Dear friends,

Another school year has begun, likely the most fascinating in my 35 years as a college professor. My students were in class this morning, cheerful and masked. When asked about their summers, they did not say what the rest of us might: “it sucked.” To the contrary, they were uniformly positive about the experience (“I had a good summer! We didn’t get to travel anywhere, but I put in a lot of hours on my job and spent a bunch of time with my family!”) and hopeful for the year ahead.

The number of students was, quite understandably, reduced: Augustana welcomed something like 550 first-years when we’d normally see 700, with a lot of the deficit coming from international students – well more than a tenth of the college – not able (or willing) to travel to the US this fall. Most have deferred admission until spring, and they’ll bring a lot of energy and perspective at a time of year when everything normally feels set and settled.

Day One began with two hours of introduction to propaganda, one of my academic specialties; I’ve been teaching “Propaganda in the Twentieth Century” for nearly 30 years now, though publishing only lightly in the area. The recurrent themes in the history of propaganda – fostering fear, playing on emotions, dividing people – have been on my mind as I’ve written this month’s missive. I hope you find it interesting.

The Eve of Destruction

Yeah, my blood’s so mad, feels like coagulatin’
I’m sittin’ here just contemplatin’
I can’t twist the truth, it knows no regulation
Handful of Senators don’t pass legislation

And marches alone can’t bring integration
When human respect is disintegratin’
This whole crazy world is just too frustratin’

And you tell me over and over and over again my friend
Ah, you don’t believe we’re on the eve of destruction

Think of all the hate there is in Red China
Then take a look around to Selma, Alabama
Ah, you may leave here for four days in space
But when you return it’s the same old place
The poundin’ of the drums, the pride and disgrace
You can bury your dead but don’t leave a trace
Hate your next door neighbor but don’t forget to say grace
And you tell me over and over and over and over again my friend
Ah, you don’t believe we’re on the eve of destruction

If you can get past the … hmmm, occasionally strained lyrics, the song feels curiously contemporary: a gridlocked Senate, protests over racism, rising conflict with China, married to a sense that we’d lost all tolerance of – much less respect for – one another.

Given that, you can hear the incredulity in the refrain: “you don’t believe we’re on the eve of destruction?” (You fool!)

The Byrds rejected the song but the Turtles (whose entire m.o. was to record songs that weren’t quite good enough for The Byrds to do) released it. The most famous version was, you might recall, Barry Maquire’s. July 1965. Raspy voice channeling fear and outrage. The song made it to #1 on the Billboard charts despite being banned by some radio stations (and all of Scotland), restricted by the BBC, and condemned by those who felt criticized. After he became a born-again Christian, Barry re-recorded the song for his album “Lighten Up” and has periodically rewritten and performed the song. Most recently, in 2008.

Sang it, but he didn’t write it. That credit goes to P. F. “Flip” Sloan, who also penned “Secret Agent Man.”

This whole crazy world is just too frustratin’.

We are, I suspect, always on the eve of destruction. And yet, somehow, we keep dodging the day of destruction.

Why is that? It might be that “destruction” is being oversold. Propagandists know that we’re easiest to control when we’re almost paralyzed with fear: when it feels like everything is spinning out of control, “all that is solid melts into air,” and that we are surrounded by threats, traitors, and enemies. And so they work hard to create precisely that sense: scenes are staged, hyped, ripped out of context, misinterpreted, tweeted, and relentlessly retweeted. Because keeping the details straight is, frankly, exhausting, most of us eventually just surrender to the propaganda and pseudo-events.

Too, it might be that we’re a bit more resilient than we think. A bit more able to step back, think it through, talk carefully, act well.

All of which we mention because the next eight weeks we’ll be deluged by hateful messages, most containing the barest grain of truth, that aim to make us rage. They’re hard to avoid, in part because they flood our environment, in part because they’re designed to be eye-catching, and, in part, because we’re drawn to them in the same way that we’re drawn to stare at the car wreck as we drive by.

Our world faces profound challenges, and the election of 2020 is going to be incredibly consequential. That’s pretty much a given. The question is, how do you navigate the months ahead so that you can make a positive difference in the world without losing your sanity and surrendering to the hate being offered up to you?

Voting would be one good move. Avoiding the propagandists would be another: ad spending – online and on TV – is apt to exceed $6 billion, and almost all of it will be negative (because negative works). You really might want to throttle back on your time spent staring at screens and the worst offenders will be your favorite sites and stations because propagandists know who you are and where you hang out. Unless you’re undecided about your vote in the upcoming election – a bit under 10% of us – more media is going to mean more anxiety. On whole, it is probably not good for you to rage-watch, rage-scroll, rage-tweet … or, well, rage.

We’ve taken to Netflix lately, watching some fascinating Asian shows, including “The Midnight Diner” (set in Toyk0) and “The Mystic Pop-Up Bar” (Seoul). They’re really interesting. Books are a good idea. Actually talking with people has its antique charms.

And if you are one of The Undecided Tenth? Perhaps talking with someone who doesn’t necessarily agree with you but who’s also trying to figure it out, would help you both.

Perhaps, given a bit less pressure and a bit more thought, we can again push the eve of destruction back to another day.

There is nothing either good or bad but thinking makes it so. (Hamlet, Act 2, Scene 2)

Extraordinary Popular Delusions and the Madness of Crowds

A fascinating book, written in 1841 Scotsman Charles Mackay. Never at a loss for words, Mackay wrote three volumes, the first of which was entitled “National Delusions.” The book opens with a series of case studies of economic manias (the South Sea Company bubble of 1711-20, the French land speculation frenzy known as the Mississippi Bubble, and the Dutch tulip mania.  “Money,” he notes in the Preface, “has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper.” (In reality, Mackay was very hesitant to let facts get in the way of a good story and historians have long known that he seriously overhyped the tulip mania because it suited his ends.)

John Waggoner has been writing – rather more gracefully and I, truth be told – about markets and investing for more than 30 years, most recently as a contributor to Kiplinger’s, Morningstar, USA Today and InvestmentNews. He suggests that MacKay also recognized the herd-like (lemming-like) behavior that’s behind much bad investing, and bad journalism:

“What a shocking bad hat!’ was the phrase that was next in vogue. No sooner had it become universal, than thousands of idle but sharp eyes were on the watch for the passenger whose hat shewed any signs, however slight, of ancient service. Immediately the cry arose, and, like the war-whoop of the Indians, was repeated by a hundred discordant throats. He was a wise man who, finding himself under these circumstances ‘the observed of all observers,’ bore his honours meekly.

Mackay came to mind again as I read two reports this month. Number One: amateur investors are yet again flocking to the markets. The most famous platform is Robinhood, with a reported 13,000,000 users but they’re not alone.

