Dear friends,

Welcome to fall. Welcome to October, the time of pumpkins.

October’s a month of surprises, from the first morning that you see frost on the grass to the appearance of ghosts and ghouls at month’s end. (Also sports mascots. Don’t ask.) It’s a month famous of market crashes – 1929, 1987, 2008 – and for being the least hospitable to stocks. And it has the prospect of setting new records for political silliness and outbreaks of foot-in-mouth disease.

It’s the month of golden leaves, apple cider, backyard fires and weekend football.  (I’m a bit torn. Sam Frasco, Augie’s quarterback, broke Ken Anderson’s school record for total offense – 469 yards in a game – and lost. In the next week, he broke his own record – 575 – and lost again.) 

It’s the month where we discover that Oktoberfest actually takes place in September, and we’ve missed it. 

In short, it’s a good month to be alive and to share with you.

Leuthold: a cyclical bear has commenced

As folks on our mailing list know, the Leuthold Group has concluded that a cyclical bear market has begun. They make the argument in the lead section of Perception for the Professional, their monthly report for paying research clients (and us). It’s pretty current, with data through September 8th. A late September update of that essay, posted on the Leuthold Group’s website, reiterates the conclusion: “We strongly suspect the decline from the September 17th intraday highs is the bear market’s second downleg, and we’d expect all major U.S. indexes to undercut their late August lows before this leg is complete.” While declines during the 3^rd quarter took some of the edge off the market’s extreme valuation, they note with concern the buoyant optimism of the “buy the dips” crowd.

Who are they?

The Leuthold Group was founded in 1981 by Steve Leuthold, who is now mostly retired to Bar Harbor, Maine. (I’m intensely jealous.) They’re an independent firm that produces financial research for institutional investors. They do unparalleled quantitative work deeply informed by historical studies that other firms simply don’t attempt. They write well and thoughtfully.

Why pay any attention?

They write well and thoughtfully. Hadn’t I mentioned? Quite beyond that, they put their research into practice through the Leuthold Core (LCORX) and Leuthold Global (GLBLX) funds. Core was a distinguished “world allocation” fund before the term existed. $10,000 entrusted to Leuthold in 1995 would have grown to $53,000 today (10/01/2015). Over that same period, an investment in the Vanguard 500 Index Fund (VFINX) would have growth to $46,000 while the average tactical allocation manager would have managed to grow it to $26,000. All of which is to say, they’re not some ivory tower assemblage of perma-bears peddling esoteric strategies to the rubes.

What’s their argument?

The bottom line is that a cyclical bear began in August and it’s got a ways to go. Their bear market targets for the S&P 500 – based on a variety of different bear patterns – are in the range of 1500-1600; it began October at about 1940. The cluster of the Russell 2000 is around 1000; the October 1 open was 1100. 

The S&P target was a composite drawn from the levels necessary to achieve:

1. a reversion to 1957-present median valuations
2. 50% retracement of gains from the October 2011 low
3. the October 2007 peak
4. the median decline in a postwar bear
5. the March 2000 secular bull market peak
6. 50% retracement of the gain from the March 2009 low
7. April 2011 market peak

Each of those represents what some technicians see as a “support level” in a typical cyclical bear. Since Leuthold recognizes that it’s not possible to be both precise and meaningful, they look for clustered values. Most of the ones about lie between 1525 and 1615, so …

They address some of the self-justificatory blather (“it’s the most hated bull market in history,” to which they reply that sales of leveraged bull market funds and equity exposure by market-timing newsletters were at records for 2014 and much of 2015 which some might think of as showin’ some lovin’), then make two arguments:

1. Market internals have been breaking down all summer.
2. After the August declines, the market’s forward P/E ratio was still higher than it was at the peaks of the last three bull markets.

In their tactical portfolios, they’ve dropped their equity exposure to 35%. Their early September asset allocation in the portfolios (such as Leuthold Core LCORX and Leuthold Global GLBLX) was:

52% long equities

21% equity hedge a/k/a short for a net long of 31%

4% EM equities, which are in addition to the long position above

20% fixed income, with both EM and TIPS eliminated in August. The rest is relatively short and higher quality.

3% cash

They seem especially chary of energy stocks and modestly positive toward consumer discretionary and health care ones.

They are torn on the emerging markets. They argue that “there must be serious fundamental problems with any asset class that commands a Normalized P/E of only 13x at the peak (in May 2015) of one of the greatest liquidity-driven bull markets in history. We now expect EM valuations will undercut their 2008 lows before the current market decline has run its course. That washout might also serve up the best stock market bargains in many years…” (emphasis in original) Valuations are already so low that they’ve discussed overriding their own models but will not abandon their discipline in favor of their guts.

The turmoil in the emerging markets has struck down saints and sinners alike. The two emerging markets funds in my personal account, Seafarer Overseas Growth & Income (SFGIX) and Grandeur Peak Emerging Opportunities (GPEOX, closed) are down about 18% from their late May highs while the EM group as a whole has declined by just over 20%. As Ed Studzinski notes, below, those declines were occasioned by a panic over Chinese stocks which triggered a trillion dollar capital flight and a liquidity crisis.

Seafarer and Grandeur Peak both have splendid records, exceptional managers and success in managing through turmoil. Given the advice that we offered readers last month – briefly put, the worst time to fix a leaky roof is in a storm – I was struck by manager Andrew Foster’s thoughtful articulation of that same perspective in the context of the emerging markets. He made the argument in a September video, in which he and Kate Jaquet discussed risk and risk management in an emerging markets portfolio.

Once a crisis begins to unfold, there’s very little we can do amid the crisis to really change how we manage the fund to somehow dampen down the risk or the exposure the fund has. .. The best way to control risk within the fund is preventative… to try and put in place a portfolio construction that anticipates different kinds of market conditions well ahead of time such that when the crisis unfolds or the volatility ensues that you’re at least reasonably well positioned for it.

The reason why it doesn’t make a great deal of sense to react substantially during a crisis is because most financial crises stem from liquidity panics or some sort of liquidity shortage. And so if you try and trade your portfolio or restructure it radically in the middle of such an event, you’re inevitably trading right into a liquidity panic. What you want to sell will be difficult to sell and you won’t realize efficient prices. What you want to buy – the stuff that might seem safe or might be able to steer you through the crisis – will inevitably be overpriced or expensive … [prices] tend to be at extremes. You’re going to manifest the risk in a more pronounced way and crystallize the loss you’re trying to avoid.

The solution he propounds is the same one you should adopt: Build an all-weather portfolio that manages to be “strong and happy” in good markets and “reasonably resilient” in bad ones.

A more striking response was offered by the good folks at Vulcan Value Partners whose Vulcan Value Partners Small Cap (VVPSX, closed) we profiled four years ago. Vulcan Value Partners does really good work (“all of our investment strategies are ranked in the top 1% of our peers since inception and both Large Cap and Focus are literally the best performing investment programs among their peers”), part and parcel of which is being really thoughtful about the risks they’re asking their partners to face. Their most recent shareholder letter is bracing:

In Small Cap, we have sold a number of positions at our estimate of fair value but have been unable to redeploy capital back into replacements at prices that provide us with a margin of safety. Consequently, cash levels are rising, and price to value ratios in the companies we do own are not as low as in Large Cap. Our investment philosophy tends to keep us fully invested most of the time. However, at extremes, cash levels can rise. We will not compromise on quality, and we will not pay fair value for anything. .. We encourage our Small Cap partners to reduce their small cap exposure in general and with us if they have better alternatives. At the very least, we strongly ask you to not add to your Small Cap allocation with us. There will be a day when we write the opposite of what we are writing today. We look forward to writing that letter, but for the time being Small Cap risks are rising and potential returns are falling. (Thanks for Press, one of the stalwarts of MFO’s discussion board, for bringing the letter to my attention.)

The Field Guide to Bears

Financial professionals tend to distinguish “cyclical” markets from “secular” ones. A secular bear market is a long-term decline that might last a decade or more. Such markets aren’t steady declines; rather, it’s an ongoing decline that’s punctuated by furious short-term market rallies – called “cyclical bulls” – that fizzle out. “Short term” is relative, of course. A short-term rally might roll on for 12-18 months before investors capitulate and the market crashes once again. As Barry Ritzholtz pointed out earlier this year, “Knowing one from the other isn’t always easy.”

There’s an old hiker’s joke that plays with the same challenge of knowing which sort of bear you’re facing:

Park visitors are advised to wear little bells on their clothes to make noise when hiking. The bell noise allows the bears to hear the hiker coming from a distance and not be startled by a hiker accidently sneaking up on them. This might cause a bear to charge. Hikers should also carry pepper spray in case they encounter a bear. Spraying the pepper in the air will irritate a bear’s sensitive nose and it will run away.

It also a good idea to keep an eye out for fresh bear scat so you’ll know if there are bears in the area. People should be able to tell the difference between black bear scat and grizzly bear scat. Black bear scat is smaller and will be fibrous, with berry seeds and sometimes grass in it. Grizzly bear scat will have bells in it and smell like pepper spray.

Some Morningstar ETF Conference Observations

Overcast and drizzling in Chicago on the day Morningstar’s annual ETF Conference opened September 29, the 6^th such event, with over 600 attendees. The US AUM is $2 trillion across 1780 predominately passive exchange traded products, or about 14% of total ETF and mutual fund assets. The ten largest ETFs , which include SPDR S&P 500 ETF (SPY) and Vanguard Total Stock Market ETF (VTI), account more for nearly $570B, or about 30% of US AUM.  Here is a link to Morningstar’s running summary of conference highlights.

Joe Davis, Vanguard’s global head of investment strategy group, gave a similarly overcast and drizzling forecast of financial markets at his opening key note, entitled “Perspectives on a low growth world.” Vanguard believes GDP growth for next 50 years will be about half that of past 50 years, because of lack of levered investment, supply constraints, and weak global demand. That said, the US economy appears “resilient” compared to rest of world because of the “blood -letting” or deleveraging after the financial crisis. Corporate balances sheets have never been stronger. Banks are well capitalized.

US employment environment has no slack, with less than 2 candidates available for every job versus more than 7 in 2008. Soon Vanguard predicts there will be just 1 candidate for every job, which is tightest environment since 1990s. The issue with employment market is that the jobs favor occupations that have been facilitated by the advent of computer and information technology. Joe believes that situation contributes to economic disparity and “return on education has never been higher.”

Vanguard believes that the real threat to global economy is China, which is entering a period of slower growth, and attendant fall-out with emerging markets. He believes though China is both motivated and has proven its ability to have a “soft landing” that relies more on sustainable growth, if slower, as it transitions to more of a consumer-based economy.

Given the fragility of the global economy, Vanguard does not see interest rates being raised above 1% for the foreseeable future. End of the day, it estimates investors can earn 3-6% return next five year via a 60/40 balanced fund.

J. Martijn Cremers and Antti Petajisto introduced a measure of active portfolio management in 2009, called Active Share, which represents the share of portfolio holdings that differ from the benchmark index holdings. A formal definition and explanation can be found here (scroll to bottom of page), extracted from their paper “How Active Is Your Fund Manager? A New Measure That Predicts Performance.”

Not everybody agrees that the measure “Predicts Performance.” AQR’s Andrea Frazzini, a principal on the firm’s Capital Management Global Stock Selection team, argued against the measure in his presentation “Deactivating Active Share.” While a useful risk measure, he states it “does not predict actual fund returns; within individual benchmarks, it is as likely to correlate positively with performance as it is to correlate negatively.” In other words, statistically indistinguishable.

AQR examined the same data as the original study and found the same quantitative result, but reached a different implication. Andrea believes the 2% higher returns versus the benchmark the original paper touted is not because of so-called high active share, but because the small cap active managers during the evaluation period happened to outperform their benchmarks. Once you break down the data by benchmark, he finds no convincing argument.

He does believe it represents a helpful risk measure. Specifically, he views it as a measure of activity.  In his view, high active share means concentrated portfolios that can have high over-performance or high under-performance, but it does not reliably predict which.

He also sees its value in helping flag closest index funds that charge high fees, since index funds by definition have zero active share.

Why is a large firm like AQR with $136B in AUM calling a couple professors to task on this measure? Andrea believes the industry moved too fast and went too far in relying on its significance.

The folks at AlphaArchitect offer up a more modest perspective and help frame the debate in their paper, ”The Active Share Debate: AQR versus the Academics.”

Charles Ellis, renowned author and founder of Greenwich Associates, gave the lunchtime keynote presentation. It was entitled “Falling Short: The Looming Problem with 401(k)s and How To Solve It.”

He started by saying he had “no intention to make an agreeable conversation,” since his topic addressed the “most important challenge to our investment world.”

The 401(k) plans, which he traces to John D. Rockefeller’s gift to his Standard Oil employees, are falling short of where they need to be to support an aging population whose life expectancy keeps increasing.

He states that $110K is the median 401(k) plus IRA value for 65 year olds, which is simply not enough to life off for 15 years, let alone 25.

The reasons for the shortfall include employers offering a “You’re in control” plan, when most people have never had experience with investing and inevitably made decisions badly. It’s too easy to opt out, for example, or make an early withdrawal.

The solution, if addressed early enough, is to recognize that 70 is the new 65. If folks delay drawing on social security from say age 62 to 70, that additional 8 years represents an increase of 76% benefit. He argues that folks should continue to work during those years to make up the shortfall, especially since normal expenses at that time tend to be decreasing.

He concluded with a passionate plea to “Help America get it right…take action soon!” His argument and recommendations are detailed in his new book with co-authors Alicia Munnell and Andrew Eschtruth, entitled “Falling Short: The Coming Retirement Crisis and What to Do About It.”

We Are Where We Are!

By Edward A. Studzinski

“Cynicism is an unpleasant way of saying the truth.”

Lillian Hellman

Current Events:

While we may be where we are, it is worth a few moments to talk about how we got here. In recent months the dichotomy between the news agendas of the U.S. financial press and the international press has become increasingly obvious. At the beginning of August, a headline on the front page of the Financial Times read, “One Trillion Dollars in Capital Flees Emerging Markets.” I looked in vain for a similar story in The Wall Street Journal or The New York Times. There were many stories about the next Federal Reserve meeting and whether they would raise rates, stories about Hillary Clinton’s email server, and stories about Apple’s new products to come, but nothing about that capital flight from the emerging markets.

We then had the Chinese currency devaluation with varying interpretations on the motivation. Let me run a theme by you that was making the rounds of institutional investors outside of the U.S. and was reported at that time. In July there was a meeting of the International Monetary Fund in Europe. One of the issues to be considered was whether or not China’s currency, the renminbi, would be included in the basket of currencies against which countries could have special drawing (borrowing) rights. This would effectively have given the Chinese currency the status of a reserve currency by the IMF. The IMF’s staff, whose response sounded like it could have been drafted by the U.S. Treasury, argued against including the renminbi. While the issue is not yet settled, the Executive Directors accepted the staff report and will recommend extending the lifespan of the current basket, now set to expire December 31, until at least September 2016. At the least, that would lock out the renminbi for another year. The story I heard about what happened next is curious but telling. The Chinese representative at the meeting is alleged to have said something like, “You won’t like what we are going to do next as a result of this.” Two weeks after the conclusion of the IMF meeting, we then had the devaluation of China’s currency, which in the minds of some triggered the increased volatility and market sell-offs that we have seen since then.

I know many of you are saying, “Pshaw, the Chinese would never do anything as irrational as that for such silly reasons.” And if you think that dear reader, you have yet to understand the concept of “Face” and the importance that it plays in the Asian world. You also do not understand the Chinese view of self – that they are a Great People and a Great Nation. And, that we disrespect them at our own peril. If you factor in a definition of long-term, measured in centuries, events become much more understandable.

One must read the world financial press regularly to truly get a picture of global events. I suggest the Financial Times as one easily accessible source. What is reported and considered front page news overseas is very different from what is reported here. It seems on occasion that the bobble-heads who used to write for Pravda have gotten jobs in public relations and journalism in Washington and Wall Street.

One example – this week the Financial Times reported the story that many of the sovereign wealth funds (those funds established by countries such as Kuwait, Norway, and Singapore to invest in stocks, bonds, and other assets, for pension, infrastructure or healthcare, among other things), have been liquidating investments. And in particular, they have been liquidating stocks, not bonds. Another story making the rounds in Europe is that the various “Quantitative Easing” programs that we have seen in the U.S., Europe, and Japan, are, surprise, having the effect of being deflationary. And in the United States, we have recently seen the three month U.S. Treasury Bill trading at negative yields, the ultimate deflationary sign. Another story that is making the rounds – the Chinese have been selling their U.S. Treasury holdings and at a fairly rapid clip. This may cause an unscripted rate rise not intended or dictated by the Federal Reserve, but rather caused by market forces as the U.S. Treasury continues to come to market with refinancing issues.

The collapse in commodity prices, especially oil, will sooner or later cause corporate bodies to float to the surface, especially in the energy sector. Counter-party (the other side of a trade) risk in hedging and lending will be a factor again, as banks start shrinking or pulling lines of credit. Liquidity, which was an issue long before this in the stock and bond markets (especially high yield), will be an even greater problem now.

The SEC, in response to warnings from the IMF and the Federal Reserve, has unanimously (which does not often happen) called for rules to prevent investors’ demands for redemptions in a market crisis from causing mutual funds to be driven out of business. Translation: don’t expect to get your money as quickly as you thought. I refer you to the SEC’s Proposal on Liquidity Risk Management Programs.

I mention that for the better of those who think that my repeated discussions of liquidity risk is “crying wolf.”

“It’s a Fine Kettle of Fish You’ve Gotten Us in, Ollie.”

I have a friend who is a retired partner from Wellington in Boston (actually I have a number of friends who are retired partners from there). Wellington is not unique in that, like Fidelity, it is very unusual for an analyst or money manager to stay much beyond the age of fifty-five.

So I asked him one day how he had his retirement investments structured, hoping I might get some perspective into thinking on the East Coast, as well as perhaps some insights into Vanguard’s products, given the close relationship between Vanguard and Wellington. His answer surprised me – “I have it all in index funds.” I asked if there were any particular index funds. Again the answer surprised me. “No bond funds, and actually only one index fund – the Vanguard S&P 500 Index Fund.” And when I asked for further color on that, the answer I got was that he was not in the business full time anymore, looking at markets and security valuations every day, so this was the best way to manage his retirement portfolio for the long-term at the lowest cost. Did he know that there were managers, that 10% or so, who consistently (or at least for a while, consistently) outperform the index? Yes, he was aware that such managers were out there. But at this juncture in his life he did not think that he either (a) had the time, interest, and energy to devote to researching and in effect “trading managers” by trading funds and (b) did not think he had any special skill set or insights that would add value in that process that would justify the time, the one resource he could not replace. Rather, he knew what equity exposure he wanted over the next twenty or thirty years (and he recognized that life expectancies keep lengthening). The index fund over that period of time would probably compound at 8% a year as it had historically with minimal transaction costs and minimal tax consequences. He could meet his needs for a diversified portfolio of equities at an expense ratio of five basis points. The rest of his assets would be in cash or cash equivalents (again, not bonds but rather insured certificates of deposit).

I have talked in the past about the need to focus on asset allocation as one gets older, and how index funds are the low cost way to achieve asset diversification. I have also talked about how your significant other may not have the same interest or ability in managing investments (trading funds) after you go on to your just reward. But I have not talked about the intangible benefits from investing in an index fund. They lessen or eliminate the danger of portfolio manager or analyst hubris blowing up a fund portfolio with a torpedo stock. They also eliminate the divergence of interests between the investment firm and investors that arises when the primary focus is running the investment business (gathering assets).

What goes into the index is determined not by the entity running the fund (although they can choose to create their own index, as some of the European banks have done, and charge fees close to 2.00%). There is no line drawn in the sand because a portfolio manager has staked his public reputation on his or her genius in investing in a particular entity. There is also no danger in an analyst recommending sale of an issue to lock in a bonus. There is no danger of an analyst recommending an investment to please someone in management with a different agenda. There is no danger of having a truncated universe of opportunities to invest in because the portfolio manager has a bias against investing in companies that have women chief executive officers. There is no danger of stock selection being tainted because a firm has changed its process by adding an undisclosed subjective screening mechanism before new ideas may be even considered. While firm insiders may know these things, it is a very difficult thing to learn them from the outside.

Is there a real life example here? I go back to the lunch I had at the time of the Morningstar Conference in June with the father-son team running a value fund out of Seattle. As is often the case, a subject that came up (not raised by me) was Washington Mutual (WaMu, a bank holding company that collapsed in 2008, trashing a bunch of mutual funds when it did). They opined how, by being in Seattle (a big small town), they had been able to observe up close and personally how the roll-up (which was what Washington Mutual was) had worked until it didn’t. Their observation was that the Old Guard, who had been at the firm from the beginning with the chair of the board/CEO had been able to remind him that he put his pants on one leg at a time. When that Old Guard retired over time, there was no one left who had the guts to perform that function, and ultimately the firm got too big relative to what had driven past success. Their assumption was that their Seattle presence gave them an edge in seeing that. Sadly, that was not necessarily the case. In the case of many an investment firm, Washington Mutual became their Stalingrad. Generally, less is more in investing. If it takes more than a few simple declarative sentences to explain why you are investing in a business, you probably should not be doing it. And when the rationale for investing changes and lengthens over time, it should serve as a warning.

I suspect many of you feel that the investment world is not this way in reality. For those who are willing to consider whether they should rein in their animal spirits, I commend to you an article entitled “Journey into the Whirlwind: Graham-and-Doddsville Revisited” by Louis Lowenstein (2006) and published by The Center for Law and Economic Studies at Columbia Law School. (Lowenstein, father of Roger Lowenstein, looks at the antics of large growth managers and conclude, “Having attracted, not investors, but speculators trying to catch the next new thing, management got the shareholders they deserved.” Snowball). When I look at the investment management profession today, as well as its lobbying efforts to prevent the imposition of stricter fiduciary standards, I question whether what they really feel in their hearts is that the sin of Madoff was getting caught.

The End

Is there anything I am going to say this month that may be useful to the long-term investor? There is at present much fear abroad in the land about investing in emerging and frontier markets today, driven by what has happened in China and the attendant ripple effect.

The question I will pose for your consideration is this. What if five years from now it becomes compellingly obvious that China has become the dominant economic force in the world? Since economic power ultimately leads to political and military power, China wins. How should one be investing a slice of one’s assets (actively-managed of course) today if one even thinks that this is a remotely possible outcome? Should you be looking for a long-term oriented, China-centric fund?

There is one other investment suggestion I will make that may be useful to the long-term investor. David has raised it once already, and that is dedicating some assets into the micro-cap stock area. Focus on those investments that are in effect too small and extraordinarily illiquid in market capitalization for the big firms (or sovereign wealth funds) to invest in and distort the prices, both coming and going. Micro-cap investing is an area where it is possible to add value by active management, especially where the manager is prepared to cap the assets that it will take under management. Look for managers or funds where the strategy cannot be replicated or imitated by an exchange traded fund. Always remember, when the elephants start to dance, it is generally not pleasant for those who are not elephants.

Edward A. Studzinski

P.S. – Where Eagles Dare

The fearless financial writer for the New York Times, Gretchen Morgenson, wrote a piece in the Sunday Times (9/27/2015) about the asset management company First Eagle Investment Management. The article covered an action brought by the SEC for allegedly questionable marketing practices under the firm’s mutual funds’ 12b-1 Plan. Without confirming or denying the allegations, First Eagle settled the matter by paying $27M in disgorgement and interest, and $12.5M in fines. With approximately $100B in assets generating an estimated $900+M in revenues annually, one does not need to hold a Tag Day for the family-controlled firm. Others have written and will write more about this event than I will.

Of more interest is the fact that Blackstone Management Partners is reportedly purchasing a 25% stake in First Eagle that is being sold by T/A Associates of Boston, another private equity firm. As we have seen with Matthews in San Francisco, investments in investment management firms by private equity firms have generally not inured to the benefit of individual investors. It remains to be seen what the purpose is of this investment for Blackstone. Blackstone had had a right-time, right-strategy investment operation with its two previously-owned closed-end funds, The Asia Tigers Fund and The India Fund, both run by experienced teams. The funds were sold to Aberdeen Asset Management, ostensibly so Blackstone could concentrate on asset management in alternatives and private equity. With this action, they appear to be rethinking that.

Other private equity firms, like Oaktree, have recently launched their own specialist mutual funds. I would note however that while the First Eagle Funds have distinguished long-term records, they were generated by individuals now absent from the firm. There is also the question of asset bloat. One has to wonder if the investment strategy and methodology could not be replicated by a much lower cost (to investors) vehicle as the funds become more commodity-like.

Which leaves us with the issue of distribution – is a load-based product, going through a network of financial intermediaries, viable, especially given how the Millennials appear to make their financial decisions? It remains to be seen. I suggest an analogy worth considering is the problem of agency-driven insurance firms like Allstate. Allstate would clearly like to not have an agency distribution system, and would make the switch overnight if it could without losing business. It can’t, because too much of the book of business would leave. And yet, when one looks at the success of GEICO and Progressive in going the on-line or 1-800 route, one can see the competitive disadvantage, especially in automobile insurance, which is the far more profitable business to capture. It remains to be seen how distribution will evolve in the investment management world, especially as pertains to funds. As fiduciary requirements change, there is the danger of the entire industry model also changing.

Why Vanguard Will Take Over the World

By Sam Lee, principal of Severian Asset Management and former editor of Morningstar ETF Investor.

Vanguard is eating everything. It is the biggest fund company in the U.S., with over $3 trillion in assets under management as of June-end, and the second biggest asset manager in the world, after BlackRock. Size hasn’t hampered Vanguard’s growth. According to Morningstar, Vanguard took in an estimated $166 billion in U.S. ETF and mutual fund assets in the year-to-date ending in August, over three times the next closest company, BlackRock/iShares. Not only do I think Vanguard will eventually overtake BlackRock, it will eventually extend its lead to become by far the most dominant asset manager in the world.

With index funds, investors mostly care about having their desired exposure at the lowest all-in cost, the most visible component of which is the expense ratio. In other words, index funds are commodities. In a commodity industry with economies of scale, the lowest-cost producer crushes the competition. Vanguard is the lowest-cost producer. Not only that, it enjoys a first-mover advantage and possesses arguably the most trusted brand in asset management. These advantages all feed on each other in virtuous cycles.

It’s commonly known Vanguard is owned by its mutual funds, so everything is run “at cost.” (This is a bit of a fiction; some Vanguard funds subsidize others or outside ventures.) “Profits” flow back to the funds as lower expense ratios. There are no external shareholders to please, no quarterly earnings targets to hit. Many cite this as the main reason why Vanguard has been so successful. However, the mutual ownership structure has not always led to lower all-in costs or dominance in other industries, such as insurance, or even in asset management. Mutual ownership is a necessary but not a sufficient condition for Vanguard’s success.

What separates Vanguard from other mutually owned firms is that it operates in a business that benefits from strong first-mover advantages. By being the first company to offer index funds widely, it achieved a critical mass of assets and name recognition before anyone else. Assets begot lower fees which begot even more assets, a cycle that still operates today.

While Vanguard locked up the index mutual fund market, it almost lost its leadership by being slow to launch exchange-traded funds. By the time Vanguard launched its first in 2001, State Street and Barclays already had big, widely traded ETFs covering most of the major asset classes. While CEO and later chairman of the board, founder Jack Bogle was opposed to launching ETFs. He thought the intraday trading ETFs allowed would be the rope by which investors hung themselves. From a pure growth perspective, this was a major unforced error. The mistake was reversed by his successor, Jack Brennan, after Bogle was effectively forced into retirement in 1999.

In ETFs, the first-movers not only enjoy economies of scale but also liquidity advantages that allows them to remain dominant even when their fees aren’t the lowest. When given the choice between a slightly cheaper ETF with low trading volume and a more expensive ETF with high trading volume, most investors go with the more traded fund. Because ETFs attract a lot of traders, the expense ratio is small in comparison to cost of trading. This makes it very difficult for new ETFs to gain traction when an established fund has ample trading volume. The first U.S. ETF, SPDR S&P 500 ETF SPY, remains the biggest and most widely traded. In general, the biggest ETFs were also the first to come out in their respective categories. The notable exceptions are where Vanguard ETFs managed to muscle their way to the top. Despite this late start, Vanguard has clawed its way up to become the second largest ETF sponsor in the U.S.

This feat deserves closer examination. If Vanguard’s success in this area was due to one-off factors such as the tactical cleverness of its managers or missteps by competitors, then we can’t be confident that Vanguard will overtake entrenched players in other parts of the money business. But if it was due to widely applicable advantages, then we can be more confident that Vanguard can make headway against entrenched businesses.

A one-off factor that allowed Vanguard to take on its competitors was its patented hub and spoke ETF structure, where the ETF is simply a share class of a mutual fund. By allowing fund investors to convert mutual fund shares into lower-cost ETF shares (but not the other way around), Vanguard created its own critical mass of assets and trading volume.

But even without the patent, Vanguard still would have clawed its way to the top, because Vanguard has one of the most powerful brands in investing. Whenever someone extols the virtues of index funds, they are also extoling Vanguard’s. The tight link was established by Vanguard’s early dominance of the industry and a culture that places the wellbeing of the investor at the apex. Sometimes this devotion to the investor manifests as a stifling paternalism, where hot funds are closed off and “needless” trading is discouraged by a system of fees and restrictions. But, overall, Vanguard’s culture of stewardship has created intense feelings of goodwill and loyalty to the brand. No other fund company has as many devotees, some of whom have gone as far as to create an Internet subculture named after Bogle.

Over time, Vanguard’s brand will grow even stronger. Among novice investors, Vanguard is slowly becoming the default option. Go to any random forum where investing novices ask how they should invest their savings.  Chances are good at least someone will say invest in passive funds, specifically ones from Vanguard.

Vanguard is putting its powerful brand to good use by establishing new lines of business in recent years. Among the most promising in the U.S. is Vanguard Personal Advisor Services, a hybrid robo-advisor that combines largely automated online advice with some human contact and intervention. VPAS is a bigger deal than Vanguard’s understated advertising would have you believe. VPAS effectively acts like an “index” for the financial advice business. Why go with some random Edward Jones or Raymond James schmuck who charges 1% or more when you can go with Vanguard and get advice that will almost guarantee a superior result over the long run?

VPAS’s growth has been explosive. After two years in beta, VPAS had over $10 billion by the end of 2014. By June-end it had around $22 billion, with about $10 billion of that  growth from the transfer of assets from Vanguard’s traditional financial advisory unit. This already makes Vanguard one of the biggest and fastest growing registered investment advisors in the nation. It dwarfs start-up robo-advisors Betterment and Wealthfront, which have around $2.5 billion and $2.6 billion in assets, respectively.

Abroad, Vanguard’s growth opportunities look even better. Passive management’s market share is still in the single digits in many markets and the margins from asset management are even fatter. Vanguard has established subsidiaries in Australia, Canada, Europe and Hong Kong. They are among the fastest-growing asset managers in their markets.

The arithmetic of active management means over time Vanguard’s passive funds will outperform active investors as a whole. Vanguard’s cost advantages are so big in some markets its funds are among the top performers.

Critics like James Grant, editor of Grant’s Interest Rate Observer, think passive investing is too popular. Grant argues investing theories operate in cycles, where a good idea transforms into a fad that inevitably collapses under its own weight. But passive investing is special. Its capacity is practically unlimited. The theoretical limit is the point at which markets become so inefficient that price discovery is impaired and it becomes feasible for a large subset of skilled retail investors to outperform (the less skilled investors would lose even more money more quickly in such an environment—the arithmetic of active management demands it). However, passive investing can make markets more efficient if investors opting for index funds are largely novices rather than highly trained professionals. A poker game with fewer patsies means the pros have to compete with each other.

There are some problems with passive investing. Regularities in assets flows due to index-based buying and selling has created profit opportunities for clever traders. Stocks added to and deleted from the S&P 500 and Russell 2000 indexes experience huge volumes of price-insensitive trading driven by dumb, blind index funds. But these problems can be solved by smart fund management, better index construction (for example, total market indexes) or greater diversity in commonly followed indexes.

Why Vanguard May Not Take Over the World

I’m not imaginative or smart enough to think of all the reasons why Vanguard will fail in its global conquest, but a few risks pop out.

First is Vanguard’s relative weakness in institutional money management (I may be wrong on this point). BlackRock is still top dog thanks to its fantastic institutional business. Vanguard hasn’t ground BlackRock into dust because expense ratios for institutional passively managed portfolios approach zero. Successful asset gatherers offer ancillary services and are better at communicating with and servicing the key decision makers. BlackRock pays more and presumably has better salespeople. Vanguard is tight with money and so may not be willing or able to hire the best salespeople.

Second, Vanguard may make a series of strategic blunders under a bad CEO enabled by an incompetent and servile board. I have the greatest respect for Bill McNabb and Vanguard’s current board, but it’s possible his successors and future boards could be terrible.

Third, Vanguard may be corrupted by insiders. There is a long and sad history of well-meaning organizations that are transformed into personal piggybanks for the chief executive officer and his cronies. Signs of corruption include massive payouts to insiders and directors, a reversal of Vanguard’s long-standing pattern of lowering fees, expensive acquisitions or projects that fuel growth but do little to lower fees for current investors (for example, a huge ramp up in marketing expenditures), and actions that boost growth in the short-run at the expense of Vanguard’s brand.

Fourth, Vanguard may experience a severe operational failure, such as a cybersecurity hack, that damages its reputation or financial capacity.

Individually and in total, these risks seem manageable and remote to me. But I could be wrong.

Summary

• Vanguard’s rapid growth will continue for years as it benefits from three mutually reinforcing advantages: mutual ownership structure where profits flow back to fund investors in the form of lower expenses, first-mover advantage in index funds, and a powerful brand cultivated by a culture that places the investor first.
• Future growth markets are huge: Vanguard has subsidiaries in Australia, Canada, Hong Kong and Europe. These markets are much less competitive than the U.S., have higher fees and lower penetration of passive investing. Arithmetic of active investing virtually guarantees Vanguard funds will have a superior performance record over time.
• Vanguard Personal Advisor Services VPAS stands a good chance of becoming the “index” for financial advice. Due to fee advantages and brand, VPAS may be able to replicate the runaway growth Vanguard is experiencing in ETFs.
• Limits to passive investing are overblown; Vanguard still has lots of runway.
• Vanguard may wreck its campaign of global domination through several ways, including lagging in institutional money management, incompetence, corruption, or operational failure.

Needles, haystacks and grails

By Leigh Walzer, principal of Trapezoid LLC.

The Holy Grail of mutual fund selection is predictive validity. In other words, does a positive rating today predict exceptional performance in the future? Jason Zweig of The Wall Street Journal recently cited an S&P study which found three quarters of active mutual funds fail to beat their benchmark over the long haul.

We believe it’s possible, with a reasonable degree of predictive validity, to identify the likelihood a manager will succeed in the future. Trapezoid’s Orthogonal Attribution Engine (OAE) searches for the proverbial needles in a haystack: portfolio managers who exhibit predictable skill, and particularly those who justify based on a statistical analysis paying the higher freight of an active fund. In today’s case only 1 fund has predictable skill, and none justify their expenses. In general fewer than 5% of funds meet our criteria.

One of our premises is that managers who made smart decisions in the past tend to continue and vice versa. We try to break out the different types of decisions that managers have to make (e.g., selecting individual securities, sectors to overweight or currency exposure to avoid). Our system works well based on “back testing;” that is, sitting here in 2015, constructing models of what funds looked like in the past and then seeing if we could predict forward. We have published the results of back-testing, available on our website. (Go to www.fundattribution.com, demo registration required, free to MFO readers.) Using data through July 2014, historical stock-picking skill predicted skill for the subsequent 12 months with 95% confidence. Performance over the past 5 years received the most weight but longer term results (when available) were also very important. We got similar results predicting sector-rotation skills. We repeated the tests using data through July 2013 and got nearly identical results.

We are also publishing forward looking predictions (for large blend funds) to demonstrate this point.

The hard part is measuring skill accurately. The key is to analyze portfolio weightings and characteristics over time. We derive this using both historic funds holdings data and regression/inference, supported by data on individual securities.

Here’s your challenge: you need to decide how high the chances of success need to be to justify choosing a higher-cost option in your portfolio. Should managers with great track records command a higher fee? Yes, with caveats. Although the statistical relationship is solid, skill predictions tend to be fairly conservative. This is a function of the inherent uncertainty about what the future will bring.

The confidence band around individual predictions is fairly wide. The noise level varies: some funds have longer and richer history, more consistent display of skill, longer manager tenure, better data, etc. The less certain we are the past will repeat, the less we should be willing to pay a manager with a great track record. In theory we might be willing to hire a manager if we have 51% confidence he will justify his fees, but investors may want a margin of safety.

Let’s look at some concrete examples of what that means. We are going to illustrate this month with utility funds. Readers who register at the FundAttribution website will be able to query individual funds and access other data. I do not own any of the funds discussed in this piece

Active utility funds are coming off a tough year. The average fund returned only 2.2% in the year ending July 31, 2015; that’s signaled by the “gross return” for the composite at the bottom of the fourth column. Expenses consumed more than half of that. This sector has faced heavy redemptions which may intensify as the Fed begins to taper.

FundAttribution tracks 15 active utility funds. (We also follow 2 rules-based funds and 30 active energy infrastructure funds.) We informally cluster them into three groups:

TABLE 1: Active Utility Funds. Data as of July 31, 2015

*”Predict” is our extrapolation of skill for the 12 months ending July 2016

The Conservative funds tend to stick to their knitting with 70-90% exposure to traditional utilities, <10% foreign exposure, and beta of under 60%. The Aggressive funds are the most adventurous in pursuing related industries and foreign stocks; their beta is 85% (boosted for Duff & Phelps by leverage).

Without being too technical, the OAE determines a target return for each fund each period based on all its characteristics. The difference between gross return and the target equals skill. Skill can be further decomposed into components (e.g. sector selection (sR) vs security selection (sS.) For today’s discussion skill will mean the combination of sR and sS. Here’s how to read the table above: the managers at Franklin Utilities – a huge Morningstar “gold” fund – did slightly better than a passive manager over the past year (before expenses) and underperformed for the past three and five years. We anticipate that they’re going to slightly underperform a passive alternative in the year ahead. That’s better than our system predicts for, say, Fidelity, Putnam or Gabelli but it’s still no reason to celebrate.

In the aggregate these funds have below average beta, moderate non-US exposure, value tilt and a slight midcap bias. The OAE’s target return for the sector over the last year is 6.3%, so the basket of active utility funds had skill of-3.7%. Only two of the 15 funds had positive skill. Negative overall skill means that investors could have chosen other sectors with similar characteristics which produced better returns.

The 2014 energy shock was a major contributing factor. These funds allocated on average only 60-70% to regulated electric and gas generation and distribution. Much of the balance went to Midstream Energy, Merchant Power, Exploration & Production, and Telecom. Those decisions explain most of the difference among funds. Funds which stayed close to home (Icon, Franklin, Rydex, and Putnam) navigated this environment best.

Security selection moved the needle at a few funds. Prudential Jennison stuck to S&P500 components but did a good job overweighting winners. Duff & Phelps had some dreadful performers in its non-utility portfolio.

Skill last year for the two Fidelity funds was impacted by volatile returns which may reflect increased risk-taking.

We use the historic skill to predict next year’s skill. Success over the past 5 years carries the most weight, but we look at managers’ track record, consistency, and trends over their entire tenure.

The predicted skill for next year falls within a relatively tight range: Prudential has the highest skill at 0.8%, Gabelli has the lowest at -1.4%. Either the difference between best and worst in this sector is not that great or our model is not sufficiently clairvoyant.

Either way, these findings don’t excite us to pay 120bps, which is the typical expense ratio in this sector. The OAE rates the probability a fund’s skill this year will justify the freight. Cost in the chart below is the differential between the expense ratio of a fund class and the ~15bp you would pay for a passive utility fund. This analysis varies by share class, the table below shows one representative class for each fund.

We look for funds with a probability of at least 60%, and (as shown in Table 2) none of the active funds here come close. Here’s how to read the table: our system predicts that Franklin Utilities will underperform by 0.2% over the next 12 years but that number is the center of a probable performance band that’s fairly wide, so it could outperform over the next year. Given its expenses of 60 basis points, how likely are they to pull it off? They have about a 40% chance of it to which we’d say, “not good enough.”

TABLE 2

The bottom line: We can’t recommend any of these funds. Franklin might be the least bad choice based on its low fees. Prudential Jennison (PCUFX) has shown flashes of replicable stock picking skill; they would be more competitive if they reduced fees.

Duff & Phelps (DPG) merits consideration. At press time this closed end fund trades at a 15% discount to NAV. This is arguably more than required to compensate investors for the high expenses. The fund is more growth-oriented than the peer group, runs leverage of 1.28x, and maintains significant foreign exposure. There is a 9% “dividend yield;” however, performance last year and over time was dreadful, the dividend does not appear sustainable, and the prospect of rising rates adds to the negative sentiment. So, the timing may not be right.

We show the Morningstar ratings of these funds for comparison. We don’t grade on a curve and from our perspective none of the funds deserve more than 3 stars. Investors looking for such exposure might improve their odds by buying and holding Vanguard Utilities ETF (VPU) with its 0.12% expense ratio or Utilities Select Sector SPDR (XLU)

It is hard for active utility funds to generate enough skill to justify their cost structure. The conservative funds have more or less matched passive indices, so why pay an extra 60 bps. The funds which took on more risk have a mixed record, and their fee structures tend to be even higher.

 Perhaps the industry has recognized this: outflows from actively-managed utility funds have accelerated to double digits over the past 2.5 years and the share of market held by passive funds has increased steadily. A number of industry players have repositioned their utility funds as dividend income funds or merged them into other strategies.

Next month: we will apply the same techniques to large blend funds where we hope to find a few active managers worthy of your attention

Investors who want a sneak preview (of the predicted skill by fund) can register at www.fundattribution.com and click the link near the bottom of the Dashboard page.

Your feedback is welcome at [email protected].

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized, searchable, and filtered as never before. For the complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

Orders

• In the first case brought under the agency’s distribution-in-guise initiative, the SEC charged First Eagle and its affiliated fund distributor with improperly using mutual fund assets to pay for the marketing and distribution of fund shares. (In re First Eagle Inv. Mgmt., LLC.)
• In the purported class action by direct investors in Northern Trust‘s securities lending program, the court struck defendants’ motion for summary judgment without prejudice. (La. Firefighters’ Ret. Sys. v. N. Trust Invs., N.A.)
• Adopting a Magistrate Judge’s recommendation, a court granted Nuveen‘s motion to dismiss a securities fraud lawsuit regarding four closed-end bond funds affected by the 2008 collapse of the market for auction rate preferred securities. Defendants included the independent chair of the funds’ board. (Kastel v. Nuveen Invs. Inc.)

New Lawsuits

• Alleging the same fee claim but for a different damages period, plaintiffs filed a second “anniversary complaint” in the fee litigation regarding six Principal target-date funds. The litigation has previously survived defendants’ motion to dismiss. (Am. Chems. & Equip., Inc. 401(k) Ret. Plan v. Principal Mgmt. Corp.)
• Investment adviser Sterling Capital is among the defendants in a new ERISA class action that challenges the selection of proprietary funds for its parent company’s 401(k) plan. (Bowers v. BB&T Corp.)

Briefs

• Calamos filed a reply brief in support of its motion to dismiss fee litigation regarding its Growth Fund. (Chill v. Calamos Advisors LLC.)
• In the ERISA class action regarding Fidelity‘s practices with respect to “float income” generated from transactions in retirement plan accounts, plaintiffs filed their opening appellate brief in the First Circuit, seeking to reverse the district court decision granting Fidelity’s motion to dismiss. The U.S. Secretary of Labor filed an amicus brief in support of plaintiffs, arguing that ERISA prohibits fiduciaries from using undisclosed float income obtained through plan administration for any purpose other than to benefit the ERISA-covered plan. (Kelley v. Fid. Mgmt. Trust Co.)

