On June 23, 2023, Robert B. Bruce (1931-2023) passed away. It diminishes a rich life and generous soul to describe him merely as “one of the portfolio managers of the Bruce Fund.” A Wisconsin graduate, he had a long-time friendship with Ab Nicholas, another renowned investor, and namesake of the Nicholas Fund, with whom he created an endowment for Wisconsin athletics. His obituary celebrates “a model of hard work, generosity, and unpretentious success” who passed away “in the embrace of his family.” From 1965-1972, Bob helped manage the Mathers Fund (MATRX) to phenomenal success, then set out on his own in 1972. He eventually purchased a small mutual fund in 1983, brought on his eldest son, Jeff, as partner and co-manager, and crafted a 40-year record of distinction and success.

But what now? What’s to be made of Bruce (the fund) after Bruce (the founder)?

Good question! Our May 2020 profile of the fund offered this Bottom Line:

Bruce is an enigmatic fund because its managers choose for it to be so. They don’t explain themselves to the public, though they do answer calls from their investors. They don’t have “a formula,” don’t rely on rigorous quantitative analysis, and don’t have “a deep bench” behind them. They do, so far as I can tell, talk to lots of contacts and industry insiders to keep a clear view of where risks and opportunities lie. They do maintain consistently low portfolio turnover while still moving when the opportunity set arises.

The two cautions about the fund are (1) the elder Mr. Bruce’s age and the implication of moving from a two-person team to a single manager without a partner and (2) the insensitivity of the portfolio to the sustainability, in an ESG sense, of the portfolio’s holdings.

That said, it is hard to imagine why an independent-minded investor wouldn’t have the fund on their due-diligence list.

Now that the first has come to pass, what’s an investor in the $500 million fund to do? That stirred a healthy conversation on the MFO discussion board and a call to manager Jeff Bruce.

The worst-case outcome is a replay of the fate of the Mathers Fund. Thomas Mathers (1914-2007) was an acerbic “go-go growth manager with an iron stomach.” He launched Mathers Fund in 1965 with three co-managers. It had a slow start, then took off, excelling in both bull and bear markets. Mr. Bruce left in 1972, and Mr. Mathers, in a move he came to regret, handed the fund off to Henry Van der Eb in 1974 and sold the advisor to him in 1981. Mr. Van der Eb describes himself as “a dyed-in-the-wool value guy.” Others likely would have said, “perma-bear.” There’s little question that Mr. Mathers would have described him as “my biggest mistake.” Under Mr. Van der Eb, Mathers transformed into a stock-light bear fund that so infuriated Mr. Mathers that he demanded that his name be taken off the fund. Mr. Van der Eb refused. Assets withered. Gabelli/GAMCO bought the fund in 1999 after a decade in which the fund trailed the S&P 500 by 18% to 3% and also trailed the average money market. Mr. Van der Eb chose to close the fund in 2018. Chuck Jaffe offered this obituary:

According to Mathers’ own annual report at the end of 2017, a $10,000 investment in the fund made when it opened in 1965 was worth $195,153 by Dec. 31, 2017; the same amount invested in the S&P 500 was worth $1.48 million.

In short, on the five-decade scale from one to disaster, Mathers Fund is a financial Chernobyl, a nuclear wreck.

Chuck always had a way with words.

Mathers is the worst-case outcome: an exceptional fund reversing direction, becoming something entirely new (and alien), suffering collapsing returns and soaring expenses. But it is not the template for manager changes in eponymous funds; that is, funds bearing the name of their founding manager(s). In some cases, the transition is utterly seamless: the Mairs and Power funds, specialists in investing with exceptional care in the US Midwest, have managed four sets of manager successions without a hiccup; each of their four funds carries a four-star designation from Morningstar.

In other cases, the transition is clouded by external factors. The Fasciano Fund was the top small cap fund of the 1990s on both an absolute return and risk-adjusted return basis. It was Michael Fasciano’s vehicle, and he drove it well. The capsule is that Michael is the sort of manager that T. Rowe Price loves: the sensible, disciplined, consistent guy who wins by hitting for average rather than for power and who rarely strikes out. And yet, Fasciano is no more. We detailed the story of the rise and fall of one of our favorite small cap funds, but the short version is the fund soared, Michael partnered with Neuberger-Berman for support, Neuberger got bought by Lehman Brothers shortly before their cataclysmic failure, and in a desperate attempt to stay afloat, Lehman ordered thousands of layoffs. Mr. Fasciano was among them, and his fund was merged out of existence.

Our colleague Ed Studzinski’s question for such funds was always the same: “Yes, but what if the manager gets hit by a bus tomorrow? What are their shareholders to do?”

The short answer: absent an obvious red flag, chill out. You’ll be fine.

To reach that conclusion, we looked at the performance of a handful of famous eponymous funds following their founders’ departure, whether through retirement, death, or dismissal. In pretty much all cases, funds flourished – at least in terms of continuing their traditional risk-adjusted performance – in the years immediately following their founders’ departure. Here’s what we found.

Nicholas without Nicholas, seven years

Albert “Ab” Nicholas, an old friend of Robert Bruce’s, passed away in August 2016 at the age of 85. He was, with his son David, co-manager of Nicholas Fund until his last days. Nicholas Fund was launched in 1969, with son David Nicholas joining as co-manager in 2011. With Mr. Nicholas’ passing, Michael Shelton was elevated to co-manager. Jeff Strong joined the team last year.

Nicholas is a four-star fund with $3.6 billion in assets. It’s characterized as a large-growth fund with a smattering of mid-cap names. We spoke in July 2023 with Larry Pavelec, COO and Executive Vice President of the adviser, about their experience managing in Mr. Nicholas’ wake.

Every firm is different. Ab’s passing gave us the opportunity for a deep reset and self-analysis. Ab was skeptical of tech and preferred backdoor tech, whereas Dave Nicholas has grown up with a greater comfort level with technology as central to our lives, and he recognizes companies like Microsoft and Apple as free cash-flow machines. We’re also probably more cap conscious than before because our investors need it. Ab was a go-anywhere guy who might move the fund to value. And we’re a little more open to marketing, though we’re sensitive to the challenge of having too much noise in the system.

David has worked with Ab on this strategy for 30+ years. The one thing that did not change was the philosophy that we follow. We try to be disciplined. Believe in the philosophy. We put our clients first. We seek to invest in companies with sustainable advantages, but we do so with a strict valuation discipline. And we continue to look to improve, to adapt to the markets.

In the seven years since the elder Mr. Nicholas’ departure, the fund has modestly outperformed its peers in total returns. While its maximum drawdown and standard deviation match its peer group, it outperforms by measures of downside deviation, bear market deviation, and risk-adjusted returns.

Post Nicholas Performance

Source: MFO Premium. Green fill signals the outperformance of its benchmark for the period since the transition. MFO Premium uses a different color-coding system in its rankings. A fund’s Lipper peer group frequently differs from its Morningstar peer group, which may account for divergent relative performance.

Yacktman without Yacktman, seven years

There are days when it looks like the Yacktman funds are just toying with the rest of us. Yacktman appears in more articles about outstanding investments at MFO than any other fund or firm.

Don Yacktman plays a lot like a character out of “Leave It To Beaver.” Quiet, self-effacing family man. Boy Scout. Devout Mormon who sang in the choir. Quietly principled: he shrugged off the 1990s when the dot-com market nearly wrecked his firm, then shrugged off the 2000s when they effortlessly doubled the S&P 500. He left his previous firm, where his fund was performing brilliantly, because they were getting “sleazy” (Pat Regnier, “Don Yacktman’s Lonely Crusade,” Money, 4/1/1999, a great story there).

His explanation for how to win in investing is simple:

He waits to buy great companies when they’re down and rides them until they recover, which great companies almost always do. You don’t need to jump in and out of stocks, he tells them. “You just need to catch the wind enough times,” he says. “And you need to be very, very patient.” (“Don Yacktman: A fund manager’s faith produces results,” Fortune, 12/13/2012).

“Being patient” translates to a willingness to hold cash, sometimes quite a lot of cash, for quite a long time until the market presents – as it eventually does – suitable opportunities. That often means suffering terrible relative returns when the market is frothy (trailing 90% of their peers in 2019 and 2021 while still making 18% per year for their investors) and crushing when the markets turn choppy (as in 2018 and 2020).

