Dear friends,

Welcome to David’s Market Timing Newsletter!  You’ll remember that, at the beginning of October, I pointed out that (1) you hated stocks and (2) you should be buying them.  One month and one large rally – small caps are up 17% for the month through 10/27 while large caps added 12% – later, I celebrate the fact that I’ve now tied Abby Joseph Cohen for great market timing calls (one each).  Unlike AJC, I promise never to do it again.

October brought more than a sizzling rally.  It brought record breaking heat to the U.K. and record-breaking snowfalls to New York and New England.  To my students and colleagues at Augustana College, it brought a blaze of color, cool mornings, warm afternoons, the end of fall trimester and a chance to slow down and savor the dance of the leaves.

Between the oppression of summer and the ferocity of winter, it’s good to have a few days in which to remember to breathe and celebrate life.  One of the pleasures of working at a small college is the opportunity to engage in that celebration with really bright, inquisitive kids.

The Observer’s Honor Roll, Unlike Any Other

Last month, in the spirit of FundAlarm’s “three-alarm” fund list, we presented the Observer’s first Roll Call of the Wretched.  Those were funds that managed to trail their peers for the past one-, three-, five- and ten-year periods, with special commendation for the funds that added high expenses and high volatility to the mix.

This month, I’d like to share the Observer’s Honor Roll of consistently bearable funds.  Most such lists start with a faulty assumption: that high returns are intrinsically good.

Wrong!

While high returns can be a good thing, the practical question is how those returns are obtained.  If they’re the product of alternately sizzling and stone cold performances, the high returns are worse than meaningless: they’re a deadly lure to hapless investors and advisors.  Investors hate losing money much more than they love making it.  One of Morningstar’s most intriguing statistics are its “investor return” numbers, which attempt to see how the average investor in a fund did (rather than how the hypothetical buy-and-hold-for-ten-years investor did).  The numbers are daunting: Fidelity Leverage Company (FLVCX) made nearly 13% a year for the past decade while its average investor lost money over that same period.

In light of that, the Observer asked a simple question: which mutual funds are never terrible?  In constructing the Honor Roll, we did not look at whether a fund ever made a lot of money.  We looked only at whether a fund could consistently avoid being rotten.  Our logic is this: investors are willing to forgive the occasional sub-par year, but they’ll flee in terror in the face of a horrible one.  That “sell low” – occasionally “sell low and stuff the proceeds in a zero-return money fund for five years” – is our most disastrous response.

We looked for no-load, retail funds which, over the past ten years, have never finished in the bottom third of their peer groups.   And while we weren’t screening for strong returns, we ended up with a list of funds that consistently provided them anyway.

U.S. stock funds

International stock funds

Blended asset funds

Specialty funds

All of these funds were rated as three stars, or better, by Morningstar (10/31/11).  Almost all took on average levels of risk, and almost all were above average performers in bear markets.  All of them had positive Sharpe ratios; that is, all of them more than rewarded investors for the risks they bore.  While we don’t offer this as a “buy” list, much less a “must have” list, investors looking for solid, long-term performance without huge risks might start their due diligence here.

Trust, But Verify

My first-year students have a child-like faith in The Internet.  They’re quite sure that the existence of the ‘net means that they can access all human knowledge and achieve unparalleled wisdom. One percipient freshman wrote that,

“As technology becomes more sophisticated, developing the capacity to help us make moral and ethical choices as well as more pragmatic decisions, what we call human wisdom will reach new levels” (quoting Marc Prensky, Digital Wisdom, 2009 – I’ll note that the term “claptrap” comes to mind whenever I read the Prensky essay) . . . our mind limits our wisdom, meaning that our daily distractions are holding us back from how intelligent we can really be. Technology however, fills those gaps with its vast memory. Technology is helping us advance our memory, helping us advance our creativity and imagination, and it is fixing our flaws . . . our digital wisdom is doing nothing but getting vaster.  Prensky makes a lot of good arguments as to why we are not in fact the stupidest generation to have walked this Earth, and I couldn’t agree more.

“Digital wisdom” remains a bit elusive, if only because of flaws in the digits that originally enter the . . . well, digits, into the databases.

There’s no clearer example of egregious error without a single human question than in the portfolio reports for Manning & Napier Dividend Focus (MNDFX).  Focus remains almost fully-invested in common stocks, with 2-4% in a money market.  I used the Observer’s incredibly helpful Falcon’s Eye fund search to track down all the major reports of MNDFX’s portfolio.  I discovered that, as of July 31 2011:

$65 million was held in a money market, and $47 million was in stocks.  That would be a 58% cash stake.  Source: Manning & Napier month-end holdings, July 31 2011.

That 61% of the fund’s assets were shorting cash and that 94% was long cash, for a net cash stake of 33%.  Source: Morningstar.

That 100.28% of the fund’s assets were invested in two Dreyfus Money Market funds.  The top ten holdings combined contributed 127% of the fund’s assets.  Good news: the money market funds had returned 10.5% each in the first seven months of 2011.  Source: Yahoo Finance.

That the fund’s top holding was one Dreyfus money market (94% of assets), the fund’s cash Hybrid must be 33%. Source: USA Today.  U.S. News and MSN both agree.

SmartMoney’s undated portfolio report shows 3.9% cash.  The Wall Street Journal’s 8/31/11 portfolio lists the Dreyfus fund at 3.02% of the portfolio.

The most striking thing is the invisibility of the error.  No editor caught it, no data specialist questioned it, no writer looked further.  It seems inevitable that given the sheer volume of information out there, you owe it to yourselves to check – and check again – on the reliability of the information you’ve received before putting your money down.

Two Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s new fund:

Manning & Napier Dividend Focus (MNDFX): Manning & Napier is likely the best management team you’ve never heard of.  Focusing on dividends is likely the best strategy to follow.  And this fund gives you the lowest cost way to combine the two.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

Pinnacle Value (PVFIX): John Deysher does micro-caps right.  Sensible, skeptical, and cash-heavy, Pinnacle Value offers a remarkably smooth version of the micro-cap ride.

Small Funds Doing Well, and Doing Good

Saturna Capital has been recognized by the Mutual Fund Education Alliance for its philanthropic efforts.  On October 27^th, they (and American Century Investments) received MFEA’s Community Investment Award for 2011.  Saturna, which advises the Sextant and Amana funds, pledged over $2.5 million toward construction of the St. Paul’s Academy Upper School.  Saturna’s leadership galvanized other constituencies in the Bellingham, Washington, community to support the project.  Their efforts played a key role in securing $6 million in bank financing and over $1 million in private donations.

The past two winners were Aberdeen Asset Management (2010) and Calvert Investments (2009).

Matthews Asia shared the award for best retail communications with Saturna.  Both Saturna’s Market Navigator newsletter and Matthews’ collection of Asia-focused newsletters, including the flagship Asia Insight, were recognized for their excellent design and content.   This is Saturna’s 15^th communication award since 2008.

Northern Funds made a series of often dramatic reductions in the fees it charges to retail investors.  They accomplished that by raising the expense waivers on three dozen funds, effective January 1, 2012. The most striking reductions include lopping 45 basis points of the expenses charged by their Emerging Markets Equity Index fund – a drop of more than half, making it less expensive than Vanguard’s offering – and 35 basis points on the Global Sustainability Index.  None of the Northern indexes will charge more than 0.30% after the changes.  Expenses on Northern’s money market funds will be cut by 10 basis points, from 0.45% to 0.35%.

Morningstar’s Halloween Tricks and Treats

Russel Kinnel, Morningstar’s director of stuff, offered up a set of “portfolio-eating zombie funds” as part of his annual Halloween review (“Yikes … These Funds Have Been Bludgeoned….” 10/31/11). He focused simply on the greatest year-to-date losses, excluding leveraged index funds.  The most ghoulish of the creatures:

1. YieldQuest Core Equity (YQCEX), down 56%.  YieldQuest, with whose adviser I had a cranky exchange when I first profiled these funds, earns a Special Dishonorable Mention for fielding three funds, in three different asset classes, each of which has lost 40% or more this year.  The other funds place 4^th and 5^th on the list of losers: 4. YieldQuest Total Return Bond (YQTRX) and 5. YieldQuest Tax Exempt Bond (YQTEX).
2. Birmiwal Oasis (BIRMX), down 55%.  Feeling a bit playful, Mr. Kinnel offers “Lesson one: Don’t invest in a fund that sounds like a tiki bar.”
3. The USX China (HPCCX), down 54% in 2011 and 14% annually for the past five years.

At #6 on Kinnel’s list is Apex Mid Cap Growth (BMCGX), down 35%, “aided” in part by a 7% expense ratio.  Apex also qualified for the Observer’s Rollcall of the Wretched (October 2011) for finishing in the bottom 25% of its peer group for the past 1, 3, 5 and 10 years plus having above average risk and high expenses.  Our happiest note about Apex:

The good news: not many people trust Suresh Bhirud with their money.  His Apex Mid Cap Growth (BMCGX) had, at last record, $293,225.  Two-thirds of that amount is Mr. Bhirud’s personal investment.  Mr. Bhirud has managed the fund since its inception in 1992 and, with annualized losses of 8% over the past 15 years, has mostly impoverished himself.

Tenth on the list is Legg Mason Capital Management Opportunity (LMOPX), down 29%.  Another Roll Call of the Wretched honoree, I noted of LMOPX, “You know you’ve got problems when trailing 91% of your peers represents one of your better recent performances.”  Alarmed at the accusation, the fund promptly settled down and now trails all of its peers (through 10/27/2011).

At the end of September, though, he offered up a basket of autumn treats: his nominees for the best funds launched in the past three years.  Kinnel highlighted 19 funds, the five which are “most ready to buy” are:

Dodge & Cox Global Stock (DODWX), “a fine bet right now.”  Low expenses, great family.

PIMCO EqS Pathfinder (PTHDX), headed by Mutual Series veterans Anne Gudefin and Chuck Lahr.

DoubleLine Total Return Bond (DBLTX).  His court trial is over and he won, but might still need to pay millions.  The one thing that the trial does make clear is that the very talented Mr. Gundlach is not a good person.  The evidence at trial paints him as an egomaniac (“I am the “A” team”), anxious to be sure no one else detracted from his glory (he had TCW meticulously remove all references to his co-manager from press mentions of his Morningstar Manager of the Year award).  Evidence not permitted at trial dealt with sexual liaisons with co-workers, drugs and porn.  I’m sure he’s as talented as he thinks he is (as for that matter is Mr. Berkowitz), but it’s hard to imagine a world in which I’d trust him with my money.

American Funds International Growth and Income (IGAAX) is “a similar story to Dodge & Cox Global.”

Hotchkis and Wiley High Yield (HWHAX) offers two former PIMCO managers running a small, good fund.

Among the funds that made both Mr. Kinnel’s list and were profiled at the Observer or at FundAlarm: Akre Focus (AKREX), Tweedy Browne Global Value II Currency Unhedged (TBCUX) and Evermore Global Value (EVGBX).

Launch alert:

Motley Fool Epic Voyage Fund launched on November 1, 2011.  It’s an international small-cap value offering, managed by the same folks who run Motley Fool Independence (FOOLX) and Great America (TMFGX) funds.  FOOLX is a global equities fund, Great America is smaller-cap domestic.  Both are above-average performers and both tend to invest broadly between market caps and styles.  $3000 investment minimum and 1.35% expenses, after waivers.

Grandeur Peak Global Opportunities (GPGOX) and Grandeur Peak International Opportunities (GPIOX) both launched October 17, 2011.  The funds are currently available directly from Grandeur Peak (http://www.grandeurpeakglobal.com or 1.855.377.PEAK), or through Schwab or Scottrade. President Eric Huefner reports that, “We expect to be available at Fidelity, Pershing, E*Trade, and various other platforms within the next few weeks.”  They’re also working with TD Ameritrade, but apparently that’s going really slow.

Former Wasatch managers Robert Gardiner and Blake Walker are attempting to build on their past success at Wasatch Global Opportunities (WAGOX) and Wasatch International Opportunities (WAIOX).  My August story, Grandeur Peaks and the road less traveled, details the magnitude (hint: considerable) of those successes.

Both funds launched with $2.00 per share prices, while the industry standard is $10.00.  Folks on the Observer’s discussion board noted the anomaly and speculated that it might be a strategy for masking volatility.  At $2.00, another change under 0.5% gets reported as “zero.”  Mr. Huefner offered a more benign explanation: “that’s what we always did at Wasatch and since we’re all from Wasatch, we decided to do it again.”

Wasatch’s rationale was symbolic: since their original offerings were all micro- to small-cap funds which would need to close with still-small asset bases, they thought the $2.00 NAV nicely reinforced the message “we’re different, we’re the small fund guys.”

Briefly Noted . . .

RiverPark Short-Term High-Yield (RPHYX) was the subject of a very positive Forbes article, entitled “For fixed-income investors, another way to beat Treasurys” (October 21 2011).  Forbes was struck by the same risk minimization that we were: “the principal, and interest payments, are virtually guaranteed.  It might not always work. But investors who can sleep at night knowing they’re holding junk bonds might be better off than investors who are barely beating inflation in the Treasury and money markets.”  The fund’s assets under management are around $25 million, up from $20 million in summer.  Almost three-quarters of that money comes from institutional investors.

T. Rowe Price Emerging Europe and Mediterranean is trying to become T. Rowe Price Emerging Europe.  Two factors are driving the change.  First, Israel was been reclassified as a “developed” market which meant that the fund eliminated its investments there.  Second, it had only limited exposure to Turkey and Egypt, which made the “and Mediterranean” designation somewhat misleading.  If shareholders (the sheep) approve, the change will become effective in March, 2012.  The fund’s manager and wretched recent record (up 15.5% annually over the past 10 years, but down 4% annually over the past five) both remain.

Meet “the New Charlie.”  Having dispatched “my Charlie” Fernandez, Bruce Berkowitz found a Fred, instead.  Fred Fraenkel joins the firm as Chief Research Officer for whom Job Number One is . . . research?  Not so much.  “As our Chief Research Officer, Fred’s first task is to find ways to better communicate with clients as to which Fairholme’s best is yet to come,” says Berkowitz.

Effective on October 18, nine Old Mutual funds disappeared into a bunch of Touchstone funds.  These include Old Mutual Analytic U.S. Long/Short Fund which melted into Touchstone U.S. Long/Short and Old Mutual Barrow Hanley Value disappeared into Touchstone Value.

Eaton Vance Global Macro Absolute Return (EAGMX) reopened to new investors on Oct. 19, 2011.  The Morningstar analyst, perhaps bewilderingly, says: “Eaton Vance Global Macro Absolute Return is like the duck on smooth water whose hidden legs are pedaling furiously under the surface.”  The data says: steadily deteriorating performance and in the basement, overall.

Eaton Vance Equity Asset Hybrid (EEAAX) will liquidate at the end of December, 2011.