In China, regular people are packing into brokerage houses to buy shares. Americans are feverishly refreshing their Robinhood and TD Ameritrade brokerage apps, while newbie traders in India are enamored with penny stocks. A growing number of Brits, too, are taking a fancy to shares. Quartz, 8/31/2020

The Wall Street Journal (8/31/2020) reports that “individuals account for a greater chunk of market activity than at any time during the past 10 years” and that Asian exchanges, in particular, are dominated by individual traders (Alexander Osipovich, “Individual-Investor Boom Reshapes U.S. Stock Market”). One source “drew parallels with the dot-com boom in the 1990s.”

Number Two: new investors are embracing risky behaviors. In part, their behavior is being shaped by an intentional, designed, series of technologically-mediated “nudges” that encourages risk-taking.

But at least part of Robinhood’s success appears to have been built on a Silicon Valley playbook of behavioral nudges and push notifications, which has drawn inexperienced investors into the riskiest trading, according to an analysis of industry data and legal filings, as well as interviews with nine current and former Robinhood employees and more than a dozen customers. And the more that customers engaged in such behavior, the better it was for the company, the data shows.

More than at any other retail brokerage firm, Robinhood’s users trade the riskiest products and at the fastest pace, according to an analysis of new filings from nine brokerage firms by the research firm Alphacution for The New York Times.

In the first three months of 2020, Robinhood users traded nine times as many shares as E-Trade customers and 40 times as many shares as Charles Schwab customers, per dollar in the average customer account in the most recent quarter. They also bought and sold 88 times as many risky options contracts as Schwab customers, relative to the average account size, according to the analysis. (“Robinhood Has Lured Young Traders, Sometimes With Devastating Results” New York Times, 7/8/2020)

They are trading at eight to 40 times the rate of more experienced investors? An ETrade survey of hundreds of young (ages 18-34) investors found that they’re much more concerned about how much they can make rather than how much they can lose. ETrade reports that for younger investors:

• Risk tolerance skyrockets since the pandemic. Over half (51%) of Gen Z and Millennial investors say their risk tolerance has increased since the coronavirus outbreak, 23 percentage points higher than the total population.
• They are taking cash off the sidelines. Over one in three investors (34%) under the age of 34 said they are moving out of cash and into new positions, 15 percentage points higher than the total population.
• And they are trading more frequently. Over half of investors (51%) under the age of 34 said they are trading equities and 46% said they’re trading derivatives more frequently since the pandemic, compared to 30% and 22% of the total population, respectively.
• They’re optimistic about a quick recovery. While only 9% of young investors said their investment portfolios have recovered since the beginning of the pandemic, 50% think it will happen in the next six months, compared to 33% of the total population.
• Health concerns come first, but portfolio concerns are a close second. Personal health (58%) and investment portfolio (53%) concerns remain the top worries for young investors in the wake of the pandemic.

“The effect [of the pandemic] on the US and global economies” was way down on their list.

Mohamed el-Erian, once PIMCO’s CIO, concludes,

It is hard to overstate the extent of today’s risk-taking in US financial markets. Yes, it would take a big shock for markets to move significantly lower — such as a renewed sharp economic downturn, a considerable monetary or fiscal policy mistake, or market defaults and liquidity accidents. But should such a move occur, the likelihood of further market turmoil would be high, especially given the current lack of a short base to buffer the downturn. This exposes small retail investors to big potential losses. (“Retail stock market investors should note professionals’ caution,” Financial Times, 8/31/2020)

Partly in response, a number of these numbers articles focus on absolute-value and long-short hedging options, ways to buffer your worst-case outcomes without abandoning the stock market.

The Strength of the Weak

The US dollar shows signs of weakening, in part because of the titanic budget deficit; $2.8 trillion so far in fiscal 2020, according to the Congressional Budget Office. The term “weak dollar” is misleading, in part because we immediately associate the words “weak” and “bad.” As in, “a weak dollar is bad.”

Not necessarily. A weak dollar is a description we use when other currencies rise in value with respect to ours. If we’re used to seeing  ₤1 being worth $1.34 and suddenly it’s worth $1.50, we decry “a weak dollar.” But if you make a $1 gizmo in the US, the weak dollar means it’s automatically more affordable – hence, more attractive – to British consumers. And if you have invested in a British company, every ₤1 earned by that company suddenly returns more to you in dollars than ever before.

Morningstar suggests (8/18/2020) that investors think about international funds that do not hedge their currency exposure. Fortune adds gold: “when the dollar is down, gold, foreign developed, and emerging-market stocks tend to perform admirably” (“A weakening U.S. dollar makes these 3 assets more attractive for your portfolio,” 8/5/2020). Evie Liu, writing at Barron’s, considers both the obvious candidates such as international equity funds and the investments that would rise in value if a weaker dollar were accompanied by rising prices (something the Fed would love to see). Her watch-list includes unhedged international equities in both developed and developing markets, gold, and community, maybe TIPs and foreign bond ETFs (“It’s Time to Prepare for a Weaker Dollar,” 8/21/2020).

Those preferences seem reflected in Research Affiliates’ latest 10-year asset class projections.

The Masked Ball

Face masks have become (blessedly, since they’re about the best protection we’ve got, see “Face Masks Really Do Matter. The Scientific Evidence Is Growing,” Wall Street Journal, 8/13/2020) the fashion accessory du jour. Because of our responsibilities as college administrators and faculty, Chip and I have had occasion to order masks from more than a dozen different manufacturers. For what perspective it offers, here’s a bit of quick reflection.

1. Disposable masks are actually a decent option: they tend to be cooler than cloth masks, reasonably efficient at their primary job, reasonably cheap (we just bought 200 online for $40), and aesthetically inoffensive. They do create a regrettable amount of plastic waste.
2. Size matters, especially if your headwear tends to be L to XL. Bunches of “one size fits most” masks are a misery, which includes many of the mass-produced masks from Hanes and Fruit of the Loom. Take the opportunity to look for sized masks.
3. Function matters, which means you need to figure out what you’re going to be doing. We found that several masks that are great for wearing out for errands are incredibly hard to teach in. Proper Cloth masks, which are stylish and comfortable with behind-the-head straps, tend to adhere to your mouth when speaking.
4. Don’t obsess about the exact fabric composition: cotton, silk, poly, modal, 3D printed … Stick with sensible, general rules of thumb. Hold it up to the light; if you can see, say, your fingers through it, it’s probably too thin. Put a drop of water on the outside of it; if the water soaks in immediately, it’s probably not so protective.
5. Generally, more layers are more effective but can get awfully warm, awfully fast.
6. Masks are probably best if hand-washed. The more you wash them, the thinner and less protective the fabric gets. And frequently the elastic ear loops get twisted beyond recognition. Regardless of hand- or machine-washing, don’t use fabric softener. It contains wax which makes the mask ineffective.
7. Outdoor Research has a comfortable mask ($20) with an anti-viral coating designed to last for 30 washes. They can’t make the anti-viral claim in the US, though apparently its efficacy is recognized by European health authorities.
8. Comfortable masks are available through Vista Print and Etsy. Vista Print, which I associate with business cards, makes comfortable masks in a huge variety of patterns. Through the summer, our go-to mask has been a comfortable two-layer cotton mask from DAVEGO at Etsy.
9. For modestly-sized heads and modestly risked environments, Shon Simon – a contract clothing manufacturer – makes inexpensive masks in dozens of colors (including six iterations of “nude”) and in packages of one to 500.
10. Personalized selfie masks are gross and disturbing, avoid them. Those are the ones with your face printed on them. Ick.

