Dear friends,

Welcome to the Vacation 2013 issue of the Observer. I’ve spent the past two weeks of July and the first days of August enjoying myself in Door County, the Cape Cod-like peninsula above Green Bay. I’ve done substantial damage to two Four Berry pies from Bea’s Ho-made Pies (jokes about the makers of the pie have been deleted), enjoyed rather more Leinies than usual, sailed on a tall ship, ziplined (ending in a singularly undignified position), putt-putted, worked with my son on his pitching, hiked miles and learned rather more than I cared to about alewives, gobies and lake levels.

I did not think (much) about mutual funds, Mr. Market, my portfolio, or the Dow’s closing level.  Indeed, I have no idea of what the market’s been doing.

Life is good.

Risk spectrum for Observer funds

We have published some dozens of profiles of new, distinguished and distinctive funds in the past couple years (click on the Funds tab if you’re curious).  Charles Boccadoro, our Associate Editor, has been working on ways to make those profiles more organized and accessible.  Here’s his take on one way of thinking about the collection.

Dashboard of MFO Profiled Funds

Each month, David provides in-depth analysis of two to four funds, continuing a FundAlarm tradition. Today, more than 75 profiles are available on MFO Funds index page. Most are quite current, but a few date back, under “Archives of FundAlarm,” so reference appropriately.

This month we roll out a new summary or “dashboard” of the many profiled funds. It’s intended to help identify funds of interest, so that readers can better scroll the index to retrieve in-depth profiles.

The dashboard presents funds by broad investment type, consistent with MFO Rating System. The three types are: fixed income, asset allocation, and equity. (See also Definitions page.)

Here is dashboard of profiled fixed income and asset allocation funds:

For each fund, the dashboard identifies current investment style or category as defined by Morningstar, date (month/year) of latest profile published, fund inception date (from first whole month), and latest 12-month yield percentage, as applicable.

Risk group is also identified, consistent with latest MFO rating. In the dashboard, funds with lowest risk will generally be at top of list, while those with highest risk will be at bottom, agnostic of M* category. Probably good to insert a gentle reminder here that risk ratings can get elevated, temporarily at least, when funds hit a rough patch, like recently with some bond and all-asset funds.

The dashboard also depicts fund absolute return relative to cash (90-day T-Bill), bonds (US Aggregate TR), and stocks (S&P 500 TR), again agnostic of M* category. If a fund’s return from inception through the latest quarter exceeds any of these indices, “Return Beats…” column will be shaded appropriately.

The Enhanced Strategy column alerts readers of a fund’s use of leverage or hedge via short positions, or if a fund holds any derivatives, like swaps or futures. If so, regardless of how small, the column will show “Yes.” It’s what David calls a kind of complexity flag. This assessment is strictly numerical using latest portfolio allocations from Morningstar’s database in Steele Mutual Fund Expert.

Finally, the column entitled “David’s Take” is a one-word summary of how each fund was characterized in its profile. Since David tends to only profile funds that have promising or at least intriguing strategies, most of these are positive. But every now and then, the review is skeptical (negative) or neutral (mixed).

We will update the dashboard monthly and, as always, improve and tailor based on your feedback. Normally the dashboard will be published atop the Funds index page, but for completeness this month, here’s dashboard of remaining equity funds profiled by MFO:

Charles/28Jul13

Would you ever need more than one long-short fund?

By bits, investors have come to understand that long-short (and possible other alternative) funds may have a place in their portfolios.  That’s a justifiable conclusion.  The question is, would you ever want need more than one long-short fund?

The lead story in our July issue made the argument, based on interviews with executives and managers are a half dozen firms, that there are at least three very distinct types of long-short funds (pure long/short on individual stocks, long on individual stocks/short on sectors or markets, long on individual stocks plus covered called exposure) .  They have different strategies and different risk-return profiles.  They are not interchangeable in a portfolio.

The folks at Long-Short Advisors gave permission to share some fascinating data with you.  They calculated the correlation matrix for their fund, the stock market and ten of their largest competitors, not all of which are pure long/short funds.  By way of context, the three-year correlation between the movement of Vanguard’s Small Cap Index Fund (NAESX) and their S&P 500 Index Fund (VFINX) is .93; that is, when you buy a small cap index as a way to diversify your large cap-heavy portfolio, you’re settling for an investment with a 93% correlation to your original portfolio.

Here are the correlations between various long/short funds:

This does not automatically justify inclusion of a second or third long-short fund in your portfolio, but it does demonstrate two things.  First, that long-short funds really are vastly different from one another, which is why their correlations are so low.  Second, a single long-short fund offers considerable diversification in a long-only portfolio and a carefully selected second fund might add a further layer of independence.

Royce Value Trust plans on exporting its investors

Royce Value Trust (RVT) is a very fine closed-end fund managed by a team led by Chuck Royce.  Morningstar rates it as a “Gold” CEF despite the fact that it has modestly trailed its peers for more than a decade.  The fund has attracted rather more than a billion in assets.

Apparently the managers aren’t happy with that development and so have propsoed exporting some of their investors’ money to a new fund.  Here’s the SEC filing:

I invite you to a special stockholder meeting of Royce Value Trust Inc. to be held on September 5, 2013. At the meeting, stockholders will be asked to approve a proposal to contribute a portion of Value Trust’s assets to a newly-organized, closed-end management investment company, Royce Global Value Trust, Inc. and to distribute to common stockholders of Value Trust shares of common stock of Global Trust.

And why would they “contribute” a portion of your RVT portfolio to their global fund?

Although Value Trust and Global Trust have the exact same investment objective of long-term growth of capital, Value Trust invests primarily in U.S. domiciled small-cap companies while Global Trust will invest primarily in companies located outside the U.S. and may invest up to 35% of its assets in the securities of companies headquartered in “developing countries.” For some time, we have been attracted to the opportunities for long-term capital growth presented in the international markets, particularly in small-cap stocks. To enable Value Trust’s stockholders to participate more directly in these opportunities, we are proposing to contribute approximately $100 million of Value Trust’s assets to Global Trust.

I see.  RVT shareholders, by decree, need more international and emerging markets exposure.  Rather than risking the prospect that they might do something foolish (for example, refuse to buy an untested new fund on their own), Royce proposes simply diversifying your portfolio into their favorite new area.  By the same logic, they might conclude that you could also use some emerging markets bonds.  Were you silly enough to think that you needed domestic small cap exposure and, hence, bought a domestic small cap fund?  “No problem!  We’ll launch and move you into …”

And why $100 million exactly?  “The $100 million target size (approximately 8% of Value Trust’s current net assets) was established to satisfy New York Stock Exchange listing standards and to seek to ensure that Global Trust has sufficient assets to conduct its investment program while maintaining an expense ratio that is competitive with those of other global small-cap value funds.”  So, as a portfolio move, RVT shareholders gain perhaps 4% exposure to small caps in developed foreign markets and 2% in emerging markets.

In one of Morningstar’s odder tables, they classified RVT as having the worst performance ever, anywhere, by anything:

You might notice the frequency with which RVT trails 100% of its peers.  Odd in a “Gold” fund?  Not so much as you might think.  When I asked Morningstar’s peerless Alexa Auerbach to check, she reported that RVT’s category contains only two funds.  The other, slightly better one is also from Royce and so the 100^th percentile ranking translates to “finished second in a two-person race.”

Experienced managers launching their own firms: Barron’s gets it (mostly) right

Barron’s featured a nice story on the challenge of launching a new fund firm and highlighted four star managers who choose to strike out on their own (“Introducing the New Guard,” July 8, p.p. L17-19). (We can’t link directly to this article, but if you Google the title you should be able to gain complimentary access to it.) They focus on four firms about which, you might have noticed, I have considerable enthusiasm:

Vulcan Value Partners, whose Vulcan Value Small Cap Fund we profiled.

Highlights: C.T. Fitzpatrick – one of the few managers whose funds I’ve profiled but with whom I’ve never spoken – distinguishes Vulcan’s approach from the Longleaf (his former employer) approach because “we place as much emphasis on business quality as we do on the discount.” He also thinks that his location in Birmingham is a plus since it’s easier to stand back from the Wall Street consensus if you’re 960 (point eight!) miles away from it. He also thinks that it makes recruiting staff easier since, delightful as New York City is, a livable, affordable smaller city with good schools is a remarkable draw.

Seafarer Capital Partners, whose Seafarer Overseas Growth & Income is in my own portfolio and to which I recently added shares.

Highlight: Andrew Foster spends about a third of this time running the business. Rather than a distraction, he thinks it’s making him a better investor by giving him a perspective he never before had. He frets about investors headlong rush into the more volatile pieces of an intrinsically volatile sector. He argues in this piece for slow-and-steady growers and notes that “People often forget that when you invest in emerging markets, you’re investing in something that is flawed but that you believe can eventually improve.”

Grandeur Peak Global Advisors, whose Grandeur Peak Global Opportunities was profiled in February 2012 and about whom we offer a short feature article and two fund profiles, all below.

Highlight: Lead manager Robert Gardiner and president Eric Huefner both began working for Wasatch as teenagers? (Nuts. I worked at a public library for $1.60/hour and was doing landscaping for less.) They reject the domestic/international split when it comes to doing security analysis and allow Mr. Gardiner to focus entirely on investing while Mr. Huefner obsesses about running a great firm. 

Okay, Barrons’ got it mostly right. They got the newest name of the fund wrong (it’s Reach, not Research), the photo caption wrong and a provocative quote wrong. Barron’s claimed that Gardiner is “intent on keeping Grandeur Peak, which is now on the small side, just shy of $1 billion under management.” Apparently Mr. Huefner said Grandeur Peak currently had a bit under a billion, that their strategies’ collective capacity was $3 billion but they’re apt to close once they hit $2 billion to give them room for growth.

RiverPark Advisors, five of whose funds we’ve profiled, two more of which we’ve pointed to and one of which is in my personal portfolio (and Chip’s). 

Highlight: Mitch Rubin’s reflection on the failure of their first venture, a hedge fund “Our mistake, we realized, was trying to create strategies we thought investors wanted to buy rather than structuring the portfolios around how we wanted to invest” and Mitch Rubin’s vitally important note, “Managers often think of themselves as the talent. But the ability to run these businesses well takes real talent.” Ding, ding, ding, ding! Exactly. There are only a handful of firms, including Artisan, RiverPark and Seafarer, where I think the quality of the business operation is consistently outstanding. (It’s a topic we return, briefly, to below in the discussion of “Two questions for potential fund entrepreneurs.”)  Lots of small firms handicap themselves by making the operations part of the business an afterthought. Half of the failure of Marx’s thought was his inability to grasp the vital and difficult role of organizing and managing your resources.

Two questions for potential fund entrepreneurs

Where will you find your first $100 million?  And who’s got the 263 hours to spend on the paperwork?

I’d expressed some skepticism about the claim in Barron’s (see above) that mutual funds need between $100 – 200 million in AUM in order to be self-sustaining.  That is, to cover both their external expenses such as legal fees, to pay for staff beyond a single manager and to – here’s a wild thought – pay the manager a salary. 

In conversations over the past month with Andrew Foster at Seafarer and Greg Parcella at Long/Short Advisors, it became clear that the figure quoted in Barron’s was pretty reasonable.  Mr. Foster points out that the break-even is lower for a second or third fund, since a viable first fund might cover most of the firm’s overhead expenses, but for a firm with a single product (and most especially an international or global one), $100 million is a pretty reasonable target. 

Sadly, many of the managers I’ve spoken with – even guys with enormous investment management skill – have a pretty limited plan for getting there beyond the “build a better mousetrap” fiction.  In truth, lots of “better mousetraps” languish.  There are 2400 funds with fewer than $100 million in the portfolio, 10% of which are current four- or five-star funds, according to Morningstar.  (Many of the rest are too new to have a Morningstar rating.)

What I didn’t realize was how long the danged paperwork for a fund takes.  One recent prospectus on file with the SEC contained the following disclosure that’s required under a federal paperwork reduction act:

Which is to say, writing a prospectus is estimated to take six weeks.  I’m gobsmacked.

The big picture at Grandeur Peak

In the course of launching their new Global Reach fund, profiled below, Grandeur Peak decided to share a bit of their firm’s long-term planning with the public. Grandeur Peak’s investment focus is small- to micro-cap stocks.  The firm estimates that they will be able to manage about $3 billion in assets before their size becomes an impediment to their performance.  From that estimate, they backed out the point at which they might need to soft close their products in order to allow room for capital growth (about $2 billion) and then allocated resource levels for each of their seven envisioned strategies.

Those strategies are:

• Global Reach, their 300-500 stock flagship fund
• Global Opportunities, a more concentrated version of Global Reach
• International Opportunities, the non-U.S. sub-set of Global Reach
• Emerging Markets Opportunities, the emerging and frontier markets subset of International Opportunities
• US Opportunities, the U.S.-only subset of Global Opportunities
• Global Value, the “Fallen Angels” sub-set of Global Reach
• Global Microcap, the micro-cap subset of Global Reach

President Eric Huefner remarks that “Remaining nimble is critical for a small/micro cap manager to be world-class,” hence “we are terribly passionate about asset capping across the firm.”  With two strategies already closed and another gaining traction, it might be prudent to look into the opportunity.

Observer fund profiles

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

Grandeur Peak Global Opportunity (GPGOX): this now-closed star goes where few others dare, into the realm of global and emerging markets small to micro-caps.  With the launch of its sibling, Global Reach, its portfolio is about to tighten and focus.

Grandeur Peak Global Reach (GPGRX): this is the fund that Grandeur Peak wanted to offer you two years ago.  It will be their most broadly-diversified, lowest-cost portfolio and will serve as the flagship for the Grandeur Peak fleet. 

LS Opportunity (LSOFX): Jim Hillary left Marsico in 2004 with a lot of money and the burning question, “what’s the best way to sustainably grow my wealth?”  His answer was a pure long/short portfolio that’s served him, his hedge fund investors, his European investors, and his high net worth investors really well.  LSOFX gives retail investors a chance to join the party.

Sextant Global High Income (SGHIX): what do income-oriented investors do when The Old Reliables fail?  Saturna Capital, which has a long and distinguished record of bond-free income investing at Amana Income (AMANX), offers this highly adaptable, benchmark-free fund as one intriguing option.

