Objective

The fund’s investment objective is capital appreciation, which they hope to obtain by investing primarily in undervalued small cap stocks.  Small caps are defined as those comparable to those in the Russell 2000, whose largest stocks are about $3.3 billion.  They can also invest up to 10% in foreign stocks, generally through ADRs.  There’s a comparable strategy – the “GRT Value Strategy – Long only U.S. Equity Strategy” – used when they’re investing in private accounts. They describe the objective there in somewhat more interesting terms.  In those accounts, they want to achieve “superior total returns while” – this is the part I like – “minimizing the probability of permanent impairment of capital.”

Adviser

GRT Capital Partners.  GRT was founded in 2001 by Gregory Fraser, Rudolph Kluiber and Timothy Krochuk.  GRT offers investment management services to institutional clients and investors in its limited partnerships.  As of 09/30/2011, they had about $315 million in assets under management.  They also advise the GRT Absolute Return (GRTHX) fund.

Managers

The aforementioned Gregory Fraser, Rudolph Kluiber and Timothy Krochuk.  Mr. Kluiber is the lead manager.  From 1995 to 2001, he ran State Street Research Aurora (SSRAX), a small cap value fund which is now called BlackRock Aurora.  Before that, he was a high yield analyst and assistant manager on State Street Research High Yield.  Mr. Fraser managed Fidelity Diversified International from 1991 to 2001.  Mr. Krochuk managed Fidelity TechnoQuant Growth Fund from 1996 to 2001 and Fidelity Small Cap Selector fund in 2000 and 2001.  The latter two “work closely with Mr. Kluiber and play an integral part in generating investment ideas and making recommendations for the Fund.” Since 2001, they’ve worked together on limited partnerships and separate accounts forGRT Capital. All three managers earned degrees from Harvard, where Mr. Kluiber and Mr. Fraser were roommates.

Management’s Stake in the Fund

As of 07/31/2011, Messrs Kluiber and Fraser each had $500,000 – $1,000,000 in the fund while Mr. Krochuk had more than $1 million.

Opening date

May 1, 2008.

Minimum investment

$2,500 for regular accounts, $500 for retirement accounts and $250 for spousal IRAs.

Expense ratio

1.30%, after waivers, on assets of $120 million, unchanged since the fund’s launch.  There’s also a 2% redemption fee for shares held fewer than 14 days.

Comments

Investors looking to strengthen the small cap exposure in their portfolios owe it to themselves to look at GRT Value.  It’s that simple.

On the theme of “keeping it simple,” I’ll add just two topics: what do they do? And why should you consider them?

What do they do?

GRT Value follows a long-established discipline.  It invests, primarily, in undervalued small company stocks.  Because of a quirk in data reporting, the portfolio might seem to have more growth stock exposure than it does.  The manager highlights three sorts of investments:

Turnaround Companies – those “that have declined in value for business or market reasons, but which may be able to make a turnaround because of, for instance, a renewed focus on operations and the sale of assets to help reduce debt.” Because indexes might be reconstituted only once or twice a year, some of the fund’s holdings remain characterized as “growth stocks” despite a precipitous decline in valuation.

Deep Value Companies – those which are cheap relatively to “the value of their assets, the book value of their stock and the earning potential of their business.”

Post-Bankruptcy Companies – which are often underfollowed and shunned, hence candidates for mispricing.

The fortunes of these three types of securities don’t move in sync, which tends to dampen volatility.

As with some of the Artisan teams, GRT uses an agricultural analogy for portfolio construction.  They have “a ‘farm team’ investment process [in which] positions often begin relatively small and increase in size as the Adviser’s confidence grows and the original investment thesis is confirmed.”  The manager’s cautious approach to new positions and broad diversification (188 names, as of 10/31/11), work to mitigate risk.

The managers are pretty humble about all of this: “There is no magic formula,” they write.  “It simply comes down to experienced managers, using well-established risk guidelines for portfolio construction” (Annual Report, 07/31/11).

Why should you consider them?

They’re winners.  The system works.  High returns, muted risk.

GRTValue seems to be an upgraded version of State Street Research Aurora, which Mr. Kluiber ran with phenomenal success for six years.  Morningstar’s valedictory assessment when he left the fund was this:

Kluiber, the fund’s manager since its 1995 inception, built it into a category standout during his tenure. In fact, the fund gained an average of 28.9% per year from March 1995 throughApril 30, 2001, while its average small-cap value peer gained 15.5%.

The same analyst noted that the fund’s risk scores were low and that “[m]anagement’s willingness to go farther afield in small-value territory has been a boon over the long haul. For instance, management doesn’t shy away from investing in traditionally more growth-oriented sectors, such as technology, if valuations and fundamentals” are compelling.  The article announcing his departure concluded, “Kluiber had built a topnotch record since Aurora’s 1995 inception. The fund’s trailing three- and five-year returns for the period endingApril 27, 2001, rank in the top 5% of the small-cap value category;Auroraalso boasted relatively low volatility and superior tax efficiency.”

Hmmm . . . high returns, low risk, high tax efficiency all maintained over time.  Those seek like awfully promising attributes in your lead manager.

Since 2004, the trio have been managing separate accounts using the strategies embodied in both Aurora andGRTValue.  They modestly trailed the Russell 2000 index in their first year of operation, then substantially clubbed it in the following three.  That reflects a focus on getting it right, every day. “We’re just grinders,” Mr. Krochuk noted.  “We come in every day and do our jobs together.”  In baseball terms, they were hoping to make contact and hit lots of singles rather than counting on swinging for the fences in pursuit of rare, spectacular gains.

Since 2008, GRT Value has continued the tradition of clubbing the competition.  At this point, the story gets muddied by Morningstar’s mistake.  Morningstar categorizes GRTVX as a mid-cap blend fund.  It’s not.  Never has been.  The portfolio is more than 80% small- and micro-cap.  The fund’s average market cap – $790 million – is less than half of the average small blend fund’s.  It’s below the Russell 2000 average.  That miscategorization throws off all of Morningstar’s peer assessments for star rating, relative returns, and relative risk.  Judged as a small-blend or small-value fund, they’re actually better than Morningstar’s five-star rating implies.

GRTVX has substantially outperformed its peers since inception: $10,000 invested at the fund’s opening has grown to $13,200, compared to $11,800 at its average peer

GRTVX has outperformed its benchmark in down markets: it has lost less, or actually registered gains, in 11 of the 14 months in which the index declined (from 01/09 – 02/12).  That’s consistent both with Mr. Kluiber’s risk-consciousness and his long-term record.

GRTVX has a consistently better risk-return profile than the best small blend funds. Morningstar analysts have identified five best-of-the-best funds in the small blend category.  Those are Artisan Small Cap Value (ARTVX, closed), Bogle Small Growth (BOGLX, the retail shares), Royce Special (RYSEX, closed), Vanguard Small Cap Index (NAESX, the retail shares) and Vanguard Tax-Managed Small-Cap Fund (VTMSX, the Admiral Shares).  Using Fund Reveal’s fine-grained risk and return data, GRTVX offers a better risk-return profile – over the trailing one, two and three year periods – than any of them.  The only fund (RYSEX) with somewhat-lower volatility has substantially lower returns.  And the only fund with better average daily returns (BOGLX) has substantially higher volatility.

Bottom Line

Nothing in life is certain, but the prospects forGRT Value’s future are about as close as you’ll get.  The managers have precisely the right experience.  They have outstanding, complementary track records.  They have an organizational structure in which they have a sense of control and commitment.  Its three year record, however measured, has been splendid.

Fund website

The fund’s website is virtually nonexistent. There’s a little more information available at the parent site, but not all that much.

Objective and Strategy

MAINX seeks total return over the long term with an emphasis on income. The fund invests in income-producing securities which will include government, quasi-governmental and corporate bonds, dividend-paying stocks and convertible securities (a sort of stock/bond hybrid).  The fund may hedge its currency exposure, but does not intend to do so routinely.  In general, at least half of the portfolio will be in investment-grade bonds.  Equities, both common stocks and convertibles, will not exceed 20% of the portfolio.

Adviser

Matthews International Capital Management. Matthews was founded in 1991.  As of December 31, 2011, Matthews had $15.3 billion in assets in its 13 funds.  On whole, the Matthews funds offer below average expenses. Over the past three years, every Matthews fund has above-average performance except for Asian Growth & Income (MACSX). They also publish an interesting and well-written newsletter on Asian investing, Asia Insight.