There will continue to be a scientific study a week on mask design. Feel free to ignore most of them and stick to first principles. At base, the best mask is the one that you will wear consistently and properly. (“Properly” means “if air goes it in, make sure it’s covered.”) They will, with time and practice, become no more intrusive than seatbelts – now used by 91% of us, though once loathed and rebelled against – are.

Thanks!

Most especially to the folks at Queens Road for the peanuts!

Love those things.

To the folks at S&F, Wilson, Quang, Michael from Dryden, and Leah for their generous – and, in some cases, generously repeated, support.

And, as ever, to the Faithful Few who contribute monthly: William and William, Matthew, Brian, David, Doug, and Gregory!

Writing in The Wall Street Journal, Simon Cable declared “‘Long-Short’ Funds Missed Their Moment” (8/9/2020, paywall). His argument: “The stock-market volatility in the first half of 2020 should have been a near-perfect period for ‘long-short’ mutual funds and exchange-traded funds to make a killing. Unfortunately, less than one in three such funds made money for investors during this tumultuous period.” His analysis was that the market’s moves were too quick for most investors to capitalize on them (even if they recognized the opportunity).

He notes that Neuberger Berman Long-Short (NLSIX) raked in the most cash and that the ProShares Long Online/Short Stores ETF had the top YTD performance.

“Most funds are mediocre” is not a terribly useful insight. We decided to identify the 10 best performing long-short funds YTD (all posted double-digit returns) and look at their longer-term prospects. We did that by asking (a) do they qualify as MFO Great Owl funds and (b) have they also been top 10 funds over the past 3- and 5-year periods.

Our findings are reassuring and, we hope, useful. All seven MFO Great Owls posted positive YTD returns, all have been consistently excellent in risk-adjusted returns over time and all outperformed the S&P 500 this year with higher YTD returns and smaller losses (down an average of -3.5% versus -19.7% for the S&P) during the tumult in the first three months of the year.

The table below summarizes the performance of 2020’s top-ten long-short equity funds. Funds that have earned the Great Owl designation are shaded in blue.

Snapshot for the top long/short funds

These are two funds from the list above (2020’s top performers) which are also MFO Great Owl funds or, at least, have landed in the top 10 of long/short funds for 2020 as well as the preceding 3- and 5-year periods. The difference between the two designations is that Great Owls must have top quintile risked-adjusted returns in every trailing period longer than one-year; some top-performing funds are simply more volatile than that metric rewards.

RiverPark Long/Short Opportunity (RLSFX): five-star fund, MFO Great Owl, $317 million in assets, 2.0% expense ratio, $1000 minimum initial investment.

Managed by Mitch Rubin, RiverPark combines thematic analysis with stock-by-stock decisions on who to invest in and who to short. Individual companies operate in a larger environment. If that environment turns hostile, even the best-run companies will struggle. As an example, if you’re in the “big box retail” business, firms with average management will be in a death spiral and even firms with great management teams will likely just end up in slow decline. If you’re in the “next-gen battery” business, firms with average management will thrive and firms with great management will soar. RiverPark invests in the best firms in rising industries and shorts the weaker firms in declining ones. RLSFX tends to have both dramatically higher returns (9.0% annually since inception, versus 4.0% ) and greater volatility (standard deviation of 10.5%, versus 9.4%) than its peers. We profiled RLSFX in 2012, shortly after its conversion from being a hedge fund, but it’s appeared in more than a dozen articles on strong alternative funds since then.

Folks interesting in a long-only fund might like at Mr. Rubin’s RiverPark Large Growth Fund (RPXFX) which is approaching its 10^th anniversary.

Alger Dynamic Opportunities (SPEDX): five-star fund, $320 million in assets, 2.0% expense ratio, $1000 minimum initial investment.

A more-or-less old-style long/short fund: they have two teams of managers, one of which specializes in small caps. They invest long in attractive growth stocks and they short companies with deteriorating fundamentals. Their net long exposure is typically 60-70%.

Hundredfold Select (SFHYX): five-star fund, MFO Great Owl, $100 million in assets, 2.9% expense ratio, $5000 minimum initial investment.

Portfolio construction begins with a basket of high-yield fixed-income securities managed for steady returns and limited volatility. These securities are complemented with alternative strategies including a variety of short-term equity trading strategies, investments in long/short, absolute, or merger strategies, and the ability to move into cash depending on market conditions.

The management fees earned by Hundredfold Advisors are passed through to a nonprofit organization called Simply Distribute which supports medical, religious, scientific, and educational nonprofits throughout the world. Since 2004, Hundredfold Advisors has donated more than $5 million to designated charities

Longboard Alternative Growth (LONAX): four-star fund, not an MFO Great Owl, $17 million in assets, 2.24% expense ratio, $2,500 minimum initial investment.

The fund’s tactical investment process allocates to a portfolio of U.S. equities as well as alternative assets such as global bonds, currencies, TIPS, commodities, and gold.

As an aside, their website made my eyes hurt. Content is thin and I don’t even see direct links to an annual report, much less any sort of shareholder communication. Morningstar categorizes their portfolio as 94% cash and 6% other, which isn’t terribly informative. In short, they may do a fine job but you’re on your own in figuring it out.

RealityShares DIVCON Dividend Defenders ETF (DFND): five-star fund, MFO Great Owl, $39 million in assets, 1.44% expense ratio.

This passive fund tracks a custom index.  The index uses DIVCON, a forward-looking dividend rating system evaluating large-cap company health indicators based on seven key factors, with a 75% long investment in companies most likely to increase dividends and a 25% short in the firms most likely to cut their dividends.

The one immediate caution is that RealityShares other two dividend-focused ETFs are not particularly good which always raises the “luck or genius” question.

Anchor Risk-Managed Equity (ATEAX): five-star fund, MFO Great Owl, $225 million in assets, 2.05 % expense ratio, $1,000 minimum initial investment.

This is a top-down quant fund that invests in ETFs, stock mutual funds, and futures contracts. If their trend-analysis models turn negative on the stock market, they move some or all of the portfolio into Treasuries, short positions, or short ETFs. The reported portfolio turnover is 1100%.

Bottom line:

Any article that begins with the sentence, “Most funds in this category have simply not proven their worth,” is bound to be right. MFO’s founding premise is that the vast majority of funds and ETFs could vanish overnight and no one, except the managers, would be any poorer for it.

The key is remembering that “most disappoint” does not immediately signal “must disappoint.” Some managers have managed to navigate, honorably, and well, through a variety of market conditions. MFO’s Great Owl designation recognizes the funds with the most consistently excellent risk-adjusted-performance.

