Dear friends,

Dear friends,

Well, we’ve done it again. Augustana just launched its 154^th set of graduates in your direction. Personally, it’s my 29^th set of them. I think you’ll enjoy their company, if not always the quality of their prose. They’re good kids and we’ve spent an awful lot of time teaching them to ask questions more profound than “how much does it pay?” or “would you like fries with that?”  We’ve tried, with some success, to explain to them that leadership flows from service, that words count, that deeds count, and that other people count.

They are, on whole, a work well begun. The other half is up to you and to them.

As for me and my colleagues, two months to recoup and then 714 more chances to make a difference.

All the noise, noise, noise, noise!

Here’s my shameful secret: I have no idea of why global stock markets at all-time highs nor when they will cease to be there. I also don’t know quite what investors are doing or thinking, much less why. Hmmm … also pretty much confused about what actions any of it implies that I should take.

I spent much of the month of May paying attention to questions like the ones implied above and my interim conclusion is that that was not a good use of my time. There are about 300 million Americans who need to make sense out of their world and about 57,000 Americans paid to work as journalists and four times that many public relations specialists who are charged with telling them what it all means. And, sadly, there’s a news hole that can never be left unfilled; that is, if you have a 30 minute news program (22.5 minutes plus commercials), you need to find 22.5 minutes worth of something to say even when you think there’s nothing to say.

And so we’re inundated with headlines like these from the May issues of The Wall Street Journal and The New York Times (noted as NYT):

Investors Abandon Riskier Assets (WSJ, May 16, C1) “Investors stepped up their retreat from riskier assets …”   Except when they did the opposite four pages later:

Higher-Yielding Bank Debt Draws Interest (WSJ, May 16, C4) “Investors are scooping up riskier bonds sold by banks …”

Small Stocks Fuel a Run to Records (WSJ, May 13, C1) but then again Smaller Stocks Slammed in Selloff (WSJ, May 21, C1)

The success of “safe” strategies is encourage folks to pursue unsafe ones. Bonds Flip Scripts on Risk, Reward (WSJ, May 27, C1) “Bonds perceived as safe have produced better returns than riskier ones for the first time since 2010… in response, many investors are doubling down on riskier debt.”And so Riskier Fannie Bonds Are Devoured (WSJ, May 21, C1).

Market Loses Ground as Investors Seek Safety (NYT, May 14) “The stock market fell back from record levels on Wednesday as investors decided it was better to play it safe… ‘There’s some internal self-correction and rotation going on beneath the surface,’ said Jim Russell, a regional investment director at U.S. Bank.”  But apparently that internal self-correction self-corrected within nine days because Investors Show Little Fear (WSJ, May 23, C1) “Many traders say they detect little fear in the market lately.  They cite a financial outlook that is widely perceived to pose little risk of an economic or market downturn: near-record stock prices, low interest rates, steady if unspectacular U.S. growth and expansive if receding Federal Reserve support for the economy and financial markets.”

And so the fearless fearful are chucking money around:

Penny Stocks Fuel Big-Dollar Dreams (WSJ, May 23, C1) “Investors are piling into the shares of small, risky companies at the fastest clip on record, in search of investments that promise a chance of outsize returns.  Investors are buying up so-called penny stocks … at a pace that far eclipses the tech boom of the 1990s.”  The author notes that average trading volume is up 40% over last year which was, we’ll recall, a boom year for stocks.

Investors Return to Emerging World (WSJ, May 29, C1) “Investors are settling in for another ride in emerging markets … The speed with which investors appear to have forgotten losses of 30% in some markets has been startling.”

Searching for Yield, at Almost Any Price (NYT, May 1) “Fixed-income investors trying to increase their income essentially have two options. One is to extend maturities. The other is to reduce credit quality. There are risks to both. The prices of long-term bonds fall sharply when interest rates go up. Lower-quality bonds are more likely to default.  These days, lower quality, rather than longer maturities, seems to be more popular. Money has poured into mutual funds that invest in bank loans — often low-quality ones. To a lesser extent, it has also gone into high-yield mutual funds that buy bonds rated below investment grade, known as junk bonds to those who are dubious of them.”