Elevator Talk #6: Brian Frank of Frank Value Fund (FRNKX)

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

Frank Value Fund (FRNKX) is not “that other Frank Fund” (John Buckingham’s Al Frank fund VALUX). It’s a concentrated, all-cap value fund that’s approaching its 10^th anniversary. It’s entirely plausible that it will celebrate its 10^th anniversary with returns in the top 10% of its peer group.

Most funds that claim to be “all cap” are sorting of spoofing you; most mean “all lot of easily-researched large companies with the occasional SMID-cap tossed in.”  To get an idea of how seriously Brian Frank means “go anywhere” when he says “go anywhere,” here’s his Morningstar portfolio map in comparison to that of the Vanguard Total Stock Market Index (VTSMX):

Vanguard Total Stock Market	Frank Value

Brian Frank is Frank Capital Partners’ co-founder, president and chief investment officer.  He’s been interested in stock investing since he was a teenager and, like many entrepreneurial managers, was a voracious reader.  At 19, his grandfather gave him $100,000 with the injunction, “buy me the best stocks.”  In pursuit of that goal, he founded a family office in 2002, an investment adviser in 2003 and a mutual fund in 2004. He earned degrees in accounting and finance from NYU.  Here’s Mr. Frank’s 200 words making his case:

What does the large-cap growth or small-cap value manager do when there are no good opportunities in their style box? They hold cash, which lowers your exposure to the equity markets and acts as a lead-weight in bull markets, or they invest in companies that do not fit their criteria and end up taking excess risk in bear markets. Neither one of these options made any sense when I was managing family-only money, and neither one made sense as we opened the strategy to the public through The Frank Value Fund. Our strategy is quantitative, meaning we go where we can numerically prove to ourselves there is opportunity. If there is no opportunity, we leave the space. It sounds simple, and it’s probably what you would do with your own money if you were an investment professional, but it is not how the fund industry is structured. If you believe in buying low-valuation, high-quality companies, and you allow your principles, not the Morningstar style-box to be your guide, I believe our fund has the structure and discipline to maintain this strategy, and I also believe because of this, we will continue to generate significant outperformance over the long-term.

The fund’s minimum initial investment is $1,500.  The fund’s website is clean and well-organized.  Brian’s most-recent discussion of the fund appears in his Second Quarter 2013 shareholder letter, though you might also enjoy his rant about the perils of passive investing.

Elevator Talk #7: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX)

Guinness Atkinson Inflation-Managed Dividend (GAINX) is about the most “normal” fund in GA’s Asia/energy/innovation-dominated line-up.  Its global equity portfolio targets “moderate current income and consistent dividend growth that outpace inflation.”  The centerpiece of their portfolio construction is what they call the “10 over 10” methodology: in order to qualify for consideration, a corporation must have demonstrated at least 10% cash flow return on investment for 10 years.  By their estimation, only 3% of corporations clear this first hurdle.

They then work their way down from a 400 stock universe to a roughly equally-weighted portfolio of 35 names, representing firms with the potential for sustained dividend growth rather than just high current yields.  Morningstar reports that their trailing twelve-month yield is 3.02% while the 10-year U.S. Treasury sits at 2.55% (both as of July 17, 2013).

Managers Ian Mortimer and Matthew Page have a curious distinction: they are British, London-based managers of a largely-U.S. equity portfolio.  While that shouldn’t be remarkable, virtually every other domestic or global fund manager of a U.S. retail fund is American and domiciled here.  Dr. Mortimer earned a Master’s degree from University College London (2003) and a doctorate from Christ College, Oxford, both in physics.  He joined GA in 2006.  Mr. Page earned a Master’s degree in physics from New College, Oxford, worked at Goldman Sachs for a year and joined GA in 2005.  The duo co-manages GA Global Innovators (IWIRX) together.  Each also co-manages an energy fund.  Here are Ian and Matt, sharing 211 words on their strategy:

In the environment of historically low bond yields, investors looking for income are concerned with the possibility of rising inflation and rising yields. We believe a rising dividend strategy that seeks either a rising dividend stream over time or the accumulation of shares through dividend reinvestment offers a systematic method of investing, where dividends provide a consistent, growing income stream through market fluctuations.

Our investment process screens for sustainable dividend paying companies.  For a company to pay a sustainable and potentially rising dividend in the future, it needs to generate consistently high return on capital, creating value each year, and distribute it in the form of a dividend.  We therefore do not seek to maximize the yield of our portfolio by screening for high yield companies, but rather focus on companies that have robust business models and settle for a moderate yield.

Companies generating consistent high return on capital exist all around the world, with 50% based in US. We also find a growing number of them in emerging markets.  They also exist across industries and market capitalisations. Given their high returns on capital 90% of these companies pay dividends.

Further, employing a bottom up value driven approach, we seek to buy these good companies when they are out of favour.

The fund’s minimum initial investment is $10,000, reduced to $5,000 for tax-advantaged accounts.  It’s available for $2500 at Fidelity and Schwab. GA is providing GAINX at 0.68%, which represents a massive subsidy for a $2 million fund.  The fund fact sheet and its homepage include some helpful and concise information about fund strategy, holdings, and performance, as well as biographies of the managers.  Given the importance of the “10 over 10” strategy to the fund’s operation, potential investors really should review their “10 over 10 Dividend Investment Strategy” white paper piece.

Our earlier Elevator Talks were:

1. February 2013: Tom Kerr, Rocky Peak Small Cap Value (RPCSX), whose manager has a 14 year track record in small cap investing and a passion for discovering “value” in the intersection of many measures: discounted cash flows, LBO models, M&A valuations and traditional relative valuation metrics.
2. March 2013: Dale Harvey, Poplar Forest Partners (PFPFX and IPFPX), a concentrated, contrarian value stock fund that offers “a once-in-a-generation opportunity to invest with a successful American Funds manager who went out on his own.”
3. April 2013: Bayard Closser, Vertical Capital Income Fund (VCAPX), “a closed-end interval fund, VCAPX invests in whole mortgage loans and first deeds of trust. We purchase the loans from lenders at a deep discount and service them ourselves.”
4. May 2013: Jim Hillary, LS Opportunity Fund (LSOFX), a co-founder of Marsico Capital Management whose worry that “the quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance” led to his faith in “in-depth research and long-term orientation in our high conviction ideas.”
5. July 2013: Casey Frazier, Versus Capital Multi-Manager Real Estate Income Fund, a second closed-end interval fund whose portfolio “includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies.  We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7 – 9% range net of fees.”

Pre-Launch Alert: Sarofim and Robeco

This is normally the space where we flag really interested funds which had become available to the public within the past 30 days.   Oddly, two intriguing funds became legal in July but have not yet launched.  This means that the fund companies might open the fund any day now, but might also mean that they’ll sit on the option for months or years.  I’ve been trying, with limited success to uncover the back story.

Robeco Boston Partners Global Long/Short Fund could have launched July 12.  It will be a global version of their Long/Short Research Fund (BPRRX).  When queries, a representative of the fund simply reported “they have yet [to] decide when they will actually launch the fund.” About the worst you can say about Long/Short Research is that it’s not as great as their flagship Robeco Boston Partners L/S Equity Fund (BPLEX).  Since launch, BPRRX has modestly trailed BPLEX but has clubbed most of its competitors.  With $1.5 billion already in the portfolio, it’s likely to close by year’s end.  The global version will be managed by Jay Feeney, Chief Investment Officer-Equities and co-manager of Long/Short Research, and Christopher K. Hart.  $2500 minimum investment.3.77%, the only redeeming feature of which is that institutional investors are getting charged almost as much (3.52%). The recent (July 1) acquisition of 90.1% of Robeco by ORIX might be contributing to the delay since ORIX has their own strategic priorities for Robeco – mostly expanding in Asia and the Middle East – but that’s not been confirmed.

Sarofim Equity (SRFMX) didn’t launch on July 1, though it might have. Sarofim sub-advises the huge Dreyfus Appreciation Fund (DGAGX) whose “principal investment strategies” bear to striking resemblance to this fund’s. (In truth, there appears to be a two word difference between the two.) DGAGX is distinguished by its negligible turnover (typically under 1%), consistently low risk and mega-cap portfolio (the average market cap is north of $100 billion). It typically captures about 80% of the market’s movements, both up and down. Over periods of three years and longer, that translates to trailing the average large cap fund by less than a percent a year while courting a bit under 90% of the short-term volatility. So why launch a direct competitor to DGAGX, especially one that’s priced below what Dreyfus investors are charged for their shares of a $6 billion fund? Good question! Dan Crumrine, Sarofim’s CFO, explained that Sarofim would like to migrate lots of their smaller separately managed accounts (say, those with just a few hundred thousand) into the mutual fund. That would save money for both Sarofim and their clients, since the separate accounts offer a level of portfolio tuning that many of these folks don’t want and that costs money to provide. Dan expects a launch sometime this fall. The fund will have a $2500 minimum and 0.71% expense ratio after waivers (and only 0.87% – still below DGAGX – before waivers).

Sarofim will not market the fund nor will they place it on the major platforms since they aren’t seeking to compete with Dreyfus; they mostly need a “friends and family” fund to help out some of their clients. This has, with other firms, been a recipe for success since the funds don’t need to charge exorbitant amounts, are grounded in a well-tested discipline, and the managers are under no pressure to grow assets.

I’ll keep you posted.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting.

Funds in registration this month won’t be available for sale until, typically, the end of September 2013. There were 12 funds in registration with the SEC this month, through July 15th.  We’ll catch up on the last two weeks of July and all of August in our September issue; we had an early cut-off date this month to accommodate my vacation.

This month’s registrations reveal two particularly interesting developments:

The re-emergence of Stein Roe.  Stein, Roe&Farnham, founded in 1932, had a very well-respected family of no-load funds, most notably Stein Roe Young Investor. There was much drama surrounding the firm. Terrible performance in 1999 led to management shake-ups and botched mergers. Columbia (formerly FleetBoston Financial, then an arm of the Bank of America, later bought by Ameriprise which itself used to be American Express Financial Advisers – jeez, are you keeping a scorecard?) bought the Stein Roe funds in 2001, first renaming them and then merging them out of existence (2007).Somewhere in there, Columbia execs took the funds hip deep in a timing scandal. In 2004, Stein Roe Investment Council – which had been doing separate accounts after the departure of its mutual funds – was purchased by Invesco and became part of their Atlantic Trust private investment group.  In the last two months, Stein Roe has begun creeping back into the retail, no-load fund world as adviser to the new family of AT funds.  Last month it announced the rebranding of Invesco Disciplined Equity (AWIEX) as AT Disciplined Equity.  This month it’s added two entirely new funds to the line-up: AT Mid Cap Equity Fundand AT Income Opportunities Fund.  The former invests in mid-cap stocks while the latter pursues income and growth through a mix of common and preferred stocks and bonds.  The minimum initial investment is $3000 for either and the expense ratios are 1.39% and 1.25%, respectively. 

The first fund to advertise training wheels. Baron is launching Baron Discovery Fund, whose market cap target is low enough to qualify it as a micro-cap fund.  It will be co-managed by two guys who have been working as Baron analysts for more than a decade.  Apparently someone at Baron was a bit ambivalent about the promotion and so they’ve created an entirely new position at the fund: “Portfolio Manager Adviser.”   They’ve appointed the manager of Baron Small Cap, Cliff Greenberg, to make sure that the kids don’t get in over their heads.  His responsibility is to “advise the co-managers of the Fund on stock selection and buy and sell decisions” and, more critically, he’s responsible “for ensuring the execution of the Fund’s investment strategy.”  Uhh … what does it tell you when the nominal managers of the fund aren’t trusted to execute the fund’s investment strategy? Perhaps that they shouldn’t be the managers of the fund?  Make no mistake: many funds have “lead” managers and “co-managers,” who presumably enact the same sort of mentorship role and oversight that Baron is building here. The difference is that, in all of the other cases that come to mind, the guy in charge is the manager.  The minimum initial investment is $2000, reduced to $500 for accounts set up with an AIP. Expenses not yet announced.

Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down a near-record 64 fund manager changes.  Freakishly, that’s the exact number of changes we identified last month.  Investors should take particular note of Bill Frels’ year-end departure from Mairs and Power and Jesper Madsen’s impended exit from Matthews and from the finance industry.  Both firms have handled past transitions very smoothly, but these are both lead managers with outstanding records.

Update #1: Celebrating three years for the ASTON/River Road Long-Short strategy

ASTON/River Road Long/Short Fund (ARLSX) launched on May 4, 2011.  It will have to wait until May 2014 to celebrate its third anniversary and June 2014 to receive its first Morningstar rating.  The strategy behind the fund, though, began operating in a series of separate accounts in June 2010.  As a result, the strategy just completed its third year and we asked manager Matt Moran about the highlights of his first three years.  He points to two in particular:

We are thrilled to have just completed our third year for the composite.  The mutual fund track record is now just a bit over two years.

[Co-manager] Daniel [Johnson] and I think there are two important points about our strategy now that we’ve hit three years:

1. Based on the Sharpe ratio, our composite ranks as the #1 strategy (attached with disclosures) of all 129 funds in the Morningstar Long-Short category over the past three years.

   We like what legendary investor Howard Marks wrote about the Sharpe ratio on page 39-40 of his 2011 masterpiece The Most Important Thing, “…investors who want some objective measure of risk-adjusted return…can only look to the so-called Sharpe ratio…this calculation seems serviceable for public market securities that trade and price often…and it truly is the best we have (my emphasis)”.

2. We’ve grown our AUM from $8 MM at the beginning of 2013 to $81.7 MM as of [mid-July, 2013].

   We are very pleased to have returned +14.1% annualized (gross) versus the Russell 3000 at +18.6% over the past three years with just [about] 45% of the volatility, a beta of 0.36, and a maximum drawdown of [about] 7.65% (vs. 20.4% for the Russell 3000).

Their long/short strategy has a nicely asymmetrical profile: it has captured 59% of the market’s upside but only 33% of the downside since inception.  ARLSX, the mutual fund which is one embodiment of the strategy, strikes us as one of three really promising “pure” long/short funds.  Folks anxious about abnormal market highs and considerable sensitivity to risk might want to poke around ARLSX’s homepage. There’s a separate and modestly more-detailed discussion on the River Road Asset Management Long-Short Equity Strategy homepage, including a nicely-done factsheet.