In 2020, all seven of the MFO Great Owls in the long-short equity category are in the black and all seven have outperformed the S&P 500’s 2.1% YTD gains. This article just highlights the four with double-digit YTD returns.

While there are some intriguing newcomers (the Virtus KAR folks seem talented and very successful across a range of funds), RiverPark Long/Short Opportunity remains the top choice based on long-term performance.

On August 24, 2020, Matthews Asia announced a long set of manager changes and one fund liquidation. While they appear in a single document, there are at least two distinct triggering events behind them.

Event One: The departure of managers Tiffany Hsiao and YuanYuan Ji. Ms. Hsiao managed Matthews China Small Companies (MCSMX, since 2015) and, with long-time lead manager Michael Oh, Matthews Asia Innovators (MATFX, since 2018). Ms. Ji was the second manager of China Small Companies. Their departure was, so far as I can tell, a surprise to all. There is no word on their reason for leaving or their next steps.

Matthews’ formal response was emphasized the firm’s unquestioned strengths and continuity: “Our firm places significant emphasis and resources on retention of talent and while we are disappointed in her decision to leave the firm, we continue to have a very deep bench of investment team talent with over 40 investment professionals.”

Event Two: The announced liquidation of Matthews Asia Value (MAVRX), which has closed to new investors and will cease to exist on September 30, 2020. The liquidation is a sad event because the strategy was thoughtful, the fund fairly successful when judged in investment terms, and the manager is fiercely intelligent and innovative. Nonetheless, the liquidation was a surprise to (almost?) no one: the fund is approaching its fifth anniversary with $10 million AUM, and assets have been dribbling away for about 18 months.

Subsequently, lead manager Beini Zhou announced his departure. CityWire avers that “The fund’s liquidation is not connected to Zhou’s departure,” a somewhat curious observation.

The departure of Ms. Hsiao is a major loss. CityWire ranks her as a “AAA” manager and describes her as “a star.” By their rating system, she was the second-ranked female portfolio manager in the US. (No, sorry, I don’t know who #1 is or how meaningful their ratings are.). She’s piloted China Small Companies to a five-star record and considerable acclaim. She’s been described as “brilliant and driven.” Over the past five years, roughly the period in which she’s managed the fund, China Small Companies has the highest returns (21.5% annualized) and highest Sharpe ratio (0.99) of any China region fund in the Lipper database. Asia Innovators, which has always been a top tier fund, has had a particularly strong performance over the past couple of years, a period that corresponds with her time on the fund.

I don’t mean to downplay the significance of Ms. Ji’s role but her tenure at Matthews is shorter and her contributions less well-documented than Ms. Hsiao’s or Mr. Zhou’s. My apologies if I’m underestimating her contributions.

“Major loss,” though, is not the same thing as “irreparable loss.” Ms. Tsiao’s departure triggered several reassignments within the Matthews corps.

The Zhou changes

Matthews Asia Value (MAVRX)

Out: Beini Zhou

In: Robert Horrocks

Note: the fund liquidates as month’s end, so Mr. Horrocks is a sort of caretaker.

Matthews Emerging Markets Equity Fund (MEGMX)

Out: Beini Zhou

In: John Paul Lech remains as the sole manager; he’s been on board since inception.

Note: the fund launched in April 2020; it is tiny but has had a strong opening run. The key is that this is one of Matthews’ first moves outside of Asia. Fortunately, Mr. Lech has had a long career as a diversified EM analyst with Oppenheimer before joining Matthews.  It might be emblematic that his languages are Spanish, French, and Portuguese rather than, say, Mandarin (one of Mr. Zhou’s languages).

The Hsiao changes

Matthews China Small Companies (MCSMX)

Out: Tiffany Hsiao and YuanYuan Ji

In: Winnie Chwang and Andrew Mattock

Note: Ms. Chwang is co-manager of Matthews China and of Matthews Asia ESG, and had worked as an analyst on China Small Companies. Mr. Mattock is the lead manager of Matthews China (MCHNX) which has the third-highest returns of any China-centered fund over the past five years. The folks at Matthews report that “Both Winnie and Andrew have significant experience researching and investing in small companies in China and have a deep understanding of the China Small Companies Strategy’s current portfolio holdings.”

Matthews Asia Innovators Fund (MATFX)

Out: Tiffany Hsiao

In: Raymond Deng as co-manager, Michael Oh continues to lead the fund.

Note: Mr. Deng is a China specialist, as Ms. Hsiao was. Mr. Oh continues to lead the fund.

The Hsiao and Zhou change

Matthews Asia Small Companies Fund (MSMLX)

Out: Beini Zhou and Tiffany Hsiao

In: Vivek Tanneeru

Note: Mr. Tanneeru co-manages Matthews Asia ESG, where he remains. He’s a well-respected pan-Asia generalist rather than a country specialist, with experience on the Asia Dividend team.

The other changes

These were made “in order to add specific country and sector expertise to our core regional Asia portfolios,” so their inclusion with the others is mostly a matter of convenience.

Matthews Asia Growth & Income (MACSX)

Out: John Paul Lech, to focus only on Emerging Markets Equity

In: Satya Patel, as co-manager behind Robert Horrocks, Ph.D., and Kenneth Lowe

Note: the Big Dogs remain at the helm, so the changes likely have minimal effect. Mr. Patel is part of Teresa Kong’s income team and his role here is to provide additional income support expertise (convertibles, dividend stocks, credit opportunities) for the Income side of “Growth & Income.”

Matthews Asia Growth (MPACX)

Out: no one.

In: Taizo Ishida remains at the helm but Michael Oh, as co-manager

Note: Mr. Oh has been added to bring more specific sector expertise. This fund, like his Innovators fund, are pure growth Pan-Asia funds so the addition makes particular sense.

Bottom line

The departures strike us as substantial but manageable losses. Matthews has handled manager transitions well in the past, it has a lot of in-house talent and has made what appear to be sensible reassignments. If you’re currently invested in any of the funds affected, I’d surely spend a bit of extra time and attention tracking performance and reading the new manager’s discussions, but there is no cause for shifting away from the funds. If I were not invested but had been considering the possibility, I would stay the course. Learn a bit more about the new folks then build up from modest initial positions as your comfort grows.

I am selective in the analysts that I receive market commentary from. They are overwhelmingly cautious. The buzz word “FOMO or Fear Of Missing Out” is used to describe retail investors piling into markets. The quote that sums up my feelings best comes from Liz Ann Sonders of Charles Schwab in “High Hopes: S&P 500 Hits All Time High Amid Pandemic/Recession”, published on Advisor Perspectives.

I worry about the signs of froth in the market and among some behavioral measures of investor sentiment: not to mention traditional valuation metrics that are historically stretched. This is not an environment in which greed should dominate investment decisions; but instead one for discipline around diversification and periodic rebalancing…

This article looks at a brief history of global and alternative funds, two Model Portfolios created from these funds, and a summary of some of the best alternative and global funds available to individual investors, in my opinion. Readers that are only interested in a Short List of Funds including fund strategies may want to skip to the Summary Section. Those interested in why I chose these funds should wade through the rest of the article.