So, all of this risk-chasing means that it’s Time to Worry About Stock Market Bubbles (NYT, May 6) “Relative to long-term corporate earnings – and more in a minute on why that measure is important – stocks have been more expensive only three times over the past century than they are today, according to data from Robert Shiller, a Nobel laureate in economics. Those other three periods are not exactly reassuring, either: the 1920s, the late 1990s and in the prelude to the 2007 financial crisis.” … Based on history, stocks look either very expensive or somewhat expensive right now. Mr. Shiller suggests that the most likely outcome may be worse returns in coming years than the market has delivered over recent decades – but still better than the returns of any other investment class.”  Great. Worst except for all the others.

Good news, though: there’s no need to worry about stock market bubbles as long as people are worrying about stock market bubbles. That courtesy of the Leuthold Group, which argues that bubbles are only dangerous once we’ve declared that there is no bubble but only a new, “permanently high plateau.”

Happily, our Republican colleagues in the House agree and seem to have decided that none of the events of 2007-08 actually occurred. Financial Crisis, Over and Already Forgotten (NYT, May 22) “Michael S. Barr, a law professor at the University of Michigan who was an assistant Treasury secretary when the financial crisis was at its worst, is working on a book titled Five Ways the Financial System Will Fail Next Time. The first of them, he says, is ‘amnesia, willful and otherwise,’ regarding the causes and consequences of the crisis. Let’s hope the others are not here yet [since a]mnesia was on full view this week.”

Wait!  Wait!  Josh Brown is pretty sure that they did occur, might well re-occur and probably still won’t get covered right:

Okay can we be honest for a second?

The similarities between now and the pre-crisis era are f**king sickening at this point.

There, I said it.  

 (After a couple paragraphs and one significant link.)

To recap – Volatility is nowhere to be found – not in currencies, in fixed income or in equities. Complacency rules the day as investors and institutions gradually add more risk, using leverage and increasingly exotic vehicles to reach for diminishing returns in an aging bull market. This as economic growth – led by housing and consumer spending – stalls out and the Fed removes stimulus that never really worked in the first place.

And once again, the media is oblivious for the most part, fixated as it is on a French economist and the valuations of text messaging startups.

(Second Verse, Same as the First, 05/29/14)

You wouldn’t imagine that those of us who try to communicate for a vocation might argue that you need to read (watch and listen) less, rather than more but that is the position that several of us tend toward.

Tadas Viskanta , proprietor of the very fine Abnormal Returns blog, calls for “a news diet” in his book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere (2012).  He argues:

A media diet, as practiced by Nassim Taleb, is a conscious effort to decrease the amount of media we consume. Most of what we consume is “empty calories.” Most of it has little information value and can only serve to crowd out other more interesting and informative sources.

That’s all consistent with Barry Ritzholz’s argument that the stuff which makes great and tingly headlines – Black Swans, imminent crashes, zombie apocalypses – aren’t what hurts the average investor most. We’re hurt most, he says during a presentation at the FPA NorCal Conference in 2014, by the slow drip, drip, drip of mistakes: high expenses, impulsive trading and performance chasing. None of which is really news.

Josh Brown, who writes under the moniker The Reformed Broker at a blog of the same name, disagrees.  One chapter of this new book The Clash of the Financial Pundits (2014)is entitled “The Myth of the Media Diet.”  Brown argues that we have no more ability to consistently abstain from news than we have to consistently abstain from sugary treats.  In his mind, the effort of suppressing the urge in the first place just leads to cheating and then a return, unreformed, to our original destructive habits: “A true media diet virtually assures an overreaction to market volatility and expert prognostication once the dieter returns to the flashing lights and headlines.”  He argues that we need to better understand the financial media in order to keep intelligently informed, rather than entirely pickled in the daily brew.

And Snowball’s take on it all?