Don Yacktman founded Yacktman Asset Management in 1992, the year he launched Yacktman Fund. Five years later, he added Yacktman Focused. Before founding the firm in 1992, he managed Selected American Shares (SLADX) for nearly a decade and was named Fund Manager of the Year by Morningstar in 1991. Don Yacktman stepped aside as CEO of Yacktman on August 1, 2013, and as portfolio manager in 2016. From launch through mid-2016, $10,000 in Yacktman grew to $104,000. The same investment in the S&P 500 grew to $81,000. Stephen Yacktman is now the lead manager of the Yacktman Funds. (Parenthetically, brother Brian Yacktman left in 2007 to launch the YCG Enhanced Fund (YCGEX), which has, over the past seven years, higher returns than both the Yacktman funds and its peer group.)

Post Yacktman Performance, 07/2016 – 06/2023

Source: MFO Premium. See the previous note concerning cell shading and peer groups.

Cook and Bynum without Bynum, five years

Messrs. Richard Cook and Dowe Bynum are concentrated value investors in the tradition of Buffett and Munger. They’ve been investing since before they were teens and even tried to start a mutual fund with $200,000 in seed money while they were in college. Within a few years after graduating college, they began managing money professionally, Cook with a hedge fund and Bynum at Goldman Sachs. By their mid-30s, they were managing an ultra-concentrated five-star fund headquartered in Birmingham, Alabama. Valuing their independence, they wanted to work far from the Wall Street crowd.

Dowe Bynum (1978-2020) passed away on Friday, July 17, 2020, at peace and surrounded by loved ones. Dowe, who eschewed his given first name, “Jasper,” was diagnosed with brain cancer about three years before. Richard Cook has been largely responsible for the day-to-day management of the portfolio since that time. Dowe’s illness deeply affected his family, his friend and partner, and their firm.

The fund, which often invested in just six or seven stocks, often concentrated in Latin America and among soft drink bottlers and distributors, is about impossible to benchmark. Lipper calls it a “global multi-cap value,” Morningstar had categorized it as a “world stock” before moving it to “emerging markets” recently. It is, as an EM equity fund, a five-star performer.

The effect of Dowe’s absence is impossible to gauge from the outside. The fund was a top-tier performer for its first five years, and money poured in; with no change in discipline but a substantial change in market conditions, it was a bottom-tier performer for the three years preceding and following Dowe’s diagnosis. Likely a misfit in its new “diversified EM” home, with 60% of its nine stock portfolio in Mexico and Chile, it has soared.

Morningstar categorizes COBYX as an emerging markets equity fund. Lipper places it in the global multi-cap value group, which is dominated by larger companies in developed markets.

We generated a five-year correlation matrix at MFO Premium, matching COBYX with its two possible peer groups.

The curious finding is not that COBYX correlates more with multi-cap value than with emerging markets (0.88 versus 0.72); it is that COBYX has a nearly identical correlation with multi-cap value as does the average emerging markets fund (0.88 versus 0.87).

The fund’s relative performance depends entirely on which of those groups strikes you as most plausible.

Post Bynum Performance, 07/ 2018 – 06 / 2023

Source: MFO Premium. See the previous note concerning cell shading and peer groups.

Muhlenkamp without Muhlenkamp, four years

Ron Muhlenkamp began his investing career in 1968, launched Muhlenkamp Fund in 1988, and managed it from just north of Pittsburgh, my hometown, which always made it a favorite. Ron was beloved by the CNBC-type talk shows for his clarity and unshakeable confidence. Through the 1990s and early years of this century, he clubbed the S&P 500, famously asking of the 2000-01 market collapse, “bear market? What bear market?” He would soon find an answer, as the fund trailed its Lipper peers in 11 of the next 14 years as Ron railed against Fed policy and interest rate insanity. I sold my own stake in the fund when I concluded that Ron had developed an unhealthy passion for reprinting his own old essays (“I told you this was going to happen!”) while the fund floundered. The fund was underwater for four years (2007, 2011, 2015, 2016), while the S&P 500 made money during that stretch.

He was joined by his son Jeff Muhlenkamp in November 2013. Son Todd serves as Muhlenkamp’s president. In February 2019, Ron handed over the day-to-day stock picking and portfolio management duties to Jeff. Ron remains engaged with the firm. Since the handover, the fund has rebounded. The most recent shareholder letter combines sensible market projections from Jeff with flat-out silly advice from Ron on how to get rich: “Just save 50% of all your money,” based on a decades-old reflection by Sir John Templeton on what worked for him after his graduation from Oxford (and assumption of a Wall Street job) in the 1930s.

Post Muhlenkamp Performance, o7/ 2019 – 06 / 2023

Source: MFO Premium. See the previous note concerning cell shading and peer groups.

Akre without Akre, 2.5 years

Akre Focus was born out of betrayal. Chuck Akre was the star manager of FBR Focus when FBR (Friedman, Billings, Ramsey & Co.) decided that he was being overpaid and offered a contract with a 50% fee reduction. Mr. Akre disagreed, said something like “poop on you,” left with his team of analysts, and launched Akre Focus in 2009. Only to discover, upon returning from an out-of-town trip, that FBR had bought his team away from him. Incensed, he hired and trained new analysts. In the years following, he clubbed the market and, measured by asset flows, clubbed FBR. Akre Focus reached $14 billion and five-star status.

Mr. Akre stepped aside from day-to-day management in December 2020, though he remains active at the firm. His most recent activities surround the purchase of Eldon Farms as a “conservation purchase” in 2021. Akre Focus is now managed by John Neff and Chris Cerrone. Mr. Neff is a Partner at Akre Capital Management and has served as portfolio manager of the fund since August 2014, initially with founder Chuck Akre. Before joining Akre, he served for ten years as an equity analyst at William Blair & Company. Mr. Cerrone, a Partner at Akre Capital Management, has served as portfolio manager of the fund since January 2020. Before that, he served as an equity analyst for Goldman Sachs for two years.

The fund has seen substantial outflows following Mr. Akre’s departure. Performance in 2021 and 2022 was substantially above average, while 2023 (through July) is solid in absolute terms and lackluster in relative terms.

Post Akre Performance, o1/ 2021 – 06 / 2023

Source: MFO Premium. See the previous note concerning cell shading and peer groups.

Walthausen without Walthausen, two years

Walthausen & Co., LLC. was an employee-owned investment adviser that John Walthausen founded in 2007 after running the Paradigm Value Fund. It specialized in small- and mid-cap value investing. In September 2007, he was joined by the entire investment team that had worked previously with him at Paradigm Capital Management, including an assistant portfolio manager, two analysts, and a head trader. John Walthausen retired on July 30, 2021, at age 75, after 14 years at the helm. Gerry Heffernan had co-managed the Fund since March 2018 and was joined by DeForest Hinman. Mr. Walthausen declared, “I am confident that Gerry, DeForest, and the rest of the team will carry the firm far into the future.”

Investors expressed less confidence. Assets in December 2021 were $100 million; assets in December 2022 dropped to $36 million, driven, so far as we can tell, by institutional redemption. The Board of Trustees concluded that they needed to sell the fund to North Star Investment Management Corporation in December 2022.

NorthStar installed the team that’s also responsible for NorthStar MicroCap. The fund was respectable in 2022 and has lagged 80% of its peers since the North Star transition (through July 30, 2023).

Post Walthausen Performance, o7/ 2021 – 06 / 2023

Source: MFO Premium. See the previous note concerning cell shading and peer groups.

Bruce without Bruce, one month

And Bruce? The Younger Mr. Bruce will persevere, I suspect. His dad was more and more a voice in the background, I suspect. Our profile noted, “They don’t explain themselves to the public, though they do answer calls from their investors.” Literally, I called the fund (they don’t publish an email address); Jeff Bruce answered on the second ring, and I talked to Jeff Bruce for about 20 minutes. He’s very pleasant and agreeable but has spent 38 years with the mantra: we talk to our shareholders, not the outsiders.” No interviews with Morningstar since the early 80s, when Mr. Mansueto was a two-person operation and a newsletter. (The younger Mr. Bruce went to high school with Mr. Mansueto, but they seemed not to be in the same social circle.)

The takeaway is that Jeff anticipates no change. He and his dad worked together for 38 years. They talked about each idea. If one of them liked it, they bought a little. If both of them liked it, they bought a lot. And vice versa with sales. The support team remains in place, and confidence is unshaken.

He does know that we’ve commented favorably on the fund’s high cash stake. (Currently, 25% with substantial overweights in defensive stocks.) He seems to appreciate the understanding. The fund is underwater today, mostly because they had anticipated a hard market. It is, he reports, their fifth-worst performance since launch. He admits that there’s somewhat limited comfort in the observation, “well, we have done worse four other times and always bounced back by sticking with the plan.”

It’s entirely cool that the manager, in their 450 square-foot world headquarters, answers the phone himself on the second ring, and enjoys talking with shareholders. Since a one-month performance table is silly, we won’t waste your time.