The Figure below shows some recent data on consumer spending, business and retail sales, employment, interest rates, inflation, and the value of the dollar. The trends are that inflation remains modest, interest rates are historically low, sales and spending have recovered to within a few percent of what they were in 2017. Employment recovery has slowed. The dollar strengthened during the early part of the recession and has been weakening since. Meanwhile, the S&P 500 has increased by 15% during the past 12 months.

Figure #1 Snapshot of the U.S. Economy

Source: Created by the Author using the St. Louis Federal Reserve FRED database

Meanwhile, commercial chapter 11 filings for the last four months are up 42% compared to the same four months in 2019. According to Challenger Gray & Christmas, “Companies announced nearly 1.6 million permanent job cuts in the first half of 2020…” The Conference Board Leading Indicators have been growing at a slower rate for the past two months. Tom Roseen at Lipper Alpha Insight points out that for the seventeenth week in a row, investors redeemed equity mutual funds, withdrawing $5.1 billion while equity ETFs had net outflows of $1.5 billion. Corporate profits are reflecting the realities of the recession as shown in Figure #2.

Figure #2: Impact on Corporate Profits

Source: Created by the Author using the St. Louis Federal Reserve FRED database

A Brief History of Global and Alternative Funds

To look at the longer-term performance of global and alternative funds, I extracted 225 funds from the Mutual Fund Observer Premium screener that have been in existence for at least 15 years. What we can see in Table #1 is that Global and International Income Funds, Absolute Return Bonds, and Conservative Mixed Asset have done well in bull and bear markets and when interest rates are falling, but not well in a year (2005) when inflation was rising.

During bull markets and when interest rates are falling, Flexible Income and Portfolio, Global Macro, Long/short, and Multi-Strategy Funds have done well. All but Flexible Income did well in 2005 when inflation was rising. In a mild recession or bear market, these funds do well but are subject to larger losses during a financial crisis, but still lower than equity.

Table #1: Long Term Performance of Global and Alternative Funds

Source: Created by the Author using Lipper Global Datafeed and the MFO Premium screener

What the table above shows is that there are not many funds that have a long term history in these categories. They may be new to retail investors, suffer from survivor bias, or are new financial innovations. Descriptions of the Lipper Categories came from Refinitiv Lipper Classifications and Refinitiv Lipper U.S. Funds Classifications. A description of the categories follows:

1. 1. Global Income Funds: Funds that state in their prospectus that they invest primarily in U.S. dollar and non-U.S. dollar debt securities of issuers located in at least three countries, one of which may be the United States.
   2. International Income Funds: Funds that state in their prospectus that they invest primarily in U.S. dollar and non-U.S. dollar debt securities of issuers located in at least countries, excluding the United States, except in periods of market weakness.
   3. Absolute Return Bond Funds: Funds that aim for positive returns in all market conditions and invest primarily in debt securities. The funds are not benchmarked against a traditional long-only market index but rather have the aim of outperforming a cash or risk-free benchmark.
   4. Absolute Return Funds: Funds that aim for positive returns in all market conditions. The goal is not to benchmark against a traditional long-only market index, but rather to outperform a cash or risk-free benchmark.
   5. Flexible Portfolio Funds: Funds that allocate their investments to both domestic and foreign securities across traditional asset classes with a focus on total return. The traditional asset classes utilized are common stocks, bonds, and money market instruments.
   6. Alternative Multi-Strategy Funds: Funds that, by prospectus language, seek total returns through the management of several different hedge-like strategies. These funds are typically quantitatively driven to measure the existing relationship between instruments and in some cases to identify a position in which the risk adjusted spread between these instruments represents an opportunity for the investment manager.
   7. Alternative Global Macro Funds: Funds that, by prospectus language, invest around the world using economic theory to justify the decision-making process. The strategy is typically based on forecasts and analysis about interest rate trends, the general flow of funds, political changes, government policies, intergovernmental relations, and other broad systemic factors. These funds generally trade a wide range of markets and geographic regions, employing a broad range of trading ideas and instruments.
   8. Alternative Long/Short Equity Funds: Domestic or foreign funds that employ portfolio strategies combining long holdings of equities with short sales of equity, equity options, or equity index options. The funds may be either net long or net short, depending on the portfolio manager’s view of the market.

In this article, I screened over 50 funds, with several in each category, that have done well over the past five years but focusing on year to date performance. The following busy Figure below is the funds included in Model Portfolios and a few other interesting funds. In the Symbol column, the symbols highlighted in green are those included in the Model Portfolios in this article, and those in blue are ones that I found attractive. The table is sorted by those included in Model Portfolios, the MFO Risk Rank, and the Fund Flows. In the Name Column, the names highlighted in blue are Great Owl Funds. In the Lipper Category Column, the Large-Cap Core category for SWAN is misleading because it mostly invests in treasuries and uses options. The funds in the MAXDD column that are highlighted in blue have both low drawdowns and high fund flows. The funds that are highlighted in red in the YTD column raise the red flag that the fund has risen high quickly. The red cells in the years 2106 through 2019 highlight funds that have inconsistent returns. The last two columns highlight funds that do well with stimulus or in a low-interest-rate environment. What the table shows is that investors are currently seeking downside protection.

Table #2: Lower Risk, Higher Return Global and Alternative Funds

Source: Created by the Author using Lipper Global Datafeed and the MFO Premium screener

Overview of Model Portfolio Results

In this article, I build two portfolios selecting funds using Mutual Fund Observer Premium screens to the Lipper Global Database. These two portfolios are compared to the Vanguard Target Retirement 2020 Fund (VTWNX) in Figure #3 below. The link to Backtest Portfolio Asset Allocation is provided here. Interested readers can change funds and allocations. I like that the Combined Global and Defensive Portfolio had low drawdowns and decent returns.

Figure #3: Model Portfolios Compared to the Vanguard Target Retirement 2020 Fund

Source: Created by the Author using Portfolio Visualizer

Both portfolios have close to 20% allocation to equities, 50 to 60 percent bonds, and 20 to 25% in cash. Some of these funds hedge and use leverage to manage risk.

Figure #4: Model Portfolio Allocations

Source: Created by the Author using Portfolio Visualizer

One criterion that I used for selecting global funds was that each fund had to have at least 30% of its assets outside of the United States. Portfolio Visualizer was used to reduce the original fifty funds into a Conservative Global Portfolio that had a drawdown of 2.6% this year with an annualized return through July of 9.5%. My last several articles on Seeking Alpha have looked at defensive funds. The second portfolio in this article combines the funds from the Conservative Global Portfolio with a Defensive Portfolio. Portfolio Visualizer is used to create a portfolio that maximizes the Sharpe Ratio over the 12 months. The link to Portfolio Optimization is here.

Global Portfolio

Each fund in the Global Portfolio has an age of 5 to 25 years except for the Fidelity Multi-Asset Income younger share class Fund (FMSDX). The portfolio had a maximum drawdown of 2.6 on a monthly basis and has an annualized return of 9.5 percent year to date.