I actually teach about this stuff for a living, from News Literacy to Communication and Emerging Technologies. My best reading of the research supports the notion that we’ve become victims of continuous partial attention. There are so many ways of reaching us and we’re so often judged by the speed of our response (my students tell me that five minutes is the longest you can wait before responding to text without giving offense), that we’re continually dividing our attention between the task at hand and a steady stream of incoming chatter. (15% of us have interrupted sex to take a cellphone call while a third text while driving.) It’s pervasive enough that there are now reports in the medical literature of sleep-texting; that is, hearing an incoming text while asleep, rousing just enough to respond and then returning to sleep without later knowing that any of this had happened. We are, in short, training ourselves to be distracted, unsure and unfocused.

Fortunately, we can also retrain ourselves to become more focused. Focus requires discipline; not “browsing” or “link-hopping,” but regular, structured attention. In general, I pay no attention to “the news” except during two narrow windows each day (roughly, the morning when I have coffee and read two newspapers and during evening commutes). During those windows, I listen to NPR News which – so far as I can determine – has the most consistently thoughtful, in-depth journalism around.

But beyond that, I do try to practice paying intense and undivided attention to the stuff that’s actually important: I neither take and make calls during my son’s ballgames, I have no browser open when my students come for advice, and I seek no distraction greater than jazz when I’m reading a book. 

It’s not smug self-indulgence, dear friends. It’s survival. I really want to embrace my life, not wander distractedly through it. For investors, that means making fewer, more thoughtful decisions and learning to trust that you’ve gotten it right rather than second-guessing yourself throughout the day and night.

How Good Is Your Fund Family?

Question: How many funds at Dodge & Cox beat their category average returns since inception?

Answer: All of them.

In the case of Dodge & Cox, “all” is five funds:  DODBX, DODFX, DODGX, DODIX, and DODWX. Since inception, or at least as far back as January 1962, through March 2014, each has beaten its category average.

Same is true for these families: First Eagle, Causeway, Marsico, and Westwood.

For purposes of this article, a “fund family” comprises five funds or more, oldest share class only, with each fund being three years or older.

Obviously, no single metric should be used or misused to select a fund. In this case, fund lifetimes are different. Funds can perform inconsistently across market cycles. Share class representing “oldest” can be different. Survivorship bias and category drift can distort findings. Funds can be mis-categorized or just hard to categorize, making comparisons less meaningful.

Finally, metrics based on historical performance may say nothing of future returns, which is why analysis houses (e.g., Morningstar) examine additional factors, like shareholder friendliness, experience, and strategy to identify “funds with the highest potential of success.”

In the case of Marsico, for example, its six funds have struggled recently. The family charges above average expense ratios, and it has lost some experienced fund managers and analysts. While Morningstar acknowledges strong fund performance within this family since inception, it gives Marsico a negative “Parent” rating.

Nonetheless, these disclaimers acknowledged, prudent investors should know, as part of their due diligence, how well a fund family has performed over the long haul.

So, question: How many funds at Pacific Life beat category average returns since inception?

Applying the same criteria as above, the sad truth is: None of them.

PL funds are managed by Pacific Life Fund Advisors LLC, a wholly owned subsidiary of Pacific Life Insurance Company of Newport Beach, CA. Here from their web-site:

Got that?

Same sad truth for these families: AdvisorOne, Praxis, Integrity, Oak Associates, Arrow Funds, Pacific Financial, and STAAR.

In the case of Oak Associates, its seven funds have underperformed against their categories by 2.4% every year for almost 15 years! (They also experience maximum drawdown of -70.0% on average, or 13.1% worse than their categories.) Yet it proudly advertises recent ranking recognition by US News and selection to Charles Schwab’s OneSource. Its motto: “A Focus on Growth.”

To be clear, my colleague Professor Snowball has written often about the difficulties of beating benchmark indices for those funds that actually try. The headwinds include expense ratios, loads, transaction fees, commissions, and redemption demands. But the lifetime over- and under-performance noted above are against category averages of total returns, which already reflect these headwinds.