Update #2: Celebrating the new website for Oakseed Opportunity Fund

Okay, I suppose it’s possible that, at the end of our profile of Oakseed Opportunity Fund (SEEDX), I might have harshed on the guys just a little bit about the quality of their website:

Mr. Park mentioned that neither of them much liked marketing.  Uhhh … it shows.  I know the guys are just starting out and pinching pennies, but really these folks need to talk with Anya and Nina about a site that supports their operations and informs their (prospective) investors.  

One of the great things about the managers of small funds is that they’re still open to listening and reacting to what they’ve heard.  And so with some great delight (and a promise to edit the snarky comment at the end of their profile), we note the appearance of an attractive and far more useful Oakseed website: 

Welcome, indeed.  Nicely done, guys!

Briefly Noted . . .

DWS Enhanced Emerging Markets Fixed Income Fund (SZEAX), an emerging markets junk bond fund (and don’t you really need more exposure to the riskiest of e.m. bonds?) changed its principal investment strategy from investing in emerging markets junk to strike the proviso “the fund invests at least 50% of its total assets in sovereign debt securities issued or guaranteed by governments, government-related entities, supranational organizations and central banks based in emerging markets.”

ING International Growth Fundbecame ING Multi-Manager International Equity Fund (IIGIX) on July 1, 2013. More Marsico fallout: the nice folks from Marsico Capital Management were shown the door by Harbor International Growth (HIIGX) in May.  Baillie Gifford pulled two managers from the ING fund to help manage the Harbor one.  ING then decided to add Lazard and J.P. Morgan as sub-advisers to the fund, in addition to Baillie Gifford and T. Rowe Price.

As of August 1, TIAA-CREF LIFECYCLE FUNDS added TIAA-CREF International Opportunities Fund to their investable universe and increased their exposure to international stocks.

As set forth more fully below, effective as of August 1, 2013, Teachers Advisors, Inc. has increased the maximum exposure of the Funds to the international sector. In addition, the Advisor has begun investing in the and, effective August 1, 2013, the international component of each Fund’s composite benchmark has been changed from the MSCI EAFE® + EM Index to the MSCI ACWI ex-USA® Index.

SMALL WINS FOR INVESTORS

Hmmm … a bit thin this month.

The folks at Fleishman/Hillard report that Cognios Market Neutral Large Cap (COGMX) has been added to the Charles Schwab, Fidelity and Pershing platforms. It’s a new no-load that’s had a bit of a shaky start.

Melissa Mitchell of CWR & Partners reports some success on the part of the Praxis funds (socially responsible, faith-based, front loaded and institutional classes) in getting Hershey’s to commit to eliminating the use of child slaves in the cocoa plantations that serve it:

The chocolate industry’s history is riddled with problems related to child slavery on African cocoa bean farms. Everence, through its Praxis Mutual Funds, is actively working with chocolate companies to address the conditions that lead to forced child labor. For the last three years, Praxis has co-led shareholders in working with Hershey – one of the world’s largest chocolatiers – to shape new solutions to this long-standing problem.

Their Intermediate Income Fund (MIIAX) has purchased $2 million in International Finance Facility for Immunisation (IFFIm) bonds, funding a program which will help save millions of children from preventable diseases. Okay, those aren’t wins for investors per se but they’re danged admirable pursuits regardless and deserve some recognition.

CLOSINGS (and related inconveniences)

Fidelity will close Fidelity Ultra-Short Bond (FUSFX) to most investors on Aug. 2, 2013. It’s one of the ultra-short funds that went off a cliff in last 2007 and never quite regained its stride. Given that the fund’s assets are far below their peak, the closure might be a sign of some larger change on the way.

Artisan is closing Artisan Small Cap (ARTSX), the flagship fund, on August 2nd. This is the second closure in the fund’s history. In October 2009, Artisan rotated a new management team in: Andrew Stephens and the folks responsible for Artisan Midcap.  Since that time, the fund’s performance has improved dramatically and assets have steadily accumulated to $1.2 billion now.  Artisan has a long tradition of closing their funds in order to keep them manageable, so the move is entirely laudable.

OLD WINE, NEW BOTTLES

Marsico has gotten the boot so often that they’re thinking of opening a shoe store. The latest round includes their dismissal from the AST Marsico Capital Growth Portfolio, which became the AST Loomis Sayles Large-Cap Growth Portfolio on July 15, 2013.  This is the second portfolio that AST pulled from Marsico in recent weeks.  The firm’s assets are now down by $90 billion from their peak.  At the same time, The New York Times celebrated Marsico Global (MGLBX) as one of three “Mutual Funds that Made Sense of a Confusing Market” (July 6, 2013).

Invesco Global Quantitative Core (GTNDX) changed its name to Invesco Global Low Volatility Equity Yield on July 31, 2013.

OFF TO THE DUSTBIN OF HISTORY

Compak Dynamic Asset Allocation Fund (CMPKX) will be liquidated on or about September 13, 2013.  It closed to all new investment on July 31, 2013.  It’s a little fund-of-funds run by Moe and Faroz Ansari, both of whom appear to be interesting and distinguished guys.  High expenses, front load, undistinguished – but not bad – performance.

Invesco Dynamics (IDYAX) merged into Invesco Mid Cap Growth (VGRAX) and Invesco Municipal Bond (AMBDX) merged into Invesco Municipal Income (VKMMX).

John Hancock Funds liquidated two tiny funds on July 30: the $1.9 million JHancock Leveraged Companies (JVCAX) and the $3.5 million JHancock Small Cap Opportunities (JCPAX).  Do you suppose it’s a coincidence that JHancock Leveraged Companies was launched at the very peak of Fidelity Leverage Company’s performance?  From inception to April 28, 2008, FLVCX turned $10,000 into $41,000 while its midcap peers reached only $16,000. Sadly, and typically, Fidelity trailed its peers and benchmark noticeably from that day to this. JHancock did better but with its hopes of riding Fidelity’s coattails smashed …

Lord Abbett Small Cap Blend Fund melted into the Lord Abbett Value Opportunities Fund (LVOAX) on July 19, 2013. The fact that Value Opps doesn’t particularly invest in small cap stocks and has struggled to transcend “mediocre” in the last several years makes this a less-than-ideal merger.

My favorite liquidation notice, quoted in its entirety: “On July 31,2013, the ASG Growth Markets Fund (AGMAX) was liquidated. The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase or exchange.” It appears mostly to have bet on emerging markets currencies. Over its short life, it managed to transform $10,000 into $9,400.

COUNTRY Bond Fund (CTLAX) and COUNTRY Growth Fund (CGRAX) will be liquidated “on or before October 31, 2013, and in any event no later than December 31, 2013.” I have no idea (1) why the word “Country” is supposed to appear in all caps (same with ASTON) or (2) why you’d liquidate a reasonably solid fund with over $300 million in assets or a mediocre one with $250 million. No word of explanation in the filing.

The King is Dead: Fountainhead Special Value Fund (KINGX) has closed to new investors in anticipation of an October liquidation. Twas a $7 million midcap growth fund that had a promising start, cratered in the 2007-09 crisis and never recovered.

In Closing . . .

That’s about it from Door County.  I’ll soon be back at my desk as we pull together the September issue.  We’ll have a look inside your target-date funds and will share four more fund profiles (including one that we’ve dubbed “Dodge and Cox without all the excess baggage”).  It’s work, but joyful.

It wouldn’t be worthwhile without your readership and your thoughtful feedback.  And it wouldn’t be possible without your support, either directly or by using our Amazon link.   Our readership, curiously enough, has spiked to 15,014 “unique visitors” this month, though our revenue through Amazon is flat.  So, we thought we’d mention the system for the benefit of the new folks.  The Amazon system is amazingly simple and painless.  If you set our link as your default bookmark for Amazon (or, as I do, use Amazon as your homepage), the Observer receives a rebate from Amazon equivalent to 6% or more of the amount of your purchase.  It doesn’t change your cost by a penny since the money comes from Amazon’s marketing budget.  While 6% of the $11 you’ll pay for Bill Bernstein’s The Investor’s Manifesto (or 6% of a pound of coffee beans, back-to-school loot or an Easton S1 composite big barrel bat) seems trivial, it adds up to about 75% of our income.  Thanks for both!

We’ll look for you.

 

Dear friends,

Welcome to summer, a time of year when heat records are rather more common than market records.  

What’s in your long/short fund?

Everybody’s talking about long/short funds.  Google chronicles 273,000 pages that use the phrase.  Bloomberg promises “a comprehensive list of long/short funds worldwide.”  Morningstar, Lipper and U.S. News plunk nearly a hundred funds into a box with that label.  (Not the same hundred funds, by the way.  Not nearly.)  Seeking Alpha offers up the “best and less long/short funds 2013.”

Here’s the Observer’s position: Talking about “long/short funds” is dangerous and delusional because it leads you to believe that there are such things.  Using the phrase validates the existence of a category, that is, a group of things where we perceive shared characteristics.  As soon as we announce a category, we start judging things in the category based on how well they conform to our expectations of the category.  If we assign a piece of fruit (or a hard-boiled egg) to the category “upscale dessert,” we start judging it based on how upscale-dessert-y it seems.  The fact that the assignment is random, silly and unfair doesn’t stop us from making judgments anyway.  The renowned linguist George Lakoff writes, “there is nothing more basic than categorization to our thought, perception, action and speech.”

Do categories automatically make sense?  Try this one out: Dyirbal, an Australian aboriginal language, has a category balan which contains women, fire, dangerous things, non-threatening birds and platypuses.

When Morningstar groups 83 funds together in the category “long/short equity,” they’re telling us “hey, all of these things have essential similarities.  Feel free to judge them against each other.”  We sympathize with the analysts’ need to organize funds.  Nonetheless, this particular category is seriously misleading.   It contains funds that have only superficial – not essential – similarities with each other.  In extended conversations with managers and executives representing a half dozen long/short funds, it’s become clear that investors need to give up entirely on this simple category if they want to make meaningful comparisons and choices.

Each of the folks we spoke to have their own preferred way of organizing these sorts of “alternative investment” funds.   After two weeks of conversation, though, useful commonalities began to emerge.  Here’s a manager-inspired schema:

1. Start with the role of the short portfolio.  What are the managers attempting to do with their short book and how are they doing it? The RiverNorth folks, and most of the others, agree that this should be “the first and perhaps most important” criterion. Alan Salzbank of the Gargoyle Group warns that “the character of the short positions varies from fund to fund, and is not necessarily designed to hedge market exposure as the category title would suggest.”  Based on our discussions, we think there are three distinct roles that short books play and three ways those strategies get reflected in the fund.
   

   Role	Portfolio tool	Translation
   Add alpha	Individual stock shorts	These funds want to increase returns by identifying the market’s least attractive stocks and betting against them
   Reduce beta	Shorting indexes or sectors, generally by using ETFs	These funds want to tamp market volatility by placing larger or smaller bets against the entire market, or large subsets of it, with no concern for the value of individual issues
   Structural	Various option strategies such as selling calls	These funds believe they can generate considerable income – as much as 1.5-2% per month – by selling options.  Those options become more valuable as the market becomes more volatile, so they serve as a cushion for the portfolio; they are “by their very nature negatively correlated to the market” (AS).

2. Determine the degree of market exposure.   Net exposure (% long minus % short) varies dramatically, from 100% (from what ARLSX manager Matt Moran laments as “the faddish 130/30 funds from a few years ago”) to under 25%.  An analysis by the Gargoyle Group showed three-year betas for funds in Morningstar’s long/short category ranging from 1.40 to (-0.43), which gives you an idea of how dramatically market exposure varies.  For some funds the net market exposure is held in a tight band (40-60% with a target of 50% is pretty common).   Some of the more aggressive funds will shift exposure dramatically, based on their market experience and projections.  It doesn’t make sense to compare a fund that’s consistently 60% exposure to the market with one that swings from 25% – 100%.

   Ideally, that information should be prominently displayed on a fund’s fact sheet, especially if the manager has the freedom to move by more than a few percent.  A nice example comes from Aberdeen Equity Long/Short Fund’s (GLSRX) factsheet:

   

   Greg Parcella of Long/Short Advisors  maintains an internal database of all of long/short funds and expressed some considerable frustration in discovering that many don’t make that information available or require investors to do their own portfolio analyses to discover it.  Even with the help of Morningstar, such self-generated calculations can be a bit daunting.  Here, for example, is how Morningstar reports the portfolio of Robeco Boston Partners Long/Short Equity BPLEX in comparison to its (entirely-irrelevant) long-short benchmark and (wildly incomparable) long/short equity peers:

   

   So, look for managers who offer this information in a clear way and who keep it current. Morty Schaja, president of RiverPark Advisors which offers two very distinctive long/short funds (RiverPark Long/Short Opportunity RLSFX and RiverPark/Gargoyle Hedged Value RGHVX) suggest that such a lack of transparency would immediately raise concerns for him as an investor; he did not offer a flat “avoid them” but was surely leaning in that direction.

3. Look at the risk/return metrics for the fund over time.  Once you’ve completed the first two steps, you’ve stopped comparing apples to rutabagas and mopeds (step one) or even cooking apples to snacking apples (step two).  Now that you’ve got a stack of closely comparable funds, many of the managers call for you to look at specific risk measures.  Matt Moran suggests that “the best measure to employ are … the Sharpe, the Sortino and the Ulcer Index [which help you determine] how much return an investor is getting for the risk that they are taking.”

As part of the Observer’s new risk profiles of 7600 funds, we’ve pulled all of the funds that Morningstar categorizes as “long/short equity” into a single table for you.  It will measure both returns and seven different flavors of risk.  If you’re unfamiliar with the varied risk metrics, check our definitions page.  Remember that each bit of data must be read carefully since the fund’s longevity can dramatically affect their profile.  Funds that were around in the 2008 will have much greater maximum drawdowns than funds launched since then.  Those numbers do not immediately make a fund “bad,” it means that something happened that you want to understand before trusting these folks with your money.

As a preview, we’d like to share the profiles for five of the six funds whose advisors have been helping us understand these issues.  The sixth, RiverNorth Dynamic Buy-Write (RNBWX), is too new to appear.  These are all funds that we’ve profiled as among their categories’ best and that we’ll be profiling in August.