The Alt Perspective: Commentary and news from DailyAlts

I think it would be safe to say that most of us are happy to see the third quarter come to an end. While a variety of issues clearly remain on the horizon, it somehow feels like the potholes of the past six weeks are a bit more distant and the more joyous holiday season is closing in. Or, it could just be cognitive biases on my part.

Either way, the numbers are in. Here is a look at the 3rd Quarter performance for both traditional and alternative mutual fund categories as reported by Morningstar.

• Large Blend U.S. Equity: -7.50%
• Foreign Equity Large Blend: -10.37
• Intermediate Term Bond: 0.32%
• World Bond: -1.22%
• Moderate Allocation: -5.59%

Anything with emerging markets suffered even more. Now a look at the liquid alternative categories:

• Long/Short Equity: -4.44
• Non-Traditional Bonds: -1.96%
• Managed Futures: 0.38%
• Market Neutral: -0.26
• Multi-Alternative: -3.05
• Bear Market: 13.05%

And a few non-traditional asset classes:

• Commodities: -14.38%
• Multi-Currency: -3.35%
• Real Estate: 1.36%
• Master Limited Partnerships: -25.73%

While some media reports have questioned the performance of liquid alternatives over the past quarter, or during the August market decline, they actually have performed as expected. Long/short funds outperformed their long-only counterparts, managed futures generated positive performance (albeit fairly small), market neutral funds look fairly neutral with only a small loss on the quarter, and multi-alternative funds outperformed their moderate allocation counterparts.

The one area in question is the non-traditional bond category where these funds underperformed both traditional domestic and global bond funds. Long exposure to riskier fixed income asset would certainly have hurt many of these funds.

Declining energy prices zapped both the commodities and master limited partnerships categories, both of which had double-digit losses. Surprisingly, real estate held up well and there is even talk of developers looking to buy-back REITs due to their low valuations.

Let’s take a quick look at asset flows for August. Investors continued to pour money into managed futures funds and multi-alternative funds, the only two categories with positive inflows in every month of 2015. Volatility also got a boost in August as the CBOE Volatility Index spiked during the month. The final category to gather assets in August was commodities, surprisingly enough.

A few research papers of interest this past month:

PIMCO Examines How Liquid Alternatives Fit into Portfolios – this is a good primer on liquid alternatives with an explanation of how evaluated and use them in a portfolio.

The Path Forward for Women in Alternatives – this is an important paper that documents the success women have had in the alternative investment business. While there is much room for growth, having a study to outline the state of the current industry helps create more awareness and attention on the topic.

Investment Strategies for Tough Times – AQR provides a review of the 10 worst quarters for the market since 1972 and shows which investment strategies performed the best (and worst) in each of those quarters.

And finally, there were two regulatory topics that grabbed headlines this past month. The first was an investor alert issued by FINRA regarding “smart beta” product. Essentially, FINRA wanted to warn investors that not all smart beta products are alike, and that many different factors drive their returns. Essentially, buyer beware. The second was from the SEC who is proposing new liquidity rules for mutual funds and ETFs. One of the more pertinent rules is that having to do with maintain a three-day liquid asset minimum that would likely force many funds to hold more cash, or cash equivalents. This proposal is now in the 90-day comment period.

Have a great October and we will talk again (in this virtual way) just after Halloween! Let’s just hope the Fed doesn’t have any tricks up their sleeve in the meantime.

Elevator Talk: Michael Underhill, Capital Innovations Global Agri, Timber, Infrastructure Fund (INNAX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we have decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Michael Underhill manages INNAX, which launched at the end of September 2012. Mr. Underhill worked as a real asset portfolio manager for AllianceBernstein and INVESCO prior to founding Capital Innovations in 2007. He also manages about $170 million in this same strategy through separate accounts and four funds available only to Canadian investors.

Assets can be divided into two types: real and financial. Real assets are things you can touch: gold, oil, roads, bridges, soybeans, and lumber. Financial assets are intangible; stocks, for example, represent your hypothetical fractional ownership of a corporation and your theoretical claim to some portion of the value of future earnings.

Most individual portfolios are dominated by financial assets. Most institutional portfolios, however, hold a large slug of real assets and most academic research says that the slug should be even larger than it is.

Why so? Real assets possess four characteristics that are attractive and difficult to achieve.

They thrive in environments hostile to stocks and bonds. Real assets are positively correlated with inflation, stocks are weakly correlated with inflation and bonds are negatively correlated. That is, when inflation rises, bonds fall, stocks stall and real assets rise.

They are uncorrelated with the stock and bond markets. The correlation of returns for the various types of real assets hover somewhere just above or just below zero with relation to both the stock and bond market.

They are better long term prospects than stocks or bonds. Over the past 10- and 20-year periods, real assets have produced larger, steadier returns than either stocks or bonds. While it’s true that commodities have cratered of late, it’s possible to construct a real asset portfolio that’s not entirely driven by commodity prices.

A portfolio with real assets outperforms one without. The research here is conflicted. Almost everything we’ve read suggests that some allocation to real assets improves your risk-return profile. That is, a portfolio with real assets, stocks and bonds generates a greater return for each additional unit of risk than does a pure stock/bond portfolio. Various studies seem to suggest a more-or-less permanent real asset allocation of between 20-80% of your portfolio. I suspect that the research oversimplifies the situation since some of the returns were based on private or illiquid investments (that is, someone buying an entire forest) and the experience of such investments doesn’t perfectly mirror the performance of liquid, public investments.

Inflation is not an immediate threat but, as Mr. Underhill notes, “it’s a lot cheaper to buy an umbrella on a sunny day than it is once the rain starts.” Institutional investors, including government retirement plans and university endowments, seem to concur. Their stake in real assets is substantial (14-20% in many cases) and growing (their traditional stakes, like yours, were negligible).

INNAX has performed relatively well – in the top 20% of its natural resources peer group – over the past three years, aided by its lighter-than-normal energy stake. The fund is down about 5% since inception while its peers posted a 25% loss in the same period. The fund is fully invested, so its outperformance cannot be ascribed to sitting on the sidelines.

Here are Mr. Underhill’s 200 words on why you should add INNAX to your due-diligence list:

There was no question about what I wanted to invest in. The case for investing in real assets is compelling and well-established. I’m good at it and most investors are underexposed to these assets. So real asset management is all we do. We’re proud to say we’re an inch wide and a mile deep.

The only question was where I would be when I made those investments. I’ve spent the bulk of my career in very large asset management firms and I’d grown disillusioned with them. It was clear that large fund companies try to figure out what’s going to raise the most in terms of fees, and so what’s going to bring in the most fees. The strategies are often crafted by senior managers and marketing people who are concerned with getting something trendy up and out the door fast. You end up managing to a “product delivery specification” rather than managing for the best returns.

I launched Capital Innovations because I wanted the freedom and opportunity to serve clients and be truly innovative; we do that with global, all-cap portfolios that strive to avoid some of the pitfalls – overexposure to volatile commodity marketers, disastrous tax drags – that many natural resources funds fall prey to. We launched our fund at the request of some of our separate account clients who thought it would make a valuable strategy more broadly available.

Capital Innovations Global Agri, Timber, Infrastructure Fund has a $2500 minimum initial investment which is reduced to $500 for IRAs and other types of tax-advantaged accounts. Expenses are capped at 1.50% on the investor shares and 1.25% for institutional shares, with a 2.0% redemption fee on shares sold within 90 days. There’s a 5.75% front load that’s waived on some of the online platforms (e.g., Schwab). The fund has about gathered about $7 million in assets since its September 2012 launch. Here’s the fund’s homepage. It’s understandably thin on content yet but there’s some fairly rich analysis on the Capital Innovations page devoted to the underlying strategy. Our friends at DailyAlts.com interviewed Mr. Underhill in December 2014, and he laid out the case for real assets there. An exceptionally good overview of the case for real asset investing comes from Brookfield Asset Management, in Real Assets: The New Essential (2013) though everyone from TIAA-CREF to NACUBO have white papers on the subject.

My retirement portfolio has a small but permanent niche for real assets, which T. Rowe Price Real Assets (PRAFX) and Fidelity Strategic Real Return (FSRRX) filling that slot.

Launch Alert: Thornburg Better World

Earlier this summer, we argued that “doing good” and “doing well” were no longer incompatible goals, if they ever were. A host of academic and professional research has demonstrated that sustainable (or ESG) investing does not pose a drag on portfolio performance. That means that investors who would themselves never sell cigarettes or knowing pollute the environment can, with confidence, choose investing vehicles that honor those principles.

The roster of options expanded by one on October 1, with the launch of Thornburg Better World International Fund (TBWAX).  The fund will target “high-quality, attractively priced companies making a positive impact on the world.” That differs from traditional socially-responsible investments which focused mostly on negative screens; that is, they worked to exclude evil-doers rather than seeking out firms that will have a positive impact.

They’ll examine a number of characteristics in assessing a firm’s sustainability: “environmental impact, carbon footprint, senior management diversity, regulatory and compliance track record, board independence, capital allocation decisions, relationships with communities and customers, product safety, labor and employee development practices, relationships with vendors, workplace safety, and regulatory compliance, among others.”

The fund is managed by Rolf Kelly, CFA, portfolio manager of Thornburg’s Socially Screened International Equity Strategy (SMA). The portfolio will have 30-60 names. The initial expense ratio is 1.83%. The minimum initial investment is $5000.

Funds in Registration

There are seven new funds in registration this month. Funds in registration with the SEC are not available for sale to the public and the advisors are not permitted to talk about them, but a careful reading of the filed prospectuses gives you a good idea of what interesting (and occasionally appalling) options are in the pipeline. Funds currently in registration will generally be available for purchase in December.

While the number is small, many of them represent new offerings from “A” tier shops: DoubleLine Global Bond, Matthews Asia Value and two dividend-oriented international index funds from Vanguard

Manager Changes

Give or take Gary Black’s departure from Calamos, there were about 46 mostly low-visibility shifts in teams.

Thinking outside the model is hazardous to one’s wealth…

The title comes from the AlphaArchitect’s DIY Investing site, which is led by Wesley Gray. We profiled the firm’s flagship ValueShares US Quantitative Value ETF (QVAL) last December. Wes, along with Jack Vogel and David Foulke, recently published the Wiley Finance Series book, “DIY Finanical Advisor – A Simple Solution to Build and Protect Your Wealth.” It’s a great read.

It represents a solid answer to the so-called “return gap” problem described by Jason Hsu of Research Associates during Morningstar’s ETF Conference yesterday. Similar to and inspired by Morningstar’s “Investor Return” metric, Jason argues that investors’ bad decisions based on performance chasing and bad timing account for a 2% annualized short-fall between a mutual fund’s long-term performance and what investors actually receive. (He was kind enough to share his briefing with us, as well as his background position paper.)

“Investors know value funds achieve a premium, but they are too undisciplined to stay the course once the value fund underperforms the market.” It’s not just retail investors, Jason argues the poor behavior has actually been institutionalized and at some level may be worse for institutional investors, since their jobs are often based on short-term performance results.

DIY Financial Advisor opens by questioning society’s reliance on “expert opinion,” citing painful experiences of Victor Niederhoffer, Meredith Whitney, and Jon Corzine. It attempts to explain why financial experts often fail, due various biases, overconfidence, and story versus evidence-based decisions. The book challenges so-called investor myths, like…

• Buffett’s famous advice: “It’s far better to buy a wonderful company at a fair price than a fair company at the wonderful price.”
• Economic growth drives stock returns.
• Payout superstition, where observers predict that lower-dividend payout ratios imply higher earnings growth.

In order to be good investors, the book suggests that we need to appreciate our natural preference for coherent stories over evidence that conflicts with the stories. Don’t be the pigeon doing a “pellet voodoo dance.”

It advocates adoption of simple and systematic investment approaches that can be implemented by normal folks without financial background. The approaches may not be perfect, but they have been empirically validated, like the capture of value and momentum premiums, to work “for a large group of investors seeking to preserve capital and capture some upside.”

Wes details how and why Harry Markowitz, who won the Nobel Prize in 1990 for his groundbreaking work in portfolio selection and modern portfolio theory, used a simple equal-weight 50/50 allocation between bond and equities when investing his own money.

The book alerts us to fear, greed, complexity, and fear tactics employed by some advisors and highlights need for DIY investors to examine fees, access/liquidity, complexity, and taxes when considering investment vehicles.

It concludes by stating that “as long as we are disciplined and committed to a thoughtful process that meets our goals, we will be successful as investors. Go forth and be one of the few, one of the proud, one of the DIY investors who took control of their hard-earned wealth. You won’t regret the decision.”

As with Wes’ previous book, Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, DIY Financial Advisor is chock full of both anecdotes and analytical results. He and his team at AlphaArchitect continue to fight the good fight and we investors remain the beneficiaries.

Briefly Noted . . .

I hardly know how to talk about this one. Gary Black is “no longer a member of the investment team managing any of the series of the Calamos Investment Trust other than the Calamos Long/Short Fund … all references to Mr. Black’s position of Global Co-CIO and his involvement with all other series of the Calamos Investment Trust except for the Calamos Long/Short Fund shall be deemed deleted from the Summary Prospectuses, Prospectuses, and Statement of Additional Information of the Calamos Investment Trust.” In addition, Mr. Black ceased managing the fund that he brought to the firm, Calamos Long/Short (CALSX), on September 30, 2015. Mr. Black’s fund had about $100 million in assets and perfectly reasonable performance. The announcement of Mr. Black’s change of status was “effectively immediately,” which has rather a different feel than “effective in eight weeks after a transition period” or something similar.

Mr. Black came to Calamos after a tumultuous stint at the Janus Funds. Crain’s Chicago Business reports that Mr. Black “expanded the Calamos investment team by 50 percent, adding 25 investment professionals, and launched four funds,” but was not necessarily winning over skeptical investors.  The firm had $23.2 billion in assets under management at the end of August, 2015. That’s down from $33.4 billion on June 30, 2012, just before his hiring.

He leaves after three years, a Calamos rep explained, because he “completed the work he was hired to do. With John’s direction, he helped expand the investment teams and create specialized teams. During the past 18 months, performance has improved, signaling the evolution of the investment team is working.” Calamos, like PIMCO, is moving to a multiple CIO model. When asked if the experience of PIMCO after Gross informed their decision, Calamos reported that “We’ve extensively researched the industry overall and believe this is the best structure for a firm our size.”

“Mr. Black’s future plans,” we’ve been told, “are undecided.”

Toroso Newfound Tactical Allocation Fund (TNTAX) is a small, expensive, underperforming fund-of-ETFs. Not surprisingly, it was scheduled for liquidation. Quite surprisingly, at the investment advisor’s recommendation, the fund’s board reversed that decision and reopened the fund to new investors.  No idea of why.

Thanks, as always, to The Shadow for his help in tracking publicly announced but often little-noticed developments in the fund industry. Especially in month’s like the one just passed, it’s literally true that we couldn’t do it without his assistance. Cheers, big guy!

SMALL WINS FOR INVESTORS

Artisan Global Value Fund (ARTGX) reopened to new investors on October 1, 2015. I’m not quite sure what to make of it. Start with the obvious: it’s a splendid fund. Five stars. A Morningstar “Silver” fund. A Great Owl. Our profiles of the fund all ended with the same conclusion: “Bottom Line: We reiterate our conclusion from 2008, 2011 and 2012: ‘there are few better offerings in the global fund realm.’” That having been said, the fund is reopening with $1.6 billion in assets. If Morningstar’s report is to be trusted, assets grew by $700 million in the past 30 days. The fund is just one manifestation of Artisan’s Global Value strategy so one possible explanation is that Artisan is shifting assets around inside the $16 billion strategy, moving money from separate accounts into the fund. And given market volatility, the managers might well see richer opportunities – or might anticipate richer opportunities in the months ahead.

Effective September 15, 2015, the Westcore International Small-Cap Fund (the “Fund”) will reopen to new investors.

CLOSINGS (and related inconveniences)

Effective September 30, 361 Managed Futures Strategy Fund (AMFQX) closed to new investors.  It’s got about a billion in assets and a record that’s dramatically better than its peers’.

Artisan International Fund (ARTIX) will soft-close on January 29, 2016. The fund is having a tough year but has been a splendid performer for decades. The key is that it has tripled in size, to $18 billion, in the past four years, driven by a series of top-tier performances.

As of the close of business on October 31, 2015, Catalyst Hedged Futures Strategy Fund (HFXAX) will close to “substantially all” new investors.

Glenmede Small Cap Equity Portfolio (GTCSX) closed to new investors on September 30^th, on short notice. The closure also appears to affect current shareholders who purchased the fund through fund supermarkets.

OLD WINE, NEW BOTTLES

Aberdeen U.S. Equity Fund

Effective October 31, 2015, the name of the Aberdeen U.S. Equity Fund will change to the Aberdeen U.S. Multi-Cap Equity Fund.

Ashmore Emerging Markets Debt Fund will change its name to Ashmore Emerging Markets Hard Currency Debt Fund on or about November 8, 2015

Columbia Marsico Global Fund (COGAX) is jettisoning Marsico (that happens a lot) and getting renamed Columbia Select Global Growth Fund.

Destra Preferred and Income Securities Fund (DPIAX) has been renamed Destra Flaherty & Crumrine Preferred and Income Fund.

Dividend Plus+ Income Fund (DIVPX) has changed its name to MAI Managed Volatility Fund.

Forward Dynamic Income Fund (FDYAX) and Forward Commodity Long/Short Strategy Fund (FCOMX) have both decided to change their principal investment strategies, risks, benchmark and management team, effective November 3.

KKM U.S. Equity ARMOR Fund (UMRAX) terminated Equity Armor’s advisory contract. KKM Financial will manage the fund, now called KKM Enhanced U.S. Equity Fund (KKMAX) on its own

Effective September 10, 2015, the Pinnacle Tactical Allocation Fund change its name to the Pinnacle Sherman Tactical Allocation Fund (PTAFX).

At an August meeting, the Boards of the Wells Fargo Advantage Funds approved removing the word “Advantage” from its name, effective December 15, 2015.

Royce 100 Fund (RYOHX) was renamed Royce Small-Cap Leaders Fund on September 15, 2015. The new investment strategy is to select “securities of ‘leading’ companies—those that in its view are trading at attractive valuations that also have excellent business strengths, strong balance sheets, and/or improved prospects for growth, as well as those with the potential for improvement in cash flow levels and internal rates of return.” Chuck Royce has run the fund since 2003. It was fine through the financial crisis, and then began stumbling during the protracted bull run and trails 98% of its peers over the past five years.

Effective November 20, 2015, Worthington Value Line Equity Advantage Fund (WVLEX) becomes Worthington Value Line Dynamic Opportunity Fund. The fund invests, so far with no success, mostly in closed-end funds. It’s down about 10% since its launch in late January and the pass-through expenses of the CEFs it holds pushes the fund’s e.r. to nearly 2.5%. At that point its investment objective becomes the pursuit of “capital appreciation and current income” (income used to be “secondary”) and Liane Rosenberg gets added as a second manager joining Cindy Starke. Rosenberg is a member of the teams that manage Value Line’s other funds and, presumably, she brings fixed-income expertise to the table. The CEF universe is a strange and wonderful place, and part of the fund’s wretched performance so far (it’s lost more than twice as much since launch than the average large cap fund) might be attributed to a stretch of irrational pricing in the CEF market. Through the end of August, equity CEFs were down 12% YTD in part because their discounts steadily widened. WVLEX was also handicapped by an international stake (21%) that was five times larger than their peers. That having been said, it’s still not clear how the changes just announced will make a difference.

OFF TO THE DUSTBIN OF HISTORY

AB Market Neutral Strategy-U.S. (AMUAX) has closed and will liquidate on December 2, 2015. The fund has, since inception, bounced a lot and earned nothing: $10,000 at inception became $9,800 five years later.

Aberdeen High Yield Fund (AUYAX) is yielding to reality – it is trailing 90% of its peers and no one, including its trustees and two of its four managers, wanted to invest in it – and liquidating on October 22, 2015.

Ashmore Emerging Markets Currency Fund (ECAX), which is surely right now a lot like the “Pour Molten Lava on my Chest Fund (PMLCX), will pass from this vale of tears on October 9, 2015.

The small-and-dull, but not really bad, ASTON/TAMRO Diversified Equity Fund (ATLVX) crosses into the Great Unknown on Halloween. It’s a curious development since the same two managers run the half billion dollar Small Cap Fund (ATASX) that’s earned Morningstar’s Silver rating.

BlackRock Ultra-Short Obligations Fund (BBUSX): “On or about November 30, 2015,all of the assets of the Fund will be liquidated completely.” It’s a perfectly respectable ultra-short bond fund, with negligible volatility and average returns, that only drew $30 million. For a giant like BlackRock, that’s beneath notice.

At the recommendation of the fund’s interim investment adviser, Cavalier Traditional Fixed Income Fund (CTRNX) will be liquidated on October 5, 2015. Uhhh … yikes!

Dreyfus International Value Fund (DVLAX) is being merged into Dreyfus International Equity Fund (DIEAX). On whole, that’s a pretty clean win for the DVLAX shareholders.

Eaton Vance Global Natural Resources Fund (ENRAX) has closed and will liquidate on or about Halloween.  $4 million dollars in a portfolio that’s dropped 41% since launch, bad even by the standards of funds held hostage to commodity prices.

Shareholders have been asked to approve liquidation of EGA Frontier Diversified Core Fund (FMCR), a closed-end interval fund. Not sure how quickly the dirty deed with be done.

Fallen Angels Value Fund (FAVLX) joins the angels on October 16, 2015.

The termination and liquidation the Franklin Global Allocation Fund (FGAAX), which was scheduled to occur on or about October 23, 2015, has again been delayed due to foreign regulatory restrictions that prohibit the fund from selling one of its portfolio securities. The new liquidation target is January 14, 2016.

The $7 million Gateway International Fund (GAIAX) will liquidate on November 12, 2015. It’s an international version of the $7.7 billion, options-based Gateway Fund (GATEX) and is run by the same team. GAIAX has lost money since launch, and in two of the three years it’s been around, and trails 90% of its peers. Frankly, I’ve always been a bit puzzled by the worshipful attention that Gateway receives and this doesn’t really clear it up for me.

Inflation Hedges Strategy Fund (INHAX) has closed and will liquidate on October 22, 2015.

Janus Preservation Series – Global (JGSAX) will be unpreserved as of December 11, 2015.

Shareholders are being asked to merge John Hancock Fundamental Large Cap Core Fund (JFLAX) into John Hancock Large Cap Equity Fund TAGRX). The question will be put to them at the end of October. They should vote “yes.”

MFS Global Leaders (GLOAX) will liquidate on November 18, 2015.

Riverside Frontier Markets Fund ceased to exist on September 25, 2015 but the board assures us that the liquidation was “orderly.”

Salient Global Equity Fund (SGEAX) will liquidate around October 26, 2015.

Transamerica is proposing a rare reorganization of a closed-end fund (Transamerica Income Shares, Inc.) into one of their open-end funds, Transamerica Flexible Income (IDITX). The proposal goes before shareholders in early November.

MFO Switches To Lipper Database

In weeks ahead, MFO will begin using a Lipper provided database to compute mutual fund risk and return metrics found on our legacy Search Tools page and on the MFO Premium beta site.

Specifically, the monthly Lipper DataFeed Service provides comprehensive fund overview details, expenses, assets, and performance data for US mutual funds, ETFs, and money market funds (approximately 29,000 fund share classes).

Lipper, part of Thomson Reuters since 1998, has been providing “accurate, insightful, and timely collection and analysis of fund data” for more than 40 years. Its database extends back to 1960.

The methodologies MFO uses to compute its Great Owl funds, Three Alarm and Honor Roll designations, and Fund Dashboard of profiled funds will remain the same. The legacy search tool site will continue to be updated quarterly, while the premium site will be updated monthly.

Changes MFO readers can expect will be 1) quicker posting of updates, typically within first week of month, 2) more information on fund holdings, like allocation, turnover, market cap, and bond quality, and 3) Lipper fund classifications instead of the Morningstar categories currently used.

A summary of the Lipper classifications or categories can be found here. The more than 150 categories are organized under two main types: Equity Funds and Fixed Income Funds.

The Equity Funds have the following sub-types: US Domestic, Global, International, Specialized, Sector, and Mixed Asset. The Fixed Income Funds have: Short/Intermediate-Term U.S. Treasury and Government, Short/Intermediate-Term Corporate, General Domestic, World, Municipal Short/Intermediate, and Municipal General.

The folks at Lipper have been a pleasure to work with while evaluating the datafeed and during the transition. The new service supports all current search tools and provides opportunity for content expansion. The MFO Premium beta site in particular features:

• Selectable evaluation periods (lifetime, 20, 10, 5, 3, and 1 year, plus full, down, and up market cycles) for all risk and performance metrics, better enabling direct comparison.
• All share classes, not just oldest.
• More than twenty search criteria can be selected simultaneously, like Category, Bear Decile, and Return Group, plus sub-criteria. For example, up to nine individual categories may be selected, along with multiple risk and age characteristics.
• Compact, sortable, exportable search table outputs.
• Expanded metrics, including Peer Count, Recovery Time, and comparisons with category averages.

Planned content includes: fund rankings beyond those based on Martin ratio, including absolute return, Sharpe and Sortino ratios; fund category metrics; fund house performance ratings; and rolling period fund performance.

In Closing . . .

The Shadow is again leading the effort on MFO’s discussion board to begin cataloging capital gain’s announcements. Ten firms had year-end estimates out as of October 1. Last year’s tally on the board reached 160 funds. Mark Wilson’s Cap Gains Valet site is still hibernating. If Mark returns to the fray, we’ll surely let you know.

It’s hard to remember but, in any given month, 7000-8000 people read the Observer for the first time. Some will flee in horror, others will settle in. That’s my excuse for repeating the exhortation to bookmark MFO’s link to Amazon.com!  While we are hopeful that our impending addition of a premium site will generate a sustainable income stream to help cover the costs of our new data feed and all, Amazon still provides the bulk of our revenue. That makes our September 2015 returns, the lowest in more than two years, a bit worrisome.

The system is simple: (1) bookmark our link to Amazon. Better yet, set it as one of your browser’s “open at launch” tabs. (2) When you want to shop at Amazon, click on that link or use that tab.  You do not have to come to MFO and click on the link on your way to Amazon. You go straight there. On your address bar, you’ll see a bit of coding (encoding=UTF8&tag=mutufundobse-20) that lets Amazon know you’re using our link. (3) Amazon then contributes an amount equivalent to 5% or so of your purchase to MFO. You’re charged nothing since it’s part of their marketing budget. And we get the few hundred a month that allows us to cover our “hard” expenses.

I’m not allowed to use the link myself, so my impending purchases of Halloween candy (Tootsie Rolls and Ring Pops, mostly) and a coloring book (don’t ask), will benefit the music program at my son’s school.

Thanks especially to the folks who made contributions to the Observer this month.  That includes a cheerful wave to our subscribers, Greg and Deb, to the good folks at Cook & Bynum and at Focused Finances, to Eric E. and Sunil, both esteemed repeat offenders, as well as to Linda Who We’ve Never Met Before and Richard. To one and all, thanks! You made it a lot easier to have the confidence to sign the data agreement with Lipper.

We’ll look for you.

Dear friends,

Investing by aphorism is a tricky business.

“Buy on the sound of cannons, sell on the sound of trumpets.” It’s widely attributed to “Baron Nathan Rothschild (1810).” Of course, he wasn’t a baron in 1810. There’s no evidence he ever said it. 1810 wouldn’t have been a sensible year for the statement even if he had said it. And the earliest attributions are in anti-Semitic French newspapers advancing the claim that some Rothschild or another triggered a financial panic for family gain.

And then there’s weiji. It’s one of the few things that Condoleeza Rice and Al Gore agree upon. Here’s Rice after a trip to the Middle East:

I don’t read Chinese but I’m told that the Chinese character for crisis is “weiji”, which means both danger and opportunity. And I think that states it very well.

And Gore, accepting the Nobel Prize:

In the Kanji characters used in both Chinese and Japanese, “crisis” is written with two symbols, the first meaning “danger,” the second “opportunity.”

John Kennedy, Richard Nixon, business school deans, the authors of The Encyclopedia of Public Relations, Flood Planning: The Politics of Water Security, On Philosophy: Notes on A Crisis, Foundations of Interpersonal Practice in Social Work, Strategy: A Step by Step Approach to the Development and Presentation of World Class Business Strategy (apparently one unencumbered by careful fact-checking), Leading at the Edge (the author even asked “a Chinese student” about it, the student smiled and nodded so he knows it’s true). One sage went so far as to opine “the danger in crisis situations is that we’ll lose the opportunity in it.”

Weiji, Will Robinson! Weiji!

Except, of course, that it’s not true. Chinese philologists keep pointing out that “ji” is being misinterpreted. At base, “ji” can mean a lot of things. Since at least the third century CE, “weiji” meant something like “latent danger.” In the early 20^th century it was applied to economic crises but without the optimistic “hey, let’s buy the dips!” sense now given it. As Victor Mair, a professor of Chinese language and literature at the University of Pennsylvania put it:

Those who purvey the doctrine that the Chinese word for “crisis” is composed of elements meaning “danger” and “opportunity” are engaging in a type of muddled thinking that is a danger to society, for it lulls people into welcoming crises as unstable situations from which they can benefit. Adopting a feel-good attitude toward adversity may not be the most rational, realistic approach to its solution.

Maybe in our March issue, I’ll expound on the origin of the phrase “furniture polish.” Did you know that it’s an Olde English term that comes from the French. It reflects the fact that the best furniture in the world was made around the city of Krakow, Poland so if you had furniture Polish, you had the most beautiful anywhere.

The good folks at Leuthold foresee a market decline of 30%, likely some time in 2015 or 2016 and likely sooner rather than later. Professor Studzinski suspects that they’re starry-eyed optimists. Yale’s Crash Confidence Index is drifting down, suggesting that investors think there will be a crash, a perception that moves contrary to the actual likelihood of a crash, except when it doesn’t. AAII’s Investor Confidence Index rose right along with market volatility. American and Chinese investors became more confident, Europeans became less confident and US portfolios became more risk-averse.

Meanwhile oil prices are falling, Russia is invading, countries are unraveling, storms are raging, Mitt’s withdrawing … egad! What, you might ask, am I doing about it? Glad you asked.

Snowball and the power of positive stupidity

My portfolio is designed to allow me to be stupid. It’s not that I try to be stupid but, being human, the temptation is almost irresistible at times. If you’re really smart, you can achieve your goals by taking a modest amount and investing it brilliantly. My family suggested that I ought not be banking on that route, so I took the road less traveled. Twenty years ago, I used free software available from Fidelity, Price and Vanguard, my college’s retirement plan providers, to determine how much I needed to invest in order to fund my retirement. I used conservative assumptions (long-term inflation near 4% and expected portfolio returns below 8% nominal), averaged the three recommendations and ended up socking away a lot each month. 

Downside (?): I needed to be careful with our money – my car tends to be a fuel-efficient used Honda or Toyota that I drive for a quarter million miles or so, I tend to spend less on new clothes each year than on good coffee (if you’re from Pittsburgh, you know Mr. Prestogeorge’s coffee; if you’re not, the Steeler Nation is sad on your behalf), our home is solid and well-insulated but modest and our vacations often involve driving to see family or other natural wonders. 

Upside: well, I’ve never become obsessed about the importance of owning stuff. And the more sophisticated software now available suggests that, given my current rate of investment, I only need to earn portfolio returns well under 6% (nominal) in order to reach my long-term goals. 

And I’m fairly confident that I’ll be able to maintain that pace, even if I am repeatedly stupid along the way. 

It’s a nice feeling. 

A quick review of my fund portfolio’s 2015 performance would lead you to believe that I managed to be extra stupid last year with a portfolio return of just over 3%. If my portfolio’s goal was to maximize one-year returns, you’d be exactly right. But it isn’t, so you aren’t. Here’s a quick review of what I was thinking when I constructed my portfolio, what’s in it and what might be next.

The Plan: Follow the evidence. My non-retirement portfolio is about half equity and half income because the research says that more equity simply doesn’t pay off in a portfolio with an intermediate time horizon. The equity portion is about half US and half international and is overweighted toward small, value, dividend and quality. The income portion combines some low-cost “normal” stuff with an awful lot of abnormal investments in emerging markets, convertibles, and called high-yield bonds. On whole the funds have high active share, long-tenured managers, are risk conscious, lower turnover and relatively low expense. In most instances, I’ve chosen funds that give the managers some freedom to move assets around.

Pure equity:

Artisan Small Cap Value (ARTVX, closed). This is, by far, my oldest holding. I originally bought Artisan Small Cap (ARTSX) in late 1995 and, being a value kinda guy, traded those shares in 1997 for shares in the newly-launched ARTVX. It made a lot of money for me in the succeeding decade but over the past five years, its performance has sucked. Lipper has it ranked as 203 out of 203 small value funds over the past five years, though it has returned about 7% annually in the period. Not entirely sure what’s up. A focus on steady-eddy companies hasn’t helped, especially since it led them into a bunch of energy stocks. A couple positions, held too long, have blown up. The fact that they’re in a leadership transition, with Scott Satterwhite retiring in October 2016, adds to the noise. I’ll continue to watch and try to learn more, but this is getting a bit troubling.

Artisan International Value (ARTKX, closed). I acquired this the same way I acquired ARTVX, in trade. I bought Artisan International (ARTIX) shortly after its launch, then moved my investment here because of its value focus. Good move, by the way. It’s performed brilliantly with a compact, benchmark-free portfolio of high quality stocks. I’m a bit concerned about the fund’s size, north of $11 billion, and the fact that it’s now dominated by large cap names. That said, no one has been doing a better job.

Grandeur Peak Global Reach (GPROX, closed). When it comes to global small and microcap investing, I’m not sure that there’s anyone better or more disciplined than Grandeur Peak. This is intended to be their flagship fund, with all of the other Grandeur Peak funds representing just specific slices of its portfolio. Performance across the group, extending back to the days when the managers ran Wasatch’s international funds, has been spectacular. All of the existing funds are closed though three more are in the pipeline: US Opportunities, Global Value, and Global Microcap.

Pure income

RiverPark Short Term High Yield (RPHYX, closed). The best and most misunderstood fund in the Morningstar universe. Merely noting that it has the highest Sharpe ratio of any fund doesn’t go far enough. Its Sharpe ratio, a measure of risk-adjusted returns where higher is better, since inception is 6.81. The second-best fund is 2.4. Morningstar insists on comparing it to its high yield bond group, with which it shares neither strategy nor portfolio. It’s a conservative cash management account that has performed brilliantly. The chart is RPHYX against the HY bond peer group.

RiverPark Strategic Income (RSIVX). At base, this is the next step out from RPHYX on the risk-return spectrum. Manager David Sherman thinks he can about double the returns posted by RPHYX without a significant risk of permanent loss of capital. He was well ahead of that pace until mid-2014 when he encountered a sort of rocky plateau. In the second half of 2014, the fund dropped 0.45% which is far less than any plausible peer group. Mr. Sherman loathes the prospect of “permanent impairment of capital” but “as long as the business model remains acceptable and is being pursued consistently and successfully, we will tolerate mark-to-market losses.” He’s quite willing to hold bonds to maturity or to call, which reduces market volatility to annoying noise in the background. Here’s the chart of Strategic Income (blue) against its older sibling.

Matthews Strategic Income (MAINX). I think this is a really good fund. Can’t quite be sure since it’s essentially the only Asian income fund on the market. There’s one Asian bond fund and a couple ETFs, but they’re not quite comparable and don’t perform nearly as well. The manager’s argument struck me as persuasive: Asian fixed-income offers some interesting attributes, it’s systematically underrepresented in indexes and underfollowed by investors (the fund has only $67 million in assets despite a strong record). Matthews has the industry’s deepest core of Asia analysts, Ms. Kong struck me as exceptionally bright and talented, and the opportunity set seemed worth pursuing.

Impure funds

FPA Crescent (FPACX). I worry, sometimes, that the investing world’s largest “free-range chicken” (his term) might be getting fat. Steve Romick has one of the longest and most successful records of any manager but he’s currently toting a $20 billion portfolio which is 40% cash. The cash stash is consistent with FPA’s “absolute value” orientation and reflects their ongoing concerns about market valuations which have grown detached from fundamentals. It’s my largest fund holding and is likely to remain so.

T. Rowe Price Spectrum Income (RPSIX). This is a fund of TRP funds, including one equity fund. It’s been my core fixed income holding since it’s broadly diversified, low cost and sensible. Over time, it tends to make about 6% a year with noticeably less volatility than its peers. It’s had two down years in a quarter century, losing about 2% in 1994 and 9% in 2008. I’m happy.

Seafarer Overseas Growth & Income (SFGIX). I believe that Andrew Foster is an exceptional manager and I was excited when he moved from a large fund with a narrow focus to launch a new fund with a broader one. Seafarer is a risk-conscious emerging markets fund with a strong presence in Asia. It’s my second largest holding and I’ve resolved to move my account from Scottrade to invest directly with Seafarer, to take advantage of their offer of allowing $100 purchase minimums on accounts with an automatic investing plan. Given the volatility of the emerging markets, the discipline to invest automatically rather than when I’m feeling brave seems especially important.

Matthews Asian Growth & Income (MACSX). I first purchased MACSX when Andrew Foster was managing this fund to the best risk-adjusted returns in its universe. It mixes common stock with preferred shares and convertibles. It had strong absolute returns, though poor relative ones, in rising markets and was the best in class in falling markets. It’s done well in the years since Andrew’s departure and is about the most sensible option around for broad Asia exposure.

Northern Global Tactical Asset Allocation (BBALX). Formerly a simple 60/40 balanced fund, BBALX uses low-cost ETFs and Northern funds to execute their investment planning committee’s firm-wide recommendations. On whole, Northern’s mission is to help very rich people stay very rich so their strategies tend to be fairly conservative and tilted toward quality, dividends, value and so on. They’ve got a lot less in the US and a lot more emerging markets exposure than their peers, a lot smaller market cap, higher dividends, lower p/e. It all makes sense. Should I be worried that they underperform a peer group that’s substantially overweighted in US, large cap and growth? Not yet.

Aston River Road Long/Short (ARLSX). Probably my most controversial holding since its performance in the past year has sucked. That being said, I’m not all that anxious about it. By the managers’ report, their short positions – about a third of the portfolio – are working. It’s their long book that’s tripping them up. Their long portfolio is quite different from their peers: they’ve got much larger small- and mid-cap positions, their median market cap is less than half of their peers’ and they’ve got rather more direct international exposure (10%, mostly Europe, versus 4%). In 2014, none of those were richly rewarding places to be. Small caps made about 3% and Europe lost nearly 8%. Here’s Mr. Moran’s take on the former:

Small-cap stocks significantly under-performed this quarter and have year-to-date as well. If the market is headed for a correction or something worse, these stocks will likely continue to lead the way. We, however, added substantially to the portfolio’s small-cap long positions during the quarter, more than doubling their weight as we are comfortable taking this risk, looking different, and are prepared to acknowledge when we are wrong. We have historically had success in this segment of the market, and we think small-cap valuations in the Fund’s investable universe are as attractive as they have been in more than two years.

It’s certainly possible that the fund is a good idea gone bad. I don’t really know yet.

Since my average holding period is something like “forever” – I first invested in eight of my 12 funds shortly after their launch – it’s unlikely that I’ll be selling anyone unless I need cash. I might eventually move the Northern GTAA money, though I have no target in mind. I suspect Charles would push for me to consider making my first ETF investment into ValueShares US Quantitative Value (QVAL). And if I conclude that there’s been some structural impairment to Artisan Small Cap Value, I might exit around the time that Mr. Satterwhite does. Finally, if the markets continue to become unhinged, I might consider a position in RiverPark Structural Alpha (RSAFX), a tiny fund with a strong pedigree that’s designed to eat volatility.

My retirement portfolio, in contrast, is a bit of a mess. I helped redesign my college’s retirement plan to simplify and automate it. That’s been a major boost for most employees (participation has grown from 23% to 93%) but it’s played hob with my own portfolio since we eliminated the Fidelity and T. Rowe funds in favor of a greater emphasis on index funds, funds of index funds and a select few active ones. My allocation there is more aggressive (80/20 stocks) but has the same tilt toward small, value, and international. I need to find time to figure out how best to manage the two frozen allocations in light of the more limited options in the new plan. Nuts.

For now: continue to do the automatic investment thing, undertake a modest bit of rebalancing out of international equities, and renew my focus on really big questions like whether to paint the ugly “I’m so ‘70s” brick fireplace in my living room.

Strange doings, currency wars, and unintended consequences

By Edward A. Studzinski

Imagine the Creator as a low comedian, and at once the world becomes explicable.     H.L. Mencken

January 2015 has perhaps not begun in the fashion for which most investors would have hoped. Instead of continuing on from last year where things seemed to be in their proper order, we have started with recurrent volatility, political incompetence, an increase in terrorist incidents around the world, currency instability in both the developed and developing markets, and more than a faint scent of deflation creeping into the nostrils and minds of central bankers. Through the end of January, the Dow, the S&P 500, and the NASDAQ are all in negative territory. Consumers, rather than following the lead of the mass market media who were telling them that the fall in energy prices presented a tax cut for them to spend, have elected to save for a rainy day. Perhaps the most unappreciated or underappreciated set of changed circumstances for most investors to deal with is the rising specter of currency wars.

So, what is a currency war? With thanks to author Adam Chan, who has written thoughtfully on this subject in the January 29, 2015 issue of The Institutional Strategist, a currency war is usually thought of as an effort by a country’s central bank to deliberately devalue their currency in an effort to stimulate exports. The most recent example of this is the announcement a few weeks ago by the European Central Bank that they would be undertaking another quantitative easing or QE in shorthand. More than a trillion Euros will be spent over the next eighteen months repurchasing government bonds. This has had the immediate effect of producing negative yields on the market prices of most European government bonds in the stronger economies there such as Germany. Add to this the compound effect of another sixty billion Yen a month of QE by the Bank of Japan going forward. Against the U.S. dollar, those two currencies have depreciated respectively 20% and 15% over the last year.

We have started to see the effects of this in earnings season this quarter, where multinational U.S. companies that report in dollars but earn various streams of revenues overseas, have started to miss estimates and guide towards lower numbers going forward. The strong dollar makes their goods and services less competitive around the world. But it ignores another dynamic going on, seen in the collapse of energy and other commodity prices, as well as loss of competitiveness in manufacturing.

Countries such as the BRIC emerging market countries (Brazil, Russia, India, China) but especially China and Russia, resent a situation where the developed countries of the world print money to sustain their economies (and keep the politicians in office) by purchasing hard assets such as oil, minerals, and manufactured goods for essentially nothing. For them, it makes no sense to allow this to continue.

The end result is the presence in the room of another six hundred pound gorilla, gold. I am not talking about gold as a commodity, but rather gold as a currency. Note that over the last year, the price of gold has stayed fairly flat while a well-known commodity index, the CRB, is down more than 25% in value. Reportedly, former Federal Reserve Chairman Alan Greenspan supported this view last November when he said, “Gold is still a currency.” He went on to refer to it as the “premier currency.” In that vein, for a multitude of reasons, we are seeing some rather interesting actions taking place around the world recently by central banks, most of which have not attracted a great deal of notice in this country.

In January of this year, the Bundesbank announced that in 2014 it repatriated 120 tons of its gold reserves back to Germany, 85 tons from New York and the balance from Paris. Of more interest, IN TOTAL SECRECY, the central bank of the Netherlands repatriated 122 tons of its gold from the New York Federal Reserve, which it announced in November of 2014. The Dutch rationale was explained as part of a currency “Plan B” in the event the Netherlands left the Euro. But it still begs the question as to why two of the strongest economies in Europe would no longer want to leave some of their gold reserves on deposit/storage in New York. And why are Austria and Belgium now considering a similar repatriation of their gold assets from New York?