Overview. Before presenting performance results for all fund families, here’s is an overall summary, which will put some of the subsequent metrics in context:

It remains discouraging to see half the families still impose front load, at least for some share classes – an indefensible and ultimately shareholder unfriendly practice. Three quarters of families still charge shareholders a 12b-1 fee. All told shareholders pay fund families $12.3 billion every year for marketing. As David likes to point out, there are more funds in the US today than there are publically traded US companies. Somebody must pay to get the word out.

Size. Fidelity has the most number of funds. iShares has the most ETFs. But Vanguard has the largest assets under management.

Expense. In last month’s MFO commentary, Edward Studzinski asked: “It Costs How Much?”

As a group, fund families charge shareholders $83.3 billion each year for management fees and operating costs, which fall under the heading “expense ratio.” ER includes marketing fees, but excludes transaction fees, loads, and redemption fees.

It turns out that no fund family with an average ER above 1.58% ranks in the top performance quintile, as defined below, and most families with an average ER above 2.00 end up in the bottom quintile.

While share class does not get written about very often, it helps reveal inequitable treatment of shareholders for investing in the same fund. Typically, different share classes charge different ERs depending on initial investment amount, load or transaction fee, or association of some form. American has the largest number of share classes per fund with nearly five times the industry average.

Rankings. The following tables summarize top and bottom performing families, based on the percentage of their funds with total returns that beat category averages since inception:

As MFO readers would expect, comparison of top and bottom quintiles reveals the following tendencies:

• Top families charge lower ER, 1.06 versus 1.45%, on average
• Fewer families in top quintile impose front loads, 21 versus 55%
• Fewer families in top quintile impose 12b-1 fees, 64 versus 88%

For this sample at least, the data also suggests:

• Top families have longer tenured managers, if slightly, 9.6 versus 8.2 years
• Top families have fewer share classes, if slightly (1.9 versus 2.3 share class ratio, after 6 sigma American is removed as an outlier; otherwise, just 2.2 versus 2.3)

The complete set of metrics, including ER, AUM, age, tenure, and rankings for each fund family, can be found in MFO Fund Family Metrics, a downloadable Google spreadsheet. (All metrics were derived from Morningstar database found in Steel Mutual Fund Expert, dated March 2014.)

A closer look at the complete fund family data also reveals the following:

Some fund families, like Oakmark and Artisan, have beaten their category averages by 3-4% every year for more than 10 years running, which seems quite extraordinary. Whether attributed to alpha, beta, process, people, stewardship, or luck…or all the above. Quite extraordinary.

While others, frankly too many others, have done just the opposite. Honestly, it’s probably not too hard to figure out why.

31May14/Charles

Good news for Credit Suisse shareholders

CS just notified its shareholders that they won’t be sharing a cell with company officials.

On May 19, 2014, the Department of Justice nailed CS for conspiracy to commit tax fraud. At base, they allowed US citizens to evade taxes by maintaining illegal foreign accounts on their behalf. CS pled guilty to one criminal charge, which dents the otherwise universal impulse “to neither admit nor deny” wrongdoing. In consequence, they’re going to make a substantial contribution to reducing the federal budget deficit. CS certainly admits to wrong-doing, they have agreed to pay “over $1.8 billion” to the government, to ban some former officials, and to “undertake certain remedial actions.” The New York Times reports that the total settlement will end up around $2.6 billion dollars. The Economist calls it $2.8 billion.

Critics of the settlement, including Senator John McCain of Arizona, were astonished that the bank was not required to turn over the names of the tax cheats nor were “any officers, directors or key executives individually accountable for wrongdoing.” Comparable action against UBS, another Swiss bank with a presence in the US mutual fund market, in 2009 forced them to disclose the identities of 4700 account holders. The fact that CS seems intent to avoid discovering the existence of wrongdoing (the Times reports that the firm “did not retain certain documents, failed to interview potentially culpable bankers before they left the firm, and did not start an internal inquiry” for a long while after they had reason to suspect a crime), some argue that the penalties should have been more severe and more targeted at senior management.