Manager(s)

Teresa Kong is the lead manager.  Before joining Matthews in 2010, she was Head of Emerging Market Investments at Barclays Global Investors (now BlackRock) and responsible for managing the firm’s investment strategies in Emerging Asia, Eastern Europe, Africa and Latin America. In addition to founding the Fixed Income Emerging Markets Group at BlackRock, she was also Senior Portfolio Manager and Credit Strategist on the Fixed Income credit team.  She’s also served as an analyst for Oppenheimer Funds and JP Morgan Securities, where she worked in the Structured Products Group and Latin America Capital Markets Group.  Kong has two co-managers, Gerald Hwang, who for the past three years managed foreign exchange and fixed income assets for some of Vanguard’s exchange-traded funds and mutual funds, and Robert Horrocks, Matthews’ chief investment officer.

Management’s Stake in the Fund

Every member of the team is invested in the fund, but the extent – typically substantial at Matthews – is not yet disclosed.

Opening date

November 30, 2011.

Minimum investment

$2500 for regular accounts, $500 for IRAs.  The fund’s available, NTF, through Fidelity, Vanguard, Scottrade and a few others.

Expense ratio

1.0%, after waivers, on $19 million in assets (as of 2/23/12).  That’s a 40 basis point decline from opening expense ratio. There’s also a 2% redemption fee for shares held fewer than 90 days.

Comments

With the Federal Reserve’s January 2012 announcement of their intent to keep interest rates near zero through 2014, conservative investors are being driven to look for new sources of income.  Ms. Kong highlights a risk the bond investors haven’t previously wrestled with: shortfall risk.  The combination of microscopic domestic interest rates with the slow depreciation of the U.S. dollar (she wouldn’t be surprised at a 2% annual loss against a basket of foreign currencies) and the corrosive effects of inflation, means that more and more “risk-free” fixed-income portfolios simply won’t meet their owners’ needs.  Surmounting that risk requires looking beyond the traditional.

For many investors, Asia is a logical destination.  Three factors support that conclusion:

1. Asian governments and corporations are well-positioned to service their debts.  On whole, debt levels are low and economic growth is substantial.  Haruhiko Kuroda of the Asian Development Bank projected (in late January 2012) that Asian economies — excluding Japan, Australia and New Zealand — to grow by around 7% in 2012, down from about 7.5% in 2011 and 9% in 2010.  France, by contrast, projects 0.5% growth, the Czech Republic foresees 0.2% and Germany, Europe’s soundest economy, expects 0.7%.
   This high rate of growth is persistent, and allows Asian economies to service their debt more and more easily each year.  Ms. Kong reports that Fitch (12/2011) and S&P (1/2012) both upgraded Indonesian debt, and she expects more upgrades than downgrades for Asia credits.
2. Most Asian debt supports infrastructure, rather than consumption.  While the Greeks were borrowing money to pay pensions, Asian governments were financing roads, bridges, transport, water and power.  Such projects often produce steady income streams that persist for decades, as well as supporting further growth.
3. Most investors are under-exposed to Asian debt markets.  Bond indexes, the basis for passive funds and the benchmark for active ones, tend to be debt-weighted; that is, the more heavily indebted a nation is, the greater weight it has in the index.  Asian governments and corporations have relatively low debt levels and have made relatively light use of the bond market.

Ms. Kong illustrated the potential magnitude of the underexposure.  An investor with a global diversified bond portfolio (70% Barclays US Aggregate bond index, 20% Barclays Global Aggregate, 10% emerging markets) would have only 7% exposure to Asia.  However you measure Asia’s economic significance (31% of global GDP, rising to 38% in the near future or, by IMF calculations, the source of 50% of global growth), even fairly sophisticated bond investors are likely underexposed.

The European debt crisis, morphing into a banking crisis, is making bank loans harder to obtain.  Asian borrowers are turning to capital markets to raise cash.  Asian blue chip firms issued $14 billion in bonds in the first two months of 2012, in a development The Wall Street Journal described as a “stampede” (02/23/12). The market for Asian debt is becoming larger, more liquid and more transparent.  Those are all good things for investors.

The question isn’t “should you have more exposure to Asian fixed-income markets,” but rather “should you seek exposure through Matthews?”  The answer, in all likelihood, is “yes.”   Matthews has the largest array of Asia investment products in the U.S. market, the deepest analytic core and the broadest array of experience.  They also have a long history of fixed-income investing in the service of funds such as Matthews Asian Growth & Income (MACSX).   Their culture and policies are shareholder-friendly and their success has been consistent.

Asia Strategic Income will be their first income-oriented fund.  Like FPA Crescent (FPACX) in the U.S. market, it has the freedom range across an entity’s capital structure, investing in equity, debt, hybrid or derivative securities depending on which offers the best returns for the risk.  The manager argues that the inclusion of modest exposure to equities will improve the fund’s performance in three ways.

1. They create a more favorable portfolio return distribution.  In essence, they add a bit more upside and the manager will try “to mitigate downside by favoring equities that have relatively low volatility, high asset coverage and an expected long term yield higher than the local 10 year Treasury.”
2. They allow the fund to exploit pricing anomalies.  There are times when one component of a firm’s capital structure might be mispriced by the market relative to another. .  Ms. Kong reports that the fund bought the convertible shares of an “Indian coal mining company.  Its parent, a London-listed natural resource company, has bonds outstanding at the senior level.  At the time of purchase, the convertibles of the subsidiary offered higher yield, higher upside than the parent’s bonds even though the Indian coal mining had better fundamentals, less leverage, and were structurally senior since the entity owns the assets directly.”
3. They widen the fund’s opportunity set.  Some governments make it incredibly difficult for foreigners to invest, or invest much, in their bonds.  Adding the ability to invest in equities may give the managers exposure to otherwise inaccessible markets.

Unlike the indexes, MAINX will weight securities by credit-worthiness rather than by debt load, which will further dampen portfolio risk.  Finally, the fund’s manager has an impressive resume, she comes across as smart and passionate, and she’s supported by a great organization.

Bottom Line

MAINX offers rare and sensible access to an important, under-followed asset class.  The long track record of Matthews’ funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class.  Despite the queasiness that conservative investors, especially, might feel about investing what’s supposed to be their “safe” money overseas, there’s a strong argument for looking carefully at this as a supplement to an otherwise stagnant fixed-income portfolio.

Fund website

Matthews Asia Strategic Income

Objective and Strategy

The fund will pursue long-term capital growth by investing in a portfolio of global equities with a strong bias towards small- and micro-cap companies. Investments will include companies based in the U.S., developed foreign countries, and emerging/frontier markets. The portfolio has flexibility to adjust its investment mix by market cap, country, and sector in order to invest where the best global opportunities exist.  The managers expect to typically have 100-150 holdings, though they are well above that for the short-term.

Adviser

Grandeur Peak Global Advisors is a small- and micro-cap focused global equities investment firm, founded in mid-2011, and comprised of a very experienced and collaborative investment team that worked together for years managing some of the Wasatch funds.  Global Opportunities and International Opportunities are their only two investment vehicles.  The funds have over $85 million in assets after three months of operation.

Managers

Robert Gardiner and Blake Walker.   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 few conclusions: (1) he loved managing money and needed to get back on the front lines, (2) the best investors will be global investor, (3) global microcap investing is the world’s most interesting sector, (4) and he had an increasing desire to manage his own firm.  He returned to active management with the launch of Wasatch Global Opportunities (WAGOX), a global go anywhere fund, focused primarily on micro and small cap companies.  From inception in late 2008 to June 2011 (the point of his departure), 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, for the second year in a row, Lipper designated WAIOX as the top International Small/Mid-Cap Growth Fund based on consistent (risk-adjusted) return for the five years through 2010.

They both speak French.  Mais oui!

Management’s Stake in the Fund

As of 1/27/2012, Mr. Gardiner is the largest shareholder in both funds, Mr. Walker “has a nice position in both funds” (their phrase) and all nine members of the Grandeur Peak Team are fund shareholders.  Eric Huefner makes an argument that I find persuasive: “We are all highly vested in the success of the funds and the firm. Every person took a significant pay cut (or passed up a significantly higher paying opportunity) to be here.”

Opening date

October 17, 2011.

Minimum investment

$2000 for regular accounts, $1000 for IRAs.  The fund’s available for purchase through all of the big independent platforms: Schwab, Fidelity, TD Ameritrade, Vanguard, Scottrade and Pershing.

Expense ratio

1.75% on $65 million in assets (as of January 27, 2012).