Harbor Funds’ Board of Trustees announced on Halloween Day that Harbor Small Company Value Fund (HISMX) will be liquidated (and dissolved!  What a Halloween-ish image) by year’s end.  HISMX was a perfectly solid little fund (top 10% of its peer group over the past three years) that never managed to become economically sustainable.  Harbor’s ongoing need to underwrite the expenses of a $10 million fund made its death inevitable.  The Board’s assertion that this was in the best interests of the fund’s shareholders, who were holding a good investment for which Harbor offers no obvious alternative, is polite drivel.  (Thanks to TheShadow for quickly noticing, and posting, the announcement.)

In closing . . .

A million thanks to the folks who have been supporting the Observer, whether through direct contributions or by using our Amazon link.  Special thanks for the ongoing support of our Informal Economist and John S, and to the new contributors this month.  I’ve been a putz about getting out thank-you notes, but they’re coming!

As you begin planning holiday shopping, please do use – and share – the link.  It costs nothing and takes no effort, but does make a real difference.

We’re hoping that by December you’ll actually see that difference.  The Observer actually has a secret identity.  Buried beneath our quiet exterior is a really attractive, highly-functional WordPress site waiting to get out.  We haven’t had the resources before to exploit those capabilities.  But now, with the combined efforts of Anya Z., a friend of the Observer who has redesigned the site, and Chip and her dedicated staff, we’re close to rolling out a new look.  Clean, functional, and easier to use: all made possible by your moral, intellectual and financial support.

And so, as we approach the season of Thanksgiving, here’s a sincere thanks and “see ya!” to one and all.

David

Dear friends,

Welcome to fall.  I know you’re not happy.  The question is: are you buying?  You said you were going to.  “Blood in the streets.  Panic in the markets.”  As wretched as conditions are, there’s reason to pause:

By Morningstar’s calculation, every sector of the market is now selling at a discount to fair value.  Most are discounted by 20% and only two defensive sectors (utilities and consumer defensives) are even close to fair value.

Also by their calculation, the bluest chip stocks (those with “wide moats”) are priced at an 18% discount, nearly identical to the discount on junk stocks (20%).

GMO’s most recent seven-year asset class return forecasts (as of 08/31/11), have US High Quality, International Large Caps and Emerging Markets Stocks set for real (i.e., inflation-adjusted) returns of 5.8 – 7.2% per year – very close to the “normal” long-term returns on the stock market.

It’s hard and it may turn out to be insane, but you have to ask: is this the time to be running away from, or toward, the sound of gunfire?

Why Google Flu Should Be Worrying the Fund Industry Sick

The flu is A Bad Thing, for flu sufferers and society alike.  Unpleasant, expensive and potentially fatal.  If you want to find out how bad the flu is in any particular part of the country, you’ve got two choices:

contact the Centers for Disease Control and receive information that tells you about the severity of the problem a week or two ago, or

check Google Flu Trends – which reports real-time on where people are searching flu-related terms – to get an accurate read, instantly.

It turns out that when people are interested in a topic, they Google it (who knew?).  As their interest grows, the number of searches rises.  As it ebbs, search activity dries up.  Google can document trends in particular topics either worldwide, by country, region or city.  Research on the method’s usefulness as an early warning indicator, conducted jointly by researchers from Google and the Centers for Disease Control, was published in Nature.

The funny thing is that interest in flu isn’t the only thing Google can track.  For any phenomenon which is important to huge numbers of people, Google can generate a seven-year chart of the changing level of people’s interest in topic.

Which brings us to mutual funds or, more narrowly, the apparent collapse of public interest in the topic.  Here’s the continually updated Google trend chart for mutual funds:

If you want to play, you can locate the search here. There’s a second Google trend analysis here, which generated a very similar graph but different secondary search options.  (It’s geeky cool.  You’re welcome.)

That trend line reflects an industry that has lost the public’s attention.  If you’ve wondered how alienated the public is, you could look at fund flows –much of which is captive money – or you could look at a direct measure of public engagement.   The combination of scandal, cupidity, ineptitude and turmoil – some abetted by the industry – may have punched an irreparable hole in industry’s prospects.

And no, the public interest hasn’t switched to ETFs.  Add that as a second search term and you’ll see how tiny their draw is.

The problem of Alarming Funds and the professionals who sustain them isn’t merely a problem for their shareholders.  It’s a problem for an entire industry and for the essential discipline which that industry must support.  Americans must save and invest, but the sort of idiocy detailed in our next story erodes the chance that will ever happen.

Now That’s Alarming!

FundAlarm maintained a huge database of wretched funds.  Some were merely bad (or Alarming), some were astoundingly bad (Three-Alarm) and some were astoundingly bad pretty much forever (the Most Alarming, Three-Alarm funds).

While we don’t have the resources to maintain a Database of Dismal, we do occasionally scan the underside of the fund universe to identify the most regrettable funds.  This month’s scan (run 09/02/2011) looked at funds that have finished in the bottom one-fourth of their peer groups for the year so far.  And for the preceding 12 months, three years, five years and ten years.  These aren’t merely “below average.”  They’re so far below average they can hardly see “mediocre” from where they are.

There are 151 consistently awful funds, the median size for which is $70 million.  Since managers love to brag about the consistency of their performance, here are the most consistently awful funds that have over a billion in assets:

September saw dramatic moves involving the two largest mutts.

Fidelity Magellan

Fidelity removed Harry Lange as manager of Fidelity Magellan (FMAGX).  Once the largest, and long the most famous, fund in the world, Magellan seems cursed.  It’s lost over $100 billion in assets under management and has chewed up and spit out several of Fidelity’s best and brightest managers.  Those include:

Jeffrey Vinik (1992-96): Vinik was a gun-slinging manager who guided Magellan to 17% annualized returns.  In late ’95 and ’96, he made a market-timing move – selling tech, buying bonds – that infuriated the Magellan faithful.  He inherited a $20 billion fund, left a $50 billion fund (in a huff), launched a hedge fund with made 50% per year, then closed the fund in 2000.  Presumably bored, he launched another hedge fund which has half its money in ETFs and bought two professional sports franchises.

Robert Stansky (1996-2005): Stansky, a former Fidelity Growth Company (FDGRX) star, inherited a $50 billion fund and – after a decade – left a $52 billion fund behind.  Those end points mask Magellan’s huge growth to $110 billion in the late 90s and subsequent collapse.  Stansky transformed Magellan from a mid-cap to a mega-cap fund, which made sense since his prior fund, a large-growth creature, so substantially crushed the competition (13% annually at Gro Co to 10% for the peer group).  A hopeful start ended with a series of weak years and Stansky opted for retirement.  He surfaced briefly as part of an abandoned plan to launch a series of Fidelity multi-manager funds.

Harry Lange (2005-11): Lange ran Fidelity Capital Appreciation (FDCAX) for a decade before taking on Magellan, and ran Fidelity Advisor Small Cap (FSCTX) for about seven years.   Described by Morningstar as “one of Fidelity’s very best managers,” FDCAX outpaced its peers by almost 50% over his tenure.  Lange inherited a $52 billion fund and left a $17 billion one.  Early in his tenure, he dumped Stansky’s blue chip names for smaller, riskier names.  That strategy worked brilliantly for three years, and then flopped badly enough that Lange left with the fund trailing 96% of its peers over his last five years.

And now it’s Jeff Feingold’s turn.  Like all the rest, Feingold is a star.  Ran a smaller fund.  Ran it well.  And now has a chance to run Magellan into . . . well, that is the cursed question, isn’t it?  Frankly, I can’t imagine any reason to put my money at risk here.

Vanguard Asset Allocation

Morningstar said: “This fund has merit for investors who are seeking an asset-allocation vehicle for the long haul…” (Analyst Report, “This mutual fund takes full advantage of its flexibility,” 2/22/11).

Vanguard, talking plainly, said “no, it doesn’t.”  On September 30, Vanguard fired the fund’s long-time managers and announced a plan to turn the firm’s most active fund into its most passive one.  Since launch, VPAAX moved its assets between three asset classes and had the ability to park 100% of the assets into any one of the classes.  Effective October 1, the fund will move toward a static, passively-managed 60/40 stock/bond split.  By year’s end, the firm will seek approval to merge it into Vanguard Balanced Index Fund (VBINX).

Just when you thought it couldn’t get any worse

I then refined the search with the Observer’s “insult to injury” criteria: funds that combined wretched performance with above-average to high risk and above average fees.  The good news: not many people trust Suresh Bhirud with their money.  His Apex Mid Cap Growth (BMCGX) had, at last record, $293,225.  Two-thirds of that amount is Mr. Bhirud’s personal investment.  Mr. Bhirud has managed the fund since its inception in 1992 and, with annualized losses of 8% over the past 15 years, has mostly impoverished himself.

The bad news: lots of people trust Bill Miller with their money.   With over $4 billion still tied up in his Legg Mason Value (LMVTX) and Legg Mason Opportunity (LMOPX), Miller has done a lot of damage.  Value spent four of the past five years at the bottom of the large-core heap (that is, it has trailed at least 93% of its peers in each of those years) and clocks in with an annualized loss of 2.3% for the past decade.   In a bizarre vote of confidence, the Board of Legg Mason closed its American Leading Companies fund and rolled all of the assets into Value.   The fund responded by losing 16.75% of that money over the next four months (rather worse than the market or its pees).   Morningstar’s bold judgment:  “We like the management but can’t recommend this bold offering as a core holding.” (emphasis mine)

The complete Roll Call of Wretched:

Trust Us: We’re Professionals, Part One

The poor schmoos invested in these wretched funds didn’t get there alone.  They had professional assistance.   52% of all the funds in Morningstar’s database carry a sales load or other arrangement designed to compensate the financial professional who advised you to buy that fund.  By contrast 88% of all large awful funds and 70% of roll call of the wretched funds are designed to be sold by financial professionals.  (I’m confident that none of the investors or advisors in these wretches are Observer readers.)

Trust Us: We’re Professionals, Part Two

Every mutual fund is overseen by a Board of Trustees, who is responsible for making sure that the fund operates in the best interests of its shareholders.  By law, a majority of those trustees must be independent of the management company.  And, by law, the trustees must explain – publicly, in print, annually – their decision about whether to keep or fire the manager.  Those discussions appear in the fund’s annual or semi-annual report.

So how do these independent trustees justify keeping the same losers atop these truly bad funds every blessed year?  To find out, I read the Boards’ justifications for each of these funds for the past couple years.  The typical strategy: “yes, but…”  As in, “yes, the fund is bad but…”  Boards typically

1. Go to great lengths to show how careful they’ve been
2. Don’t mention how bad the fund has
3. And find one bright spot – any bright spot – as grounds for ratifying the contract and retaining their profitable spots on the board.

Here’s the Legg Mason Opportunity board at work:

The Board received and reviewed performance information for the Fund and for a group of funds selected by Lipper, an independent provider of investment company data. The Board was provided with a description of the methodology Lipper used to determine the similarity of the Fund with the funds included in the Performance Universe. The Lipper data also included a comparison of the Fund’s performance to a benchmark index selected by Lipper. The Board also received from the independent contract consultant analysis of the risk adjusted performance of the Fund compared with its corresponding Lipper benchmark index. The Board also reviewed performance information for the Fund showing rolling returns based upon trailing performance. In addition, the Directors noted that they also had received and discussed at periodic intervals information comparing the Fund’s performance to that of its benchmark index.

So, they’ve gotten a huge amount of data and have intimate knowledge of how the data was compiled.

The Board noted the Fund’s underperformance during the 3, 5 and 10 years ended June 30, 2010 and noted more recent favorable performance . . .

You’ll notice that they don’t say “The Board noted that the fund has trailed 99-100% of its peers for every trailing standard period from one to ten years.”  But it has.  Back to the board:

which resulted in first quintile performance for the one-year ended June 30, 2010.

There’s the ray of light.  The Board might have – but didn’t – note that this was a rebound from the fund’s horrendous performance in the preceding twelve months.

The Board further considered the Adviser’s commitment to, and past history of, continual improvement and enhancement of its investment process, including steps recently taken by the Adviser to improve performance and risk awareness. As a result, the Board concluded that it was in the best interest of the Fund to approve renewal of the Management and Advisory Agreements.

Each Trustee receives $132,500 annually from Legg Mason for the part-time job of “somber ratifier.”

The Alger Board of Wobblies Trustees simply hid Alger Mid Cap Growth in the crowd:

. . . the performance for the near term (periods of 1 year or less through 6/30/10) of some of the Funds (Small Cap, Growth Opportunities, Convertible) generally surpassed (sometimes by a wide margin) or matched their peer group and benchmark, while others (Mid Cap, SMid Cap, Health Sciences) generally fell short (again, sometimes by a wide margin) of those measures, and the performance of still others (Large Cap, Capital Appreciation, Balanced) was mixed . . . (emphasis added)

The Board does not, anywhere, acknowledge the fund’s above average risks.  Of the high expenses they say:

All of the Funds’ expense ratios, except those of Health Sciences Fund, exceeded their peer median. The Trustees determined that such information should be taken into account . . . [for the funds as a group] the profit margin in each case was not unacceptable.

And still, without confronting the fact that Mid-Cap Growth trails 90% of its peers (technically, 87-95% depending on which share class you’re looking at) over the past one, three, five and ten years, “The Board determined that the Funds’ overall performance was acceptable.”

Alger’s Board members receive between $74,000 – 88,000 for their work.  None, by the way, has any investment in this fund.

The most bizarre judgment, though, was rendered by the Board of the Tanaka Growth Fund:

The Board next considered the investment performance of the Fund and the Advisor’s performance.  The Board generally approved of the Fund’s performance.  The Board noted with approval the Advisor’s ongoing efforts to maintain such consistent investment discipline.

Tanaka trails 95%, 97%, 99%, 97% and 96% of its peers (in order) for 2011 YTD and the past 1, 3, 5 and 10 year periods.  Consistent, indeed.

Mutual Fund Math: Fun Facts to Figure

Folks on the Observer discussion board occasionally wonder, “how many funds are there?” The best answer to which is, “uh-huh.”

There are 21,705 funds listed in Morningstar’s database, as of 09/30/11.  But that’s not the answer since many of the funds are simply different share classes of the same product.  The Alger Mid Cap Growth Fund, lamented above, comes in 10 different packages.  Many of the American Funds (for example, American Funds AMCAP) come with 18 different share classes.

Ask the database to report only “distinct portfolios,” and the total drops to 6628.  That includes neither closed-end nor exchange-traded funds.

The average no-load fund now has 2.7 share classes (often Retail, Institutional, Advisor).  The average load-bearing fund has 4.1 classes.