If you want to get into the details, the Times also has a nice online archive of the legal documents in the case.

Here’s the good news part: CS reports that “The recent settlements … do not involve the Funds or Credit Suisse Asset Management, LLC, Credit Suisse Asset Management Limited or Credit Suisse Securities (USA) LLC [and] will not have any material impact on the Funds or on the ability of the CS Service Providers to perform services for the Funds.” Of course the fact that CSAM is tied to a criminal corporation would impede their ability to run US funds except for a “temporary exemptive order” from the SEC “to permit them to continue serving as investment advisers and principal underwriters for U.S.-registered investment companies, such as the Funds. Due to a provision in the law governing the operation of U.S.-registered investment companies, they would otherwise have become ineligible to perform these activities as a result of the plea in the Plea Agreement.”

If the SEC makes permanent its temporary exemptive order, then CSAM could continue to manage the funds albeit with the prospect of somewhat-heightened regulatory interest in their behavior. If the commission does not grant permanent relief, the house of cards will begin to tumble.

Which is to say, the SEC is going to play nice and grant the exemption.

One other bit of good news for CS and its shareholders: at least you’re not BNP Paribas which was hoping to get off with an $8 billion slap on the wrist but might actually be on the hook for $10 billion in connection with its assistance to tax dodgers.

Another argument for a news diet: Reuters on the end of the world

A Reuter’s story of May 28 reads, in its entirety:

BlackRock CEO says leveraged ETFs could ‘blow up’ whole industry

May 28 (Reuters) – BlackRock Inc Chief Executive Larry Fink said on Wednesday that leveraged exchange-traded funds contain structural problems that could “blow up” the whole industry one day.

Fink runs a company that oversees more than $4 trillion in client assets, including nearly $1 trillion in ETF assets.

“We’d never do one (a leveraged ETF),” Fink said at Deutsche Bank investment conference in New York. “They have a structural problem that could blow up the whole industry one day.”

Didja notice anything perhaps missing from that story?  You know, places where the gripping narrative might have gotten just a bit thin?

How about: WHAT DOES “BLOW UP” EVEN MEAN? WHAT INDUSTRY EXACTLY?  Or WHY?

Really, guy, you claim to be covering the end of the world – or of the investment industry or ETF industry or something – and the best you could manage was 75 words that skipped, oh, every essential element of the story?

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. 

Dodge & Cox Global Bond (DODLX): Dodge & Cox, which has been helping the rich stay rich since the Great Depression, is offering you access to the world’s largest asset class, international bonds.  Where their existing Income fund (DODIX) is domestic and centered on investment-grade issues, Global Bond is a converted limited partnership that can go anywhere and shows a predilection for boldness.

RiverNorth/Oaktree High Income (RNOTX): “high income” funds are often just high-yield bond funds with a handful of dividend stocks tossed in for flavor. RiverNorth and Oaktree promise a distinctive and principled take on the space: they’re allocating resources tactically between three very distinct high-income asset classes. Oaktree will pursue their specialty in senior loan and high-yield debt investing while RiverNorth continues to exploit inefficiency and volatility with their opportunistic closed-end fund strategy. They are, at base, looking for investors rational enough to profit from the irrationality of others.

Lookin’ goooood!

As you’ve noticed, the Observer’s visual style is pretty minimalist – there are no flashing lights, twirling fonts, or competing columns and there’s pretty minimal graphic embellishment.  We’re shooting for something that works well across a variety of platforms (we know that a fair chunk of you are reading this on your phone or tablet while a brave handful are relying on dial-up connections).

From time to time, fund companies commission more visually appealing versions of those reprints.  When they ask for formatted reprints, two things happen: we work with them on what are called “compliance edits” so that they don’t run afoul of FINRA regulations and, to a greater or lesser extent, our graphic design team (well, Barb Bradac is pretty much the whole team but she’s really good) works to make the profiles more visually appealing and readable.

Those generally reside on the host companies’ websites, but we thought it worthwhile to share some of the more recent reprints with folks this month.  Each of the thumbnails opens into a full .pdf file in a separate tab.