Comments

This is a choice, not an echo.  Most “global” funds invest in huge, global corporations.  Of roughly 250 global stock funds, 80% have average market caps over $10 billion.  Only six qualify as small cap funds.   While that large cap emphasis dampens risk, it also tends to dampen rewards and produces rather less diversification value for a portfolio.

Grandeur Peak Global Opportunities goes where virtually no one else does: tiny companies across the globe.  While these are intrinsically risky investments, they also offer the potential for huge rewards.  The managers invest exclusively in what they deem to be high-quality companies, measured by factors such as the strength of the management team, the firm’s return on capital and debt burden, and the presence of a sustainable competitive advantage.  They look for a mix of three sorts of securities:

Best-In-Class Growth Companies: fast earnings growth, good management, strong financials.  The strategy is to “find them small & undiscovered; buy and hold” until the market catches on.  In the interim,  capture the compounded earnings growth.

Fallen Angels: good growth companies that hit “a bump in the road” and are priced as value stocks.  The strategy is to buy them low and hold through the recovery.

Stalwarts: basically, blue chip micro-cap stocks.  Decent but not great growth, great financials, and the prospect of dividends or stock buy-backs.  The strategy is to buy them at a fair price but be careful of overpaying since their growth may be decelerating.

The question is: can this team manage an acceptable risk / reward balance for their investors.  The answer is: yes, almost certainly.

The reason for my confidence is simple: they’ve done it before and they’ve done it splendidly.  As their manager bios note, Gardiner and Blake have a record of producing substantial rewards for mutual fund investors and the two Grandeur Peak funds follow the same discipline as their Wasatch predecessors.

The real question for investors interested in global micro/small-cap investing is “why here rather than Wasatch?”  I put that question to Eric Huefner, Grandeur Peak’s president, who himself was a Wasatch executive.  He made three points:

1. We have structured our team differently. All six members of our research team are global analysts. At Wasatch we had an International Team and a Domestic Team. The two teams talked with each other, but we didn’t have global analysts. We believe that to pick the best companies in the world you have to be looking at companies from every corner of the world. Each of our analysts (which includes the PMs) has primary responsibility for 1-2 sectors globally. This ensures that we are covering all sectors, and developing sector expertise, but with a global view. Yet, our team is small enough that all six members are actively involved in vetting every idea that goes into the portfolios.
2. We feel more nimble than we did at Wasatch. Today (01/29/12) we have $87 million under management, whereas Wasatch has billions in Global Small Caps (including both funds and other accounts). When you are trying to move in and out of micro cap stocks this nimbleness really pays off – small amounts that add up. We plan to keep our firm a small boutique so that we don’t lose our ability to buy the stocks we want to.
3. We have great respect for the team at Wasatch and believe they are well positioned to continue their success. Running our own firm has simply been a long-time dream of ours. I would be kidding you to say that 2011 wasn’t a distracting year for Robert and Blake as we got our new firm up and running. We feel like we’re off to a good start, and the organizational tasks are now behind us. Robert and Blake are very much re-focused on research as we begin 2012, and we have committed to minimizing their marketing efforts in order to keep our priority on research/performance. The good news is that since it’s our own firm everyone is highly energized and having a great time.

The final point in Grandeur Peak’s favor is obvious and unstated: they have the guys that actually produced the record Wasatch now holds.

Bottom Line

Both the team and the strategy are distinctive and proven.  Few people pursue this strategy, and none pursue it more effectively than Messrs. Gardiner and Blake.  Folks looking for a way to add considerable diversity to the typical large/domestic/balanced portfolio really owe it to themselves to spend some time here.

Website

Grandeur Peak Global Opportunities

Objective and Strategy

The Bretton Fund seeks to achieve long-term capital appreciation by investing in a small number of undervalued securities. The fund invests in common stocks of companies of all sizes. It normally holds a core position of between 15 to 20 securities whose underlying firms combine a defensible competitive advantage, relevant products, competent and shareholder-oriented management, growth, and a low level of debt.  The manager wants to invest “in ethical businesses” but does not use any ESG screens; mostly he avoids tobacco and gaming companies.

Adviser

Bretton Capital Management, LLC.  Bretton was founded in 2010 to advise this fund, which is its only client.

Manager

Stephen Dodson.  From 2002 to 2008, Mr. Dodson worked at Parnassus Investments in San Francisco, California, where he held various positions including president, chief operating officer, chief compliance officer and was a co-portfolio manager of a $25 million California tax-exempt bond fund. Prior to joining Parnassus Investments, Mr. Dodson was a venture capital associate with Advent International and an investment banking analyst at Morgan Stanley. Mr. Dodson attended the University of California, Berkeley, and earned a B.S. in Business Administration from the Haas School of Business.

Management’s Stake in the Fund

Mr. Dodson has over a million dollars invested in the fund.  As of April 5, 2011, Mr. Dodson and his family owned about 75% of the fund’s shares.

Opening date

September 30, 2010.

Minimum investment

$5000 for regular accounts, $1000 for IRAs or accounts established with an automatic investment plan.  The fund’s available for purchase through E*Trade and Pershing.

Expense ratio

1.5% on $3 million in assets.

Comments

Mr. Dodson is an experienced investment professional, pursuing a simple discipline.  He wants to buy deeply discounted stocks, but not a lot of them.  Where some funds tout a “best ideas” focus and then own dozens of the same large cap stocks, Bretton seems to mean it when he says “just my best.”

As of 9/30/11, the fund held just 15 stocks.  Of those, six were large caps, three mid-caps and six small- to micro-cap.  His micro-cap picks, where he often discerns the greatest degree of mispricing, are particularly striking.  Bretton is one of only a handful of funds that owns the smaller cap names and it generally commits ten or twenty times as much of the fund’s assets to them.

In addition to being agnostic about size, the fund is also unconstrained by style or sector.  Half of the fund’s holdings are characterized as “growth” stocks, half are not.   The fund offers no exposure at all in seven of Morningstar’s 11 industry sectors, but is over weighted by 4:1 in financials.

This is the essence of active management, and active management is about the only way to distinguish yourself from an overpriced index.  Bretton’s degree of concentration is not quite unprecedented, but it is remarkable.  Only six other funds invest with comparable confidence (that is, invests in such a compact portfolio), and five of them are unattractive options.

Biondo Focus (BFONX) holds 15 stocks and (as of January 2012) is using leverage to gain market exposure of 130%.  It sports a 3.1% e.r.  A $10,000 investment in the fund on the day it launched was worth $7800 at the end of 2011, while an investment in its average peer for the same period would have grown to $10,800.

Huntington Technical Opportunities (HTOAX) holds 12 stocks (briefly: it has a 440% portfolio turnover), 40% cash, and 10% S&P index fund.  The expense ratio is about 2%, which is coupled with a 4.75% load.  From inception, $10,000 became $7200 while its average peer would be at $9500.

Midas Magic (MISEX).  The former Midas Special Fund became Midas Magic on 4/29/2011.  Dear lord.  The ticker reads “My Sex” and the name cries out for Clara Peller to squawk “Where’s The Magic?”  The fund reports 0% turnover but found cause to charge 3.84% in expenses anyway.  Let’s see: since inception (1986), the fund has vastly underperformed the S&P500, its large cap peer group, short-term bond funds, gold, munis, currency . . . It has done better than the Chicago Cubs, but that’s about it.  It holds 12 stocks.

Monteagle Informed Investor Growth (MIIFX) holds 12 stocks (very briefly: it reports a 750% turnover ratio) and 20% cash.  The annual report’s lofty rhetoric (“The Fund’s goal is to invest in these common stocks with demonstrated informed investor interest and ownership, as well as, solid earnings fundamentals”) is undercut by an average holding period of six weeks.  The fund had one brilliant month, November 2008, when it soared 36% as the market lost 10%.  Since then, it’s been wildly inconsistent.

Rochdale Large Growth (RIMGX) holds 15 stocks and 40% cash.  From launch through the end of 2011, it turned $10,000 to $6300 while its large cap peer group went to $10,600.

The Cook & Bynum Fund (COBYX) is the most interesting of the lot.  It holds 10 stocks (two of which are Sears and Sears Canada) and 30% cash.  Since inception it has pretty much matched the returns of a large-value peer group, but has done so with far lower volatility.

And so fans of really focused investing have two plausible candidates, COBYX and BRTNX.  Of the two, Bretton has a far more impressive, though shorter, record.  From inception through the end of 2011, $10,000 invested in Bretton would have grown to $11,500.  Its peer group would have produced an average return of $10,900. For 2011 as a whole, BRTNX’s returns were in the top 2% of its peer group, by Morningstar’s calculus.   Lipper, which classifies it as “multi-cap value,” reports that it had the fourth best record of any comparable fund in 2011.  In particular, the fund outperformed its peers in every month when the market was declining.  That’s a particularly striking accomplishment given the fund’s concentration and micro-cap exposure.