Investing as monkey business

Mental Floss, a bi-monthly magazine which promises to “help you feel smart again,” declared September/October 2011 to be their money issue.  It’s a wonderful light read (did you know that the symbol for the British pound was derived from the Latin for “pound,” since one pound of silver was used to strike 240 pound coins?) that featured one fascinating article on monkeys as investors.  Researchers, interested in the question of whether our collective financial incompetence is rooted in genetics, actually taught a colony of monkeys to use money in order to buy food.

Among the findings: monkeys showed precisely the same level of loss aversion that humans do.  In rough terms, both species find losses about three times more painful than they find gains pleasurable.  As a result, the monkey pursued risk-averse strategies in allocating their funds.

Despite the pain, we, in general, do not.  Instead, we pursue risk-averse strategies after allocating our funds: we tend to buy painfully risky investments (often at their peak) and then run off howling (generally at their nadir).

Would you like some pasta with your plans?

The Wall Street Journal recently profiled investment advisors who publish weekly, monthly or quarterly newsletters as a way to keep their clients informed, focused and reassured (“Keys to Making the Write Investments,” 09/19/11).  Among the firms highlighted is Milestones Financial Planning of Mayfield, Kentucky whose owner (Johanna Turner) is a long-time reader of, and supporter of, both FundAlarm and the Observer.  In addition to her monthly “mutual fund find” feature, Johanna shares recipes (mostly recently for vegetarian spaghetti – which would be all the better with a side of meatballs).  Her most recent newsletter, and recipe, is here.

Two Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s new fund:

Mairs & Power Small Cap (MSCFX): Mairs & Power rolls out a new fund about, oh, every half century or so.  Their last launch before this was 1961.  The firm specializes in long-term, low-turnover, low-flash investing.  Their newest fund, a pure extension of the Mairs & Power Growth Fund discipline, is sure to appeal to fans of The Newhart Show, fly-tying, the Duluth Trading Company and other sensible, sensibly-paced pursuits.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

SouthernSun Small Cap Fund (SSSFX): measured as a small-cap value fund, SSSFX has been one of the two top in the field lately.  But it’s actually more of a smid-cap core fund.  And, surprisingly, it’s also one of the top two funds there, too.  With an incredibly compact, high-quality portfolio and low-turnover style, it’s surprising so few have heard of it.

Launch alert:

Grandeur Peak Global Opportunities and Grandeur Peak International Opportunitiesboth launch October 17, 2011.

Former Wasatch managers Robert Gardiner and Blake Walker are attempting to build on their past success with  Wasatch Global Opportunities (WAGOX) and Wasatch International Opportunities (WAIOX).  My August story, Grandeur Peaks and the road less traveled, details the magnitude (hint: considerable) of those successes.

Briefly Noted . . .

SEC time travel continues.  The SEC’s current filings page for September 6 contained 62 prospectus filings – of which precisely two are for September 6.  The other 60 had originally been filed as early as October 14, 2010.  Still no explanation for why “today’s filings” include 14 month old filings.

Effective November 4, Nakoma Absolute Return (NARFX) will become Schooner Global Absolute Return Fund.   Very few details are available, but since the change did not require shareholder approval, it seems likely that the Nakoma team and objectives will – for better and worse – remain in place.

In another sign of the direction in which the marketing winds are blowing, Jensen Fund (JENSX) is changing its name to Jensen Quality Growth Fund.

Federated Balanced Allocation (BAFAX) will merge into Federated Asset Allocation (FSTBX) on Sept. 30, 2012.

Value Line Convertible (VALCX) will merge into Value Line Income & Growth (VALIX) on Dec. 16, 2011.

GMO will liquidate GMO Tobacco-Free Core Fund (GMTCX) at the end of December, 2011 and GMO Tax-Managed U.S. Equities Fund (GTMUX) at the end of October, 2011.

Munder Asset Allocation Balanced (MUBAX) will liquidate on Oct. 14.

Invesco Van Kampen Global Tactical Asset Allocation (VGTAX) will liquidate on Oct. 28.  Despite an exceptionally solid record and an exceptionally trendy name, the fund drew only $21 million in assets in just under three years and so it’s a deadster.

Four small Highmark Funds (did you even know there were Highmark funds?) will be merged out of existence in October, 2011.  The dead funds walking are HighMark Fundamental Equity (HMFAX), HighMark Small Cap Value (HMSCX), HighMark Diversified Equity Allocation (HEAAX) and HighMark Income Plus Allocation (HMPAX).

Allianz RCM Global Resources (ARMAX) is now Allianz RCM Global Commodity Equity.  Alec Patterson joined as co-manager.

In closing . . .

Dwindling consumer confidence is reflected in the Observer’s Amazon revenue, which drifted down by a third from August to September.  If you’ve looking to a particularly compelling purchase, consider picking up a copy of Baumeister and Tierney’s Willpower: Rediscovering the Greatest Human Strength (Penguin, 2011).  Roy Baumeister is an Eminent Scholar (really, that’s part of his official title) doing research in social psychology at Florida State.  John Tierney is a very skilled science journalist with The New York Times.  I first heard about Baumeister’s research in a story on National Public Radio, picked up the book and have found it pretty compelling.  Here’s a précis of their argument:

• Willpower is central to success in life,
• You have a limited supply of it, so that exercising will in one area (quitting smoking) leaves you powerless to cope with another (controlling your diet) but
• Your stock of willpower can be quickly and substantially increased through exercise.

The implications of this research, from how we invest to how we teach our children, are enormous.  This is a particularly readable way into that literature.

That said, a number of people contributed to the Observer through our PayPal link in September and I’d especially like to thank Old_Joe and CathyG for their continuing support, both financial and intellectual.  Thanks, guys!

Speaking of support, we’ve added short biographies of the two people who do the most to actually make the site function: Accipiter and Chip.  If you’d like to learn just a bit more about them and their work here, it’s in the About Us section.

Keep those cards and letters coming!  We appreciate them all and do as much as we can to accommodate your insights and concerns.

Be brave – October is traditionally one of the two scariest months for the stock market – and celebrate the golden hues of autumn.  I’ll see you again just after Halloween!

With respect,

David

Dear friends,

Almost all of the poems about the end of summer and beginning of fall are sad, wistful things.  They’re full of regrets about the end of the season of growth and crammed with metaphors for decline, decay, death and despair.

It’s clear that poets don’t have investment portfolios.

The fact that benchmarks such as the Dow Jones Industrial average and Vanguard Total Bond Market are both showing gains for the year masks the trauma that has led investors to pull money out of long-term funds for six consecutive weeks.  Whether having the greatest outflows since the market bottom in March 2009 is a good thing remains to be seen.

Roller coasters are funny things.  They’re designed to scare the daylights out of you, and then deposit you back exactly where you started.  It might be a sign of age (or, less likely, wisdom) that I’d really prefer a winding garden path or moving walkway to the thrills now on offer.

The Latest Endangered Species: Funds for Small Investors

Beginning in the mid-1990s, I maintained “The List of Funds for Small Investors” at the old Brill/Mutual Funds Interactive website.  I screened for no-load funds with minimums of $500 or less and for no-load funds that waived their investment minimums for investors who were willing to start small but invest regularly.  That commitment was made through an Automatic Investing Plan, or AIP.

At the time, the greatest challenge was dealing with the sheer mass of such funds (600 in all) and trying to identify the couple dozen that were best suited to new investors trying to build a solid foundation.

Over the years, almost all of those funds ceased to be “funds for small investors.”  Some closed and a fair number added sales loads but the great majority simply raised their investment minimums.  In the end, only one major firm, T. Rowe Price, persevered in maintaining that option.

And now they’re done with it.

Effective on August 1, Price eliminated several policies which were particularly friendly to small investors.  The waiver of the minimum investment for accounts with an Automatic Asset Builder (their name for the AIP) has been eliminated. Rather than requiring a $50 minimum and $50/month thereafter, AAB accounts now require $2500 minimum and $100/thereafter.

The minimum subsequent investment on retail accounts was raised from $50 to $100.

The small account fee has been raised to $20 per account under $10,000. The fee will be assessed in September. You can dodge the fee by signing up for electronic document delivery.

Price changed the policies in response to poor behavior on the part of investors. Too many investors started with $50, built the account to $300 and then turned off the asset builder. Price then had custody of a bunch of orphaned accounts which were generating $3/year to cover management and administrative expenses.  It’s not clear how many such accounts exist. Bill Benintende, one of Price’s public relations specialists, explains “that’s considered proprietary information so it isn’t something we’d discuss publicly.”  This is the same problem that long-ago forced a bunch of firms to raise their investment minimums from $250- 500 to $2500.

Two groups escaped the requirement for larger subsequent investments.  Mr. Benintende says that 529 college savings plans remain at $50 and individuals who already have operating AAB accounts with $50 investments are grandfathered-in unless they make a change (for example, switching funds or even the day of the month on which an investment occurs).

That’s a real loss, even if a self-inflicted one, for small investors.  Nonetheless, there remain about 130 funds accessible to folks with modest budgets and the willingness to make a serious commitment to improving their finances.  By my best reading, there are thirteen smaller fund families and a half dozen individual funds still taking the risk of getting stiffed by undisciplined investors.  The families willing to waive their normal investment minimums are:

There are, in addition, a number of individual funds with minimums reduced or waived for folks willing to commit to an automatic investment.  Those include Barrett  Opportunity (SAOPX), Cullen High Dividend Equity (CHDEX), Giordano (GIORX), Primary Trend (PTFDX), Sector Rotation (NAVFX), and Stonebridge Small Cap Growth (SBAGX).

On a related note: Fidelity would like a little extra next year

Fidelity will begin charging an “annual index fund fee” of $10.00 per fund position to offset shareholder service costs if your fund balance falls below $10,000, effective December 2011.  They’re using the same logic: small accounts don’t generate enough revenue to cover their maintenance costs.

The Quiet Comeback of Artisan Small Cap (ARTSX)

The second fund in which I ever invested (AIM Constellation was the first) was Artisan Small Cap (ARTSX). Carlene Murphy Ziegler had been a star manager at Stein, Roe and at Strong.  With the support of her husband, Andrew, she left to start her own fund company and to launch her own fund.  Artisan Small Cap was a solid, mild-manned growth-at-a-reasonable price creature that drew a lot of media attention, attracted a lot of money, helped launch a stellar investment boutique, and quickly closed to new investors.

But, somewhere in there, the fund got out of step with the market.  Rather than being stellar, it slipped to okay and then “not too bad.”  It had some good years and was never terrible, but it also never managed to have two really good years back-to-back.  The firm added co-managers including Marina Carlson, who had worked so successful with Ziegler at the Strong Funds.  Ziegler stepped aside in 2008 and Carlson in 2009.

At that point, manager responsibilities were given to Andrew Stephens and the team that runs Artisan Mid Cap Fund (ARTMX).  ARTMX has posted remarkably strong, consistent results for over a decade.  It’s been in the top 10-15% of midcap growth funds for the past 1, 3, 5 and 10 year periods.  It has earned four or five star ratings from Morningstar for the past 3, 5, and 10 year periods.

Since taking over in October 2009, ARTSX has outperformed its peers.  $10,000 invested on the day the new team arrived would have gain to $13,900, compared to $13,100 at its peers.   Both year to date and for the three, turbulent summer months, it’s in the top 2% of small growth funds.  It has a top 5% record over the past year and top 15% over the past three.

Artisan has a very good record of allowing successful teams to expand their horizons. Scott Satterwhite’s team from Artisan Small Cap Value (ARTVX) inherited Artisan Mid Cap Value (ARTQX) and the large cap Artisan Value (ARTLX) funds, and has reproduced their success in each.  The same occurred with the Artisan International Value team running Artisan Global Value and Artisan International running Artisan International Small Cap.

Given that track record and the fund’s resurgence under the Stephen’s team, it might be time to put Artisan Small Cap back on the radar.

Fund Update: RiverPark Short-Term High Yield

We profiled RPHYX in July as one of the year’s most intriguing new funds. It’s core strategy – buying, for example, called high yield bonds – struck me “as a fascinating fund.  It is, in the mutual fund world, utterly unique . . .  And it makes sense.  That’s a rare and wonderful combination.”

The manager, David Sherman of Cohanzick Management, has been in remarkably good spirits, if not quite giddy, because market volatility plays into the fund’s strengths.  There are two developments of note.

The manager purchased a huge number of additional shares of RPHYX after the market rout on Monday, August 8.  (An earlier version of this note, on the Observer’s discussion board, specified an amount and he seemed a bit embarrassed by the public disclosure so I’ve shifted to the demure but accurate ‘huge number’ construction.)

The fund’s down about 0.4% since making its monthly distribution (which accounts for most of its NAV changes). For those keeping score, since August 1, Fidelity Floating Rate High Income (FFHRX, a floating-rate loan fund that some funds here guessed would parallel RiverPark) is down 4%, their new Global High-Income fund (FGHNX) is down 5% and Fidelity High Income (SPHIX) is down 4.5%.

Fortunately, the fund generates huge amounts of cash internally. Because durations are so short, he’s always got cash from the bonds which are being redeemed. When we spoke on August 10^th, he calculated that if he did nothing at all with the portfolio, he’d get a 6% cash infusion on August 16, a 10% infusion on August 26th, and cash overall would reach 41% of the portfolio in the next 30 days. While he’s holding more cash than usual as a matter of prudent caution, he’s also got a lot to buy with.

And the market has been offering a number of exceptional bargains. He pointed to called HCA bonds which he first bought on July 27 at a 3.75% annualized yield. This week he was able to buy more at a 17% yield. Since the bonds would be redeemed at the end of August by a solidly-profitable company, he saw very little risk in the position. Several other positions (Las Vegas Sands public preferred and Chart Industries convertibles) have gone from yielding 3-3.5% to 5-6% available yields in the last two weeks.

He was also shortening up the portfolio to take advantage of emerging opportunities. He’s selling some longer-dated bonds which likely won’t be called in order to have more cash to act on irrational bargains as they present themselves. Despite an ultra-short duration, the fund is now yielding over 5%. The Fed, meanwhile, promises “near zero” interest rates for the next two years.

Mr. Sherman was at pains to stress that he’s not shilling for the fund. He doesn’t want to over-promise (this is not the equivalent of a savings account paying 5%) and he doesn’t want to encourage investors to join based on unrealistic hopes of a “magic” fund, but he does seem quite comfortable with the fund and the opportunity set available to him.

Note to the Securities and Exchange Commission: Hire a programmer!

Every day, the SEC posts all of its just-received filings online and every day I read them.  (Yep.  Really gotta get a life.) Here is a list of all of today’s prospectus filings.  In theory, if you visit on September 1^st and click on “most recent,” you’ll get a screen full of filings dated September 1^st.

Except when you don’t.  Here, for example, is a screen cap of the SEC new filings for August 22, 2011:

Notice how very far down this list you have to go before finding even one filing from August 22^nd (it’s the ING Mutual Funds listing).  On July 25th, 43 of 89 entries were wrong (including one originally filed in 2004).