Bottom Line

The evidence is consistent, though our survey is not encyclopedic. In almost all instances, funds perform credibly in the years (two to seven, in our survey) following the departure of their founding manager. They might or might not reach the heights of excellence seen under The Great Man’s guidance, but they do not betray their shareholders.

That’s a broad generalization. Your results might vary. If that prospect unnerves you, consider one of two alternate paths. One prudent course for active investors is usually a functional team or a firm (T Rowe Price, Mairs & Power) with a good record for manager replacement. The prudent course for skeptics might be a passive strategy that’s not purely market-cap or debt weighted.

Vanguard’s clients have grown from about 20 million with $3.8 billion in assets in 2016 to 30 million now with nearly $8 billion in assets. Vanguard is the world’s largest mutual fund company with more market share of mutual funds than the next three competitors combined. For this article, I read Inside Vanguard: Leadership Secrets from the Company That Continues to Rewrite the Rules of the Investing Business by Charles D. Ellis, a longtime director of Vanguard. I want to know the direction of customer service performance, plans for technology advancement, and more about Vanguard Personal Advisor Services.

Vanguard has and is making large strides to improve customer service, which has suffered in large part due to rapid growth and the COVID pandemic. Mr. Ellis wrote:

“Vanguard has fallen behind key competitors like Fidelity and Schwab in advice to investors. The reasons range from the firm’s explosive growth in assets to its long-ago reluctance to automate, compounded by pandemic-era challenges with many representatives working remotely. The problems are multiple. Routine service requests can take hours, not minutes to resolve. Mistakes are made… While this is a problem that can be solved, it has been a serious error to allow it to become widespread.”

This article is divided into the following sections:

• Section 1, A Brief History of Vanguard
• Section 2, Reviews
• Section 3, Customer Service
• Section 4, Technology
• Section 5, Education and Support
• Section 6, Vanguard’s Investment Philosophy and Portfolio Construction
• Section 7, Vanguard Advisory Services
• Section 8, Active-Passive Fund Performance

As a follow-up to previous articles, Readers who are interested in finding an independent financial advisor may find these links useful: National Association of Personal Financial Advisors, The Financial Planning Association, and Investment Adviser Public Disclosure.

A BRIEF HISTORY OF VANGUARD

Vanguard’s Mission: “To take a stand for all investors, to treat them fairly, and to give them the best chance for investment success.”

Vanguard is owned by the investors in the funds and focuses on low-cost, long-term investing through funds, and does not participate in all services that other full-service providers do. During the 2008 financial crisis, when Wall Street Banks were failing, being bailed out, and/or laying off employees, Vanguard remained stable.

An in-depth history of Vanguard can be found on the Vanguard Corporate website. Below I focus on the past two decades of technological development, customer service, and advisory services.

• 2001: Offers William Sharpe’s Financial Engines online portfolio service free to clients with $100,000.
• 2008: F. William McNabb III was named Vanguard CEO, succeeding John J. Brennan. Mr. McNabb’s goals were high fund performance, crew engagement, and lowering expense ratios. He focused on developing new products, cybersecurity, and regulatory changes.
• 2011: Vanguard forms a division dedicated to serving financial advisors and broker-dealers. Introduced the Mobile-App.
• 2015: Vanguard unveiled Personal Advisor Services (hybrid robo-advisor), which had $47 billion in assets in its first year.
• 2016: Announced plans to open an Innovation Center to “build capabilities that we believe give our clients the best chance for investment success. At the time, 90% of its interactions with clients were done digitally.
• 2018: Mortimer J. (Tim) Buckley assumed the CEO position and focused on offering custom-tailored financial advice and increasing capital investments in technology.
• 2019: According to Statista, the number of employees at the Vanguard Group fell from 12,604 in 2019 to 11,634 in 2020 during COVID before rising to 11,845 in 2021.
• 2020: Vanguard inaugurates Digital Advisor for financial planning and money management service and selects Infosys as a partner to provide cloud-based record keeping.
• 2021: Vanguard launched the New Mobile App. Vanguard announced that it was adopting a hybrid work model for the majority of employees to work remotely on Mondays and Fridays.
• 2023: Vanguard’s Personal Advisor Service has now grown to $243 billion, up from $47 billion in 2016.

REVIEWS

Accolades: A Recognized Industry Leader is a list of companies recognizing Vanguard for achievements, including Forbes magazine, which named Vanguard one of the “World’s Best Employers” (October 2021). Sixty-one percent of 1,368 Vanguard employees reviewing it at INDEED rate Vanguard with more than three stars, while seventeen percent rate Vanguard with less than three stars for an overall rating of 3.6.

Consumer Affairs (CA): Fifty-four percent of one hundred and thirty-six reviews rate Vanguard with four or five stars, while twenty-one percent rate it with one or two stars. The pros are the robo-advisor option, educational resources, and low-cost funds, while the cons are few features on the website, fund minimums, slow response time, and customer service.

Edith Balazs at Broker Chooser rates Vanguard 4.5 out of 5 overall and the same for customer service describing great customer service and providing fast and relevant answers.

TopRatedFirms gives Vanguard 3 stars, with a 4-star rating for its investment system and three stars for customer service. Most of the investor reviews are critical. It is interesting to note that there were 11 comments in 2019, 28 in 2020, 71 in 2021, and 107 in 2022, but only 22 in the first six months of 2023. I take this reduction in complaints as an indication that the issues peaked during the COVID pandemic and are being resolved.

Bogleheads – Anyone Still Favor Vanguard? (2023): Bogleheads is “Investing Advice Inspired by John Bogle,” so I found this discussion particularly relevant. I summarize a few comments:

• “They offer integrity and meet my needs.”
• “I will never understand the willingness of some of my fellow Bogleheads to put all their life savings in just one basket, i.e., brokerage firm. It seems like a sucker bet. So, yes, I still favor Vanguard as well as Fidelity, Schwab, and…”
• “Calls to customer service regarding custodial IRAs were answered promptly. Additionally, I find transferring money between Vanguard and my CU, along with purchasing CDs and treasuries easy.”
• “I’ve had good and bad service with Vanguard and other companies.
• “My experience has been that customer service is always good.”
• “I still favor Vanguard. I like their website. Everything is so easy to use with Vanguard. I have always received very good customer service with Vanguard.”

CUSTOMER SERVICE

Kim Clark at Kiplinger describes some of the strengths and weaknesses in Vanguard Faces Competition and Criticism (June 2023). Vanguard’s strengths are simplicity, low cost, and quality funds. Vanguard’s weaknesses are cited as being overly cautious, slow to react, and below average customer service. Vanguard is now about two-thirds through a technology upgrade aimed at improving customer service and has focused on its advisory services, including tax loss harvesting. Ms. Clark says:

“Morningstar last year called Vanguard’s advice programs the best overall in the industry because of their low costs, services such as goal-planning tools, and portfolio construction. Kiplinger readers gave Vanguard ‘above average’ ratings for its customer service and advice programs this spring. Vanguard also ranked at the top for do-it-yourself investors in a recent J.D. Power survey.”

Vanguard Faces Competition and Criticism, by Kim Clark, Kiplinger, June 19, 2023.

Morningstar gives Vanguard a Parent Rating of “High” because of its ownership structure, low costs, and direct-to-investor playbook while acknowledging client service missteps. They say that “Vanguard has built an increasingly compelling ecosystem of advice for investors with simple to complex needs.”

Christine Benz interviewed Vanguard CEO Tim Buckley in November 2018 regarding complaints about poor customer service, as reported in “At Vanguard, Heavy Investments to Boost Customer Service.” Mr. Buckley explained that at that time [in 2018], 90% of calls went through in 60 seconds, but issues existed with “asset transfers”. Mr. Ellis noted that Vanguard has introduced new contact center technology, reorganized client service teams, and accelerated efforts to redesign and improve clients’ digital experience.

TECHNOLOGY

In September 2022, Marco De Freitas wrote “Empowering Investors Through Digital Platforms,” in which he described ongoing technological developments and how the COVID pandemic drove the wider adoption of apps, websites, and videoconferencing. Vanguard’s efforts center around increasing self-service and enabling better control and consumer decision-making. Vanguard conducted a survey of clients to determine preferences which showed that 60% of clients preferred conducting financial activities online.

Examples of online tools include the Quick Start screen and the Tools and Calculators Overview. The Mobile App upgrade experienced technical difficulties after its rollout but has been largely resolved. In 2020, Vanguard partnered with Infosys to enhance its defined contribution business, particularly reporting.