Bottom Line

Bretton has the courage of its convictions.  Those convictions are grounded in an intelligent reading of the investment literature and backed by a huge financial commitment by the manager and his family.  It’s a fascinating vehicle and deserves careful attention.

Fund website

Bretton Fund

This profile has been updated since it was originally published. The updated profile can be found at http://www.mutualfundobserver.com/2012/09/northern-global-tactical-asset-allocation-fund-bbalx-september-2011-updated-september-2012/

Objective

The fund seeks a combination of growth and income. Northern’s Investment Policy Committee develops tactical asset allocation recommendations based on economic factors such as GDP and inflation; fixed-income market factors such as sovereign yields, credit spreads and currency trends; and stock market factors such as domestic and foreign earnings growth and valuations.  The managers execute that allocation by investing in other Northern funds and outside ETFs.  As of 6/30/2011, the fund holds 10 Northern funds and 3 ETFs.

Adviser

Northern Trust Investments.  Northern’s parent was founded in 1889 and provides investment management, asset and fund administration, fiduciary and banking solutions for corporations, institutions and affluent individuals worldwide.  As of June 30, 2011, Northern Trust Corporation had $97 billion in banking assets, $4.4 trillion in assets under custody and $680 billion in assets under management.  The Northern funds account for about $37 billion in assets.  When these folks say, “affluent individuals,” they really mean it.  Access to Northern Institutional Funds is limited to retirement plans with at least $30 million in assets, corporations and similar institutions, and “personal financial services clients having at least $500 million in total assets at Northern Trust.”  Yikes.  There are 51 Northern funds, seven sub-advised by multiple institutional managers.

Managers

Peter Flood and Daniel Phillips.  Mr. Flood has been managing the fund since April, 2008.  He is the head of Northern’s Fixed Income Risk Management and Fixed Income Strategy teams and has been with Northern since 1979.  Mr. Phillips joined Northern in 2005 and became co-manager in April, 2011.  He’s one of Northern’s lead asset-allocation specialists.

Management’s Stake in the Fund

None, zero, zip.   The research is pretty clear, that substantial manager ownership of a fund is associated with more prudent risk taking and modestly higher returns.  I checked 15 Northern managers listed in the 2010 Statement of Additional Information.  Not a single manager had a single dollar invested.  For both practical and symbolic reasons, that strikes me as regrettable.

Opening date

Northern Institutional Balanced, this fund’s initial incarnation, launched on July 1, 1993.  On April 1, 2008, this became an institutional fund of funds with a new name, manager and mission and offered four share classes.  On August 1, 2011, all four share classes were combined into a single no-load retail fund but is otherwise identical to its institutional predecessor.

Minimum investment

$2500, reduced to $500 for IRAs and $250 for accounts with an automatic investing plan.

Expense ratio

0.68%, after waivers, on assets of $18 million. While there’s no guarantee that the waiver will be renewed next year, Peter Jacob, a vice president for Northern Trust Global Investments, says that the board has never failed to renew a requested waiver. Since the new fund inherited the original fund’s shareholders, Northern and the board concluded that they could not in good conscience impose a fee increase on those folks. That decision that benefits all investors in the fund. Update – 0.68%, after waivers, on assets of nearly $28 million (as of 12/31/2012.)

Comments

The case for this fund can be summarized easily.  It was a perfectly respectable institutional balanced fund which has become dramatically better as a result of two sets of recent changes.

Northern Institutional Balanced invested conservatively and conventionally.  It held about two-thirds in stocks (mostly mid- to large-sized US companies plus a few large foreign firms) and one-third in bonds (mostly investment grade domestic bonds).   Northern’s ethos is very risk sensitive which makes a world of sense given their traditional client base: the exceedingly affluent.  Those folks didn’t need Northern to make a ton of money for them (they already had that), they needed Northern to steward it carefully and not take silly risks.  Even today, Northern trumpets “active risk management and well-defined buy-sell criteria” and celebrates their ability to provide clients with “peace of mind.”  Northern continues to highlight “A conservative investment approach . . . strength and stability . . .  disciplined, risk-managed investment . . . “

As a reflection of that, Balanced tended to capture only 65-85% of its benchmark’s gains in years when the market was rising but much less of the loss when the market was falling.  In the long-term, the fund returned about 85% of its 65% stock – 35% bond benchmark’s gains but did so with low volatility.

That was perfectly respectable.

Since then, two sets of changes have made it dramatically better.  In April 2008, the fund morphed from conservative balanced to a global tactical fund of funds.  At a swoop, the fund underwent a series of useful changes.

The asset allocation became fluid, with an investment committee able to substantially shift asset class exposure as opportunities changed.

The basic asset allocation became more aggressive, with the addition of a high-yield bond fund and emerging markets equities.

The fund added exposure to alternative investments, including gold, commodities, global real estate and currencies.

Those changes resulted in a markedly stronger performer.  In the three years since the change, the fund has handily outperformed both its Morningstar benchmark and its peer group.  Its returns place it in the top 7% of balanced funds in the past three years (through 8/25/11).  Morningstar has awarded it five stars for the past three years, even as the fund maintained its “low risk” rating.  Over the same period, it’s been designated a Lipper Leader (5 out of 5 score) for Total Returns and Expenses, and 4 out of 5 for Consistency and Capital Preservation.

In the same period (04/01/2008 – 08/26/2011), it has outperformed its peer group and a host of first-rate balanced funds including Vanguard STAR (VGSTX), Vanguard Balanced Index (VBINX), Fidelity Global Balanced (FGBLX), Leuthold Core (LCORX), T. Rowe Price Balanced (RPBAX) and Dodge & Cox Balanced (DODBX).

In August 2011, the fund morphed again from an institutional fund to a retail one.   The investment minimum dropped from $5,000,000 to as low as $250.  The expense ratio, however, remained extremely low, thanks to an ongoing expense waiver from Northern.  The average for other retail funds advertising themselves as “tactical asset” or “tactical allocation” funds is about 1.80%.

Bottom Line

Northern GTA offers an intriguing opportunity for conservative investors.  This remains a cautious fund, but one which offers exposure to a diverse array of asset classes and a price unavailable in other retail offerings.  It has used its newfound flexibility and low expenses to outperform some very distinguished competition.  Folks looking for an interesting and affordable core fund owe it to themselves to add this one to their short-list.

Fund website

Northern Global Tactical Asset Allocation

Update – 3Q2011 Fact Sheet

Fund Profile, 2nd quarter, 2012

© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

This profile has been updated since it was originally published. The updated profile can be found at http://www.mutualfundobserver.com/2012/09/riverpark-short-term-high-yield-fund-rphyx-july-2011-updated-october-2012/

Objective

The fund seeks high current income and capital appreciation consistent with the preservation of capital, and is looking for yields that are better than those available via traditional money market and short term bond funds.  They invest primarily in high yield bonds with an effective maturity of less than three years but can also have money in short term debt, preferred stock, convertible bonds, and fixed- or floating-rate bank loans.

Adviser

RiverPark Advisers.  Executives from Baron Asset Management, including president Morty Schaja, formed RiverPark in July 2009.  RiverPark oversees the five RiverPark funds, though other firms manage three of the five.  Until recently, they also advised two actively-managed ETFs under the Grail RP banner.  A legally separate entity, RiverPark Capital Management, runs separate accounts and partnerships.  Collectively, they have $90 million in assets under management, as of May 2011.

Manager

David Sherman, founder and owner of Cohanzick Management of Pleasantville (think Reader’s Digest), NY.  Cohanzick manages separate accounts and partnerships.  The firm has more than $320 million in assets under management.  Since 1997, Cohanzick has managed accounts for a variety of clients using substantially the same process that they’ll use with this fund. He currently invests about $100 million in this style, between the fund and his separate accounts.  Before founding Cohanzick, Mr. Sherman worked for Leucadia National Corporation and its subsidiaries.  From 1992 – 1996, he oversaw Leucadia’s insurance companies’ investment portfolios.  All told, he has over 23 years of experience investing in high yield and distressed securities.  He’s assisted by three other investment professionals.

Management’s Stake in the Fund

30% of the fund’s investments come from RiverPark or Cohanzick.  However, if you include friends and family in the equation, the percentage climbs to about 50%.