Two-thirds of all Wall Street trades emanate from high-frequency traders, whose computers execute trades in 250 microseconds (“Not So Fast,” The Economist, 08/06/11).  Those trades increase market volatility and asset correlations, to the detriment of most investors.  The SEC’s difficulty in merely getting the date right on their form postings doesn’t give me much confidence in their ability to take on the problems posed by technology.

Four Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s two new funds:

RiverPark/Wedgewood (RWGFX): David Rolfe makes it seem so simple.  Identify great companies, buy only the best of them, buy only when they’ve on sale, and hold on.  For almost 19 years he’s been doing to same, simple thing – and doing it with unparalleled consistency and success.  His strategy is now available to retail investors.

Walthausen Select Value (WSVRX): the case for this focused small- to mid-cap fund is simple.  Manager John Walthausen has performed brilliantly with the last three funds he’s run and his latest fund seeks to build on one of those earlier models.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

Northern Global Tactical Asset Allocation (BBALX): up until August 1^st, you could access to the best ideas of Northern Investment Policy Committee only if you had $5 million to meet this fund’s minimum or $500 million in assets at Northern.  And then it became a retail fund ($2500) with an institutional pedigree and expenses (0.68%).  Folks looking for a conservative core fund just stumbled onto a really solid option.

Walthausen Small Cap Value (WSCVX): we profiled this fund shortly after launch as one of the year’s best new funds.  Three years on, it’s running rings around its competition and starting to ask about when it will be necessary to close to new investors.  A somewhat volatile choice, it has produced remarkable results.

Briefly noted . . .

Berwyn Income (BERIX) will reopen to new investors on Sept. 19. The $1.3 billion fund closed in November 2010, but says the board, “recent volatility in the market has led to new investment opportunities for the Fund.”  BERIX makes a lot of sense in turbulent markets: modest stake in dividend-paying stocks and REITs, plus corporate bonds, preferred shares, convertibles and a slug of cash.  Lots of income with some prospect for capital growth.  The fund more than doubled in size between 2008 and 2009, then doubled in size again between 2009 and 2010.  At the end of 2008, it was under $240 million.  Today it carries a billion more in heft.  Relative performance has drifted down a bit as the fund has grown, but it remains really solid.

Fidelity is bringing out two emerging market funds in mid-October. The less interesting, Emerging Markets Discovery, will be their small- to mid-cap fund. Total Emerging Markets will be a 60/40 balanced fund. The most promising aspect of the balanced fund is the presence of John Carlson, who runs New Markets Income (FNMIX) at the head of the management team.  FNMIX has a splendid long-term record (Carlson’s been there for 16 years) but it’s currently lagging because it focuses on dollar-denominated debt rather than the raging local currency variety.  Carlson argues that local currencies aren’t quite the safe haven that newbies believe and that, in any case, they’re getting way overvalued.  He’ll have a team of co-managers who, I believe, run some of Fidelity’s non-U.S. funds.  Fido’s emerging markets equity products have not been consistently great, so investors here might hope for index-like returns and a much more tolerable ride than a pure equity exposure would offer. The opening expense ratio will be 1.4% and the minimum investment will be $2500.

Northern Funds are reducing the operating expenses on all of their index funds, effective January 1, 2012.  The seven funds involved are:

Nicely done!

Forward Management introduced a new no-load “investor” share class for Forward International Real Estate Fund (FFIRX), the Forward Real Estate Long/Short Fund (FFSRX), and the Forward Global Infrastructure Fund (FGLRX). Forward Real Estate (FFREX) already had a no-load share class.  The funds are, on whole, respectable but not demonstrably great. The minimum investment is $4,000.

DWS Strategic Income (KSTAX) becomes DWS Unconstrained Income on Sept. 22, 2011. At that point, Philip Condon will join the management team of the fund.  “Unconstrained” is the current vogue term for income funds, with PIMCO leading the pack by offering unconstrained Bond (also packaged as Harbor Unconstrained Bond), Tax-Managed Bond and Fixed Income funds.  All of them have been underperformers in their short lives, suggesting that the ability to go anywhere doesn’t immediately translate into the wisdom to go somewhere sensible.

Litman Gregory Asset Management has renamed its entire line of Masters’ Select funds as Litman Gregory Masters Funds name.

PIMCO Developing Local Markets (PLMIX) has changed its name to PIMCO Emerging Markets Local Currency, presumably to gain from the “local currency debt” craze.

Dreyfus S&P Stars Opportunities (BSOBX) will change its name to Dreyfus MidCap Core on Nov. 1, 2011.

DWS RREEF Real Estate Securities (RRRRX) will close Sept. 30, 2011.

JPMorgan U.S. Large Cap Core Plus (JLCAX) closed to new investors on Sept. 2, 2011.

Scout TrendStar Small Cap (TRESX) is merging into Scout Small Cap (UMBHX).

MFS Core Growth (MFCAX) merged into MFS Growth (MFEGX) in August.

Effective Sept. 15, 2011, GMO Global Balanced Asset Allocation Fund (GMWAX) will be renamed GMO Global Asset Allocation Fund and it will no longer be bound to keep at least 25% each in stocks and bonds.

Forward Funds is changing Forward Large Cap Equity (FFLAX), a mild-mannered fund with a slight value bias, into Forward Large Cap Dividend Fund.  After November 1, at least 80% of the portfolio will be in . . . well, large cap, dividend-paying stocks.   Not to rain on anybody’s parade, but all of its top 25 holdings are already dividend-paying stocks which implies marketing rather than management drove the change.

Likewise, Satuit Capital Micro Cap has been changed to the Satuit Capital U.S. Emerging Companies Fund (SATMX).   The Board hastened to assure shareholders that the change was purely cosmetic: “there are no other changes to the Fund being contemplated as a result of this name change.”  Regardless, it’s been a splendid performer (top 1% over the past decade) with an elevated price tag (1.75%)

DWS Climate Change (WRMAX) becomes DWS Clean Technology on October 1, 2011.

A few closing notes . . .

We’re very pleased to announce the launch of The Falcon’s Eye.  Originally written by a FundAlarm board member, Falcon, the Eye provides a quick and convenient link to each of the major profiles for any particular fund.  Simply click on “The Falcon’s Eye” link on the main menu bar atop this page and enter one or more ticker symbols.  A new windows pops up, giving the fund name and direct links to ten major source of information:

And, of course, the Observer itself.

Mark whichever sources interest you, click, and the Eye will generate direct links to that site’s profile of or reporting on your fund.  Thanks to Accipiter for his tireless work on the project, and to Chip, Investor, Catch22 and others for their support and beta testing of it.  It is, we think, a really useful tool for folks who are serious about understanding their investments.

Thanks to all of you for using or sharing the Observer’s link to Amazon.com, which is providing a modest but very steady revenue stream.  Special thanks for the folks who’ve chosen to contribute to the Observer this month and, especially, to the good folks at Milestones Financial Planning in Kentucky for their ongoing support.  We’re hoping for a major upgrade in the site’s appearance, in addition to the functionality upgrades that Chip and Accipiter have worked so faithfully on.

Looking for the archive? There is an archive of all Observer and later FundAlarm commentaries, links to which usually appear at the top of this page. This month we encountered a software glitch that was scrambling the list, so we’ve temporarily hidden it. Once out tech folks have a chance to play with the code, it’ll be back where it belongs. Thanks for your patience!

Keep those cards and letters, electronic or otherwise, coming.  I love reading your thoughts.

See you in October!

David

Dear friends,

The folks in Washington are, for the most part, acting like six-year-olds who missed their nap times.  The New York Fed is quietly warning money market managers to reduce their exposure to European debt.  A downgrade of the federal government’s bond rating seems nearly inevitable. The stock market managed only one three-day set of gains in a month.

In short, it’s summer again.

Grandeur Peak and the road less traveled

A team of managers, led by Robert Gardiner, and executives left Wasatch Advisors at the end of June 2011 to strike out on their own.  In mid July they announced the formation of Grandeur Peak Global Advisors and they filed to launch two mutual funds.  The new company is immediately credible because of the success that Mr. Gardiner and colleague Blake Walker had as Wasatch managers.

Robert Gardiner managed or co-managed Wasatch Microcap (WMICX), Small Cap Value (WMCVX) and Microcap Value (WAMVX, in which I own shares).  In 2007, he took a sort of sabbatical from active management but continued as Director of Research.  During that sabbatical, he reached a couple conclusions: (1) global microcap investing was the world’s most interesting sector and (2) he’d like to manage his own firm.  He returned to active management with the launch of Wasatch Global Opportunities (WAGOX), a global micro-to small-cap fund.  From inception in late 2008 to July 2011, WAGOX turned a $10,000 investment into $23,500 while an investment in its average peer would have led to a $17,000 portfolio.  Put another way, WAGOX earned $13,500 or 92% more than its average peer managed.

Blake Walker co-managed Wasatch International Opportunities (WAIOX) from 2005-2011.  The fund was distinguished by outsized returns (top 10% of its peer group over the past five years, top 1% over the past three), and outsized stakes in emerging markets (nearly 50% of assets) and micro- to small-cap stocks (66% of assets, roughly twice what peer funds have).  In March 2011, Lipper designated WAIOX as the top International Small/Mid-Cap Growth Fund based on consistent (risk-adjusted) return for the five years through 2010. In March 2009, it had received Lipper’s award for best three-year performance.

Wasatch published an interesting paper on the ongoing case for global small and micro-cap investing, “Think International, Think Small” (January 2011).

Gardiner had talked with Wasatch about starting his own firm for a number of years. At age 46, he decided that it was time to pursue that dream. Grandeur Peak’s president, Eric Huefner described the eventual departure of Gardiner & co. as “very friendly,” and he stressed the ongoing ties between the firms.  The fact that Grandeur Peak is one of the most visible mountains in the Wasatch Range, one does get a sense of amity.

According to SEC filings and pending SEC approval, Grandeur Peaks will launch two funds at the beginning of October: Global Opportunities and International Opportunities.  Both will be managed jointed by Messrs. Gardiner and Walker. The short version:

Grandeur Peak Global Opportunities will seek long-term growth by investing, primarily, in a small- and micro-cap global portfolio.  The target universe is stocks valued under $5 billion, though up to one-third of the portfolio might be invested in worthy, larger firms.  Emerging markets exposure will range from 5-50%.   The minimum investment will be $2000, reduced to $1000 for funds with an automatic investment plan.  Expenses will be capped at 1.75% with a 2% redemption fee on shares held for 60 days or less.

Grandeur Peak International Opportunities will seek long-term growth by investing, primarily, in a small- and micro-cap international portfolio.  The target universe is stocks valued under $2.5 billion.  Emerging markets exposure will range from 10-60%.   As with Global, the minimum investment will $2000, reduced to $1000 for funds with an automatic investment plan, and expenses will be capped at 1.75% with a 2% redemption fee on shares held for 60 days or less.

Global’s investment strategies closely parallel Wasatch Global’s.  International differs from its Wasatch counterpart in a couple ways: its target universe has a higher cap ($1 billion for Wasatch, $2.5 billion for Grandeur) and it has a bit more wiggle room on emerging markets exposure (20-50% for Wasatch, 10 – 60% for Grandeur).

A key difference is that Grandeur intends to charge substantially less for their funds.  Both of the new funds will have expenses capped at 1.75%, while the Wasatch funds charge 1.88 and 2.26% for International and Global, respectively. That expense cap represents a substantial and, I’m sure, well considered risk for Grandeur.  Small global funds cost a lot to run.  A fund’s actual expenses are listed in its annual report to shareholders.  There are a couple dozen no-load, retail global funds with small asset bases.  Here are the asset bases and actual expenses for a representative sample of them:

Advisory Research Global Value (ADVWX), $13 million in assets, 5.29% in expenses

Artisan Global Equity (ARTHX), $15 million, 1.5%

Alpine Global Infrastructure (AIFRX ), $12 million , 3.03%

Chou Equity Opportunity (CHOEX), $24 million, 28.6%

Commonwealth Global (CNGLX), $15 million, 3.02%

Encompass (ENCPX), $25 million, 1.45%

Jubak Global Equity (JUBAX), $35 million, 5.43%

Roge Partners (ROGEX), $13.5 million, 2.46%

Unlike many start-ups, Grandeur has chosen to focus initially on the mutual fund market, rather than managing separate accounts or partnerships for high net worth individuals and institutions.

Mr. Gardiner is surely familiar with Robert Frost’s The Road Not Taken, from which we get the endlessly quoted couplet, “Two roads diverged in a wood, and I— I took the one less traveled by.”  From microcap growth investing to international microcaps to launching his own firm, he’s traveled many “paths less traveled by.” And he’s done it with consistent success.  I wish him well with the launch of Grandeur Peaks and hope to speak with one or another of the managers after their funds launch in October.

And yet I’m struck by Frost’s warning that his poem was “tricky, very tricky that one.”  Americans uniformly read the poem to say “I took the road less traveled and won as a result.”  In truth, the poem says no such thing and recounts a tale told, many years later, “with a sigh.”

Fund Update: RiverPark Short Term High Yield (RPHYX)

Like Grandeur Peak, RiverPark Advisors grew from the decision of high-profile executives and managers to leave a well-respected mid-sized fund company.  Morty Schaja, president of Baron Asset Management, left with an investment team in 2009 to found RiverPark.  The firm runs two small funds (RiverPark Small Cap Growth RPSFX and Large Cap Growth RPXFX) and advises three other, sub-advised funds.

I profiled (and invested in) RiverPark Short Term High Yield, one of the sub-advised funds, in July.  The short version of the profile is this: RPHYX has the unique and fascinating strategy (investing in called high yield bonds, among other things) that allows it to function as a cash management fund with a yield 400-times greater than the typical money market.  That profile engendered considerable discussion and a number of reader questions.  The key question is whether Cohanzick, the adviser, had the strategy in place during the 2008 meltdown and, if so, how it did.

Mr. Schaja was kind enough to explain that while there wasn’t a stand-alone strategy in 2008, these investments did quite well as part of Cohanzick’s broader portfolios during the turmoil.  He writes?

Unfortunately, the pure separate accounts using this strategy only began in 2009, so we have to look at investments in this strategy that were part of larger accounts (investing the excess cash).   While we can’t predict how the fund may perform in the hypothetical next crisis, we take comfort that in 2008 the securities performed exceedingly well.  As best as we can tell there were some short term negative marks as liquidity dried up, but no defaults.  Therefore, for those investors that were not forced to sell, within weeks and months the securities matured at par.   Therefore, under this hypothetical scenario, even if the Fund’s NAV fell substantially over a few days because markets became illiquid and pricing difficult, we would expect the Fund’s NAV would rebound quickly (over a few months) as securities matured.  If we were lucky enough to receive positive flows into the Fund in such an environment, the Fund could take advantage of short term volatility to realize unusually and unsustainable significantly higher returns.