Long/short managers aren’t the only folks concerned with managing risk.  For the sake of perspective, we calculated the returns on a bunch of the risk-conscious funds that we’ve profiled.  We looked, in particular, at the recent turmoil since it affected both global and domestic, equity and bond markets.

Downside protection in one ugly stretch, 05/28/2013 – 06/24/2013

Strategy	Represented by	Returned
Traditional balanced	Vanguard Balanced Index Fund (VBINX)	(3.97)
Global equity	Vanguard Total World Stock Index (VTWSX)	(6.99)
Absolute value equity a/k/a cash-heavy funds	ASTON/River Road Independent Value (ARIVX) Bretton (BRTNX) Cook and Bynum (COBYX) FPA International Value (FPIVX) Pinnacle Value (PVFIX)	(1.71) (2.51) (3.20) (3.30) (1.75)
Pure long-short	ASTON/River Road Long-Short (ARLSX) Long/Short Opportunity (LSOFX) RiverPark Long Short Opportunity (RLSFX) Wasatch Long/Short (FMLSX)	(3.34) (4.93) (5.08) (3.84)
Long with covered calls	Bridgeway Managed Volatility (BRBPX) RiverNorth Dynamic Buy-Write (RNBWX) RiverPark Gargoyle Hedged Value (RGHVX)	(1.18) (2.64) (4.39)
Market neutral	Whitebox Long/Short Equity (WBLSX)	(1.75)
Multi-alternative	MainStay Marketfield (MFLDX)	(1.11)

Charles, widely-read and occasionally whimsical, thought it useful to share two stories and a bit of data that lead him to suspect that successful long/short investments are, like Babe Ruth’s “called home run,” more legend than history.

Notes from the Morningstar Conference

If you ever wonder what we do with contributions to the Observer or with income from our Amazon partnership, the short answer is, we try to get better.  Three ongoing projects reflect those efforts.  One is our ongoing visual upgrade, the results of which will be evident online during July.  More than window-dressing, we think of a more graphically sophisticated image as a tool for getting more folks to notice and benefit from our content.  A second our own risk profiles for more than 7500 funds.  We’ll discuss those more below.  The third was our recent presence at the Morningstar Investment Conference.  None of them would be possible without your support, and so thanks!

I spent about 48 hours at Morningstar and was listening to folks for about 30 hours.  I posted my impressions to our discussion board and several stirred vigorous discussions.  For your benefit, here’s a sort of Top Ten list of things I learned at Morningstar and links to the ensuing debates on our discussion board.

Day One: Northern Trust on emerging and frontier investing

Attended a small lunch with Northern managers.  Northern primarily caters to the rich but has retail share class funds, FlexShare ETFs and multi-manager funds for the rest of us. They are the world’s 5th largest investor in frontier markets. Frontier markets are currently 1% of global market cap, emerging markets are 12% and both have GDP growth 350% greater than the developed world’s. EM/F stocks sell at a 20% discount to developed stocks. Northern’s research shows that the same factors that increase equity returns in the developed world (small, value, wide moat, dividend paying) also predict excess returns in emerging and frontier markets. In September 2012 they launched the FlexShares Emerging Markets Factor Tilt Index Fund (TLTE) that tilts toward Fama-French factors, which is to say it holds more small and more value than a standard e.m. index.

Day One: Smead Value (SMVLX)

Interviewed Bill Smead, an interesting guy, who positions himself against the “brilliant pessimists” like Grantham and Hussman.  Smead argues their clients have now missed four years of phenomenal gains. Their thesis is correct (as were most of the tech investor theses in 1999) but optimism has been in such short supply that it became valuable.  He launched Smead Value in 2007 with a simple strategy: buy and hold (for 10 to, say, 100 years) excellent companies.  Pretty radical, eh?  He argues that the fund universe is 35% passive, 5% active and 60% overly active. Turns out that he’s managed it to top 1-2% returns over most trailing periods.  Much the top performing LCB fund around.  There’s a complete profile of the fund below.

Day One: Morningstar’s expert recommendations on emerging managers

Consuelo Mack ran a panel discussion with Russ Kinnel, Laura Lallos, Scott Burns and John Rekenthaler. One question: “What are your recommendations for boutique firms that investors should know about, but don’t? Who are the smaller, emerging managers who are really standing out?”

Dead silence. Glances back and forth. After a long silence: FPA, Primecap and TFS.

There are two possible explanations: (1) Morningstar really has lost touch with anyone other than the top 20 (or 40 or whatever) fund complexes or (2) Morningstar charged dozens of smaller fund companies to be exhibitors at their conference and was afraid to offend any of them by naming someone else.

Since we notice small funds and fund boutiques, we’d like to offer the following answers that folks could have given:

Well, Consuelo, a number of advisors are searching for management teams that have outstanding records with private accounts and/or hedge funds, and are making those teams and their strategies available to the retail fund world. First rate examples include ASTON, RiverNorth and RiverPark.

Or

That’s a great question, Consuelo.  Individual investors aren’t the only folks tired of dealing with oversized, underperforming funds.  A number of first-tier investors have walked away from large fund complexes to launch their own boutiques and to pursue a focused investing vision. Some great places to start would be with the funds from Grandeur Peak, Oakseed, and Seafarer.

Mr. Mansueto did mention, in his opening remarks, an upcoming Morningstar initiative to identify and track “emerging managers.”  If so, that’s a really good sign for all involved.

Day One: Michael Mauboussin on luck and skill in investing

Mauboussin works for Credit Suisse, Legg Mason before that and has written The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (2012). Here’s his Paradox of Skill: as the aggregate level of skill rises, luck becomes a more important factor in separating average from way above average. Since you can’t count on luck, it becomes harder for anyone to remain way above average. Ted Williams hit .406 in 1941. No one has been over .400 since. Why? Because everyone has gotten better: pitchers, fielders and hitters. In 1941, Williams’ average was four standard deviations above the norm. In 2012, a hitter up by four s.d. would be hitting “just” .380. The same thing in investing: the dispersion of returns (the gap between 50th percentile funds and 90th percentile funds) has been falling for 50 years. Any outsized performance is now likely luck and unlikely to persist.

This spurred a particularly rich discussion on the board.

Day Two: Matt Eagan on where to run now

Day Two started with a 7:00 a.m. breakfast sponsored by Litman Gregory. (I’ll spare you the culinary commentary.) Litman runs the Masters series funds and bills itself as “a manager of managers.” The presenters were two of the guys who subadvise for them, Matt Eagan of Loomis Sayles and David Herro of Oakmark. Eagan helps manage the strategic income, strategic alpha, multi-sector bond, corporate bond and high-yield funds for LS. He’s part of a team named as Morningstar’s Fixed-Income Managers of the Year in 2009.

Eagan argues that fixed income is influenced by multiple cyclical risks, including market, interest rate and reinvestment risk. He’s concerned with a rising need to protect principal, which leads him to a neutral duration, selective shorting and some currency hedges (about 8% of his portfolios).

He’s concerned that the Fed has underwritten a hot-money move into the emerging markets. The fundamentals there “are very, very good and we see their currencies strengthening” but he’s made a tactical withdrawal because of some technical reasons (I have “because of a fund-out window” but have no idea of what that means) which might foretell a drop “which might be violent; when those come, you’ve just got to get out of the way.”

He finds Mexico to be “compelling long-term story.” It’s near the US, it’s capturing market share from China because of the “inshoring” phenomenon and, if they manage to break up Pemex, “you’re going to see a lot of growth there.”

Europe, contrarily, “is moribund at best. Our big hope is that it’s less bad than most people expect.” He suspects that the Europeans have more reason to stay together than to disappear, so they likely will, and an investor’s challenge is “to find good corporations in bad Zip codes.”

In the end:

• avoid indexing – almost all of the fixed income indexes are configured to produce “negative real yields for the foreseeable future” and most passive products are useful mostly as “just liquidity vehicles.”
• you can make money in the face of rising rates, something like a 3-4% yield with no correlation to the markets.
• avoid Treasuries and agencies
• build a yield advantage by broadening your opportunity set
• look at convertible securities and be willing to move within a firm’s capital structure
• invest overseas, in particular try to get away from the three reserve currencies.

Eagan manages a sleeve of Litman Gregory Masters Alternative Strategies (MASNX), which we’ve profiled and which has had pretty solid performance.

Day Two: David Herro on emerging markets and systemic risk

The other breakfast speaker was David Herro of Oakmark International.  He was celebrated in our May 2013 essay, “Of Oaks and Acorns,” that looked at the success of Oakmark international analysts as fund managers.

Herro was asked about frothy markets and high valuations. He argues that “the #1 risk to protect against is the inability of companies to generate profits – macro-level events impact price but rarely impact long-term value. These macro-disturbances allow long-term investors to take advantage of the market’s short-termism.” The ’08-early ’09 events were “dismal but temporary.”

Herro notes that he had 20% of his flagship in the emerging markets in the late 90s, then backed down to zero as those markets were hit by “a wave of indiscriminate inflows.” He agrees that emerging markets will “be the propellant of global economic growth for the next 20 years” but, being a bright guy, warns that you still need to find “good businesses at good prices.” He hasn’t seen any in several years but, at this rate, “maybe in a year we’ll be back in.”

His current stance is that a stock needs to have 40-50% upside to get into his portfolio today and “some of the better quality e.m. firms are within 10-15% of getting in.”  (Since then the e.m. indexes briefly dropped 7% but had regained most of that decline by June 30.) He seemed impressed, in particular, with the quality of management teams in Latin America (“those guys are really experienced with handling adversity”) but skeptical of the Chinese newbies (“they’re still a little dodgy”).

He also announced a bias “against reserve currencies.” That is, he thinks you’re better off buying earnings which are not denominated in dollars, Euros or … perhaps, yen. His co-presenter, Matt Eagan of Loomis Sayles, has the same bias. He’s been short the yen but long the Nikkei.

In terms of asset allocation, he thinks that global stocks, especially blue chips “are pretty attractively priced” since values have been rising faster than prices have. Global equities, he says, “haven’t come out of their funk.” There’s not much of a valuation difference between the US and the rest of the developed world (the US “is a little richer” but might deserve it), so he doesn’t see overweighting one over the other.

Day Two: Jack Bogle ‘s inconvenient truths

Don Phillips had a conversation with Bogle in a huge auditorium that, frankly, should dang well have had more people in it.  I think the general excuse is, “we know what Bogle’s going to say, so why listen?”  Uhhh … because Bogle’s still thinking clearly, which distinguishes him from a fair number of his industry brethren?  He weighed in on why money market funds cost more than indexed stock funds (the cost of check cashing) and argued that our retirement system is facing three train wrecks: (1) underfunding of the Social Security system – which is manageable if politicians chose to manage it, (2) “grotesquely underfunded” defined benefit plans (a/k/a pension plans) whose managers still plan to earn 8% with a balanced portfolio – Bogle thinks they’ll be lucky to get 5% before expenses – and who are planning “to bring in some hedge fund guys” to magically solve their problem, and (3) defined contribution plans (401k’s and such) which allow folks to wreck their long-term prospects by cashing out for very little cause.

Bogle thinks that most target-date funds are ill-designed because they ignore Social Security, described by Bogle as “the best fixed-income position you’ll ever have.”  The average lifetime SS benefit is something like $300,000.  If your 401(k) contains $300,000 in stocks, you’ll have a 50/50 hybrid at retirement.  If your 401(k) target-date fund is 40% in bonds, you’ll retire with a portfolio that’s 70% bonds (SS + target date fund) and 30% stocks.  He’s skeptical of the bond market to begin with (he recommends that you look for a serious part of your income stream from dividend growth) and more skeptical of a product that buries you in bonds.

Finally, he has a strained relationship with his successors at Vanguard.  On the one hand he exults that Vanguard’s structural advantage on expenses is so great “that nobody can match us – too bad for them, good for us.”  And the other, he disagrees with most industry executives, including Vanguard’s, on regulations of the money market industry and the fund industry’s unwillingness – as owners of 35% of all stock – to stand up to cultures in which corporations have become “the private fiefdom of their chief executives.”  (An issue addressed by The New York Times on June 29, “The Unstoppable Climb in CEO Pay.”)  At base, “I don’t disagree with Vanguard.  They disagree with me.”

Day Three: Sextant Global High Income

This is an interesting one and we’ll have a full profile of the fund in August. The managers target a portfolio yield of 8% (currently they manage 6.5% – the lower reported trailing 12 month yield reflects the fact that the fund launched 12 months ago and took six months to become fully invested). There are six other “global high income” funds – Aberdeen, DWS, Fidelity, JohnHancock, Mainstay, Western Asset. Here’s the key distinction: Sextant pursues high income through a combination of high dividend stocks (European utilities among them), preferred shares and high yield bonds. Right now about 50% of the portfolio is in stocks, 30% bonds, 10% preferreds and 10% cash. No other “high income” fund seems to hold more than 3% equities. That gives them both the potential for capital appreciation and interest rate insulation. They could imagine 8% from income and 2% from cap app. They made about 9.5% over the trailing twelve months through 5/31. 

Day Three: Off-the-record worries

I’ve had the pleasure of speaking with some managers frequently over months or years, and occasionally we have conversations where I’m unsure that statements were made for attribution.  Here are four sets of comments attributable to “managers” who I think are bright enough to be worth listening to.

More than one manager is worried about “a credit event” in China this year. That is, the central government might precipitate a crisis in the financial system (a bond default or a bank run) in order to begin cleansing a nearly insolvent banking system. (Umm … I think we’ve been having it and I’m not sure whether to be impressed or spooked that folks know this stuff.) The central government is concerned about disarray in the provinces and a propensity for banks and industries to accept unsecured IOUs. They are acting to pursue gradual institutional reforms (e.g., stricter capital requirements) but might conclude that a sharp correction now would be useful. One manager thought such an event might be 30% likely. Another was closer to “near inevitable.”

More than one manager suspects that there might be a commodity price implosion, gold included. A 200 year chart of commodity prices shows four spikes – each followed by a retracement of more than 100% – and a fifth spike that we’ve been in recently.

More than one manager offered some version of the following statement: “there’s hardly a bond out there worth buying. They’re essentially all priced for a negative real return.”