Opening date

September 30, 2010.

Minimum investment

$1,000.

Expense ratio

1.25% after waivers on $20.5 million in assets.  The prospectus reports that the actual cost of operation is 2.65% with RiverPark underwriting everything above 1.25%.  Mr. Schaja, RiverPark’s president, says that the fund is very near the break-even point. Update – 1.25%, after waivers, on $53.7 million in assets (as of 12/31/2011.)

Comments

The good folks at Cohanzick are looking to construct a profitable alternative to traditional money management funds.  The case for seeking an alternative is compelling.  Money market funds have negative real returns, and will continue to have them for years ahead.  As of June 28 2011, Vanguard Prime Money Market Fund (VMMXX) has an annualized yield of 0.04%.  Fidelity Money Market Fund (SPRXX) yields 0.01%.  TIAA-CREF Money Market (TIRXX) yields 0.00%.  If you had put $1 million in Vanguard a year ago, you’d have made $400 before taxes.  You might be tempted to say “that’s better than nothing,” but it isn’t.  The most recent estimate of year over year inflation (released by the Bureau of Labor Statistics, June 15 2011) is 3.6%, which means that your ultra-safe million dollar account lost $35,600 in purchasing power.  The “rush to safety” has kept the yield on short term T-bills at (or, egads, below) zero.  Unless the U.S. economy strengths enough to embolden the Fed to raise interest rates (likely by a quarter point at a time), those negative returns may last through the next presidential election.

That’s compounded by rising, largely undisclosed risks that those money market funds are taking.  The problem for money market managers is that their expense ratios often exceed the available yield from their portfolios; that is, they’re charging more in fees than they can make for investors – at least when they rely on safe, predictable, boring investments.  In consequence, money market managers are reaching (some say “groping”) for yield by buying unconventional debt.  In 2007 they were buying weird asset-backed derivatives, which turned poisonous very quickly.  In 2011 they’re buying the debt of European banks, banks which are often exposed to the risk of sovereign defaults from nations such as Portugal, Greece, Ireland and Spain.  On whole, European banks outside of those four countries have over $2 trillion of exposure to their debt. James Grant observed in the June 3 2011 edition of Grant’s Interest Rate Observer, that the nation’s five largest money market funds (three Fidelity funds, Vanguard and BlackRock) hold an average of 41% of their assets in European debt securities.

Enter Cohanzick and the RiverPark Short Term High Yield fund.  Cohanzick generally does not buy conventional short term, high yield bonds.  They do something far more interesting.  They buy several different types of orphaned securities; exceedingly short-term (think 30-90 day maturity) securities for which there are few other buyers.

One type of investment is redeemed debt, or called bonds.  A firm or government might have issued a high yielding ten-year bond.  Now, after seven years, they’d like to buy those bonds back in order to escape the high interest payments they’ve had to make.  That’s “calling” the bond, but the issuer must wait 30 days between announcing the call and actually buying back the bonds.  Let’s say you’re a mutual fund manager holding a million dollars worth of a called bond that’s been yielding 5%.  You’ve got a decision to make: hold on to the bond for the next 30 days – during which time it will earn you a whoppin’ $4166 – or try to sell the bond fast so you have the $1 million to redeploy.  The $4166 feels like chump change, so you’d like to sell but to whom?

In general, bond fund managers won’t buy such short-lived remnants and money market managers can’t buy them: these are still nominally “junk” and forbidden to them.  According to RiverPark’s president, Morty Schaja, these are “orphaned credit opportunities with no logical or active buyers.”  The buyers are a handful of hedge funds and this fund.  If Cohanzick’s research convinces them that the entity making the call will be able to survive for another 30 days, they can afford to negotiate purchase of the bond, hold it for a month, redeem it, and buy another.  The effect is that the fund has junk bond like yields (better than 4% currently) with negligible share price volatility.

Redeemed debt (which represents 33% of the June 2011 portfolio) is one of five sorts of investments typical of the fund.  The others include

• Corporate event driven (18% of the portfolio) purchases, the vast majority of which mature in under 60 days. This might be where an already-public corporate event will trigger an imminent call, but hasn’t yet.  If, for example, one company is purchased by another, the acquired company’s bonds will all be called at the moment of the merger.
• Strategic recapitalization (10% of the portfolio), which describes a situation in which there’s the announced intention to call, but the firm has not yet undertaken the legal formalities.  By way of example, Virgin Media has repeatedly announced its intention to call certain bonds in August 2011. The public announcements gave the manager enough comfort to purchase the bonds, which were subsequently called less than 2 weeks later.  Buying before call means that the fund has to post the original maturities (five years) despite knowing the bond will cash out in (say) 90 days.  This means that the portfolio will show some intermediate duration bonds.
• Cushion bonds (14%), refers to a bond whose yield to maturity is greater than its current yield to call.  So as more time goes by (and the bond isn’t called), the yield grows. Because I have enormous trouble in understanding exactly what that means, Michael Dekler of Cohanzick offered this example:

A good example is the recent purchase of the Qwest (Centurylink) 7.5% bonds due 2014.  If the bonds had been called on the day we bought them (which would have resulted in them being redeemed 30 days from that day), our yield would only have been just over 1%.  But since no immediate refinancing event seemed to be in the works, we suspected the bonds would remain outstanding for longer.  If the bonds were called today (6/30) for a 7/30 redemption date, our yield on the original purchase would be 5.25%.  And because we are very comfortable with the near-term credit quality, we’re happy to hold them until the future redemption or maturity.

• Short term maturities (25%), fixed and floating rate debt that the manager believes are “money good.”

What are the arguments in favor of RPHYX?

• It’s currently yielding 100-400 times more than a money market.  While the disparity won’t always be that great, the manager believes that these sorts of assets might typically generate returns of 3.5 – 4.5% per year, which is exceedingly good.
• It features low share price volatility.  The NAV is $10.01 (as of 6/29/11).  It’s never been higher than $10.03 or lower than $9.97.  Almost all of the share price fluctuation is due to their monthly dividend distributions.    A $0.04 cent distribution at the end of June will cause the NAV will go back down to about $9.97. Their five separately managed accounts have almost never shown a monthly decline in value.  The key risk in high-yield investing is the ability of the issuer to make payments for, say, the next decade.  Do you really want to bet on Eastman Kodak’s ability to survive to 2021?  With these securities, Mr. Sherman just needs to be sure that they’ll survive to next month.  If he’s not sure, he doesn’t bite.  And the odds are in his favor.  In the case of redeemed debt, for instance, there’s been only one bankruptcy among such firms since 1985.
• It offers protection against rising interest rates.  Because most of the fund’s securities mature within 30-60 days, a rise in the Fed funds rate will have a negligible effect on the value of the portfolio.
• It offers experienced, shareholder-friendly management.  The Cohanzick folks are deeply invested in the fund.  They run $100 million in this style currently and estimate that they could run up to $1 billion. Because they’re one of the few large purchasers, they’re “a logical first call for sellers.  We … know how to negotiate purchase terms.”  They’ve committed to closing both their separate accounts and the fund to new investors before they reach their capacity limit.

Bottom Line

This strikes me as a fascinating fund.  It is, in the mutual fund world, utterly unique.  It has competitive advantages (including “first mover” status) that later entrants won’t easily match.  And it makes sense.  That’s a rare and wonderful combination.  Conservative investors – folks saving up for a house or girding for upcoming tuition payments – need to put this on their short list of best cash management options.

Financial disclosure: I intend to shift $1000 from the TIAA-CREF money market to RPHYX about one week after this profile is posted (July 1 2011) and establish an automatic investment in the fund.  That commitment, made after I read an awful lot and interviewed the manager, might well color my assessment.  Caveat emptor.

Note to financial advisers: Messrs Sherman and Schaja seem committed to being singularly accessible and transparent.  They update the portfolio monthly, are willing to speak individually with major investors and plan – assuming the number of investors grows substantially – to offer monthly conference calls to allow folks to hear from, and interact with, management.

Fund website

RiverPark Short Term High Yield

Update: 3Q2011 Fact Sheet

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact [email protected].

Objective

The fund pursues long-term growth by investing in 30-50 undervalued global stocks.  Generally it avoids small cap caps, but can invest up to 30% in emerging and less developed markets.   The managers look for four characteristics in their investments:

1. A high quality business
2. With a strong balance sheet
3. Shareholder-focused management
4. Selling for less than it’s worth.

The managers can hedge their currency exposure, though they did not do so until they confronted twin challenges to the Japanese yen: unattractive long-term fiscal position plus the tragedies of March 2011. The team then took the unusual step of hedging part of their exposure to the Japanese yen.