One reader wondered with RPHYX would act rather like a floating-rate fund, which Mr. Schaja rather doubted:

In an environment where default risk is of primary concern, we would expect the Fund to compare favorably to a floating rate high income fund.   While floating rate funds protect investors from increasing interest rates they are typically invested in securities with longer maturities and therefore inherently greater default risk.   Additionally, the Fund is focused not only on securities with limited duration but where Cohanzick believes there is limited risk of default in the short period until the time in which it believes the securities will either mature or be redeemed.

It is striking to me that during the debt-related turmoil of the last weeks of August, RPHYX’s net asset value never moved: it sold for $9.98 – 10.01 with most of the change accounted for by the fund’s monthly income distribution.  It remains, in my mind, a fascinating option for folks distraught by money market funds taking unseen risks and returning nothing.

Fund Update: Aston/River Road Independent Value

One of my last FundAlarm profiles celebrated the launch of Aston/River Road Independent Value (ARIVX) was “the third incarnation of a splendid, 15-year-old fund.”  Eric Cinnamond, the manager here and formerly of Intrepid Small Cap (ICMAX), has an outstanding record for investing in small and midcap stocks while pursuing an “absolute return” strategy.  He hates losing money and does it rarely.  The bottom line was, and is, this:

Aston / River Road Independent Value is the classic case of getting something for nothing. Investors impressed with Mr. Cinnamond’s 15 year record – high returns with low risk investing in smaller companies – have the opportunity to access his skills with no higher expenses and no higher minimum than they’d pay at Intrepid Small Cap. The far smaller asset base and lack of legacy positions makes ARIVX the more attractive of the two options. And attractive, period.

Mr. Cinnamond wrote at the end of July with a series of updates on his fund.

Performance is outstanding.  The fund is up 8% YTD, through the end of July 2011.  In the same period, his average peer is up 1.3% and ICMAX (his former fund) is up 0.73%. Eric notes that, “The key to performance YTD has been our equity performance and limiting mistakes. Although this is too short of a period to judge a Fund, it’s ideally our ultimate goal in this absolute return strategy — limit mistakes and require an adequate return given the risk of each small cap equity investment.”

The portfolio is half cash, 48% at the end of the second quarter.  Assuming that the return on cash is near-zero, that means that his stocks have returned around 16% so far this year.

Money is steadily flowing in.  He notes, “We are now at $265 million after seven months with good flows and a healthy institutional pipeline.”  He plans to partially close the fund at around $800 million in assets.

The fund is more attractive to advisors than to institutions, though it should be quite attractive to bright individual investors as well.  The problem with institutions, he believes, is that they’re more style-box bound than are individual advisors.  “The absolute return strategy requires flexibility so it doesn’t fit perfectly in the traditional institutional consultant style box.  For most consultants, the Independent Value strategy would not be used as their core small cap allocation as it has above average tracking error.  For the most part, advisors seem to be less concerned about the risk of looking different than a benchmark and are more concerned about protecting their private clients’ capital…so it’s a nice fit.”

On the bigger picture issues, Eric is “hopeful volatility increases in the near future — ultimately creating opportunity.”  He notes that the government’s “printing party” has inflated the earnings of a lot of firms, many of them quite marginal.  He’s concerned with valuation distortions, but comfortable that patience and discipline will, now as ever, see him through.

Cash Isn’t Trash (but it’s also not enough)

ARIVX is not alone in holding huge cash reserves this year, but it is alone in profiting from it. There are 75 retail, no-load funds which were holding at least 40% in cash this year.  ARIVX has the best YTD returns (7.92%) followed by Merk Hard Currency (MERKX) at 7.46% with several dozen cash-heavy funds under water so far this year.  The great bulk of those funds have returned between 1-3% while the (volatile) Total U.S. Market index is up 4% (as of July 29, 2011). Notable cash-heavy funds include

Hussman Strategic Total Return (HSTRX), an always-defensive mix of bonds, foreign currencies, cash and precious-metals exposure.   Five stars, up 2.3% YTD.

Intrepid Small Cap (ICMAX), Mr. Cinnamond’s previous fund, now run by the very competent team that almost handles Intrepid Capital (ICMBX). Five stars, up 0.73%.

Pinnacle Value (PVFIX), John Deysher’s perennially cash-heavy microcap value fund.  Five stars, down 1.7%.

Forester Discovery (INTLX), international sibling to the only equity fund to have made money in 2008.   Four stars, up 2.3%.

Congressional Effect Fund (CEFFX), a three-star freak that goes entirely to cash whenever Congress is in session.  800% portfolio turnover, 2.3% returns.

Harbor Bond (HABDX), a clone of the titanic PIMCO Total Return (PTTRX) fund.  Bill Gross is nervous, having raised cash and cut risk.  Five stars, up 4%.

Morningstar’s Hot on My Heels!

Morningstar ran a couple essays this month that reflect issues that the Observer took up earlier.

Russel Kinnel, Morningstar’s director of mutual fund research, felt the urge to “get really contrarian” and look at four of the smallest funds in the Morningstar 500 (“Four Tiny but Potent Mutual Funds,” 08/01/2011).  They’re described as “being ignored by fund investors, but they’ve really got a lot to like.”  Three of the four have been profiled here, while (WHG Balanced) the fourth has a $100,000 minimum investment.   That’s a bit rich for my budget.

The funds, with links to the Observer’s profiles, are:

Queens Road Small Cap Value (QRSVX):  “Manager Steve Scruggs has done a great job of deep value investing . . . Its return on $10,000 since that time is $25,500 versus $20,100 for the average small-value fund.”

Ariel Focus (ARFFX): “Can Ariel’s emphasis on stable, low-valuation companies work in a focused large-cap fund? I think so. The emphasis on stability has kept volatility roughly in line with other large-blend funds despite the concentration.”

Masters Select Focused Opportunities (MSFOX): “Now, this fund really counts as contrarian. It has a Morningstar rating of 1 star, and its 20-stock portfolio has added up to high risk . . . [They have several excellent sub-advisers who have had a long stretch of poor performance.] That’s not likely to continue, and this fund could well have a bright future.”  My concern when MSFOX launched was that taking six ideas from each of three teams might not get you the same results that you’d get if any of the sub-advisers had the option to construct the whole portfolio.  That still seems about right.

WHG Balanced (WHGBX): “. . . a virtual clone, GAMCO Westwood Balanced (WEBAX), dates back to 1991, and Mark Freeman and Susan Byrne have a strong record over that period. Moreover, it’s conservatively positioned with high-quality stocks and high-quality bonds.”

In Investors Behaving Badly, analyst Shannon Zimmerman fretted about the inability of investors to profit from the “wildly volatile yet in some ways utterly predictable performance” performance of Fidelity Leveraged Company Stock fund (FLVCX). Manager Tom Soviero buys the stock of the kinds of companies which have been forced to issue junk bonds.  Zimmerman notes that the fund has some of the industry’s strongest returns over the decade, but that it’s so wildly volatile that very few investors have held on long enough to benefit: “in all trailing periods of three or more years, [the fund’s investor returns] rank among the peer group’s worst.”  In closing, Zimmerman struck a cautious, balanced note:

As an analyst, I try to square the vicious circle outlined above by giving Soviero credit where it’s due but encouraging prospective buyers, not to beware, but to be aware of the fund’s mandate and its penchant for wild performance swings.

The Observer highlighted the same fund in May 2011, in “Successor to ‘The Worst Best Fund Ever’.”  We were growling about a bunch of fawning articles about “The Decade’s Best Stock Picker,” almost none of which confronted the truth of the matter: wildly volatile funds are a disaster.  Period.  Their excellent returns don’t matter because (1) 90% of their investors flee at the worst possible moment and (2) the remainder eat the resulting tax bill and performance distortions.  We concluded:

People like the idea of high-risk, high-return funds a lot more than they like the reality of them. Almost all behavioral finance research finds the same dang thing about us: we are drawn to shiny, high-return funds just about as powerfully as a mosquito is drawn to a bug-zapper.

And we end up doing just about as well as the mosquito does.

Two Funds and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s two new funds:

T. Rowe Price Global Infrastructure (TRGFX): governments around the world are likely to spend several trillion dollars a year on building or repairing transportation, power and water systems.  Over the past decade, owning either the real assets (that is, owning a pipeline) or stock in the asset’s owners has been consistently profitable.  Price has joined the dozen or so firms which have launched funds to capitalize on those large, predictable investments.  It’s not clear that rushing in, here or in its peers, is called for.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.

Marathon Value (MVPFX): Marathon is the very archetype of a “star in the shadows.”  It’s an unmarketed, friends-and-family fund that exists to give smaller stakeholders access to the adviser’s stock picking.  The fund has a nearly unparalleled record for excellent risk-managed returns over the decade and it’s certainly worth the attention of folks who know they need stock exposure but who get a bit queasy at the thought. Thanks to the wise and wily Ira Artman for recommending a profile of the fund.

And ten other funds that our readers think are really worth your time

One intriguing thread on the Observer’s discussion board asked, “what fund do you to love more and more over the years“?  While several folks made the obvious point (“don’t love an investment, it can’t love you back”), a number of readers contributed thoughtful and well-argued choices.  The most popular, all-weather funds:

Permanent Portfolio (PRPFX), endorsed by ron, MikeM, rono.  “I’m not sure there has been a better “low risk – great return” fund then PRPFX.”

FPA Crescent (FPACX), Scott, MikeM, “one fund with a terrific long-term track record.”

Oakmark Equity & Income (OAKBX), from ron, cee (The fund just does great year after year and even in the 2008 bear market it only lost 16%. This will be a long-term relationship :)

Matthews Asian Growth & Income (MACSX), DavidS, Scott, PatShuff, “our oldest fund for lower volatility Asian exposure.”  Andrew Foster just left this fund in order to found Seafarer Capital

I’m not sure that it’s just a sign of the times that the common characteristic of these longest-term holdings is the flexibility they accord their managers, their low risk and long-tenured management.

Other interesting nominees included two Fidelity funds (the hybrids Capital & Income FAGIX and Global Balanced FGBLX), Franklin Income (FKINX), Metropolitan West Total Return Bond (MWTRX), Matthews Asia Dividend (MAPIX) and T. Rowe Price Spectrum Income (RPSIX), my own favorite fund-of-Price funds.

Briefly Noted . . .

Joseph Rohm is no longer manager of the T. Rowe Price Africa & Middle East (TRAMX) after leaving T. Rowe on June 30 to relocate to his hometown, Cape Town, South Africa.  It’s hard to know what to make of the move or the fund.  Two reasons:

The management team has shifted several times already.  Rohm was the founding manager, but his stint lasted only ten weeks.  Alderson then stepped in for 18 months, followed by 27 months of Rohm again, and now Alderson.  That’s awfully unusual, especially for Price which values management stability and smooth transitions.

The fund lacks a meaningful peer group or public benchmark.  Measured against diversified emerging markets funds, TRAMX stinks with deep losses in 2011 (through July 29) and a bottom of the heap peer ranking since inception.  The problem is that it’s not a diversified emerging markets fund.   While it would be tempting to measure it against one of the existing Africa ETFs – SPDR S&P Emerging Middle East and Africa (GAF), for instance – those funds invest almost exclusively in a single country, South Africa.  GAF has 90% of its assets in South Africa and virtually 100% in just three countries (South Africa, Egypt and Morocco).

Ed Giltanen, a Price representative, expects a new management team to be in-place within a few months.  Morningstar recommends that folks avoid the fund.  While the long-term case for investing in Africa is undamaged, it’s hard to justify much short term movement in the direction of TRAMX.

On June 30, Guinness Atkinson launched its Renminbi Yuan & Bond Fund.  It invests in Renminbi Yuan-denominated bonds issued by corporations and by the Chinese government.  It may also hold cash, bank deposits, CDs and short-term commercial paper denominated in Renminbi or Yuan. Edmund Harriss will manage the fund.  He also manages three other GA funds: China & Hong Kong Fund, the Asia Focus Fund, and the Asia Pacific Dividend Fund. The China & Hong Kong fund has been around a long time and it’s been a solid but not outstanding performer.  The two newer funds have been modestly unfortunate.  The expense ratio will be 0.90% and there’s a $10,000 minimum investment for regular accounts.  That is reduced to $5000 if you’re already a GA shareholder, or are buying for a retirement or gift account.

I’ve long argued that an emerging-markets balanced fund makes a huge amount of investment sense, but the only option so far has been the closed-end First Trust/Aberdeen Emerging Opportunities (FEO).  I’m pleased to report that Franklin Templeton will launch Templeton Emerging Markets Balanced, likely by October 1.  The fund will been managed by famous guys including Michael Hasenstab and Mark Mobius. “A” shares of the fund will cost 1.53%.

The rush to launch emerging markets bond funds continues with MFS’s planned launch of MFS Emerging Markets Debt Local Currency in September 2011.  The industry has launched, or filed to launch, more than a dozen such funds this year.

Aston closed and liquidated the Aston/New Century Absolute Return ETF (ANENX) in late July.  The three-year-old was a fund of ETFs while its parent, New Century Alternative Strategies (NCHPX) is a very solid, high expense fund of hedge-like mutual funds.

Aston also canned Fortis Investment Management as the subadvisor to Aston/Fortis Real Estate (AARIX). Harrison Street Securities replaced them on the renamed Aston/Harrison Street Real Estate fund.

TCW is in the process of killing off two losing funds.  TCW Large Cap Growth (TGLFX) will merge into TCW Select Equities (TGCNX) and TCW Relative Value Small Cap (TGOIX) merges into TCW Value Opportunities (TGVOX).  In an additional swipe, the Large Cap Growth managers will be dismissed from the team managing TCW Growth (TGGIX).  Owie.

Wells Fargo Advantage Strategic Large Cap Growth (ESGAX) has a new manager: Tom Ognar and his team.  The change is worth noting just because I’ve always liked the manager’s name: it has that “Norse warrior” ring to it.  “I am Ognar the Fierce and I am here to optimize your portfolio.”

New names and new missions

Janus Dynamic Allocation (JAMPX), a consistently mediocre three-year-old, will become more global in fall.  Its name changes to Janus World Allocation and it will switch from a domestic benchmark to the MSCI All Country World index.

Janus Long/Short (JALSX) will become Janus Global Market Neutral on September 30, and will change its benchmark from the S&P500 to a 3-month T-Bill index.

ING Janus Contrarian (IJCAX) fired Janus Capital Management as subadvisor and changed its name to ING Core Growth and Income Portfolio. The fund is currently managed by ING Investment Management, and will merge into ING Growth and Income in early 2012.

Effective Sept. 1, 2011, Invesco Select Real Estate Income (ASRAX) will change its name to Invesco Global Real Estate Income.  The name change is accompanying by prospectus changes allowing a more-global portfolio and a global benchmark.