EDUCATION AND SUPPORT

I looked at Vanguard’s online resources and am pleased with the enhancements to Vanguard’s Investor Resources, especially their economic and market outlook. They have a lot of information available about choosing investment accounts, planning for retirement, and market insights and economic analysis, among others. They have an easy-to-use filter for the calculators and tools available.

If you click on the “Support” icon, you are redirected to online guided support which lists dozens of topics and frequently asked questions. There is also the “Message Center” for sending questions to Vanguard. Clicking on “Technical Support” at the bottom of the page takes you to common topics related to computer, mobile, and access issues. You can sign up for The Vanguard View monthly newsletter. You can also call support at 800-284-7245 Monday through Friday from 8 a.m. to 8 p.m. ET. For those wanting more support, there is the option to use Vanguard Personal Advice Services at a cost of 0.3% of assets managed, which is low compared to competitors. They do not have 24/7 phone service nor a “chat” feature.

INVESTMENT PHILOSOPHY AND PORTFOLIO CONSTRUCTION

A Look Ahead with Vanguard is a recent (January 2023) interview with Vanguard CEO Tim Buckley. Mr. Buckley points out the pitfalls of trying to time the markets and highlights Vanguard’s philosophy of “staying the course.” He discusses how return forecasts can be used in setting allocations for the long term. Mr. Buckley’s answer to why an investor should choose Vanguard summarizes its mission of putting client’s “interest first and letting them keep more of their return.” Finally, he touches on Vanguard’s development of quality, low-cost advice as a customer service.

Vanguard Principles for Investing Success describes its four principles to improve an investor’s chances of achieving investment success:

1. Think About Your Goals: Retirement, buying a home, etc.
2. Stay Balanced: Find the right level of risk and reward.
3. Keep Costs Low: See Vanguard Return Cost Savings to Shareholders
4. Be Disciplined: Invest for the long-term and don’t try to time the market.

Their philosophy on asset allocation is:

“Asset allocation and diversification are powerful tools for achieving an investment goal. A portfolio’s allocation among asset classes will determine a larger proportion of its return and the majority of its volatility risk. Broad diversification reduces a portfolio’s exposure to specific risks while providing an opportunity to benefit from the markets’ current leaders.”

What appeals to me about Vanguard Personal Advisory Services is the financial simulation tool called the Vanguard Capital Markets Model (VCMM) that generates expected long-term returns and volatility, a summary of which can be viewed in Our Investment And Economic Outlook, June 2023. Vanguard uses the Capital Markets Model and Asset Allocation Model to develop long-term customized portfolios to develop a glide path for investors. Vanguard’s Portfolio Construction Framework is a detailed look at how Vanguard designs portfolios.

VANGUARD ADVISORY SERVICES

The trend of shifting from defined benefit retirement plans to defined contribution savings plans has increased the burden on individuals to understand investing and the impact of taxes. This is the primary driver behind the rise in advisory services. Mr. Ellis says that many of Vanguard’s clients are of moderate means with simpler needs for advice than at some competitors.

Vanguard’s investment strategies are “designed with a disciplined, long-term approach that focuses on managing risk through appropriate asset allocation and diversification”. “From Assets To Income: A Goals-Based Approach To Retirement Spending” by Vanguard is a comprehensive article on using goals for financial planning.

Kiplinger Reader’s Choice Awards for 2023, in their July issue, rated Vanguard outstanding in the Wealth Managers category for Trustworthy Advisors, Quality of Advice, Most Recommended, and Overall Satisfaction.

The Client Relationship Summary (CRS) provides the details of how the service works, from setting goals, developing an investment strategy and asset allocation, lifetime goal forecasting with multiple goals using the Vanguard Capital Markets Model, risk tolerance, advisor consultations, range of solutions, fees, annual update discussions, and much more. Vanguard has the Digital (robo) Advisor, Personal Advisor hybrid option with a team of advisors, Personal Advisor Select that also has a dedicated advisor, and Personal Advisor Wealth Management, as described in this link.

Vanguard recently increased its number of on-staff advisors from three hundred to a thousand, mostly through internal transfers. Vanguard’s approach to investor advice is for advisors to focus on financial planning, long-term investment programs, and behavioral coaching to stay with the plan. Advisors per client can be found at Investor.com. Vanguard has one advisor per 408 clients while Fidelity has one advisor per 113 clients. In my opinion, this largely reflects the level of services needed.

I read the Personal Advisor Services reviews by The Tokenist (7.5/10), Best Robo Advisors (Best Overall Hybrid), Michael Toub at DoughRoller, Rickie Houston at Business Insider (4.54/5), and Elizabeth Ayoola at Nerdwallet (4.3/5). In general, positive comments regarding the Vanguard Personal Advisory Services are:

• Investments in customer service have paid off
• Good financial planning services and investment plan
• Reporting
• Monitoring progress toward goals
• Ability to run “what if” scenarios
• Accounts are reviewed quarterly and rebalanced as needed.
• A range of projected account balances can be reviewed
• One of the best options for people looking for easily-managed investments and personalized help
• Good access to an advisor
• Vanguard has a “B” from the Better Business Bureau, reflecting how well it interacts with customers

ACTIVE-PASSIVE FUND PERFORMANCE

The Vanguard Financial Advisor suggested the Active-Passive Approach to me, which falls under the “Wealth Growth” objective. Mr. Ellis describes why index funds are often considered “passive” but says that most index funds are actually “actively managed” because of the sophisticated work to replicate the index. Table #1 contains all Vanguard funds for the past ten years. I divided the funds into active non-index funds, active index funds, and passive index funds. What we see is that active index funds have the lowest volatility, while active non-index funds usually have the highest return. The active index funds gain some ground on risk-adjusted return as measured by the Martin Ratio.

Table #1: Active vs Passive Fund Performance

Source: Author Using Mutual Fund Observer

Closing Thoughts

I have developed a multi-strategy approach in which I managed Buckets 1 and 2 that will be used during the next ten years, low-cost Vanguard Personal Advisory Select Services to manage a portion of long-term investments using the Vanguard Capital Markets Model, and Fidelity Wealth Services to manage a portion of long-term investments according to the business cycle.

The primary benefit is to provide advice for my wife in case I pass away before her. Secondary benefits are to have professional money management advice. Other benefits are to get assistance with Roth conversions, required minimum distributions, and personalized customer service from dedicated advisors.

“Small value” is one of the market’s most inefficiently priced corners, and it has long been the home of famously successful and iconoclastic investors, from Joel Tillinghast with his love of low-priced stocks to Chuck Royce, who obsessed with tiny blue chip companies. So here’s an easy question:

Over the past quarter century, what has been the most successful small value fund you could have bought?

If you’re one of the five people nationwide who would have answered “Aegis Value,” congratulations! You got it!

While the past guides us, we must live in the future. Scott Barbee believes there may be a once-in-a-generation wealth-creating opportunity in certain Canadian energy stocks. Aegis Value Fund has done the work and owns some of these stocks. Barbee’s track record over 25 years means we should pay close attention to what he is saying. If you never buy into his fund, you should still read the article to understand how a master investor thinks through opportunities.

My synopsis of our long and engaging conversation will highlight five issues:

1. The Aegis Value track record
2. Barbee’s background and perspective
3. The nature of his investable universe, and,
4. This rare and fascinating opportunity in a corner of the energy market.

We’ll start with the fund.

Introduction to Aegis Value

Aegis Value invests in a portfolio of about 70 very, very small North American companies. They look for stocks that are “significantly undervalued” given fundamental accounting measures, including book value, revenues, or cash flow. The managers consider themselves “deep value” investors. As of July 2023, 62% of the portfolio is invested in Canadian stocks and 24% in the US.

Many analysts consider microcaps to be a distinct asset class rather than just a subset of small caps. Microcaps are generally covered, at most, by a single analyst. The stocks in microcap portfolios tend to be one-fifth to one-tenth the size of those in small cap portfolios. They tend to be thinly traded, have high insider ownership, and are more likely to be acquired by a larger firm, all of which means that their stock prices are subject to large moves that are not driven by broader market forces. It is not an arena that rewards dilettantes.

Fortunately, Aegis is guided by one of the longest-tenured and most successful teams in the arena. Aegis has the highest returns of any small-cap value fund over the 25 years since launch and has been a top 5 fund over the past 20-, 15-, 10- and 5-year periods. The Mutual Fund Observer has previously profiled the Aegis Value fund and Scott Barbee in 2013 and 2009. While badly dated, those profiles do talk a bit more about the manager’s process and perspectives.

I recently had a long conversation/Q&A with Barbee about his views on the market, his lived history in the markets, the Aegis portfolio, and many things in between. I enjoyed his honest, down-to-earth, conviction-driven thought process, the answers that come out of such analysis, and what promise it holds for investors.