At the same time, we have seen Russia, with its currency under attack and not by its own doing or desire as a result of economic sanctions. Putin apparently believes this is a deliberate effort to stimulate unrest in Russia and force him from power (just because you are paranoid, it doesn’t mean you are wrong). As a counter to that, you see the Russian central bank being the largest central bank purchaser of gold, 55 tons, in Q314. Why? He is interested in breaking the petrodollar standard in which the U.S. currency is used as the currency to denominate energy purchases and trade. Russia converts its proceeds from the sale of oil into gold. They end up holding gold rather than U.S. Treasuries. If he is successful, there will be considerably less incentive for countries to own U.S. government securities and for the dollar to be the currency of global trade. Note that Russia has a positive balance of trade with most of its neighbors and trading partners.

Now, my point in writing about this is not to engender a discussion about the wisdom or lack thereof in investing in gold, in one fashion or another. The students of history among you will remember that at various points in time it has been illegal for U.S. citizens to own gold, and that on occasion a fixed price has been set when the U.S. government has called it in. My purpose is to point out that there have been some very strange doings in asset class prices this year and last. For most readers of this publication, since their liabilities are denominated in U.S. dollars, they should focus on trying to pay those liabilities without exposing themselves to the vagaries of currency fluctuations, which even professionals have trouble getting right. This is the announced reason, and a good one, as to why the Tweedy, Browne Value Fund and Global Value Fund hedge their investments in foreign securities back into U.S. dollars. It is also why the Wisdom Tree ETF’s which are hedged products have been so successful in attracting assets. What it means is you are going to have to pay considerably more attention this year to a fund’s prospectus and its discussion of hedging policies, especially if you invest in international and/or emerging market mutual funds, both equity and fixed income.

My final thoughts have to do with unintended consequences, diversification, and investment goals and objectives. The last one is most important, but especially this year. Know yourself as an investor! Look at the maximum drawdown numbers my colleague Charles puts out in his quantitative work on fund performance. Know what you can tolerate emotionally in terms of seeing a market value decline in the value of your investment, and what your time horizon is for needing to sell those assets. Warren Buffett used to speak about evaluating investments with the thought as to whether you would still be comfortable with the investment, reflecting ownership in a business, if the stock market were to close for a couple of years. I would argue that fund investments should be evaluated in similar fashion. Christopher Browne of Tweedy, Browne suggested that you should pay attention to the portfolio manager’s investment style and his or her record in the context of that style. Focus on whose record it is that you are looking at in a fund. Looking at Fidelity Magellan’s record after Peter Lynch left the fund was irrelevant, as the successor manager (or managers as is often the case) had a different investment management style. THERE IS A REASON WHY MORNINGSTAR HAS CHANGED THEIR METHODOLOGY FROM FOLLOWING AND EVALUATING FUNDS TO FOLLOWING AND EVALUATING MANAGERS.

Diversification is another key issue to consider. Outstanding Investor Digest, in Volume XV, Number 7, published a lecture and Q&A with Philip Fisher that he gave at Stanford Business School. If you don’t know who Philip Fisher was, you owe it to yourself to read some of his work. Fisher believed strongly that you had achieved most of the benefits of risk reduction from diversification with a portfolio of from seven to ten stocks. After that, the benefits became marginal. The quote worth remembering, “The last thing I want is a lot of good stocks. I want a very few outstanding ones.” I think the same discipline should apply to mutual fund portfolios. You are not building an investment ark, where you need two of everything.

Finally, I do expect this to be a year of unintended consequences, both for institutional and individual investors. It is a year (but the same applies every year) when predominant in your mind should not be, “How much money can I make with this investment?” which is often tied to bragging rights at having done better than your brother-in-law. The focus should be, “How much money could I lose?” And my friend Bruce would ask if you could stand the real loss, and what impact it might have on your standard of living? In 2007 and 2008, many people found that they had to change their standard of living and not for the better because their investments were too “risky” for them and they had inadequate cash reserves to carry them through several years rather than liquidate things in a depressed market.

Finally, I make two suggestions. One, the 2010 documentary on the financial crisis by Charles Ferguson entitled “Inside Job” is worth seeing and if you can’t find it, the interview of Mr. Ferguson by Charlie Rose, which is to be found on line, is quite good. As an aside, there are those who think many of the most important and least watched interviews in our society today are conducted by Mr. Rose, which I agree with and think says something about the state of our society. And for those who think history does not repeat itself, I would suggest reading volume I, With Fire and Sword of the great trilogy of Henryk Sienkiewicz about the Cossack wars of the Sixteenth Century set in present day Ukraine. I think of Sienkiewicz as the Walter Scott of Poland, and you have it all in these novels – revolution and uprising in Ukraine, conflict between the Polish-Lithuanian Commonwealth and Moscow – it’s all there, but many, many years ago. And much of what is happening today, has happened before.

I will leave you with a few sentences from the beginning pages of that novel.

It took an experienced ear to tell the difference between the ordinary baying of the wolves and the howl of vampires. Sometimes entire regiments of tormented souls were seen to drift across the moonlit Steppe so that sentries sounded the alarm and garrisons stood to arms. But such ghostly armies were seen only before a great war.

Genius, succession and transition at Third Avenue

The mutual fund industry is in the midst of a painful transition. As long ago as the 1970s, Charles Ellis recognized that the traditional formula could no longer work. That formula was simple:

1. Read Dodd and Graham
2. Apply Dodd and Graham
3. Crush the competition
4. Watch the billions flow in.

Ellis’s argument is that Step 3 worked only if you were talented and your competitors were not. While that might have described the investing world in the 1930s or even the 1950s, by the 1970s the investment industry was populated by smart, well-trained, highly motivated investors and the prospect of beating them consistently became as illusory as the prospect of winning four Super Bowls in six years now is. (With all due respect to the wannabees in Dallas and New England, each of which registered three wins in a four year period.)

The day of reckoning was delayed by two decades of a roaring stock market. From 1980 – 1999, the S&P 500 posted exactly two losing years and each down year was followed by eight or nine winning ones. Investors, giddy at the prospect of 100% and 150% and 250% annual reports, catapulted money in the direction of folks like Alberto Vilar and Garrett Van Wagoner. As the acerbic hedge fund manager Jim Rogers said, “It is remarkable how many people mistake a bull market for brains.”

That doesn’t deny the existence of folks with brains. They exist in droves. And a handful – Charles Royce and Marty Whitman among them – had “brains” to the point of “brilliance” and had staying power.

For better and worse, Step 4 became difficult 15 years ago and almost a joke in the past decade. While a handful of funds – from Michael C. Aronstein’s Mainstay Marketfield (MFLDX) and The Jeffrey’s DoubleLine complex – managed to sop up tens of billions, flows into actively-managed fund have slowed to a trickle. In 2014, for example, Morningstar reports that actively-managed funds saw $90 billion in outflows and passive funds had $156 billion in inflows.

The past five years have not been easy ones for the folks at Third Avenue funds. It’s a firm with that earned an almost-legendary reputation for independence and success. Our image of them and their image of themselves might be summarized by the performance of the flagship Third Avenue Value Fund (TAVFX) through 2007.

The Value Fund (blue) not only returned more than twice what their global equity peers made, but also essential brushed aside the market collapse at the end of the 1990s bubble and the stagnation of “the lost decade.” Investors rewarded the fund by entrusting it with billions of dollars in assets; the fund held over $11 billion at its peak.

But it’s also a firm that struggled since the onset of the market crisis in late 2007. Four of the firm’s funds have posted mediocre returns – not awful, but generally below-average – during the market cycle that began in early October 2007 and continues to play out. The funds’ five- and ten-year records, which capture parts of two distinct market cycles but the full span of neither, make them look distinctly worse. That’s been accompanied by the departure of both investment professionals and investor assets:

Third Avenue Value (TAVFX) saw the departure of Marty Whitman as the fund’s manager (2012) and of his heir presumptive Ian Lapey (2014), along with 80% of its assets. The fund trails about 80% of its global equity peers over the past five and ten years, which helps explain the decline. Performance has rallied in the past three years with the fund modestly outperforming the MSCI World index through the end of 2014, though investors have been slow to return.

Third Avenue Small Cap Value (TASCX) bid adieu to manager Curtis Jensen (2014) and analyst Charles Page, along with 80% of its assets. The fund trails 85% of its peers over the past five years and ten years.

Third Avenue International Value (TAVIX) lost founding manager Amit Wadhwaney (2014), his co-manager and two analysts. Trailing 96% of its peers for the past five and ten years, the fund’s AUM declined by 86% from its peak assets.

Third Avenue Focused Credit (TFCIX) saw its founding manager, Jeffrey Gary, depart (2010) to found a competing fund, Avenue Credit Strategies (ACSAX) though assets tripled from around the time of his departure to now. The fund’s returns over the past five years are almost dead-center in the high yield bond pack.

Only Third Avenue Real Estate Value (TAREX) has provided an island of stability. Lead manager Michael Winer has been with the fund since its founding, he’s got his co-managers Jason Wolfe (2004) and Ryan Dobratz (2006), a growing team, and a great (top 5% for the past 3, 5, 10 and 15 year periods) long-term record. Sadly, that wasn’t enough to shield the fund from a 67% drop in assets from 2006 to 2008. Happily, assets have tripled since then to about $3 billion.

In sum, the firm’s five mutual funds are down by $11 billion from their peak asset levels and nearly 50% of the investment professionals on staff five years ago, including the managers of four funds, are gone. At the same time, only one of the five funds has had performance that meets the firm’s long-held standards of excellence.

Many outsiders noted not just the departure of long-tenured members of the Third Avenue community, but also the tendency to replace some those folks with outsiders, including Robert Rewey, Tim Bui and Victor Cunningham. The most prominent change was the arrival, in 2014, of Robert Rewey, the new head of the “value equity team.” Mr. Rewey formerly was a portfolio manager at Cramer Rosenthal McGlynn, LLC, where his funds’ performance trailed their benchmark (CRM Mid Cap Value CRMMX, CRM All Cap Value CRMEX and CRM Large Cap Opportunity CRMGX) or exceeded it modestly (CRM Small/Mid Cap Value CRMAX). Industry professionals we talked with spoke of “a rolling coup,” the intentional marginalization of Mr. Whitman within the firm he created and the influx of outsiders. Understandably, the folks at Third Avenue reject that characterization, noting that Mr. Whitman is still at TAM, that he attends every research meeting and was involved in every hiring decision.

Change in the industry is constant; the Observer reports on 500 or 600 management changes – some occasioned by a manager’s voluntary change of direction, others not – each year. The question for investors isn’t “had Third Avenue changed?” (It has, duh). The questions are “how has that change been handled and what might it mean for the future?” For answers, we turned to David Barse. Mr. Barse has served with Mr. Whitman for about a quarter century. He’s been president of Third Avenue, of MJ Whitman LLC and of its predecessor firm. He’s been with the operation continuously since the days that Mr. Whitman managed the Equity Strategies Fund in the 1980s.

From that talk and from the external record, I’ve reached three tentative conclusions:

1. Third Avenue Value Fund’s portfolio went beyond independent to become deeply, perhaps troublingly, idiosyncratic during the current cycle. Mr. Whitman saw Asia’s growth as a powerful driver to real estate values there and the onset of the SARS/avian flu panics as a driver of incredible discounts in the stocks’ prices. As a result, he bought a lot of exposure to Asian real estate and, as the markets there declined, bought more. At its peak, 65% of the fund’s portfolio was exposed to the Asian real estate market. Judging by their portfolios, neither the very successful Real Estate Value Fund nor the International Value Fund, the logical home of such investments, believed that it was prudent to maintain such exposure. Mr. Winer got his fund entirely out of the Asia real estate market and Mr. Wadhwaney’s portfolio contained none of the stocks held in TAVFX. Reportedly members of Mr. Whitman’s own team had substantial reservations about the extent of their investment and many shareholders, including large institutional investors, concluded that this was not at all what they’d signed up for. Third Avenue has now largely unwound those positions, and the Value Fund had 8.5% of its 2014 year-end portfolio in Hong Kong.
2. “Succession planning” always works better on paper than in the messy precinct of real life. Mr. Whitman and Mr. Barse knew, on the day that TAVFX launched, that they needed to think about life after Marty. Mr. Whitman was 67 when the fund launched and was setting out for a new adventure around the time that most professionals begin winding down. In consequence, Mr. Barse reports, “Succession planning was intrinsic to our business plans from the very beginning. This was a fantastic business to be in during the ‘90s and early ‘00s. We pursued a thoughtful expansion around our core discipline and Marty looked for talented people who shared his discipline and passion.” Mr. Whitman seems to have been more talented in investment management than in business management and none of this protégés, save Mr. Winer, showed evidence of the sort of genius that drove Mr. Whitman’s success. Finally, in his 89^th year of life, Mr. Whitman agreed to relinquish management of TAVFX with the understanding that Ian Lapey be given a fair chance as his successor. Mr. Lapey’s tenure as manager, both the five years which included time as co-manager with Mr. Whitman and the 18 months as lead manager, was not notably successful.
3. Third Avenue is trying to reorient its process from “the mercurial genius” model to “the healthy team” one. When Third Avenue was acquired in 2002 by the Affiliated Managed Group (AMG), the key investment professionals signed a ten year commitment to stay with the firm – symbolically important if legally non-binding – with a limited non-compete period thereafter. 2012 saw the expiration of those commitments and the conclusion, possibly mutual, that it was time for long-time managers like Curtis Jensen and Amit Wadhwaney to move on. The firm promoted co-managers with the expectation that they’d become eventual successors. Eventually they began a search for Mr. Whitman’s successor. After interviewing more than 50 candidates, they selected Mr. Rewey based on three factors: he understood the nature of a small, independent, performance-driven firm, he understood the importance of healthy management teams and he shared Mr. Whitman’s passion for value investing. “We did not,” Mr. Barse notes, “make this decision lightly.” The firm gave him a “team leader” designation with the expectation that he’d consciously pursue a more affirmative approach to cultivating and empowering his research and management associates.

It’s way too early to draw any conclusions about the effects of their changes on fund performance. Mr. Barse notes that they’ve been unwinding some of the Value Fund’s extreme concentration and have been working to reduce the exposure of illiquid positions in the International Value Fund. In the third quarter, Small Cap Value eliminated 16 positions while starting only three. At the same time, Mr. Barse reports growing internal optimism and comity. As with PIMCO, the folks at Third Avenue feel they’re emerging from a necessary but painful transition. I get a sense that folks at both institutions are looking forward to going to work and to the working together on the challenges they, along with all active managers and especially active boutique managers, face.

The questions remain: why should you care? What should you do? The process they’re pursuing makes sense; that is, team-managed funds have distinct advantages over star-managed ones. Academic research shows that returns are modestly lower (50 bps or so) but risk is significantly lower, turnover is lower and performance is more persistent. And Third Avenue remains fiercely independent: the active share for the Value Fund is 98.2% against the MSCI World index, Small Cap Value is 95% against the Russell 2000 Value index, and International Value is 97.6% against MSCI World ex US. Their portfolios are compact (38, 64 and 32 names, respectively) and turnover is low (20-40%).

For now, we’d counsel patience. Not all teams (half of all funds claim them) thrive. Not all good plans pan out. But Third Avenue has a lot to draw on and a lot to prove, we wish them well and will keep a hopeful eye on their evolution.

Where are they now?

We were curious about the current activities of Third Avenue’s former managers. We found them at the library, mostly. Ian Lapey’s LinkedIn profile now lists him as a “director, Stanley Furniture Company” but we were struck by the current activities of a number of his former co-workers:

Apparently time at Third Avenue instills a love of books, but might leave folks short of time to pursue them.

Would you give somebody $5.8 million a year to manage your money?

And would you be steamed if he lost $6.9 million for you in your first three months with him?

If so, you can sympathize with Bill Gross of Janus Funds. Mr. Gross has reportedly invested $700 million in Janus Global Unconstrained Bond (JUCIX), whose institutional shares carry a 0.83% expense ratio. So … (mumble, mumble, scribble) 0.0083 x 700,000,000 is … ummmm … he’s charging himself $5,810,000 for managing his personal fortune.

Oh, wait! That overstates the expenses a bit. The fund is down rather more than a percent (1.06% over three months, to be exact) so that means he’s no longer paying expenses on the $7,420,000 that’s no longer there. That’d be a $61,000 savings over the course of a year.

It calls to mind a universally misquoted passage from F. Scott Fitzgerald’s short story, “The Rich Boy” (1926)

Let me tell you about the very rich. They are different from you and me. They possess and enjoy early, and it does something to them, makes them soft, where we are hard, cynical where we are trustful, in a way that, unless you were born rich, it is very difficult to understand. 

Hemingway started the butchery by inventing a conversation between himself and Fitzgerald, in which Fitzgerald opines “the rich are different from you and me” and Hemingway sharply quips, “yes, they have more money.” It appears that Mary Collum, an Irish literary critic, in a different context, made the comment and Hemingway pasted it seamlessly into a version that made him seem the master.

P.S. please don’t tell the chairman of Janus. He’s the guy who didn’t know that all those millions flowing from a single brokerage office near Gross’s home into Gross’s fund was Gross’s money. I suspect it’s just better if we don’t burden him with unnecessary details.

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before. For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

Decision

• The court granted Vanguard‘s motion to dismiss shareholder litigation regarding two international funds’ holdings of gambling-related securities: “the court concludes that plaintiffs’ claims are time barred and alternatively that plaintiff has not established that the Board’s refusal to pursue plaintiffs’ demand for litigation violated Delaware’s business judgment rule.” Defendants included independent directors. (Hartsel v. Vanguard Group Inc.)

Settlement

• Morgan Keegan defendants settled long-running securities litigation, regarding bond funds’ investments in collateralized debt obligations, for $125 million. Defendants included independent directors. (In re Regions Morgan Keegan Open-End Mut. Fund Litig.; Landers v. Morgan Asset Mgmt., Inc.)

Briefs

• AXA Equitable filed a motion for summary judgment in fee litigation regarding twelve subadvised funds: “The combined investment management and administrative fees . . . for the funds were in all cases less than 1% of fund assets, and in some cases less than one half of 1%. These fees are in line with industry medians.” (Sanford v. AXA Equitable Funds Mgmt. Group, LLC; Sivolella v. AXA Equitable Life Ins. Co.)
• Plaintiffs filed their opposition to Genworth‘s motion for summary judgment in a fraud case regarding an investment expert’s purported role in the management of the BJ Group Services portfolios. (Goodman v. Genworth Fin. Wealth Mgmt., Inc.)
• Plaintiffs filed their opposition to SEI defendants’ motion to dismiss fee litigation regarding five subadvised funds: By delegating “nearly all of its investment management responsibilities to its army of sub-advisers” and “retaining substantial portions of the proceeds for itself,” SEI charges “excessive fees that violate section 36(b) of the Investment Company Act.” (Curd v. SEI Invs. Mgmt. Corp.)

Answer

• Having previously lost its motion to dismiss, Harbor filed an answer to excessive-fee litigation regarding its subadvised International and High-Yield Bond Funds. (Zehrer v. Harbor Capital Advisors, Inc.)

The Alt Perspective: Commentary and news from DailyAlts.

By Brian Haskin, editor of DailyAlts.com

Last month, I took a look at a few of the trends that took shape over the course of 2014 and noted how those trends might unfold in 2015. Now that the full year numbers are in, I thought I would do a 2014 recap of those numbers and see what they tell us.

Overall, assets in the Liquid Alternatives category, including both mutual funds and ETFs, were up 10.9% based on Morningstar’s classification, and 9.8% by DailyAlts classification. For ease of use, let’s call it 10%. Not too bad, but quite a bit short of the growth rates seen earlier in the year that hovered around 40%. But, compared to other major asset classes, alternative funds actually grew about 3 times faster. That’s quite good. The table below summarizes Morningstar’s asset flow data for mutual funds and ETFs combined:

The macro shifts in investor’s allocations were quite subtle, but nonetheless, distinct. Assets growth increased at about an equal rate for both stocks and bonds at a 3.4% and 3.7%, respectively, while commodities fell out of favor and lost 3.4% of their assets. However, with most investors underinvested in alternatives, the category grew at 10.9% and ended the year with $199 billion in assets, or 1.4% of the total pie. This is a far cry from institutional allocations of 15-20%, but many experts expect to see that 1.4% number increase to the likes of 10-15% over the coming decade.

Now, let’s take a look a more detailed look at the winning and loosing categories within the alternatives bucket. Here is a recap of 2014 flows, beginning assets, ending assets and growth rates for the various alternative strategies and alternative asset classes that we review:

The dominant category over the year was what Morningstar calls non-traditional bonds, which took in $22.8 billion. Going into 2014, investors held the view that interest rates would rise and, thus, they looked to reduce interest rate risk with the more flexible non-traditional bond funds. This all came to a halt as interest rates actually declined and flows to the category nearly dried up in the second half.

On a growth rate perspective, multi-alternative funds grew at a nearly 34% rate in 2014. These funds allocate to a wide range of alternative investment strategies, all in one fund. As a result, they serve as a one-stop shop for allocations to alternative investments. In fact, they serve the same purpose as fund-of-hedge funds serve for institutional investors but for a much lower cost! That’s great news for retail investors.

Finally, what is most striking is that the asset flows to alternatives all came in the first half of the year – $36.2 billion in the first half and only $622 million in the second half. Much of the second half slowdown can be attributed to two factors: A complete halt in flows to non-traditional bonds in reaction to falling rates, and billions in outflows from the MainStay Marketfield Fund (MFLDX), which had an abysmal 2014. The good news is that multi-alternative funds held steady from the first half to the second – a good sign that advisors and investors are maintaining a steady allocation to broad based alternative funds.

For 2015, expect to see multi-alternative funds continue to gather assets at a steady clip. The managed futures category, which grew at a healthy 19.5% in 2014 on the back of multiple difficult years, should see continued action as global markets and economies continue to diverge, thus creating a more favorable environment for these funds. Market neutral funds should also see more interest as they are designed to be immune to most of the market’s ups and downs.

Next month we will get back to looking at a few of the intriguing fund launches for early 2015. Until then, hold on for the ride and stay diversified!

Observer Fund Profiles

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past two or three years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Osterweis Strategic Investment (OSTVX). I’m always intrigued by funds that Morningstar disapproves of. When you combine disapproval with misunderstanding, then add brilliant investment performance, it becomes irresistible for us to address the question “what’s going on here?” Short answer: good stuff.

Pear Tree Polaris Foreign Value Small Cap (QUSOX). There are three, and only three, great international small cap funds: Wasatch International Opportunities (WAIOX), Grandeur Peak International Opportunities (GPIOX) and Pear Tree Polaris Foreign Value Small Cap. Why have you only heard of the first two?

TrimTabs Float Shrink ETF (TTFS). This young ETF is off to an impressive start by following what it believes are the “best informed market participants.” This is a profile by our colleague Charles Boccadoro, which means it will be data-rich!

Touchstone Sands Capital Emerging Markets Growth (TSEMX). Sands Capital has a long, strong record in tracking down exceptional businesses and holding them close. TSEMX represents the latest extension of the strategy from domestic core to global and now to the emerging markets.

Conference Call Highlights: Bernie Horn, Polaris Global Value

About 40 of us gathered in mid-January to talk with Bernie Horn. It was an interesting talk, one which covered some of the same ground that he went over in private with Mr. Studzinski and me but one which also highlighted a couple new points.

Highlights:

• The genesis of the fund was in his days as a student at the Sloan School of Management at MIT at the end of the 1970s. It was a terrible decade for stocks in the US but he was struck by the number of foreign markets that had done just fine. One of his professors, Fischer Black, an economist whose work with Myron Scholes on options led to a Nobel Prize, generally preached the virtues of the efficient market theory but carries “a handy list of exceptions to EMT.” The most prominent exception was value investing. The emerging research on the investment effects of international diversification and on value as a loophole to EMT led him to launch his first global portfolios.
• His goal is, over the long-term, to generate 2% greater returns than the market with lower volatility.
• He began running separately-managed accounts but those became an administrative headache and so he talked his investors into joining a limited partnership which later morphed into Polaris Global Value Fund (PGVFX).
• The central discipline is calculating the “Polaris global cost of equity” (which he thinks separates him from most of his peers) and the desire to add stocks which have low correlations to his existing portfolio.
• The Polaris global cost of capital starts with the market’s likely rate of return, about 6% real. He believes that the top tier of managers can add about 2% or 200 bps of alpha. So far that implies an 8% cost of capital. He argues that fixed income markets are really pretty good at arbitraging currency risks, so he looks at the difference between the interest rates on a country’s bonds and its inflation rate to find the last component of his cost of capital. The example was Argentina: 24% interest rate minus a 10% inflation rate means that bond investors are demanding a 14% real return on their investments. The 14% reflects the bond market’s judgment of the cost of currency; that is, the bond market is pricing-in a really high risk of a peso devaluation. In order for an Argentine company to be attractive to him, he has to believe that it can overcome a 22% cost of capital (6 + 2 + 14). The hurdle rate for the same company domiciled elsewhere might be substantially lower.
• He does not hedge his currency exposure because the value calculation above implicitly accounts for currency risk. Currency fluctuations accounted for most of the fund’s negative returns last year, about 2/3s as of the third quarter. To be clear: the fund made money in 2014 and finished in the top third of its peer group. Two-thirds of the drag on the portfolio came from currency and one-third from stock selections.
• He tries to target new investments which are not correlated with his existing ones; that is, ones that do not all expose his investors to a single, potentially catastrophic risk factor. It might well be that the 100 more attractively priced stocks in the world are all financials but he would not overload the portfolio with them because that overexposes his investors to interest rate risks. Heightened vigilance here is one of the lessons of the 2007-08 crash.
• An interesting analogy on the correlation and portfolio construction piece: he tries to imagine what would happen if all of the companies in his portfolio merged to form a single conglomerate. In the conglomerate, he’d want different divisions whose cash generation was complementary: if interest rates rose, some divisions would generate less cash but some divisions would generate more and the net result would be that rising interest rates would not impair the conglomerates overall free cash flow. By way of example, he owns energy exploration and production companies whose earnings are down because of low oil prices but also refineries whose earnings are up.
• He instituted more vigorous stress tests for portfolio companies in the wake of the 2007-09 debacle. Twenty-five of 70 companies were “cyclically exposed”. Some of those firms had high fixed costs of operations which would not allow them to reduce costs as revenues fell. Five companies got “bumped off” as a result of that stress-testing.

A couple caller questions struck me as particularly helpful:

Ken Norman: are you the lead manager on both the foreign funds? BH: Yes, but … Here Bernie made a particularly interesting point, that he gives his associates a lot of leeway on the foreign funds both in stock selection and portfolio construction. That has two effects. (1) It represents a form of transition planning. His younger associates are learning how to operate the Polaris system using real money and making decisions that carry real consequences. He thinks that will make them much better stewards of Polaris Global Value when it becomes their turn to lead the fund. (2) It represents a recruitment and retention strategy. It lets bright young analysts know that they have a real role to play and a real future with the firm.

Shostakovich, a member of the Observer’s discussion board community and investor in PGVFX: you’ve used options to manage volatility. Is that still part of the plan? BH: Yes, but rarely now. Three reasons. (1) There are no options on many of the portfolio firms. (2) Post-08, options positions are becoming much more expensive, hence less rewarding. (3) Options trade away “excess” upside in exchange for limiting downside; he’s reluctant to surrender much alpha since some of the firms in the portfolio have really substantial potential.

Bottom line: You need to listen to the discussion of ways in which Polaris modified their risk management in the wake of 2008. Their performance in the market crash was bad. They know it. They were surprised by it. And they reacted thoughtfully and vigorously to it. In the absence of that one period, PGVFX has been about as good as it gets. If you believe that their responses were appropriate and sufficient, as I suspect they were, then this strikes me as a really strong offering.

We’ve gathered all of the information available on Polaris Global Value Fund, including an .mp3 of the conference call, into its new Featured Fund page. Feel free to visit!

Conference Call Upcoming: Matthew Page and Ian Mortimer, Guinness Atkinson Funds

We’d be delighted if you’d join us on Monday, February 9th, from noon to 1:00 p.m. Eastern, for a conversation with Matthew Page and Ian Mortimer, managers of Guinness Atkinson Global Innovators (IWIRX) and Guinness Atkinson Dividend Builder (GAINX). These are both small, concentrated, distinctive, disciplined funds with top-tier performance. IWIRX, with three distinctive strategies (starting as an index fund and transitioning to an active one), is particularly interesting. Most folks, upon hearing “global innovators” immediately think “high tech, info tech, biotech.” As it turns out, that’s not what the fund’s about. They’ve found a far steadier, broader and more successful understanding of the nature and role of innovation. Guinness reports:

Guinness Atkinson Global Innovators is the #1 Global Multi-Cap Growth Fund across all time periods (1,3,5,& 10 years) this quarter ending 12/31/14 based on Fund total returns.

They are ranked 1 of 500 for 1 year, 1 of 466 for 3 years, 1 of 399 for 5 years and 1 of 278 for 10 years in the Lipper category Global Multi-Cap Growth.

Goodness. And it still has under $200 million in assets.

Matt volunteered the following plan for their slice of the call:

I think we would like to address some of the following points in our soliloquy.

• Why are innovative companies an interesting investment opportunity?
• How do we define an innovative company?
• Aren’t innovative companies just expensive?
• Are the most innovative companies the best investments?

I suppose you could sum all this up in the phrase: Why Innovation Matters.

In deference to the fact that Matt and Ian are based in London, we have moved our call to noon Eastern. While they were willing to hang around the office until midnight, asking them to do it struck me as both rude and unproductive (how much would you really get from talking to two severely sleep-deprived Brits?).

Over the past several years, the Observer has hosted a series of hour-long conference calls between remarkable investors and, well, you. The format’s always the same: you register to join the call. We share an 800-number with you and send you an emailed reminder on the day of the call. We divide our hour together roughly in thirds: in the first third, our guest talks with us, generally about his or her fund’s genesis and strategy. In the middle third I pose a series of questions, often those raised by readers. Here’s the cool part, in the final third you get to ask questions directly to our guest; none of this wimpy-wompy “you submit a written question in advance, which a fund rep rewords and reads blankly.” Nay nay. It’s your question, you ask it. The reception has been uniformly positive.

HOW CAN YOU JOIN IN?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over two hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Funds in Registration

There continued to be remarkably few funds in registration with the SEC this month and I’m beginning to wonder if there’s been a fundamental change in the entrepreneurial dynamic in the industry. There are nine new no-load retail funds in the pipeline, and they’ll launch by the end of April. The most interesting development might be DoubleLine’s move into commodities. (It’s certainly not Vanguard’s decision to launch a muni-bond index.) They’re all detailed on the Funds in Registration page.

Manager Changes

About 50 funds changed part or all of their management teams in the past month. An exceptional number of them were part of the continuing realignment at PIMCO. A curious and disappointing development was the departure of founding manager Michael Carne from the helm of Nuveen NWQ Flexible Income Fund (NWQAX). He built a very good, conservative allocation fund that holds stocks, bonds and convertibles. We wrote about the fund a while ago: three years after launch it received a five-star rating from Morningstar, celebration followed until a couple weeks later Morningstar reclassified it as a “convertibles” fund (it ain’t) and it plunged to one-star, appealed the ruling, was reclassified and regained its stars. It has been solid, disciplined and distinctive, which makes it odd that Nuveen chose to switch managers.

You can see all of the comings and goings on our Manager Changes  page.

Briefly Noted . . .

On December 1, 2014, Janus Capital Group announced the acquisition of VS Holdings, parent of VelocityShares, LLC. VelocityShares provides both index calculation and a suite of (creepy) leveraged, reverse leveraged, double leveraged and triple leveraged ETNs.

Fidelity Strategic Income (FSICX) is changing the shape of the barbell. They’ve long described their portfolio as a barbell with high yield and EM bonds on the one end and high quality US Treasuries and corporates on the other. They’re now shifting their “neutral allocation” to inch up high yield exposure (from 40 to 45%) and drop investment grade (from 30 to 25%).

GaveKal Knowledge Leaders Fund (GAVAX/GAVIX) is changing its name to GaveKal Knowledge Leaders Allocation Fund. The fund has always had an absolute value discipline which leads to it high cash allocations (currently 25%), exceedingly low risk … and Morningstar’s open disdain (it’s currently a one-star large growth fund). The changes will recognize the fact that it’s not designed to be a fully-invested equity fund. Their objective changes from “long-term capital appreciation” to “long-term capital appreciation with an emphasis on capital preservation” and “fixed income” gets added as a principal investment strategy.

SMALL WINS FOR INVESTORS

Palmer Square Absolute Return Fund (PSQAX/PSQIX) has agreed to a lower management fee and has reduced the cap on operating expenses by 46 basis points to 1.39% and 1.64% on its institutional and “A” shares.

Likewise, State Street/Ramius Managed Futures Strategy Fund (RTSRX) dropped its expense cap by 20 basis points, to 1.90% and 1.65% on its “A” and institutional shares.

CLOSINGS (and related inconveniences)

Effective as of the close of business on February 27, 2015, BNY Mellon Municipal Opportunities Fund (MOTIX) will be closed to new and existing investors. It’s a five-star fund with $1.1 billion in assets and five-year returns in the top 1% of its peer group.

Franklin Small Cap Growth Fund (FSGRX) closes to new investors on February 12, 2015. It’s a very solid fund that had a very ugly 2014, when it captured 240% of the market’s downside.

OLD WINE, NEW BOTTLES

Stand back! AllianceBernstein is making its move: all AllianceBernstein funds are being rebranded as AB funds.

OFF TO THE DUSTBIN OF HISTORY

Ascendant Natural Resources Fund (NRGAX) becomes only a fond memory as of February 27, 2015.

AdvisorShares International Gold and AdvisorShares Gartman Gold/British Pound ETFs liquidated at the end of January.

Cloumbia is cleaning out a bunch of funds at the beginning of March: Columbia Masters International Equity Portfolio, Absolute Return Emerging Markets Macro Fund,Absolute Return Enhanced Multi-Strategy Fund and Absolute Return Multi-Strategy Fund. Apparently having 10-11 share classes each wasn’t enough to save them. The Absolute Return funds shared the same management team and were generally mild-mannered under-performers with few investors.

Direxion/Wilshire Dynamic Fund (DXDWX) will be dynamically spinning in its grave come February 20^th.

Dynamic Total Return Fund (DYNAX/DYNIX) will totally return to the dust whence it came, effective February 20^th. Uhhh … if I’m reading the record correctly, the “A” shares never launched, the “I” shares launched in September 2014 and management pulled the plug after three months.

Loeb King Alternative Strategies (LKASX) and Loeb King Asia Fund (LKPAX) are being liquidated at the end of February because, well, Loeb King doesn’t want to run mutual funds anymore and they’re getting entirely out of the business. Both were pricey long/short funds with minimal assets and similar success.

New Path Tactical Allocation Fund became liquid on January 13, 2015.

In “consideration of the Fund’s asset size, strategic importance, current expenses and historical performance,” Turner’s board of directors has pulled the plug on Turner Titan Fund (TTLFX). It wasn’t a particularly bad fund, it’s just that Turner couldn’t get anyone (including one of the two managers and three of the four trustees) to invest in it. Graveside ceremonies will take place on March 13, 2015 in the family burial plot.

In Closing . . .

I try, each month, to conclude this essay with thanks to the folks who’ve supported us, by reading, by shopping through our Amazon link and by making direct, voluntary contributions. Part of the discipline of thanking folks is, oh, getting their names right. It’s not a long list, so you’d think I could manage it.

Not so much. So let me take a special moment to thank the good folks at Evergreen Asset Management in Washington for their ongoing support over the years. I misidentified them last month. And I’d also like to express intense jealousy over what appears to be the view out their front window since the current view out my front window is

With extra careful spelling, thanks go out to the guys at Gardey Financial of Saginaw (MI), who’ve been supporting us for quite a while but who don’t seem to have a particularly good view from their office, Callahan Capital Management out of Steamboat Springs (hi, Dan!), Mary Rose, our friends Dan S. and Andrew K. (I know it’s odd, but just knowing that there are folks who’ve stuck with us for years makes me feel good), Rick Forno (who wrote an embarrassingly nice letter to which we reply, “gee, oh garsh”), Ned L. (who, like me, has professed for a living), David F., the surprising and formidable Dan Wiener and the Hastingses. And, as always, to our two stalwart subscribers, Greg and Deb. If we had MFO coffee mugs, I’d sent them to you all!

Do consider joining us for the talk with Matt and Ian. We’ve got a raft of new fund profiles in the works, a recommendation to Morningstar to euthanize one of their long-running features, and some original research on fund trustees to share. In celebration of our fourth birthday this spring, we’ve got surprises a-brewin’ for you.

Until then, be safe!

Dear friends,

Welcome to the New Year!

And to an odd question: why is it a New Year?  That is, why January 1?  Most calendrical events correspond to something: cycles of the moon and stars, movement of the seasons, conclusions of wars or deaths of Great Men.

But why January 1?  It corresponds with nothing.

Here’s the short answer: your recent hangover and binge of bowl watching were occasioned by the scheming of some ancient Roman high priest, named a pontifex, and the political backlash to his overreach. Millennia ago, the Romans had a year that started sensibly enough, at the beginning of spring when new life began appearing. But the year also ended with the winter solstice and a year-end party that could stretch on for weeks.  December, remember? Translates as “the tenth month” out of ten.

So what happened in between the party and the planting? The usual stuff, I suppose: sex, lies, lies about sex, dinner and work.  What didn’t happen was politics: new governments, elected in the preceding year, weren’t in power until the new year began. And who decided exactly when the new year began? The pontifex. And how did the pontifex decide? Oracles, goat entrails and auguries, mostly. And also a keen sense of whether he liked the incoming government more than the outgoing one.  If the incoming government promised to be a pain in the butt, the new year might start a bit later.  If the new government was full of friends, the new year might start dramatically earlier. And if the existing government promised to be an annoyance in the meanwhile, the pontifex could declare an extended religious holiday during which time the government could not convene.

Eventually Julius Caesar and the astronomer Sosigenes got together to create a twelve month calendar whose new year commenced just after the hangover from the year-end parties faded. Oddly, the post-Roman Christian world didn’t adopt January 1 (pagan!) as the standard start date for another 1600 years.  Pope Gregory tried to fiat the new start day. Protestant countries flipped him off. In England and the early US, New Year’s Day was March 25^th, for example. Eventually the Brits standardized it in their domains in 1750.

Pagan priest examining the gall bladder of a goat. Ancient politics and hefty campaign contributions.

So, why exactly does it make sense for you to worry about how your portfolio did in 2014?  The end date of the year is arbitrary. It corresponds neither to the market’s annual flux nor to the longer seven(ish) year cycles in which the market rises and falls, much less your own financial needs and resources.

I got no clue. You?

I’d hoped to start the year by sharing My Profound Insights into the year ahead, so I wandered over to the Drawer of Clues. Empty. Nuts. The Change Jar of Market Changes? Nothing except some candy wrappers that my son stuffed in there. The white board listing The Four Funds You Must Own for 2015? Carried off by some red-suited vagrant who snuck in on Christmas Eve. (Also snagged my sugar cookies and my bottle of Drambuie. Hope he got pulled over for impaired flying.)

Oddly, I seem to be the only person who doesn’t know where things are going. The Financial Times reports that “the ‘divergence’ between the economies of the US and the rest of the world … features in almost every 2015 outlook from Wall Street strategists.” Yves Kuhn, an investment strategist from Luxembourg, notes the “the biggest consensus by any margin is to be long dollar, short euro … I have never seen such a consensus in the market.” Barron’s December survey of economists and strategists: “the consensus is ‘stick with the bull.’” James Paulsen, allowed that “There’s some really, really strong Wall Street consensus themes right now” in favor of US stocks, the dollar and low interest rates.  

Of course, the equally universal consensus in January 2014 was for rising interest rates, soaring energy prices and a crash in the bond market.

Me? I got no clue. Here’s the best I got:

• Check to see if you’ve got a plan. If not, get one. Fund an emergency account. Start investing in a conservative fund for medium time horizon needs. Work through a sensible asset allocation plan for the long-term. It’s not as hard as you want to imagine it is.
• Pursue it with some discipline. Find a sustainable monthly contribution. Set your investments on auto-pilot. Move any windfalls – whether it’s a bonus or a birthday check – into your savings. If you get a raise (I’m cheering for you!), increase your savings to match.
• Try not to screw yourself. Again. Don’t second guess yourself. Don’t obsess about your portfolio. Don’t buy because it’s been going up and you’re feeling left out. Don’t sell because your manager is being patient and you aren’t.
• Try not to let other people screw you. Really, if your fund has a letter after its name, figure out why. It means you’re paying extra. Be sure you know what exactly you’re paying and why.
• Make yourself useful, ‘cause then you’ll also make yourself happy. Get in the habit of reading again. Books. You know: the dead tree things. There’s pretty good research suggesting that the e-versions disrupt sleep and addle your mind. Try just 30 minutes in the evening with the electronics shut down, perusing Sarah Bakewell’s How to Live: A Life of Montaigne in One Question and Twenty Attempts at an Answer (2011) or Sherry Turkle’s Alone Together: Why We Expect More from Technology and Less from Each Other (2012). Read it with someone you enjoy hugging. Upgrade your news consumption: listen to the Marketplace podcasts or programs. Swear you’ll never again watch a “news program” that has a ticker constantly distracting you with unexplained 10 word snippets that pretend to explain global events. Set up a recurring contribution to your local food bank (I’ll give you the link to mine if you can’t find your own), shelter (animal or otherwise), or cause. They need you and you need to get outside yourself, to reconnect to something more important than YouTube, your portfolio or your gripes.

For those irked by sermonettes, my senior colleague has been reflecting on the question of what lessons we might draw from the markets of 2014 and offers a far more nuanced take in …

Reflections – 2014

By Edward Studzinski

The Mountains are High, and the Emperor is Far, Far Away

Chinese Aphorism

Year-end 2014 presents investors with a number of interesting conundrums. For a U.S. dollar investor, the domestic market, as represented by the S&P 500, provided a total return of 13.6%, at least for those invested in it by the proxy of Vanguard’s S&P 500 Index Fund Admiral Shares. Just before Christmas, John Authers of the Financial Times, in a piece entitled “Investment: Loser’s Game” argued that this year, with more than 90% of active managers on track to underperform their benchmarks, a tipping point may have finally been reached. The exodus of money from actively managed funds has accelerated. Vanguard is on track to take in close to $200B (yes, billion) into its passive funds this year.

And yet, I have to ask if it really matters. As I watch the postings on the Mutual Fund Observer’s discussion board, I suspect that achieving better than average investment performance is not what motivates many of our readers. Rather, there is a Walter Mittyesque desire to live vicariously through their portfolios. And every bon mot that Bill (take your pick, there are a multitude of them) or Steve or Michael or Bob drops in a print or televised interview is latched on to as a reaffirmation the genius and insight to invest early on with one of The Anointed. The disease exists in a related form at the Berkshire Hathaway Annual Circus in Omaha. Sooner or later, in an elevator or restaurant, you will hear a discussion of when that person started investing with Warren and how much money they have made. The reality is usually less that we would like to know or admit, as my friend Charles has pointed out in his recent piece about the long-term performance of his investments.

Rather than continuing to curse the darkness, let me light a few candles.