Table #3: Global Portfolio – Mutual Fund Observer Portfolio Tool

Source:  Created by the Author using Lipper Global Datafeed and the MFO Premium screener

All of the funds outperformed the BlackRock iShares Core Conservative Allocation ETF (AOK) during the first seven months of the year. Alger Dynamic Opportunities (SPEDX) and Horizon Issachar (LIONX) have done well, but raise the question about how much they might fall if conditions changes. Matthews Asia Dividend (MAPIX) raises concerns about the impact of trade tensions if conditions worsen.

Figure #5: Global Portfolio Funds Year to Date

Created by the Author using Yahoo Finance

The next table shows how well the funds have done since January 2018. The future is guaranteed to be different than the past, but past performance does give a perspective of how the funds might behave in stressed conditions.

Figure #6: Global Portfolio Funds From January 2018

Created by the Author using Yahoo Finance

Combined Global and Defensive Portfolio

I wanted to see how a Model Portfolio would perform if I combined the Global Portfolio above with Defensive Funds that I had written about on Seeking Alpha. I combined the funds and used Portfolio Visualizer to maximize the Sharpe Ratio. The results are shown using the Portfolio Visualizer Portfolio Tool. One thing to note is that the recent trend is downward on many of the more defensive funds.

Table #4: Global and Defensive Portfolio – Mutual Fund Observer Portfolio Tool

Source:  Created by the Author using Lipper Global Datafeed and the MFO Premium screener

Investors interested in Advisors Shares Spectrum Low Volatility (SVARX), but don’t like the high expense ratio also may want to evaluate Columbia Thermostat Flexible Portfolio (CTAFX and COTZX) which are available at Vanguard. The Prospectus highlights changes Columbia Thermostat implemented in May which increases the allocation to stocks.

Figure #7: Global and Defensive Portfolio Funds Year to Date

Created by the Author using Yahoo Finance

Figure #8: Global and Defensive Portfolio Funds from January 2018

Created by the Author using Yahoo Finance

Summary – The Short List

After screening all global and alternative funds that are available to retail investors, reviewing the MFO metrics for short term and intermediate-term performance, using Portfolio Visualizer to narrow the list, and reviewing chart trends, I selected the following funds from 14 different Lipper Categories to look into their strategies. I have arranged them loosely starting with defensive funds, followed by safer bonds, mixed assets, and alternative funds, and ending with funds that focus more on equity. Investors should have diversified, balanced portfolios appropriate for their risk tolerance. As someone nearing retirement and with the current high-risk environment, I choose to focus more on managing risk. As a traditional bond and stock fund investor (who adjusts allocations according to the business cycle), I limit exposure to alternatives to 15% of my portfolio. The strategies are paraphrased below and investors are advised to read the prospectus before investing.

1. 1. Flexible Income Funds:

Aptus Defined Risk (DRSK) invests 90% or more in investment-grade bonds with maturities spread over the next 7 or 8 years. The Fund invests in Call Options in individual companies and ETFs with expirations of 1 to 6 months to gain exposure to security appreciation and Put Options on ETFs to protect from market declines. DRSK has too short of a history for an accurate comparison to the S&P 500. For the past year and a half, it has returned 14.75 compared to 15.8% for the S&P 500. During the recent bear market, it returned 2.9% compared to losing 19.5% for the S&P 500 on a monthly basis. I like DRSK for the downside protection.

ALTERNATIVE FUND: Advisory Research Strategic Income (ADVNX) has an 8-year performance record and is classified as a Great Owl.

1. 2. Mixed Asset Target Today: Fidelity Freedom Index Income (FIKFX) has done well this year. It is a fund of funds with 11% in domestic equities, 8% in international equities, 46% in investment-grade bonds, 3% in long term treasuries, 11% in inflation-protected treasuries, and 23% in short-term funds. That is a safe allocation for many conservative investors during this uncertain time. Over the next year or two, FIKFX will be stable, but won’t have the tailwinds of falling interest rates.
   3. Absolute Return Funds attempt to have positive returns in all markets and to outperform a cash or risk-free benchmark. I list four funds here and have written that I prefer investing in a basket of alternatives rather than having larger allocations to a single fund. The following four funds were effective in reducing volatility this year. The three Absolute Return Funds (ATACX, PHDG, TAIL) and SWAN returned 14.9%, 5.45, 23.5%, and 0.1% respectively during the recent bear market. On an annualized basis year to date, ATACX, PHDG, TAIL, and SWAN returned 33.6%, 14.0%, 5.2%, and 19.9% respectively. ATACX and PHDG have been in existence for over seven years with ATACX being classified as a Great Owl Fund and both are listed as Honor Roll. SWAN and TAIL are relatively new funds.

1. 1. 1. ATAC Rotation (ATACX) invests in equity and bond ETFs and may also use inverse and leveraged exchange-traded products. ATAC uses quantitative analysis to allocate “primarily between equities and bonds depending on the potential for near-term stock market volatility as signaled through inter-market trends and relative prices.”
      2. Invesco S&P Downside Hedged (PHDG) is an actively managed ETF that uses quantitative analysis to invest primarily in equity ETFs, but also volatility funds and cash. The Fund invests such that a “greater portion of the Benchmark’s weight will be allocated to equity securities during periods of low volatility, and a greater portion of its weight will be allocated to the VIX Futures Index during periods of increased volatility.”
      3. Amplify BlackSwan Growth & Treasury (SWAN) invests using a rules-based, quantitative approach with least 80% primarily in U.S. Treasuries, and long-dated call options on the SPDR SYP 500 ETF. The goal is to preserve capital during “Black Swan Events” while attempting to capture 70% of the upside of the S&P 500 over a full market cycle. The Prospectus cautions that SWAN is not a substitute for a money market fund, nor does it attempt to replicate the returns of the S&P 500.
      4. Cambria Tail Risk (TAIL) is more like an Absolute Return Fund so I include it here. It invests “in cash and U.S. government bonds, and utilizing a put option strategy to manage the risk of a significant negative movement in the value of domestic equities”. Cambria spends about one percent of the fund’s assets each month buying put options.

4. Alternative Multi-Strategy Funds: Rowe Price Multi-Strategy Total Return (TMSRX) is a two-year fund that had a maximum drawdown of 5% on a monthly basis and has returned 8.2% on an annualized basis year to date. Its goal is to have returns that are attractive to cash while maintaining low volatility. The fund primarily seeks exposure to the following strategies: Macro and Absolute Return; Fixed Income Absolute Return; Equity Research Long/Short; Quantitative Equity Long/Short; Volatility Relative Value; Style Premia; Dynamic Global FX; Dynamic Credit; and Global Stock. For those investors who want reasonable returns, this single fund may be the basket of alternatives that I mentioned earlier.

ALTERNATIVE FUND: Grant Park Multi Alternative Strategies (GPANX) is a six-year-old fund with $294 million in assets under management. It is on Mutual Fund Observer’s Honor Roll. Its expenses are 1.9% with a yield of 10.8%. It had no drawdown on a monthly basis year to date and has an annualized return of 6.4% for the past year. It is available through Fidelity.