More than one manager suggested that the term “emerging markets” was essentially a linguistic fiction. About 25% of the emerging markets index (Korea and Taiwan) could be declared “developed markets” (though, on June 11, they were not) while Saudi Arabia could become an emerging market by virtue of a decision to make shares available to non-Middle Eastern investors. “It’s not meaningful except to the marketers,” quoth one.

Day Three: Reflecting on tchotchkes

Dozens of fund companies paid for exhibits at Morningstar – little booths inside the McCormick Convention Center where fund reps could chat with passing advisors (and the occasional Observer guy).  One time honored conversation starter is the tchotchke: the neat little giveaway with your name on it.  Firms embraced a stunning array of stuff: barbeque sauce (Scout Funds, from Kansas City), church-cooked peanuts (Queens Road), golf tees, hand sanitizers (inexplicably popular), InvestMints (Wasatch), micro-fiber cloths (Payden), flashlights, pens, multi-color pens, pens with styluses, pens that signal Bernanke to resume tossing money from a circling helicopter . . .

Ideally, you still need to think of any giveaway as an expression of your corporate identity.  You want the properties of the object to reflect your sense of self and to remind folks of you.  From that standard, the best tchotchke by a mile were Vanguard’s totebags.  You wish you had one.  Made of soft, heavy-weight canvas with a bottom that could be flattened for maximum capacity, they were unadorned except for the word “Vanguard.”  No gimmicks, no flash, utter functionality in a product that your grandkids will fondly remember you carrying for years.  That really says Vanguard.  Good job, guys!

The second-best tchotchke (an exceedingly comfortable navy baseball cap with a sailboat logo) and single best location (directly across from the open bar and beside Vanguard) was Seafarer’s.  

It’s Charles in Charge! 

My colleague Charles Boccadoro has spearheaded one of our recent initiatives: extended risk profiles of over 7500 funds.  Some of his work is reflected in the tables in our long/short fund story.  Last month we promised to roll out his data in a searchable form for this month.  As it turns out, the programmer we’re working with is still a few days away from a “search by ticker” engine.  Once that’s been tested, chip will be able to quickly add other search fields. 

As an interim move, we’re making all of Charles’ risk analyses available to you as a .pdf.  (It might be paranoia, but I’m a bit concerned about the prospect of misappropriation of the file if we post it as a spreadsheet.)  It runs well over 100 pages, so I’d be a bit cautious about hitting the “print” button. 

Charles’ contributions have been so thoughtful and extensive that, in August, we’ll set aside a portion of the Observer that will hold an archive of all of his data-driven pieces.  Our current plan is to introduce each of the longer pieces in this cover essay then take readers to Charles’ Balcony where complete story and all of his essays dwell.  We’re following that model in …

Timing method performance over ten decades

The Healthy Debate. In Professor David Aronson’s 2006 book, entitled “Evidence-Based Technical Analysis,” he argues that subjective technical analysis, which is any analysis that cannot be reduced to a computer algorithm and back tested, is “not a legitimate body of knowledge but a collection of folklore resting on a flimsy foundation of anecdote and intuition.”

He further warns that falsehoods accumulate even with objective analysis and rules developed after-the-fact can lead to overblown extrapolations – fool’s gold biased by data-mining, more luck than legitimate prediction, in same category as “literate monkeys, Bible Codes, and lottery players.”

Read the full story here.

Announcing Mutual Fund Contacts, our new sister-site

I mentioned some months ago a plan to launch an affiliate site, Mutual Fund Contacts.  June 28 marked the “soft launch” of MFC.  MFC’s mission is to serve as a guide and resource for folks who are new at all this and feeling a bit unsteady about how to proceed.  We imagine a young couple in their late 20s planning an eventual home purchase, a single mom in her 30s who’s trying to organize stuff that she’s not had to pay attention to, or a young college graduate trying to lay a good foundation.

Most sites dedicated to small investors are raucous places with poor focus, too many features and a desperate need to grab attention.  Feh.  MFC will try to provide content and resources that don’t quite fit here but that we think are still valuable.  Each month we’ll provide a 1000-word story on the theme “the one-fund portfolio.”  If you were looking for one fund that might yield a bit more than a savings account without a lot of downside, what should you consider?  Each “one fund” article will recommend three options: two low-minimum mutual funds and one commission-free ETF.  We’ll also have a monthly recommendation on three resources you should be familiar with (this month, the three books that any financially savvy person needs to start with) and ongoing resources (this month: the updated “List of Funds for Small Investors” that highlights all of the no-load funds available for $100 or less – plus a couple that are close enough to consider).

The nature of a soft launch is that we’re still working on the site’s visuals and some functionality.  That said, it does offer a series of resources that, oh, say, your kids really should be looking at.  Feel free to drop by Mutual Fund Contacts and then let us know how we can make it better.

Everyone loves a crisis

Larry Swedroe wrote a widely quoted, widely redistributed essay for CBS MoneyWatch warning that bond funds were covertly transforming themselves into stock funds in pursuit of additional yield.  His essay opens with:

It may surprise you that, as of its last reporting date, there were 352 mutual funds that are classified by Morningstar as bond funds that actually held stocks in their portfolio. (I know I was surprised, and given my 40 years of experience in the investment banking and financial advisory business, it takes quite a bit to surprise me.) At the end of 2012, it was 312, up from 283 nine months earlier.

The chase for higher yields has led many actively managed bond funds to load up on riskier investments, such as preferred stocks. (Emphasis added)

Many actively managed bond funds have loaded up?

Let’s look at the data.  There are 1177 bond funds, excluding munis.  Only 104 hold more than 1% in stocks, and most of those hold barely more than a percent.  The most striking aspect of those funds is that they don’t call themselves “bond” funds.  Precisely 11 funds with the word “Bond” in their name have stocks in excess of 1%.  The others advertise themselves as “income” funds and, quite often, “strategic income,” “high income” or “income opportunities” funds.  Such funds have, traditionally, used other income sources to supplement their bond-heavy core portfolios.

How about Larry’s claim that they’ve been “bulking up”?  I looked at the 25 stockiest funds to see whether their equity stake should be news to their investors.  I did that by comparing their current exposure to the bond market with the range of exposures they’ve experienced over the past five years.  Here’s the picture, ranked based on US stock exposure, starting with the stockiest fund:

		Bond category	Current bond exposure	Range of bond exposure, 2009-2013
Ave Maria Bond	AVEFX	Intermediate	61	61-71
Pacific Advisors Government Securities	PADGX	Short Gov’t	82	82-87
Advisory Research Strategic Income	ADVNX	Long-Term	16	n/a – new
Northeast Investors	NTHEX	High Yield	54	54-88
Loomis Sayles Strategic Income	NEFZX	Multisector	65	60-80
JHFunds2 Spectrum Income	JHSTX	Multisector	77	75-79
T. Rowe Price Spectrum Income	RPSIX	Multisector	76	76-78
Azzad Wise Capital	WISEX	Short-Term	42	20-42 *
Franklin Real Return	FRRAX	Inflation-Prot’d	47	47-69
Huntington Mortgage Securities	HUMSX	Intermediate	85	83-91
Eaton Vance Bond	EVBAX	Multisector	63	n/a – new
Federated High Yield Trust	FHYTX	High Yield	81	81-87
Pioneer High Yield	TAHYX	High Yield	57	55-60
Chou Income	CHOIX	World	33	16-48
Forward Income Builder	AIAAX	Multisector	35	35-97
ING Pioneer High Yield Portfolio	IPHIX	High Yield	60	50-60
Loomis Sayles High Income	LSHIX	High Yield	61	61-70
Highland Floating Rate Opportunities	HFRAX	Bank Loan	81	73-88
Epiphany FFV Strategic Income	EPINX	Intermediate	61	61-69
RiverNorth/Oaktree High Income	RNHIX	Multisector	56	n/a – new
Astor Active Income ETF	AXAIX	Intermediate	74	68-88
Fidelity Capital & Income	FAGIX	High Yield	84	75-84
Transamerica Asset Allc Short Horizon	DVCSX	Intermediate	85	79-87
Spirit of America Income	SOAIX	Long-term	74	74-90

*WISEX invests within the constraints of Islamic principles.  As a result, most traditional interest-paying, fixed-income vehicles are forbidden to it.

From this most stock-heavy group, 10 funds now hold fewer bonds than at any other point in the past five years.  In many cases (see T Rowe Price Spectrum Income), their bond exposure varies by only a few percentage points from year to year so being light on bonds is, for them, not much different than being heavy on bonds.

The SEC’s naming rule says that if you have an investment class in your name (e.g. “Bond”) then at least 80% of your portfolio must reside in that class. Ave Maria Bond runs right up to the line: 19.88% US stocks, but warns you of that: “The Fund may invest up to 20% of its net assets in equity securities, which include preferred stocks, common stocks paying dividends and securities convertible into common stock.”  Eaton Vance Bond is 12% and makes the same declaration: “The Fund may invest up to 20% of its net assets in common stocks and other equity securities, including real estate investment trusts.”

Bottom line: the “loading up” has been pretty durn minimal.  The funds which have a substantial equity stake now have had a substantial equity stake for years, they market that fact and they name themselves to permit it.

Fidelity cries out: Run away!

Several sites have noted the fact that Fidelity Europe Cap App Fund (FECAX) has closed to new investors.  Most skip the fact that it looks like the $400 million FECAX is about to get eaten, presumably by Fidelity Europe (FIEUX): “The Board has approved closing Fidelity Europe Capital Appreciation Fund effective after the close of business on July 19, 2013, as the Board and FMR are considering merging the fund.” (emphasis added)

Fascinating.  Fidelity’s signaling the fact that they can no longer afford two Euro-centered funds.  Why would that be the case? 

I can only imagine three possibilities:

1. Fidelity no longer finds with a mere $400 million in AUM viable, so the Cap App fund has to go.
2. Fidelity doesn’t think there’s room for (or need for) more than one European stock strategy.  There are 83 distinct U.S.-focused strategies in the Fidelity family, but who’d need more than one for Europe?
3. Fidelity can no longer find managers capable of performing well enough to be worth the effort.
   

   	Expenses	Returns TTM	Returns 5 yr	Compared to peers – 5 yr
   Fidelity European funds for British investors
   Fidelity European Fund A-Accumulation	1.72% on $4.1B	22%	1.86	3.31
   Fidelity Europe Long-Term Growth Fund	1.73 on $732M	29	n/a	n/a
   Fidelity European Opportunities	1.73 on $723M	21	1.48	3.31
   Fidelity European funds for American investors
   Fidelity European Capital Appreciation	0.92% on $331M	24	(1.57)	(.81)
   Fidelity Europe	0.80 on $724M	23	(1.21)	(0.40)
   Fidelity Nordic	1.04% on $340M	32	(0.40)	The Morningstar peer group is “miscellaneous regions” – ignore it

   Converted at ₤1 = $1.54, 25 June 2013.

In April of 2007, Fidelity tried to merge Nordic into Europe, but its shareholders refused to allow it.  At the time Nordic was one of Fidelity’s best-performing international funds and had $600 million in assets.  The announced rationale:  “The Nordic region is more volatile than developed Europe as a whole, and Fidelity believes the region’s characteristics have changed sufficiently to no longer warrant a separate fund focused on the region.”  The nature of those “changes” was not clear and shareholders were unimpressed.

It is clear that Fidelity has a personnel problem.  When, for example, they wanted to bolster their asset allocation funds-of-funds, they added two new Fidelity Series funds for them to choose from.  One is run by Will Danoff, whose Contrafund already has $95 billion in assets, and the other by Joel Tillinghast, whose Low-Priced Stock Fund lugs $40 billion.  Presumably they would have turned to a young star with less on their plate … if they had a young star with less on their plate.  Likewise, Fidelity Strategic Adviser Multi-Manager funds advertise themselves as being run by the best of the best; these funds have the option of using Fidelity talent or going outside when the options elsewhere are better.  What conclusions might we draw from the fact that Strategic Advisers Core Multi-Manager (FLAUX) draws one of its 11 managers from Fido or that Strategic Advisers International Multi-Manager (FMJDX) has one Fido manager in 17?  Both of the managers for Strategic Advisers Core Income Multi-Manager (FWHBX) are Fidelity employees, so it’s not simply that the SAMM funds are designed to showcase non-Fido talent.

I’ve had trouble finding attractive new funds from Fidelity for years now.  It might well be that the contemplated retrenchment in their Europe line-up reflects the fact that Fido’s been having the same trouble.

Observer Fund Profiles:

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

Forward Income Builder (IAIAX): “income,” not “bonds.”  This is another instance of a fund that has been reshaped in recent years into an interesting offering.  Perception just hasn’t yet caught up with the reality.

Smead Value (SMVLX): call it “Triumph of the Optimists.”  Mr. Smead dismisses most of what his peers are doing as poorly conceived or disastrously poorly-conceived.  He thinks that pessimism is overbought, optimism in short supply and a portfolio of top-tier U.S. stocks held forever as your best friend.

Elevator Talk #5: Casey Frazier of Versus Capital Multi-Manager Real Estate Income Fund

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

Versus Capital Multi-Manager Real Estate Income Fund is a closed-end interval fund.  That means that you can buy Versus shares any day that the market is open, but you only have the opportunity to sell those shares once each quarter.  The advisor has the option of meeting some, all or none of a particular quarter’s redemption requests, based on cash available and the start of the market. 

The argument for such a restrictive structure is that it allows managers to invest in illiquid asset classes; that is, to buy and profit from things that cannot be reasonably bought or sold on a moment’s notice.  Those sorts of investments have been traditionally available only to exceedingly high net-worth investors either through limited partnerships or direct ownership (e.g., buying a forest).  Several mutual funds have lately begun creating into this space, mostly structured as interval funds.  Vertical Capital Income Fund (VCAPX), the subject of our April Elevator Talk, was one such.  KKR Alternative Corporate Opportunities Fund, from private equity specialist Kohlberg Kravis Roberts, is another.