Scott Barbee on Scott Barbee

“My dad worked for Aramco, and I grew up in Saudi Arabia. I am a mechanical engineer by training. Before starting Aegis, I worked for Chevron for a couple of summers and for Simmons & Company, an oil service investment bank. When I research energy and precious metals companies – the fund owns a lot of those right now – part of the analysis, and one that I enjoy, is to get into the scope of engineering for the mining projects. This is not the kind of work that can be outsourced to a computer or quantitative engine for algorithmic trading strategies. I am often a contrarian, but not always, understanding that sometimes the crowd can be correct.”

Scott Barbee on Aegis Value Fund

“The fund started in 1997, at the tail end of the mutual manager celebrity status era. Managers like Michael Price and Peter Lynch were still venerated. But since then, the mantle of the celebrity managers appears to have moved to the hedge fund universe, which seems like the investment of choice for the wealthy. Meanwhile, retail investors have switched to index investing and don’t have a desire for active mutual funds. We are an odd duck in that we do detailed work on stocks as if we were a hedge fund without charging the performance fees.”

Aegis is a small, five-person team. As of June 2023, employees and their families have a combined $48 million investment in the fund out of the fund’s total assets of $342 million. Barbee has been continuously managing the fund since the start of the fund in 1997. There are benefits that come out of having the same person run the fund successfully for this long. All investors make mistakes, and Mr. Barbee admits to his share of them. Good investors learn from past mistakes and shepherd the investments better in the next market cycle. Barbee is deeply self-aware, self-critical when required, and optimistic enough about the portfolio’s future to have the required psychological balance.

The fund has made investors money since its inception by finding and investing in stocks of deep value and small capitalization companies in the USA and Canada. This particular segment of the market is not what David Snowball would call “low ulcer.” Rather this is the crossroads where scamsters, accounting and balance sheet frauds, flawed business models, fallen angels, and misunderstood companies all meet. When the economy goes sour, investors in the zip code are prone to panic selling. Barbee’s successful track record and the occasional large drawdowns his fund has endured reflect the perils of this illiquid and highly volatile market segment.

“As a deep value investor, if you get it wrong, you can get hit. It’s one thing to forecast Cisco earnings wrong in 1999 and lose money conventionally, but if a deep value manager loses money failing to spot an accounting scam in a small mining stock, that can really damage their reputation,” said Barbee.

Performance for the bean counters

A low ulcer fund it is not, but, boy, is this man good at sticking to his craft and compounding capital!!

A successful trade from the past

Junior Gold miners

“Between 2012 to early 2016, there was about an 85% decline in the stocks of junior gold miners. Given this collapse, we sensed all the scamsters had left for greener pastures in crypto, cannabis, or whatever. Who was left was a precious metals billionaire geologist and other technically savvy investors collecting assets on the cheap. A lot of gold stocks were showing up on our watchlist, and we could afford to be selective. As an engineer, I spoke to the management teams that were putting these assets into production and figured the assets were likely to work. At that time, both traditional cyclical assets and precious metals were being puked by CIOs (Chief Investment Officers) on account of their high volatility. We bought these high volatility precious metal discards believing these stocks offered an opportunity for strong returns uncorrelated with the rest of the portfolio.”

To be correct about deep value, the buyer of stocks has to believe that the seller’s view of the world is somehow wrong. Otherwise, why bother buying? Barbee’s contrarian view helps. But he is not buying stocks in a random shotgun manner, spraying money all over the place. There is a process.

The Watchlist

Barbee keeps track of how many stocks are showing up in his deep value universe watchlist. He shared the chart with the readers below.

“The number of stocks which show up as small-cap, deep value, as of June 2023 are among the highest since the 2008-2009 crisis and the Covid pandemic. Usually, the number of names on the watchlist is correlated to the high yield spread. The more distressed the high yield market, the greater the number of stocks on the list. But right now, interestingly, the high yield spread is very low. Yet, we are seeing a lot more candidates.”

Given that the stock market is trading close to its all-time highs, I asked Barbee how he reconciles this large number of candidates. There are multiple reasons, he says.

First, he points to research by Cliff Asness at AQR that shows the value factor, a measure of the valuation disparity between growth and value stocks, is at historically high levels. “Clearly, many growth stocks are high because of the Artificial Intelligence (AI) enthusiasm. That needs to be sorted out. But the watchlist is also unusually high today because many bank stocks are trading at a discount to book value. The held-to-maturity securities losses from higher interest rates do not hit the book value immediately. Adjusted for those losses, the list would be smaller.”

The Macro view

Our conversation is making it clear that Barbee is nervous about the macroeconomic fundamentals. He very much considers the macro condition when selecting deep value stocks.

“Historically, we would be willing to hold a bit more cash, like we did in 1998-2000.” Currently, the fund holds about 4% in cash. “But the level of debt, fiscal imbalance, the amount of debt coming due in the next two years, and the weakness in the economy lead me to believe that we are going to experience more inflation and dollar debasement in the next few years. Presently, the Federal Reserve is very hawkish and is willing to create damage to fight inflation. But the moment the economic weakness becomes clear for all to see, we suspect the Central Bank will become a lot more dovish.”

“Can you tell me precisely where you see the problem in the economy outside of Commercial Real Estate (CRE),” I asked Barbee, “Who and where is going to be in trouble?”

Barbee believes that outside of CRE, the problem lies with Leveraged Loans of Private Equity funds. He points to research on PE buyouts by Verdad Advisers. From a May 2022 report, Private Equity: Still Overrated and Overvalued, we can see that PE firms buyouts multiples, and debt leverage used has dramatically gone up. “When the economy slows,” says Barbee, “the PE firms are going to get hit twice – once from slowing earnings and a second time from rising rates.”

I’ve read many of his semi-annual reports, and Barbee has consistently railed against high-priced mega cap growth. Fortunately, he hasn’t shorted them, nor does he play in bonds. Barbee directs his energy and views into honing his portfolio, which brings us to energy companies.

The Aegis portfolio

Energy and Materials stocks make up almost 88% of the fund.

Chart: compliments of Whalewisdom.com (thank you for the free subscription for MFO)

The chart below is from the Aegis fund’s presentation. Focus on the grey line which shows the Price to Book value of the fund’s positions. The funds historical average Price-to-Book has rarely traded at a premium to Book Value. Right now, the P/BV of the fund’s positions stand at 0.87x (or a 13% discount to Book).

Comparatively, the S&P 500’s Price to Historical Book Value currently stands at 4.3x (the index trades at 430% premium to the book value).

“Although the Aegis fund’s book value is much lower than the broader markets’, how do you explain the relatively high book value of the positions in the fund right now compared to history,” I asked. There are implications for future returns when the fund’s P/BV is that high (even though its much lower than the S&P).

“Book value is not an indicator you use by itself,” started Barbee. “You have to look at it in the context of leverage held by the company as well as the longevity of the assets held by the company,” which led to his focus on the companies the portfolio holds.

“The higher P/BV may reflect the high inflation we have experienced in the recent past. The Book Values are not valued higher to adjust for the replacement cost of the assets.”

I asked how he thinks the situation will work itself out. Will companies mark their book values higher?

Barbee points to a piece Warren Buffett wrote in 1977, How Inflation Swindles the Equity Investor, and then explains the fund’s position in energy stocks.

“Does the company really have low-cost debt? Are the assets really long-term in nature? How much leverage does the company have? To beat the inflation swindler, I like the fund’s energy holdings. Right now, in energy, the crowd might be wrong.

• Investors are expecting a recession and a decline in crude oil consumption during the recession. People are thinking about the most recent pandemic driven recession. But if you go back to previous recessions, there is very little dent in energy use.
• We have China and India trying to ascend into wealthier, more industrialized nations, and that trend is not going away.
• The idea of abundant renewables is nice to talk about but difficult to execute. Over the last ten years, $3.8 trillion has been spent on alternative energy. Yet, fossil fuels as a percentage of energy consumption have declined from 82% of total use to 81%!
• Banks are forcing energy companies to reduce leverage
• ESG is causing many investors to divest from energy companies
• The perverse effect of bank + ESG led deleveraging is that higher interest rates have not been painful for energy companies (unlike the pain in CRE and PE Leveraged Loans).
• Because of these non-economic actors being involved in the energy space, energy poverty is a far more likely problem.
• Shale oil wells fracking production data show peaking production.
• China is still opening up slowly. What happens when growth speeds up there?
• Russia does not have access to Western oil production expertise. They can get by for the first year or so, but then production starts slowing.
• We have gone from 97 million barrels per day of Liquid Fuel consumption in 2021 to 102 in 2023.
• (This one got me): From 2007 to 2023, cumulative inflation has been 45%. Today’s 70$ price of Oil is ~$45 in 2007 dollars. Do you remember the price of oil roughly traded at $120 in 2007?
• Energy companies are slimmer today, more efficient, and despite the much lower oil price, have Free Cash Flow yield in the high teens and low EBITDA multiples. They are using cash flow to pay down debt and then repurchase shares. These are hugely accretive transactions to existing shareholders.
• At today’s oil prices, many energy companies could pay off their debt and buy back all their stock within 5 to 7 years out of projected cash flows.
• Several Canadian stocks, like MEG Energy, in the portfolio have reserve lives of 25+ years.