The Fund allocates its assets among four independent, underlying strategies. Each strategy seeks to identify profitable opportunities across multiple, liquid foreign, and domestic markets. The Fund invests primarily in (1) derivatives, (2) US equities, (3) open- and closed-end funds and exchange-traded funds, (4) American Depository Receipts, (5) currencies and (6) domestic and foreign investment grade fixed income instruments.

1. 5. International Income Funds: Vanguard International Bond (VTABX) invests in government, government agency, corporate, and securitized non-U.S. investment-grade fixed-income investments, all issued in currencies other than the U.S. dollar and with maturities of more than one year. It hedges against currency risk. The fund has been a consistent performer with a yield of over 3%. It won’t have the benefit of falling interest rates over the next year or two but may benefit if the dollar continues to weaken.
   6. Mixed Asset Target Conservative: Vanguard LifeStrategy Income (VASIX) is a fund of funds that has a target allocation of 56% to Vanguard Total Bond Market II Index Fund, 24% to Vanguard Total International Bond Index Fund, 12% to Vanguard Total Stock Market Index Fund, and 8% to Vanguard Total International Stock Index Fund. It is a good conservative fund that will not have the tailwind of falling interest rates but will benefit if the dollar continues to weaken. Some investors may want to invest in the Admiral shares of the component funds and rebalance themselves.
   7. Alternative Global Macro Funds: Rowe Price Dynamic Global Bond (RPIEX) normally invests at least 80% of its net assets in bonds, and seeks to offer some protection against rising interest rates and provide a low correlation with the equity markets. The fund normally invests at least 40% of its net assets in foreign securities, including securities of emerging market issuers, which may be denominated in U.S. dollars or non-U.S. dollar currencies.
   8. Global Income Funds: Janus Global Henderson Global Bond (JHBTX) invests at least 80% of its net assets in corporate bonds, government notes and bonds, convertible bonds, commercial and residential mortgage-backed securities, and zero-coupon bonds. The Fund invests in corporate debt securities of issuers in a number of different countries including emerging markets, which may include the United States. The Fund will not have the tailwind of falling interest rates.
   9. Alternative Credit Focus: WSTCM Credit Select Risk-Managed (WAMBX) uses a quantitative model to invest in a combination of U.S. high-yield debt securities, U.S. investment-grade debt securities, and U.S. Treasury debt obligations mostly within the U.S.
   10. Multi-Sector Income: State Street Total Return Tactical (TOTL) invests at least 80% of the Fund’s net assets primarily in securities issued or guaranteed by the U.S. government or its agencies, instrumentalities or sponsored corporations; inflation-protected public obligations of the U.S. Treasury; agency and non-agency residential mortgage-backed securities; agency and non-agency commercial mortgage-backed securities; agency and non-agency asset-backed securities; domestic corporate bonds; fixed income securities issued by foreign corporations and foreign governments including emerging markets; bank loans; municipal bonds; and other securities of any maturity. The fund has been a consistent performer and has a yield of over 3%.
   11. Absolute Return Bond Funds: Carillon Reams Unconstrained Bond (SUBFX, formerly Scout Unconstrained Bond) will invest at least 80% of its net assets in bonds, debt securities, mortgage- and asset-backed securities and other similar instruments issued by various U.S. and non-U.S. public- or private-sector entities. The Fund may invest in high yield bonds, options, and futures contracts.
   12. Flexible Portfolio Funds:

a. Fidelity Multi-Asset Income (FMSDX) invests in domestic and foreign issuers of equity and debt securities, including common and preferred stock, investment-grade debt securities, lower-quality debt securities, floating-rate securities, and convertible securities. The Managers analyze a security’s structural features and current pricing, its issuer’s potential for success, and the credit, currency, and economic risks of the security and its issuer to select investments.

b. ALTERNATIVE FUND: Columbia Thermostat (CTFAX, COTZX) invests such that when “the S&P 500® Index goes up in relation to trading range bands that are predetermined by the Investment Manager, the Fund sells a portion of its stock Portfolio Funds and invests more in the bond Portfolio Funds, and when the S&P 500® Index goes down in relation to the predetermined bands, the Fund increases its investment in the stock Portfolio Funds. I like the approach of CTFAX, but include it as an alternative fund because in May it changed its allocations to hold a higher percentage in stocks. These are available through Vanguard.

13. International Multi-Cap Core: Vanguard Developed Markets (VTMGX) “employs an indexing investment approach designed to track the performance of the FTSE Developed All Cap ex US Index, a market-capitalization-weighted index that is made up of approximately 3873 common stocks of large-, mid-, and small-cap companies located in Canada and the major markets of Europe and the Pacific region. If the dollar continues to weaken then Europe may be the beneficiary. I own two European equity funds, but like VTMGX as being more diversified and less volatile.

14. Alternative Long/Short Equity Funds have a low correlation to the stock market and can be used to lower volatility. After reviewing the available funds in this category, I am not inclined to invest in them. For a slightly different take, see David Snowball’s “The Long and Short of It” elsewhere in this month’s issue.

Alger Dynamic Opportunities (SPEDX) invests long in companies with rapidly growing demand or market dominance that may be benefitting from new regulations, new product innovation, or new management. The Fund may short companies that it believes will lag the market. The Fund has had an annualized return of 27.4 percent year to date with growth doing so well and is attracting new funds. I took profits in my growth funds over the past couple of months and will pass on SPEDX.

ALTERNATIVE FUND: Hussman Strategic Growth (HSGFX)

Disclaimer

I am not an economist nor an investment professional. I became interested in economic forecasting and modeling in 2007 when a mortgage loan officer told me that there was a huge financial crisis coming. There were signs of financial stress if you knew where to look. I have read dozens of books on business cycles since then. Discovering the rich database at the St. Louis Federal Reserve (FRED) provides most of the data to create an Investment Model. The tools at Mutual Fund Observer provide the means for implementing and validating the Investment Model.

On August 26, I added Palm Valley Capital Fund (PVCMX) to my non-retirement portfolio.

Why does this make sense?

My portfolio has a simple, static asset allocation: 50% stocks, 50% not. Within stocks, the default is 50% here, 50% there plus 50% larger, 50% smaller. When we calculated the likely downside of my portfolio in a 2008-like event, the loss was in the range of 25%. That’s not catastrophic.

Currently, my portfolio is overweight in international stocks, 50% rather than my targeted 25%, and underweight in US stocks, at 15%. That’s driven by two forces: (1) managers who have the freedom to invest in the US or elsewhere have, with some frequency, been choosing “elsewhere.” (2) The funds in my automatic investing plan (T Rowe Price Spectrum Income, Seafarer Overseas, Grandeur Peak Global Microcap) offer more fixed income and international equity exposure than US equity.

Palm Valley Capital, a fund that’s value-oriented, largely domestic and largely small cap, begins to redress that imbalance.