MFS Sector Rotational (SRFAX) changed its name to MFS Equity Opportunities on August 1, 2011.

DWS Strategic Income (KSTAX) will change its name to DWS Unconstrained Income at the end of September.  “Strategic” is so 2010 . . . this season, everyone is wearing “unconstrained.”

Dreyfus S&P Stars Opportunities (BSOBX) becomes Dreyfus MidCap Core on November 1st.

The FaithShares folks will close and liquidate their entire line of ETFs (the Baptist, Catholic, Christian, Lutheran and Methodist Values ETFs).  The ETFs in question were fine investment vehicles except for two small flaws: (1) poor returns and (2) utterly no investor interest.  FaithShares will then change their name to Exchange Traded Concepts, LLC.  And what will ETC, LLC do?   Invoking the “those who can’t do, consult” dictum, they propose to sell their expertise as ETF providers to other aspiring investment managers.   Their motto: “Launch your own ETF without lifting a finger.”  Yep, that’s the level of commitment I’d like to see in an adviser.

In closing . . .

Special thanks to “Accipter,” a long-time contributor to the FundAlarm and Observer discussion boards and Chip, the Observer’s Technical Director, for putting dozens of hours into programming and testing The Falcon’s Eye.  Currently, when you enter a fund’s ticker symbol into a discussion board comment, our software automatically generates a link to a new window, in which you find the fund’s name and links to a half dozen fund reports.  Falcon’s Eye will provide direct access through a search box; it’ll cover ETFs as well and will include links to the Observer’s own fund profiles.  This has been a monumental project and I’m deeply grateful for their work.  Expect the Eye to debut in the next two weeks.

Thanks, too, to the folks who have used the Observer’s Amazon link.  If you haven’t done so yet, visit the “Support Us” page where you’ll see the Amazon link.  From there, you can bookmark it, set it as your homepage, right-click and play it on your desktop or copy it and share it with your deranged brother-in-law.  In addition, we’ve created the Observer’s Amazon store to replace our book recommendations page.  Click on “Books” to visit it.  The Amazon store brings together our readers’ best ideas for places to learn more about investing and personal finance in general.  We’ll add steadily to the collection, as you find and recommend new “must read” works.

With respect,

David

Dear friends,

The craziness of summer always amazes me.  People, who should be out watching their kids play Little League, or lounging in the shade with a cold drink, instead fret like mad about the end of the (investing) world as we know it.  Who would have guessed, despite all of the screaming, that it’s been a pretty decent year in the market so far?  Vanguard’s Total Stock Market Index fund (VTSMX) returned 6.3% in the first six months of 2011.  The market turbulence in May and June still constituted a drop of less than 3% from the market’s late April highs.

In short, more heat than light, so far.

Justice Thomas to investors: “Sue the Easter Bunny!”

On June 13^th, the Supreme Court issued another ruling (Janus Capital Group vs. First Derivative Traders)  that seemed to embrace political ideology rather more than the facts of the case. The facts are simple: Janus’s prospectuses said they did not tolerate market-timing of the funds.  In fact, they actively colluded in it.  When the news came out, Janus stock dropped 25%.  Shareholders sued, claiming that the prospectus statements were material and misleading.  The Court’s conservative bloc, led by Skippy Thomas, said that stockholders could sue the business trust in which the funds are organized, but not Janus.  Since the trust has neither employees nor assets, it seems to offer an impregnable legal defense against any lies embedded in a prospectus.
The decision strikes me as asinine and Thomas’s writing as worse.  The only people cheerleading for the decision are Janus’s lawyers (who were active in the post-decision press release business) and the editorial page writers for The Wall Street Journal:

In Janus Capital Group Inc. v. First Derivative Traders, investors claimed to have been misled into buying shares of stock at a premium by prospectuses that misrepresented Janus Investment Fund’s use of so-called market timing. . .

The Court’s ruling continues a string of recent cases that put limits on trial-bar marauding, but the dissent by the four liberal Justices all but invites further attempts. As in so many legal areas, this Supreme Court is only a single vote away from implementing through the courts a political agenda that Congress has consistently refused to pass.

The editorial can sustain its conclusion only by dodging the fact (the business trust is a shell) and quoting Thomas’s thoughtless speechwriter/speechmaker analogy (which fails to consider the implication of having the writer and maker being the same person).   The Journal‘s news coverage recognized the problem with the ruling:

William Birdthistle, a professor at the Chicago-Kent College of Law, said the ruling disregarded the practical reality that mutual funds are dominated by their investment advisers, who manage the business and appoint the funds’ boards of directors.

“Everyone knows the fund is an empty marionette. It doesn’t do anything,” said Prof. Birdthistle, who filed a brief supporting the Janus investors. “You’re left with a circumstance where no one is responsible for this.”

The New York Times gets closer:

With Justice Clarence Thomas writing for a 5-to-4 majority, the Supreme Court has made it much harder for private lawsuits to succeed against mutual fund malefactors, even when they have admitted to lying and cheating.

The court ruled that the only entity that can be held liable in a private lawsuit for “any untrue statement of a material fact” is the one whose name the statement is presented under. That’s so even if the entity presenting the statement is a business trust — basically a dummy corporation — with no assets, while its owner has the cash.

Justice Thomas’s opinion is short and, from the mutual fund industry’s perspective, very sweet: Janus Capital Group and Janus Capital Management were heavily involved in preparing the prospectuses, but they didn’t “make” the statements so they can’t be held liable. . . Which means that there is no one to sue for the misleading prospectuses.

The ICI was publicly silent (too busy preparing their latest “fund expenses have too plummeted” and “America, apple pie and 12(b)1 fee” press releases,) though you have to imagine silent high-fives in the hallway.  I’m not sure of what to make of Morningstar’s reaction.  They certainly expressed no concern about, displeasure with or, alternately, support for the decision.  Mostly they conclude that there’s no threat in the future:

The ruling should not have a material impact on Janus mutual fund shareholders, according to Morningstar’s lead Janus fund analyst, Kathryn Young. Janus has had procedures in place since 2003 to prevent market-timing . . .

Uhhh . . .  Uhhh . . .  if those procedures are expressed as a sort of contract – communicated to investors – in the prospectus . . .  uhhh . . . hello?

The more pressing question is whether the decision also guts the SEC’s enforcement power, since the decision seems to insulate a firm’s decision-makers from the legal consequences of their acts.  It’s unclear why that insulation wouldn’t protect them from regulators quite as thoroughly as from litigators.

In short, you’ll have about as much prospect of winning a suit against the Easter Bunny as you will of winning against a fund’s fictitious structure.

The Odd Couple: Manager Gerry Sullivan and the Vice Fund (VICEX)

One of the fund industry’s nicest guys, Gerry Sullivan, has been appointed to run an awfully unlikely fund: VICEX.  Gerry has managed the Industry Leaders fund (ILFIX) since its launch.  The fund uses a quantitative approach to identify industries in which there are clear leaders and then looks to invest in the one or two leading firms.  The fund has a fine long-term record, though it’s been stuck in the mud for the past couple years.  The problem is the fund’s structural commitment to financial stocks, which have been the downfall of many good managers (think: Bruce Berkowitz, 90% financials, bottom 1% of large cap funds through the first half of 2011).  Since financial services match the criteria for inclusion, Sullivan has stuck with them – and has been stuck with them.  The rest of the portfolio is performing well, and he’s waiting for the inevitable rebound in U.S. financials.

In the interim, he’s been appointed manager of two very distinctive, sector-limited funds:

Generation Wave Growth Fund (GWGF), a sort of “megatrends” fund targeting the health care, financial services and technology sectors, and

Vice Fund (VICEX), which invests in “sin stocks.”  It defines those as stocks involved with aerospace/defense, gaming, tobacco and alcoholic beverages.

I’m sure there are managers with less personal engagement in sin industries than Gerry (maybe John Montgomery, he of the church flute choir, at Bridgeway), but not many.

Almost all of the research on sin stocks reaches the same conclusion: investing here is vastly more profitable than investing in the market as a whole.  Sin stocks tend to have high barriers to entry (can you imagine anyone starting a new tobacco company?  or a new supersonic fighter manufacturer?) and are often mispriced because of investor uneasiness with them.  Over the medium- to long-term, they consistently outperform both the market and socially-responsible indexes.  One recent study found a global portfolio of sin stocks outperforming the broad market indexes in 35 of 37 years, with “an annual excess return between 11.15% and 13.70%”  (Fabozzi, et al, “Sin Stock Returns,” Journal of Portfolio Management, Fall 2008).

About two-thirds of the portfolio will be selected using quantitative models and one-third with greater qualitative input.  He’s begun reshaping the portfolio, and I expect to profile the fund once he’s had a couple quarters managing it.

Who You Callin’ a “Perma-bear”?

Kiplinger’s columnist Andrew Feinberg wrote an interesting column on the odd thought patterns of most perma-bears (“Permanent Pessimists,” May 2011).  My only objection is his assignment of Jeremy Grantham to the perma-bear den.  Grantham is one of the founders of the institutional money manager GMO (for Grantham, Mayo, and van Otterloo).  He writes singularly careful, thoughtful analyses – often poking fun at himself and his own errors (“I have a long and ignoble history of being early on market calls and, on two occasions, damaged the financial well-being of two separate companies – Batterymarch and GMO”) – which are accessible through the GMO website.

Feinberg notes that Grantham has been bearish on the US stock market for 20 years.  That’s a half-truth.  Grantham has been frequently bearish about whatever asset class has been most in vogue recently.  The bigger questions are, is he wrong and is he dangerous?  In general, the answers are “sometimes” and “not so much.”

One way of testing Grantham’s insights is to look at the performance of GMO funds that have the flexibility to actually act on his recommendations.  Those funds have consistently validated Grantham’s insights.  GMO Global Balanced, Global Equity Allocation and U.S. Equity Allocation are all value-conscious funds whose great long-term records seem to validate the conclusion that Grantham, skeptical and grumpy or not, is right quite often enough.

Who You Callin’ “Mr. Charge Higher Prices”?

This is painful, but an anonymous friend in the financial services industry sent along really disturbing ad for a webinar (a really ugly new word).  The title of the June 8^th webinar was “How to Influence Clients to Select Premium-Priced Financial Products and Services! (While Reinforcing Your Valuable Advice).”    The seminar leader “is known as Mr. Charge Higher Prices because he specializes in teaching how to get to the top of your customer’s price . . . and stay there!”

Sound sleazy?  Not at all, since the ad quotes a PhD, Professor of Ethics saying that the seminar leader shows you how to sell high-priced products which are also “higher-value products that more closely align with their goals and objectives.  [He] teaches them how to do so with integrity and professionalism.”  Of course, a quick internet search of the professor’s name and credentials turns up the fact that his doctorate is from an online diploma mill and not a university near London. It’s striking that seven years after public disclosure of his bought-and-paid-for PhD, both the ethicist and Mr. Higher Prices continue to rely on the faux credential in their advertising.

And so, one simple ad offers two answers to the question, “why don’t investors trust me more?”

Two Funds, and why they’re worth your time

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s two new funds:

RiverPark Short Term High Yield (RPHYX): put your preconceptions aside and pick up your copy of Graham and Dodd’s Security Analysis (1940).  Benjamin Graham was the genius who trained the geniuses and one of his favorite investments was “cigar butt stocks.”  Graham said of cigar butts found on the street, they might only have two or three good puffs left in them but since they were so cheap, you should still pick them up and enjoy them.  Cigar butt stocks, likewise: troubled companies in dying industries that could be bought for cheap and that might still have a few quarters of good returns.

You could think of RiverPark as a specialist in “cigar butt bonds.” They specialize in buying high-yield securities that have been, or soon will be, called.  Effectively, they’re buying bonds that yield 4% or more, but which mature in the next month or two.  The result is a unique, extremely low volatility cash management fund that’s earning several hundred times more than a money market.

Stars in the shadows: Small funds of exceptional merit. There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight gf them.

The stars are all time-tested funds, many of which have everything except shareholders.

The selection of this month’s star was inspired by a spate of new fund launches.  As a result of some combination of anxiety about a “new normal” investing world dominated by low returns and high volatility, fund companies have become almost obsessive about launching complex, expensive funds, whose managers have an unprecedented range of investment options.  Eight of the nine no-load funds on July’s funds in registration page represent that sort of complex strategy:

• Litman Gregory Masters Alternative Strategies
• PIMCO Credit Absolute Return Fund
• PIMCO Inflation Response Multi-Asset
• PIMCO Real Income 2019 and 2029
• PIMCO Tax Managed Real Return Fund
• Schooner Global Absolute Return Fund
• Toews Hedged Commodities Fund

The same thing’s true of the May and June lists: 75% “alternative strategy” funds.

We don’t list load-bearing funds, in general, but recent registrations and launches there show the same pattern:

• Franklin Templeton Global Allocation
• BlackRock Credit Opportunities
• BlackRock Emerging Market Long/Short Equity
• Parametric Structured Commodity Strategy Fund
• Neuberger Berman Global Allocation

The question is: if managers asked to execute a simple strategy (say, buying domestic stocks) couldn’t beat a simple index (the S&P 500), what’s the prospect that they’re going to soar when charged with executing hugely complex strategies?

This month’s star tests the hypothesis, “simpler really is better”:

ING Corporate Leaders Trust Series B (LEXCX): at $500 million in assets, you might think LEXCX a bit large to qualify as “in the shadows.”  This 76 year old fund is almost never in the news.  There’s never been an interview with its manager, because it has no manager.  There’s never been a shift in portfolio strategy, because it has no portfolio strategy.  Born in the depths of the Great Depression, LEXCX has the industry’s simplest, more stable portfolio.  It bought an equal number of shares of America’s 30 leading companies in 1935, and held them.  Period.  No change.  No turnover.  No manager.

The amazing thing?  This quiet antique has crushed not only its domestic stock peers for decades now, it’s also outperforming the high-concept funds in the very sort of market that should give them their greatest advantage.  Read on, Macduff!

Nassim Taleb is launching a Black Swan ETF!

Or not. Actually just “not.”

Nassim Taleb, a polymath academic, is the author of Fooled by Randomness (2001) and The Black Swan: The Impact of the Highly Improbable (2007).  The latter book, described by the Times of London as one of the “Books that helped to change the world,” argues that improbable events happen rather frequently, are effectively unpredictable, and have enormous consequences.  He seems to have predicted the 2007-09 meltdown, and his advice lends itself to specific portfolio actions.