Aegis has found companies with excellent fundamentals, where I believe the crowd is wrong, and where there may be a generational wealth building opportunity.”

“What could go wrong in the thesis?” I asked.

“There could be another pandemic, there could be massive improvements in battery technology, or there could be a heavy depression. In 2014 to 2016, the portfolio performed very poorly. The portfolio was down 55%. We held levered energy service companies. Now, we hold companies with extremely long-life assets and significantly less, and in many cases zero, financial leverage.”

Conclusion

It was an intense discussion, a thorough and detailed investment perspective from a fund manager dedicated to his craft. Many people in the investment world believe the crowd is wrong. After all, one needs a certain level of ego to buy and sell stocks – remember the efficient market hypothesis. You could have a blue sky, God is great, Cathie Wood view of the world. Or you can scour the markets for small, cheap companies, that have all the ingredients to compound capital. This is what Scott Barbee does. And it’s worked for the fund’s long-term returns.

The truly difficult thing, one even Scott Barbee doesn’t know, is how big the next drawdown in the fund is going to be. I get the sense he knows bearing volatility is part of his job. That there is $48 million of employees and family money in a $320 million fund goes a long way in providing confidence that Barbee believes in his ability to compound capital. I believe so too. I am an investor in the fund.

Aegis Value website.

“Greenhushing” is greenwashing’s psychotic twin. “Greenwashing” is the practice of pretending to care about the environment; in fund terms, it occurs when marketers jam an inconsequential, mealy-mouthed sentence into a fund’s prospectus (“will consider ESG factors in all portfolio decisions to the extent they reflect financially material concerns”) and then marketing them as a sign of 21st-century sensibilities, notwithstanding the fund’s extensive coal holdings. DWS is in the spotlight currently as it tries to resolve charges from both the US SEC and German investigators that arose from claims by their former sustainability chief that the investor “made false statements” about sustainability actions.

“Greenhushing” is the newer phenomenon of running, as far and as fast as possible, from any accusations that your firm finds issues surrounding environmental sustainability, workforce equity, community engagement, or corporate boards that are not closed clubs at all relevant.

Greenhushing is driven by two concerns. First, they’re scared to death of the demagogues who attempt to fuel their political ascendance by demonizing the willingness of managers to consider some factors that they consider financially relevant. Thirty-seven states have seen anti-ESG bills introduced in the last legislative session.

To be clear: red in this map is not “Republican.” It is “at least one anti-ESG bill introduced.” The yellow flags signal the instances in which at least one bill became law. (Source: Pleiades 2023 Statehouse Report).

Second, their original ESG commitments were often an inch deep, to begin with. A 2022 survey by Deloitte revealed that most companies view ESG commitments through the lens of “brand recognition and reputation.” A separate review by the EU (2021) found that something like half of all “green claims” were “exaggerated, deceptive, or false.” Upon further review, MSCI downgraded 95 percent of the AAA ratings it had given European ESG ETFs.

And so, they flee. The most recent instance was the decision by Loomis Sayles to withdraw from the Climate 100, a coalition of large investors that had committed to pressure companies to reduce their carbon output. Loomis’s explanation of their decision is an epic word salad:

I can confirm that in June 2023 Loomis Sayles chose to withdraw as a signatory of the Climate Action 100+ initiative as a result of our routine evaluations to ensure that all our industry commitments continue to be aligned with the firm’s ESG philosophy,’ the spokesperson said. ‘Our ESG philosophy remains unchanged: we believe risks and opportunities associated with material ESG factors are inherent to investment decision-making and clients’ long-term financial success. In service of our fiduciary duty, we believe the best way to consider ESG is through integration that aims to identify the financial materiality of ESG factors. (“Loomis Sayles exits Climate Action 100, citing ‘fiduciary duty,” Citywire, July 31, 2023).

Other markers of anxious greenhushing:

S&P Global has stopped handing out scores to corporate borrowers on ESG criteria (“S&P drops ESG scores from debt ratings amid scrutiny,” Financial Times, 8/7/2023)

“ESG is perhaps the most glaringly absent term in this round of earnings transcripts.

• • • “The number of S&P 500 companies citing ‘ESG’ on earnings calls has declined (quarter over quarter) in four of the past five quarters,” according to a Fact Set study.
    • “The term was cited by only 56 of the S&P 500 this quarter, down 24% (from 74 mentions) since last quarter and down roughly 64% (156 mentions) since its peak in Q4 of 2021.” (“Corporate America is rebranding ESG,” Axios, 8/10/2023, good article!)

Perhaps fittingly, greenhushing (the blue line) receives far less attention than greenwashing (the red line):

Source: “Greenhushing, greenwashing,” Google Trends, 8/4/2023.

All of this plays out, even while the public, across age and ideology, supports action at all levels to address global warming (“What the data says about Americans’ views of climate change,” Pew Research Center, 8/9/2023). And the public continues to demand evidence of corporate responsibility in both social and environmental arenas (Alan Murray, “Consumers are rejecting the anti-woke movement to demand CEOs speak out on important social issues,” Fortune, 8/11/2023). Even a majority of Republican voters want their candidates to leave corporations alone to make their own decisions. In a classic failure to communicate, most Americans do not support Biden’s climate initiatives (at least when you label them “the Inflation Reduction Act”), while simultaneously calling for more of the initiatives in … well, yes, the Inflation Reduction Act (“Most disapprove of Biden’s handling of climate change, Post-UMD poll finds,” Washington Post, 8/7/2023).

Bottom Line

The planet is in, so to speak, a world of hurt, from Canadian and Hawaiian wildfires to recording the warmest month and highest sea temperatures on record. We need to act with far more unity, speed, and force than we’ve shown any willingness to do if we’re to avert an epic catastrophe.

The reporting on greenhushing paints a pretty consistent picture: non-investment firms are extending their corporate sustainability initiatives as a matter of good business practice, though they’re not talking about them. Mid-sized investment firms are backtracking after one year of weak performance, redemptions, and political heat. Fund boutiques, which rarely get noticed in the national political furor, continue to plug along.

As the US enters the lunacy of a presidential election cycle, it might benefit all of us to issue, through our words and actions, a simple two-word message to the peddlers of overheated conspiracies and fearful rhetoric: “Cool it.”

Introduction: Trouble in the Emerging Market Equities asset class

Emerging Market Equities (EM Eq), as tracked by the iShares MSCI Emerging Market ETF, are up almost 10% this year. That would generally be welcome news for the ignored asset class. But the news is not good enough. I have the distinct sense that investors of multiple stripes are “giving up” on EM Eq. There isn’t a wholesale liquidation as much as the flow of money in EM has slowed down. The long-held conviction that EM Eq is an asset class where one has to be involved has now changed.

I reached out to Andrew Foster, founder of Seafarer Capital Partners, Chief Investment Officer, Lead Portfolio Manager of the Seafarer Overseas Growth and Income Fund, and a Co-Manager of the Seafarer Overseas Value Fund, and no stranger to the MFO readership.

“Is the EM Eq asset class narrative in trouble?” I asked Andrew as if it was a financial 911 call on behalf of curious investors. I’ll cover three topics in my review of that July 2023 call:

1. an introduction to Seafarer Capital Partners and its funds
2. the problem with “emerging markets” as an asset class
3. the rise of EM stock buybacks and their role in portfolio construction

Introduction to Seafarer Capital Partners

Seafarer is a preeminent emerging markets equity investment boutique. Morningstar’s William Samuel Rocco, one of the firm’s longest-tenured analysts, offers these highlights:

The firm, which was founded by Andrew and Michelle Foster in 2011 … is 100% employee-owned and offers two diversified emerging-market strategies. Andrew Foster, who serves as CIO and as a portfolio manager, is a seasoned and skilled investor with considerable emerging-market expertise. Michelle Foster, who serves as CEO, has a strong resume as well. Seafarer has grown its investment and operations/executive teams wisely over the years—and expanded the roles of several individuals along the way—and the firm is well-staffed overall.