A sample of recent reprints:

Beck, Mack & Oliver	Tributary Balanced	Evermore Global Value
Intrepid Income	Guinness Atkinson Inflation Managed Dividend	RiverPark/Gargoyle Hedged Value

And what about the other hundred profiles?

We’ve profiled about a hundred funds, all of which are accessible under the Funds tab at the top of the page. Through the kind of agency of my colleague Charles, there’s also a monthly update for every profiled fund in his MFO Dashboard, which he continues to improve. If you want an easy, big picture view, check out the Dashboard – also on the Funds page. 

Elevator Talk: David Bechtel, Principal, Barrow All-Cap Core (BALAX / BALIX)

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.

Barrow All-Cap Core has the unusual distinction of sporting a top tier five year record despite being less than one year old. The secret is that the fund began life as a private partnership at the end of 2008. It was designed as a public equity vehicle run by private equity investors.

Their argument is that they understand both value and business prospects in ways that are fundamentally different than typical stock investors do. Combining both operating experience with a record of buying entire companies, they’re used to different metrics and different perspectives.

While you might be tempted to dismiss that as “big talk,” two factors might moderate your skepticism. First, their portfolio – typically about 200 names – really is way different from their competitors’. While Morningstar benchmarks them against the large-value group (a style box in which Barrow places just 5% of their money), the fund nearly reversed the size profile of its peers: it has about 20% in large caps, 30% in mid caps and 50% in small caps. Its peer group has about 80% in large caps. The entire portfolio is invested in six sectors, with effectively zero exposure to the four others (including financials and tech). By almost any measure (long-term earnings growth, level of corporate debt, free cash flow generation), their portfolio is substantially higher-quality than its peers. Second, the strategy’s performance – primarily as a private partnership, lately as a mutual fund – has been absolutely first tier: top 3% since inception 12/31/08 and in the top 20% in every calendar year since inception. Overall they’ve earned about 20% annually, better than both the S&P 500 and its large-value peers.

BALAX is managed by Nicholas Chermayeff, formerly of Morgan Stanley’s Principal Investment Group, and Robert F. Greenhill, who co-founded Barrow Street Advisors LLC, the fund’s advisor, after a stint at Goldman Sachs’ Whitehall Funds. Both are Harvard graduates (unlike some of us). The Elevator Talk itself, though, was provided by Yale graduate David Bechtel, a Principal of Barrow Street Advisors LLC, the fund’s advisor, who serves on its Investment Committee, and advises on the firm’s business development activities. He is a Founder and Managing Member of Outpost Capital Management LLC which structures and manages investments in the natural resources and financial services sectors. Mr. Bechtel offered just a bit more than 200 words to explain Barrow’s distinctiveness:

We are, first and foremost, private equity investors. Since Barrow Street was founded in 1997, we have invested and managed hundreds of millions in private market opportunities. The public equity strategy (US stocks only) used in Barrow All-Cap was funded by our own capital in 2008.

We launched this strategy and the fund to meet what we viewed as a market need. We take a private equity approach to security selection. We are not a “value” manager – selecting stocks based on low p/e, etc. – nor a pure “quality” manager – buying blue chips at any price. We look for very high quality companies whose shares are temporarily trading at a discount.

We look at value and quality the way a control investor in a business would. We emphasize cash flow, sales growth per unit of capital, operating margins, and we like companies that reinvest in their businesses. That gives us a very good feeling that not only is the management team interested in growing their business, but also that the business itself is good at generating cash.

On the valuation side, we’re looking for firms that are “momentarily” trading well-below intrinsic value. The general idea is to look at total enterprise value – equity market cap plus debt and preferred stock minus cash on the books – which controls for variations on capital structures, leverage, etc.

We’re trying to differentiate by combining our private equity approach to quality and value into one strategy at the security selection level. And, we are just as dedicated to portfolio diversification to help our investors better weather market volatility. It’s a portfolio without compromises. We think that’s very unusual in the mutual fund universe.

