, but there’s a bit more delay if things work through PayPal then we need to manually set up an account.

So, thanks!

Thanks, as ever, to The Shadow for his ceaseless review of the SEC’s entrails. By way of example, here’s the list of fund developments he highlighted from just the past week’s SEC filings.

That’s an amazing service and invaluable resource.

Thanks to the good-spirited crew on the discussion board, and to the folks who’ve joined the board just this month: dczaplicki, DavidK44, Jimbo, Bobby, young, john N, rabockma1 and georgelively. I hope your stay is a good one.

Take care! Track us down at Morningstar if you’re able, peer in at the mid-conference posts on the discussion board if you’re not. Regardless, we’ll be back soon.

With a summertime nod to William Butler Yeats, “Sailing to Byzantium,” and not so much to the movie that cribbed a line from him.

I

That is no country for old men. The young
In one another’s arms, birds in the trees,
—Those dying generations—at their song,
The salmon-falls, the mackerel-crowded seas,
Fish, flesh, or fowl, commend all summer long
Whatever is begotten, born, and dies.
Caught in that sensual music all neglect
Monuments of unageing intellect.

II

An aged man is but a paltry thing,
A tattered coat upon a stick, unless
Soul clap its hands and sing, and louder sing
For every tatter in its mortal dress,
Nor is there singing school but studying
Monuments of its own magnificence;
And therefore I have sailed the seas and come
To the holy city of Byzantium.

We noted, with great sadness, the death of Marty Whitman on April 16, 2018, at age 93. Mr. Whitman was one of a small group of utterly iconic figures. Much like Ralph “The Big Squirrel” Wanger, Warren “I’ve been semi-retired for decades” Buffett or Michael “The Meanest S.O.B. on Wall Street” Price, Mr. Whitman was resolutely, fiercely independent, a facile writer and greatly admired.

We are less saddened by the fact that he passed away – it’s an experience we’ll all share, and he led a long and consequential life – than by the shambles around him. The same drive, confidence in his judgment and unabashed independence that made his reputation and his empire also unmade them. Flagship Third Avenue Value Fund (TAVFX) which he managed until he was 88 now receives a “negative” assessment by Morningstar on each of the five characteristics they assess.

His fate is shared by two other legends. Few of us get a gold watch (or a pension) as a going away present from our employers, fewer are given a mutual fund to manage. That, as it turns out, is a good thing.

Bill Miller had a titanic career at Legg Mason, and I mean that in both senses of the world. Morningstar’s Bridget Hughes wrote the capstone in 2011, at the announcement of his imminent departure:

The fund’s performance record is so remarkable that it’s hard to believe the same manager has been in place for the whole of it. Bill Miller, who has been on board since its 1982 inception … led the fund to a record-setting 15-consecutive calendar years of beating the S&P 500 Index. Between 1991 and 2005, the fund was up an annualized 16.44%, compared with the S&P 500 Index’s 11.52% gain.

Since then, the fund’s performance has been awful. Between January 2006 and October 2011, the fund has suffered a huge setback, losing 36.13% (7.4% annualized), which compares with the S&P 500 Index’s 13.45% gain (2.19%).

As a sort of parting gift, Mr. Miller (and his son, also Bill Miller) received the Miller Income Opportunity Fund (LMCJX). Our 2014 profile of the fund was not enthused: “If you believe that Mr. Miller’s range of investment competence knows no limits, this is the fund for you.” At base, the fund permits Mr. Miller to exercise his genius across an unlimited array of asset classes. The results, to date, have been … mixed. Morningstar gives it a one star rating in the odd “70-85% equity” group, noting high risks, high expenses and low returns. Against its Lipper “flexible portfolio” peer group, it’s shown higher volatility, more ulcers and lower returns than its peers.

The Tale of Two Bills

At the very least, I never suspected that Mr. Miller was crazy. Bill Gross, on the other hand, raised that possibility. (His wife, in a 2016 divorce filing, echoes concerns about “irrational and frightening behavior.”) After an exceedingly messy breakup with PIMCO, which he co-founded and for which he’d managed hundreds of billions of dollars, Janus hastily cooked up the Janus Global Unconstrained Bond Fund (JUCAX) for him to manage. That fund charges him with finding “maximum total return” and frees  him to invest in virtually any income-producing security. The fund has attracted billions in assets, quite possibly including more than a billion of Mr. Gross’s own money.