Adviser

Artisan Partners of Milwaukee, Wisconsin.   Artisan has five autonomous investment teams that oversee twelve distinct U.S., non-U.S. and global investment strategies. Artisan has been around since 1994.  As of 3/31/2011 Artisan Partners had approximately $63 billion in assets under management (March 2011).  That’s up from $10 billion in 2000. They advise the 12 Artisan funds, but only 6% of their assets come from retail investors. Update – Artisan Partners had approximately $57.1 billion in assets under management, as of 12/31/2011.

Manager

Daniel J. O’Keefe and David Samra, who have worked together since the late 1990s.  Mr. O’Keefe co-manages this fund, Artisan International Value (ARTKX) and Artisan’s global value separate account portfolios.  Before joining Artisan, he served as a research analyst for the Oakmark international funds and, earlier still, was a Morningstar analyst.  Mr. Samra has the same responsibilities as Mr. O’Keefe and also came from Oakmark.  Before Oakmark, he was a portfolio manager with Montgomery Asset Management, Global Equities Division (1993 – 1997).  Messrs O’Keefe, Samra and their five analysts are headquartered in San Francisco.  ARTKX earns Morningstar’s highest accolade: it’s an “analyst pick” (as of 04/11).

Management’s Stake in the Fund

Each of the managers has over $1 million here and over $1 million in Artisan International Value.

Opening date

December 10, 2007.

Minimum investment

$1000 for regular accounts, reduced to $50 for accounts with automatic investing plans.  Artisan is one of the few firms who trust their investors enough to keep their investment minimums low and to waive them for folks willing to commit to the discipline of regular monthly or quarterly investments.

Expense ratio

1.5%, after waivers, on assets of $57 million (as of March 2011). Update – 1.5%, after waivers, on assets of $91 million (as of December 2011).

Comments

Artisan Global Value is the first “new” fund to earn the “star in the shadows” designation.  My original new fund profile of it, written in February 2008, concluded: “Global is apt to be a fast starter, strong, disciplined but – as a result – streaky.”  I have, so far, been wrong only about the predicted streakiness.  The fund’s fast, strong and disciplined approach has translated into consistently superior returns from inception, both in absolute and risk-adjusted terms.  Its shareholders have clearly gotten their money’s worth, and more.

What are they doing right?

Two things strike me.  First, they are as interested in the quality of the business as in the cost of the stock.  O’Keefe and Samra work to escape the typical value trap (“buy it!  It’s incredibly cheap!”) by looking at the future of the business – which also implies understanding the firm’s exposure to various currencies and national politics – and at the strength of its management team.  One of the factors limiting the fund’s direct exposure to emerging markets stocks is the difficulty of finding sufficiently high quality firms and consistently shareholder-focused management teams.  If they have faith in the firm and its management, they’ll buy and patiently wait for other investors to catch up.

Second, the fund is sector agnostic.   Some funds, often closet indexes, formally attempt to maintain sector weights that mirror their benchmarks.  Others achieve the same effect by organizing their research and research teams by industry; that is, there’s a “tech analyst” or “an automotive analyst.”  Mr. O’Keefe argues that once you hire a financial industries analyst, you’ll always have someone advocating for inclusion of their particular sector despite the fact that even the best company in a bad sector might well be a bad investment.  ARTGX is staffed by “research generalists,” able to look at options across a range of sectors (often within a particular geographic region) and come up with the best ideas regardless of industry.  That independence is reflected in the fact that, in eight of ten industry sectors, ARTGX’s position is vastly different than its benchmark’s.  Too, it explains part of the fund’s excellent performance during the 2008 debacle. During the third quarter of 2008, the fund’s peers dropped 18% and the international benchmark plummeted 20%.  Artisan, in contrast, lost 3.5% because the fund avoided highly-leveraged companies, almost all banks among them.

Why, then, are there so few shareholders?

Manager Dan O’Keefe offered two answers.  First, advisors (and presumably many retail investors) seem uncomfortable with “global” funds.  Because they cannot control the fund’s asset allocation, such funds mess up their carefully constructed plans.  As a result, many prefer picking their international and domestic exposure separately.  O’Keefe argues that this concern is misplaced, since the meaningful question is neither “where is the firm’s headquarters” or “on which stock exchange does this stock trade” (the typical dividers for domestic/international stocks) but, instead, “where is this company making its money?”  Colgate-Palmolive (CL) is headquartered in the U.S. but generates less than a fifth of its sales here.  Over half of its sales come from its emerging markets operations, and those are growing at four times the rate of its domestic or developed international market shares.  (ARTGX does not hold CL as of 3/31/11.)  His hope is that opinion-leaders like Morningstar will eventually shift their classifications to reflect an earnings or revenue focus rather than a domicile one.

Second, the small size is misleading.  The vast majority of the assets invested in Artisan’s Global Value Strategy, roughly $3.5 billion, are institutional money in private accounts.  Those investors are more comfortable with giving the managers broad discretion and their presence is important to retail investors as well: the management team is configured for investing billions and even a tripling of the mutual fund’s assets will not particularly challenge their strategy’s capacity.

What are the reasons to be cautious?

There are three aspects of the fund worth pondering.  First, the expense ratio (1.50%) is above average even after expense waivers.  Even fully-grown, the fund’s expenses are likely to be in the 1.4% range (average for Artisan).  Second, the fund offers limited direct exposure to emerging markets.  While it could invest up to 30%, it has never invested more than 9% and, since late-2009, has had zero.  Many of the multinationals in its portfolio do give it exposure to those economies and consumers.  Third, the fund offers no exposure to small cap stocks.  Its minimum threshold for a stock purchase is a $2 billion market cap.  That said, the fund does have an unusually high number of mid-cap stocks.

Bottom Line

On whole, Artisan Global Value offers a management team that is as deep, disciplined and consistent as any around.  They bring an enormous amount of experience and an admirable track record stretching back to 1997.  Like all of the Artisan funds, it is risk-conscious and embedded in a shareholder-friendly culture.  There are few better offerings in the global fund realm.

Fund website

Artisan Global Value fund

Update – December 31, 2011 (4Q) – Fact Sheet (pdf)

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact [email protected].

. . . from the archives at FundAlarm

These profiles have not been updated. The information is only accurate as of the original date of publication.

February 1, 2010

FundAlarm Annex – Fund Report

Objective

The fund seeks long-term capital appreciation by investing, mostly, in US stocks of various sizes, though it is likely to hold small and mid-cap stocks more frequently than large cap ones. The fund may also invest in “other equity-like instruments.”  The manager looks for companies with good management teams (those with “a history of treating public shareholders like partners”), little reliance on debt markets and above-average returns on equity.  Once they find such companies, they wait until the stock sells at a discount to “a conservative estimate of the company’s intrinsic value.”  The Fund is non-diversified, with both a compact portfolio (25 or so names) and a willingness to put a lot of money (often three or four times more than a “neutral weighting” would suggest) in a few sectors.

Adviser

Akre Capital Management, LLC, an independent Registered Investment Advisor located in Middleburg, VA. Mr. Akre, the founder of the firm, has been managing portfolios since 1986, and has worked in the industry for over 40 years. At 12/30/09, the firm had over $500 million in assets under management split between Akre Capital Management, which handles the firm’s separately managed accounts ($1 million minimum), a couple hedge funds, and Akre Focus Fund.  Mr. Akre founded ACM in 1989, while his business partners went on to form FBR.  As a business development move, it operated it as part of Friedman, Billings, Ramsey & Co. from 1993 – 1999 then, in 2000, ACM again became independent.

Manager

Charles Akre, who is also CEO of Akre Capital Management. Mr. Akre has been in the securities business since 1968 and was the sole manager of FBR Focus (FBRVX) from its inception in 1996 to mid-2009.  He holds a BA in English Literature from American University, which I mention as part of my ongoing plug for a liberal arts education.

Managements Stake in the Fund

Mr. Akre and his family have “a seven figure investment in Akre Focus, larger than my investment in the FBR fund had been.”

Opening date

August 31, 2009 though the FBR Focus fund, which Mr. Akre managed in the same style, launched on December 31, 1996.

Minimum investment

$2,000 for regular accounts, $1000 for IRAs and accounts set up with automatic investing plans.

Expense ratio

1.46% on assets of about $150 million.  There’s also a 1.00% redemption fee on shares held less than 30 days.