Word that “Taleb is launching a black swan ETF” is rippling through various blogs, discussion boards (both here and Morningstar) and websites.  There are three small problems with the story:

1. Taleb isn’t launching anything.  The original story, “Protect Your Tail,” from Forbes magazine, points to Taleb’s former investment partner and hedge fund manager, Mark Spitznagel.  The article notes, “After Taleb became seriously ill the duo shut the fund. Taleb has since given up money management . . .”
2. It’s not clear that Spitznagel is launching anything.  Forbes says, “In July Universa intends to tap the financial adviser market by offering its own black swan ETF. The fund will mimic some of the strategies employed by its institutional-only hedge fund and will have an expense ratio of 1.5%.”  Unfortunately, as of late June, there’s no such fund in registration with the SEC.
3. And you wouldn’t need it if there was such a fund.  Spitznagel himself calls for allocating “about 1% of an investment portfolio to fund such a ‘black swan protection protocol.'”  (Hmmm… in my portfolio that’d be about $12.50.)  If you wanted to have some such protection without a fund with a trendy name, you could adopt Taleb’s recommendation for a “barbell strategy,” in which you place 80% into stable investments, like government bonds and cash, and 20% into risky ones, such stocks and commodities.

Oddly enough, that comes close to describing the sort of strategy already pursued by funds like Permanent Portfolio (PRPFX) and Fidelity Strategic Income (FSICX) and those funds charge half of the reported “black swan” expenses.

Briefly noted:

Long-time SmartMoney columnist, James B. Stewart has moved to The New York Times.  Stewart helped found the publication and has been writing the “Common Sense” column for it for 19 years, yet the letter from the editor in that issue made no mention of him and his own final column offered his departure as an afterthought. On June 24^th, his first column, also entitled “Common Sense,” appeared in the Times.  Stewart’s first story detailed the bribery of Mexican veterinarians by Tyson Foods.  He’ll be a Saturday columnist for the Business Day section of the paper, but they’re no word on what focus – if any – the feature might have.

For those interested in hiking their risk profiles, Matthews Asia launched its new Matthews China Small Companies Fund (MCSMX) on May 31, 2011.  As with most Matthews funds, there’s a lead manager (Richard Gao, who also manages Matthews China MCHFX) and a guy who’s there in case the manager gets hit by a bus (Henry Zhang, also the back-up guy on Matthews China).

Possible investors will want to read Andrew Foster’s new commentary for Seafarer Capital.  Andrew managed Matthews Asia Growth & Income (2005-2011) before leaving to found Seafarer.  While he has not yet filed to launch a mutual fund, Andrew has been posting a series of thoughtful essays on Asian investing, including several that focus on odd numbers and Chinese finance.  He promises in the next essay to look at BRICS in general but will also “touch upon China’s elevated (some would say breakneck) pace of investment, and what it means for the future of that country.”

Investors will also want to look at the prevalence of financial fraud in Chinese companies.  A recent Barron’s article provides a list of 20 Chinese firms that had a stop trading on the NASDAQ recently, a sign that their American accountants wouldn’t sign-off on the books.  While Matthews has a fine record and Gao promises extensive face-to-face meetings and fundamental research, these seem to be investments treacherous even for major firms.

Vanguard’s new actively managed emerging-markets fund, Vanguard Emerging Markets Select Stock (VMMSX) launched at the end of June.  It will complement their existing emerging markets index fund (VEIEX), the largest e.m. fund in existence.  Vanguard has four high-quality sub-advisors (M&G Investment Management, Oaktree Capital Management, Pzena Investment Management, and Wellington Management) none of whom have yet run an emerging markets funds.  Minimum investment is $3000 and the expense ratio is 0.95%, far below the category average.Rejoice!  AllianceBernstein is liquidating AllianceBernstein Global Growth (ABZBX). It’s no surprise, given the fund’s terrible performance of late.

Schwab plans to liquidate Schwab YieldPlus (SWYSX), a fund which once had $12 billion in assets.  Marketed as a higher-yield alternative to money markets, it blew apart in 2008 – down 47% – and Schwab has spent hundreds of millions on federal and state claims related to the fund, and faced charges filed by the SEC. Schwab will liquidate Schwab Tax-Free YieldPlus (SWYTX) and Schwab California Tax-Free YieldPlus (SWYCX) at the same time.

Vanguard Structured Large-Cap Growth liquidated on May 31, 2011.

John Hancock Classic Value Mega Cap (JMEAX) will liquidate on Aug. 19, 2011.

Calvert Large Cap Growth (CLGAX) will merge into Calvert Equity (CSIEX), assuming that shareholders (baaaa!) approve.  They’ve got the same management team and Calvert will lower CSIEX’s expenses a bit.

Morgan Stanley Special Growth (SMPAX) will soon merge into Morgan Stanley Institutional Small Company Growth (MSSGX).

ING Value Choice (PAVAX) and ING Global Value Choice (NAWGX) will close to most new investors on July 29, 2011.

Nuveen Tradewinds Value Opportunities (NVOAX) and Nuveen Tradewinds Global All-Cap (NWGAX) will close to most new investors on August 1, 2011.

Fidelity Advisor Mid Cap (FMCDX) will change its name to Fidelity Advisor Stock Selector Mid Cap on August 1, 2011.

JPMorgan Dynamic Small Cap Growth (VSCOX) and JPMorgan Small Cap Growth (PGSGX) will close to most new investors on August 12, 2011.

The MFO Mailbag . . .

I receive a couple dozen letters a month.  By far, the most common is a notice that someone goofed up their email address when signing up our e-mail notification service or registering for the site.  Regrets to Wolfgang and fjujv1.  The system generated a flood of mail reporting on its daily failure to reach you.  For other folks, please double-check the email you register with and, if you have a spam blocker, put the Mutual Fund Observer on your “white list” or our mail won’t get through.

Is there a Commentary archive (Les S)?  Yes, Les, there is.  You just can’t see it yet.  Chip is adjusting the site navigation and, within a week, the April through June commentaries will be available through links on the main commentary page.

Will the Observer post lists of Alarming, Three-Alarm and Most Alarming Three-Alarm funds (Joe B, Judy S, Ed S)?  Sorry, but no.  Those were Roy’s brainchild and I lack the time, expertise and passion needed to maintain them.  Morningstar’s free fund screener will allow you to generate lists of one-star funds, but I’m not familiar with other free screening tools aimed at finding the stinkers.

Is it still possible to access stuff you’d written at FundAlarm (Charles C)?  Not directly now that FundAlarm has gone dark.  I’d be happy to share copies of anything that I’ve retained (drop an email note), though that’s a small fraction of FundAlarm’s material.  There’s an interesting back door.  Google allows you to search for cached material by site.  That is, for example, you can ask The Google if it could provide a list of all references to Fidelity Canada that appeared at FundAlarm.com.  To do that, simple add the word site, a colon, and a web address to your search.

Fidelity Canada site:fundalarm.com

If the word “cached” appears next to a result, it means that Google has saved a copy of that page for you.

Shouldn’t Marathon Value be considered a Star in the Shadows (Ira A)?  Yes, quite possibly. Ira has recommended several other find small funds in the past and Marathon Value (MVPFX) seems to be another with a lot going for it.  I’ll check it out.  Thanks, Ira.  If you’ve got a fund you think we should look at more closely, drop a line to [email protected], and I’ll do a bit of reading.

In closing . . .

Thanks to all the folks who’ve provided financial support for the Observer this month.  In addition to a half dozen friends who provided cash contributions, either via PayPal or by check, readers purchased almost 250 items through the Observer’s Amazon link.  We have, as a result, paid off almost all of our start-up expenses.  Thanks!

For July, we’ll role out three new features: our Amazon store (which will make it easier to find highly-recommended books on investing, personal finance and more), our readers’ guide to the best commentary on the web, and The Falcon’s Eye.  (Cool, eh?)  Currently, if you enter a fund’s ticker symbol in a discussion board post, it generates a pop-up window linking you to the best web-based resources for researching and assessing that fund.  In July we’ll roll that out as a free-standing tool: a little box leading you to a wealth of information, including the Observer’s own fund profiles.

Speaking of which, there are a number of fund profiles in the works for August and September.  Those include Goodhaven Fund, T. Rowe Price Global Infrastructure and Emerging Markets Local Currency Bond funds, RiverPark Wedgewood Fund and, yes, even Marathon Value.

Until then, take care and keep cool!

David

Dear friends,

After a lovely month in England, I returned to discover that things are getting back to “normal” again in the financial markets.

Top executives of publicly traded money management firms got raises averaged 33% “as improved financial results and increases in assets under management put them further away from the market turmoil of years past” (Randy Diamond, “Good times rollin’ once again for money manager execs,” Pensions and Investments Online, May 16 2011). While paltry by bankers’ standards, some of the money firm chiefs should be able to cover their mortgages: Larry Fink of BlackRock took home $24 million, while Janus CEO Richard Weil and Affiliated Managers Group CEO Sean Healey each got $20 million.

Pension plans are moving back into hedge fund investing.  According to the consulting firm Prequin, pension plans have 6.8% of their money in hedge funds now compared to 3.6% in 2007.  One motive for the change: hedge funds have returned 6.8% on average over the decade compared to 5.7% for the plans’ stock investments.  By increasing exposure to hedge funds, the plans can mask the magnitude of their uncovered commitments.  That is, they can project higher future returns and so argue that they’ll surely be able to cover their apparently huge deficits.  (“Pensions leap back to hedge funds,” WSJ, May 27 2011)

Rich folks are losing interest in managing their own investments, and are back to handing money over to their “wealth managers” to shepherd.  In 2009, 69% of high net worth investors wanted to take “an active role” in managing their investments.  It’s down to 47% in 2011, which Clifford Favrot of Delta Financial Advisers describes as “returning to normal” (“Rich relax a bit but stay on guard,” WSJ, May 27 2011).

In general, any time folks decide that it’s time to stop worrying, it’s time to start worrying.  Worrier par excellence Jeremy Grantham of GMO argues that the strong performance of risk assets – both stocks and bonds – is detached from the underlying economy.  His advice: “the environment has simply become too risky to justify prudent investors hanging around, hoping to get luck.  So now is not the time to float along with the Fed, but to fight it.”  While Grantham ruefully admits “to a long and ignoble history of being early on market calls” (well, sometimes two years early), he’s renewed his calls to concentrate on high quality US blues and emerging market equities (“Time to be serious – and probably too early – once again,” GMO Quarterly Letter, May 2011).

Part of Wall Street’s Normal: Gaming the System

Folks who suspect that the game is rigged against them have gotten a lot of fodder in the last two months.  A widely discussed article in Rolling Stone Magazine (“The Real Housewives of Wall Street,” April 2011) looks at how federal bailout money was allocated.  In general: (1) poorly and (2) to the rich.  While Stone is not generally a voice of conservatism, its story might have a comfortable home even in the National Review:

. . . the government attempted to unfreeze the credit markets by handing out trillions to banks and hedge funds. And thanks to a whole galaxy of obscure, acronym-laden bailout programs, it eventually rivaled the “official” budget in size — a huge roaring river of cash flowing out of the Federal Reserve to destinations neither chosen by the president nor reviewed by Congress, but instead handed out by fiat by unelected Fed officials using a seemingly nonsensical and apparently unknowable methodology.

Stone argues that “the big picture” of a multi-trillion dollar bailout is simply too big for human comprehension, but that you can learn a lot by looking through the lens of the assistance given a single firm: Waterfall TALF Opportunity.  While Waterfall received a pittance – a mere quarter billion compared to Goldman Sachs $800 billion – Waterfall was distinguished by the credentials of its two chief investors: Christy Mack and Susan Karches.

Christy is the wife of John Mack, the chairman of Morgan Stanley. Susan is the widow of Peter Karches, a close friend of the Macks who served as president of Morgan Stanley’s investment-banking division. Neither woman appears to have any serious history in business, apart from a few philanthropic experiences. Yet the Federal Reserve handed them both low-interest loans of nearly a quarter of a billion dollars through a complicated bailout program that virtually guaranteed them millions in risk-free income.

Stone details the story of the women’s risk-free profits, courtesy of a category of bailout program they describe as “giving already stinking rich people gobs of money for no ****ing reason at all.”  Waterfall investors put up $15 million, then received $220 million in federal funds with the promise that they could receive 100% of any investment gains but be responsible for only 10% of any investment losses they incurred.  It’s a fascinating, frustrating story.

Happily, the women wouldn’t need to worry about investment losses as long as they accepted guidance from the world’s best investors: members of the U.S. House of Representatives.  A study in Business and Politics examined the financial disclosure records of all the members of Congress.  They concluded that somehow members of Congress outperformed the stock market by “6.8% per annum after compounding – better than hedge-fund superstars.”  U.S. Senators performed even better.  While it’s possible that House members are simply smarter than hedge fund managers, the authors darkly conclude “We find strong evidence that Members of the House have some type of non-public information which they use for personal gain” (“Fire Your Hedge Fund, Hire Your Congressman,” Barron’s, 05/26/2011).

It’s the world’s scariest ad!

Remember Larry, Darryl and Darryl from the old Newhart TV show?  The three deranged brothers launched their first business – “Anything for a Buck”. They’ll do anything for a buck. If it’s something cool like digging up an old witch’s body from the cellar, they might even pay you the buck!

Apparently they’re now the masterminds behind iShares, whose slogan seems to be “anything can be an ETF!”

Fairholme Fund wobbles

Fairholme Fund (FAIRX), a huge, idiosyncratic beast run by Morningstar’s equity manager of the decade, Bruce Berkowitz, has had a bad year.  The fund trails its average peer by 15 percentage points of the past year and ranks in the bottom 1% of large cap value funds for the past quarter, two quarters and four quarters (as of June 2011).  The fund sucked in $4 billion of anxious money in 2010 after a long, remarkable run.  Predictable as the rains in spring, $1 billion of assets rushed back out the door in April alone (per Morningstar fund flow estimates).  That’s three times worse than any other month in its history.

Bruce Berkowitz didn’t dodge the fund’s problems in a May 11 conference call with investors:

Here are my thoughts on the Fairholme Funds recent performance: horrible, [and] that’s the summary in hindsight and it may be to be expected over the short term.

We’ve always stated in our reports that short-term performance should not be over emphasized. It’s the long term that counts. This is not the first time we’ve underperformed; it won’t be the last time and I don’t think it’s reality to outperform every month, quarter or year.

So it’s been lousy for months, we’ve been losing, we’re way underperforming, and it may stay lousy for more time.

He argues that the short-term problem is his decision to buy financial stocks (now 90% of the portfolio), which is expects to continue buying.  “We need to buy low and buy lower and buy lower. Even when the crowd yells you’re wrong. This is how we’ve achieved our performance over the past decade and this is how we will achieve our performance in the next couple of decades.”

One of his highest-visibility holdings, St. Joe Corporation (JOE) a Florida land company.  They started as a paper mill, got rich, got stupid, bought a bunch of stuff they shouldn’t have (brokerage firms, for example), had no debt but made no money.  After a long battle, Fairholme took control of St. Joe in March, forcing out the CEO and much of the board.

Why care?