Here’s Morningstar’s picture of the fund’s lifetime performance:

That’s sort of hurt in a relative performance way. The fraction of its peers with better performance than JUCAX (as of 5/31/18):

Our 2014 profile of the fund reflected on Mr. Gross’s turbulent final years at PIMCO and asked “what risk are you assuming in pursuit of those very modest gains over the relatively modest period in which he’s likely to run the fund? Shorn of his vast analyst corps and his place on the world stage, the answer is not clear.” We concluded that it wasn’t a prudent investment.

The New York Times observed, approaching his 70s and worth $2 billion, Mr. Gross might have taken his separation from PIMCO as an opportunity to step away and pursue new passions. “Instead he chose revenge,” with would occur as his new fund trounced his former PIMCO charge. Umm, it hasn’t and the ill-timed bet on Italian bonds, which cost JUCAX 3% in a single day, hasn’t helped (“Bill Gross, Revered Fund Manager, Is Having a Year to Forget,” NYT, 5/30/2018, though this article might be subject to a paywall).

That all makes me a bit anxious of the impending launch of the Seven Canyons Funds, Strategic Income and World Innovators. The force behind Seven Canyons is Samuel S. Stewart, who founded the Wasatch Funds in 1975. Mr. Stewart recently turned 75 and reached an agreement with Wasatch which allowed him to take two of their funds (he manages Strategic Income (WASIX), he and son Josh Stewart co-manage World Innovators (WAGTX)) with him. Seven Canyons was founded in 2017 by Spencer Stewart, another of Mr. Stewart’s sons who was previously a portfolio manager of Grandeur Peak Emerging Markets Opportunities Fund (GPEOX). In announcing Spencer Stewart’s departure, Grandeur Peak’s CEO Blake Walker reported that “Spencer Stewart has decided to follow his heart and pursue a new path.”

Unlike the Miller and Gross departures, Dr. Stewart’s move to Seven Canyons seems – so far as I can determine from the public record – entirely amicable and long-planned. Their funds will be officially Seven Canyons offerings sometime in the third quarter of this year.

Bottom line:

You may not know it. You may not want to admit it. But you’d certainly be running one.

How do I know? Because managed futures funds operate exactly the way you do. Managed futures funds are momentum investors; they choose some number of asset classes (US stocks, currencies, EM bonds, commodities, whatever) to include in their portfolios. They then invest in the asset classes that show the greatest upward momentum, avoid assets that are drifting, and short those that are falling. You could also imagine a control panel with eight toggle switches, one for each asset class, and three positions for each switch (positive, neutral, negative). Managers look at relative strength data and might flip three switches up and three switches down.

Voila! You bet on the winners and against the losers, and rake in the profits. You also block out the gloomy Guses who ask questions like, “wouldn’t you call that a ‘buy high and pray you can sell even higher’ game? They’re old and spend entirely too much time worrying about state of their bowel movements.

In a 2014 interview with Morningstar, Mike Harris, a hedge fund manager whose firm launched Equinox Campbell Strategy (EBSAX) explains the appeal of the strategy.

A managed futures fund is a liquid alternative investment that really helps to smooth the ride in the portfolio because of the uncorrelated nature of the returns, particularly to traditional assets like stocks and bonds.

Oftentimes we tell people that some of the benefits of managed futures is that it’s actively managed, which means it doesn’t have a bias to be long-only like many products in investors’ portfolios. It can effectively make money in both rising and falling markets from its ability to be both long and short. Oftentimes it’s traded in a systematic fashion. So, we’re using models to trade the markets, and we’re using science and data to back-test those returns.

It’s clear that most investors buy into the logic. As the global political climate becomes ever more unhinged, investors steadily migrate toward the market’s riskier segments. Domestic small cap growth funds, for example, saw over $7 billion in inflows YTD. Meanwhile, the market’s few remaining grown-ups have seen steady, nearly unrelenting outflows. Those affected range from small but excellent absolute value guys like Zeke Ashton at the $25 million Centaur Total Return Fund (TILDX) to huge and still excellent absolute value guys like Steve Romick at the $16-billion-but-formerly-$21-billion FPA Crescent (FPACX).