1. When are index funds appropriate for an investment program? For most of middle America, I am hard pressed to think of when they are not. They are particularly important for those individuals who are not immortal. You may have constructed a wonderful portfolio of actively-managed funds. Unfortunately, if you pass away suddenly, your spouse or family may find that they have neither the time nor the interest to devote to those investments that you did. And that assumes a static environment (no personnel changes) in the funds you are invested in, and that the advisors you have selected, if any, will follow your lead. But surprise – if you are dead, often not at the time of your choice, you cannot control things from the hereafter. Sit in trust investment committee meetings as I did for many years, and what you will most likely hear is – “I don’t care what old George wanted – that fund is not on our approved list and to protect ourselves, we should sell it, regardless of its performance or the tax consequences.”
2. How many mutual funds should one own? The interplay here is diversification and taxes. I suspect this year will prove a watershed event as investors find that their actively-managed fund has generated a huge tax bill for them while not beating its respective benchmark, or perhaps even losing money. The goal should probably be to own fewer than ten in a family unit, including individual and retirement investments. The right question to ask is why you invested in a particular fund to begin with. If you can’t remember, or the reason no longer applies, move on. In particular, retirement and 401(k) assets should be consolidated down to a smaller number of funds as you get older. Ideally they should be low cost, low expense funds. This can be done relatively easily by use of trustee to trustee transfers. And forget target date funds – they are a marketing gimmick, predicated on life expectancies not changing.
3. Don’t actively managed funds make sense in some circumstances? Yes, but you really have to do a lot of due diligence, probably more than most investment firms will let you do. Just reading the Morningstar write-ups will not cut it. I think there will be a time when actively-managed value funds will be the place to be, but we need a massive flush-out of the industry to occur first, followed by fear overcoming greed in the investing public. At that point we will probably get more regulation (oh for the days of Franklin Roosevelt putting Joe Kennedy in charge of the SEC, figuring that sometimes it makes sense to have the fox guarding the hen house).
4. Passive funds are attractive because of low expenses, and the fact that you don’t need to worry about managers departing or becoming ill. What should one look for in actively-managed funds? The simple answer is redundancy. Dodge and Cox is an ideal example, with all of their funds managed by reasonably-sized committees of very experienced investment personnel. And while smaller shops can argue that they have back-up and succession planning, often that is marketing hype and illusion rather than reality. I still remember a fund manager more than ten years ago telling me of a situation where a co-manager had been named to a fund in his organization. The CIO told him that it was to make the Trustees happy, giving the appearance of succession planning. But the CIO went on to say that if something ever happened to lead manager X, co-manager Y would be off the fund by sundown since Y had no portfolio management experience. Since learning such things is difficult from the outside, stick to the organizations where process and redundancy are obvious. Tweedy, Browne strikes me as another organization that fits the bill. Those are not meant as recommendations but rather are intended to give you some idea of what to look for in kicking tires and asking questions.

A few final thoughts – a lot of hedge funds folded in 2014, mainly for reasons of performance. I expect that trend to spread to mutual funds in 2015, especially those that are at best marginally profitable. Some of this is a function of having the usual acquiring firms (or stooges, as one investment banker friend calls them) – the Europeans – absent from the merger and acquisition trail. Given the present relationship of the dollar and the Euro, I don’t expect that trend to change soon. But I also expect funds to close just because the difficulty of outperforming in a world where events, to paraphrase Senator Warren, are increasingly rigged, is almost impossible. In a world of instant gratification, that successful active management is as much an art as a science should be self-evident. There is something in the process of human interaction which I used to refer to as complementary organizational dysfunction that produces extraordinary results, not easily replicable. And it involves more than just investment selection on the basis of reversion to the mean.

One example of genius would be Thomas Jefferson, dining alone, or Warren Buffet, sitting in his office, reading annual reports.  A different example would be the 1927 Yankees or the Fidelity organization of the 1980’s. In retrospect what made them great is easy to see. My advice to people looking for great active management today – look for organizations without self-promotion, where individuals do not seek out to be the new “It Girl” and where the organizations focus on attracting curious people with inquiring but disciplined minds, so that there ends up being a creative, dynamic tension. Avoid organizations that emphasize collegiality and consensus. In closing, let me remind you of that wonderful scene where Orson Welles, playing Harry Lime in The Third Man says,

… in Italy for 30 years under the Borgias they had warfare, terror, murder, and bloodshed, but they produced Michelangelo, Leonardo da Vinci, and the Renaissance. In Switzerland they had brotherly love – they had 500 years of democracy and peace, and what did they produce? The cuckoo clock.

Where In The World Is Your Fund Adviser?

When our esteemed colleague Ed Studzinski shares his views on an adviser or fund house, he invariably mentions location.

I’ve started to take notice.

Any place but Wall Street
Some fund advisers seem to identify themselves with their location. Smead Capital Management, Inc., which manages Smead Value Fund (SMVLX), states: ”Our compass bearings are slightly Northwest of Wall Street…” The firm is headquartered in Seattle.

SMVLX is a 5-year Great Owl sporting top quintile performance over the past 5-, 3-, and even 1-year periods (ref. Ratings Definitions):

Bill Smead believes the separation from Wall Street gives his firm an edge.

Legendary value investor Bruce Berkowitz, founder of Fairholme Capital Management, LLC seems to agree. Fortune reported that he moved the firm from New Jersey to Florida in 2006 in order to … ”put some space between himself and Wall Street … no matter where he went in town, he was in danger of running into know-it-all investors who might pollute his thinking. ’I had to get away,’ he says.”

In 2002, Charles Akre of Akre Capital Management, LLC, located his firm in Middleburg, Virginia. At that time, he was sub-advising Friedman, Billings, Ramsey & Co.’s FBR Focus Fund, an enormously successful fund. The picturesque town is in horse country. Since 2009, the firm’s Akre Focus Fund (AKREX/AKRIX) is a top-quintile performer and another 5-year Great Owl:

Perhaps location does matter?

Tales of intrigue and woe
Unfortunately, determining an adviser’s actual work location is not always so apparent. Sometimes it appears downright labyrinthine, if not Byzantine.

Take Advisors Preferred, LLC. Below is a snapshot of the firm’s contact page. There is no physical address. No discernable area code. Yet, it is the named adviser for several funds with assets under management (AUM) totaling half a billion dollars, including Hundredfold Select Alternative (SFHYX) and OnTrack Core Fund (OTRFX).

Advisors Preferred turns out to be a legal entity that provides services for sub-advisers who actually manage client money without having to hassle with administrative stuff … an “adviser” if you will by name only … an “Adviser for Hire.” To find addresses of the sub-advisers to these funds you must look to the SEC required fund documents, the prospectus or the statement of additional information (SAI).

Hunderfold Funds is sub-advised by Hunderfold Funds, LLC, which gives its sub-advisory fees to the Simply Distribute Charitable Foundation. Actually, the charity appears to own the sub-adviser. Who controls the charity? The people that control Spectrum Financial Inc., which is located, alas, in Virginia.

The SAI also reveals that the fund’s statutory trust is not administered by the adviser, Advisors Preferred, but by Gemini Funds Services, LLC. The trust itself is a so-called shared or “series trust” comprised of independent funds. Its name is Northern Lights Fund Trust II. (Ref. SEC summary.) The trust is incorporated in Delaware, like many statutory trusts, while Gemini is headquartered in New York.

Why use a series trust? According to Gemini, it’s cheaper. “Rising business costs along with the increased level of regulatory compliance … have magnified the benefits of joining a shared trust in contrast to the expenses associated with registering a standalone trust.”

How does Hundredfold pass this cost savings on to investors? SFHYX’s latest fact sheet shows a 3.80% expense ratio. This fee is not a one-time load or performance based; it is an annual expense.

OnTrack Funds is sub-advised by Price Capital Management, Inc, which is located in Florida. Per the SEC Filing, it actually is run out of a residence. Its latest fact sheet has the expense ratio for OTRFX at 2.95%, annually. With $130M AUM, this expense translates to $3.85M per year paid by investors the people at Price Capital (sub adviser), Gemini Funds (administrator), Advisors Preferred (adviser), Ceros Financial (distributer), and others.

What about the adviser itself, Advisors Preferred? It’s actually controlled by Ceros Financial Services, LLC, which is headquartered in Maryland. Ceros is wholly-owned by Ceros Holding AG, which is 95% owned by Copiaholding AG, which is wholly-owned by Franz Winklbauer.  Mr. Winklbauer is deemed to indirectly control the adviser. In 2012, Franz Winklbauer resigned as vice president of the administrative board from Ceros Holding AG. Copiaholding AG was formed in Switzerland.

Which is to say … who are all these people?

Where do they really work?

And, what do they really do?

Maybe these are related questions.

If it’s hard to figure out where advisers work, it’s probably hard to figure out what they actually do for the investors that pay them.

Guilty by affiliation
Further obfuscating adviser physical location is industry trend toward affiliation, if not outright consolidation. Take Affiliated Managers Group, or more specifically AMG Funds LLC, whose main office location is Connecticut, as registered with the SEC. It currently is the named adviser to more than 40 mutual funds with assets under management (AUM) totaling $42B, including:

• Managers Intermediate Duration Govt (MGIDX), sub advised by Amundi Smith Breeden LLC, located in North Carolina,
• Yacktman Service (YACKX), sub advised by Yacktman Asset Management, L.P. of Texas, and
• Brandywine Blue (BLUEX), sub advised by Friess Associates of Delaware, LLC, located in Delaware (fortunately) and Friess Associates LLC, located in Wyoming.

All of these funds are in process of being rebranded with the AMG name. No good deed goes unpunished?

AMG, Inc., the corporation that controls AMG Funds and is headquartered in Massachusetts, has minority or majority ownership in many other asset managers, both in the US and aboard. Below is a snapshot of US firms now “affiliated” with AMG. Note that some are themselves named advisers with multiple sub-advisers, like Aston.

AMG describes its operation as follows: “While providing our Affiliates with continued operational autonomy, we also help them to leverage the benefits of AMG’s scale in U.S. retail and global product distribution, operations and technology to enhance their growth and capabilities.”

Collectively, AMG boasts more than $600B in AUM. Time will tell whether its affiliates become controlled outright and re-branded, and more importantly, whether such affiliation ultimately benefits investors. It currently showcases full contact information of its affiliates, and affiliates like Aston showcase contact information of its sub-advisers.

Bottom line
Is Bill Smead correct when he claims separation from Wall Street gives his firm an edge? Does location matter to performance? Whether location influences fund performance remains an interesting question, but as part of your due diligence, there should be no confusion about knowing where your fund adviser (and sub-adviser) works.

Closing the capital gains season and thinking ahead

This fall Mark Wilson has launched Cap Gains Valet to help investors track and understand capital gains distributions. In addition to being Chief Valet, Mark is chief investment officer for The Tarbox Group in Newport Beach, CA. He is, they report, “one of only four people in the nation that has both the Certified Financial Planner® and Accredited Pension Administrator (APA) designations.” As the capital gains season winds down, we asked Mark if he’d put on his CIO hat for a minute and tell us what sense an investor should make of it all. Yeah, lots of folks got hammered in 2014 but that’s past. What, we asked, about 2015 and how we act in the year ahead? Here are Mark’s valedictory comments:

As 2014 comes to a close, so does capital gains season. After two straight months thinking about capital gains distributions for CapGainsValet.com, it is a great time for me to reflect on the website’s inaugural year.

At The Tarbox Group (my real job), our firm has been formally gathering capital gains estimates for the mutual funds and ETFs we use in client accounts for over 20 years. Strategizing around these distributions has been part of our year-end activities for so long I did not expect to learn much from gathering and making this information available. I was wrong. Here are some of the things I learned (or learned again) from this project:

• Checking capital gains estimates more than once is a good idea. I’m sure this has happened before, but this year we saw a number of funds “up” their estimates a more than once before their actual distribution date. Given that a handful of distributions doubled from their initial estimates, it is possible that having this more up-to-date information might necessitate a different strategy.
• Many mutual fund websites are terrible. Given the dollars managed and fees fund companies are collecting, there is no reason to have a website that looks like a bad elementary school project. Not having easily accessible capital gains estimates is excusable, but not having timely commentary, performance information, or contact information is not.
• Be wary of funds that have a shrinking asset base. This year I counted over 50 funds that distributed more than 20% of their NAV. The most common reason for the large distributions… funds that have fallen out of favor and have had huge redemptions. Unfortunately, shareholders that stick around often get stuck with the tax bill.
• Asset location is important. We found ourselves saying “good thing we own that in an IRA!” more than once this year. Owning actively managed funds in tax deferred accounts reduces stress, extra work and tax bills. Deciding which account to hold your fund can be as important a decision as which fund to hold.

CapGainsValet is “going dark” this week. Be on the lookout for our return in October or November. In the meantime, have a profitable 2015!

Fund companies explain their massive taxable distributions to us

Well, actually, most of them don’t.

I had the opportunity to chat with Jason Zweig as he prepared his year end story on how to make sense out of the recent state of huge capital gains distributions. In preparing in advance of my talk with Jason, I spent a little time gettin’ granular. I used Mark Wilson’s site to track down the funds with the most extraordinary distributions.

Cap Gains Valet identified a sort of “dirty dozen” of funds that paid out 30% or more of their NAV as taxable distributions. “Why on earth,” we innocently asked ourselves, “would they do that?” So we started calling and asking. In general, we discovered that fund advisers reacted to the question about the same way that you react to the discovery of curdled half-and-half in your coffee: with a wrinkled nose and irritated expression.

For those of you who haven’t been following the action, here’s our cap gains primer:

Capital gains are profits that result from the sales of appreciated securities in a portfolio. They come in two flavors: long-term capital gains, which result from the sale of stocks the fund has held for a while, and short-term gain gains, which usually result for the bad practice of churning the portfolio.

Even funds which have lost a lot of money can hit you with a capital gains tax bill. A fund might be down 40% year-to-date and if the only shares it sold were the Google shares it wangled at Google’s 2004 IPO, you could be hit with a tax bill for a large gain.

Two things trigger large taxable distributions: a new portfolio manager or portfolio strategy which requires cleaning out the old portfolio or forced redemptions because shareholders are bolting and the manager needs to sell stuff – often his best and most liquid stuff – to meet redemptions.

So, how did this Dirty Dozen make the list?

Neuberger Berman Large Cap Disciplined Growth (NBCIX, 53% distribution). I had a nice conversation with Neil Groom for Neuberger Berman. He was pretty clear about the problem: “we’ve struggled with performance,” and over 75% of the fund shares have been redeemed. The manager liquidates shares pro rata – that is, he sells them all down evenly – and “there are just no losses to offset those sales.” Neuberger is now underwriting the fund’s expenses to the tune of $300,000/year but remains committed to it for a couple reasons. One is that they see it as a core investment product. And the other is that the fund has had long winning streaks and long losing streaks in the past, both of which they view as a product of their discipline rather than as a failing by their manager.

We reached out to the folks at Russell LifePoints 2040 Strategy (RXLAX, 35% distribution) and Russell LifePoints 2050 Strategy (RYLRX, 33% distribution): after getting past the “what does it matter? These funds are held in tax-deferred retirement accounts” response – why is true but still doesn’t answer the question “why did this happen to you and not all target-date funds?” Russell’s Kate Stouffer reported that the funds “realized capital gains in 2014 predominantly as a result of the underlying fund reallocation that took place in August 2014.” The accompanying link showed Russell punting two weak Russell funds for two newly-launched Russell funds overseen by the same managers.

Turner Emerging Growth (TMCGX, 48% distribution), Midcap Growth (TMGFX, 42% distribution) and Small Cap Growth (TSCEX, 54% distribution): I called Turner directly and bounced around a bit before being told that “we don’t speak to the media. You’ll need to contact our media relations firm.” Suh-weet! I did. They promised to make some inquiries. Two weeks later, still no word. Two of the three funds have changed managers in the past year and Turner has seen a fair amount of asset outflows, which together might explain the problem.

Janus Forty (JDCAX, 33% distribution): about a half billion in outflows, a net loss in assets of about 75% from its peak plus a new manager in mid-2013 who might be reshaping the portfolio.

Eaton Vance Large-Cap Value (EHSTX, 29% distribution): new lead manager in mid-2014 plus an 80% decline in assets since 2010 led to it.

Nationwide HighMark Large Cap Growth (NWGLX, 42% distribution): another tale of mass redemption. The fund had $73 million in assets as of July 2013 when a new co-manager was added. The fund rose since then, but a lot less than its peers or its benchmark, investors decamped and the fund ended up with $40 million in December 2014.

Nuveen NWQ Large-Cap Value (NQCAX, 47% distribution) has been suffering mass redemptions – assets were $1.3 billion in mid-2013, $700 million in mid-2014, and $275 million at year’s end. The fund also had weak and inconsistent returns: bottom 10% of its peer group for the past 1, 3 and 5 years and far below average – about a 20% return over the current market cycle as compared to 38% for its large cap value peers – despite a couple good years.

Wells Fargo Small Cap Opportunities (NVSOX, 41% distribution) has a splendid record, low volatility, a track record for reasonably low payouts, a stable management team … and crashing assets. The fund held $700 million in October 2013, $470 million in March 2014 and $330 million in December 2014. With investment minimums of $1 million (Administrative share class) and $5 million (Institutional), the best we can say is that it’s nice to see rich people being stupid, too.

A couple of these funds are, frankly, bad. Most are mediocre. And a couple are really good but, seemingly, really unlucky. For investors in taxable accounts, their fate highlights an ugly reality: your success can be undermined by the behavior of your funds’ other investors. You really don’t want to be the last one out the door, which means you need to understand when others are heading out.

Hear “it’s a stock-pickers market”? Run quick … away

Not from the market necessarily, but from any dim bulb whose insight is limited not only by the need to repeat what others have said, but to repeat the dumbest things that others have said.

“Active management is oversold.” Run!

“Passive investing makes no sense to us or to our investors.” Run faster!

Ted, the discussion board’s indefatigable Linkster, pointed us at Henry Blodget’s recent essay “14 Meaningless Phrases That Will Make You Sound Like A Stock-Market Wizard” at his Business Insider site.  Yes, that Henry Blodget: the poster child for duplicitous stock “analysis” who was banned for life from the securities industry. He also had to “disgorge” $2 million in profits, a process that might or might not have involved a large bucket. In any case, he knows whereof he speaks.)  He pokes fun at “the trend is your friend” (phrased differently it would be “follow the herd, that’s always a wise course”) and “it’s a stockpicker’s market,” among other canards.

Chip, the Observer’s tech-crazed tech director, appreciated Blodget’s attempt but recommends an earlier essay: “Stupid Things Finance People Say” by Morgan Housel of Motley Fool. Why? “They cover the same ground. The difference is the he’s actually funny.”

Hmmm …

Blodget: “It’s not a stock market. It’s a market of stocks.” It sounds deeply profound — the sort of wisdom that can be achieved only through decades of hard work and experience. It suggests the speaker understands the market in a way that the average schmo doesn’t. It suggests that the speaker, who gets that the stock market is a “market of stocks,” will coin money while the average schmo loses his or her shirt.

Housel: “Earnings were positive before one-time charges.” This is Wall Street’s equivalent of, “Other than that, Mrs. Lincoln, how was the play?”

Blodget: “I’m cautiously optimistic.” A classic. Can be used in almost all circumstances and market conditions … It implies wise, prudent caution, but also a sunny outlook, which most people like.

Housel: “We’re cautiously optimistic.” You’re also an oxymoron.

Blodget: “Stocks are down on ‘profit taking.” …It sounds like you know what professional traders are doing, which makes you sound smart and plugged in. It doesn’t commit you to a specific recommendation or prediction. If the stock or market goes down again tomorrow, you can still have been right about the “profit taking.” If the stock or market goes up tomorrow, you can explain that traders are now “bargain hunting” (the corollary). Whether the seller is “taking a profit” — and you have no way of knowing — the buyer is at the same time placing a new bet on the stock. So collectively describing market activity as “profit taking” is ridiculous.

Housel: “The Dow is down 50 points as investors react to news of [X].” Stop it, you’re just making stuff up. “Stocks are down and no one knows why” is the only honest headline in this category.

Your pick.  Or try both for the same price!

Alternately, if you’re looking to pick up hot chicks as well as hot picks at your next Wall Street soiree, The Financial Times helpfully offered up “Strategist’s icebreakers serve up the season’s party from hell” (12/27/2014). They recommend chucking out the occasional “What’s all the fuss about the central banks?” Or you might try the cryptic, “Inflation isn’t keeping me up at night — for now.”

Top developments in fund industry litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before. For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

New Lawsuit

• The plaintiff in existing fee litigation regarding ten Russell funds filed a new complaint, covering a different damages period, that additionally adds a new section 36(b) claim for excessive administrative fees. (McClure v. Russell Inv. Mgmt. Co.)

Orders

• The court consolidated ERISA lawsuits regarding “stable value funds” offered by J.P. Morgan to 401(k) plan participants. (In re J.P. Morgan Stable Value Fund ERISA Litig.)
• The court preliminarily approved a $9.475 million settlement of an ERISA class action that challenged MassMutual‘s receipt of revenue-sharing payments from unaffiliated mutual funds. (Golden Star, Inc. v. Mass Mut. Life Ins. Co.)
• The court gave its final approval to the $22.5 million settlement of Regions Morgan Keegan ERISA litigation. Plaintiffs had alleged that defendants imprudently caused and permitted retirement plans to invest in (1) Regions common stock (“despite the dire financial problems facing the Company”), (2) certain bond funds (“heavily and imprudently concentrated and invested in high-risk structured finance products”), and (3) the RMK Select Funds (“despite the fact that they incurred unreasonably expensive fees and were selected . . . solely to benefit Regions”). (In re Regions Morgan Keegan ERISA Litig.)

Briefs

• The plaintiff filed a reply brief in her appeal to the Eighth Circuit regarding gambling-related securities held by the American Century Ultra Fund. Defendants include independent directors. (Seidl v. Am. Century Cos.)
• In the ERISA class action alleging that TIAA-CREF failed to honor redemption and transfer requests in a timely fashion, the plaintiff filed her opposition to TIAA-CREF’s motion to dismiss. (Cummings v. TIAA-CREF.)

Amended Complaints

• Plaintiffs filed an amended complaint in the consolidated fee litigation regarding the Davis N.Y. Venture Fund: “The investment advisory fee rate charged to the Fund is as much as 96% higher than the rates negotiated at arm’s length by Davis with other clients for the same or substantially the same investment advisory services.” (In re Davis N.Y. Venture Fund Fee Litig.)
• Plaintiffs filed an amended complaint in the consolidated fee litigation regarding the Harbor International and and High-Yield Bond Funds: “Defendant charges investment advisory fees to each of the Funds that include a mark-up of more than 80% over the fees paid by Defendant to the Subadvisers who provide substantially all of the investment advisory services required by the Funds.” (Zehrer v. Harbor Capital Advisors, Inc.)

The Alt Perspective: Commentary and news from DailyAlts.

By Brian Haskins, editor of DailyAlts.com

As they say out here in Hollywood, that’s a wrap. Now we can close the books on 2014 and take a look at some of the trends that emerged over the year, and make a few projections about what might be in store for 2015. So let’s jump in.

Early in 2014, it was clear that assets were flowing strongly into liquid alternatives, with twelve-month growth rates hovering around 40% for most of the first half of the year. While the growth rates declined as the year went on, it was clear that 2014 was a real turning point in both asset growth and new fund launches. In total, more than $26 billion of net new assets flowed into the category over the past twelve months.

Three of the categories that garnered the most new asset flows were non-traditional bonds, long/short equity and multi-alternative strategies. Each of these makes sense, as follows:

• Non-traditional bonds provide a hedge against a rise in interest rates, so investors naturally were looking for a way to avoid what was initially thought to be a sure thing in 2014 – rising rates. As we know, that turned not to be the case, and instead we saw a fairly steady decline in rates over the year. Nonetheless, investors who flowed into these funds should be well positioned should rates rise in 2015.
• On the equity side, long/short equity provides a hedge against a decline in the equity markets, and here again investors looked to position their portfolios more conservatively given the long bull run. As a result, long/short equity funds saw strong inflows for most of the year with the exception of the $11.9 billion MainStay Marketfield Fund (MFLDX) which experienced more than $5 billion of outflows over eight straight months on the back of a difficult performance period. As my old boss would say, they have gone from the penthouse to the doghouse. But with nearly $12 billion remaining in the fund and a 1.39% management fee, their doghouse probably isn’t too bad.
• Finally, investors favored multi-alternative funds steadily during the year. These funds provide an easy one-stop-shop for making an allocation to alternatives, and for many investors and financial advisors, these funds are a solid solution since they package multiple alternative investment strategies into one fund. I would expect to see multi-alternative funds continue to play a dominant role in portfolios over the next few years while the industry becomes more comfortable with evaluating and allocating to single strategy funds.

Now that the year has come to a close, we can take a step back and look at 2014 from a big picture perspective. Here are five key trends that I saw emerge over the year:

1. The conversion of hedge funds into mutual funds – This is an interesting trend that will likely continue, and gain even more momentum in 2015. There are a few reasons why this is likely. First, raising assets in hedge funds has become more difficult over the past five years. Institutional investors allocate a bulk of their assets to well-known hedge fund managers, and performance isn’t the top criteria for making the allocations. Second, investing in hedge funds involves the review of a lot of non-standard paperwork, including fee agreements and other terms. This creates a high barrier to entry for smaller investors. Thus, the mutual fund vehicle is a much easier product to use for gathering assets with smaller investors in both the retail and institutional channels. As a result, we will see many more hedge fund conversions in the coming years. Third, the track record and the assets of a hedge fund are portable over to a mutual fund. This gives new mutual funds that convert from a hedge fund a head start over all other new funds.
2. The re-emergence of managed futures funds – A divergence in global economic policies among central banks created more opportunities for managers that look for asset prices that move in opposite directions. Managed futures managers do just that, and 2014 proved to be the first year in many where they were able to put positive, double digit returns on the board. It is likely that 2015 will be another solid year for these strategies as strong price trends will likely continue with global interest rates, currencies, commodity prices and other assets over the year.
3. More well-known hedge fund managers are getting into the liquid alternatives business – It’s hard to resist strong asset flows if you are an asset manager, and as discussed above, the asset flows into liquid alternatives have been strong. And expectations are that they will continue to be strong. So why wouldn’t a decent hedge fund manager want to get in the game and diversify their business away from institutional and high net worth assets. Some of the top hedge fund managers are recognizing this and getting into the space, and as more do, it will become even more acceptable for those who haven’t.
4. A continued increase in the use of alternative beta strategies, and the introduction of more complex alternative beta funds – Alternative beta (or smart beta) strategies give investors exposure to specific “factors” that have otherwise not been easy to obtain historically. With the introduction of alternative beta funds, investors can now fine tune their portfolio with specific allocations to low or high volatility stocks, high yielding stocks, high momentum stocks, high or low quality stocks, etc. A little known secret is that factor exposures have historically explained more of an active manager’s excess returns (returns above a benchmark) than individual stock selection. With the advent of alternative beta funds in both the mutual fund and ETF format, investors have the ability to build more risk efficient portfolios or turn the knobs in ways they haven’t been able to in the past.
5. An increase in the number of alternative ETFs – While mutual funds have a lower barrier to entry for investors than hedge funds, ETFs are even more ubiquitous. Nearly every ETF can be purchased in nearly every brokerage account. Not so for mutual funds. The biggest barrier to seeing more alternative ETFs has historically been the fact that most alternative strategies are actively managed. This is slowly changing as more systematic “hedge fund” approaches are being developed, along with alternative ETFs that invest in other ETFs to gain their underlying long and short market exposures. Expect to see this trend continue in 2015.

There is no doubt that 2015 will bring some surprises, but by definition we don’t know what those are today. We will keep you posted as the year progresses, and in the meantime, Happy New Year and all the best for a prosperous 2015!

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

RiverPark Large Growth (RPXFX/RPXIX): it’s a discipline that works. Find the forces that will consistently drive growth in the years ahead.  Do intense research to identify great firms that are best positioned to reap enduring gains from them. Wait. Wait. Wait. Then buy them when they’re cheap. It’s worked well, except for that pesky “get investors to notice” piece.

River Park Large Growth Conference Call Highlights

On December 17th we spoke for an hour with Mitch Rubin, manager of RiverPark Large Growth (RPXFX/RPXIX), Conrad van Tienhoven, his long-time associate, and Morty Schaja, CEO of RiverPark Funds. About 20 readers joined us on the call.

Here’s a brief recap of the highlights:

• The managers have 20 years’ experience running growth portfolios, originally with Baron Asset Management and now with RiverPark. That includes eight mutual funds and a couple hedge funds.
• Across their portfolios, the strategy has been the same: identify long-term secular trends that are likely to be enduring growth drivers, do really extensive fundamental research on the firm and its environment, and be patient before buying (the target is paying less than 15-times earnings for companies growing by 20% or more) or selling (which is mostly just rebalancing within the portfolio rather than eliminating names from the portfolio).
• In the long term, the strategy works well. In the short term, sometimes less so. They argue for time arbitrage. Investors tend to underreact to changes which are strengthening firms. They’ll discount several quarters of improved performance before putting a stock on their radar screen, then may hesitate for a while longer before convincing themselves to act. By then, the stock may already have priced-in much of the potential gains. Rubin & co. try to track firms and industries long enough that they can identify the long-term winners and buy during their lulls in performance.

In the long term, the system works. The fund has returned 20% annually over the past three years. It’s four years old and had top decile performance in the large cap growth category after the first three years.

Then we spent rather a lot of time on the ugly part.

In relative terms, 2014 was wretched for the fund. The fund returned about 5.5% for the year, which meant it trailed 93% of its peers. It started the year with a spiffy five-star rating and ended with three. So, the question was, what happened?

Mitch’s answer was presented with, hmmm … great energy and conviction. There was a long stretch in there where I suspect he didn’t take a breath and I got the sense that he might have heard this question before. Still, his answer struck me as solid and well-grounded. In the short term, the time arbitrage discipline can leave them in the dust. In 2014, the fund was overweight in a number of underperforming arenas: energy E&P companies, gaming companies and interest rate victims.

• Energy firms: 13% of the portfolio, about a 2:1 overweight. Four high-quality names with underlevered balance sheets and exposure to the Marcellus shale deposits. Fortunately for consumers and unfortunately for producers, rising production, difficulties in selling US natural gas on the world market and weakening demand linked to a spillover from Russia’s travails have caused prices to crater.
  
  The fundamental story of rising demand for natural gas, abetted by better US access to the world energy market, is unchanged. In the interim, the portfolio companies are using their strong balance sheets to acquire assets on the cheap.

• Gaming firms: gaming in the US, with regards to Ol’ Blue Eyes and The Rat Pack, is the past. Gaming in Asia, they argue, is the future. The Chinese central government has committed to spending nearly a half trillion dollars on infrastructure projects, including $100 billion/year on access, in and around the gambling enclave of Macau. Chinese gaming (like hedge fund investing here) has traditionally been dominated by the ultra-rich, but gambling is culturally entrenched and the government is working to make it available to the mass affluent in China (much like liquid alt investing here). About 200 million Chinese travel abroad on vacation each year. On average, Chinese tourists spend a lot more in the casinos and a lot more in attendant high-end retail than do Western tourists. In the short term, President Xi’s anti-corruption campaign has precipitated “a vast purge” among his political opponents and other suspiciously-wealthy individuals. Until “the urge to purge” passes, high-rolling gamblers will be few and discreet. Middle class gamblers, not subject to such concerns, will eventually dominate. Just not yet.
• Interest rate victims: everyone knew, in January 2014, that interest rates were going to rise. Oops. Those continuingly low rates punish firms that hold vast cash stakes (think “Google” with its $50 billion bank account or Schwab with its huge network of money market accounts). While Visa and MasterCard’s stock is in the black for 2014, gains are muted by the lower rates they can charge on accounts and the lower returns on their cash flow.

Three questions came up:

• Dan Schein asked about the apparent tension between the managers’ commitment to a low turnover discipline and the reported 33-40% turnover rate. Morty noted that you need to distinguish between “name turnover” (that is, firms getting chucked out of the portfolio) and rebalancing. The majority of the fund’s turnover is simple internal rebalancing as the managers trim richly appreciated positions and add to underperforming ones. Name turnover is limited to two or three positions a year, with 70% of the names in the current portfolio having been there since inception.
• I asked about the extent of international exposure in the portfolio, which Morningstar reports at under 2%. Mitch noted that they far preferred to invest in firms operating under US accounting requirements (Generally Accepted Accounting Principles) and U.S. securities regulations, which made them far more reliable and transparent. On the other hand, the secular themes which the managers pursue (e.g., the rise of mobile computing) are global and so they favor U.S.-based firms with strong global presence. By their estimate, two thirds of the portfolio firms derive at least half of their earnings growth from outside the US and most of their firms derived 40-50% of earnings internationally; Priceline is about 75%, Google and eBay around 60%. Direct exposure to the emerging markets comes mainly from Visa and MasterCard, plus Schlumberger’s energy holdings.
• Finally I asked what concern they had about volatility in the portfolio. Their answer was that they couldn’t predict and didn’t worry about stock price volatility. They were concerned about what they referred to as “business case volatility,” which came down to the extent to which a firm could consistently generate free cash from recurring revenue streams (e.g., the fee MasterCard assesses on every point-of-sale transaction) without resorting to debt or leverage.

For folks interested but unable to join us, here’s the complete audio of the hour-long conversation.

The RPXFX Conference Call

As with all of these funds, we’ve created a new Featured Funds page for RiverPark Large Growth Fund, pulling together all of the best resources we have for the fund.

Conference Calls Upcoming

We anticipate three conference calls in the next three months and we would be delighted by your company on each of them. We’re still negotiating dates with the managers, so for now we’ll limit ourselves to a brief overview and a window of time.

At base, we only do conference calls when we think we’ve found really interesting people for you to talk with. That’s one of the reasons we do only a few a year.

Here’s the prospective line-up for winter.

Bernard Horn is manager of Polaris Global Value (PGVFX) and sub-adviser to a half dozen larger funds. Mr. Horn is president of Polaris Capital Management, LLC, a Boston-based global and international value equity firm. Mr. Horn founded Polaris in 1995 and launched the Global Value Fund in 1998. Today, Polaris manages more than $5 billion for 30 clients include rich folks, institutions and mutual and hedge funds. There’s a nice bio of Mr. Horn at the Polaris Capital site.

Why talk with Mr. Horn? Three things led us to it. First, Polaris Global is really good and really small. After 16 years, it’s a four- to five-star fund with just $280 million in assets. He seems just a bit abashed by that (“we’re kind of bad at marketing”) but also intent on doing right for his shareholders rather than getting rich. Second, his small cap international fund (Pear Tree Polaris Foreign Value Small Cap QUSOX) is, if anything, better and it trawls the waters where active management actually has the greatest success. Finally, Ed and I have a great conversation with him in November. Ed and I are reasonably judgmental, reasonably well-educated and reasonably cranky. And still we came away from the conversation deeply impressed, as much by Mr. Horn’s reflections on his failures as much as by his successes. There’s a motto often misattributed to the 87 year old Michelangelo: Ancora imparo, “I am still learning.” We came away from the conversation with a sense that you might say the same about Mr. Horn.

Matthew Page and Ian Mortimer are co-managers of Guinness Atkinson Global Innovators (IWIRX) and Guinness Atkinson Dividend Builder (GAINX), both of which we’ve profiled in the past year. Dr. Mortimer is trained as a physicist, with a doctorate from Oxford. He began at Guinness as an analyst in 2006 and became a portfolio manager in 2011. Mr. Page (the friendly looking one over there->) earned a master’s degree in physics from Oxford and somehow convinced the faculty to let him do his thesis on finance: “Financial Markets as Complex Dynamical Systems.” Nice trick! He spent a year with Goldman Sachs, joined Guinness in 2005 and became a portfolio co-manager in 2006.

Why might you want to hear from the guys? At one level, they’re really successful. Five star rating on IWIRX, great performance in 2014 (also 2012 and 2013), laughably low downside capture over those three years (almost all of their volatility is to the upside), and a solid, articulated portfolio discipline. In 2014, Lipper recognized IWIRX has the best global equity fund of the preceding 15 years and they still can’t attract investors. It’s sort of maddening. Part of the problem might be the fact that they’re based in London, which makes relationship-building with US investors a bit tough. At another level, like Mr. Horn, I’ve had great conversations with the guys. They’re good listeners, sharp and sometimes witty. I enjoyed the talks and learned from them.

David Berkowitz will manage the new RiverPark Focused Value Fund once it launches at the end of March. Mr. Berkowitz earned both a bachelor’s and master’s degree in chemical engineering at MIT before getting an MBA at that other school in Cambridge. In 1992, Mr. Berkowitz and his Harvard classmate William Ackman set up the Gotham Partners hedge fund, which drew investments from legendary investors such as Seth Klarman, Michael Steinhardt and Whitney Tilson. Berkowitz helped manage the fund until 2002, when they decided to close the fund, and subsequently managed money for a New York family office, the Festina Lente hedge fund (hmmm … “Make haste slowly,” the family motto of the Medicis among others) and for Ziff Brother Investments, where he was a Partner as well as the Chief Risk and Strategy Officer. He’s had an interesting, diverse career and Mr. Schaja speaks glowingly of him. We’re hopeful of speaking with Mr. Berkowitz in March.

Would you like to join in?

It’s very simple. In February we’ll post exact details about the time and date plus a registration link for each call. The calls cost you nothing, last exactly one hour and will give you the chance to ask the managers a question if you’re so moved. It’s a simple phone call with no need to have access to a tablet, wifi or anything.

Alternately, you can join the conference call notification list. One week ahead of each call we’ll email you a reminder and a registration link.

Launch Alert: Cambria Global Momentum & Global Asset Allocation

Cambria Funds recently launched two ETFs, as promised by its CIO Mebane Faber, who wants to “disrupt the traditional high fee mutual fund and hedge fund business, mostly through launching ETFs.” The line-up is now five funds with assets under management totaling more than $350M:

• Cambria Shareholder Yield ETF (SYLD)
• Cambria Foreign Shareholder Yield ETF (FYLD)
• Cambria Global Value ETF (GVAL)
• Cambria Global Momentum ETF (GMOM)
• Cambria Global Asset Allocation ETF (GAA)

We wrote about the first three in “The Existential Pleasures of Engineering Beta” this past May. SYLD is now the largest actively managed ETF among the nine categories in Morningstar’s equity fund style box (small value to large growth). It’s up 12% this year and 32% since its inception May 2013.

GMOM and GAA are the two newest ETFs. Both are fund of funds.

GMOM is based on Mebane’s definitive paper “A Quantitative Approach To Tactical Asset Allocation” and popular book “The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets.” It appears to be an in-house version of AdvisorShares Cambria Global Tactical ETF (GTAA), which Cambria stopped sub-advising this past June. Scott, a frequent and often profound contributor to our discussion board, describes GTAA in one word: “underwhelming.” (You can find follow some of the debate here.) The new version GMOM sports a much lower expense ratio, which can only help. Here is link to fact sheet.

GAA is something pretty cool. It is an all-weather strategic asset allocation fund constructed for global exposure across diverse asset classes, but with lower volatility than your typical long term target allocation fund. It is a “one fund for a lifetime” offering. (See DailyAlts “Meb Faber on the Genesis of Cambria’s Global Tactical ETF.”) It is the first ETF to have a permanent 0% management fee. Its annual expense ratio is 0.29%. From its prospectus:

Here’s is link to fact sheet, and below is snapshot of current holdings:

In keeping with the theme that no good deed goes unpunished. Chuck Jaffe referenced GAA in his annual “Lump of Coal Awards” series. Mr. Jaffe warned “investors should pay attention to the total expense ratio, because that’s what they actually pay to own a fund or ETF.” Apparently, he was irked that the media focused on the zero management fee. We agree that it was pretty silly of reporters, members of Mr. Jaffe’s brotherhood, to focus so narrowly on a single feature of the fund and at the same time celebrate the fact that Mr. Faber’s move lowers the expenses that investors would otherwise bear.

Launch Alert: ValueShares International Quantitative Value

Wesley Gray announced the launch of ValueShares International Quantitative Value ETF (IVAL) on 19 December, his firm’s second active ETF. IVAL is the international sister to ValueShares Quantitative Value ETF (QVAL), which MFO profiled in December. Like QVAL, IVAL seeks the cheapest, highest quality value stocks … within the International domain. These stocks are selected in quant fashion based on value and quality criteria grounded in investing principles first outlined by Ben Graham and validated empirically through academic research.

The concentrated portfolio currently invests in 50 companies across 14 countries. Here’s breakout:

As with QVAL, there is no sector diversification constraint or, in this case, country constraint. Japan dominates current portfolio. Once candidate stocks pass the capitalization, liquidity, and quality screens, value is king.

Notice too no Russia or Brazil.

Wesley explains: “We only trade in liquid tradeable names where front-running issues are minimized. We also look at the custodian costs. Russia and Brazil are insane on both the custodial costs and the frontrunning risks so we don’t trade ’em. In the end, we’re trading in developed/developing markets. Frontier/emerging don’t meet our criteria.”

Here is link to IVAL overview. Dr. Gray informs us that the new fund’s expense ratio has just been reduced by 20bps to 0.79%.

Launch Alert: Pear Tree Polaris Small Cap Fund (USBNX/QBNAX)

On January 1, a team from Polaris Capital assumed control of the former Pear Tree Columbia Small Cap Fund, which has now been rechristened. For the foreseeable future, the fund’s performance record will bear the imprint of the departed Columbia team.  The Columbia team had been in place since the middle 1990s and the fund has, for years, been a study in mediocrity.  We mean that in the best possible way: it rarely cratered, it rarely soared and it mostly trailed the pack by a bit. By Morningstar’s calculation, the compounding effect of almost always losing by a little ended up being monumental: the fund trailed more than 90% of its peers for the past 1, 3, 5, and 10 year periods while trailing two-thirds over them over the past 15 years.

Which is to say, your statistical screens are not going to capture the fund’s potential going forward.

We think you should look at the fund, and hope to ask Mr. Horn about it on a conference call with him.  Here are the three things you need to know about USNBX if you’re in the market for a small cap fund:

• The management team here also runs Pear Tree Polaris Foreign Value Small Cap Fund (QUSOX / QUSIX) which has earned both five stars from Morningstar and a Great Owl designation from the Observer.
• The new subadvisory agreement pays Polaris 20 basis points less than Columbia received, which will translate into lower expenses that investors pay.
• The portfolio will be mostly small cap ($100 million – $5 billion) US stocks but they’ve got a global watch-list of 500 names which are candidates for inclusion and they have the ability to hedge the portfolio. The foreign version of the fund has been remarkable in its ability to manage risk: they typically capture one-third as much downside risk as their peers while capturing virtually all of the upside.

The projected expense ratio is 1.44%. The minimum initial investment is $2500, reduced to $1000 for tax-advantaged accounts and for those set up with an automatic investing plan. Pear Tree has not, as of January 1, updated the fund’s webpage is reflect the change but you should consider visiting Pear Tree’s homepage next week to see what they have to say about the upgrade.  We’ll plan profiles of both funds in the months ahead.

Funds in Registration

Yikes. We’ve never before had a month like this: there’s only one new, no-load retail fund on file with the SEC. Even if we expand the search to loaded funds, we only get to four or five.  Hmmm …

The one fund is RiverPark Focused Value Fund. It will be primarily a large cap domestic equity fund whose manager has a particular interest in “special situations” such as spin-offs or reorganizations and on firms whose share prices might have cratered. They’ll buy if it’s a high quality firm and if the stock trades at a substantial discount to intrinsic value. It will be managed by a well-known member of the hedge fund community, David Berkowitz.

Manager Changes

This month also saw an uptick in manager turnover; 73 funds reported changes, about 50% more than the month before. The most immediately noticeable of which was Bill Frels’ departure from Mairs & Power Growth (MPGFX) and Mairs & Power Balanced (MAPOX) after 15 and 20 years, respectively. They’re both remarkable funds: Balanced has earned five stars from Morningstar for the past 3, 5, 10 and since inception periods while Growth has either four or five stars for all those periods. Both invest primarily in firms located in the upper Midwest and both have negligible turnover.

Mr. Frels’ appointment occasioned considerable anxiety years ago because he was an unknown guy replacing an investing legend, George Mairs. At the time, we counseled calm because Mairs & Power had themselves calmly and deliberately planned for the handout.  I suppose we’ll do the same today, though we might use this as an excuse for calling M&P to update our 2011 profile of the fund. That profile, written just as M&P appointed a co-manager in what we said was evidence of succession planning, concluded “If you’re looking for a core holding, especially for a smaller portfolio where the reduced minimum will help, this has to be on the short-list of the most attractive balanced funds in existence.”  We were right and we don’t see any reason to alter that conclusion now.

Updates

Andrew Foster and the folks at Seafarer Partners really are consistently better communicators than almost any of their peers.  In addition to a richly informative website and portfolio metrics that almost no one else thinks to share, they have just published a semi-annual report with substantial content.