Casey Frazieris Chief Investment Officer for Versus, a position he’s held since 2011.  From 2005-2010, he was the Chief Investment Officer for Welton Street Investments, LLC and Welton Street Advisors LLC.  Here’s Mr. Frazier’s 200 (and 16!) words making the Versus case:

We think the best way to maximize the investment attributes of real estate – income, diversification, and inflation hedge – is through a blended portfolio of private and public real estate investments.  Private real estate investments, and in particular the “core” and “core plus” segments of private real estate, have historically offered steady income, low volatility, low correlation, good diversification, and a hedge against inflation.  Unfortunately institutional private real estate has been out of reach of many investors due to the large size of the real estate assets themselves and the high minimums on the private funds institutional investors use to gain exposure to these areas.  With the help of institutional consultant Callan Associates, we’ve built a multi-manager portfolio in a 40 Act interval structure we feel covers the spectrum of a core real estate allocation.  The allocation includes real estate private equity and debt, public equity and debt, and broad exposure across asset types and geographies.  We target a mix of 70% private real estate with 30% public real estate to enhance liquidity, and our objective is to produce total returns in the 7% – 9% range net of fees with 5% – 6% of that coming from income.  Operationally, the fund has daily pricing, quarterly liquidity at NAV, quarterly income, 1099 reporting and no subscription paperwork.

Versus offers a lot of information about private real estate investing on their website.  Check the “fund documents” page. The fund’s retail, F-class shares carry an annual expense of 3.30% and a 2.00% redemption fee on shares held less than one year.  The minimum initial investment is $10,000.  

Conference Call Upcoming: RiverNorth/Oaktree High Income, July 11, 3:15 CT

While the Observer’s conference call series is on hiatus for the summer (the challenge of coordinating schedules went from “hard” to “ridiculous”), we’re pleased to highlight similar opportunities offered by folks we’ve interviewed and whose work we respect.

In that vein, we’d like to invite you to join in on a conference call hosted by RiverNorth to highlight the early experience of RiverNorth/Oaktree High Income Fund.  The fund is looking for high total return, rather than income per se.  As of May 31, 25% of the portfolio was allocated to RiverNorth’s tactical closed-end fund strategy and 75% to Oaktree.  Oaktree has two strategies (high yield bond and senior loan) and it allocates more or less to each depending on the available opportunity set.

Why might you want to listen in?  At base, both RiverNorth and Oaktree are exceedingly successful at what they do.  Oaktree’s services are generally not available to retail investors.  RiverNorth’s other strategic alliances have ranged from solid (with Manning & Napier) to splendid (with DoubleLine).  On the surface the Oaktree alliance is producing solid results, relative to their Morningstar peer group, but the fund’s strategies are so distinctive that I’m dubious of the peer comparison.

If you’re interested, the RiverNorth call will be Thursday, July 11, from 3:15 – 4:15 Central.  The call is web-based, so you’ll be able to read supporting visuals while the guys talk.  Callers will have the opportunity to ask questions of Mr. Marks and Mr. Galley.  Because RiverNorth anticipates a large crowd, you’ll submit your questions by typing them rather than speaking directly to the managers. 

How can you join in?  Just click

You can also get there by visiting RiverNorthFunds.com and clicking on the Events tab.

Launch Alert

Artisan Global Small Cap (ARTWX) launched on June 25, after several delays.  It’s managed by Mark Yockey and his new co-managers/former analysts, Charles-Henri Hamker and Dave Geisler.  They’ll apply the same investment discipline used in Artisan Global Equity (ARTHX) with a few additional constraints.  Global Small will only invest in firms with a market cap of under $4 billion at the time of purchase and might invest up to 50% of the portfolio in emerging markets.  Global Equity has only 7% of its money in small caps and can invest no more than 30% in emerging markets (right now it’s about 14%). Just to be clear: this team runs one five-star fund (Global), two four-star ones (International ARTIX and International Small Cap ARTJX), Mr. Yockey was Morningstar’s International Fund Manager of the Year in 1998 and he and his team were finalists again in 2012.  It really doesn’t get much more promising than that. The expenses are capped at 1.50%.  The minimum initial investment is $1000.

RiverPark Structural Alpha (RSAFX and RSAIX) launched on Friday, June 28.  The fund will employ a variety of options investment strategies, including short-selling index options that the managers believe are overpriced.  A half dozen managers and two fund presidents have tried to explain options-based strategies to me.  I mostly glaze over and nod knowingly.  I have become convinced that these represent fairly low-volatility tools for capturing most of the stock market’s upside. The fund will be comanaged by Justin Frankel and Jeremy Berman. This portfolio was run as a private partnership for five years (September 2008 – June 2013) by the same managers, with the same strategy.  Over that time they managed to return 10.7% per year while the S&P 500 made 6.2%.  The fund launched at the end of September, 2008, and gained 3.55% through year’s end.  The S&P500 dropped 17.7% in that same quarter.  While the huge victory over those three months explains some of the fund’s long-term outperformance, its absolute returns from 2009 – 2012 are still over 10% a year.  You might choose to sneeze at a low-volatility, uncorrelated strategy that makes 10% annually.  I wouldn’t.  The fund’s expenses are hefty (retail shares retain the 2% part of the “2 and 20” world while institutional shares come in at 1.75%).  The minimum initial investment will be $1000.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details. Every day we scour new SEC filings to see what opportunities might be about to present themselves. Many of the proposed funds offer nothing new, distinctive or interesting.

Funds in registration this month won’t be available for sale until, typically, the end of August 2013. There were 13 funds in registration with the SEC this month, through June 25^th.  The most interesting, by far, is:

RiverPark Strategic Income Fund.  David Sherman of Cohanzick Management, who also manages the splendid but closed RiverPark Short Term High Yield Fund (RPHYX, see below) will be the manager.  This represents one step out on the risk/return spectrum for Mr. Sherman and his investors.  He’s giving himself the freedom to invest across the income-producing universe (foreign and domestic, short- to long-term, investment and non-investment grade debt, preferred stock, convertible bonds, bank loans, high yield bonds and up to 35% income producing equities) while maintaining a very conservative discipline.  In repeated conversations, it’s been very clear that Mr. Sherman has an intense dislike of losing his investors’ money.  His plan is to pursue an intentionally conservative strategy by investing only in those bonds that he deems “Money Good” and stocks whose dividends are secure.  He also can hedge the portfolio and, as with RPHYX, he intends to hold securities until maturity which will make much of the fund’s volatility more apparent than real.   The expense ratio is 1.25% for retail shares, 1.00% for institutional. The minimum initial investments will be $1000 for retail and $1M for institutional.

Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down a near-record 64 fund manager changes. 

Briefly Noted . . .

If you own a Russell equity fund, there’s a good chance that your management team just changed.  Phillip Hoffman took over the lead for a couple funds but also began swapping out managers on some of their multi-manager funds.  Matthew Beardsley was been removed from management of the funds and relocated into client service. 

SMALL WINS FOR INVESTORS

Seventeen BMO Funds dropped their 2.00% redemption fees this month.

BRC Large Cap Focus Equity Fund (BRCIX)has dropped its management fee from 0.75% to 0.47% and capped its total expenses at 0.55%.  It’s an institutional fund that launched at the end of 2012 and has been doing okay.

LK Balanced Fund (LKBLX) reduced its minimum initial investment for its Institutional Class Shares from $50,000 to $5,000 for IRA accounts.  Tiny fund, very fine long-term record but a new management team as of June 2012.

Schwab Fundamental International Small Company Index Fund (SFILX) and Schwab Fundamental Emerging Markets Large Company Index Fund (SFENX) have capped their expenses at 0.49%.  That’s a drop of 6 and 11 basis points, respectively.

CLOSINGS (and related inconveniences)

Good news for RPHYX investors, bad news for the rest of you.  RiverPark Short Term High Yield (RPHYX) has closed to new investors.  The manager has been clear that this really distinctive cash-management fund had a limited capacity, somewhere between $600 million and $1 billion.  I’ve mentioned several times that the closure was nigh.  Below is the chart of RPHYX (blue) against Vanguard’s short-term bond index (orange) and prime money market (green).

OLD WINE, NEW BOTTLES

For all of the excitement over China as an investment opportunity, China-centered funds have returned a whoppin’ 1.40% over the past five years.  BlackRock seems to have noticed and they’ve hit the Reset button on BlackRock China Fund (BACHX).  As of August 16, it will become BlackRock Emerging Markets Dividend Fund.  One wonders if the term “chasing last year’s hot idea” is new to them?

On or about August 5, 2013, Columbia Energy and Natural Resources Fund (EENAX, with other tickers for its seven other share classes) will be renamed Columbia Global Energy and Natural Resources Fund.  There’s no change to the strategy and the fund is already 35% non-U.S., so it’s just marketing fluff.

“Beginning on or about July 1, 2013, all references to ING International Growth Fund (IIGIX) are hereby deleted and replaced with ING Multi-Manager International Equity Fund.”  Note to ING: the multi-manager mish-mash doesn’t appear to be a winning strategy.

Effective May 22, ING International Small Cap Fund (NTKLX) may invest up to 25% of its portfolio in REITs.

Effective June 28, PNC Mid Cap Value Fund became PNC Mid Cap Fund (PMCAX).

Effective June 1, Payden Value Leaders Fund became Payden Equity Income Fund (PYVLX).  With only two good years in the past 11, you’d imagine that more than the name ought to be rethought.

OFF TO THE DUSTBIN OF HISTORY

Geez, the dustbin is filling quickly.

The Alternative Strategies Mutual Fund (AASFX) closed to new investors in June and will liquidate by July 26, 2013.  It’s a microscopic fund-of-funds that, in its best year, trailed 75% of its peers.  A 2.5% expense ratio didn’t help.

Hansberger International Value Fund (HINTX) will be liquidated on or about July 19, 2013.   It’s moved to cash pending dissolution.

ING International Value Fund (IIVWX) is merging into ING International Value Equity (IGVWX ), formerly ING Global Value Choice.   This would be a really opportune moment for ING investors to consider their options.   ING is merging the larger fund into the smaller, a sign that the marketers are anxious to bury the worst of the ineptitude.  Both funds have been run by the same team since December 2012.  This is the sixth management team to run the fund in 10 years and the new team’s record is no better than mediocre.    

In case you hadn’t noticed, Litman Gregory Masters Value Fund (MSVFX) was absorbed by Litman Gregory Masters Equity Fund (MSENX) in late June, 2013.  Litman Gregory’s struggles should give us all pause.  You have a firm whose only business is picking winning fund managers and assembling them into a coherent portfolio.  Nonetheless, Value managed consistently disappointing returns and high volatility.  How disappointing?  Uhh … they thought it was better to keep a two-star fund that’s consistently had higher volatility and lower returns than its peers for the past decade.  We’re going to look at the question, “what’s the chance that professionals can assemble a team of consistently winning mutual fund managers?” when we examine the record (generally parlous) of multi-manager funds in an upcoming issue.

Driehaus Large Cap Growth Fund (DRLGX) was closed on June 11 and, as of July 19, the Fund will begin the process of liquidating its portfolio securities. 

The Board of Fairfax Gold and Precious Metals Fund (GOLMX and GOLLX) “has concluded that it is in the best interests of the Fund and its shareholders that the Fund cease operations,” which they did on June 29, 2013

Forward Global Credit Long/Short Fund (FGCRX) will be liquidated on or around July 26, 2013.  I’m sure this fund seemed like a good idea at the time.  Forward’s domestic version of the fund (Forward Credit Analysis Long/Short, FLSRX) has drawn $800 million into a high risk/high expense/high return portfolio.  The global fund, open less than two years, managed the “high expense” part (2.39%) but pretty much flubbed on the “attract investors and reward them” piece.   The light green line is the original and dark blue is Global, since launch.

Henderson World Select Fund (HFPAX) will be liquidated on or about August 30, 2013.

The $13 million ING DFA Global Allocation Portfolio (IDFAX) is slated for liquidation, pending shareholder approval, likely in September.

ING has such a way with words.  They announced that ING Pioneer Mid Cap Value Portfolio (IPMVX, a/k/a “Disappearing Portfolio”) will be reorganized “with and into the following ‘Surviving Portfolio’ (the ‘Reorganization’):

Disappearing Portfolio	Surviving Portfolio
ING Pioneer Mid Cap Value Portfolio	ING Large Cap Value Portfolio

So, in the best case, a shareholder is The Survivor?  What sort of goal is that?  “Hi, gramma!  I just invested in a mutual fund that I hope will survive?” Suddenly the Bee Gees erupt in the background with “stayin’ alive, stayin’ alive, ah, ah, ah … “  Guys, guys, guys.  The disappearance is scheduled to occur just after Labor Day.

Stephen Leeb wrote The Coming Economic Collapse (2008).  The economy didn’t, his fund did.  Leeb Focus Fund (LCMFX) closed at the end of June, having parlayed Mr. Leeb’s insights into returns that trailed 98% of its peers since launch. 

On June 20, 2013, the board of directors of the Frontegra Funds approved the liquidation of the Lockwell Small Cap Value Fund (LOCSX).  Lockwell had a talented manager who was a sort of refugee from a series of fund mergers, acquisitions and liquidations in the industry.  We profiled LOCSX and were reasonably positive about its prospects.  The fund performed well but never managed to attract assets, partly because small cap investing has been out of favor and partly because of an advertised $100,000 minimum.  In addition to liquidating the fund, the advisor is closing his firm. 

Tributary Core Equity Fund (FOEQX) will liquidate around July 26, 2013.  Tributary Balanced (FOBAX), which we’ve profiled, remains small, open and quite attractive. 

I’ve mentioned before that I believe Morningstar misleads investors with their descriptions of a fund’s fee level (“high,” “above average” and so on) because they often use a comparison group that investors would never imagine.  Both Tributary Balanced and Oakmark Equity & Income (OAKBX) have $1000 minimum investments.  In each case, Morningstar insists on comparing them to their Moderate Allocation Institutional group.  Why?

In Closing . . .

We have a lot going on in the month ahead: Charles is working to create a master listing of all the funds we’ve profiled, organized by strategy and risk.  Andrew and Chip are working to bring our risk data to you in an easily searchable form.  Anya and Barb continue playing with graphics.  I’ve got four profiles underway, based on conversations I had at Morningstar.

And … I get to have a vacation!  When you next hear from me, I’ll be lounging on the patio of LeRoy’s Water Street Coffee Shop in lovely Ephraim, Wisconsin, on the Door County peninsula.  I’ll send pictures, but I promise I won’t be gloating when I’m doing it.