That movement is reflected in Morningstar’s judgments of market valuation. By their assessment, the highest quality (i.e., wide moat) firms are undervalued and becoming more so, while the lowest quality (i.e., no moat) firms are overvalued, though less so that at the start of the year. Similarly, the most stable firms (i.e., those with low “fair value” volatility) are undervalued and becoming more so, while the opposite is true for firms with high uncertainty.

To conventional investors, people who think high prices and high instability are bad, it hardly seems prudent to have many switches set to “risk on.” It is, however, behavior we’ve see before … mostly notably in 2007. Back then, the institutional investor Grantham, Mayo, van Otterloo graphed the unconventional risk-reward tradeoff:

They point out the obvious: “The slope of the line should be positive – riskier assets should be priced to deliver higher returns. But the Great Moderation changed investor perceptions of risk such that the slope went strongly negative.” (Is Investing Starting to Get Difficult Again?, 2018)

The pre-crisis complacency seems to be reasserting itself. The team at PIMCO, which manages $1.8 trillion in assets, wrote in May 2018:

Ten years after the financial crisis, the global economy and financial markets could be entering a new era of potentially radical change that will make the next decade look very different from the last. Investors who assume that the future will resemble the post-crisis past could be in for a series of rude awakenings. (Joachim Fels, Andrew Balls, Daniel J. Ivascyn, Rude Awakenings)

The core question: how well does a disciplined “buy high, sell low (or short low)” strategy work for investors?

Measured by the performance of the managed futures group, the core answer is “poorly.”

It’s dangerous to generalize about the performance of the managed futures group because so many of its members have liquidated: Wakefield, State Street/Ramius, Forward, AlphaCentric/IMFC, Equinox Crable, Equinox Systematic, Mariner and others have all shuffled off to the Graveyard of Good Ideas At The Time.

There is only one managed futures mutual fund that has survived this entire market cycle, Rydex Managed Futures Strategy (RYMFX) which was recently rechristened Guggenheim Managed Futures Strategy. We wrote a short profile of the fund in November 2008 in which I observed, “I have an intrinsic distrust of complex strategies whose success has occurred largely on paper but folks committed to finding a market neutral component for their portfolio might put this on the same due-diligence list as Nakoma Absolute Return (NARFX) and Hussman Strategic Growth (HSGFX).” I might have been more right than I knew, since those other two funds are extinct and awful, respectively.

RYMFX, meanwhile, has managed to book an annual loss of 1.2% since the start of this market cycle in late 2007. Uhhh … it has booked an annualized loss of 2.7% over the past 10 years and that places it in the top 1% of all managed futures funds. (Oh, right, the liquidation thing. There are only three managed futures funds with a 10 year record and a loss of 2.7% is as good as it gets.)

To broaden the comparison, I pulled the three-year performance record for all managed futures funds from the MFO Premium fund screener. The simplified results, with two possible benchmarks, are below.

To the clear: we are not criticizing these managers, or suggesting that they’re anything less than disciplined, well-trained and diligent. We’re arguing that the record of these attempts show that, even with years of experience, advanced credentials, swamps of data and so much computing power that Google calls them for the answers to questions, trusting your ability to move between asset categories in pursuit of exceptional returns is essentially futile.

Don’t try this at home.

Try this instead:

Our recommendations for fund investors remains the same: make your plans before panic strikes, work backward from an understanding of the risks you face and the extent of losses you can bear, build an asset allocation that creates a margin of safety for you and your family, and execute the plan with experienced managers who are shielding you from unjustified risk now in pursuit of exceptional returns in the future.

Over the summer months, we’ll try to introduce you (or re-introduce you) to managers and strategies that might contribute to that outcome. This month we provide an updated profile of Centaur Total Return (TILDX) with profiles of Zeo Strategic Income (ZEOIX), LS Opportunity (LSOFX), 361 Global Long/Short (AGAZX), Holbrook Income (HOBEX), Camelot Event Driven and others on the way.