Why now?

On August 26, Palm Valley announced that the fund was now available through TD Ameritrade. I assume that it will be added to the Schwab list soon, given the acquisition of TD by Schwab. The advisor is still working on Fidelity.

The fund has already attracted $12.6 million, with modest but steady inflows. It appears, for example, that the fund drew an additional $1 million in the last week of August. The managers have invested between $100-500,000 in, each, in addition to their stake in the adviser.

What do they do?

Palm Valley Capital (PVCMX) is an absolute-value small cap equity fund managed by Eric Cinnamond and Jayme Wiggins. Very few equity managers hew to an absolute value orientation. At base, it recognizes that stocks are worth owning but they’re not always worth owning. They are risky and owning them requires some margin of safety built into the price to compensate you for that risk. The absolute value mantra is: “if it’s not cheap enough, I’m not buying.”

In general, that means that most absolute value managers are … well, unemployed. There’s an endless, painful cycle that such managers face: the market crashes, they deploy the often substantial cash reserves when everyone else is selling in a panic, the fund soars, investors (belatedly) rush in, and then the market returns to normal. “Normal” generally means a period of rational exuberance (in which absolute value managers make a bunch of money) then a period of irrational exuberance (in which they sell off holdings which have become overvalued and have lost their margin of safety, and often find few replacements). Cash builds as markets soar, investors grow restless then charge off in search of more exciting options … often right around the time the market crashes.

Mr. Cinnamond has been navigating these waters since 1996, first at Evergreen Small Cap (1996-98), then Intrepid Endurance (1998-2010), and finally Aston/River Road Independent Value (2010-2016). Mr. Wiggins started at Intrepid in 2002 and succeeded Mr. Cinnamond as manager of Intrepid Endurance in 2010 when he was also Intrepid’s chief investment officer.

In 2019, the duo launched Palm Valley Capital Fund which has performed brilliantly. It is a small-cap value fund with significant exposure to microcap stocks; Morningstar classifies it as a small-core fund. Here is Morningstar’s report for the top three small value and blend funds for 2020.

Depending on whether you consider it small value or small core, it’s beating its peers by 25 – 30% YTD.

Small core is led by Aperture Discovery Equity (ADISX), a fund with a record of less than a year which is advised by the US branch of a fairly large UK adviser. It’s a long/short small-cap fund that reportedly it booked a 60% gain in Q2. Lipper considers it a long/short equity fund. Either assignment makes sense since the fund describes itself as “primarily” a long-based small-cap fund that “opportunistically …may also take short positions.” No idea of how much of 2020’s gains are attributable to long versus short positions. The fund sports a painfully high expense ratio (2.45%) with a very low investment minimum. The manager is from the private investment world; most recently, Diker Investments LLC, a small- and micro-cap specialist.

Small value is led by NorthStar Micro Cap (NSMVX), a hedge fund that converted about 10 years ago. We profiled their dividend fund last year. Neither Aperture nor North Star holds much cash.

Palm Valley falls in second place, regardless of which category you assign it to. Palm Valley is distinguished from its two competitors by having:

• managers with far longer track records
• substantially lower expense ratios
• an absolute-value orientation.

That last point provides striking context for the fund’s 2020 performance: the portfolio generated 15% returns while averaging about 70% in cash. (The actual stake has ranged from 52% – 92% as opportunities for buying arose or holdings became overvalued and had to be trimmed, but the managers agree that 70% is “a good average to use.) The math requires that the average stock in the portfolio has returned about 50% YTD, which is a yawning chasm from the 15% average loss for small-value funds as a group.

Bottom line

We noted in our May 2020 Elevator Talk with Messrs. Cinnamond and Wiggins that the fund has excelled because of the presence of two very good stock pickers and a rigid investment discipline. There are few better stewards in the small-cap space. I had previously invested in both Intrepid Endurance and Aston / RiverRoad Independent Value. That is not a “buy” recommendation because we don’t make buy recommendations. It is a recommendation that investors who are leery of the increasingly toppy behavior of the large-cap growth stocks that have dominated the past decade, might want to move, sooner rather than later, to expand their due-diligence list to include Palm Valley and the handful of remaining absolute-value funds that we’ve profiled before.

On August 31, I added T. Rowe Price Multi-Strategy Total Return (TMSRX) to my non-retirement portfolio. I funded that position by transferring about half of my stake in T. Rowe Price Spectrum Income (RPSIX).

Why does this make sense?

I traditionally have minimal savings, in the sense of money in a savings account at the bank. That decision makes sense for me because my income is incredibly predictable (a perk of being a tenured senior member of the faculty at a strong college), though it grows minimally. Because savings accounts have for so long offered near-zero to negative real returns, I chose to keep the money otherwise destined for savings in exceedingly low volatility funds that offered the prospect of low- to mid-single-digit returns. RiverPark Short Term High Yield (RPHYX, 3% annual returns, 0.8% standard deviation, 1% maximum drawdown since inception) and Spectrum Income (RPSIX, 4.5% annual reports, 5.1% standard deviation, 9.7% maximum drawdown over the same 9-year period) earned spots in my portfolio as a low-volatility, steady returns sort of funds.

I’ve been tracking TMSRX since inception, about 2.5 years ago. It has offered slightly higher returns since inception than RPSIX has over the same period (about 5.5% annually versus 5.0%) with substantially lower volatility (5.8% standard deviation versus 7.9%, maximum drawdown of -4.7% versus -9.7%) and a lower correlation to the US stock market.

Why now?

This change has been on my mind since we profiled Multi-Strategic Total Return in July 2020 but, like you, I’d had a bunch of other stuff on my mind. The decision to add Palm Valley Capital (see Portfolio Update #1 in this issue) offered a convenient spur to make this second adjustment.

The fund has attracted $93 million, with very modest inflows. It appears, for example, that the fund drew an additional $1 million in the last week of August. Manager Richard de los Reyes has invested over $1 million in his fund and Stefan Hubrich has invested between $500,000 and $1 million.

What do they do?

This is a hedge fund-like operation that draws on T. Rowe Price’s vast, global network of analysts who cover a myriad of asset classes. The managers seek to invest in “non-market sources of return,” that is, returns that can be delivered whether the market rises or not. That’s possible by choosing investments that are intrinsically uncorrelated with the market or by using hedges to offset market exposure. If, for example, you have a stock investor who is capable of using good security selection to produce returns 4% higher than the market’s, you would then hedge your market exposure so that you could harvest the 4%. When the market rises or falls by 10%, you would still earn 4%.

The strategies currently available to the managers include Macro and Absolute Return; Fixed Income Absolute Return; Equity Research Long/Short; Quantitative Equity Long/Short; Volatility Relative Value; Style Premia; Dynamic Global FX; Dynamic Credit; and Global Stock.

That lineup might expand as Price discovers new sources of non-market returns.

Bottom line

This is a tweak rather than a spasm. I think I can modestly raise my portfolio’s likely returns while adding a bit more insulation against market volatility and decline.