Two arguments struck me.  First, the fund’s performance was hampered by their decision to avoid bad companies:

the Fund’s lack of exposure to small and mid-size technology companies – mostly located in Taiwan – caused it to lag the benchmark during the market’s run-up. While interesting investments occasionally surface among the sea of smaller technology firms located in and around Taipei, this group of companies in general is not distinguished by sustainable growth. Most companies make components for consumer electronics or computers, and while some grow quickly for a while, often their good fortune is not sustainable, as their products are rapidly commoditized, or as technological evolution renders their products obsolete. Their share prices can jump rapidly higher for a time when their products are in vogue. Nevertheless, I rarely find much that is worthwhile or sustainable in this segment of the market, though there are sometimes exceptions.

As a shareholder in the fund, I really do applaud a discipline that avoids those iffy but easy short-term bets.

The second argument is more interesting and a lot more important for the investing community. Andrew argues that “value investing” might finally be coming to the emerging markets.

Yet even as the near-term is murky, I believe the longer-term outlook has recently come into sharper focus. A very important structural change – one that I think has been a long time in coming – has just begun to reshape the investment landscape within the developing world. I think the consequence of this change will play out over the next decade, at a minimum.

For the past sixteen years, I have subscribed to an investment philosophy that stresses “growth” over “value.” By “value,” I mean an investment approach that places its primary emphasis on the inherent cheapness of a company’s balance sheet, and which places secondary weight on the growth prospect of the company’s income statement..

In the past, I have had substantial doubts as to whether a classic “value” strategy could be effectively implemented within the developing world – “value” seemed destined to become a “value trap.”  … In order to realize the value embedded in a cheap balance sheet, a minority investor must often invest patiently for an extended period, awaiting the catalyst that will ultimately unlock the value.

The problem with waiting in the developing world is that most countries lack sufficient legal, financial, accounting and regulatory standards to protect minority investors from abuse by “control parties.” A control party is the dominant owner of a given company. Without appropriate safeguards, minorities have little hope of avoiding exploitation while they wait; nor do they have sufficient legal clout to exert pressure on the control party to accelerate the realization of value. Thus in the past, a prospective “value” investment was more likely to be a “trap” than a source of long-term return.

Andrew’s letter outlines a series of legal and structural changes which seem to be changing that parlous state and he talks about the implications for his portfolio and, by extension, for yours. You should go read the letter.

Seafarer Growth & Income (SFGIX) is closing in on its third anniversary (February 15, 2015) with $122 million in assets and a splendid record, both in terms of returns and risk-management. The fund finished 2014 with a tiny loss but a record better than 75% of its peers.  We’re hopeful of speaking with Andrew and his team as they celebrate that third anniversary.

Speaking of third anniversaries, Grandeur Peak funds have just celebrated theirs. Their success has been amazing, at least to the folks who weren’t paying attention to their record in their preceding decade.  Eric Heufner, the firm’s president, shared some of the highlights in a December email:

… our initial Funds have reached the three-year milestone.  Both Funds ranked in the Top 1% of their respective Morningstar peer groups for the 3 years ending 10/31/14, and each delivered an annualized return of more than 20% over the period. The Grandeur Peak Global Opportunities Fund was the #1 fund in the Morningstar World Stock category and the Grandeur Peak International Opportunities Fund was the #2 fund in the Morningstar Foreign Small/Mid Growth category.  We also added two new strategies over the past year 18 months.  [He shared a performance table which comes down to this: all of the funds are top 10% or better for the available measurement periods.] 

Our original team of 7 has now grown to a team of 30 (16 full-time & 14 part-time).  Our assets under management have grown to $2.4 billion, and all four of our strategies are closed to additional investment—we remain totally committed to keeping our portfolios nimble.  We still plan to launch other Funds, but nothing is imminent.

And, too, their discipline strikes me as entirely admirable: all four of their funds have now been hard-closed in accordance with plans that they announced early and clearly. 2015 should see the launch of their last three funds, each of which was also built-in early to the firm’s planning and capacity calculations.

Finally, Matthews Asia Strategic Income (MAINX) celebrated its third anniversary and first Morningstar rating in December, 2014. The fund received a four-star rating against a “world bond” peer group. For what interest it holds, that rating is mostly meaningless since the fund’s mandate (Asia! Mostly emerging) and portfolio (just 70% bonds plus income-producing equities and convertibles) are utterly distant from what you see in the average world bond fund. The fund has crushed the one or two legitimate competitors in the space, its returns have been strong and its manager, Teresa Kong, comes across a particularly smart and articulate.

Briefly Noted . . .

Investors have, as predicted, chucked rather more than a billion dollars into Bill Gross’s new charge, Janus Unconstrained Bond (JUCAX) fund. Despite holding 75% of that in cash, Gross has managed both to lose money and underperform his peers in these opening months.  Both are silly observations, of course, though not nearly so silly as the desperate desire to rush a billion into Gross’s hands.

SMALL WINS FOR INVESTORS

Effective January 1, 2015, Perkins Small Cap Value Fund (JDSAX) reopened to new investors. I’m a bit ambivalent here. The fund looks sluggish when measured by the usual trailing periods (it has trailed about 90% of its peers over the past 3 and 5 year periods) but I continue to think that those stats mislead as often as they inform since they capture a fund’s behavior in a very limited set of market conditions. If you look at the fund’s performance over the current market cycle – from October 1 2007 to now – it has returned 78% which handily leads its peers’ 61% gain. Nonetheless the team is making adjustments which include spending down their cash (from 15% to 5%), which is a durned odd for a value discipline focused on high quality firms to do. They’re also dropping the number of names and adding staff. It has been a very fine fund over the long term but this feels just a bit twitchy.

CLOSINGS (and related inconveniences)

A couple unusual cases here.

Aegis High Yield Fund (AHYAX/AHYFX) closed to new investors in mid-December and has “assumed a temporary defensive position.” (The imagery is disturbing.) As we note below, this might well signal an end to the fund.

The more striking closure is GL Beyond Income Fund (GLBFX). While the fund is tiny, the mess is huge. It appears that Beyond Income’s manager, Daniel Thibeault (pronounced “tee-bow”), has been inventing non-existent securities then investing in them. Such invented securities might constitute a third of the fund’s portfolio. In addition, he’s been investing in illiquid securities – that is, stuff that might exist but whose value cannot be objectively determined and which cannot be easily sold. In response to the fraud, the manager has been arrested and charged with one count of fraud.  More counts are certainly pending but conviction just on the one original charge could carry a 20-year prison sentence. Since the board has no earthly idea of what the fund’s portfolio is worth, they’ve suspended all redemptions in the fund as well as all purchased. 

GL Beyond Income (it’s certainly sounding awfully ironic right now, isn’t it?) was one of two funds that Mr. Thibeault ran. The first fund, GL Macro Performance Fund (GLMPX), liquidated in July after booking a loss of nearly 50%. Like Beyond Income, it invested in a potpourri of “alternative investments” including private placements and loans to other organizations controlled by the manager.

There have been two pieces of really thoughtful writing on the crime. Investment News dug up a lot of the relevant information and background in a very solid story by Mason Braswell on December 30^th.  Chuck Jaffe approached the story as an illustration of the unrecognized risks that retail investors take as they move toward “liquid alts” funds which combine unusual corporate structures (the GL funds were interval funds, meaning that you could not freely redeem your shares) and opaque investments.

Morningstar, meanwhile, remains thoughtfully silent.  They seem to have reprinted Jaffe’s story but their own coverage of the fraud and its implications has been limited to two one-sentence notes on their Advisor site.

OLD WINE, NEW BOTTLES

Effective January 1, 2015, the name of the AIT Global Emerging Markets Opportunities Fund (VTGIX) changed to the Vontobel Global Emerging Markets Equity Institutional Fund.

American Century One Choice 2015 Portfolio has reached the end of its glidepath and is combining with One Choice In Retirement. That’s not really a liquidation, more like a long-planned transition.

Effective January 30, 2015, the name of the Brandes Emerging Markets Fund (BEMAX) will be changed to the Brandes Emerging Markets Value Fund.

At the same time that Brandes gains value, Calamos loses it. Effective March 1, Calamos Opportunistic Value Fund (CVAAX) becomes plain ol’ Calamos Opportunistic Fund and its benchmark will change from Russell 1000 Value to the S&P 500. Given that the fund is consistently inept, one could imagine calling for new managers … except for the fact that the fund is managed by the firm’s founder and The Gary Black.

Columbia Global Equity Fund (IGLGX) becomes Columbia Select Global Equity Fund on or about January 15, 2015. At that point Threadneedle International Advisers LLC takes over and it becomes a focused fund (though no one is saying how focused or focused on what?).

Effective January 1, 2015, Ivy International Growth Fund (IVINX) has changed to Ivy Global Growth Fund. Even before the change, over 20% of the portfolio was invested in the US.

PIMCO EqS^® Dividend Fund (PQDAX) became PIMCO Global Dividend Fund on December 31, 2014.

Effective February 28, 2015, Stone Ridge U.S. Variance Risk Premium Fund (VRLIX) will change its name to Stone Ridge U.S. Large Cap Variance Risk Premium Fund.

Effective December 29, 2014, the T. Rowe Price Retirement Income Fund has changed its name to the T. Rowe Price Retirement Balanced Fund.

The two week old Vertical Capital Innovations MLP Energy Fund (VMLPX) has changed its name to the Vertical Capital MLP & Energy Infrastructure Fund.

Voya Strategic Income Fund has become Voya Strategic Income Opportunities Fund. I’m so glad. I was worried that they were missing opportunities, so this reassures me. Apparently their newest opportunities lie in being just a bit more aggressive than a money market fund, since they’ve adopted the Bank of America Merrill Lynch U.S. Dollar Three-Month LIBOR Constant Maturity Index as their new benchmark. Not to say this is an awfully low threshold, but that index has returned 0.34% annually from inception in 2010 through the end of 2014.

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Core Fixed Income Fund (PCDFX) will be liquidated on February 12, 2015.

Aegis High Yield Fund (AHYAX/AHYFX) hard-closed in mid-December. Given the fund’s size ($36 million) and track record, we’re thinking it’s been placed in a hospice though that hasn’t been announced. Here’s the 2014 picture:

AllianzGI Opportunity (POPAX) is getting axed. The plan is to merge the $90 million small cap fund into its $7 million sibling, AllianzGI Small-Cap Blend Fund (AZBAX). AZBAX has a short track record, mostly of hugging its index, but that’s a lot better than hauling around the one-star rating and dismal 10 year record that the larger fund’s managers inherited in 2013. They also didn’t improve upon the record. The closing date of the Reorganization is expected to be on or about March 9, 2015, although the Reorganization may be delayed.

Alpine Global Consumer Growth Fund (AWCAX) has closed and will, pending shareholder approval, be terminated in early 2015. Given that the vast majority of the fund’s shares (70% of the retail and 95% of the institutional shares) are owned by the family of Alpine’s founder, Sam Leiber, I’ve got a feeling that the shareholder vote is a done deal.

The dizzingly bad Birmiwal Oasis Fund (BIRMX) is being put out of manager Kailash Birmiwal’s misery. From 2003 – 07, the fund turned $10,000 into $67,000 and from 2007 – present it turned that $67,000 back into $21,000. All the while turning the portfolio at 2000% a year. Out of curiosity, I went back and reviewed the board of trustee’s decision to renew Mr. Birmiwal’s management contract in light of the fund’s performance. The trustees soberly noted that the fund had underperformed its benchmark and peers for the past 1-, 5-, 10-year and since inception periods but that “performance compared to its benchmark was competitive since the Fund’s inception which was reflective of the quality of the advisory services, including research, trade execution, portfolio management and compliance, provided by the Adviser.” I’m not even sure what that sentence means. In the end, they shrugged and noted that since Mr. B. owned more than 75% of the fund’s shares, he was probably managing it “to the best of his ability.”

I’m mentioning that not to pick on the decedent fund. Rather, I wanted to offer an example of the mental gymnastics that “independent” trustees frequently go through in order to reach a preordained conclusion.

The $75 million Columbia International Bond fund (CNBAX) has closed and will disappear at the being of February, 2015.

DSM Small-Mid Cap Growth Fund (DSMQZ/DSMMX) was liquidated and terminated on short notice at the beginning of December, 2014.

EP Strategic US Equity (EPUSX) and EuroPac Hard Asset (EPHAX) are two more lost lambs subject to “termination, liquidation and dissolution,” both on January 8^th, 2015.

Fidelity trustees unanimously approved the merge of Fidelity Fifty (FFTYX) into Fidelity Focused Stock (FTGQX). Not to point out the obvious but they have the same manager and near-identical 53 stock portfolios already. Shareholders will vote in spring and after baaa-ing appropriately, the reorganization will take place on June 5, 2015.

The Frost Small Cap Equity Fund was liquidated on December 15, 2014.

It is anticipated that the $500,000 HAGIN Keystone Market Neutral Fund (HKMNX) will liquidate on or about December 30, 2014 based on the Adviser’s “inability to market the Fund and that it does not desire to continue to support the Fund.”

Goldman Sachs World Bond Fund (GWRAX) will be liquidated on January 16, 2014. No reason was given. One wonders if word of the potential execution might have leaked out and reached the managers, say around June?

The $300 million INTECH U.S. Managed Volatility Fund II (JDRAX) is merging into the $100 million INTECH U.S. Managed Volatility Fund (JRSAX, formerly named INTECH U.S. Value Fund). Want to guess which of them had more Morningstar stars at the time of the merger? Janus will “streamline” (their word) their fund lineup on April 10, 2015.

ISI Strategy Fund (STRTX), a four star fund with $100 million in assets, will soon merge into Centre American Select Equity Fund (DHAMX). Both are oriented toward large caps and both substantially trail the S&P 500.

Market Vectors Colombia ETF, Latin America Small-Cap Index ETF, Germany Small-Cap ETF and Market Vectors Bank and Brokerage ETF disappeared, on quite short notice, just before Christmas.

New Path Tactical Allocation Fund (GTAAX), an $8 million fund which charges a 5% sales load and charges 1.64% in expenses – while investing in two ETFs at a time, though with a 600% turnover we can’t know for how long – has closed and will be vaporized on January 23, 2015.

The $2 million Perimeter Small Cap Opportunities Fund (PSCVX) will undergo “termination, liquidation and dissolution” on or about January 9, 2015.

ProShares is closing dozens of ETFs on January 9^th and liquidating them on January 22^nd. The roster includes:

SSgA IAM Shares Fund (SIAMX) has been closed in preparation for liquidation cover January 23, 2015. That’s just a mystifying decision: four-star rating, low expenses, quarter billion in assets … Odder still is the fund’s investment mandate: to invest in the equity securities of firms that have entered into collective bargaining agreements with the International Association of Machinists (that’s the “IAM” in the name) or related unions.

UBS Emerging Markets Debt Fund (EMFAX) will experience “certain actions to liquidate and dissolve the Fund” on or about February 24, 2015. The Board’s rationale was that “low asset levels and limited future prospects for growth” made the fund unviable. They were oddly silent on the question of the fund’s investment performance, which might somehow be implicated in the other two factors:

In Closing . . .

Jeez, so many interesting things are happening. There’s so much to share with you. Stuff on our to-do list:

• Active share is a powerful tool for weeding dead wood out of your portfolio. Lots and lots of fund firms have published articles extolling it. Morningstar declares you need to “get active or get out.” And yet neither Morningstar nor most of the “have our cake and eat it, too” crowd release the data. We’ll wave in the direction of the hypocrites and give you a heads up as the folks at Alpha Architect release the calculations for everyone.
• Talking about the role of independent trustees in the survival of the fund industry. We’ve just completed our analysis of the responsibilities, compensation and fund investments made by the independent trustees in 100 randomly-selected funds (excluding only muni bond funds). Frankly, our first reactions are (1) a few firms get it very right and (2) most of them have rigged the system in a way that screws themselves. You can afford to line your board with a collection of bobble-head dolls when times are good but, when times are tough, it reads like a recipe for failure.
• Not to call the ETF industry “scammy, self-congratulatory and venal” but there is some research pointing in that direction. We’re hopeful of getting you to think about it.
• Conference calls with amazing managers, maybe even tricking Andrew Foster into a reprise of his earlier visits with us.
• We’ve been talking with the folks at Third Avenue funds about the dramatic changes that this iconic firm has undergone. I think we understand them but we still need to confirm things (I hate making errors of fact) before we share. We’re hopeful that’s February.
• There are a couple new services that seem intent on challenging the way the fund industry operates. One is Motif Investing, which allows you to be your own fund manager. There are some drawbacks to the service but it would allow all of the folks who think they’re smarter than the professionals to test that hypothesis. The service that, if successful, will make a powerful social contribution is Liftoff. It’s being championed by Josh Brown, a/k/a The Reformed Broker, and the folks at Ritholtz Wealth Management. We mentioned the importance of automatic investing plans in December and Josh followed with a note about the role of Liftoff in extending such plans: “We created a solution for this segment of the public – the young, the underinvested and the people who’ve never been taught anything about how it all works. It’s called Liftoff … We custom-built portfolios that correspond to a matrix of answers the clients give us online. This helps them build a plan and automatically selects the right fund mix. The bank account link ensures continual allocation over time.” This whole “young and underinvested” thing does worry me. We’ll try to learn more.
• And we haven’t forgotten the study of mutual funds’ attempts to use YouTube to reach that same young ‘n’ muddled demographic. It’s coming!

Finally, thanks to you all. A quarter million readers came by in 2014, something on the order of 25,000 unique visitors each month.  The vast majority of you have returned month after month, which makes us a bit proud and a lot humbled.  Hundreds of you have used our Amazon link (if you haven’t bookmarked it, please do) and dozens have made direct contributions (regards especially to the good folks at Emerald Asset Management and to David Force, who are repeat offenders in the ‘help out MFO’ category, and to our ever-faithful subscribers). We’ll try to keep being worth the time you spend with us.

We’ll look for you closer to Valentine’s Day!

Dear friends,

The Christmas of the early American republic – of the half century following the Revolution – would be barely recognizable to us. It was a holiday so minor as to be virtually invisible to the average person. You’ll remember the famous Christmas of 1776 when George Washington crossed the Delaware on Christmas and surprised the Hessian troops who, one historian tells us, were “in blissful ignorance of local custom” and had supposed that there would be celebration rather than fighting on Christmas. Between the founding of the Republic and 1820, New England’s premier newspaper – The Hartford Courant – had neither a single mention of Christmas-keeping nor a single ad for holiday gifts. In Pennsylvania, the Harrisburg Chronicle – the newspaper of the state’s capital – ran only nine holiday advertisements in a quarter century, and those were for New Year’s gifts. The great Presbyterian minister and abolitionist orator Henry Ward Beecher, born in 1813, admitted that he knew virtually nothing about Christmas until he was 30: “To me,” he writes, “Christmas was a foreign day.” In 1819, Washington Irving, author of The Legend of Sleepy Hollow and Rip van Winkle, mourned the passing of Christmas. And, in 1821, the anonymous author of Christmas-keeping lamented that “In London, as in all great cities … the observances of Christmas must soon be lost.” Though, he notes, “Christmas is still a festival in some parts of America.”

Why? At base, Christmas was suppressed by the actions and beliefs of just two groups: the rich people . . . and the poor people.

The rich — the Protestant descendants of the founding Puritans, concentrated in the booming commercial and cultural centers of the Northeast – reviled Christmas as pagan and unpatriotic. About which they were at least half right: pagan certainly, unpatriotic . . . ehhh, debatable.

Here we seem to have a contradiction in terms: a pagan Christmas. To resolve the contradiction, we need to separate a religious celebration of Christ’s birth from a celebration of Christ’s birth on December 25^th. Why December 25^th? The most important piece of the puzzle is obscured by the fact that we use a different calendar system – the Gregorian – than the early Christians did. Under their calendar, December 25^th was the night of the winter solstice – the darkest day of the year but also the day on which light began to reassert itself against the darkness. It is an event so important that every ancient culture placed it as the centerpiece of their year. We have record of at least 40 holidays taking place on, or next to, the winter solstice. Our forebears rightly noted that the choice of December 25^th with a calculated marketing decision meant to draw pagans away from one celebration and into another.

So the Puritans were correct when they pointed out – and they pointed this out a lot – that Christmas was simply a pagan feast in Christian garb. Increase Mather found it nothing but “mad mirth…highly dishonorable to the name of Christ.” Cromwell’s Puritan parliament banned Christmas-keeping in the 1640s and the Massachusetts Puritans did so in the 1650s.

And while the legal bans on Christmas could not be sustained, the social ones largely were.

The rich, who didn’t party, were a problem. The poor, who did, were a far bigger one.

There was, by long European tradition, a period of wild festivity to celebrate New Year’s. Society’s lowest classes – slaves or serfs or peasants or blue collar toilers – temporarily slipped their yokes and engaged in a period of wild revelry and misrule.

In America, the parties were quite wild. Really quite wild.

Think: Young guys.

Lots of them.

With guns.

Drunk.

Ohhh . . . way drunk, lots of alcohol, to . . . uh, drive the cold winter away.

And a sense of entitlement – a sense that their social betters owed them good food, small bribes and more alcohol.

Then add lots more alcohol.

Roving gangs, called “callithumpian bands,” roamed night after night – by a contemporary account “shouting, singing, blowing trumpets and tin horns, beating on kettles, firing crackers … hurling missiles” and demanding some figgy pudding. Remember?

Oh, bring us a figgy pudding and a cup of good cheer

We won’t go until we get some;

We won’t go until we get some;

We won’t go until we get some, so bring some out here

Back then, that wasn’t a song. It was a set of non-negotiable demands.

In a perverse way, what saved Christmas was its commercialization. Beginning in New York around 1810 or 1820, merchants and civic groups began “discovering” old Dutch Christmas traditions (remember New York started as New Amsterdam) that surrounded family gatherings, communal meals and presents. Lots of presents. The commercial Christmas was a triumph of the middle class. Slowly, over a generation, they pushed aside old traditions of revelry and half-disguised violence. By creating a civic holiday which helped to bridge a centuries’ old divide between Christian denominations – the Christmas-keepers and the others – and gave people at least an opportunity to offer a fumbling apology, perhaps in the form of a Chia pet, for their idiocy in the year past and a pledge to try better in the year ahead.

I might even give it a try, minus regifting my Chia thing.

Harness the incomparable power of lethargy!

We are lazy, inconstant, wavering and inattentive. It’s time to start using it to our advantage. It’s time to set up a low minimum/low pain account with an automatic investment plan.

About a third of us have saved nothing. The reasons vary. Some of us simply can’t; about 60 million of us – the bottom 20% of the American population – are getting by (or not) on $21,000/year. Over the past 40 years, that group has actually seen their incomes decline by 1%. Folks with just high school diplomas have lost about 20% in purchasing power over that same period. NPR’s Planet Money team did a really good report on how the distribution of wealth in the US has changed over the past 40 years.

A rather larger group of us could save, or could save more, but we’re thwarted by the magnitude of the challenge. Picking funds is hard, filling out forms is scary and thinking about how far behind we are is numbing. So we sort of panic and freeze. That reaction is only so-so in possums; it pretty much reeks in financial planning.

Fortunately, you’ve got an out: low minimum accounts with automatic investment plans. That’s not the same as a low minimum mutual fund account. The difference is that low minimum accounts are a bad idea and an economic drain to all involved; when I started maintaining a list of funds for small investors in the 1990s, there were over 600 no-load options. Most of those are gone now because fund advisers discovered an ugly truth: small accounts stay small. Full of good intentions people would invest the required $250 or $500 or whatever, then bravely add $100 in the next month but find that cash was a bit tight in the next month and that the cat needed braces shortly thereafter. Fund companies ended up with thousands of accounts containing just a few hundred dollars each; those accounts might generate just $3 or 4 a year in fees, far below what it cost to keep them open. Left to its own a $250 account would take 20 years to reach $1,000, a nice amount but not a meaningful one.

But what if you could start small then determinedly add a pittance – say $50 – each month? Over that same 20 year period, your $250 account with a $50 monthly addition would grow to $29,000. Which, for most of us, is really meaningful.

Would you like to start moving in that direction? Here’s how.

If you do not have an emergency fund or if you mostly want to sleep well at night, make your first fund one that invests mostly in cash and bonds with just a dash of stocks. As we noted last month, such a stock-light portfolio has, over the past 65 years, captured 60% of the stock market’s gains with only 25% of its risks. Roughly 7% annual returns with a minimal risk of loss. That’s not world-beating but you don’t want world-beating. For a first fund or for the core of your emergency fund, you want steady, predictable and inflation-beating.

Consider one of these two:

TIAA-CREF Lifestyle Income Fund (TSILX). TIAA-CREF is primarily a retirement services provider to the non-profit world. This is a fund of other TIAA-CREF funds. About 20% of the fund is invested in dividend-paying stocks, 40% in short-term bonds and 40% in other fixed-income investments. It charges 0.83% per year in expenses. You can get started for just $100 as long as you set up an automatic investment of at least $100/month from your bank account. Here’s the link to the account application form. You’ll have to print off the pdf and mail it. Sorry that they’re being so mid-90s about it.

Manning & Napier Strategic Income, Conservative Series (MSCBX). Manning & Napier is a well-respected, cautious investment firm headquartered in Fairport, NY. Their funds are all managed by the same large team of people. Like TSILX, it’s a fund-of-funds and invests in just five of M&N’s other funds. About 30% of the fund is invested in stocks and 70% in bonds. The bond portfolio is a bit more aggressive than TSILX’s and the stock portfolio is larger, so this is a slightly more-aggressive choice. It charges 0.88% per year in expenses. You can get started for just $25 (jeez!) as long as you set up a $25 AIP. Do yourself a favor a set a noticeably higher bar than that, please. Here’s the direct link to the fund application form. Admittedly it’s a poorly designed one, where they stretch two pages of information they need over about eight pages of noise. Be patient with them and with yourself, it’s just not that hard to complete and you do get to fill it out online.

Where do you build from there? The number of advisers offering low or waived minimums continues to shrink, though once you’re through the door you’re usually safe even if the firm ups their requirement for newcomers.

Here’s a quick warning: Almost all of the online lists of funds with waived or reduced minimum contain a lot of mistakes. Morningstar, for instance, misreports the results for Artisan (which does waive its minimum) as well as for DoubleLine, Driehaus, TCW and Vanguard (which don’t). Others are a lot worse, so you really want to follow the “trust but verify” dictum.

Here are some of your best options for adding funds to your monthly investing portfolio:

Do you have a fund family that really should be on this list but we missed? Sorry ‘bout that! But we’ll fix it if only you’ll let us know!

Correcting our misreport of FPA Paramount’s (FPRAX) expense ratio

In our November profile of FPRAX, we substantially misreported FPRAX’s expense ratio. The fund charges 1.26%, not 0.92% as we reported. . Morningstar, which had been reporting the 0.92% charge until late November, now reports a new figure. The annual report is the source for the 1.06% number, the prospectus gives 1.26%.  The difference is that one is backward-looking, the other forward looking.

Where did the error originate? Before the fall of 2013, Paramount operated as a domestic small- to mid-cap fund which focused on high quality stocks. At that point the expense ratio was 0.92%. That fall FPA changed its mandate so that it now focuses on a global, absolute value portfolio.  Attendant to that change, FPA raised the fund’s expense ratio from 0.92 to 1.26%. We didn’t catch it. Apologies for the error.

The next question: why did FPA decide to charge Paramount’s shareholders an extra 37%? I’ve had the opportunity to chat at some length with folks from FPA, including Greg Herr, who serves as one of the managers for Paramount. The shortest version of the explanation came in an email:

… the main reasons we sought a change in fees was because [of] the increased scope of the mandate and comparable fees charged by other world stocks funds.

FPA notes that the fund’s shareholders voted overwhelmingly to raise their fees. The proxy statement adds a bit of further detail:

FPA believes that the proposed fee would be competitive with other global funds, consistent with fees charged by FPA to other FPA Funds (and thus designed to create a proper alignment of internal incentives for the portfolio management team), and would allow FPA to attract and retain high quality investment and trading personnel to successfully manage the Fund into the future.

Based on our conversations and the proxy text, here’s my best summary of the arguments in favor of a higher expense ratio:

• It’s competitive with what other companies charge
• The fund has higher costs now
• The fund may have higher costs in the future, for example higher salaries and larger analyst teams
• FPA wants to charge the same fee to all of our shareholders

Given the fund’s current size ($304 million), the additional 34 bps translates to an additional $1.03 million/year transferred from shareholders to the adviser.

Let’s start with the easy part. Even after the repricing, Paramount remains competitively priced. We screened for all retail, no-load global funds with between $100-500 million in their portfolios, and then made sure to add the few other global funds that the Observer already profiled. There are 35 such funds. Twelve are cheaper than Paramount, 21 are more expensive. Great Owls appear in highlighted blue rows, while profiled funds have links to their MFO profiles.

Unfortunately other people’s expenses are a pretty poor explanation for FPA’s prices.

There are two ways of reading FPA’s decision:

1. We’re going to charge what the market will bear. Welcome to capitalism. The cynical reading starts with the suspicion that the fund’s expenses haven’t risen by a million dollars. While FPA cites research, trading, settlement and compliance expenses that are higher in a global fund than in a domestic fund, the fact that every international stock in Paramount’s portfolio was already in International Value’s means that the change required no additional analysts, no additional research trips, no additional registrations, certifications or subscriptions. While Paramount’s shareholders might need to share the cost of those reports with International Value’s (which lowers the cost of running International Value), at best it’s a wash: International Value’s expenses should fall as Paramount’s rise.
2. We need to raise fees a lot in the short term to be sure we can do right by our shareholders in the long term. There are increased expenses, they were fully disclosed to the fund’s board, and that the board acted thoughtfully and in good faith in deciding to propose a higher expense ratio. They also argue that it makes sense that Paramount and International Value’s shareholders should pay the same rate for their manager’s services, the so-called management fee, since they’ve got the same managers and objectives. Before the change, FPIVX shareholders paid 1% and FPRAX shareholders paid 0.65%. The complete list of FPA management fees:
   

   FPA New Income	Non-traditional bond	0.50
   FPA Capital	Mid-cap value	0.65
   FPA Perennial	Mid-cap growth	0.65
   FPA Crescent	Free-range chicken	1.00
   FPA International Value	International all-cap	1.00
   FPA Paramount	Global	1.00

   Finally, the new expenses create a sort of war-chest or contingency fund which will give the adviser the resources to address opportunities that are not yet manifest.

So what do we make of all this? I don’t know. I respect and admire FPA but this decision is disquieting and opaque. I’m short on evidence, which is frustrating.

That, sadly, is where we need to leave it.

Whitney George and the Royce Funds part ways

We report each month on manager changes, primarily at equity and balanced funds. All told, nearly 700 funds have reported changes so far in 2014. Most of those changes have a pretty marginal effect. Of the 68 manager changes we reported in our November issue, only 12 represented house cleanings. The remainder were simply adding a new member to an existing team (20 instances) or replacing part of an existing team (36 funds).

Occasionally, though, manager departures are legitimate news and serious business, both for a fund’s shareholders and the larger investing community.

And so it is with the departure of Whitney George from Royce Funds.

Mr. George has been with Royce Funds for 23 years, both as portfolio manager and with founder Charles Royce, co-Chief Investment Officer. He manages the $65 million Royce Privet hedge fund (‘cause “privet” is a kind of hedge, you see) and the $170 million Royce Focus Trust (FUND), an all-cap, closed-end fund. On November 10, Royce announced that Mr. George was leaving to join Toronto-based Sprott Asset Management and that, pending shareholder approval, Privet and Focus were going with him. At the same time he stepped aside from the management (sole, co- or assistant) of five open-end funds: Royce Global Value (RIVFX), Low-Priced Stock (RYLPX), Premier (RPFFX), SMid-Cap Value (RMVSX) and Value (RYVFX). They are all, by Morningstar’s reckoning, one- or two-star funds. As of May 2014, Mr. George was connected with the management of more than $15 billion in assets.

Why? The firm’s leadership was contemplating long term succession planning for Chuck and decided on an executive transition that did not include Whitney. The position of president went to Chris Clark. Sometime thereafter, he concluded that his greatest contributions and greatest natural strengths lay in managing investments for Canadians and began negotiating a separation. He’ll remain with Royce through the end of the first quarter of 2015, and will remain domiciled in New York City rather than moving to Toronto and feigning an interest in the Maple Leafs, Blue Jays, Rock, Raptors or round bacon.

What’s worth knowing?

• The media got it wrong. In 2009, Mr. George was named co-chief investment officer along with Chuck Royce. At the time Royce was clear that this was not succession planning (this was “not in preparation for Mr. Royce retiring at some point”); which is to say, Mr. George was not being named heir apparent. Outsiders knew better: “The succession plan has become clearer recently: Whitney George was promoted to co-chief investment officer in 2009, and for now he serves alongside Chuck Royce” Karen Anderson, Morningstar, 12/01/10.
• Succession is clearer now. Royce’s David Gruber allowed that the 2009 move was contingency planning, not succession planning. There now are succession plans: the firm has created a management committee to help Mr. Royce, who is 75, run the firm. While Mr. Royce has no plans on retiring, they “would rather make these decisions now than when Chuck is 85” and imagine that “Chris Clark will become CEO in the next several years.” Mr. Clark has been with Royce for over seven years, has been a manager for them and used to be a hedge fund manager. He’s now their co-CIO.
• The change will make a difference in the funds. David Nadel, an international equity specialist for them, will take over the international sleeve of Global Value. Mr. Royce assumes the lead on Premier, his 13^th Most significantly, James Stoeffel intends to reorient the Low-Priced Stock portfolio toward, well, low-priced stocks. The argument is that low-priced stocks are inefficiently priced stocks. They have limited interest to institutions for some reason, especially those priced below $10. Stocks priced below $5 cannot be purchased on margin, which further limits their market. Mr. Stoeffel intends to look more closely now at stocks priced near $10 rather than those in the upper end of the allowable range ($25). Up until the last three years, RLPSX has stayed step-for-step with Joel Tillinghast and the remarkable Fidelity Low-Priced Stock Fund (FLPSX). If they can regain that traction, it would be a powerful addition to Royce’s lagging lineup.
• Royce is making interesting decisions. Messrs. George and Royce served as co-CIOs from 2009 to the end of 2013. At that point, the firm appointed Chris Clark and Francis Gannon to the role. The argument strikes me as interesting: Royce does not want their senior portfolio managers serving as CIOs (or, for that matter, as CEO). They believe that the CIO should complement the portfolio managers, rather than just being managers. The vision is that Clark and Gannon function as the firm’s lead risk managers, trying to understand the bigger picture of threats and challenges and working with a new risk management committee to find ways around them. And the CEO should have demonstrated business management skills, rather than demonstrated investment management ones. That’s rather at odds with the prevailing “great man” ideology. And, frankly, being at odds with the prevailing ideology strikes me as fundamentally healthy.

Succession is an iffy business, especially when a firm’s founder was a titanic personality. We learned that in the barely civil transition from Jack Bogle to John Brennan and some fear that we’re seeing it as Marty Whitman becomes marginalized at Third Avenue. We’ll follow-up on the Third Avenue transition in our January issue and, for now, continue to watch Royce Funds to see if they’re able to regain their footing in the year ahead.

Top developments in fund industry litigation – November 2014

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before.

“We built Fundfox from the ground up for mutual fund insiders,” says attorney-founder David M. Smith. “Directors and advisory personnel now have easier and more affordable access to industry-specific litigation intelligence than even most law firms had before.”

The core offering is a database of case information and primary court documents for hundreds of industry cases filed in federal courts from 2005 through the present. A Premium Subscription also includes robust database searching—by fund family, subject matter, claim, and more.

Orders

• In a win for Fidelity, the U.S. Supreme Court denied a certiorari petition in an ERISA class action regarding the float income generated by transactions in plan accounts. (Tussey v. ABB Inc.)
• Extending the fund industry’s losing streak, the court denied Harbor’s motion to dismiss excessive fee litigation regarding the subadvised International Fund: “Although it is far from clear that Zehrer [the plaintiff-shareholder] will be able to meet the high standard for liability under § 36(b), he has alleged sufficient facts specific to the fees paid to Harbor Capital to survive a motion to dismiss.” (Zehrer v. Harbor Capital Advisors, Inc.)
• The court dismissed Nuveen from an ERISA class action regarding services rendered by FAF Advisors, holding that the contract for Nuveen’s purchase of FAF “unambiguously indicates that Nuveen did not assume any liability that FAF may have had” with respect to the plan at issue. (Adedipe v. U.S. Bank, N.A.)

Briefs

• Genworth filed a motion for summary judgment in the class action alleging that defendants misrepresented the role that Robert Brinker played in the management of the BJ Group Services portfolio. (Goodman v. Genworth Fin. Wealth Mgmt., Inc.)
• SEI Investments filed a motion to dismiss an amended complaint challenging advisory and transfer agent fees for five funds. (Curd v. SEI Invs. Mgmt. Corp.)
• In the ERISA class action regarding TIAA-CREF’s account closing procedures, defendants filed a motion seeking dismissal of interrelated state-law claims as preempted by ERISA. (Cummings v. TIAA-CREF.)

Amended Complaint

• Plaintiffs filed an amended complaint in a consolidated class action regarding an alleged Ponzi scheme related to “TelexFree Memberships.” Defendants include a number of investment service providers, including Waddell & Reed. (Abdelgadir v. TelexElectric, LLLP.)

Supplemental Complaint

• In the class action regarding Northern Trust’s securities lending program, a pension fund’s board of trustees filed a supplemental complaint asserting individual non-class claims. (La. Firefighters’ Ret. Sys. v. N. Trust Invs., N.A.)

The Alt Perspective: Commentary and news from DailyAlts.

Brian Haskin publishes and edits the DailyAlts site, which is devoted to the fastest-growing segment of the fund universe, liquid alternative investments. Here’s his quick take on the DailyAlts mission:

Our aim is to provide our readers (investment advisors, family offices, institutional investors, investment consultants and other industry professionals) with a centralized source for high quality news, research and other information on one of the most dynamic and fastest growing segments of the investment industry: liquid alternative investments.

Brian offers this as his take on the month just past.

NO PLACE TO HIDE

Asset flows into and out of mutual funds and ETFs provide the market with insights about investor behavior, and in this past month it was clear that investors were not happy about active management and underperformance. While the data is lagged a month (October flow data becomes available in November, for instance), asset flows out of alternative mutual funds and ETFs exceeded inflows for the first time in…. well quite a while.

As noted in the table below, alternatives suffered $2.8 billion in outflows across both active and passive strategies. This is a stark change from previous months whereby the category generated consistent positive inflows. Of the $2.8 billion in outflows however, the MainStay Marketfield Fund, a long/short equity fund, contributed $2.2 billion. Market neutral funds also suffered outflows, while managed futures, multi-alternative and commodity funds all saw reasonable inflows.

However, alternatives were not the only category hit in October. Actively managed funds were hit to the tune of $31 billion in outflows, while passive funds recorded $54 billion in inflows. Definitely a shift in investor preferences as active funds in general struggle to keep up with their passive counterparts.

NEW FUND LAUNCHES IN NOVEMBER

Year to date, we have seen 80 new alternative funds hit the market, and six of those were launched in November (this may be revised upward in the next few days; see List of New Funds for more information). Both the global macro and managed futures categories had two new entrants, while other new funds fell into the long/short equity and mutli-alternative categories. Two notable new funds are as follows:

• Neuberger Berman Global Long Short Fund – There are not many pure global long/short funds, yet a larger opportunity set creates more potential for value added. The portfolio manager is new to Neuberger Berman, but not new to global investing. With its global mandate, this fund has the potential to work well alongside a US focused long/short fund.
• Eaton Vance Global Macro Capital Opportunities Fund – This fund is also global but looks for opportunities across multiple asset classes including equity and fixed income securities. The fund carries a moderate fee relative to other multi-alternative funds, and Eaton Vance has had longer-term success with other global macro funds.

FUND REGISTRATIONS IN NOVEMBER

October was the final month to register a fund and still get it launched in 2014, and as a result, November only saw eight new alternative funds enter the registration process, all of which fall into the alternative fixed income or multi-alternative categories. Two of these that look promising are:

• Franklin Mutual Recovery Fund – If you like distressed fixed income, then keep an eye out for the launch of this fund. This fund goes beyond junk and looks for bonds and other fixed income securities of distressed or bankrupt companies.
• Collins Long/Short Credit Fund – If interest rates ever rise, long/short credit funds can help get out of the way of volatile fixed income markets. The sub-advisor of this new fund has a record of delivering fairly steady returns over past several years while beating the Barclays Aggregate Bond Index.

NOVEMBER’S TOP RESEARCH / EDUCATIONAL ARTICLES

Education is critical when it comes to newer and more complex investment approaches, and liquid alternatives fit that description. The good news is that asset managers, investment consultants and other thought leaders in the industry publish a wide range of research papers that are available to the public. At DailyAlts, we provide summaries of these papers, along with links to the full versions. The top three research related articles in November were:

• The Sharpe Ratio is Not the Best Metric for Maximizing Portfolio Efficiency
• MLP Investment Guide for Taxable and Non-Taxable Investors
• The Free Lunch Effect: The Value of Decoupling Diversification and Risk

OTHER NEWS

Probably the most interesting news during the month was the SEC’s approval of Eaton Vance’s proposal to launch Exchange Traded Managed Funds, which essentially combines the intra-day trading, brokerage account availability and lower operating costs of exchange traded funds (ETFs) with the less frequent transparency (at least quarterly disclosure of holdings) of mutual funds. Think of actively managed mutual funds in an ETF wrapper.

Why is this significant? The ETF market is growing at a much faster rate than the mutual fund market, and so far most of the flows into ETFs have been into indexed ETFs. Now the door is open for actively managed ETFs with less transparency than a typical ETF, so expect to see over the next few years a long line of active fund management companies shift gears away from mutual funds and prepping new ETMF structures on the heels of Eaton Vance’s approval from the SEC. Many active fund managers that have wanted to tap the growth of the ETF market now have a mechanism to do so, assuming they can either create their own structure without violating patents held by Eaton Vance, or license the technology directly from Eaton Vance.

Visit us at DailyAlts.com for ongoing news and information about liquid alternatives.

Dodging the tax bullet

We’re entering capital gains season, a time when funds make the distributions that will come back to bite you around April 15^th. Because funds operate as pass-through vehicles for tax purposes, investors can end up paying taxes in two annoying circumstances: when they haven’t sold a single share of a fund and when the fund is losing money. The sooner you know about a potential hit, the better you’re able to work on offsetting strategies. We’re offering two short-term resources to help you sort through.

Our colleague The Shadow, one of our discussion board’s most vigilant members, has assembled links to the announced distributions for over 160 fund families. If you want to go directly there, let your mouse hover over the Resources tab at the top of this page and the link will appear.

Beyond that, Mark Wilson has launched Cap Gains Valet to help you. In addition to being Chief Valet, Mark is chief investment officer for The Tarbox Group in Newport Beach, CA. He is, they report, “one of only four people in the nation that has both the Certified Financial Planner® and Accredited Pension Administrator (APA) designations.” Mark’s site, which is also free and public, offers a nice search engine, interpretive articles and a list of funds with the most horrifyingly large distributions. Here’s a friendly suggestion to any of you invested in the Turner Funds: go now! There’s a good chance that you’re going to say something that rhymes with “oh spit.”

We asked Mark what advice he could offer to avoid taking another hit next year. Here’s his year-end planning list for you:

Keeping More of What You Make

Between holiday shopping, decorating and goodie eating there is more than enough going on this time of year without worrying about the tax consequences from mutual fund capital gain distributions.

I have already counted over 450 funds that will distribute more than 10% of their net asset value (NAV) this year, and 50 of these are expected to distribute in excess of 20%! Mutual fund information providers, fund marketers, and most fund managers focus on total investment returns, so they do not care much about taxable distributions. Of course, total returns are very important, but it is not what you make, it is what you keep! After-tax returns are what are most important for the taxable investor.