Comments

In 1997, Mr. Akre became of founding manager of FBR Small Cap Growth – Value fund, which became FBR Small Cap Value, the FBR Small Cap, and finally FBR Focus (FBRVX). Across the years and despite many names, he applied the same investment strategy that now drives Akre Focus.

Here’s his description of the process:

The process we employ for evaluating and identifying potential investments (compounding machines) consists of three key steps:

1. We look for companies with a history of above average return on owner’s capital and, in our assessment, the ability to continue delivering above average returns going forward. Investors who want returns that are better than average need to invest in businesses that are better than average. This is the pond we seek to fish in.
2. We insist on investing only with firms whose management has demonstrated an acute focus on acting in the best interest of all shareholders. Managers must demonstrate expertise in managing the business through various economic conditions, and we evaluate what they do, say and write for demonstrations of integrity and acting in the interest of shareholders.
3. We strive to find businesses that, through the nature of the business or skill of the manager, present clear opportunities for reinvestment in the business that will deliver above average returns on those investments.

Whether looking at competitors, suppliers, industry specialists or management, we assess the future prospects for business growth and seek out firms that have clear paths to continued success.

Mr. Akre’s discipline leads to four distinguishing characteristics of his fund’s portfolio:

1. It tends to be concentrated in (though not technically limited to) small- to mid-cap stocks.  His explanation of that bias is straightforward: “that’s where the growth is.”
2. It tends to make concentrated bets.  He’s had as much as a third of the portfolio in just two industries (gaming and entertainment) and his sector weightings are dramatically different from those of his peers or the S&P500.
3. It tends to stick with its investments.  Having chosen carefully, Mr. Akre tends to wait patiently for an investment to pay off.  In the past ten years, FBRVX never had a turnover ratio above 26% and often enough it was in the single digits.
4. It tends to have huge cash reserves when the market is making Mr. Akre queasy.  From 2001 – 04, FBRVX’s portfolio averaged 33.5% cash – and crushed the competition. It was in the top 2% of its peer group in three of those four years and well above average in the fourth year.

Those same patterns seem to be playing out in Akre Focus.  At year’s end, he was 65% in cash.  Prompted by a reader’s question, I asked whether he had a goal for deploying the cash; that is, did he plan to be “fully invested” at some point?  His answer was,no.  He declared himself to be “very cautious about the market” because of the precarious state of the American consumer (overextended, uncertain, underemployed).  He allowed that he’d been moving “gingerly” into the market and had been making purchases weekly.  He’s trying to find investments that exploit sustained economic weakness.  While he has not released his complete year-end portfolio, three of his top ten holdings at year-end were added during the fourth quarter:

• WMS Industries, a slot machine manufacturer. He’s been traditionally impressed by the economics of the gaming industry but with the number of casino visits and spending per visit both down dramatically, his attention has switched from domestic casino operators to game equipment manufacturers who serve a worldwide clientele.  By contrast, long-time FBRVX holding Penn National Gaming – which operates racetracks and casinos – is a “dramatically smaller” slice of AKREX’s portfolio.
• optionsXpress, an online broker that allows retail investors to leverage or hedge their market exposure.
• White River Capital, which securitizes and services retail car loans and which benefits from growth in the low-end, used car market

Potential investors need to be aware of two issues.

First, despite Morningstar’s “below average” to “low” risk grades, the fund is not likely to be mild-mannered. FBRVX has trailed its peer group – often substantially – in four of the past ten years.  If benchmarked against Vanguard’s Midcap Index fund (VIMSX), the same thing would be true of Mr. Akre’s private account composite.  Over longer periods, though, his returns have been very solid. Over the past decade returns for FBRVX (11% annually, as of 12/31/09)  more than doubled its average peer’s return while his separate accounts (8%) earned about a third more than VIMSX (6%) and trounced the S&P500 (-1.0%).

Second, Mr. Akre, at age 67, is probably . . . uhhh, in the second half of his investing career.  Marty Whitman, Third Avenue Value’s peerless 83-year-old star manager, spits in my general direction for mentioning it.  Ralph Wanger, who managed Acorn (ACRNX) to age 70 and won Morningstar’s first “fund manager lifetime achievement award” in the year of his retirement from the fund, might do the same – but less vehemently.  Mr. Akre was certainly full of piss and vinegar during our chat and the new challenge of building AKREX as an independent fund is sure to be invigorating.

Bottom Line:

Partnership is important to Mr. Akre.  He looks for it in his business relationships, in his personal life, and in his investments.  Folks who accept the challenge of being Mr. Akre’s partner – that is, investors who are going to stay with him – are apt to find themselves well-rewarded.

Fund website

Akre Focus Fund

FundAlarm © 2010

. . . from the archives at FundAlarm

These profiles have not been updated. The information is only accurate as of the original date of publication.

May 1, 2009

FundAlarm Annex – Fund Report

Fund name:

Aegis Value (AVALX)

Objective

The fund seeks long-term capital appreciation by investing (mostly) in domestic companies whose market caps are ridiculously small. On whole, these are stocks smaller than those held in either of Bridgeway’s two “ultra-small” portfolios.

Adviser:

Aegis Financial Corporation of Arlington, VA. AFC, which has operated as a registered investment advisor since 1994, manages private account portfolios, and has served as the Fund’s investment advisor since the fund’s inception. They also advise Aegis High Yield.

Manager

Scott L. Barbee, CFA, is portfolio manager of the fund and a Managing Director of AFC. He was a founding director and officer of the fund and has been its manager since inception. He’s also a portfolio manager for approximately 110 equity account portfolios of other AFC clients managed in an investment strategy similar to the Fund with a total value of approximately $80 million. Mr. Barbee received an MBA degree from the Wharton School at the University of Pennsylvania.

Management’s Stake in the Fund:

As of August 31, 2008, Mr. Barbee owned more than $1 million of fund shares. He will also be the sole owner of the adviser upon retirement of the firm’s co-founder this year.

Opening date

May 15, 1998

Minimum investment

$10,000 for regular accounts and $5,000 for retirement accounts, though at this point they might be willing to negotiate.

Expense ratio

1.43% on assets of $66 million

Comments:

Let’s get the ugly facts of the matter out of the way first. Aegis Value is consistently a one- to two-star small value fund in Morningstar’s rating system. It has low returns and high risk. The fund’s assets are one-tenth of what they were five years ago.

‘Nuff said, right?

Maybe. Maybe not. I’ll make four arguments for why Aegis deserves a second, third, or perhaps fourth look.

First, if we’d been having this discussion one year ago (end of April 2008 rather than end of April 2009), the picture would have been dramatically different. For the decade from its founding through last May, Aegis turned a $10,000 initial investment into $36,000. Its supposed “small value” peer group would have lagged almost $10,000 behind, while the S&P500 would have been barely visible in the dust. Over that period, Aegis would have pretty much matched the performance of Bridgeway’s fine ultra-small index fund (BRSIX) with rather less volatility.

Second, ultra-small companies are different: benchmarking them against either small- or micro-cap companies leads to spurious conclusions. By way of simple example, Aegis completely ignored the bear market for value stocks in the late 1990s and the bear market for everybody else at the beginning of this century. While it’s reasonable to have a benchmark against which to measure a fund’s performance, a small cap index might not be much more useful than a total market index for this particular fund.

Third, ultra-small companies are explosive: Between March 9 and April 29, 2009, AVALX returned 66.57%. That sort of return is entirely predictable for tiny, deep-value companies following a recession. After merely “normal” recessions, Morningstar found that small caps posted three-year returns that nearly doubled the market’s return. But the case for tiny stocks after deep declines is startling. Mr. Barbee explained in his January 22 shareholder letter:

. . . in the 5 years following 1931, the Fama/French Small Value Benchmark returned a cumulative 538 percent without a down year, or over 44 percent per year. Even including the damaging “double-dip” recession of 1937, the benchmark returned over 21 percent annually for the 7 years through 1938. After market declines in 1973 and 1974, over the next 7 years (1975 through 1981), the Fama/French Small Value Benchmark returned a cumulative 653 percent without a down year, or greater than 33 percent per year.

Fourth, the case for investing in ultra-small companies is especially attractive right now. They are deeply discounted. Despite the huge run-up after March 9, “the companies held by the … Fund now trade at a weighted average price-to-book of 29.4%, among the very lowest in the Fund’s nearly 11-year history.” The universe of stocks which the manager finds most attractive – tiny companies selling for less than their book value – has soared to 683 firms or about five times the number available two years ago. After the huge losses of 2008 and early 2009, the fund now packs a tax-loss carryforward which will make any future gains essentially tax-free.