Dear friends,

I had imagined this as the “post-storm, pre-cliff” edition of the Observer but it appears that “post-storm” would be a very premature characterization.  For four million of our friends who are still without power, especially those along the coast or in outlying areas, the simple pleasures of electric lighting and running water remain a distant hope.  And anything that looks like “normal” might be months in their future.  Our thoughts, prayers, good wishes and spare utility crews go out to them.

I thought, instead, I’d say something about the U.S. presidential election.  This is going to sting, but here it is:

It’s going to be okay.

Hard to believe, isn’t it?  We’re acculturated into viewing the election if as it were some apocalyptic video game whose tagline reads: “America can’t survive .”  The reality is, we can and we will.  The reality is that both Obama and Romney are good guys: smart, patriotic, obsessively hard-working, politically moderate, fact-driven, given to compromise and occasionally funny.  The reality is that they’re both trapped by the demands of electoral politics and polarized bases.

But, frankly, freed of the constraints of those bases, these guys would agree on rather more than they disagree on.  In a less-polarized world, they could run together as a ticket (Obomney 2020!) and do so with a great deal of camaraderie and mutual respect. (Biden-Ryan, on the other hand, would be more than a little bit scary.)  Neither strikes me as a great politician or polished communicator; that’s going to end up constraining – and perhaps crippling – whoever wins.

Why are we so negative?  Because negative (“fear and loathing on the campaign trail”) raises money (likely $6 billion by the time it’s all done) and draws viewers.  While it’s easy to blame PACs, super PACs and other dark forces for that state, the truth is that the news media – mainstream and otherwise – paint good men as evil.  A startling analysis conducted by the Project for Excellence in Journalism found that 72% of all character references to Messrs. Obama and Romney are negative, one of the most negative set of press portrayals on record.

I live in Iowa, labeled a “battleground state,” and I receive four to six (largely poisonous) robo-calls a day.  And so here’s the final reality: Iowa is not a battleground and we’d all be better off if folks stopped using the term.  It’s a place where a bunch of folks are worried, a bunch of folks (often the same ones) are hopeful and we’re trying to pick as best we can.

The Last Ten: T. Rowe Price in the Past Decade

In October we launched “The Last Ten,” a monthly series, running between now and February, looking at the strategies and funds launched by the Big Five fund companies (Fido, Vanguard, T Rowe, American and PIMCO) in the last decade.  We started with Fidelity, once fabled for the predictable success of its new fund launches.  Sadly, the pattern of the last decade is clear and clearly worse: despite 154 fund launches since 2002, Fidelity has created no compelling new investment option and only one retail fund that has earned Morningstar’s five-star designation, Fidelity International Growth (FIGFX).  We suggested three causes: the need to grow assets, a cautious culture and a firm that’s too big to risk innovative funds.

T. Rowe Price is a far smaller firm.  Where Fidelity has $1.4 trillion in assets under management, Price is under $600 billion.  Fidelity manages 340 funds.  Price has 110.  Fidelity launched 154 funds in a decade, Price launched 22.

	Morningstar Rating	Category	Size (millions, slightly rounded)
Africa & Middle	★★★	Emerging Markets Stock	150
Diversified Mid Cap Growth	★★★	Mid-Cap Growth	200
Emerging Markets Corporate Bond	—	Emerging Markets Bond	30
Emerging Markets Local Currency	—	Emerging Markets Bond	50
Floating Rate	—	Bank Loan	80
Global Infrastructure	—	Global Stock	40
Global Large-Cap	★★★	Global Stock	70
Global Real Estate	★★★★★	Global Real Estate	100
Inflation Protected Bond	★★★	Inflation-Protected Bond	570
Overseas Stock	★★★	Foreign Large Blend	5,000
Real Assets	—	World Stock	2,760
Retirement 2005	★★★★	Target Date	1,330
Retirement 2010	★★★	Target Date	5,850
Retirement 2015	★★★★	Target Date	7,340
Retirement 2025	★★★	Target Date	9,150
Retirement 2035	★★★★	Target Date	6,220
Retirement 2045	★★★★	Target Date	3,410
Retirement 2050	★★★★	Target Date	2,100
Retirement 2055	★★★★★	Target-Date	490
Retirement Income	★★★	Retirement Income	2,870
Strategic Income	★★	Multisector Bond	270
US Large-Cap Core	★★★	Large Blend	50

What are the patterns?

1. Most Price funds reflect the firm’s strength in asset allocation and emerging asset classes. Price does really first-rate work in thinking about which assets classes make sense and in what configuration. They’ve done a good job of communicating that research to their investors, making things clear without making them childish.
2. Most Price funds succeed. Of the funds launched, only Strategic Income (PRSNX) has been a consistent laggard; it has trailed its peer group in four consecutive years but trailed disastrously only once (2009).
3. Most Price funds remain reasonably nimble. While Fido funds quickly swell into the multi-billion range, a lot of the Price funds have remaining under $200 million which gives them both room to grow and to maneuver. The really large funds are the retirement-date series, which are actually funds of other funds.
4. Price continues to buck prevailing wisdom. There’s no sign of blossoming index fund business or the launch of a series of superfluous ETFs. There’s a lot to be said for knowing your strengths and continuing to develop them.

Finally, Price continues to deliver on its promises. Investing with Price is the equivalent of putting a strong singles-hitter on a baseball team; it’s a bet that you’ll win with consistency and effort, rather than the occasional spectacular play. The success of that strategy is evident in Price’s domination of . . .

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 second 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.

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

	Strategy	Assets (millions)	2011 Honoree or the reason why not
Fidelity Growth Company (FDGRX)	Large Growth	44,100	Rotten 2002
Laudus Growth Investors US Large Cap Growth (LGILX)	Large Growth	1,400	2011 Honoree
Merger (MERFX)	Market Neutral	4,700	Rotten 2002
Robeco All Cap Value (BPAVX)	Large Value	400	Not around in 2002
T. Rowe Price Capital Opportunities (PRCOX)	Large Blend	400	2011 Honoree
T. Rowe Price Mid-Cap Growth (RPMGX)	Mid-Cap Growth	18,300	2011 Honoree
TIAA-CREF Growth & Income (TIIRX)	Large Blend	2,900	Not around in 2002
TIAA-CREF Mid-Cap Growth (TCMGX)	Mid-Cap Growth	1,300	Not around in 2002
Vanguard Explorer (VEXPX)	Small Growth	9,000	2011 Honoree
Vanguard Mid Cap Growth (VMGRX)	Mid-Cap Growth	2,200	2011 Honoree
Vanguard Morgan Growth (VMRGX)	Large Growth	9,000	2011 Honoree

International stock funds

American Century Global Growth (TWGGX)	Global	400	2011 Honoree
Driehaus Emerging Markets Growth (DREGX)	Emerging Markets	900	2011 Honoree
Thomas White International (TWWDX)	Large Value	600	2011 Honoree
Vanguard International Growth (VWIGX)	Large Growth	17,200	2011 Honoree

Blended asset funds

Buffalo Flexible Income (BUFBX)	Moderate Hybrid	600	2011 Honoree
Fidelity Freedom 2020 (FFFDX)	Target Date	14,300	2011 Honoree
Fidelity Freedom 2030 (FFFEX)	Target Date	11,000	Rotten 2002
Fidelity Puritan (FPURX)	Moderate Hybrid	20,000	2011 Honoree
Manning & Napier Pro-Blend Extended Term (MNBAX)	Moderate Hybrid	1,300	2011 Honoree
T. Rowe Price Balanced (RPBAX)	Moderate Hybrid	3,400	2011 Honoree
T. Rowe Price Personal Strategy Balanced (TRPBX)	Moderate Hybrid	1,700	2011 Honoree
T. Rowe Price Personal Strategy Income (PRSIX)	Conservative Hybrid	1,100	2011 Honoree
T. Rowe Price Retirement 2030 (TRRCX)	Target Date	13,700	Not around in 2002
T. Rowe Price Retirement 2040 (TRRDX)	Target Date	9,200	Not around in 2002
T. Rowe Price Retirement Income (TRRIX)	Retirement Income	2,900	Not around in 2002
Vanguard STAR (VGSTX)	Moderate Hybrid	14,800	2011 Honoree
Vanguard Tax-Managed Balanced (VTMFX)	Conservative Hybrid	1,000	Rotten 2002

Specialty funds

Fidelity Select Industrials (FCYIX)	Industrial	600	Weak 2002
Fidelity Select Retailing (FSRPX)	Consumer Cyclical	600	Weak 2002
Schwab Health Care (SWHFX)	Health	500	2011 Honoree
T. Rowe Price Global Technology (PRGTX)	Technology	700	2011 Honoree
T. Rowe Price Media & Telecomm (PRMTX)	Communications	2,400	2011 Honoree

Reflections on the Honor Roll

These funds earn serious money.  Twenty-nine of the 33 funds earn four or five stars from Morningstar.  Four earn three stars, and none earn less.  By screening for good risk management, you end up with strong returns.

This is consistent with the recent glut of research on low-volatility investing.  Here’s the basic story: a portfolio of low-volatility stocks returns one to two percent more than the stock market while taking on 25% less risk.

That’s suspiciously close to the free lunch we’re not supposed to get.

There’s a very fine, short article on low-volatility investing in the New York Times: “In Search of Funds that Don’t Rock the Boat” (October 6, 2012).  PIMCO published some of the global data, showing (at slightly numbing length) that the same pattern holds in both developed and developing markets: “Stock Volatility: Not What You Might Think” (January 2012). There are a slug of ETFs that target low-volatility stocks but I’d be hesitant to commit to one until we’d looked at other risk factors such as turnover, market cap and sector concentration.

The roster is pretty stable.  Only four funds that qualified under these screens at the end of 2011 dropped out in 2012.  They are:

FPA Crescent (FPACX) – a 33% cash stake isn’t (yet) helping.  That said, this has been such a continually excellent fund that I worry more about the state of the market than about the state of Crescent.

New Century Capital (NCCPX) – a small, reasonably expensive fund-of funds that’s trailing 77% of its peers this year.  It’s been hurt, mostly, by being overweight in energy and underweight in resurgent financials.

New Century International (NCFPX) – another fund-of-funds that’s trailing about 80% of its peers, hurt by a huge overweight in emerging markets (primarily Latin), energy, and Canada (which is sort of an energy play).

Permanent Portfolio (PRPFX) – it hasn’t been a good year to hold a lot of Treasuries, and PRPFX by mandate does.

The list shows less than half of the turnover you’d expect if funds were there by chance.

One fund deserves honorable mention.  T. Rowe Price Capital Appreciation (PRCWX) has only had one relatively weak year in this century; in 2007, it finished in the 69^th percentile which made it (barely) miss inclusion.

What you’ve heard about T. Rowe Price is true.  You know all that boring “discipline, consistency, risk-awareness” stuff.  Apparently so.  There are 10 Price funds on the list, nearly one-third of the total.  Second place: Fidelity and Vanguard, far larger firms, with six funds.

Sure bets?  Nope.  Must have?  Dear God, no.  A potentially useful insight into picking winners by dodging a penchant for the occasional disaster?  We think so.

In dullness there is strength.

“TrimTabs ETF Outperforms Hedge Funds”

And underperforms pretty much everybody else.  The nice folks at FINAlternatives (“Hedge Fund and Private Equity News”) seem to have reproduced (or condensed) a press release celebrating the first-year performance of TrimTabs Float Shrink ETF (TTFS).

(Sorry – you can get to the original by Googling the title but a direct-link always takes you to a log-in screen.)

Why is this journalism?  They don’t offer the slightest hint about what the fund does.  And, not to rain on anybody’s ETF, but their trailing 12-month return (21.46% at NAV, as of 10/18) places them 2050th in Morningstar’s database.  That list includes a lot of funds which have been consistently excellent (Akre Focus, BBH Core Select (closing soon – see below), ING Corporate Leaders, Mairs & Power Growth and Sequoia) for decades, so it’s not immediately clear what warrants mention.

Seafarer Rolls On

Andrew Foster’s Seafarer Overseas Growth & Income Fund (SFGIX) continues its steady gains.

The fund is outperforming every reasonable benchmark: $10,000 invested at the fund’s inception has grown to $10,865 (as of 10/26/12).  The same amount invested in the S&P’s diversified emerging markets, emerging Asia and emerging Latin America ETFs would have declined by 5-10%.

Assets are steadily rolling in: the fund is now at $17 million after six months of operation and has been gaining nearly two million a month since summer.

Opinion-makers are noticing: Andrew and David Nadel of Royce Global Value (and five other funds ‘cause that’s what Royce managers do) were the guests on October 26th edition of Wealth Track with Consuelo Mack.  It was good to hear ostensible “growth” and “value” investors agree on so much about what to look for in emerging market stocks and which countries they were assiduously avoiding.  The complete interview on video is available here.  (Thanks to our endlessly vigilant Ted for both the heads-up and the video link.)

Legg Mason Rolls Over

Legg Mason seems to be struggling.  On the one hand we have the high visibility struggles of its former star manager, Bill Miller, who’s now in the position of losing more money for more people than almost any manager.  Their most recent financial statement, released July 27, shows that assets, operating revenue, operating income, and earnings are all down from the year before.   Beside that, there’s a more fundamental struggle to figure out what Legg Mason is and who wants to bear the name.

On October 5 2009 Legg announced a new naming strategy for its funds:

Most funds that were formerly named Legg Mason or Legg Mason Partners will now include the Legg Mason name, the name of the investment affiliate and the Fund’s strategy (such as the Legg Mason ClearBridge Appreciation Fund or the Legg Mason Western Asset Managed Municipals Fund).

The announced rationale was to “leverage the Legg Mason brand awareness.”

Welcome to the age of deleveraging:  This year those same funds are moving to hide the Legg Mason taint.  Western Asset dropped the Legg Mason number this summer.  Clearbridge is now following suit, so that the Legg Mason ClearBridge Appreciation Fund is about to become just Clearbridge Appreciation.

Royce, another Legg Mason affiliate, has never advertised that association.  Royce has always had a great small-value discipline. Since being acquired by Legg Mason in 2001, the firm acquired two other, troubling distinctions.