You can keep more of what you make by considering these factors before you make your investment:

• Use funds with embedded losses or low potential capital gains exposures. Are there really quality funds that have little/no gains? Yes, and Mutual Fund Observer (MFO) is a great site to find these opportunities. The most likely situations are when an experienced manager opens his/her own shop or when one takes over a failing fund and makes it their own.
• Use funds with low turnover and with a long-term investment philosophy. Paying taxes on annual long-term capital gains is not pleasant; however, it is the short-term gains that are the real killer. Short-term gains are taxed at your ordinary income tax rates. Worse yet, short-term capital gains distributions are not offset by other types of capital losses, as these are reported on a completely different tax schedule. Fund managers who trade frequently might have attractive returns, but their returns have to be substantially higher than tax-efficient managers to offset the higher tax bite they are generating.
• Think about asset location. Putting your most tax-inefficient holdings in your tax-deferred accounts will help you avoid these issues. Funds that typically have significant taxable income, high turnover, or mostly short-term gains should be placed in your IRA, Roth IRA, etc. High yield funds, REIT funds and many alternative strategies are usually ideal funds to place in tax-deferred accounts.
• Use index funds or broad based indexed ETFs. I know MFO is not an index fund site, but it is clear that it is not easy to choose funds that beat comparable broad based, low cost index funds or ETFs. When taxes are added to the equation, the hurdle gets even higher. Using index-based holdings in taxable accounts and active fund managers in tax-deferred accounts can make for a great compromise.

I hope considering these strategies will leave you with a little more to spend on the holidays in 2015. Mark.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

Polaris Global Value (PGVFX) Polaris sports one of the longer records among global stock funds, low expenses, excellent tax efficiency, dogged independence and excellent long term returns. Well, no wonder they have such a small fund!

RiverPark Structural Alpha (RSAFX) Structural Alpha starts with a simple premise: people are consistently willing to overpay in order to hedge their risks. That makes the business of selling insurance to them consistently profitable if you know what you’re doing and don’t get greedy. Justin and Jeremy have proven over the course of years that (1) they do and (2) they don’t, much to their investors’ gain. For folks disgusted with bonds and overexposed to stocks, it’s an interesting alternative.

ValueShares US Quantitative Value (QVAL) We don’t typically profile ETFs, but our colleague Charles Boccadoro has been in an extended conversation with Wesley Gray, chief architect of Alpha Architect, and he offers an extended profile with a wealth of unusual detail for this quant’s take on buying “the cheapest, highest quality value stocks.”

Conference call with Mitch Rubin, CIO and PM, RiverPark Large Growth Fund, December 17th, 7:00 Eastern

We’d be delighted if you’d join us on Wednesday, December 17^th, for a conversation with Mitch Rubin, chief investment officer for the RiverPark Funds. Over the past several years, the Observer has hosted a series of hour-long conference calls between remarkable investors and, well, you. The format’s always the same: you register to join the call. We share an 800-number with you and send you an emailed reminder on the day of the call. We divide our hour together roughly in thirds: in the first third, our guest talks with us, generally about his or her fund’s genesis and strategy. In the middle third I pose a series of questions, often those raised by readers. Here’s the cool part, in the final third you get to ask questions directly to our guest; none of this wimpy-wompy “you submit a written question in advance, which a fund rep rewords and reads blankly.” Nay nay. It’s your question, you ask it.

The stability of the Chinese economy has been on a lot of minds lately. Between the perennial risks of the unregulated shadow banking sector and speculation fueled by central bank policies to the prospect of a sudden crackdown on whatever the bureaucrats designate as “corruption,” the world’s second largest stock market – and second largest economy – has been excessively interesting.

Mr. Rubin and his fund have a fair amount of exposure to China. In the second week of December, he and his team will embark on a research trip to the region. They’ve agreed to speak with us about the trip and the positioning of his fund almost immediately after the jet lag has passed.

RiverPark’s president Morty Schaja is coordinating the call and offers this explanation from why you might want to join it.

Given the planned openings of new casinos and the expected completion of the bridge from Hong Kong to Macau, Mitch and his team believe that the current stock weakness presents an unusual opportunity for investors.

Generally speaking Mitch is excited about the opportunity for the Fund post a period of relative underperformance. This year many of the fund’s positions – relative to both the market and, more importantly, to their expected growth – are now as inexpensive as they have been in some time. The Fund is trading at a weighted average price-earnings ratio (PE) of about 13x 2016 earnings, a discount to the market as a whole. This valuation is, in Mitch’s view, especially compelling given that their holdings have demonstrated substantially faster earnings growth of 15-20% or more as compared with the 7% historical earnings growth for the market. Given these valuations and the team’s continued confidence in the long-term earnings growth of the companies, they believe the Fund is especially well positioned going into year end.

It will be an interesting opportunity to talk with Mitch about how he thinks about the vicissitudes of “relative performance” (three excellent years are being followed by one poor one) and shareholder twitchiness.

HOW CAN YOU JOIN IN?

If you’d like to join in, just click on register and you’ll be taken to the Chorus Call site. In exchange for your name and email, you’ll receive a toll-free number, a PIN and instructions on joining the call. If you register, I’ll send you a reminder email on the morning of the call.

Remember: registering for one call does not automatically register you for another. You need to click each separately. Likewise, registering for the conference call mailing list doesn’t register you for a call; it just lets you know when an opportunity comes up. 

WOULD AN ADDITIONAL HEADS UP HELP?

Over two hundred readers have signed up for a conference call mailing list. About a week ahead of each call, I write to everyone on the list to remind them of what might make the call special and how to register. If you’d like to be added to the conference call list, just drop me a line.

Funds in registration

There were remarkably few funds in registration with the SEC this month, just four and a half. That reflects, in part, the fact that advisers wanted to get new funds launched by December 30^th and the funds in registration now won’t be available until February. It might also reflect a loss of confidence within the fund industry, since it’s the lowest total we’ve recorded in nine years. That said, several of the new registrations will end up being solid and useful offerings: T. Rowe Price is launching a global high income bond fund and a global unconstrained bond fund while Vanguard will offer an ultra-short bond fund for the ultra-nervous. They’re all detailed on the Funds in Registration page.

Manager changes

This month also saw a modest level of manager turnover; 53 funds reported changes, the most immediately noticeable of which was Mr. George’s departure from various Royce funds. More-intriguing changes include the appointment of former Janus manager and founding partner of Arrowpoint Minyoung Sohn to manage Meridian Equity Income (MEIFX). At about the same time, Bernard Horn and Polaris Capital were appointed to manage Pear Tree Columbia Small Cap Fund (USBNX) which I assume will become Pear Tree Polaris Small Cap Fund on January 1. Polaris already subadvises Pear Tree Polaris Foreign Value Small Cap Fund (QUSOX / QUSIX) which has earned both five stars from Morningstar and a Great Owl designation from the Observer.

We know you’re communicating in new ways …

But why don’t you communicate in simple ones? It turns out that fund firms are, with varying degrees of conviction, invading the world of cat videos. A group called Corporate Insights maintains a series of Mutual Fund Monitor reports, the most recent of which is “Fund Films Go Viral: The Diverse Strategies of Fund Firms on YouTube.” They were kind enough to share a copy and a quick reading suggests that firms have a long way to go if they intend to use sites like YouTube to reach younger prospective investors. We’ll talk with the report’s authors in December and pass along what we learn.

In the meanwhile: all fund firms have immediate access to a simple technology that could dramatically increase the number of people noticing what you’ve written and published. And you’re not using it. Why is that?

Chip, our technical director and founding partner, has been looking at the possibility of aggregating interesting content from fund advisers and making it widely available.  The technology to acquire that content is called Real Simple Syndication, or RSS for short. At base the technology simply pushes your new content out to folks who’ve already expressed an interest in it; the Observer, for example, subscribes to the New York Times RSS feed for mutual funds. When they write it there, it pops up here.

Journalists, analysts, investors and advisers could all receive your analyses automatically, without needing to remember to visit your site, in their inboxes. And yet, Chip discovered, almost no one uses the feed (or, in at least one case, made a simple coding mistake that made their feed ineffective).

If you work with or for a fund company, would you let us know why? And if you don’t know, would you ask someone in web services?  In either case, drop Chip a note to let her know what’s up. We’d be happy to foster the common good by getting more people to notice high-quality independent shops, but we’d need your help. Thanks!

Briefly noted . . .

If you ever wondered I look like, you’re in luck. The Wall Street Journal ran a nice interview with me, entitled, “Mutual Funds’ Professor Can Flunk Them.” Embarrassed that the only professional pictures of me were from my high school graduation, I duped a very talented colleague into taking a new set, one of which appears in the Journal article. Pieces of the article, though not the radiant portrait, were picked up by Ben Carlson, at A Wealth of Common Sense; Cullen Roche, at Pragmatic Capitalism; and Joshua Brown, at The Reformed Broker.

A reader has requested that we share word of Seafarer‘s upcoming conference call. Here it is:

SMALL WINS FOR INVESTORS

DuPont Capital Emerging Markets Fund (DCMEX) reopened to new investors on December 1, 2014. It sports a $1 million minimum, $348 million portfolio and record that trails 96% of its peers over the past three years. On the upside, the fund appointed two additional managers in mid-October.

Guggenheim Alpha Opportunity Fund (SAOAX) reopens to new and existing investors on January 28^th. At the same time they’ll get a new long/short strategy and management team. Okay, I’m baffled. Here’s the fund’s performance under its current strategy and managers (blue line) versus long/short benchmark (orange line):

If you’d invested $10,000 in the average long/short fund on the day the SAOAX team came on board, your account would have grown by 25%. If you’d given your money to the SAOAX team, it would have grown by 122%. That’s rarely grounds for kicking the scoundrels out. Admittedly the fund has a minuscule asset base ($11 million after 11 years) but that seems like a reason to change the marketing team, doesn’t it?

As a guy who likes redemption fees since they benefit long-term fund holders at the expense of traders, I’m never sure of whether their elimination qualifies as a “small win” or a “small loss.” In the holiday spirit, we’ll classify the elimination of those fees from four Guinness Atkinson funds (Inflation-Managed Dividend, Global Innovators, Alternative Energy, Global Energy and Alternative Energy) as “wins.” After the New Year, though, we’re back to calling them losses.

Invesco European Small Company Fund (ESMAX) has reopened to existing investors though it remains closed to new ones. It’s the best open-end fund in its space, but then it’s almost the only open-end mutual fund in its space. Its two competitors are Royce European Smaller-Companies (RESNX) and DFA Continental Small Company (DFCSX). ESMAX handily outperforms either. There are a couple ETF alternatives to it, the best being WisdomTree Europe SmallCap Dividend ETF (DFE). DFE’s a bit more volatile but a lot cheaper (58 bps versus 146), available and has posted near-identical returns over the past five years.

Loomis Sayles gives new meaning to “grandfathered-in.” While several Loomis Sayles funds (notably Small Cap Growth and Small Cap Value) remain closed to new investors, as of November 19, 2014 they became available to Natixis employees … and to their grandparents. Also grandkids. Had I mentioned mothers-in-law? The institutional share classes of a half dozen funds are available to family members without a minimum investment requirement. Yes, indeed, if your wretched son-in-law (really, none of us have any idea of what your daughter saw in that ne’er do well) works for Natixis you can at least comfort yourself with your newly gained access to first-rate investment management.

Market Vectors lowered the expense cap on Market Vectors Investment Grade Floating Rate ETF (NYSE Arca: FLTR) from 0.19% to 0.14%. As the release discusses, FLTR is an interesting option for income investors looking to decrease interest rate sensitivity in their portfolios. The fund was recently recognized by Morningstar at the end of September with a 5-star overall rating. 

CLOSINGS (and related inconveniences)

None that I could find. I’m not sure what to make of the fact that the Dow has had 29 record closes through late November, and still advisers aren’t finding cause to close any funds. It might be that stock market records aren’t translating to fund flows, or it might be that advisers are seeing flows but are loathe to close the doors.

OLD WINE, NEW BOTTLES

Effective January 28, 2015, AQR is renaming … well, pretty much everything.

The ticker symbols remain the same.

Effective December 19, 2014, a handful of BMO funds add the trendy “allocation” moniker to their names:

On January 14, 2015, Cloud Capital Strategic Large Cap Fund (CCILX) is becoming Cloud Capital Strategic All Cap Fund. It will be as strategic as ever, but now will be able to ply that strategy on firms with capitalizations down to $169 million.

Effective December 30, 2014, the name of the CMG Managed High Yield Fund (CHYOX) will be changed to CMG Tactical Bond Fund. And “high yield bond” will disappear from the mandate. Additionally, effective January 28, 2015, the Fund will no longer have a non-fundamental policy of investing at least 80% of its assets in fixed income securities.

Crystal Strategy Leveraged Alternative Fund has become the Crystal Strategy Absolute Return Plus Fund (CSLFX). That change occurred less than a year after launch but that fund has attracted only $5 million, which might be linked to high expenses (2.3%), a high sales load and losing money while their multi-alternative peers were making it. It’s another instance where “change the name” doesn’t seem to be the greatest imperative.

Deutsche International Fund (SUIAX) has changed its name to Deutsche CROCI® International Fund and Deutsche Equity Dividend (KDHAX) has become Deutsche CROCI® Equity Dividend Fund. Oddly the name change does not appear to be accompanied by any explanation of what’s up with the CROCI (cash return on capital invested??) thing. CROCI was part of Deutsche Bank’s research operation until late 2013.

Effective December 8, 2014, Guinness Atkinson Asia Pacific Dividend Fund (GAADX) will be renamed Guinness Atkinson Asia Pacific Dividend Builder Fund with this strategy clarification:

The Advisor uses fundamental analysis to assess a company’s ability to maintain consistent, real (after inflation) dividend growth. The Advisor seeks to invest in companies that have returned a real cash flow return on investment of at least 8% for each of the last eight years, and, in the opinion of the Advisor, are likely to grow their dividend over time.

At the same time, Guinness Atkinson Inflation Managed Dividend Fund (GAINX) becomes Guinness Atkinson Inflation Managed Dividend Builder Fund.

RESQ Absolute Income Fund has become the RESQ Strategic Income Fund (RQIAX). It now “seeks income with an emphasis on total return and capital preservation as a secondary objective.” “Capital appreciation” is out; “total return” is in. And again, the fund has been around for less than a year so changing the name and strategy doesn’t seem like evidence of patience and planning. Oh, too, RESQ Absolute Equity Fund is now RESQ Dynamic Allocation Fund (RQEAX). It appears to be heightening the visibility of international equities in the investment plan and adding popular words to the name.

Orion/Monetta Intermediate Bond Fund is now Varsity/Monetta Intermediate Bond Fund (MIBFX). Sorry, Orion, you’ve been chopped!

Effective November 12, 2014, Virtus Mid-Cap Value Fund became Virtus Contrarian Value Fund (FMIVX). By the end of January 2015, the principle investment strategy be tweaked but in reading the old and new text side-by-side, I couldn’t quite figure out what was changing. A performance chart of the fund suggests that it’s pretty much a mid-cap value index fund with slightly elevated volatility and noticeably elevated expenses.

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Global Select Opportunities Fund (BJGQX), formerly Artio Select Opportunities, formerly Artio Global Equity, formerly Julius Baer Global Equity Fund, is disappearing. Either shareholders will approve a merger with Aberdeen Global Equity Fund or the trustees will liquidate it. Note from the Observer: vote for the merger. Global Equity has been a dramatically better fund.

AIS Tactical Asset Allocation Portfolio (TAPAX) has closed and will liquidate by December 15, 2014.

AllianceBernstein Global Value Fund (ABAGX) will liquidate and dissolve around January 16, 2015. Not to be picking on the decedent, but don’t “liquidate” and “dissolve” conjure the exact same image, sort of what happened to the witch in The Wizard of Oz?

In distinction to most such actions, the Board of Trustees of the ALPS ETF Trust ordered “an orderly liquidation” of the VelocityShares Emerging Markets DR ETF, VelocityShares Russia Select DR ETF and VelocityShares Emerging Asia DR ETF. All are now “former options.”

BMO Pyrford Global Strategic Return Fund (BPGAX) and BMO Global Natural Resources Fund (BAGNX) are both scheduled to be liquidated on December 23, 2014, perhaps part of an early Christmas present to their investors. BAGNX has, in six short months of existence, parlayed a $1,000 investment into an $820 portfolio, rather more dismal than even its average peer.

BTS Bond Asset Allocation Fund (BTSAX) will be merging into the BTS Tactical Fixed Income Fund (BTFAX) on December 12, 2014.

DSM Small-Mid Cap Growth Fund (DSMQX) will liquidate on December 2, 2014.

Eaton Vance Asian Small Companies Fund (EVASX) bites the dust on or about January 23, 2015. Despite the addition of How Teng Chiou as a co-manager in March (I’m fascinated by that name), the fund has drawn neither assets nor kudos.

Huntington Income Generation Fund (HIGAX) is another victim of poor planning, impatience and the redundant “dissolve and liquidate” fate. The fund launched in January 2014, performed miserably, for which reason the D&L is scheduled for December 19, 2014.

MassMutual Premier Focused International Fund was dissolved, liquidated and terminated, all on November 14^th. We’re not sure of the order of occurrence.

The 20 year old, $150 million Victory Special Value Fund (SSVSX) has merged into the two year old, $8 million Victory Dividend Growth Fund (VDGAX). Cynics would suggest an attempt to bury Special Value’s record of trailing 85% of its peers by merging into a tiny fund run by the same manager. We wouldn’t, of course. Only cynics would say that.

Virginia Equity Fund decided to liquidate before it launched. Here’s the official word: “the Fund’s investment adviser, recommended to the Board to approve the Plan based on the inability to raise sufficient capital necessary to commence operations. As a result, the Board of Trustees has concluded that it is in the best interest of the sole shareholder to liquidate the Fund.”

Wright Total Return Bond Fund (WTRBX) disappears at the same moment that 2014 does.

In Closing . . .

In November we picked up about 1500 new registrants for our monthly email notification. Greetings to you all and, especially, to the nice folks at Smart Chicken. Love your work! Welcome to one and all.

A number of readers deserve thanks for their support in the month just passed. And so to the amazing Madame Nadler: “thanks! We’re not going anywhere.” To the folks at Gaia Capital: cool logo, though I’m still not sure that “proactive” is a word. To Jason, Matt and Tyler: “thanks” are in the mail! (Soon, anyway.) For Jason and our other British readers, by the way, we are trying to extend the Amazon partnership to Amazon UK. Finally thanks, as always, to our two stalwart subscribers, Deb and Greg. Do let us know how we can make the beta version of the premium site better.

November also saw us pass the 30,000 “unique visitors” threshold for the first time. Thanks to you all, but dropping by and imagining possibilities smarter and better than behemoth funds and treacherous, trendy trading products.

Finally, I promise I won’t mention this again (in 2014): Frankly it would help a lot if folks who haven’t already done so would take a moment to bookmark our Amazon link. Our traffic has grown by almost 80% in the past 12 months and that extra traffic increases our operating expenses by a fair bit. At the same time our Amazon revenue for November grew by (get ready!) $1.48 from last year, a full one-third of one percent. While we’re grateful for the extra $1.48, it doesn’t quite cover the added hosting and mail expenses.

The Amazon thing is remarkably quick, painless and helpful. The short story is that Amazon will rebate to us an amount equivalent to about 6% of whatever you purchase through our Associates link. It costs you nothing, since it’s built into Amazon’s marketing budget. It adds no steps to your shopping. And it doesn’t require that you come to the Observer to use it. Just set it as a bookmark, use it as your homepage or use it as one of the opening tabs in your browser. Okay, here’s our link. Click on it then click on the star on the address bar of your browser – they all use the same symbol now to signal “make a bookmark!” If you want to Amazon as your homepage or use it as one of your opening tabs but don’t know how, just drop me a note with your browser’s name and we’ll send off a paragraph.

There are, in addition, way cool smaller retailers that we’ve come across but that you might not have heard of. The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

Some guys wear ties rarely enough that they need to keep that little “how to tie a tie” diagram taped to their bathroom mirrors. Other guys really wish that they had a job where they wore ties rarely enough that they needed to keep that little “how to tie a tie” diagram taped up.

Duluth sells clothes, and accessories, for them. I own rather a lot of it. Their stuff is remarkably well-made and, more importantly, thoughtfully made. Their clothes are designed, for example, to allow a great deal of freedom of motion; they accomplish that by adding panels where other folks just have seams. Admittedly they cost more than department store stuff. Their sweatshirts, by way of example, are $45-50 when they’re not on sale. JCPenney claims that their sweatshirts are $55 but on perma-sale for $20 or so. The difference is that Duluth’s are substantially better: thicker fabric, longer cut, with thoughtful touches like expandable/stretchy side panels.

QuoteArts.com is a small shop that consistently offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen. Steve Metivier, who runs the site, shared one of his favorites:

The text reads “’tis not too late to seek a newer world.” The original cards are, of course, sharper and don’t have the copyright watermark. Steve writes that “we’ve found that a number of advisors and other professionals buy our cards to keep in touch with their clients throughout the year. So, we offer a volume discount of 100 or more cards. The details can be found on our specials page.”

We hope it’s a joyful holiday season for you all, and we look forward to seeing you in the New Year.

Dear friends,

In a college with more trees than students, autumn is stunning. Around the campus pond and along wooded paths, trees begin to erupt in glorious color. At first the change is slow, more teasing than apparent. But then we always have a glorious reign of color … followed by a glorious rain of leaves. It’s more apparent then than ever why Augustana was recognized as having one of America’s 25 most beautiful campuses.

Every morning, teaching schedule permitting, I park my car near Old Main then conspire to find the longest possible route into the building. Instead of the simple one block walk east, I head west, uphill and through the residential neighborhoods or south, behind the natural sciences building and up a wooded hillside. I generally walk unencumbered by technology, purpose or companions. 

Kicking the leaves is not optional.

photo courtesy of Augustana Photo Bureau

I listen to the crunching of acorns underfoot and to the anxious scouring of black squirrels. I look at the architecture of the houses, some well more than a century old but still sound and beautiful. I breathe, sniffing for the hint of a hardwood fire. And I left my mind wander where it wants to, too.  Why are some houses enduringly beautiful, while others are painful before they’re even complete?  How might more volatile weather reshape the landscape? Are my students even curious about anything? Would dipping their phones in epoxy make a difference? Maybe investors don’t want to know what their managers actually do? Where would we be if folks actually did spend less? Heck, most of them have already been forced to. I wonder if folks whose incomes and wealth are rapidly rising even think about the implications of stagnation for the rest of us? Why aren’t there any good donut shops anymore?  (Nuts.)

You might think of my walks as a luxury or a harmless indulgence by a middle-aged academic. You’d be wrong. Very wrong.

The world has conspired to heap so many demands upon our attention than we can barely focus long enough to button our shirts. Our attention is fragmented, our time is lost (go on, try to remember what you actually did Friday) and our thinking extends no further than the next interruption. It makes us sloppy, unhappy and unimaginative.

Have you ever thought about including those characteristics in a job description: “We’re hoping to find sloppy, unhappy and unimaginative individuals to take us to the next level!  If you have the potential to become so distracted by minutiae and incessant interruption that you can’t even remember any other way, we have the position for you.”

Go take a walk, dear friends. Go take a dozen. Take them with someone who makes you want to hold a hand rather than a tablet. The leaves beckon and you’ll be better for it. 

On the discreet charm of a stock light portfolio

All the signs point to stocks. The best time of the year to buy stocks is right after Halloween. The best time in the four year presidential cycle to be in stocks is just after the midterm elections. Bonds are poised for a bear market. Markets are steadying. Stocks are plowing ahead; the Total Stock Market Index posted gains of 9.8% through the first 10 months of 2014.

And yet, I’m not plowing into stocks. That’s not a tactical allocation decision, it’s strategic. My non-retirement portfolio, everything outside the 403(b), is always the same: 50% equity, 50% income. Equity is 50% here, 50% there, as well as 50% large and 50% small. Income tends to be the same: 50% short duration/cash-like substances, 50% riskier assets, 50% domestic, 50% international. It is, as a strategy, designed to plod steadily.

My asset allocation has some similarities to Morningstar’s “conservative retirement saver” portfolio, which they gear “toward still-working individuals who expect to retire in 2020 or thereabouts.”  Both portfolios are about 50% in equities and both have a medium term time horizon of around 7-10 years.  On whole, though, I appear to be both more aggressive and more conservative than Morningstar’s model.  I’ve got a lot more exposure to international and, particularly, emerging markets stocks (through Seafarer, Grandeur Peak and Matthews) and bonds (through Matthews and Price) than they do.  I favor managers who have the freedom to move opportunistically between asset classes (FPA Crescent is the show piece, but managers at eight of my 10 funds have more than one asset class at their disposal).  At the same time, I’ve got a lot more exposure to short-term and cash-management strategies (through Price and two fine RiverPark funds).  My funds are cheaper than average (I’m not cheap, I’m rationally cost-conscious) though pricier than Morningstar’s, which reflects their preference for large (no, I didn’t called them “bloated”) funds.

You might benefit from thinking about whether a more diversified stock-light portfolio might help you better balance your personal goals (sleeping well) with your financial ones (eating well). There’s good evidence to guide us.

T. Rowe Price is one of my favorite fund companies, in part because they treat their investors with unusual respect. Price’s publications depart from the normal marketing fluff and generally provide useful, occasionally fascinating, information.

I found two Price studies, in 2004 and again in 2010, particularly provocative. Price constructed a series of portfolios representing different levels of stock exposure and looked at how the various portfolios would have played out over the past 50-60 years.

The original study looked at portfolios with 20, 40, 60, 80 and 100% stocks. The update dropped the 20% portfolio and looked at 0, 40, 60, 80, and 100%. Price updated their research for us and allowed us to release it here.

T. Rowe Price, October 30 2014. Used with permission.

Over the last 65 years, periods which included devastating bear markets for both stocks and bonds, a stock-light portfolio returned 6.8% annually. That translates to receiving about 60% of the returns of an all-equity portfolio with about 25% of the volatility. Going from 20% stocks to 100% increases the chance of having a losing year by 350%, increases the average loss in down years by 1400% and nearly quadruples volatility.

On face, that’s not a compelling case for a huge slug of equities. The findings of behavioral finance research nibbles away at the return advantage of a stock-heavy portfolio by demonstrating that, on average, we’re not capable of holding assets which are so volatile. We run at the wrong time and hide too long. Morningstar’s “Mind the Gap 2014” research suggests that equity investors lose about 166 basis points a year to their ill-timed decisions. Over the past 15 years, S&P 500 investors have lost nearly 200 basis points a year.

Here’s the argument: you might be better with slow and steady, even if that means saving a bit more or expecting a bit less. For visual learners, here’s a picture of what the result might look like:

The blue line represents the performance, since January 2000, of T. Rowe Price Spectrum Income (RPSIX) which holds 80% or so in a broadly diversified income portfolio and 20% or so in dividend-paying stocks. The orange line is Vanguard 500 Index (VFINX). I’m happy to admit that maxing-out the graph, charting the funds for 25 years rather than 14, gives a major advantage to the 500 Index. But, as we’re already noted, investors don’t act based on a 25 year horizon.

I know what you’re going to say: (1) we need stocks for the long-run and (2) the bear is about to maul the bond world. Both are true, in a limited sort of way.

First, the mantra “stocks for the long-term” doesn’t say “how much stock” nor does it argue for stocks at any particular juncture; that is, it doesn’t justify stocks now. I’m profoundly sympathetic to the absolute value investors’ argument that you’re actually being paid very poorly for the risks you’re taking. GMO’s latest asset class projections have the broad US market with negative real returns over the next seven years.

Second, a bear market in bonds doesn’t look like a bear market in stocks. A bear market in stocks looks like 25 or 35 or 45% down. Bonds, not so much. A bear market in bonds is generally triggered by rising interest rates. When rates rise, two things happen: the market value of existing low-rate bonds falls while the payouts available from newly issued bonds rises.

The folks at Legg Mason looked at 90 years of bond market returns and graphed them against changes in interest rates. The results were published in Rate-Driven Bond Bear Markets (2013) and they look like this:

The vertical axis is you, gaining or losing money. The horizontal axis measures rising or falling rates. In the 41 years in which rates have risen, the bond index fell on only nine occasions (the lower right quandrant). In 34 other years, rising rates were accompanied by positive returns, fed by the income payouts of the newly-issued bonds. And even when bonds fall, they typically lose 2-3%. Only 1994 registered a hefty 9% loss.

Price’s research makes things even a bit more positive. They argue that simply using a monolithic measure (intermediate Treasuries, the BarCap aggregate or whatever) underestimates the potential of diversifying within fixed income. Their most recent work suggests that a globally diversified portfolio, even without resort to intricate derivative strategies or illiquid investments, might boost the annual returns of a 60/40 portfolio. A diversified 60/40 portfolio, they find, would have beaten a vanilla one by 130 basis points or so this century. (See “Diversification’s Long-Term Benefits,” 2013.)

This is not an argument against owning stocks or stock funds. Goodness, some of my best friends (the poor dears) own them or manage them. The argument is simpler: fix the roof when it’s not raining. Think now about what’s in your long-term best interest rather than waiting for a sickened panic to make the decision for you. One of the peculiar signs of my portfolio’s success is this: I have no earthly idea of how it’s doing this year.  While I do read my managers’ letters eagerly and even talk with them on occasion, I neither know nor care about the performance over the course of a few months of a portfolio designed to serve me over the course of many years. 

And as you think about your portfolio’s shape for the year ahead or reflect on Charles’ and Ed’s essays below, you might find the Price data useful. The original 2004 and 2010 studies are available at the T. Rowe Price website.

Mediocrity and frustration

I’ve been fully invested in the market for the past 14 years with little to show for it, except frustration and proclamations of even more frustration ahead. During this time, basically since start of 21st century, my portfolio has returned only 3.9% per year, substantially below historical return of the last century, which includes among many other things The Great Depression.

I’ve suffered two monster drawdowns, each halving my balance. I’ve spent 65 months looking at monthly statements showing retractions of at least 20%. And, each time I seem to climb-out, I’m greeted with headlines telling me the next big drop is just around the corner (e.g., “How to Prepare for the Coming Bear Market,” and “Are You Prepared for a Stock Selloff ?“)

I have one Nobel Prize winner telling me the market is still overpriced, seeming every chance he gets. And another telling me that there is nothing I can do about it…that no amount of research will help me improve my portfolio’s performance.

Welcome to US stock market investing in the new century…in the new millennium.

The chart below depicts S&P 500 total return, which includes reinvested dividends, since December 1968, basically during the past 46 years. It uses month-ending returns, so intra-day and intra-month fluctuations are not reflected, as was done in a similar chart presented in Ten Market Cycles. The less frequent perspective discounts, for example, bear sightings from bear markets.

The period holds five market cycles, the last still in progress, each cycle comprising a bear and bull market, defined as a 20% move opposite preceding peak or trough, respectively. The last two cycles account for the mediocre annualized returns of 3.9%, across 14-years, or more precisely 169 months through September 2014.

Journalist hyperbole about how “share prices have almost tripled since the March 2009 low” refers to the performance of the current bull market, which indeed accounts for a great 21.9% annualized return over the past 67 months. Somehow this performance gets decoupled from the preceding -51% return of the financial crisis bear. Cycle 4 holds a similar story, only investors had to suffer 40 months of protracted 20% declines during the tech bubble bear before finally eking out a 2% annualized return across its 7-year full cycle.

Despite advances reflected in the current bull run, 14-year annualized returns (plotted against the secondary axis on the chart above) are among the lowest they been for the S&P 500 since September 1944, when returns reflected impacts of The Great Depression and World War II.

Makes you wonder why anybody invests in the stock market.

I suspect all one needs to do is see the significant potential for upside, as witnessed in Cycles 2-3. Our current bull pales in comparison to the truly remarkable advances of the two bull runs of 1970-80s and 1990s. An investment of $10,000 in October 1974, the trough of 1973-74, resulted in a balance of $610,017 by August 2000 – a 6000% return, or 17.2% for nearly 26 years, which includes the brief bear of 1987 and its coincident Black Monday.

Here’s a summary of results presented in the above graph, showing the dramatic differences between the two great bull markets at the end of the last century with the first two of the new century, so far:

But how many funds were around to take advantage 40 years ago? Answer: Not many. Here’s a count of today’s funds that also existed at the start of the last five bull markets:

Makes you wonder whether the current mediocrity is simply due to too many people and perhaps too much money chasing too few good ideas?

The long-term annualized absolute return for the S&P 500 is 10%, dating back to January 1926 through September 2014, about 89 years (using database derived from Goyal and Shiller websites). But the position held currently by many value oriented investors, money-managers, and CAPE Crusaders is that we will have to suffer mediocre returns for the foreseeable future…at some level to make-up for excessive valuations at the end of the last century. Paying it seems for sins of our fathers.

Of course, high valuation isn’t the only concern expressed about the US stock market. Others believe that the economy will face significant headwinds, making it hard to repeat higher market returns of years past. Rob Arnott describes the “3-D Hurricane Force Headwind” caused by waves of Deficit spending, which artificially props-up GDP, higher than published Debt, and aging Demographics.

Expectations for US stocks for the next ten years is very low, as depicted in the new risk and return tool on Research Affiliates’ website (thanks to Meb Faber for heads-up here). Forecast for large US equities? Just 0.7% total return per year. And small caps? Zero.

Good grief.

What about bonds?

Plotted also on the first chart presented above is 10-year average T-Bill interest rate. While it has trended down since the early 1980’s, if there is a correlation between it and stock performance, it is not obvious. What is obvious is that since interest rates peaked in 1981, US aggregate bonds have been hands-down superior to US stocks for healthy, stable, risk-adjusted returns, as summarized below:

Sure, stocks still triumphed on absolute return, but who would not take 8.7% annually with such low volatility? Based on comparisons of absolute return and Ulcer Index, bonds returned more than 70% of the gain with just 10% of the pain.

With underlining factors like 33 years of declining interest rates, it is no wonder that bond funds proliferated during this period and perhaps why some conservative allocation funds, like the MFO Great Owl and Morningstar Gold Metal Vanguard Wellesley Income Fund (VWINX), performed so well. But will they be as attractive the next 33 years, or when interest rates rise?

As Morningstar’s Kevin McDevitt points out in his assessment of VWINX, “the fund lagged its average peer…from July 1, 1970, through July 1, 1980, a period of generally rising interest rates.” That said, it still captured 85% of the S&P500 return over that period and 76% during the Cycle 2 bull market from October 1974 through August 1987.

Of course, predicting interest rates will rise and interest rates actually rising are two different animals, as evidenced in bond returns YTD. In fact, our colleague Ed Studzinski recently pointed out the long term bonds have done exceptionally well this year (e.g., Vanguard Extended Duration Treasury ETF up 26.3% through September). Who would have figured?

I’m reminded of the pop quiz Greg Ip presents in his opening chapter of “Little Book of Economics”: The year is 1990. Which of the following countries has the brighter future…Japan or US? In 1990, many economists and investors picked Japan. Accurately predicting macroeconomics it seems is very hard to do. Some say it is simply not possible.

Similarly, the difficulty mutual funds have to consistently achieve top-quintile performance, either across fixed time periods or market cycles, or using absolute or risk-adjusted measures, is well documented (e.g., The Persistence Scorecard – June 2014, Persistence is a Killer, In Search of Persistence, and Ten Market Cycles). It does not happen. Due to the many underlying technical and psychological variables of the market place, if not the shear randomness of events.

In his great book “The Most Important Thing,” Howard Marks describes the skillful defensive investor as someone who does not lose much when the market goes down, but gains a fair amount when the market goes up. But this too appears very hard to do consistently.

Vanguard’s Convertible Securities Fund (VCVSX), sub-advised by OakTree Capital Management, appears to exhibit this quality to some degree, typically capturing 70-100% of upside with 70-80% of downside across the last three market cycles.

Since bull markets tend to last much longer than bear markets and produce returns well above the average, capturing a “fair amount” does not need to be that high. Examining funds that have been around for at least 1.5 cycles (since October 2002, oldest share class only), the following delivered 50% or more total return during bull markets, while limiting drawdowns to 50% during bear markets, each relative to S&P 500. Given the 3500 funds evaluated, the final list is pretty short.

VWINX is the oldest, along with Lord Abbett Bond-Debenture Fund (LBNDX) . Both achieved this result across the last four full cycles. As a check against performance missing the 50% threshold during out-of-cycle or partial-cycle periods, all funds on this list achieved the same result over their lifetimes.

For moderately conservative investors, these funds have not been mediocre or frustrating at all, quite the contrary. For those with an appetite for higher returns and possess the attendant temperament and investing horizon, here is a link to similar funds with higher thresholds: MFO Pain-To-Gain Funds.

We can only hope to have it so good going forward.

I fear that Charles and I may have driven poor Ed over the edge.  After decades of outstanding work as an investment professional, this month he’s been driven to ask …

Investing – Why?

By Edward Studzinski

“The most costly of all follies is to believe passionately in the palpably not true.  It is the chief occupation of mankind.”

          H.L. Mencken

I will apologize in advance, for this may end up sounding like the anti-mutual fund essay. Why do people invest, and specifically, why do they invest in mutual funds?  The short answer is to make money. The longer answer is hopefully more complex and covers a multitude of rationales. Some invest for retirement to maintain a standard of living when one is no longer working full-time, expecting to achieve returns through diversified portfolios and professional management above and beyond what they could achieve by investing on their own. Others invest to meet a specific goal along the path of life – purchase a home, pay for college for the children, be able to retire early. Rarely does one hear that the goal of mutual fund investing is to become wealthy. In fact, I can’t think of any time I have ever had anyone tell me they were investing in mutual funds to become rich. Indeed if you want to become wealthy, your goal should be to manage a mutual fund rather than invest in one. 

How has most of the great wealth been created in this country? It has been created by people who started and built businesses, and poured themselves (and their assets) into a single-minded effort to make those businesses succeed, in many instances beyond anyone’s wildest expectations. And at some point, the wealth created became solidified as it were by either selling the business (as the great philanthropist Irving Harris did with his firm, Toni Home Permanents) or taking it public (think Bill Gates or Jeff Bezos with Microsoft and Amazon). And if one goes further back in time, the example of John D. Rockefeller with the various Standard Oil companies would loom large (and now of course, we have reunited two of those companies, Standard Oil Company of New Jersey aka Exxon and Standard Oil Company of New York aka Mobil as Exxon-Mobil, but I digress).

So, this begs the question, can one become wealthy by investing in a professionally-managed portfolio of securities, aka a mutual fund? The answer is – it depends. If one wants above-average returns and wealth creation, one usually has to concentrate one’s investments. In the mutual fund world you do this by investing in a concentrated or non-diversified fund. The conflict comes when the non-diversified fund grows beyond a certain size of assets under management and number of investments.  It then morphs from an opportunistic investment pool into a large or mega cap investment pool. The other problem arises with the unlimited duration of a mutual fund. Daily fund pricing and daily fund flows and redemptions do have a cost. For those looking for a real life example (I suspect I know the answer but I will defer to Charles to provide the numbers in next month’s MFO), contrast the performance over time of the closed-end fund, Source Capital (SOR) run by one of the best value investment firms, First Pacific Advisors with the performance over time of the mutual funds run by the same firm, some with the same portfolio managers and strategy. 

The point of this is that having a fixed capital structure lessens the number of issues with which an investment manager has to deal (focus on the investment, not what to do with new money or what to sell to meet redemptions). If you want a different real life example, take a look at the long-term performance of one of the best investment managers to come out of Harris Associates, whom most of you have never heard of, Peter B. Foreman, and his partnership Hesperus Partners, Ltd.

Now the point of this is not to say that you cannot make money by investing in a mutual fund or a pool of mutual funds. Rather, as you introduce more variables such as asset in-flows, out-flows, pools of analysts dedicated to an entire fund group rather than one investment product, and compensation incentives or disincentives, it becomes harder to generate consistent outperformance. And if you are an individual investor who keeps increasing the number of mutual funds that he or she has invested in (think Noah and the Ark School of Personal Investment), it becomes even more difficult

A few weeks ago it struck me that in the early 1980’s, when I figured out that I was a part of the sub-species of investor called value investor (not “value-oriented investor” which is a term invented by securities lawyers for securities lawyers), I made my first investment in Berkshire Hathaway, Warren Buffett’s company. That was a relatively easy decision to make back then. I recently asked my friend Greg Jackson if he could think of a handful of investments, stocks like Berkshire (which has in effect been a closed-end investment portfolio) that today one could invest in that were one-decision investments. Both of us are still thinking about the answer to that question. 

Has something changed in the world in investing in the last fifteen or twenty years? Yes, it is a different world, in terms of information flows, in terms of types of investments, in terms of derivatives, in terms of a variety of things. What it also is is a different world in terms of time horizons and patience.  There is a tremendous amount of slippage that can eat into investment returns today in terms of trading costs and taxes (even at capital gains rates). And as a professional investment manager you have lots of white noise to deal with – consultants, peer pressure both internal and external, and the overwhelming flow of information that streams by every second on the internet. Even sitting in Omaha, the net of modern communications still drops over everything. 

So, how does one improve the odds of superior long-term performance? One has to be prepared to step back and stand apart. And that is increasingly a difficult proposition. But the hardest thing to do as an investment manager, or in dealing with one’s own personal portfolio, is to sometimes just do nothing. And yes, Pascal the French philosopher was right when he said that most of men’s follies come from not being able to sit quietly in one room. Even more does that lesson apply to one’s investment portfolio. More in this vein at some future date, but those are the things that I am musing about now.

“ … if you want to become wealthy, your goal should be to manage a mutual fund rather than invest in one.”  It’s actually fairer to say, “manage a large firm’s mutual fund” since many of the managers of smaller, independent funds are actually paying for the privilege of investing your money: their personal wealth underwrites some of the fund’s operations while they wait for performance to draw enough assets to cross the financial sustainability threshold.  One remarkably successful manager of a small fund joked that “you and I are both running non-profits.  The difference is that I hadn’t intended to.”

In the Courts: Top Developments in Fund Industry Litigation

Fundfox, launched in 2012, is the mutual fund industry’s only litigation intelligence service, delivering exclusive litigation information and real-time case documents neatly organized and filtered as never before.

“We built Fundfox from the ground up for mutual fund insiders,” says attorney-founder David M. Smith. “Directors and advisory personnel now have easier and more affordable access to industry-specific litigation intelligence than even most law firms had before.”

The core offering is a database of case information and primary court documents for hundreds of industry cases filed in federal courts from 2005 through the present. A Premium Subscription also includes robust database searching—by fund family, subject matter, claim, and more.

Settlement

• Fidelity settled a six-year old whistleblower case that had been green-lighted by the U.S. Supreme Court earlier this year. (Zang v. Fid. Mgmt. & Research Co.)

Briefs

• American Century defendants filed their opening appellate brief (under seal) in a derivate action regarding the Ultra Fund’s investments in gambling-related securities. Defendants include independent directors. (Seidl v. Am. Century Cos.)
• Fidelity filed a motion to dismiss a consolidated ERISA class action that challenges Fidelity’s practices with respect to “redemption float” (i.e., the cash held to pay checks sent to 401(k) plan participants who have withdrawn funds from their 401(k) accounts). (In re Fid. ERISA Float Litig.)
• First Eagle filed a reply brief in support of its motion to dismiss fee litigation regarding two international equity funds: “Plaintiffs have not identified a single case in which a court allowed a § 36(b) claim to proceed based solely on a comparison of the adviser’s fee to a single, unknown fee that the adviser receives for providing sub-advisory services to another client.” (Lynn M. Kennis Trust v. First Eagle Inv. Mgmt., LLC.)

Amended Complaints

• Plaintiffs filed an amended complaint in the excessive-fee litigation regarding five SEI funds, adding a new claim regarding the level of transfer agent fees. (Curd v. SEI Invs. Mgmt. Corp.)
• ERISA class-action plaintiffs filed an amended complaint alleging that TIAA-CREF failed to honor customer requests to pay out funds in a timely fashion. (Cummings v. TIAA-CREF.)

Answer

Having lost its motion to dismiss, Principal filed an answer in excessive-fee litigation regarding six of its LifeTime Funds. (Am. Chems. & Equip., Inc. 401(k) Ret. Plan v. Principal.

For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

The Alt Perspective:  Commentary and News from DailyAlts.