The flagship Overseas Growth & Income is managed by Mr. Foster, Paul Espinosa, and Lydia So, with Kate Jaquet serving as long-time co-manager and analyst. It invests roughly one third of the portfolio in value, one-third in core, and one-third in growth. The younger Seafarer Overseas Value Fund is managed (brilliantly) by Paul Espinosa, co-managed by Mr. Foster, and has earned both Morningstar’s five-star rating and MFO’s Great Owl designation. Seafarer’s disciplined approach is reflected in the performance since the inception of both funds. Each substantially outperforms its peers (by 390 and 330 bps, respectively) with lower volatility (measured by the fund’s maximum drawdown, standard deviation, and downside deviation) and higher risk-adjusted returns (measured by the Ulcer Index, Sharpe ratio, Sortino ratio, and Martin ratio).

Seafarer Overseas Growth & Income, Lifetime Performance (03/20120 – 07/2023)

Seafarer Overseas Value, Lifetime Performance (06/2016 – 07/2023)

Source: Lipper Global Datafeed and MFO Premium. Detailed definitions and complete data for each is available at MFO Premium.

Seafarer’s 17 professionals manage $2.2 billion in assets (as of March 29, 2023).

Five Problems With Emerging Markets as a Passive Asset Class

Together we listed some of the reasons why EM Eq presently feels orphaned:

MARKET PERFORMANCE HAS SUCKED

Over the last 5 years, the passively managed iShares MSCI Emerging Markets ETF (EEM) has returned a total of 3%. Not 3% in dividends, not 3% annualized (which too would be bad), but 3% in TOTAL RETURNS!! The annualized return over the last 10 years is 2.4% a year. Why bother?

The EEM is currently trading at about $41 per share, a price it had also seen in May 2007. For over a decade and a half, the traditional passive market for emerging stocks has been flat. This tests people’s patience in a jarring way.

While the EEM’s 10% returns for the first seven months of 2023 are satisfying, it is still dwarfed by the 19% gains for Vanguard Total Stock Market ETF (VTI), and easily topped by the 14% for iShares Core MSCI EAFE ETF (IEFA)

ECONOMY GROWTH IS WEAKENING

MFO’s April 2023 interview with Lewis Kaufman of the Artisan Developing World Advisor (APDYX) was hugely instructional in learning how his and now consensus views on EM have evolved over the last years. EM growth has slowed down; China and many other countries have settled into the middle-income trap; limited skilled labor and limited capital pools of savings serve as constraints to productivity growth and capital formation. There are no easy answers to the growth trap.

GEOPOLITICAL RISK IS RISING

China and Taiwan stocks combined account for nearly 44% of the MSCI Emerging Market country allocations. That region also happens to be the biggest flash point for geopolitical risk.

Warren Buffett liquidated his $4.1 billion stock position in Taiwan Semiconductor earlier this year, merely months after acquiring it. Even if he is wrong about his assessment of geopolitical risks, the fact that he got out is enough for many who closely follow his actions.

“I feel better about the capital that we’ve got deployed in Japan than in Taiwan. I wish it (Taiwan Semi) weren’t sold, but I think that’s a reality.”

The Russian sanctions (and what that did to Russian equities) as a weapon of geopolitical warfare are relatively new in the hands of Western policymakers. It’s a scenario investors had not planned for.

PASSIVE INVESTING HAS FAILED

This is a conundrum for many investors today. Passive indexing and investing works perfectly fine in US Equities. Unless investors want to invest in specific managers for whatever reason, US investors do not have to pay active managers. Investors tried the same approach abroad. It has not worked well. Over the past 10 years, 24 of the 25 best-performing funds and ETFs, whether measured by total return or by risk-adjusted return, are actively managed.

EMERGING MARKETS NO LONGER PROVIDE THE BETA BOOST

In previous US equity bull markets, EM equities acted as a high beta version of growth and allowed people to juice the returns they would have earned in the US. These days, US technology stocks do the trick. There is even less reason for investors to leave the US Dollar and go abroad.

Yes, there are many problems with EM as an asset class, and yes, we must now look ahead.

Mr. Foster concluded, “Unfortunately, there are no big picture ideas about how to fix EM as an asset class. However, there is a substantial difference between what EM as a passive asset class offers and what active EM fund managers offer.”

Investment Framework for EM for investors still interested in investing outside the USA

A TRACKABLE INDEX VS. WHERE MONEY SHOULD BE INVESTED

“What makes a sound investment versus what is easily trackable are two different things,” says Foster. Seafarer has a research paper titled A Tale of Two Indices that tries to explain this problem.

Let us consider my former employer Goldman Sachs’s contribution in the creation of the BRICs acronym (a group that stands for Brazil, Russia, India, and China).

“On one hand, the BRICS put the Emerging Markets asset class on the map, brought attention to their economies, and brought in dollars into the asset class. But, on the other, there really is no organic connection between these countries to be together as a group,” says Andrew.

“That same problem is evident on a larger scale in the MSCI Emerging Market Index. It’s easy to build an index, to categorize countries as EM and stocks to fill the weights, but there was never a reason why these countries and companies belonged together in one group.”

We talked about how few investors understand this difference (between what is trackable vs. what is investable). He promised to take up the challenge in his conversations with investment committees and other research.

Would investors be better served if we stopped thinking about Emerging Markets as an asset class? What should we track instead even if we could all agree the current notion of bucketing all EM countries in one big bucket never made sense?? No clear answers exist. We must make peace with EM Eq as an asset class while acknowledging that passive investing has not worked well there.

SILVER LINING IN FUNDAMENTALS

“The biggest fundamental change in EM stocks is going to come through the stock buybacks. It’s also one of the most difficult information metrics to capture and track,” said Foster.

Finding details on buybacks, especially in EM, is difficult. The data is buried deep inside balance sheets, if it is reported at all. There is a difference between announced and executed buybacks.

“Dividends are much easier to track, and they are a starting point for our fundamental analysis. Dividends tell us that the company has true power to generate consistent profits. But buybacks is where the story is going to be in the future.”

Why are stock buybacks so important? Take a look at this chart from Seafarer. The blue bars represent the actual dollar volume of buybacks by companies in the MSCI EM vs. MSCI USA indices. Buybacks were big in the US from 2000-2010 and got even bigger from 2011-2021. Comparatively, the blue bars in EM were small in the first decade and continued to be small in the second decade. That’s changing now.

Disclaimer from the good folks at Seafarer Capital: “The views and information discussed in this presentation are as of the date of publication, are subject to change, and may not reflect Seafarer Capital Partners’ current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only, and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein. The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses, either direct or consequential, caused by the use of this information.”

“Ten years ago, there were zero companies in Seafarer’s portfolio that were engaged in buybacks. Over the last five years, as many as half of our portfolio companies have been involved in buying back shares. Over the last year, over a third of the companies were involved in these share repurchases,” according to Foster. “Maybe I am biased toward our set of portfolio companies and the changing behavior in buybacks, but it is happening as we speak.” 

In other words, the blue bar for MSCI EM Equities is going to expand and get bigger, and with that, returns will accrue to the shareholders.

In the US, stock buybacks are now the predominant mechanism through which corporations return capital to shareholders, exceeding substantially the amount committed to dividends. Such buybacks were generally illegal in the US until 1982 because they ran afoul of laws limiting insider stock price manipulation. The CFA Institute (2022) enumerates the advantages of stock buybacks:

There has been much controversy about share repurchases in recent years. On the one hand, proponents of share repurchases say that this payout method provides liquidity and price support, returns excess cash in a flexible way, corrects undervaluation, and conveys information to the market. These aspects of buybacks are also often cited by practitioners as motivations for their share repurchase decisions. Academic research provides evidence that supports this view as well.

They quickly noted that it can also be misused to enrich executives (who could imagine such behavior?) and mislead investors, which means that investors and regulators need to exercise exceptional vigilance in weighing the motivations and impacts of such buybacks.

Perhaps some of the stock bought back in EM corporations is to mop up the Employee Stock Ownership Plan (ESOPs), but it’s interesting that these companies now actually have a culture of employee stock ownership at all. Remember, a majority of EM companies have founding families as controlling shareholders.

“Fundamentally, there is also a process of maturation across many economies right now. Most EM countries have inflation under control due to aggressive hiking before the Fed got into aggressive hiking (except India). Brazil and Mexico’s inflation are under far more control than in the US. Orthodox Central Bank behavior is a sign of political independence and improving institutional strength,” adds Foster.