The Mutual Fund Observer is the product of a virtual team and, when our colleagues from England and Trinidad were working with us, a virtual global team. Chip and I reside in Iowa, Ed and Sam in Illinois, Charles in California, Bob C in Ohio and Dennis in Montana. One of the great attractions of the Morningstar conference is that it gives us a chance to work side-by-side on interviews and stories, and to share quick and personal reactions to the ideas and personalities we encounter.

As ever, we’ll try to offer some quick responses in the form of end-of-day posts to the MFO Discussion Board and to the MFO Premium commentary.

Our agendas vary. Sam Lee is slated to contribute to Tuesday’s panel, “Crypto, Blockchain, and Lamborghinis, Oh My!” Charles and I will be in attendance, intent on photobombing Sam. The only real question is whether our “Blockchain Blockheads” and “Sam I Am” t-shirts arrive in time for the occasion.

Ed won’t be officially in attendance, but will be available to confabulate at local taverns and in our retreat after the conference. Chip might well be splitting time between tech-centered panels and giving her niece a tour of Chicago.

Charles and I split time between listening in on panels, meeting managers, chatting with MFO readers and looking for interesting leads among the 100 fund firms showing in the Exhibit Hall. So far I have time set for conversations with a series of managers:

• Venk Reddy, Zeo
• Jon Angrist, Cognios
• Tom Stringfellow, Frost Investment
• Tom Florence, 361 Capital
• Arun David and (possibly “and/or”) Vince Rivers of JOHCM
• Beini Zhou, Matthews Asia and particular Matthews Asia Value Fund

I’ll also report on the comments of two really smart guys: Jeremy Grantham of GMO and behavioral economist (also Nobel Prize winner) Daniel Kahneman.

Charles’s list overlaps mine just a bit:

• Darin Leone, Portfolio Strategist, Manning & Napier,
• Anne-Laurence Roucher, Portfolio Manager, Natixis ESG Funds
• Venkatesh Reddy, Portfolio Manager, ZEOIX
• David Lafferty, Chief Marketing Strategist, Natixis
• Tom Stringfellow, CIO Frost
• Kip Meadows, CEO Nottingham
• Phil Bak, CEO Exponential ETFs

We will, with luck, have a chance to add to that list over the next 10 days. If you’d like to say “hi” to either of us, just drop us a note!

Quaker Funds, based in Berwyn PA, are a small family at tactical allocation funds. As they imagine a transition which will include an ESG focus, it became clear that Thomas Kirchner’s event-driven fund would be something of an anomaly. Event arbitrage funds aim to profit from predictable but short-lived market anomalies when, for example, a firm announces a change of control or reorganization. Limiting himself to relatively rare events in a relatively limited slice of the equity universe makes very little sense, so QEAAX/QEAIX is trying to join the Camelot fund family.

But that’s been delayed because the fund’s shareholders won’t open – or answer – their mail. The move to Camelot requires shareholder approval with at least 50.1% of shareholders voting yea or nay. After months of effort, only 41% of shareholders had weighed in. Why? One obstacle is investor privacy safeguards; when you click the “don’t allow third parties to contact me” option on your account set-up, you make it impossible for proxy solicitors to find you. Another obstacle is the fear of scams: during one recent contact attempt, a young voice shouted out from the background, “it’s a scam, mom! Don’t tell them anything, hang up!” And, as ever, people are lazy: we delete emails and trash paper mail, rather than going to the trouble to respond.

Here’s a plea from the fund’s managers: vote! (Please.) The solicitation process is expensive and is delaying what they believe to be an essential step for the fund.

Apparently Morningstar endorses the move. Their website has already renamed the fund, despite the fact that the vote hasn’t yet closed.

QEAAX is rated by Morningstar as a four-star fund. It began life in November 2003 as Pennsylvania Avenue Event-Driven (PAEDX) then, in June 2010, became Quaker Event Arbitrage (QEAAX) as part of Mr. Kirchner’s attempt to broaden the fund’s investor base. The fund (blue line) has handily outperformed its Morningstar peer group over its lifetime.

Bottom line: if you’re associated with the fund and haven’t voted, please do so. The same goes for shareholders of T. Rowe Price funds who, likewise, have been receiving proxy notices in the mail this month.