PREPARE FOR VOLATILITY

The markets delivered investors both tricks and treats in October. Underlying the modestly positive top-line U.S. equity and bond market returns for the month was a 64% rise, and subsequent decline, in the CBOE Volatility Index, otherwise known as VIX. This dramatic rise in the VIX coincided with a sharp, mid-month decline in equity markets. But with Halloween looming, the market goblins wanted to deliver some treats, and in fact did so as they pushed the VIX down to end the month 12.3% lower than it started. In turn, the equity markets rallied to close the month at all-time highs on Halloween day.

But as volatility creeps back into the markets, opportunities arise. Investment strategies that rely on different segments of the market behaving differently, such as managed futures and global macro, can thrive as global central bank policies diverge. And indeed they have. The top three managed futures funds have returned an average of 14.7% year-to-date through Oct. 31, according to data from Morningstar.

Other strategies that rely heavily on greater dispersion of returns, such as equity market neutral strategies, are also doing well this year. Whereas managed futures and global macro strategies take advantage of diverging prices at a macro level (U.S equities vs. Japanese equities, or Australian dollar vs. the Euro), market neutral funds take advantage of differences in individual stock price performance. And many of these funds have done just that this year. Through October 31, the three best performing equity market neutral funds have an average return of 11.9% year-to-date, according to data from Morningstar.

All three of these strategies generate returns by investing both long and short, generally in equal amounts, and maintain low levels of net exposure to individual markets. As a result, they can be used to effectively diversify portfolios away from stocks and bonds. And as volatility picks up, these funds have a greater opportunity to add value.  

NEW FUND LAUNCHES IN OCTOBER

As of this writing, seven new alternative funds have been launched in October, and like last month when four new funds launched on the last day of the month, we expect to add a few more to the October count. Five of the new funds are packaged as mutual funds, and two are ETFs, while five are multi-strategy funds, one is long/short, one is managed futures and one is market neutral. Two notable launches that dovetail on the discussion above are as follows:

• ProShares Managed Futures Strategy Fund (FUTS) – This is a low cost, systematic managed futures fund that invests across multiple asset classes.
• AQR Equity Market Neutral Fund (QMNIX) – This is a pure equity market neutral fund that will target a beta of 0 relative to the US equity markets.

NEW FUNDS REGISTERED IN OCTOBER

October saw 13 new alternative funds register with the S.E.C. covering a wide swath of strategies including multi-strategy, long/short equity, arbitrage, global macro and managed futures. Two notable funds are:

• Balter Discretionary Global Macro Fund – This is the second mutual fund from Balter Liquid Alternatives and will provide investors with exposure to Willowbridge Associates, a discretionary global macro manager that was formed in 1988.
• PIMCO Multi-Strategy Alternative Fund – This fund will be sub-advised by Research Affiliates and will invest in a range of alternative mutual funds and ETFs managed and offered by PIMCO.

OTHER NOTABLE NEWS

• The SEC rejected two proposals for non-transparent ETFs (exchange traded funds that don’t have to disclose their holdings on a daily basis). This is a setback for this new product structure that may ultimately bring more alternative strategies to the ETF marketplace.
• Education continues to be a hot topic among advisors and other investors looking to use alternative mutual funds and ETFs. The two most viewed articles on DailyAlts in October had to do with investor education and related research articles: AllianceBernstein Provides Thought Leadership on Liquid Alts and Neuberger Berman Calls Alts ‘The New Traditionals’.
• The S.E.C. continues to examine liquid alternative funds, and potentially has an issue with some fund disclosures. Norm Champ, the S.E.C. director leading the investigations, spoke recently at an industry event and noted that there appears to be some discrepancies between what funds are permitted to do per their prospectuses, and what is actually being done in the funds. Interestingly, he noted that prospectuses sometimes disclose more strategies than are actually being used in the funds.

Have a joyful Thanksgiving, and feel free to stop by DailyAlts.com for more updates on the liquid alternatives market.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

FPA Paramount (FPRAX): Paramount has just completed Year One under its new global, absolute value discipline.  If it weren’t for those danged emerging markets (non) consumers and anti-corruption drives, the short term results would likely have been as bright as the long-term promise.

Launch Alert: US Quantitative Value (QVAL)

My colleague Charles Boccadoro has been in conversation with Wesley Gray and the folks at Alpha Architect.  While ETFs are not our traditional interest, the rise of actively managed ETFs and the recently thwarted prospect for non-transparent, actively managed ETFs, substantially blurs the line between them and open-end mutual funds.  When we encounter particularly intriguing active ETF options, we’re predisposed to share them with you. Based on the investing approach detailed in his highly praised 2013 book Quantitative Value, this fund qualifies. Wesley Gray launched the U.S. Quantitative Value ETF (QVAL) on 22 October 2014.

Dr. Gray gave an excellent talk at the recent Morningstar conference with a somewhat self-effacing title borrowed from Warren Buffet: Beware of Geeks Bearing Formulas. His background includes serving as a US Marine Corps intelligence officer and completing both an MBA and a PhD from the University of Chicago’s Booth School of Business. He appears well prepared to understand and ultimately exploit financial opportunities created by behavioral biases and inefficiencies in the market.

The fund employs a Benjamin Graham value philosophy, which Dr. Gray has been studying since his 12th birthday, when his late grandmother gave him a copy of The Intelligent Investor. In quant-fashion, the fund attempts to implement the value strategy in systematic fashion to help protect against behavioral errors. Behaviors, for example, that led to the worst investor returns for the past decade’s best performing fund – CGM Focus Fund (2000-09). “We are each our own worst enemy,” Dr. Gray writes.

The fund uses academically-based and empirically-validated approaches to identify quality and price. In this way, Dr. Gray has actually challenged a similar strategy, called “The Magic Formula,” made popular by Joel Greenblatt’s book The Little Book That Beats the Market. The issue appears to be that The Magic Formula systematically forces investors to pay too high for quality. Dr. Gray argues that price is actually a bigger determinant of ultimate return than quality.

QVAL currently holds 40 stocks so we classify it as a concentrated portfolio, though not technically non-diversified. Its expense ratio is 0.79%, substantially less than the former Formula Investing funds (now replaced by even more expensive Gotham funds). The fund has quickly collected $8M in AUM. An international version (IVAL) is pending. We plan to do an in-depth profile of QVAL soon.

Alpha Shares maintains separate sites for its Alpha Shares advisory business and its Value Shares active ETFs.  Folks trying to understand the evidence behind the strategy would be well-advised to start with the QVAL factsheet, which provides the five cent tour of the strategy, then look at the research in-depth on the “Our Ideas” tab on the advisor’s homepage

Funds in Registration

The intrepid David Welsch, spelunker in the SEC database, tracked down 23 new no-load, retail funds in registration this month. In general, these funds will be available for purchase at the very end of December.  Advisors really want to have a fund live by December 30^th or reporting services won’t credit it with “year to date” results for all of 2015. A number of the prospectuses are incredibly incomplete (not listing, for example, a fund manager, minimums, expenses or strategies) which suggests that they’re panicked about having something on file.

Highlights among the registrants:

• Arbitrage Tactical Equity Fund will inexplicably do complicated things in pursuit of capital appreciation. Given that all of the Arbitrage funds could be described in the same way, and all of them are in the solid-to-excellent range, that’s apparently not a bad thing. 
• Greenhouse MicroCap Discovery Fund will pursue long-term capital appreciation by investing in 50-100 microcaps “run by disciplined management teams possessing clear strategies for growth that … trade at a discount to intrinsic value.” The fund intrigues me because Joseph Milano is one of its two managers. Milano managed T. Rowe Price New America Growth Fund (PRWAX) quite successfully from 2002-2013. PRWAX is a large growth fund but a manager’s disciplines often seem transferable across size ranges.
• Intrepid International Fund will seek long-term capital appreciation by investing in foreign stocks but it is, by prospectus, bound to invest only 40% of its portfolio overseas. Curious. The Intrepid funds are all built around absolute value disciplines: if the case for risky assets isn’t compelling, they won’t buy them.  That’s led to some pretty strong records across full market cycles, and pretty disappointing ones if you look only at little slices of time.  One of the managers of Intrepid Income was handle the reins here.

Manager Changes

This month saw 67 manager changes including the departures of several high profile professionals, including Abhay Deshpande of the First Eagle Funds.

Updates

PIMCO has been punted from management of Forward Investment Grade Fixed-Income Fund (AITIX) and Principal Global Multi-Strategy Fund (PMSAX). I’m afraid that the folks at the erstwhile “happiest place on earth” must be a bit shell-shocked. Since Mr. Gross stomped off, they’ve lost contracts – involving either the Total Return Fund or all of their services – with the state retirement systems in New Hampshire and Florida, the teachers’ retirement system in Arkansas, Ford Motor’s 401(k), Advanced Series Trust, Massachusetts Mutual Life Insurance Co., Alabama’s and California’s 529 College Savings accounts, Russell Investments, British wealth manager St. James Place, Schwab’s Target Date funds and a slug of city retirement plans. Consultant DiMeo Schneider & Associates, whose clients have about a billion in PIMCO Total Return, has issued “a universal sell recommendation” on PIMCO and Schwab reportedly is saying something comparable to its private clients.

Three short reactions:

The folks firing PIMCO are irresponsible.  The time to dump PIMCO would have been during the period that Gross was publicly unraveling. Leaving after you replace the erratic titan with a solid, professional team suggests either they weren’t being diligent or they’re grabbing for headlines or both.

PIMCO crisis management appears inept. “We are PIMCO (dot com)!” Really? I don’t tweet but enormous numbers of folks do and PIMCO’s Twitter feed is lame. One measure of impact is retweeting and only three of the past 20 tweets have been retweeted 10 or more times. There appears to be no coherent focus or intensity, just clutter and business-as-usual as the wobble gets worse.

Financial writers should be ashamed. In the months leading up to Gross’s departure, I found just three or four people willing to state the obvious. Now many stories, if not virtually every story, about PIMCO being sacked pontificates about the corrosive effect of months of increasingly erratic behavior. Where we these folks when their readers needed them? Oh right, hiding behind “the need to maintain access.”

By the way, the actual Pontiff seems to be doing a remarkably good job of pontificating. He seems an interesting guy. It will be curious to see whether his efforts are more than just a passing ripple on a pond, since the Vatican specializes in enduring, absorbing then forgetting reformist popes.

Grandeur Peak Global Opportunities (GPGOX) and Grandeur Peak International Opportunities (GPIOX) have now changed their designation from “non-diversified” to “diversified” portfolios. Given that they hold more than 200 stocks each, that seems justified.

photo courtesy of Augustana Photo Bureau

Briefly Noted . . .

Kent Gasaway has resigned as president of the Buffalo Funds, though he’ll continue to co-manage Buffalo Small Cap Fund (BUFSX) and the Buffalo Mid Cap Fund (BUFMX).

At about the same time, Abhay Deshpande has resigned as manager of the First Eagle Global (SGENX), Overseas (SGOVX) and US Value (FEVAX) funds. It’s curious that his departure, described as “amicable,” has drawn essentially no notice given his distinguished record and former partnership with Jean-Marie Eveillard.

Chou America makes it definite. According to their most recent SEC filing, the unexplained changes that might happen on December 6 now definitely will happen on December 6:

Robeco Boston Partners Long/Short Research Fund (BPRRX) is closed to new investors, which is neither news (it happened in spring) nor striking (Robeco has a long record of shuttering funds). What is striking is their willingness to announce the trigger that will lead them to reopen the fund:

Robeco reserves the right to reopen the Fund to new investments from time to time at its discretion, should the assets of the Fund decline by more than 5% from the date of the last closing of the Fund. In addition, if Robeco reopens the Fund, Robeco has discretion to close the Fund thereafter should the assets of the Fund increase by more than 5% from the date of the last reopening of the Fund.

Portfolio 21 Global Equity Fund (PORTX) “is excited to announce” that it’s likely to be merge with Trillium Asset Management and that its president, John Streur, has resigned.

Wasatch Funds announced the election of Kristin Fletcher to their board of trustees. I love it when funds have small, highly qualified boards. Ms. Fletcher surely qualifies, with over 35 years in the industry including a stint as the Chairman and CEO of ABN AMRO, and time at First Interstate Bank, Standard Chartered Bank, Export-Import Bank of the U.S., and Wells Fargo Bank.

SMALL WINS FOR INVESTORS

Aristotle International Equity (ARSFX) and Aristotle/Saul Global Opportunities Fund (ARSOX) have reduced their initial purchase minimum from $25,000 to $2,500 and their subsequent investment minimum to $100. Both funds have been cellar-dwellers over their short lives; presumably rich folks have enough wretched opportunities in hedge funds and so weren’t drawn here.

Effective November 1, Forward trimmed five basis points of the management fee for the various classes of Forward Emerging Markets Fund (PGERX). The fund is tiny, mediocre and running at a loss of .68%, so this is a marketing move rather than an adjustment to the economies of scale.

The trustees for O’Shaughnessy Enhanced Dividend (OFDAX/OFDCX) and O’Shaughnessy Small/Mid Cap Growth Fund (OFMAX) voted to eliminate the fund’s “A” and “C” share classes and transitioning those investors into the lower-cost Institutional share class. Neither makes a compelling case for itself.

On October 9, 2014, the Board of Trustees of Philadelphia Investment Partners New Generation Fund (PIPGX) voted to remove the fund’s sales charge. The fund has earned just under 5% per year for the past three years, handily trailing its long-short peer group.

Break out the bubbly! PSP Multi-Manager Fund (CEFFX/CEFIX) has slashed its expenses – exclusive of a long list of exceptions – from 3.0% to 2.64%. The fund inherits its predecessor Congressional Effect Fund’s dismal record, so don’t hold bad long-term returns against the current team. They’ve only been on-board since late August 2014. If you’d like, you’re more than welcome to hold a 2.64% e.r. against them instead.

Hartford Total Return Bond Fund (HABDX) has dropped its management fee by 12 basis points. I’m not certain that the reduction is related to the departure of the $200 Million Man, manager Bill Gross, but the timing is striking.

As of October 1, 2014, the investment advisory fee paid to Charles Schwab for the Laudus Mondrian International Equity Fund (LIEQX) was dropped by 10 basis points to 0.75%.

Each of the Litman Gregory Masters Fund’s Investor Class shares is eliminating its redemption fee.

PIMCO Emerging Markets Bond Fund (PAEMX) has dropped its management charge by 5 basis points to 50 basis points.

Similarly, RBC Global Asset Management will see its fees reduced by 10 basis points for the RBC BlueBay Emerging Market Corporate Bond Fund (RECAX) and by 5 basis points for the RBC BlueBay Emerging Market Select Bond Fund (RESAX), RBC BlueBay Global High Yield Bond Fund (RHYAX) and RBC BlueBay Global Convertible Bond Fund.

CLOSINGS (and related inconveniences)

The American Beacon International Equity Index Fund (AIIIX) will close to new investors on December 31, 2014. Uhhh … why? It’s an index fund tracking the largest international index.

Effective December 1, 2014, American Century One Choice 2015 Portfolio (ARFAX) will be closed to new investors. One presumes that the fund is in the process of liquidating as it reaches its target date, which its assets transferring to a retirement income fund.

OLD WINE, NEW BOTTLES

Just before Christmas, the AllianzGI Wellness Fund (RAGHX) will change its name to the AllianzGI Health Sciences Fund and it will begin investing in, well, health sciences-related companies. Currently it also invests in “wellness companies,” those promoting a healthy lifestyle. Not to dismiss the change, but pretty much all of the top 25 holdings are health-sciences companies already and Morningstar places 98% of its holdings in the healthcare field.

Effective January 15, 2015, Calvert High Yield Bond Fund (CYBAX) will shift its principal investment strategy from investing in bonds with intermediate durations to those “with varying durations,” with the note that “duration and maturity will be managed tactically.” At the same time Calvert Global Alternative Energy Fund (CGAEX) will be renamed Calvert Global Energy Solutions Fund, presumably because “alternative energy” is “so Obama.” I’ll note in passing that I really like the clarity of Calvert’s filings; they make it ridiculously easy to understand exactly what they do now and what they’ll be doing in the future. Thanks for that.

Effective December 30, 2014, CMG Managed High Yield Fund (CHYOX) will be renamed CMG Tactical Bond Fund. It appears as if the fund’s adviser decided to change its name and principal strategy within two weeks of its initial launch. They had filed to launch this fund in April 2013, appeared to have delayed for nearly 20 months, launched it and then immediately questioned the decision. Why am I not finding this reassuring?

Equinox EquityHedge U.S. Strategy Fund is chucking its “let’s hire lots of star sub-advisers” strategy in favor of investing in derivatives and ETFs on their own. Following the change, the investment advisory fee drops from 1.95% to 0.95% but “the Board also approved a decrease in the fee waiver and expense reimbursement arrangements with the Adviser to correspond with the decreased advisory fee.” The new system caps “A” share expenses at 1.45% except for a long list of uncapped items which might push the total substantially higher.

First Pacific Low Volatility Fund (LOVIX) has been renamed Lee Financial Tactical Fund. Headquartered in Honolulu. I feel a field trip coming on.

On October 1, Forward announced plans to reposition Forward Global Dividend Fund (FFLRX) as Forward Foreign Equity Fund on December 1. The new investment strategy statement is unremarkable, except for the absence of the word “dividend” anywhere in it. Two weeks later Forward filed an indefinite suspension of the change, so FFLRX lives on but conceivably on borrowed time.

Goldman Sachs Municipal Income Fund becomes Goldman Sachs Strategic Municipal Income Fund in December. The strategy in question involves permitting investments in high yield munis and in a 2-8 year duration band.

Effective December 17, Janus’s INTECH subsidiary will be “applying a managed volatility approach” to four of INTECH’s funds, at which point their names will change:

Laudus Mondrian Institutional Emerging Markets (LIEMX) and Laudus Mondrian Institutional International Equity (LIIEX) funds are pursuing one of those changes that make sense primarily to the fund’s accountants and lawyers. Instead of being the Institutional EM Fund, it will become the Institutional share class Laudus Mondrian Emerging Markets (LEMIX). Likewise with International Equity.

photo courtesy of Augustana Photo Bureau

OFF TO THE DUSTBIN OF HISTORY

Aberdeen Global Select Opportunities Fund (BJGQX) is going to merge into the Aberdeen Global Equity Fund (GLLAX) following what the adviser refers to as “the completion of certain conditions” a/k/a approval by shareholders. Neither fund is particularly good and they have overlapping management teams, but Select is microscopic and pretty much doomed.

Boston Advisors Broad Allocation Strategy Fund (BABAX) will be liquidated come December 18, 2014. It’s a small, overpriced fund-of-funds that’s managed to lag in both up markets and down markets over its short life.

HNP Growth and Preservation Fund (HNPKX) is slated for liquidation in mid-November. It was a reasonably conservative managed futures fund that was hampered by modest returns and high expenses. We wrote a short profile of it a while ago.

iShares isn’t exactly cleaning house, but they did bump off 18 ETFs in late October. The descendants include their entire Target Date lineup plus a couple real estate, emerging market sector and financial ETFs. The full list is:

• iShares Global Nuclear Energy ETF (NUCL)
• iShares Industrial/Office Real Estate Capped ETF (FNIO)
• iShares MSCI Emerging Markets Financials ETF (EMFN)
• iShares MSCI Emerging Markets Materials ETF (EMMT)
• iShares MSCI Far East Financials ETF (FEFN)
• iShares NYSE 100 ETF (NY)
• iShares NYSE Composite ETF (NYC)
• iShares Retail Real Estate Capped ETF (RTL)
• iShares Target Date Retirement Income ETF (TGR)
• iShares Target Date 2010 ETF (TZD)
• iShares Target Date 2015 ETF (TZE)
• iShares Target Date 2020 ETF (TZG)
• iShares Target Date 2025 ETF (TZI)
• iShares Target Date 2030 ETF (TZL)
• iShares Target Date 2035 ETF (TZO)
• iShares Target Date 2040 ETF (TZV)
• iShares Target Date 2045 ETF (TZW)
• iShares Target Date 2050 ETF (TZY)

Lifetime Achievement Fund (LFTAX) “has concluded that it is in the best interests of the Fund and its shareholders that the Fund cease operations.” The orderly dissolution of the fund will take until March 31, 2015.

Effective October 13, 2014, the Nationwide Enhanced Income Fund and the Nationwide Short Duration Bond Fund were reorganized into the Nationwide HighMark Short Term Bond Fund (NWJSX).

QS LEGG MASON TARGET RETIREMENT 2015,

Speaking of mass liquidations, Legg Mason decided to bump off its entirely target-date lineup, except for Target Retirement 2015 (LMFAX), effective mid-November.

• QS Legg Mason Target Retirement 2020,
• QS Legg Mason Target Retirement 2025,
• QS Legg Mason Target Retirement 2030,
• QS Legg Mason Target Retirement 2035,
• QS Legg Mason Target Retirement 2040,
• QS Legg Mason Target Retirement 2045,
• QS Legg Mason Target Retirement 2050
• QS Legg Mason Target Retirement Fund.

Robeco Boston Partners International Equity Fund merged into John Hancock Disciplined Value International Fund (JDIBX) on September 26, 2014.

Symons Small Cap Institutional Fund (SSMIX) has decided to liquidate, done in by “the Fund’s small asset size and the increasing regulatory and operating costs borne by the adviser.” Trailing 98-99% of its peers over the past 1, 3 and 5 year periods probably didn’t help its case.

Effective immediately, the USFS Funds Limited Duration Government Fund (USLDX) is closed to new purchases, its manager has left and all references to him in the Fund’s Summary Prospectus, Prospectus and SAI have been “deleted in their entirety.” Given that the fund is small and sad, and the adviser’s website doesn’t even admit it exists, I’m thinking the “closed to new investors and the manager’s out the door” might be a prelude to a watery grave.

The Japan Fund (SJPNX) just became The Former Japan Fund as it ended a long and rambling career by being absorbed into the Matthews Japan Fund (MJFOX, as in Michael J. Fox). The Japan Fund, launched in the late 1980s as Scudder Japan, was one of the first funds to target Japan – at just about the time Japan’s market peaked.

Effective October 20, 2014, three Virtus Insight money market funds (Government Money Market, Money Market and Tax-Exempt Money Market) were liquidated.

Bon Voya-age: Voya Global Natural Resources Fund (LEXMX – another of the old Lexington funds, along with our long-time favorite Lexington Corporate Leaders LEXCX) is merging in Voya International Value Equity (NAWGX). LEXMX has led its peers in four of the past five years but seems not to have drawn enough assets to satisfy the adviser’s needs. In the interim, International Value will be rechristened Voya Global Value Advantage.

In Closing . . .

One of our greatest challenges each month is balancing the needs and interests of our regular readers with those of the folks who are encountering us for the first time. Of the 25,000 folks who’ve read the Observer in the past 30 days, 40% ~ say, 10,000 ~ were first-time visitors. That latter group might reasonably be wondering things like “who on earth are these people?” and “where are the ads?” The following is for them and for anyone who’s still wondering “what’s up here?”

photo courtesy of Carolyn Yaschur, Augustana College

Who is the Observer?

The Mutual Fund Observer operates as a public service, a place for individuals to interact, grow, learn and gain confidence. It is a free, independent, non-commercial site, financially supported by folks who value its services. We write for intellectually curious, serious investors – managers, advisers, and individuals – who need to get beyond marketing fluff and computer-generated recommendations.

We have about 25,000 readers, 95% of whom are resident in the US.

The Observer is published by David Snowball, a Professor of Communication Studies and former Director of Debate at Augustana College in Rock Island, Illinois. While I might be the “face” of the Observer, I’m also only one piece of it. The strength of the Observer is the strength of the people it has drawn. There is a community of folks, fantastically successful in their own rights, who provide us with an incredibly powerful advantage. Some (Charles and Edward, as preeminent examples) write for us, some write to us (mostly in private emails) and some (David Smith at Fundfox and Brian Haskin at DailyAlts) share their words and expertise with us. They all share a common passion: to teach and hence to learn. Their presence, and yours, makes this infinitely more than Snowball 24/7.

What’s our mission?

We’ll begin with the obvious: about 80% of all mutual funds could shut their doors today and not be missed.  If I had to describe them, I’d use words like

• Large
• Unimaginative
• Undistinguished
• Asset sponges

They thrive by never being bad enough to dump and so, year after year, their numbers swell. By one estimate, 30% of all mutual fund money is invested in closet index funds – nominally active funds whose strategy and portfolio is barely distinguishable from an index. One of Russel Kinnel’s sharper lines of late was, “New funds tend to be mediocre because fund companies make them that way” (“New Funds Generate More Excitement Than Results,” 10/16/14). Add “larger” in front of “fund companies” and I’d nod happily. The situation is worse in ETF-land where the disappearance of 90% of offerings would likely improve the performance of 99% of investor portfolios.

Sadly those are the funds that win analyst coverage and investor attention.  The structure of the investment company industry is such that the funds you should consider most seriously are the ones about which you hear the least: small, nimble, independent entities with skilled managers who – in many cases – have left major firms in disgust at the realization that the corporation’s needs were going to trump their investors’ needs. Where the mantra at large companies is “let’s not do anything weird,” the mantra at smaller firms seems to be “let’s do the right thing for our investors.”

That’s who we write about, convinced that there are opportunities there that you really should recognize and consider with all seriousness.

How can you best use it?

Give yourself time and go beyond the obvious.

We tend to publish longer pieces that most sites and many of those essays assume that you’re smart, interested and thoughtful. We don’t do fluff though we celebrate quirky. The essays that Charles posts tend to be incredibly data-rich. Ed’s essays tend to be driven by a sharply trained, deeply inquisitive mind and decades of experience; he understands more about what’s going on just under the surface or behind closed doors than most of us could ever aspire to. They bear re-reading.

We have a lot of resources not immediately evident in the monthly update you’ve just read. I’ll highlight four and suggest you click around a bit on the top menu bar.

1. We share content from, and link to, people who impress us. David Smith and FundFox do an exceptional job of following and organizing the industry’s legal travails; it strikes me as an indispensable tool for trustees, reporters and folks whose names are followed by the letters J and D.  Brian Haskin and the folks are DailyAlts are dedicated to comprehensive tracking of the industry’s fastest growing, most complex corner.  Both offer resources well beyond our capacity and strike us as really worth following.
2. We offer tools that do cool things. Want detailed, current, credible risk measures for any fund? Risk Profile Search. A searchable list of every fund whose risk-adjusted returns beat its peers in every trailing period?  Great Owls.  A quick way to generate lists of candidates for a portfolio?  Miraculous Multi-Search.  Every manager change at an equity, balanced or alts fund over the past three years.  Got it.  Chip’s Manager Changes master list. Most of them are under the Search Tools tab, but the Navigator – which links you directly to any specified fund’s page on a dozen credible news and rating sites – is a Resource. 
3. We have profiles of over 100 funds, generally small, new and distinctive. Charles’s downloadable dashboard gives you quick access to updated risk and return information on each. There are archived audio interviews with the managers of some of the most intriguing of them. We present the active share calculations for every fund we profile and host one of the web’s largest collections of current active share data.
4. We have searchable editorial and analytic content back to our inception. Curious about everything we’ve reported on Seafarer Growth & Income (SFGIX) since its inception?  It’s there.  Our discussion of the fall o’ Fidelity funds? 

Quite independent of which (fiercely independent of which, I dare say) is the Observer’s mutual fund discussion board, which has had 1600 users and 65,000 posts.

We also answer our mail.

How do we pay for it?

Because the folks most in need of a quiet corner and reasonable people are those least able to pay a subscription, we’ve never charged one. When readers wish to support the Observer, they have four pretty simple, entirely voluntary channels:

1. They can use our Amazon.com link for their online shopping. On average, Amazon rebates to us an amount equivalent to about 7% of your purchase. Hint! Hint! There are holidays coming. If you’re one of those people who participate in “holiday shopping”, use this link. It costs you nothing. There really are no strings attached.
2. They can contribute directly through PayPal.
3. They can become de facto subscribers through an automatic monthly contribution through PayPal.
4. They can send a check. Or cash. Heck, we’d take fruitcakes and would delight in good chocolates.

All of that is laid out on our Support Us page.

Our goal each month is not to be great. It’s to be a bit better than we were last month. Frankly, the more you help – with ideas, encouragement, criticism and support – the likelier that is to occur.

Speaking of de facto subscribers, the number has doubled in the last month. Thanks Greg, Deb appreciates the company!  Charles is developing a remarkably sophisticated fund search function; in thanks and in hopes of getting feedback, we’ve extended access to our subscribers. If our recent rate of subscriber growth (i.e., doubling monthly) keeps up, we’ll crack 8200 in a year and I think we’d hit 16,777,216 by the end of the following year. Charles, the energetic one among us, has promised to greet each of you at the door.

I’m sure by now that you’ve set your clocks back.  But what about your other fall chores?  Change the batteries in your smoke detectors.  If you don’t have spare batteries on hand, leave a big Post-It note on the door to the garage so you remember to buy some.  If your detector predates the Obama administration, it’s time for a change.  And when was the last time you called your mom, changed your furnace filters or unwrapped that mysterious aluminum foil clad nodule in the freezer?  Time to get to it, friends!

For December, we’ll profile three new funds and think with you about the results of our latest research project focusing on the extent to which fund trustees are willing to entrust their own money to the funds they oversee.  We’ve completed reviews of 80 of our target 100 funds and, so far, 515 trustees might have a bit of explaining to do. 

Also coming in December, our pilot episode of the soon-to-be-hit reality TV show: So you think you can be an equity fund manager!  It’ll be hosted by some cheeky chick from Poughkeepsie who sports a faux British accent.

It looks so easy.  And so profitable.  Our British confreres boiled the attraction down in a single three minute video.

Wealth Management Parody from SCM on Vimeo. Thanks to Ted, one of the discussion board’s senior members, for bringing it to our attention.

In December we’ll look at Motif, a service mentioned to us by actual fund managers who are intrigued by it and which would let you run your own mutual fund (or six), in real time with real money.

Your money.

See you then!

Dear friends,

If it weren’t for everything else I’ve read in the news this week (a “blood feud” between DoubleLine and Morningstar? Blood feud? Really? “Pa! Grab your shotgun. Ah dun seen one a them filthy Mansuetos down by the crik!”), the silliest story of the week would be the transformation of candidate’s mutual fund portfolios into attack fodder. And not even attacks for the right reasons!

Republican U.S. Senate candidate Terri Lynn Land attacked her opponent for owning shares of the French firm Total SA. Three weeks later Democrat Gary Peters struck back after discovering that Land (the wretch!) owned “C” shares of Well Fargo Absolute Return (WARCX)and WARCX in turn owns GMO Benchmark-Free Allocation which owns five other GMO funds, one of which has 3% of its portfolio invested in Total SA stock. “She got her hand caught in the cookie jar,” quoth the Democrat.

Land’s total profit from WARCX was between $200-1000. Total SA represented 4% of a fund that was itself 14% of another fund. Hmmm … maybe 0.5% of her perhaps $200 windfall was Total SA so, yup, the issue came down to $1 worth of cookie.

Of course, it wasn’t about the money. It was about the principle. As politics so often are.

Also in Michigan Democrat Mark Schauer attacked the Republican governor’s tax break which benefited companies “even if they send jobs overseas.” The Republican struck back after discovering that Schauer owned shares of Growth Fund of America (AGTHX) which “has a portfolio of companies that make goods overseas, such as Apple.” Here in the Quad Cities, the Democrat candidate for Congress has been attacked for her investment in Janus Overseas (JAOSX), whose 7% holding in Li and Fung Enterprises raised Republican hackles. Congressional candidate Martha Robertson was attacked for owning stock in the treacherous, border-jumping, tax-inverting Burger King – which turns out to be held in the portfolio of a mutual fund she bought 36 years ago. Minnesota senator Al Franken was found to own Lazard, the parent company of a somehow objectionable company, via shares in a socially responsible mutual fund.

Yup. That sure would have been the craziest story of the month except for …

Notes on The Greatest (ill-timed mutual fund manager transition) Story Ever Told

Bill Gross arriving at Janus

Making sense of Mr. Gross’s departure from PIMCO is the very epitome of an “above my pay grade and outside my circle of competence” story. I don’t know why he left. I don’t know whether PIMCO has a toxic environment or, if so, whether he was the source or the firewall. And I certainly don’t know who, among the many partisans furiously spinning their stories, is even vaguely close to speaking the truth.

Here are, however, seven things that I do believe to be true.

If your adviser has recommended moving out of PIMCO funds, you should fire him. If your endowment consultant has advised moving out of PIMCO funds, fire them. If your newsletter editor has rushed out a special bulletin urging you to run, cancel your subscription, demand a refund and send the money to us. (We’ll buy chocolate.) If your spouse is planning on selling PIMCO shares, fir … distract him with pie and that adorable story about a firefighter giving oxygen to baby hamsters. (Also switch him to decaf and consider changing the password on your brokerage account.)

At base, Mr. Gross made some contribution to his core fund’s long-term outperformance, which is in the range of 100-200 basis points/year. In the long term, say over the course of decades, that’s huge. For the immediate future, it’s utterly trivial and irrelevant.

Note to PIMCO (from academe): Thank you! Thank you! Thank you! On behalf of all of us who teach Crisis Communications, Strategic Comm, Media Relations or Public Relations, thanks. Your handling of the story has been manna and will be the source of case studies for years.

For those of you without the time to take a crisis communications course, let me share the five word version of it: Get ahead of the story. Play it, don’t let it play you. Mr. Gross’s departure was absolutely predictable, even if the precise timing wasn’t. The probability of his unhappy departure was exceedingly high, even if the precise trigger was unknown. The firm’s strategists have either known it, or had a responsibility to know it, for the past six months. You could have been planning positive takes. You could have been helping journalists, long in advance, imagine positive frames for the story.

As is, you appeared to be somewhere between scrambling and flailing. About the most positive coverage you could generate was a whiny headline, “Bill Gross relied on us,” and a former employee’s human interest assessment, “El-Erian: PIMCO’s new CIO is one of the most considerate and decent people I know.”

We’d been living off BP’s mishandling of the Gulf oil disaster for years, but it was endless and getting stale. Roger Goodell has certainly offered himself up (latest: he’s got bodyguards and they assault photographers) but it’s great to have a Menu of Misses and Messes to work with.

Note (1) to Janus: You don’t have a Global Unconstrained Bond Fund. Or didn’t at the point that you announced that Mr. Gross was running it:

You might blame the “Global” slip-up on your IT team. It turns out that it’s not just the low-level gnomes. Janus president Richard Weil also invoked the non-existent Global Unconstrained Fund:

Morningstar echoed the confusion:

I called a Janus phone rep, who affirmed that of course they had a Global Unconstrained Fund, followed by a bunch of tapping, a “that’s odd,” an “uh-oh” and a “I’ll have to refer this up the line.” Two hours later Janus filed the name change announcement with the SEC.

Dudes: you were at the top of the news cycle. Everyone was looking. This was just chance to prove to everyone that you were relevant. Why deflect the story with careless goofs? You could have filed a two sentence SEC notice, with no mention of Mr. Gross, the week before. You didn’t. Why, too, does the fund have an eight page summary prospectus with five pages of text, two pages labeled “Intentionally Blank” and another page also blank (even blanker than the two preceding pages with writing on them), but apparently unintentionally so?

Note (2) to Janus: That’s the best picture of Mr. Gross that you could find? Really? Uhhh … that’s not a fund manager. That’s the Grinch.

Note to the ETF zealots, dancing around a bonfire and attempting to howl like wolves: Stop it, you’re embarrassing.

If you actually believed the credo that you so piously pronounce, there’d be about three ETFs in existence, each with a trillion in assets. They’d be overseen by a nonprofit corporation (hi, Jack!) which would charge one basis point. All the rest of you would be off somewhere, hawking nutraceuticals and testosterone supplements for a living. We’ll get to you later.

Note to pundits tossing around 12 figure guesstimates about PIMCO outflows: Stop it, you’re not helping anyone. I know you want to get headlines and build your personal brand. That’s fine, go date a Kardashian. There are a bunch of them available and apparently their standards are pretty … uhhh, flexible. Making up scary pronouncements with blue sky numbers (“we anticipate as much as $400 billion in outflows…”) does nothing more than encourage people to act poorly.

Note to our readers and other PIMCO investors: this is likely the best news you’ve had in a year. PIMCO has been twisting itself in knots over this issue. It’s been a daily distraction and a source of incredible tension and anxiety for dozens upon dozens of management and investment professionals. The situation had been steadily worsening. And now it’s done.

We don’t much cover PIMCO funds. Like the American Funds, they’re way too big to be healthy or interesting. That said, PIMCO has launched innovative and successful new funds over the past five years. Their collective Morningstar performance ratings (4.4 stars for the average domestic equity fund, 3.8 stars for taxable bond funds, 3.6 for international stocks and 1.9 for muni bonds) are well above average.

There is, I suspect, a real prospect of very healthy outcomes for PIMCO and their investors from all this. I suspect that a lot of people may start to look forward to coming to work again. That it will be a lot easier to attract and retain talent. And that a lot of folks will hear the call to step up and take up the slack. You might want to give them to chance to do just that.

Ever wonder what Mr. Gross did when he wasn’t prognosticating?

When I explained to Chip, overseer of our manager changes data, that Mr. Gross was moving on and that his departure affected a six page, single-spaced list of funds (accounting for all of the share classes and versions), she threatened to go all Air France on us and institute a work stoppage. Shuddering, I promised to share the master list of Gross changes with you in the cover essay.  The manager changes page will reflect just some of the higher-profile funds in his portfolio.

Here’s a partial list, courtesy of Morningstar, of the funds he was responsible for:

• PIMCO Total Return, the quarter trillion dollar beast he was famous for

And the other 34:

• MassMutual Select PIMCO Total Return
• PIMCO Emerging Markets Fundamental IndexPLUS Absolute Return Strategy
• JHFunds2 Total Return
• Target Total Return Bond
• AMG Managers Total Return Bond
• PIMCO GIS Total Return Bond
• PIMCO Worldwide Fundamental Advantage Absolute Return Strategy, the fund with the highest buzzwords-to-content ratio of any.
• Transamerica Total Return
• 37 iterations of PIMCO GIS Unconstrained Bond
• Consulting Group Core Fixed-Income
• Harbor Unconstrained Bond
• PIMCO Unconstrained Bond
• PIMCO Total Return IV
• Principal Core Plus Bond
• PL Managed Bond
• PIMCO Fundamental Advantage Absolute Return Strategy
• VY PIMCO Bond
• PIMCO International StocksPLUS® Absolute Return Strategy
• PIMCO Small Cap StocksPLUS® Absolute Return Strategy
• PIMCO Fundamental IndexPLUS Absolute Return
• PIMCO StocksPLUS Absolute RETURN Short Strategy
• PIMCO GIS Low Average Duration
• PIMCO StocksPLUS Absolute Return
• Old Mutual Total Return
• PIMCO GIS StocksPlus
• PIMCO Moderate Duration
• PIMCO StocksPLUS
• PIMCO Low Duration III
• PIMCO Total Return II
• PIMCO Low Duration II
• PIMCO Total Return III
• Harbor Bond
• PIMCO Low Duration
• Prudential Income Builder

As we note with PIMCO GIS Unconstrained (the GIS standing for “global investor series”), there can be literally dozens of manifestations of the same portfolio, denominated in different currencies and hedged and unhedged forms, offers to investors in a dozen different nations.

Morningstar ETF Conference Notes

By Charles Boccadoro

The pre-autumnal weather was perfect. Blue skies. Warm days. Cool nights. Vibrant city scene. New construction. Breath-taking architecture. Diverse eateries, like Lou Malnati’s deep dish pizza. Stylist bars and coffee shops. Colorful flower boxes on The River Walk. Shopping galore. An enlightened public metro system that enables you to arrival at O’Hare and 45 minutes later be at Clark/Lake in the heart of downtown. If you have not visited The Windy City since say when the Sears Tower was renamed the Willis Tower, you owe yourself a walk down The Magnificent Mile.

At the opening keynote, Ben Johnson, Morningstar’s director responsible for coverage of exchange traded funds (ETFs) and conference host, noted that ETFs today hold $1.9T in assets versus just $700M only five years ago, during the first such conference. He explained that 72% is new money, not just appreciation.

The conference had a total of 671 attendees, including 470 registered attendees (mostly financial advisors, but this number also includes PR people and individual attendees), 123 sponsor attendees, 43 speakers, and 35 journalists, but not counting a very helpful M* staff and walk-ins. Five years ago? Just shy of 300 attendees.

The Dirty Words of Finance

AQR’s Ronen Israel spoke of Style Premia, which refers to source of compelling returns generated by certain investment vehicle styles, specifically Value, Momentum, Carry (the tendency for higher-yielding assets to provide higher returns than lower-yielding assets), and Defensive (the tendency for lower-risk and higher-quality assets to generate higher risk-adjusted returns). He argues that these excess returns are backed by both theory, be it efficient market or behavioral science, and “decades of data across geographies and asset groups.”

He presented further data that indicate these four styles have historically had low correlation. He believes that by constructing a portfolio using these styles across multiple asset classes investors will yield more consistent returns versus say the tradition 60/40 stocks/bond balanced portfolio. Add in LSD, which stands for leverage, shorting and derivatives, or what Mr. Israel jokingly calls “the dirty word of finance,” and you have the basic recipe for one of AQR’s newest fund offerings: Style Premia Alternative (QSPNX). The fund seeks long-term absolute (positive) returns.

Shorting is used to neutralize market risk, while exposing the Style Premia. Leverage is used to amplify absolute returns at defined portfolio volatility. Derivatives provide most efficient vehicles for exposure to alternative classes, like interest rates, currencies, and commodities.

When asked if using LSD flirted with disaster, Mr. Israel answered it could be managed, alluding to drawdown controls, liquidity, and transparency.

(My own experience with a somewhat similar strategy at AQR, known as Risk Parity, proved to be highly correlated and anything but transparent. When bonds, commodities, and EM equities sank rapidly from May through June 2013, AQR’s strategy sank with them. Its risk parity flagship AQRNX drew down 18.1% in 31 trading days…and the fund house stopped publishing its monthly commentary.)

When asked about the size style, he explained that their research showed size not to be that robust, unless you factored in liquidity and quality, alluding to a future paper called “Size Matters If You Control Your Junk.”

When asked if his presentation was available on-line or in-print, he answered no. His good paper “Understanding Style Premia” was available in the media room and is available at Institutional Investor Journals, registration required.

Launched in October 2013, the young fund has generated nearly $300M in AUM while slightly underperforming Vanguard’s Balanced Index Fund VBINX, but outperforming the rather diverse multi-alternative category.

QSPNX er is 2.36% after waivers and 1.75% after cap (through April 2015). Like all AQR funds, it carries high minimums and caters to the exclusivity of institutional investors and advisors, which strikes me as being shareholder unfriendly. Today, AQR offers 27 funds, 17 launched in the past three years. They offer no ETFs.

In The Shadow of Giants

PIMCO’s Jerome Schneider took over the short-term and funding desk from legendary Paul McCulley in 2010. Two years before, he was at Bear Stearns. Today, think popular active ETF MINT. Think PAIUX.

During his briefing, he touched on 2% being real expected growth rate. Of new liquidly requirements for money market funds, which could bring potential for redemption gates and fees, providing more motivation to look at low duration bonds as an alternative to cash. He spoke of 14 year old cars that needed to be replaced and expected US housing recovery.

He anticipates capital expenditure will continue to improve, people will get wealthier, and for US to provide a better investment outlook than rest of world, which was a somewhat contrarian view at the conference. He mentioned global debt overhang, mostly in the public sector. Of working age population declining. And, of geopolitical instability. He believes bonds still play a role in one’s portfolio, because historically they have drawn down much less than equities.

It was all rather disjointed.

Mostly, he talked about the extraordinary culture of active management at PIMCO. With time tested investment practices. Liquidity sensitivity. Risk management. Credit research capability, including 45 analysts across the globe that he begins calling at 03:45…the start of his work day. He touted PIMCO’s understanding of tools of the trade and trading acumen. “Even Bill Gross still trades.” He displayed a picture of himself that folks often mistook for a young Paul McCulley.