Bottom Line

Mr. Barbee, his family and his employees continue to buy shares of Aegis Value. He’s remained committed to “buying deeply-discounted small-cap value stocks,” many of which have substantial cash hoards. Investors wondering “how will I ever make up for last year’s losses?” might find the answer in following his lead.

Fund website

Aegis Value fund

FundAlarm © 2009

Fund name

Pinnacle Value (PVFIX)

Objective

Pinnacle Value seeks long-term capital appreciation by investing in small- and micro-cap stocks that it believes trade at a discount to underlying earnings power or asset values.  It might also invest in companies undergoing unpleasant corporate events (companies beginning a turnaround, spin-offs, reorganizations, broken IPOs) as well as illiquid investments.  It also buys convertible bonds and preferred stocks which provide current income plus upside potential embedded in their convertibility.  The fund can also use shorts and options for hedging.  The manager writes that “while our structure is a mutual fund, our attitude is partnership and we built in maximum flexibility to manage the portfolios in good markets and bad.”

Adviser

Bertolet Capital of New York.  Bertolet advises one $10 million account as well as this fund.

Manager

John Deysher, Bertolet’s founder and president.  From 1990 to 2002 Mr. Deysher was a research analyst and portfolio manager for Royce & Associates.  Before that he managed equity and income portfolios at Kidder Peabody for individuals and small institutions.  The fund added an equities analyst, Mike Walters, in January 2011.

Manager’s Investment in the fund

In excess of $1,000,000, making him the fund’s largest shareholder.  He also owns the fund’s advisor.

Opening date

April Fool’s Day, 2003.

Minimum investment

$2500 for regular accounts and $1500 for IRAs.  The fund is currently available in 25 states, though – as with other small funds – the manager is willing to register in additional states as demand warrants.  A key variable is the economic viability of registered; Mr. Deysher notes that the registration fees in some states exceed $1000 while others are only $100.  The fund is available through TD Ameritrade, Fidelity, Schwab, Vanguard and other platforms.

Expense ratio

1.47% on assets of $47 million.  Some sources report a slightly higher ratio, but that’s based on the fund’s ownership of a number of closed-end and exchange-traded funds.  There is a 1% redemption fee for shares held less than a year.

Comments

Could you imagine a “Berkshire Hathaway for ultra-micro-caps”?  Five factors bring the comparison to mind.  With Deysher, you’re got:

1. a Buffett devotee.  This is one of very few funds that provides a link to Berkshire Hathaway on its homepage and which describes Mr. Buffett’s reports as a source of ideas for companies small enough to fit the portfolio.

   Like Mr. Buffett, Mr. Deysher practices high commitment investing and expects it of the companies he invests in.  His portfolio holds only 47 stocks and his largest holding consumes 4% of the fund.  The fund’s prospectus allows for as much as 10% in a single name.  One of the key criteria for selecting stocks for the portfolio is high insider ownership, because, he argues, that personal investment makes them “pay more attention to capital allocation and not do dumb things just to satisfy Wall Street.”

   Also like Buffett, he invests in businesses that he can understand and companies which practice very conservative accounting and have strong balance sheets. That excludes many financial and tech names from consideration.

2. a willingness to go against the crowd.  Deysher invests in companies so small that, in some instances, no other fund has even noticed them.  He owns companies with trade on exchanges, but also bulletin board and pink sheet stocks.  As a result, his median market cap (MMC) is incredibly low.  How low?

   The average market cap is under $250 million, 10^thlowest of the 2300 domestic stock funds that Morningstar tracks, and he’s willing to consider companies with a market cap as low as $10 million.

   Deysher acquires these shares through both open-market and private placements.  He seems intensely aware of the need to do fantastic original research on these firms and to proceed carefully so as not to upset the often-thin market for their shares.

   One interesting measure of his independence is Morningstar’s calculation of his “best fit” index.  Morningstar runs regressions to try to figure out what a fund “acts like.”  Vanguard’s Small Value Index acts like, well, an index – it tracks the Russell 2000 Value almost perfectly.  Pinnacle acts like, well, nothing else.  Its “best fit” index is the Russell Mid-Cap Value index which tracks firms 22 times larger than those in Pinnacle.  When last I checked, the closest surrogate was the MSCI EAFE non-dollar index.  That is, from the perspective of statistical regression, the fund acted more like a foreign stock fund than a small cap US one.  (Not to worry – even there the correlation was extremely small.)

3. a patient, cash-rich investor.  Like Mr. Buffett, Mr. Deysher sort of likes financial panic.  He’s only willing to buy stocks that have been deeply discounted, and panics often provide such opportunities.  “Volatility,” he says, “is our friend.”  Since his friend has visited so often, I asked whether he had gone on a buying spree. The answer was, yes, on a limited basis.  Even after the instability of the past months, most small caps still carry an unattractive premium to the price he’s willing to pay. There are “not a lot of bargains out there.”  He does allow, however, that we’re getting within 5 – 10% of some interesting buying opportunities for his fund.

   And he does have the resources to go shopping.  Just over 42% of the portfolio is in cash (as of mid-October, 2011). While that is well down from the 53% it held at the end of the first quarter of 2011, it still provides a substantial war chest in the case of instability in the months ahead.  Part of those opportunities come when stocks “go dark,” that is they deregister with the SEC and delist from NASDAQ.  At that point, there’s often a sharp price drop which can provide a valuable entry point for watchful investors.

4. a strong track record. All of this wouldn’t matter if he weren’t successful.  But he is.  The fund has returned 3.9% annually over the past five years (as of 9/30/2011), while its average peer lost 1.4%. As of that same date, it earned top 1% returns for the past month, three months, six months and year-to-date, with top 2% returns for the past year and for the trailing five years.  That’s accomplished by staying competitive in rising markets and strongly outperforming in falling ones.  During the market meltdown from October 2007 to March 2009, Pinnacle lost 25% while his peers lost over 50%.  While his peers roared ahead in the junk-driven rally in 2009 and early 2010, they still trail Pinnacle badly from the start of the meltdown to now (i.e., October 2011).  That reflects the general pattern: by any measure of volatility, Pinnacle has about one-third of the downside risk experienced by its peers.
    
5. a substantial stake in the fund’s outcome.  As is often the case, Mr. Deysher is his own largest shareholder.  Beyond that, though, he receives no salary, bonus or deferred compensation.  All of his income comes from Bertolet’s profits.  And he has committed to investing all of those profits into shares of the fund.

   He has, in addition, committed to closing the fund as soon as money becomes a problem.  His argument, often repeated, is pretty clear: “We expect to close the fund at some point.  We don’t know if we will close it at $100 million or $500 million, but we won’t dilute the quality of investment ideas just to grow assets.”

Over the past few years, Mr. Deysher experimented with adding some additional elements to the portfolio. Those included a modest bond exposure and short positions on a growth index, both achieved with ETFs.  He also added some international exposure when he bought closed-end funds that were selling at a “crazy” discount to their own NAVs.

Quick note on CEF pricing: CEFs have both a net asset value (the amount a single share of the fund is worth, based on the minute-to-minute value of all the stocks in the portfolio) and a market value (the amount that a single share of the fund is worth, based on what it’s selling for at that moment.   In a panicked market, there can be huge disconnects between those two prices.  Those disconnects sometimes allow investors to buy $100 in stock for $60. Folks who purchase such deeply discounted shares can pocket substantial profits even if the market continues to fall.

Mr. Deysher reports that the bond ETF purchase was about a break even proposition, but that the short ETFs have been sold to generate tax losses.  He pledges to avoid both “inverse and long-macro bets” in the future, but notes that the CEFs have been very profitable.  While those positions have been pared back, he’s open to repeating that investment should the opportunity again present itself.

Bottom line

The manager trained with and managed money for twelve years with the nation’s premium small cap investor, Chuck Royce.  He seems to have internalized many of the precepts that have made both Mr. Royce and Mr. Buffett successful.

Pinnacle Value offers several compelling advantages over better known rivals: the ability to take meaningful positions in the smallest of the small, a willingness to concentrate and the ability to hedge.

Many smart people hold two beliefs in tension about small cap investing: (1) it’s a powerful tool in the long term and (2) it may have come too far too fast.  If you share those concerns, Pinnacle may offer you a logical entry point – Mr. Deysher shares your concerns, he has his eye on good companies that will become attractive investments should their price fall, and he’s got the cash to move when it’s time.  In the interim, the cash pile offers modest returns through the interest it earns and considerable downside cushion.

Company website

Pinnacle Value

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact [email protected].