There’s an interesting argument that St. Joe was less important for its huge land holdings than for its ability to make investments that Fairholme itself cannot make.  A fascinating article in Institutional Investor notes:

St. Joe may not seem like a major prize in the big scheme of things, with a market value of just $2.4 billion, but Berkowitz and Charles Fernandez, his No. 2 at Fairholme for the past three and a half years, saw a huge opportunity. Not only did they think that the company’s real estate operations could be worth a lot more in the future, they saw St. Joe as a way to buy assets that a regulated mutual fund would be prohibited from owning directly. In essence, if successful, they could transform their flagship Fairholme Fund into something akin to a hedge fund or an investment vehicle like Warren Buffett’s Berkshire Hathaway.

“We’re trying to go in a direction we think most mutual funds will be going — where we have the flexibility to do private transactions and public transactions, and the ability to do what makes sense for our shareholders,” Berkowitz says. (“Fairholme’s Bruce Berkowitz Is Beating Hedge Fund Managers at Their Own Game,” Institutional Investor, 05/19/2011).

Indeed, in his conference call, Berkowitz says, “JOE is, at its heart, an asset manager.”

The possibilities are intriguing.  In his interview with the Observer, Mr. Berkowitz argued that Fairholme’s size ($20 billion in assets) was critical to its future.  While many observers felt the fund was too unwieldy, Berkowitz argues that only its size allows it to become party to a set of expensive, unconventional opportunities.

Beyond the simple matter of corporate restructurings, bankruptcies and other conventional “special situations,” managers are looking increasingly far afield for opportunities.  Hedge fund manager David Einhorn, who lost big to Berkowitz in the St. Joe fight, recently announced a $200 million investment in the New York Mets.   And bond maestro Jeff Gundlach pushed the investment potential of gemstones at a recent investment conference:

[Gundlach] likes gold for its “Biblical street cred, if such a thing is possible.” But he advocates gem stones over gold. “Gold has shown itself to be money and pretty. Gems have also shown themselves to be money and prettier,” he says.  (Mark Gongloff, gundlach-leads-off-with-prostitutes, WSJ Marketbeat blog, 05/25/2011

Hmmm . . . perhaps Newt Gingrich’s reported $500,000 bill with Tiffany’s isn’t just egregious excess: it’s creative portfolio management.

This never turns out well: the emerging markets debt obsession grows

A lot of emerging market debt funds are now coming to market, many of them specializing in debt priced in some local currency.  By Morningstar’s estimate, of the 20 emerging-markets local-currency funds, 14 have been opened in the last year.  These funds are a vote against the future of the US dollar and in favor of currencies supported – largely – by commodity-producing economies and growing populations.  Among the recent notable entrants:

Harbor Emerging Markets Debt (HAEDX) launched on May 2, 2011, and invests in securities that are economically tied to emerging markets, or priced in emerging-markets currencies. It’s being sub-advised, as all Harbor funds are.  The subadvisor is Stone Harbor Investment Partners whose Stone Harbor Emerging Markets Debt (SHMDX) has returned 10.5% annualized since inception. Harbor Emerging Markets Debt has an expense ratio of 1.05% and a $1000 minimum.

Aberdeen Asset Management launched Aberdeen Emerging Markets Debt Local Currency (ADLAX) on May 2, 2011. Brett Diment will lead the team responsible for managing the fund.

Forward Management launched Forward Emerging Markets Corporate Debt (FFXIX) on May 3, 2011. The fund will invest mainly in emerging-markets corporate debt, and will be subadvised by SW Asset Management. David Hinman and Raymond Zucaro will manage the fund.

T. Rowe Price launched T. Rowe Price Emerging Markets Local Currency Bond on May 26. The fund will invest in bonds denominated in emerging-markets currencies or derivatives that provide emerging-markets bond exposure.  Andrew Keirle and Christopher Rothery who manage the fund also have been managing a similar strategy for institutional investors in the T. Rowe Price Funds SICAV–Emerging Local Markets Bond Fund since 2007. That said, the institutional fund has consistently trailed T. Rowe Price Emerging Markets Bond (PREMX) since inception.

HSBC filed to launch HSBC Emerging Markets Debt, which will invest primarily in U.S.-dollar-denominated while Emerging Markets Local Debt will invest in local-currency debt. Both should come on-line on June 30, 2011.

PIMCO Developing Local Markets (PLMDX) will be renamed PIMCO Emerging Markets Currency on August 16, to reflect a slight strategy shift. The fund holds positions in short maturity local bonds and currency derivatives.  The change will give the managers a bit more freedom to choose which countries to pursue.

Emerging market bond funds have returned an average of 12-13% annually over the past 10-15 years. On face, easier and more diverse access to these assets should be a good thing.  Remember two things:  First, the asset class has done so well that future returns are likely modest.  Grantham, Mayo, van Otterloo (GMO) projects real returns on emerging market debt of just1.7% annually over the next 5-7 years (Asset Class Return Forecast, 04/30/2011).   That’s well below their projection for E.M. stocks (4.5% real) or U.S. blue chip companies (4.0%).   Second, much of those gains took place when relatively few investment companies were interested.  In 2003 for example, investors placed only $14 billion to work in emerging market debt.  Fidelity New Market Income (FNMIX) earned 31% that year. In 2010, it was $72 billion and the Fido fund returned 11%.  As more funds pile in, profits are going to become fewer and opportunities thinner.  While E.M. debt is a valid asset class, joining the herd rushing toward it might bear a moment’s reflect.

Funds worth your attention

Really worth it.  Every month the Observer profiles two to four funds that we think you really need to know more about.  They fall into two categories:

Most intriguing new funds: good ideas, great managers. These are funds that do not yet have a long track record, but which have other virtues which warrant your attention.  They might come from a great boutique or be offered by a top-tier manager who has struck out on his own.  The “most intriguing new funds” aren’t all worthy of your “gotta buy” list, but all of them are going to be fundamentally intriguing possibilities that warrant some thought.  This month’s two new fund:

Fidelity Global Strategies (FDYSX): this relatively young fund has one of Fidelity’s broadest, most ambitious mandates.  In June 2011, it was rechristened to highlight a global approach.  It’s not clear that the changes are anything more than pouring old wine in a new bottle.

Stars in the shadows: Small funds of exceptional merit.  There are thousands of tiny funds (2200 funds under $100 million in assets and many only one-tenth that size) that operate under the radar.  Some intentionally avoid notice because they’re offered by institutional managers as a favor to their customers (Prospector Capital Appreciation and all the FMC funds are examples).  Many simply can’t get their story told: they’re headquartered outside of the financial centers, they’re offered as part of a boutique or as a single stand-alone fund, they don’t have marketing budgets or they’re simply not flashy enough to draw journalists’ attention.  There are, by Morningstar’s count, 75 five-star funds with under $100 million in assets; Morningstar’s analysts cover only eight of them.

The stars are all time-tested funds, many of which have everything except shareholders.  This month’s star:

RiverNorth Core Opportunity (RNCOX): going, going, gone as of June 30.  This former “most intriguing new fund” is larger than most “stars,” but it deserves recognition for two reasons.  First, it’s truly a one-of-a-kind offering.  Second, its imminent closing makes this the idea time for potential investors to do their research and make a decision before regrets set in.

Research on the cutting edge of “duh”

Investment managers and strategies plow through an enormous amount of behavioral research these days, trying to use the predictable patterns of human (i.e., investor) behavior to better position their portfolios.  That said, a remarkable amount of published research in the area seems to cry out “duh!”

On unusually warm days, people are more likely to believe in global warming than they are on cold days, according to a survey of 1200 Americans and Australians by the Center for Decision Sciences at the Columbia Business School.

In a related study, people sitting in a steadily warming room are more likely to believe in global warming than those who are not.

On sunny days, investors are more like to choose stocks over bonds but when it’s ridiculously hot, investors become cranky and markets become volatile.

By the way, if you hand folks a warm drink, they’re more likely to rate you as a “warm” person than it you hand them a cold drink.

Extreme market volatility is bad for investors’ hearts: among Chinese investors anyway.  A 1% market jump correlates with a 2% jump in heart attacks among Chinese investors (and you thought you had problems with emerging markets’ volatility).

If you build more highways, that is, if you make driving easier and more convenient, people drive more, according to a study soon to be published in the American Economic Review.

Work is stressful, which can be scientifically measured by checking levels of the stress hormone cortisol.  A new study in the Journal of Family Psychology suggests that women’s stress levels drop when their husbands are helping with chores, but it’s the opposite for men: Their stress levels fall when their wives are busy while they’re relaxing. Oddly, the scientists didn’t report results for families in which dad did the housework, and mom relaxed.

Briefly noted:

Janus did something right and cool: kudus to Janus for publicizing the investments made by each manager in each fund, as well as in Janus funds as a whole.  While this information is purely available (it’s in the Statement of Additional Information), I know of no other fund company that brings it all together in one place.  For those interested, check here to see how serious their Janus manager is about his or her fund.

Janus Venture (JAVTX) reopened to new investors on May 6 and launched a series of new share classes (A, C, S and I).  As usual, it’s not clear why Janus re-opened the fund: it has a larger portfolio ($1.3 billion) for a small cap fund, the largest in its history, and small caps are already coming off an extended run.  The best reason to take the fund seriously, at least if you can access it without a load, is the strength of its new management team.  Janus Triton (JATTX) managers Chad Meade and Brian Schaub have run Venture for less than a year, but have made a real difference in that time.  They’ve decreased the fund’s concentration and eliminated some of its micro-cap exposure, and have generated very solid returns.  Triton, also a small cap fund, has been an exceedingly solid performer for Janus and noticeably less volatile than the typical Janus fund.  The advantage of a fee cap (holding total expenses to 1.05% for the next year) makes it more attractive still.

Journalists are funny. You can almost hear the breathlessness in Neal Anderson’s prose: “The MFWire has learned that the Boston-based mutual fund giant is re-branding the large cap blend fund as the Fidelity Global Strategies Fund. . . “(“Fido Shifts a Fund’s Name and Strategies,” 05/04/2011).  True enough, but it’s not exactly as if you needed a secret contact to find this out: Fidelity duly submitted the paperwork and it was made publicly available a week before in the SECs EDGAR database.

RiverNorth Core Opportunity (RNCOX) will close to new investors on June 30, 2011.  You really might want to read the new fund profile this month.

The Quant Funds have a new name.  They’re now the Pear Tree Funds because the former name “no longer reflects the true nature of the mutual fund family.”  At base, the funds have three sub-advisors (Polaris, PanAgora and Columbia Partners), not all of who are quant investors and the advisor felt “the former name no longer reflects the true nature” of their funds.  Apparently “pear trees” (dense, brittle and short-lived) comes closer.

During the FundAlarm hiatus, Fidelity launched Fidelity Conservative Income Bond (FCONX).  It’s an ultra-short term bond fund run by Kim Miller.  While he’s been with Fidelity for 20 years, his management experience is limited most to money market funds, though he was on the team for several of the Asset Manager and municipal bond funds.  The fund’s expense ratio is 0.40% and it has accumulated $100 million in assets in three months.  (A slow start for a Fido fund!)

Similarly, the BearlyBullish fund registered in March and launched in early May.  At base, it’s a mid- to large-cap stock fund, mostly invested in the US and Canada.  When the managers’ market indicators turn negative, the fund simply moves more of its assets to cash.  That strategy worked in 2008, when the separately managed accounts that use this system dropped 24% while the broad market dropped by 37%.  It’s run by a team from Alpha Capital Management.  The investment minimum is $1000 and the expense ratio is 1.49%.

Nuveen Quantitative Large Cap Core (FQCAX) changed its name to Nuveen Quantitative Enhanced Core.

Old Mutual Strategic Small Companies (OSSAX) changed its name to Old Mutual Copper Rock International Small Cap. The fund also changed its strategy from a domestic small-cap strategy to an international small-cap strategy.

Pending shareholder approval on June 27, Madison Mosaic Small/Mid-Cap Fund will become NorthRoad International Fund (MADMX) and the Fund’s investment objective will be changed from “long-term growth” to “long-term capital appreciation by investing in non-U.S. companies.” Under the proposal, total fund operating expenses will decrease from 1.25% to 1.15% (annualized). Madison owns a majority stake in New York-based NorthRoad already.  Northroad handles institutional accounts now and their three managers have good credentials, both in previous employment (Lazard Asset Management in a couple cases) and colleges (Williams, Columbia, Yale).  The Small/Mid-Cap fund drew negligible assets and was only a so-so performer in its short life, so this is likely a substantial gain for the firm and its shareholders.

Dreyfus Core Value will merge into Dreyfus Strategic Value (DAGVX) on Nov. 16.

MFS Core Growth (MFCAX) will merge into MFS Growth (MFEGX).

Munder Large-Cap Growth has merged into Munder Growth Opportunities (MNNAX).

RidgeWorth Large Cap Quantitative Equity (SQEAX) will merge into RidgeWorth Large Cap Core Growth Stock (CFVIX) on July 15.

Loomis Sayles Disciplined Equity liquidated on May 13.

William Blair Emerging Markets Growth (BIEMX) will close to new investors on June 30.  Heartland Value Plus (HRVIX) closed to new investors in mid-May.  Heartland noted some skepticism about the state of the small cap market in justifying their close.

In closing . . .

Google Analytics offers fascinating snapshots of the Observer community.  7000 people have visited the site and about a thousand drop by more than once a day.  Greetings to visitors from Canada, Spain, Israel, Mexico and the U.K. – our most popular countries outside the U.S.  A cheery smile to the women who (secretly) use the Observer: research just released by the market-research firm Mintel Group discovered that women, more than men, were likely to make their investments through mutual funds (“Girls just want to have funds,” Barron’s, 05/21/2011).  Over half of all the folks who wrote me before the launch of the Observer were women who relied on FundAlarm’s research and discussions, though most admitted to never feeling quite brave enough to post.

Men, contrarily, were more likely to use ETFs, stocks, options and futures – and to trade actively.  (Note to the guys: stop that!)

In addition, a special wave to our one visitor from Kenya, who seems faithfully to have read every page on the site!

Thanks to all the folks who’ve provided financial support to the Observer of the past month.  Thanks especially to the six friends of the Observer who made direct contributions through PayPal.  In response to a couple notes, I’ve also posted my snail mail address for the sake of people who want to either write or send a check (which dodges PayPal’s fees).   In addition, our Amazon link led to 244 purchases in May, which contributes a lot.  Thanks to you all!

A special thanks to Roy Weitz, who stepped in as moderator during my three weeks in England.

We read, and respond to, everything we can.  Chip continues to monitor the Board’s technical questions and I try to handle any of the emailed notes.  If you have a question, comment, compliment or concern, just write me!

If you write, please remember to include your name and contact information.  I’m always interested in learning about funds or investment trends that intrigue you, but I’m exceedingly wary of anonymous tips.

Take care and I’ll see you again on July 1!

David