Cannot help but think what an awkward time it must be for the good folks at PIMCO. And be reminded of another giant’s quote: “Only when the tide goes out do you discover who’s been swimming naked.”

Youthful Hosts

Surely, it is my own graying hair, wrinkled bags, muddled thought processes, and inarticulate mannerisms that makes me notice something extraordinary about the people hosting and leading the conference’s many panels, workshops, luncheons, keynotes, receptions, and sidebars. They all look very young! In addition to being clear thinkers, articulate public speakers, helpful and gracious hosts.

It would not be too much of a stretch to say that the combined ages of M*’s Ben Johnson, Ling-Wei Hew, and Samuel Lee together add up to one Eugene Fama. Indeed, when Mr. Johnson sat across from Nobel laureate Professor Fama, during a charming lunch time keynote/interview, he could have easily been an undergraduate from University of Chicago.

Is it because the ETF industry itself is young? Or, is it as a colleague explains: “Morningstar has hard time holding on to good talent because it is a stepping stone to higher paying jobs at places like BlackRock.”

Whatever the reason, if we were all as knowledgeable about investing as Mr. Lee and the rest of the youthful staff, the world of investing would be a much better place.

Damp & Disappointing

That’s how JP Morgan’s Dr. David Kelly, Chief Global Strategist, describes our current recovery. While I did not agree with everything, it was hands-down the best talk of the conference. At one point he said that he wished he could speak for another hour. I wished he could have too.

“Damp and disappointing, like an Irish summer,” he explained.

Short term US prospects are good, but long term not good. “In the short run, it’s all about demand. But in the long run, it’s all about supply, which will be adversely impacted by labor and productivity.” The labor force is not growing. Baby boomers are retiring en masse. He also showed data that productivity was likely not growing, blaming lack of capital expenditure. (Hard to believe since we seem to work 24/7 these days thanks to amazing improvements communications, computing, information access, manufacturing technology, etc. All the while, living longer.)

Dr. Kelly offered up fixes: 1) corporate tax reform, including 10% flat rate, and 2) immigration reform, that allows the world’s best, brightest, and hardest working continued entry to the US. But since congress only acts in crisis, he concedes his forecast prepares for slowing US growth longer term.

Greater opportunity for long term growth is overseas. Manufacturing momentum is gaining around world. Cyclical growth will be higher than US while valuations remain lower and work force is younger. Simply put, they have more room to grow. Unfortunately, US media bias “always gives impression that the rest of the world is in flames…it shows only bad news.”

JP Morgan remains underweight fixed income, since monetary policy remains abnormal, and cautiously over weight US equities. The thing about Irish summers is…everything is green. Low interest rates. Higher corporate margins. Normal valuation. Although he takes issue with the phrase “All the easy money has been made in equities.” He asks “When was it ever easy?”

Alpha Architect

Dr. Wesley Gray is a former US Marine Captain, a former assistant and now adjunct professor at Drexel University, co-author of Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and founder of AlphaArchitect, LLC.

He earned his MBA and Finance PhD from University of Chicago, where Professor Fama was on his doctoral committee. He offers a fresh perspective in the investment community. Straight talking and no holds barred. My first impression – a kind of amped-up, in-your-face Mebane Faber. (They are friends.)

In fact, he starts his presentation with an overview of Mr. Faber’s book “The Ivy Portfolio,” which at its simplest form represents an equal allocation strategy across multiple and somewhat uncorrelated investment vehicles, like US stocks, world stocks, bonds, REITS, and commodities.

Dr. Gray argues that simple, equal allocation remains tough to beat. No model works all the time; in fact, the simple equal allocation strategy has under-performed the past four years, but precisely because forces driving markets are unstable, the strategy will reward investors with satisfactory returns over the long run. “Complexity does not add value.”

He seems equally comfortable talking efficient market theory and how to maximize a portfolio’s Sharpe ratio as he does explaining why the phycology of dynamic loss aversion creates opportunities in the market.

When Professor Fama earlier in the day dismissed a question about trend-following, answering “No evidence that this works,” Dr. Gray wished he would have asked about the so-called “Prime anomaly…momentum. Momentum is pervasive.”

When Dr. Gray was asked, “Will your presentation would be made available on-line?” He answered “Absolutely.” Here is link to Beware of Geeks Bearing Formulas.

His firm’s web site is interesting, including a new tools page, free with an easy registration. They launch their first ETF aptly called Alpha Architect’s Quantitative Value (QVAL) on 20 October, which will follow the strategy outlined in the book. Basically, buy cheap high-quality stocks that Wall Street hates using systematic decision making in a transparent fashion. Definitively a candidate MFO fund profile.

Trends Shaping The ETF Market

Ben Johnson hosted an excellent overview ETF trends. The overall briefings included Strategic Beta, Active ETFs (like BOND and MINT), and ETF Managed Portfolios.

Points made by Mr. Johnson:

1. Active vs passive is a false premise. Today’s ETFs represent a cross-section of both approaches.

2. “More assets are flowing into passive investment vehicles that are increasingly active in their nature and implementation.”

3. Smart beta is a loaded term. “They will not look smart all the time” and investors need to set expectations accordingly.

4. M* assigns the term “Strategic Beta” to a growing category of indexes and exchange traded products (ETPs) that track them. “These indexes seek to enhance returns or minimize risk relative to traditional market cap weighted benchmarks.” They often have tilts, like low volatility value, and are consistently rules-based, transparent, and relatively low-cost.

5. Strategic Beta subset of ETPs has been explosive in recent years with 374 listed in US as of 2Q14 or 1/4 of all ETPs, while amassing $360M, or 1/5th of ETP AUM. Perhaps more telling is that 31% of new cash flows for ETPs in 2013 went into Strategic Beta products.

6. Reduction or fees and a general disillusionment with active managers are two of several reasons behind the growth in these ETFs.  These quasi active funds charge a fraction of traditional fees. A disillusionment with active managers is evidenced in recent surveys made by Northern Trust and PowerShares.

M* is attempting to bring more neutral attention to these ETFs, which up to now has been driven by product providers. In doing so, M* hopes to help set expectation management, or ground rules if you will, to better compare these investment alternatives. With ground rules set, they seek to highlight winners and call out losers. And, at the end of the day, help investors “navigate this increasingly complex landscape.”

They’ve started to develop the following taxonomy that is complementary to (but not in place of) existing M* categories.

Honestly, I think their coverage of this area is M* at its best.

Welcomed Moderation

Mr. Koesterich gave the conference opening keynote. He is chief investment strategist for BlackRock. The briefing room was packed. Several hundred people. Many standing along wall. The reception afterward was just madness. His briefing was entitled “2014 Mid-Year Update – What to Know / What to Do.”

He threaded a somewhat cautiously reassuring middle ground. Things aren’t great. But, they aren’t terrible either. They are just different. Different, perhaps, because the fed experiment is untested. No one really knows how QE will turn out. But in mean time, it’s keeping things together.

Different, perhaps, because this is first time in 30-some years where investors are facing a rising interest rate environment. Not expected to be rapid. But rather certain. So bonds no longer seem as safe and certainly not as high yield as in recent decades.

To get to the punch-line, his advice is: 1) rethink bonds – seek adaptive strategies, look to EM, switch to terms less interest rate sensitive, like HY, avoiding 2-5 year maturities, look into muni’s on taxable accounts, 2) generate income, but don’t overreach – look for flexible approaches, proxies to HY, like dividend equities, and 3) seek growth, but manage volatility – diversify to unconstrained strategies

More generally, he thinks we are in a cyclical upswing, but slower than normal. Does not expect US to achieve 3.5% annual GDP growth (post WWII normal) for next decade. Reasons: high debt, aging demographics, and wage stagnation (similar to Rob Arnott’s 3D cautions).

He cited stats that non-financial debt has actually increased 20-30%, not decreased, since financial crisis. US population growth last year was zero. Overall wages, adjusted for inflation, same as late ’90s. But for men, same as mid ‘70s. (The latter wage impact has been masked by more credit availability, more women working, and lower savings.) All indicative of slower growth in US for foreseeable future, despite increases in productivity.

Lack of volatility is due to fed, keeping interest rates low, and high liquidity. Expects volatility to increase next year as rates start to rise. He believes that lower interest rates so far is one of year’s biggest surprises. Explains it due to pension funds shifting out of equities and into bonds and that US 10 year is pretty good relative to Japan and Europe.

On inflation, he believes tech and aging demographics tend to keep inflation in check.

BlackRock continues to like large cap over small cap. Latter will be more sensitive to interest rate increases.

Anything cheap? Stocks remain cheaper than bonds, because of extensive fed purchases during QE. Nothing cheap on absolute basis, only on relative basis. “All asset classes above long term averages, except a couple niche areas.”

“Should we all move to cash?” Mr. Koesterich answers no. Just moderate our expectations going forward. Equities are perhaps 10-15% above long term averages. But not expensive compared to prices before previous drops.

One reason is company margins remain high. For couple of same reasons: low credit interest and low wages. Plus higher productivity, which later appeared contrary to JP Morgan’s perspective.

He advises investors be selective in equities. Look for value. Like large over small. More cyclical companies. He likes tech, energy, manufacturing, financials going forward. This past year, folks have driven up valuations of “safe” equities like utilities, staples, REITS. But those investments tend to work well in recessions…not so much in rising interest rate environment. EM relatively inexpensive, but fears they are cheap for reason. Lots of divided arguments here at BlackRock. Japan likely good trade for next couple years due to Japanese pension funds shifting to organic assets.

He closed by stating that only New Zealand is offering a 10 year sovereign return above 4%. Which means, bond holders must take on higher risk. He suggests three places to look: HY, EM, muni’s.

Again, a moderate presentation and perhaps not much new here. While I personally remain more cautiously optimistic about US economy, compared to mounting predictions of another big pull-back, it was a welcomed perspective.

Beta Central

I’m hard-pressed to think of someone who has done more to enlighten investors about the benefits of ETF vehicles and opportunities beyond buy-and-hold US market cap than Mebane Faber. At this conference especially, he represents a central figure helping shape investment opportunities and strategies today.

He was kind enough to spend a few minutes before his panel on dividend investing and ETFs, which he held with Morningstar’s Josh Peters and Samuel Lee.

He shared that Cambria recently completed a funding campaign to expand its internal operations using the increasingly popular “Crowd Funding” approach. They did not use one of the established shops, like EquityNet, simply because of cost.  A couple hundred “accredited investors” quickly responded to Cambria’s request to raise $1-2M. The investors now have a private stake in the company. Mebane says they plan to use the funds to increase staff, both research and marketing. Indeed, he’s hiring: “If you are an A+ candidate, incredibly sharp, gritty, and super hungry, come join us!”

The new ETF Global Momentum (GMOM), which we mentioned in the July commentary, is due out soon, he thinks this month. Several others are in pipeline: Global Income and Currency Strategies ETF (FXFX), Emerging Shareholder Yield ETF (EYLD), Sovereign High Yield Bond ETF (SOVB), and Value and Momentum ETF (VAMO), which will make for a total of eight Cambria ETFs. The initial three ETFs (SYLD, FYLD, and GVAL) have attracted $365M in their young lives.

He admitted being surprised that Mark Yusko of Morgan Creek Funds agreed to take over AdvisorShares Global Tactical ETF GTAA, which now has just $20M AUM.

He was also surprised and disappointed to read about the SEC’s probe in F2 Investments, which alleges overstated performance results. F2 specializes in strategies “designed to protect investors from severe losses in down markets while providing quality participation in rising markets” and they sub-advise several Virtus ETFs. When WSJ reported that F2 received a so-called Wells notice, which portends a civil case against the company, Mebane posted “first requirement for anyone allocating to separate account investment advisor – GIPS audit. None? Move on.” I asked, “What’s GIPS?” He explains it stands for Global Investment Performance Standards and was created by the CFA Institute.

Mebane continues to write, has three books in work, including one on top hedge funds. Speaking of insight into hedge funds, subscribers joining his The Idea Farm after 31 December will pay a much elevated $499 annually.

Observer Fund Profiles:

Each month the Observer provides in-depth profiles of between two and four funds. Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds. “Stars in the Shadows” are older funds that have attracted far less attention than they deserve.

This month’s funds call into two broad categories: The Fallen Titans Funds and Stealthy Funds from “A” Tier Teams.

Le roi est mort, vive le roi’s new fund

Janus Unconstrained Bond (JUCAX) On October 6, Bill Gross, The Bond King, completes the transition from running 34 funds and $1.8 trillion in assets to managing a single $13 million portfolio. Like a Walmart at dawn on Black Friday, the fund is sure is see a huge crush of anxious, half-unhinged shoppers jammed against the doors.

Miller Income Opportunity (LMCJX) On February 26, Bill Miller, The Guy Who Bested the S&P 15 Years in a Row, partnered with his son to manage a new fund with a slightly misleading name (the portfolio produces little income) and hedge fund like freedom (and fees).

Quiet funds from “A” tier teams

Meridian Small Cap Growth (MSAGX) Small growth stocks have been described as “a failed asset class” because of the inability of most professional investors to control the sector’s downside well enough to benefit from its upside. Fortunately Chad Meade and Brian Schaub didn’t know that it was impossible to profit handsomely by limiting a small growth portfolio’s downside and so, for the past seven years, they’ve been doing exactly that. After moving from Janus to Meridian, they get to do it with a small, nimble fund.

Sarofim Equity (SRFMX) Have you ever looked at a large fund with a sensible strategy, solid management team and fine long-term record and thought to yourself “sure wish they were running a small, new fund doing the exact same thing for noticeably less money”? If so, the management team behind Dreyfus Appreciation has an opportunity for you to consider.

Elevator Talk: Justin Frankel, RiverPark Structural Alpha (RSAFX/RSAIX)

Since the number of funds we can cover in-depth is smaller than the number of funds worthy of in-depth coverage, we’ve decided to offer one or two managers each month the opportunity to make a 200 word pitch to you. That’s about the number of words a slightly-manic elevator companion could share in a minute and a half. In each case, I’ve promised to offer a quick capsule of the fund and a link back to the fund’s site. Other than that, they’ve got 200 words and precisely as much of your time and attention as you’re willing to share. These aren’t endorsements; they’re opportunities to learn more.

Justin Frankel (presumably not the JF described as “the world’s most dangerous geek”) co-manages Structural Alpha with his colleague Jeremy Berman. RiverPark launched the fund in June 2013, but the strategy’s public record is considerably longer. It began life in September 2008 as Wavecrest Partners Fund, LP which the guys ran alongside separate accounts for rich folks. Justin and I spent some time discussing the fund over warm drinks in lovely Milwaukee this August.

Structural Alpha embodies an options-based strategy. Every time I write that, my head begins to hurt because I struggle to explain them even to myself. Investors use options as a sort of portfolio insurance. The managers here sell options because those options are structurally overpriced; that is, there’s a predictable excess profit for the sellers built into the market just as you pay more for your insurance policies than you’ll ever get out of them.

The portfolio has four components – long-dated options which tend to move in the direction of the stock market, short-dated options which tend to be market independent, a permanent hedge which buffers the long options’ downside risk and a huge amount of cash which serves as collateral on the options they’ve sold. The guys invest that cash in short-term securities which produce income for the fund. As market conditions change, the managers adjust the size of the options components to keep the fund’s risk exposure within predetermined limits. That is, there are times when their market indicators show that the long-dated portion is carrying the potential for too much downside and so they’ll dial back that component.

Here’s what that performance looks like, including the strategy’s time as a hedge fund. RiverPark is the blue line, its painfully inept peer group is on the orange line and the S&P 500 is green.

Over the better part of a full market cycle, the Structural Alpha strategy captured the 80% of the stock index’s returns – the strategy gained about 70% while the S&P rose 87% – while largely sidestepping any sustained losses. On average, it captures about 20% of the market’s down market performance and 40% of its up market. The magic of compounding then works in their favor – by minimizing their losses in falling markets, they have little ground to make up when markets rally and so, little by little, they catch up with a pure equity portfolio.

Justin Frankel

It’s clear that they might substantially lag in sustained, low volatility rallies but it’s also clear that they’ll make money for their investors even then.

Here are Justin’s 200 words on how you might buy some insurance:

The RiverPark Structural Alpha Fund is a market-neutral, hedged equity strategy. Our goal is to generate equity-like returns with fixed-income like volatility. We use a consistent and systematic investment process that focuses first on the management of risk, and then on the management of return.

The core of our investment philosophy is that excessive returns are rarely realized, and therefore should be traded for the opportunity to generate more stable returns, protect against some market declines, and reduce overall portfolio volatility. Secondarily, we believe that index options are overpriced, and by systematically selling these options we can generate positive returns without market exposure. This is why we use the term Structural Alpha in the fund’s name.

Jeremy Berman

Importantly, we have no view of the market and do not change our holdings or market exposure based on market conditions. Specifically, we use options to set zones of protection and to allow the fund to perform in up markets while maintaining a constant hedge to help protect the fund in down markets. The non-linear profile of options makes them ideally suited to implement our philosophy. Our portfolio naturally gets more exposed to the market as it declines (which means that we are constantly buying lower), and gets less exposed to the market when it rises (which means we are constantly selling higher).

Over the long run, the fund is slightly long-biased. Therefore, we believe it should perform better in rising markets. In our opinion, small and consistent gains over time, when compounded, will yield above average risk-adjusted returns for our shareholders. We believe our structural approach to investing gives the strategy a high probability for success across a range of different market environments.

RiverPark Structural Alpha has a $1000 minimum initial investment. Expenses are capped at 2.0% on the investor shares and the fund has about gathered about $7 million in assets since its June 2013 launch. Here’s the fund’s homepage, which has a funny video of the guys talking through the strategy. It’s a sort of homemade ten minute video and has much of the unprepossessing charm of Sheldon Cooper’s “Fun with flags” videos on The Big Bang Theory. Spoiler alert: the first two minutes are the managers sharing their biographies and the last seven minutes are soundless images of slides and disclaimers (I feel the compliance group’s hand here). If you’d like to listen to a précis of the strategy, start listening at about the 4:00 minute mark through to about 6:50. They make a complex strategy about as clear as anyone I’ve yet heard.

Launch Alert: T. Rowe Price International Concentrated Equity (PRCNX)

It’s rare that a newly launched fund receives both a “Great Owl” (top quintile risk-adjusted returns in all trailing periods longer than a year) and Morningstar five star rating, but Price’s International Concentrated Equity Fund (PRCNX) managed the trick. On August 22, 2014, T. Rowe released a retail version of its outstanding Institutional International Concentrated Equity Fund (RPICX). That fund launched in July 2010. Federico Santilli, who has managed the RPICX since inception, will manage the new fund. He claims to be style, sector and region-agnostic, willing to go wherever the values are best. He targets “companies that have solid positions in attractive industries, have an ability to generate visible and durable free cash flow, and can create shareholder value over time.”

The portfolio holds 60 large cap names, weighting them equally but turning them over with alarming speed, about 150% per year. The portfolio offers little direct exposure to the emerging markets but the multinationals that dominate the portfolio (Royal Bank of Scotland, Sony, drug maker Glaxo, Honda) derive much of their earnings from consumers in those newer markets.

The fund has performed well. It has been in or near the top 10% of foreign large blend funds each year. $10,000 invested there at inception would have grown to $15,700 (as of late September, 2014) while its average peer would have generated $13,700 with noticeably higher volatility. It has been the second-strongest performer among all the T. Rowe Price international funds, trailing only International Discovery (PRIDX), whose lead is tiny.

PRCNX is not merely a share class of RPICX. It is a separate fund, managed by the same guy using the same discipline. Nonetheless, the portfolios may show significant differences depending on what names are attractive when money flows into each fund.

The expense ratio is capped at 0.90%, barely higher than the Institutional fund’s 0.75%, under February 2017. The minimum initial investment is $2500, reduced to $1000 for IRAs. The fund’s homepage is here but the institutional fund’s homepage has a far greater array of information and strategy detail. Price would urge me to remind you that the information about the institutional fund is designed to inform qualified investors and analysts and it’s not aimed to persuading you to buy the retail fund.

Funds in Registration

Our colleague David Welsch tracked down 12 new no-load, retail funds in registration this month. In general, these funds will be available for purchase by late November. A number of the prospectuses are incredibly incomplete (not listing, for example, a fund manager) which suggests that they’re just gearing up for the traditional year-end rush to launch new funds. Highlights among the registrants:

• 361 Global Long/Short Equity Fund, which will feature a global long/short portfolio. Its most notable for its cast of managers, including Blaine Rollins from 361 Capitals and Harindra de Silva from Analytic Investors. Mr. Rollins ran Janus Fund at the height of its popularity (sadly, that would be around the year 2000), left investing in 2006 but has since returned to cofound 361, a liquid alts firm that’s dedicated to trying to prevent the sorts of losses the Janus funds suffered. Mr. Silva has roots going back to the PBHG Funds in the 1990s. The fund is no-load with a $2500 minimum, but we don’t yet know the expenses.
• American Century Multi-Asset Income Fund, which will primarily seek income with a conservative balanced portfolio. You might anticipate 40% dividend-paying stocks and 60% bonds. It will be team-managed with a reasonable 0.91% e.r. and $2,000 minimum.
• DoubleLine Long Duration Total Return Bond Fund, which will sport an effective average duration of 10 years or more. That’s a fascinating launch since long duration funds are highly interest rate sensitive and most observers anticipate rising rates (eventually). The Other Bond King and Vitaliy Liberman will manage the fund. The expenses aren’t yet set. The minimum initial investment will be $2,000 for “N” shares.

Manager Changes

Yikes.  This month saw 93 manager changes without accounting for the full extent of the turmoil caused by Mr. Gross’s change of employment. 

Top Developments in Fund Industry Litigation – September 2014

Fundfox is the only intelligence service to focus exclusively on litigation involving U.S.-registered investment companies, their directors and advisers. Each month editor David Smith shares word of the month’s litigation-related highlights. Folks whose livelihood ride on such matters need to visit FundFox and chat a bit with David about the service.

New Lawsuit

• Harbor was hit with new excessive-fee litigation, alleging that it charges advisory fees to its International and High-Yield Bond Funds that include a mark-up of more than 80% over the fees paid by Harbor to unaffiliated subadvisers who do most of the work. (Tumpowsky v. Harbor Capital Advisors, Inc.)

Orders

• The court consolidated a pair of fee lawsuits regarding the Davis N.Y. Venture Fund. (In re Davis N.Y. Venture Fund Fee Litig.)
• In a pair of ERISA lawsuits regarding a J.P. Morgan pooled stable value investment fund, the court transferred venue to the S.D.N.Y. (Adams v. J.P. Morgan Ret. Plan Servs., LLC; Ashurst v. J.P. Morgan Ret. Plan Servs. LLC.)
• The court denied defendants’ motion to dismiss excessive-fee litigation regarding six Principal LifeTime funds: “[W]hile Plaintiff has included some generalized statements regarding the mutual fund industry in its complaint, Plaintiff is not relying solely on speculation and has included some specific factual allegations regarding Defendants and their practices.” (Am. Chems. & Equip., Inc. 401(k) Ret. Plan v. Principal Mgmt. Corp.)
• The court gave its final approval to a $19.5 million settlement of an ERISA class action regarding TIAA-CREF‘s procedures for closing retirement plan accounts. (Bauer-Ramazani v. TIAA-CREF.)

Brief

• The plaintiff filed her opening brief in an appeal concerning American Century‘s liability for the Ultra Fund’s investments in off-shore Internet gambling businesses. Defendants include independent directors. (Seidl v. Am. Century Cos.)

Amended Complaint

• After surviving a motion to dismiss, a plaintiff filed an amended complaint alleging Securities Act violations in connection with four closed-end Morgan Keegan bond funds (n/k/a Helios funds). (Small v. RMK High Income Fund, Inc.)

For a complete list of developments last month, and for information and court documents in any case, log in at www.fundfox.com and navigate to Fundfox Insider.

Liquid Alternative Observations

Brian Haskin publishes and edits the DailyAlts site, which is devoted to the fastest-growing segment of the fund universe, liquid alternative investments. Here’s his quick take on the DailyAlts mission:

Our aim is to provide our readers (investment advisors, family offices, institutional investors, investment consultants and other industry professionals) with a centralized source for high quality news, research and other information on one of the most dynamic and fastest growing segments of the investment industry: liquid alternative investments.

I like the site for a couple reasons. The writing is clean, the stories are fresh and the content seems thoughtful. Beyond that, one of the ways that the Observer tries to help folks is by linking them to the resources they need. There are really important areas that are outside our circle of competence and beyond our resources, and we’re deeply grateful for folks like David Smith at FundFox and Brian for their generous willingness to share leads and insights.

Brian offers this as his take on the month just past.

A Key Turning Point

September 2014 may be a month to remember – jot it down in the depths of your memory as it may be a useful data point some time down the road. Why? Because it was the point at which the largest pension fund in the United States, the California Public Employee Retirement System (CalPERS), decided not to push forward with a larger allocation to hedge funds, and instead reversed course and cut their allocation to zero.

Citing costs and complexity, it is easy to see why the prior would be a problem for the taxpayer funded pension system. As James B. Stewart stated in his article for The New York Times, “the fees CalPERS paid [to hedge funds] would have soared to $1.35 billion” if they increased their hedge fund program to a meaningful allocation of their portfolio (~10-15%).

That’s clearly not a number that would make any investment committee member comfortable. The “CalPERS Decision” may be the real turning point for liquid alternatives, which are essentially hedge funds without performance fees wrapped in mutual fund or exchange traded fund wrappers.

By eliminating the performance fee, which generally is equal to 20% of annual returns, investors will reap the short- and long-term benefit of substantially lower costs. This lower cost will be attractive not only to individual investors and their advisors, but also to a much broader universe of investors that includes family offices, endowments, foundations and pension funds. Hedge funds are a key source of diversification for many of these investors already, and as more high quality mutual fund and ETF choices become available, investors will shift assets from higher cost hedge funds to lower cost liquid alternative vehicles.

It should be noted that most, but not all, alternative mutual funds do not incur a performance fee similar to a hedge fund performance fee. However, certain structures within mutual funds do allow for the mutual fund to indirectly purchase limited partnerships (i.e. hedge funds) that charge traditional hedge fund fees, including a performance fee.

New Fund Launches

As of this writing, September saw only six new alternative fund launches, with five of those being mutual funds. Additional launches often occur on the last day of the month, so others may be near, including a long/short equity fund from Goldman Sachs and a multi-alternative fund from Lazard. Two notable new funds that have launched are as follows:

• AQR Style Premia Alternative LV Fund (QSLIX) – this is a low volatility version of an existing AQR fund, but is interesting because it takes a leveraged market neutral approach to investing across multiple asset classes using a factor based investment approach. With a targeted volatility level similar to intermediate term bonds, this fund could be a good substitute for long-only fixed income if rates start to rise.
• Eaton Vance Richard Bernstein Market Opportunities Fund (ERMIX) – this new global macro fund is managed by the former Chief Investment Strategist at Merrill Lynch and the fund’s namesake, Richard Bernstein. The market environment is getting better for global macro funds as the Fed eases up on QE and more natural market trends re-emerge. Keep an eye on this one.

A full list of new funds can be found on the DailyAlts’ New Fund Listing.

New Fund Registrations

We tracked ten new alternative mutual fund filings in September, which means that the end of the year will be flush with new funds. Four of the filings are for long/short equity, which has been a recipient of significant inflows over the past year. Two of the notable filings outside of long/short equity include the following:

o  State Street Global Macro Absolute Return Fund – another go-anywhere global macro fund that will invest across global markets and asset classes. As with the new Eaton Vance fund above, the timing could be good and the universe for global macro funds is relatively small.

o   Palmer Square Long Short Credit Fund – just in time for rising interest rates, this new fund comes from a boutique asset management firm with a highly experienced fixed income team. The fund has a wide range of credit oriented securities that it can use on both a long and short basis to generate absolute (positive) returns over full market cycles.

Other Items of Interest

• On the ETF front, First Trust launched an actively managed long/short equity ETF. We’ll keep an eye on this low cost vehicle to see how well a long/short strategy can do in an ETF wrapper.
• HedgeCo launched HedgeCoVest, a managed accounts platform available to individual investors for as little as $30,000. Investors can get a hedge fund managed in their own brokerage account with full liquidity and transparency. This could be a real market disruptor.
• TFS marked the 10-year anniversary of their TFS Market Neutral Fund (TFSMX). Quite an accomplishment, especially when (in hindsight) being “market neutral” over the past five years has not been a desirable bet. But as we know, the next five years won’t be like the past five years. Congrats to TFS.

We look forward to bringing readers of the Mutual Fund Observer monthly insights on the evolving market for alternative mutual funds.

Meh. Just meh.

From time to time, I come across what strikes me as an extraordinarily cool website or online retailer. In the past those have included the DailyAlts site and the Duluth Trading Company. When that happens, I’m predisposed to share word about the site with you, for your sake and for theirs.

I still remember a sign in the hot dog shop’s window from when I was in grad school: “eat here or we’ll both go hungry.” It’s sort of like that.

I have lately been delighted with the little online shop, meh. If we were Vikings, that would be “meh son of woot” or “meh wootson.” Woot was an online shop launched in 2004. The founders worked as wholesalers and looked at the challenge of selling what I think of as “orphan goods.” That is, stuff where the quantity available is substantial but too small to be profitably distributed through a mainline retailer. Woot was distinguished by two characteristics: (1) a one-deal-one-day business model in which shoppers were offered one deeply discounted item each day and at the day’s end, the item vanished. And (2) a snarky dismissiveness of their own offerings.

It was sufficiently cool that Amazon.com bought it in 2010 and messed it up by, oh, 2011. Instead of advertising one great deal, Amazon thought they should offer one deal in each of ten categories, plus Side Deals and Woot!Plus deals and miscellaneous sale items from Amazon’s own site and goodness knows what else.

Woot’s founders decided to try again (presumably after the expiration of non-compete agreements) and, with the help of Kickstarter funding, launched meh. Like the original Woot!, meh offers precisely one deal for no more than 24 hours. The site is tantalizing for two reasons: (1) the stuff is always cheap and sometimes outstanding and (2) checking each day takes me about 30 seconds since there’s, well, just one thing.

What sort of “one thing”? 40 AA Panasonic batteries for $5. Two refurbished 39” Emerson LCD TVs for $300 (not $300 each, $300 for the pair). A Phillips Blu-ray player for $15. Down alternative comforters for $18-20. (I bought two for my son’s bed, under the assumption that 14-year-olds will eventually spot, stain or shred pretty much anything within reach.) A padded laptop, a refurbished Dyson DC41 vacuum, Bluetooth keyboards for your tablet. Stuff.

It’s a small operation. Shipping tends to be slow. They charge $5 per item to ship unless you join their Very Mediocre Person service where you get unlimited free shipping for $5/month. A lot, but not all, of the stuff is refurbished. Neither bells nor whistles are in evidence. On whole they are, I guess, sort of “meh.”

That said, they’re also worth visiting. (And no, we have no relationship of any sort with them. You’re so suspicious.) meh.

Briefly Noted . . .

Effective November 1, 2014, Catalyst/Lyons Hedged Premium Return Fund (CLPAX/ CLPFX) will pursue “long-term capital appreciation and income with less downside volatility than the equity market.” That’s a bold departure from the current promise to seek “long-term capital appreciation and income with low volatility and low correlation to the equity market.”

On October 1^st, FTSE and Research Affiliates rolled out a new set of low-volatility indexes. As with many RAFI products, the stocks in the index are weighted using fundamental factors, as opposed to market capitalization. Jason Hsu, one of the RA co-founders, describes it as “a next generation approach that produces a low volatility core universe which is valuation-aware, without uncomfortable country or sector active bets.” Given that there’s $60 billion in funds, ETFs and separate accounts benchmarked against the existing FTSE RAFI indexes, you might reasonably expect the product launches to commence in the near future.

Matthews raised the expense ratio on Matthews China Fund (MCHFX) by one basis point at the end of September, netting them a cool $110,000 on a $1.1 billion fund. MCHFX and Matthews Asia Dividend have both qualified for access to Chinese “A” shares, expenses relating to which apparently triggered the one bp bump.

In another odd development, the Board of Trustees of the Value Line Core Bond Fund (VAGIX) approved a 3:1 reverse stock split on or about October 17, 2014. It’s incredibly rare for a fund to execute a split or a reverse split because the fund’s NAV has absolutely no relevance to its operation. With stocks, share prices that are too low might trigger a delisting alert and shares prices that are too high (think Berkshire Hathaway Cl A shares) might impede trading. Funds have no such excuse. When I spoke with a fund rep, she dutifully read Value Line’s one-sentence rationale to me: “It will realign our fund’s NAV with their peers’ and daily performance would be more appropriately reported.” Neither she nor I nor why the former was important or how the latter occurred, so I rack it up to “it’s Value Line. They do that sort of thing.”

Seafarer adds capacity

As Seafarer Overseas Growth & Income (SFGIX) grows steadily in size, it’s now over $117 million, and approaches its third anniversary, Andrew Foster has taken the opportunity to add to his analyst corps.  The estimable Kate Jacquet (Morningstar keeps misspelling her name as “Jacque”) is joined by Paul Espinosa and Sameer Agarwal.   Paul was a London-based analyst who has worked for Legg Mason, JP Morgan, Citigroup and Salomon Brothers.  He’s got some interesting experience in small cap and market neutral strategies.  Sameer grew up in India and worked for an India-based mutual fund before joining Royal Bank of Scotland and later Cartica Management, LLC.  Cartica is a sort of liquid alts manager focusing on the emerging markets.  I’ll ask Andrew in the month ahead how the guys’ work with what appear to be hedged products might contribute to Seafarer’s famously risk-conscious approach.

Seafarer reduced its expenses again, to 1.25% for Investor shares, though Morningstar continues to report a higher cost. 

SMALL WINS FOR INVESTORS

Appleseed (APPLX/APPIX) is lowering their expenses for both investor and institutional classes. Manager Joshua Strauss writes: “As we begin a new fiscal year Oct. 1, we will be trimming four basis points off Appleseed Fund Investor shares, resulting in a 1.20% net expense ratio. At the same time, we will be lowering the net expense ratio on Institutional shares by four basis points, to 0.95%.” It’s a risk-conscious, go-anywhere sort of fund that Morningstar has recognized as one of the few smaller funds that’s impressed them.

CLOSINGS (and related inconveniences)

Grandeur Peak Global Reach (GPROX), which was already soft closed to new investors, imposed a hard close on virtually all investors on September 30^th.

“Effective immediately, and until further notice” Guggenheim Alpha Opportunity Fund (SAOAX) has closed to all investors. That’s odd. It’s an exceedingly solid long/short fund with negligible assets. There’s been some administrative reshuffling going on but no clear indication of the fund’s future.

OLD WINE, NEW BOTTLES

The Absolute Opportunities Fund has been renamed the Absolute Credit Opportunities Fund (AOFOX). Its prospectus is being revised to reflect a focus on credit-related strategies. At the same time, the fund’s expense ratio is dropping from a usurious 2.75% down to a high 1.60%.

Chilton Realty Income & Growth Fund (REIAX) has become West Loop Realty Fund.

Effective on September 2, 2014, Dreyfus Select Managers Long/Short Equity Fund (DBNAX) became Dreyfus Select Managers Long/Short Fund (DBNAX). Dropping the word “equity” from the name allows the managers to invest more than 20% of the portfolio in non-equity securities but it’s not clear that any great change is in the works. The new prospectus still relegates non-equity securities to one line at the end of paragraph four: “The fund may invest, to a limited extent, in bonds and other fixed-income securities.”

Effective October 1, 2014, Mellon Capital Management Corporation replaced PVG Asset Management Corporation as sub-adviser to the Dunham Loss Averse Equity Income Fund (DAAVX),which was then re-named the Dunham Dynamic Macro Fund.

John Hancock China Emerging Leaders Fund (JCHLX) is rethinking the whole “China” thing and has become just the John Hancock Emerging Leaders Fund. The change allows them to invest across the emerging markets. DFA will still manage the fund.

Effective at the close of business on October 15, 2014, Loomis Sayles Capital Income Fund (LSCAX) becomes Loomis Sayles Dividend Income Fund. The investment strategies change to stipulate the fact that they’ll be investing, mostly, in equities.

Effective September 16, 2014, Market Vectors Wide Moat ETF (MOAT) became Market Vectors Morningstar Wide Moat ETF.

Pioneer is planning to find Solutions for you. Effective mid November, all of the Pioneer Ibbotson Allocation funds will jettison Ibbotson and gain Solutions. So, for example, Pioneer Ibbotson Growth Allocation Fund (GRAAX) will be Pioneer Solutions: Growth Fund. Moderate Allocation (PIALX) will become Solutions: Balanced and Conservative Allocation (PIAVX) will become Solutions: Conservative. Some as-yet undisclosed strategy and manager changes will accompany the name changes.

In that same “let’s add the name of someone well-known to our fund’s name” vein, what was Ramius Trading Strategies Managed Futures Fund (RTSRX) is now State Street/Ramius Managed Futures Strategy Fund. SSgA replaced Horizon Cash Management LLC as manager.

OFF TO THE DUSTBIN OF HISTORY

Dreyfus Emerging Asia Fund (DEAAX) becomes Dreyfus Submerging Asia Fund on or about October 30, 2014. The decision to liquidate caps a sorry seven year run for the tiny, volatile fund which made a ton of money for investors in 2009 (130%) but was unrelievedly bad the rest of the time.

Driehaus Global Growth Fund (DRGGX)is slated to liquidate on October 20, 2014. Cycling through a half dozen managers in a half dozen years certainly didn’t solve the fund’s performance problems and might well have deepened them.

Forward Managed Futures Strategy Fund (FUTRX) no longer has a future, a fact which will be formalized with the fund’s liquidation on October 31, 2014. The fund has lost about 12% since launch in 2012. The whole managed futures universe has performed so abysmally that you have to wonder if regression to the mean is about to rescue some of the surviving funds.

Huntington International Equity Fund (HIEAX) is merging into Huntington Global Select Markets Fund (HGSAX). Effectively both funds are being liquidated. HEIAX disappears entirely and HGSAX transforms from an underperforming equity markets stock fund to a global balanced fund with no particular tilt toward the Ems. The same management team that struggled with these as international equity funds will be entrusted with the new incarnation of Global Select. The best news is a new expense cap of 1.21% on Select. The worst news is that much of the combined portfolio might have to be liquidated to complete the transition.

Morgan Stanley Global Infrastructure Fund (UTLAX)will be absorbed by its institutional sibling, MSIF Select Global Infrastructure (MTIPX). They’re essentially the same fund, except for the fact that the surviving fund is much smaller and charges more. And, too, they’re both really good funds.

Nationwide International Value Fund (NWVAX)will be liquidated on December 19^th for all the usual reasons.

Effective November 14, 2014, Northern Large Cap Growth Fund (NOEQX) will merge into Northern Large Cap Core Fund (NOLCX). The Growth Fund shareholders get a major win out of the deal, since they’re joining a far stronger, larger, cheaper fund. The reorganization does not require a shareholder vote.

Perimeter Small Cap Growth Fund (PSCGX/PSIGX) has closed to new investors in anticipation of being liquidated on Halloween. The fund’s redemption fee has been waived, just in case you want to get out early.

On or about November 14, 2014, Pioneer Ibbotson Aggressive Allocation Fund (PIAAX) merges into Pioneer Ibbotson Growth Allocation Fund (GRAAX) At the same time, Growth Allocation changes its name to Pioneer Solutions – Growth Fund.

This is kind of boring, but here’s word that PNC Pennsylvania Tax Exempt Money Market Fund and PNC Ohio Municipal Money Market Fund both liquidate in early October.

QuantShares U.S. Market Neutral Momentum Fund (MOM) and QuantShares U.S. Market Neutral Size Fund (SIZ) are under threat of delisting. “The staff of NYSE Regulation, Inc. recently advised the Trust that the Funds’ shares currently are not in compliance with NYSE Arca, Inc.’s continued listing standards with respect to the number of record or beneficial holders. Therefore, commencing on or about September 16, 2014, NYSE Arca will attach a “below compliance” (.BC) indicator to each Fund’s ticker symbol … Should the Staff determine to delist a Fund, or should the Adviser conclude that a Fund cannot be brought into compliance with NYSE Arca’s continued listing standards, the Adviser will recommend the Fund’s liquidation to the Fund’s Board of Trustees and attempt to provide shareholders with advance notice of the liquidation.”

Pending shareholder approval, Sentinel Capital Growth Fund (BRGRX – it’d read as “Boogers” if it were a license plate) and Sentinel Growth Leaders Fund (BRFOX) will merge into Sentinel Common Stock Fund (SENCX). The shareholder meeting will nominally occur in lovely Montpelier, Vermont, on November 14^th. It wouldn’t be unusual for the merger to then occur by year’s end.

TCW Growth Fund (TGGYX) will liquidate around Halloween, 2014.

Turner Large Growth Fund (TCGFX) will soon merge into Turner Midcap Growth Fund (TMGFX), pending shareholder approval. I’ve never really gotten the Turner Funds. They always feel like holdovers from the run and gun ‘90s to me. The fact that Midcap Growth suffered a 56% drawdown during the financial crisis and is routinely a third more volatile than its peers fits with that impression.

Wade Tactical L/S Fund (WADEX) plans to cease and desist around the middle of October.

The Board of Directors for Western Asset Global Multi-Sector Fund (WALAX)has determined that “it is in the best interests of the fund and its shareholders to terminate the fund.” It seemed they long ago also determined it was in shareholders’ best interest not to invest in the fund:

The fund is expected to cease operations on or about November 14, 2014.

On January 30, 2015, Wilmington Short Duration Government Bond Fund (ASTTX) will be merged into the Wilmington Short-Term Corporate Bond Fund (MVSAX). Likewise the Wilmington Maryland Municipal Bond Fund (ARMRX) will be merged into the Wilmington Municipal Bond Fund (WTABX). The latter, muni into muni, makes more sense on face than the former.

The WY Core Fund (SGBFX/SGBYX) disappeared on September 30^th, just in case you were wondering why there’s an empty seat at the table.

In Closing . . .

As I sat in my study, 11:30 p.m. CDT on the last day of September, finishing this essay, my internet connection disappeared.  Then the lights flickered, flashed then failed.  Nuts.  The MidAmerican Energy outage map shows that I was one of precisely two customers to lose power.  This is the second time since moving to my new home in May that the power disappeared just as we were trying to finishing an update.  The first time it happened we were in a world of hurt, both having lost a bunch of writing and having the rest of the new issue trapped inside an inert machine.

This time we were irked and modestly inconvenienced. The difference is that after the first major outage, Chip identified and I bought a really good uninterruptible power supply (UPS) for us. While it’s not an industrial grade unit, it allowed me to save everything, move it for safekeeping to an external solid-state drive and finish the story I was working on before shutting the system down. We resumed work a bit before dawn and finished everything roughly on time.

All of which is to say thank you! to all the folks who’ve supported the Observer.  I was deeply grateful that we had the resources at hand to react, quickly and frugally, to resolve the problems caused by the first outage.  Thanks to all the folks who use our Amazon link (feel free to share it!), to Joe and Bladen (cool old English name, linked to a village in Oxfordshire) who contributed to our resources this month but most especially to Deb who, in an odd sense, is the Observer’s only subscriber.  Deb arranged a monthly auto-transfer from her PayPal account which provides us with a modest, very welcome stipend at the beginning of each month.

The other project that you helped support this month was the first ever face-to-face meeting of the folks who write for you each month.  Charles, Chip, Ed and I gathered in Chicago in the immediate aftermath of the Morningstar ETF Conference to discuss (some would say “plot”) the Observer’s future.  Among our first priorities coming out of the meeting is to formalize the Observer as a legal enterprise: incorporation, pursue of 501(c)3 tax-exempt organization status, better liability and intellectual property protection and so on.  None of that will immediately change the Observer but it all lays the foundation for a more sustainable future.  So thanks for your help in covering the expenses there, too.

Take care and enjoy October.  It tends to be a rough and tumble month in the markets, but a fine time for visiting orchards with your family and starting the holiday fruitcakes.

As ever,