PATIENCE

To give perspective into the future, Foster spoke about Japan, which is having its moment in the sun. People look at shareholder activism and corporate behavior and laud Japanese companies and the government. Foster says when he was managing Japanese assets at his previous employer, the trend for better shareholder activism was already in place as early as the mid-2000s. They talked a lot about it as they added relevant Japanese companies to the portfolio. But it takes time for the various kinks to be worked out and for the little streams to become a giant wave.

While the macro trends are still against EM, and while anecdotes of buybacks or improving institutional strength are not powerful enough, patience will pay in investing in some of the EM companies.

CONCLUDING ADVICE FROM ANDREW FOSTER:

1. Be patient and watch micro behavior.
2. Valuations in EM are pretty low.
3. I don’t believe in Mean Reversion, but I do believe good things are fundamentally happening across our portfolio companies.

…AND FROM YOURS TRULY:

Successful EM Eq portfolio managers don’t care about the weights of stocks in the MSCI EM Index. Investors might research active managers and start following their work, performance, and portfolio construction carefully. As the accompanying note on the Moerus Worldwide Value fund and the interview with Amit Wadhwaney shows, there are managers out there who are good at their craft. The power of discrimination is required to decide where passive is fine and where active is needed. Use that power carefully but firmly.

Seafarer Capital Partners website.

Disclosure: I own shares of both Overseas Growth & Income and Overseas Value in my personal account.

Our profile of Moerus Worldwide Value ended with the note, “Moerus offers a rare and intriguing opportunity to invest alongside (in another of legendary value investor Marty. Whitman’s phrases) a distinguished ‘aggressive conservative investor.’” In the years since that profile first appeared, Moerus has posted top tier returns for the past one-, three- and five-year periods. After rising 6.4% last year (2022), the fund is up another 20.6% through July 30, 2023 which about doubles the returns of its peers.

MFO’s publisher, David Snowball, puts manager Amit Wadhwaney in the short list of the most thought-provoking people he’s spoken with. That judgment piqued my curiosity, and I sat down with Mr. Wadhwaney for a long conversation in February 2023, the results of which we published in our March 2023 issue. Mr. Wadhwaney’s continued success with a smaller cap value portfolio in a market largely obsessed with large / growth / momentum led me to reach out to him again in July 2023.

What explains this good performance, and is this likely to continue? What about the current market environment is supportive of the fund’s strategy and positions? I reached out to the Moerus team once again to learn about the fund’s progress this year. We sat down in the Moerus fund’s office on West 38^th Street in what once called the Garment District. Amit weaved together a tapestry of his fund and strategy, and I walked away with an even greater appreciation for their work.

My synopsis of our long and engaging conversation will highlight five issues:

1. the Moerus Worldwide strategy and record
2. positioning the Moerus portfolio
3. the argument for fundamental analysis in portfolio building, and,
4. the portfolio in its macroeconomic setting.

We’ll start with the fund.

Introduction to Moerus Worldwide Value

Moerus Worldwide Value invests in a portfolio of 15-50 great stocks with no particular interest in paralleling some index’s sector, size, or country weightings. The common themes are (1) high-quality companies, which are (2) deeply undervalued. The portfolio is constructed from the bottom-up through fundamental analysis.  As of July 31, 2023, the fund is invested in 35 stocks and five other securities.

The fund is managed by Amit Wadhwaney. Prior to founding Moerus, he was portfolio manager and partner at Third Avenue Management LLC, where he managed Third Avenue International Value (TAVIX) from December 2001 to June 2014. Near the end of his tenure there, Morningstar described him as having “proved his mettle as a skilled and thoughtful investor, and his continued presence on the fund remains its main draw.” In addition to an M.B.A. in Finance from The University of Chicago, he holds degrees in economics, chemical engineering, and mathematics.

The fund launched in May 2016. Morningstar places its performance in the top tier of its peer group for every trailing period from one month to five years against its Foreign Small/Mid peer group. It likewise leads its Lipper Global Small/Mid peer group for the past one-, three- and five-year periods. The caveat is that those long-term numbers reflected four lean years (it substantially trailed its Morningstar peer group in 2017, 2018, 2019, and 2020 then crushed them in 2021, 2022, and 2023 (through 7/30).

 The Moerus Fund allocations make the performance even more interesting

To understand and appreciate Moerus fund’s performance, let us look at a key few equity benchmarks for the year so far. The MSCI EAFE, which tracks non-US international developed stocks, is up 12%, and Vanguard FTSE Emerging Market ETF (VWO) is up 6.7%. Within the US market, which is up about 18%, the Vanguard Value ETF (VTV) is up 5.7%, and the Vanguard Growth ETF (VUG) is up 35.1% so far in 2023.

Now, let’s look at Moerus’ geographical allocation: 87% of the portfolio is outside the US.

Next, compare its position in exposure, where only a quarter of the portfolio is in growth stocks. And these are not the same kind of growth stocks one would find in a technology fund.

Ycharts data

Source: Ycharts data

Moerus shows that it is possible to be invested in stocks other than Mega cap US Tech and still be up 17.5% for the year. Investors often talk about the lack of diversification and the market’s narrow breadth in the US. The Moerus portfolio is sourcing returns from small and micro, international, and value. That’s diversification and breadth right there!

What does Moerus own?

The top six holdings in the Moerus fund as of June 2023 are Cia. Brasileira de Distribuição (CBD), Despegar.com Corp, Tidewater Inc, Spectrum Brands Holdings Inc., EXOR, Westaim Corp, and Conduit. These stocks account for about 26% of the fund.

To be candid, I know nothing about the business model of the stocks in the Moerus portfolio. Among the 35 stocks in the fund as of May 2023, I could probably list the business models of no more than five stocks. Here’s what I learnt: the fund managers at Moerus know these stocks cold.

Wadhwaney spent almost 90 minutes explaining to me the minutiae of many of his stock investments and the related thesis. The Fund Performance and Attribution section of the Q2 2023 Quarterly Review and Outlook brings out some of those stories. To repeat and in addition to what the report says:

1. 1. SPB Spectrum Brands: Spectrum is a global consumer products company; you might recognize brands like Black Flag, Iams pet foods, or Remington razors. “You would also know them if you bought any locks like Baldwin or Kwikset,” relates Wadhwaney. “Recently, they sold their Locks business for net proceeds of USD 3.6 Billion. The company’s entire Market Cap was USD 3.2 Billion. They will be buying back USD 1 Billion in shares. The market trades on earnings and momentum, trading the stock like a yo-yo, but the Sum of the Parts works out nicely if you do the work.”
   2. IDFC First Bank in India: where the CEO has merged a Non-Bank Financial Company (First Bank) with a deposit-taking bank (IDFC) and has been working on reducing funding costs by depending on retail banking. As the interest costs decline for the combined entity, earnings will improve.
   3. Wheaton: “Usually, we do not invest in precious metals companies since they have something magical built into their price. They are disconnected from reality and very expensive. But Wheaton has a silver streaming business and has now expanded into gold and cobalt streaming. In the streaming business, the company makes an upfront investment with a mining company. In return, the streaming company gets a deeply discounted price for purchasing the mined metals. Wheaton had collapsed at one point, and we bought it and we have been sitting on it for years.”

Why should we look at the investment thesis stock-by-stock?

There are two main reasons: The first reason is to make it clear that these stocks are not about Artificial Intelligence, Cryptocurrency, Quantum Mechanics, Electric Vehicles, Virtual Reality, or Social Media related advertising. Yes, there is life in the investment universe outside of the themes that get pummeled into our heads because companies like Microsoft, Apple, and Google are everywhere.

“There is nothing wrong with growth stocks. I just won’t pay up for them,” says Wadhwaney.

The second reason to lay out these stocks is to gain an appreciation that this kind of asset-based investing requires a different kind of investment skill set than ready-shoot-aim investing in the world of meme stocks and faith-based technology companies. There is a graveyard of deep-value stocks in the world. Many of them are traps. A sophisticated hand with a deep history of these businesses and the people who start/operate these businesses is required to navigate through the opportunity set. The Moerus team has that experience and a steady hand.

What kind of market environment works for the fund’s strategy?

Wadhwaney believes periods of mild or moderate inflation are good for the companies that make the portfolio. “Inflation gooses activity and boosts asset values. In addition, periods where financing is harder to get, are also good for these companies. If the capital equity markets are more difficult, or when banks refuse to give funding, then the existing assets on the company’s books start becoming more valuable. Corporate activity follows, which then leads to unlocking of embedded value.” There is more on this in the Quarterly outlook.

In Conclusion

Thoughtful investors want small, want international, and need value in the portfolio. The Moerus fund provides that answer. It’s run by a thoughtful team with decades of experience in value investing and with very good pedigree. Investors should take notice.

Moerus Worldwide Value website