1. Managers who are covering too many funds.  By way of a quick snapshot, here are the funds managed by 72-year-old Chuck Royce (and this is after he dropped several):
   

   Since …	He’s managed …
   12/2010	Royce Global Dividend Value
   08/2010	Royce Micro-Cap Discovery
   04/2009	Royce Partners
   06/2008	Royce International Smaller-Companies
   09/2007	Royce Enterprise Select
   12/2006	Royce European Smaller Companies
   06/2005	Royce Select II
   05/2004	Royce Dividend Value
   12/2003	Royce Financial Services
   06/2003	Royce 100
   11/1998	Royce Select I
   12/1995	Royce Heritage
   12/1993	Royce Total Return
   12/1991	Royce Premier
   11/1972	Royce Pennsylvania Mutual

    

   Their other senior manager, Whitney George, manages 11 funds.  David Nadel works on nine, Lauren Romeo helps manage eight.

2. A wild expansion out of their traditional domestic small-value strength.  Between 1962 and 2001, Royce launched nine funds – all domestic small caps.  Between 2001 and the present, they launched 21 mutual funds and three closed-end funds in a striking array of flavors (Global Select Long/Short, International Micro-Cap, European Smaller Companies).  While many of those later launches have performed well, many have found no traction in the market.  Fifteen of their post-2001 launches have under $100 million in assets, 10 have under $10 million.  That translates into higher expenses in some already-expensive niches and a higher hurdle for the managers to overcome.Legg reports progressively weaker performance among the Royce funds in recent years:
   

   Three out of 30 funds managed by Royce outperformed their benchmarks for the 1-year period; 4 out of 24 for the 3-year period; 12 out of 19 for the 5-year period; and all 11 outperformed for the 10-year period.

That might be a sign of a fundamentally unhealthy market or the accumulated toll of expenses and expansion.  Shostakovich, one of our discussion board’s most experienced correspondents, pretty much cut to the chase on the day Royce reopened its $1.1 billion micro-cap fund to additional investors: “Chuck sold his soul. He kept his cashmere sweaters and his bow ties, but he sold his soul. And the devil’s name is Legg Mason.”  Interesting speculation.

Observer Fund Profiles

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

Scout Unconstrained Bond (SUBFX): If these guys have a better track record than the one held by any bond mutual fund (and they do), why haven’t you heard of it?  Worse yet, why hadn’t I?

Stewart Capital Mid-Cap (SCMFX):  If this is one of the top two or three or ten mid-cap funds in operation (and it is), why haven’t you heard of it?  Worse yet, why hadn’t I?

Launch Alert: RiverNorth Dynamic Buy-Write Fund (RNBWX)

On  October 12, 2012, RiverNorth launched their fourth fund, RiverNorth Dynamic Buy-Write Fund.  “Buy-write” describes a sort of “covered call” strategy in which an investor might own a security and then sell to another investor the option to buy the security at a preset price in a preset time frame.  It is, in general, a defensive strategy which generates a bit of income and some downside protection for the investor who owns the security and writes the option.

As with any defensive strategy, you end up surrendering some upside in order to avoid some of the downside.  RiverNorth’s launch announcement contained a depiction of the risk-return profiles for a common buy-write index (the BXM) and three classes of stock:

A quick read is that the BXM offered 90% of the upside of the stock market with only 70% of the downside, which seems the very definition of a good tradeoff.

RiverNorth believes they can do better through active management of the portfolio.  The fund will be managed by Eric Metz, who joined RiverNorth in 2012 and serves as their Derivatives Strategist.  He’s been a partner at Bengal Capital, a senior trader at Ronin Capital and worked at the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange (CBOE).   The investment minimum is $5000.  Expenses are capped at 1.80%.

Because the strategy is complex, the good folks at RiverNorth have agreed to an extended interview at their offices in Chicago on November 8^th.  With luck and diligence, we’ll provide a full profile of the fund in our December issue.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public.  The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.  Every day we scour new SEC filings to see what opportunities might be about to present themselves.  Many of the proposed funds offer nothing new, distinctive or interesting.  Some are downright horrors of Dilbertesque babble.

Twenty-nine new no-load funds were placed in registration this month.  Those include three load-bearing funds becoming no-loads, two hedge funds merging to become one mutual fund, one institutional fund becoming retail and two dozen new offerings.  An unusually large number of the new funds feature very experienced managers.  Four, in particular, caught our attention:

BBH Global Core Select is opening just as the five-star BBH Core Select closes.  Core Select invests about 15% of its money outside the U.S., while the global version will place at least 40% there.  One of Core Select’s managers will co-manage the new fund with a BBH analyst.

First Trust Global Tactical Asset Allocation and Income Fund will be an actively-managed ETF that “seek[s] total return and provide income [and] a relatively stable risk profile.”  The managers, John Gambla and Rob A. Guttschow, had been managing five closed-end funds for Nuveen.

Huber Capital Diversified Large Cap Value Fund, which will invest in 40-80 large caps that trade “at a significant discount to the present value of future cash flows,” will be run by Joseph Huber, who also manages the five-star Huber Small Cap Value (HUSIX) and Huber Equity Income (HULIX) funds.

Oakseed Opportunity Fund is a new global fund, managed by Greg L. Jackson and John H. Park. These guys managed or co-managed some “A” tier funds (Oakmark Global, Acorn, Acorn Select and Yacktman) before moving to Blum Capital, a private equity firm, from about 2004-2012.

Details on these funds and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

On a related note, we also tracked down about 50 fund manager changes, including the blockbuster announcement of Karen Gaffney’s departure from Loomis Sayles.

RiverPark Long/Short Opportunity conference call

Based on the success of our September conference call with David Sherman of Cohanzick Asset Management and RiverPark’s president, Morty Schaja, we have decided to try to provide our readers with one new opportunity each month to speak with an “A” tier fund manager.

The folks at RiverPark generously agreed to participate in a second conference call with Observer readers. It will feature Mitch Rubin, lead manager of RiverPark Long/Short Opportunity (RLSFX), a fund that we profiled in August as distinctive and distinctly promising.  This former hedge fund crushed its peers.

I’ll moderate the call.  Mitch will open by talking a bit about the fund’s strategy and then will field questions (yours and mine) on the fund’s strategies and prospects. The call is November 29 at 7:00 p.m., Eastern. Participants can register for the conference by navigating to  http://services.choruscall.com/diamondpass/registration?confirmationNumber=10020992

We’ll have the winter schedule in our December issue.  For now, I’ll note that managers of several really good funds have indicated a willingness to spend serious time with you.

Small Funds Communicating Smartly

The Mutual Fund Education Alliance announced their 2012 STAR Awards, which recognize fund companies that do a particularly good job of communicating with their investors.  As is common with such awards, there’s an impulse to make sure lots of folks get to celebrate so there are 17 sub-categories in each of three channels (retail, advisor, plan participant) plus eleven overall winners, for 62 awards in total.

US Global Investors was recognized as the best small firm overall, for “consistency of messaging and excellent use of the various distribution outlets.”  Matthews Asia was celebrated as the outstanding mid-sized fund firm.  Judges recognized them for “modern, effective design [and] unbelievable branding consistency.”

Ironically, MFEA’s own awards page is danged annoying with an automatic slide presentation that makes it hard to read about any of the individual winners.

Congratulations to both firms.  We’d also like to point you to our own Best of the Web winners for most effective site design: Seafarer Funds and Cook & Bynum Fund, with honorable mentions to Wintergreen, Auxier Focus and the Tilson Funds.

Briefly Noted . . .

Artio meltdown continues.  The Wall Street Journal reports that Richard Pell, Artio’s CEO, has stepped down.  Artio is bleeding assets, having lost nearly 50% of their assets under management in the past 12 months.  Their stock price is down 90% since its IPO and we’d already reported the closure of their domestic-equity funds.  This amounts to a management reshuffle, with Artio’s president becoming CEO and Pell remaining at CIO.  He’ll also continue to co-manage the once-great (top 5% over 15 years, bottom 5% over the past five years) Artio International Equity Fund (BJBIX) with Rudolph-Riad Younes.

SMALL WINS FOR INVESTORS

Dreyfus/The Boston Company Small Cap Growth Fund (SSETX) reopened to new investors on November 1, 2012. It’s a decent little fund with below average expenses.  Both risk and return tend to be below average as well, with risk further below average than returns.

Fidelity announced the launch of a dozen new target-date funds in its Strategic Advisers Multi-Manager Series, 2020 through 2055 and Retirement Income.  The Multi-Manager series allows Fidelity to sell the skills of non-Fidelity managers (and their funds) to selected retirement plans.  Christopher Sharpe and Andrew Dierdorf co-manage all of the funds.

CLOSINGS

The board of BBH Core Select (BBTEX) has announced its imminent closure.  The five-star large cap fund has $3.2 billion in assets and will close at $3.5 billion.  Given its stellar performance and compact 30-stock portfolio, that’s certainly in its shareholders’ best interests.  At the same time, BBH has filed to launched a Global Core fund by year’s end.  It will be managed by one of BBTEX’s co-managers.  For details, see our Funds in Registration feature.

Invesco Balanced-Risk Commodity Strategy (BRCAX) will close to new investors effective November 15, 2012.

Investment News reports that 86 ETFs ceased operations in the first 10 months of 2012.  Wisdom Tree announced three more in late October (LargeCap Growth ROI,  South African Rand SZR and Japanese Yen JYF). Up until 2012, the greatest number of closures in a single calendar year was 58 during the 2008 meltdown.  400 more (Indonesian Small Caps, anyone?) reside on the ETF Deathwatch for October 2012; ETFs with tiny investor bases and little trading activity.  The hidden dimension of the challenge provided by small ETFs is the ability of their boards to dramatically change their investment mandates in search of new assets.  Investors in Global X S&P/TSX Venture 30 Canada ETF (think “Canadian NASDAQ”) suddenly found themselves instead in Global X Junior Miners ETF (oooo … exposure to global, small-cap nickel mining!).

OLD WINE, NEW BOTTLES

Under the assumption that indecipherable is good, Allianz announced three name changes: Allianz AGIC Structured Alpha Fund is becoming AllianzGI Structured Alpha Fund. Allianz AGIC U.S. Equity Hedged Fund becomes AllianzGI U.S. Equity Hedged Fund and Allianz NFJ Emerging Markets Value Fund becomes AllianzGI NFJ Emerging Markets Value Fund.

BBH Broad Market (BBBIX) has changed its name to BBH Limited Duration Fund.

Effective December 3, 2012, the expensive, small and underperforming Forward Aggressive Growth Allocation Fund (ACAIX) will be changed to the Forward Multi-Strategy Fund. Along with the new name, this fund of funds gets to add “long/short, tactical and other alternative investment strategies” to its armamentarium.  Presumably that’s driven by the fact that the fund does quite poorly in falling markets: it has trailed its benchmark in nine of the past nine declining quarters.  Sadly, adding hedge-like funds to the portfolio will only drive up expenses and serve as another drag on performance.

Schwab Premier Income (SWIIX) will soon become Schwab Intermediate-Term Bond, with lower expenses but a much more restrictive mandate.  At the moment the fund can go anywhere (domestic, international and emerging market debt, income- and non-income-producing equities, floating rate securities, REITs, ETFs) but didn’t, while the new fund will invest only in domestic intermediate term bonds.

Moving in the opposite direction, Alger Large Cap Growth Institutional (ALGRX) becomes Alger Capital Appreciation Focus at the end of the year. The fund will adopt an all-cap mandate, but will shrink the target portfolio size from around 100 stocks to 50.

OFF TO THE DUSTBIN OF HISTORY

The Board of Directors of Bhirud Funds Inc. has approved the liquidation of Apex Mid Cap Growth Fund (BMCGX) effective on or about November 14, 2012. In announcing Apex’s place on our 2012 “Roll Call of the Wretched,” we noted:

The good news: not many people trust Suresh Bhirud with their money.  His Apex Mid Cap Growth (BMCGX) had, at last record, $192,546 – $100,000 below last year’s level.  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 9.2% over the past 15 years, has mostly impoverished himself.

We’re hopeful he puts his remaining assets in a nice, low-risk index fund.

The Board of Trustees of Dreyfus Investment Funds approved the liquidation of Dreyfus/The Boston Company Small Cap Tax-Sensitive Equity Fund (SDCEX) on January 8, 2013.  Ironically, this fund has outperformed the larger, newly-reopened SSETX.  And, while they were at it, the Board also approved the liquidation of Dreyfus Small Cap Fund (the “Fund”), effective on January 16, 2013

ING will liquidate ING Alternative Beta (IABAX) on December 7, 2012.  In addition to an obscure mandate (what is alternative beta?), the fund has managed to lose money over the past three years while drawing only $18 million in assets.

Munder International Equity Fund (MUIAX) is slated to be merged in Munder International Fund — Core Equity (MAICX), on December 7, 2012.

Uhhh . . .

Don’t get me wrong.  MUIAX is a bad fund (down 18% in five years) and deserves to go.  But MAICX is a worse fund by far (it’s down 29% in the same period).  And much smaller.  And newer.

This probably explains why I could never serve on a fund’s board of directors.  Their logic is simply too subtle for me.

Royce Mid-Cap (RMIDX) is set to be liquidated on November 19, 2012. It’s less than three years old, has performed poorly and managed to draw just a few million in assets.  The management team is being dispersed among Royce’s other funds.

It was named Third Millennium Russia Fund (TMRFX) and its charge was to invest “in securities of companies located in Russia.”  This is a fund that managed to gain or lose more than 70% in three of the past 10 years.  Investors have largely fled and so, effective October 10, 2012, the board of trustees tweaked things.  It’s now called Toreador International Fund and its mandate is to invest “outside of the United States.”  As of this writing, Morningstar had not yet noticed.

In Closing . . .

We’ve added an unusual bit of commercial presence, over to your right.  Amazon created a mini-site dedicated to the interests of investors.  In addition to the inevitable links to popular investing books, it features a weekly blog post, a little blog aggregator at the bottom (a lot of content from Bloomberg, some from Abnormal Returns and Seeking Alpha), and some sort of dead, dead, dead discussion group.  We thought you might find some of it useful or at least browseable, so we decided to include it for you.

And yes, it does carry MFO’s embedded link.  Thanks for asking!

Thanks, too, to all the folks (Gary, Martha, Dean, Richard, two Jacks, and one Turtle) who contributed to the Observer in October.

We’ll look for you in December.