The fund has both institutional and retail share classes. The retail class (BALAX) has a $2500 minimum initial investment. Expenses are 1.41% with about $22 million in assets. The institutional share class (BALIX) is $250,000 and 1.16%. Here’s the fund’s homepage. The content there is modest but useful. 

Funds in Registration

Funds currently in registration with the SEC will generally be available for purchase some time in July, 2014. Our dauntless research associate David Welsch tracked down 12 new no-load funds in registration this month. While there are no immediately tantalizing registrants, there are two flexible bond funds being launched by well-respected small fund families (Weitz Core Plus Income and William Blair Bond Fund) plus the conversion of a pretty successful private options-hedged equity strategy (V2 Hedged Equity Fund, though I would prefer that we not name our investments after the Nazi “Vengeance Weapon 2”).

All of the new registrants are available on the June Funds in Registration page.

Manager Changes

The manager change story-of-the-month comes from S&P Capital IQ. While the report is not publicly available, its conclusion is widely reported: “Of 6,185 U.S. equity mutual funds tracked by Rosenbluth’s firm, more than a thousand of them, or 16.3%, have experienced a manager change since February 2011.” Oddly, the journalists reporting on the story including Brendan Conaway at Barron’s and the Mutual Fund Wire staff, don’t seem to ask the fundamental question: how often does it matter?  They do point to do instances cited by Rosenbluth (Janus Contrarian and Fidelity Growth & Income) where the manager change was worth noting, but don’t ask how typical those cases are.

A far more common pattern, however, is that what’s called a “fund manager change” is actually a partial shuffle of an existing management team. For example, our May “manager changes” feature highlighted 52 manager changes but 36 of those (70% of the total) were partial changes. Example would be New Covenant Growth Fund (NCGFX) where one of the 17 members of the management team departed, Fidelity Series Advisor Growth Opportunities Fund (FAOFX) where there’s a long-term succession strategy or a bunch of the Huntington funds where no one left but a new co-manager was added to the collection.

Speaking of manager changes, Chip this month tracked down 57 sets of them.

Updates: the Justin Frankel/Josh Brown slapfest over liquid alts

Josh Brown, the above-named “reformed broker,” ran a piece in mid-May entitled Brokers, Liquid Alts and the Fund that Never Goes Up. He discusses the fate of Andrew Lo and ASG Diversifying Strategies Fund (DSFAX):

Dr. Andrew Lo vehicle called ASG Diversifying Strategies Fund. The idea was that Dr. Lo, perhaps one of the most brilliant quantitative scientists and academicians in finance (MIT, Harvard, all kinds of awards, PhDs out the ass, etc), would be incorporating a variety of approaches to manage the fund using all asset classes, derivatives and trading methodologies that he and his team saw fit to apply.

What actually did happen was this: Andy Lo, maybe one of the smartest men in the history of finance, managed to invent a product that literally cannot make money in any environment. It’s an extraordinarily rare accomplishment; I don’t think you could go out and invent something that always loses money if you were actually attempting to.

Brown’s argument is less with liquid alts as an arena for investing, and more with the brokers who continue to push investors into a clearly failed strategy.

Justin Frankel, probably the only RiverPark manager that we haven’t spoken with and co-manager of RiverPark Structural Alpha Fund (RSAFX), quickly rushed to the barricades to defend Alt-land from the barbarian horde (and, in doing so, responded to an argument that Brown wasn’t actually making). He published his defense on, of all things, his Tumblr page:

The Wall Street machine has a long history of favoring institutions over individuals, and the ultra-high net worth over the mass affluent. After all, finance is a service industry, and it is those larger clients that pay the lion’s share of fees.

Liquid Alternatives are simply hedge fund strategies wrapped in a mutual fund format … From a practical standpoint, investors should view these strategies as a way to diversify either bond or stock holdings in order to provide non-correlated returns to their investment portfolios, cushion portfolios against downside risks, and improve risk-adjusted returns.

Individual investors have become more sophisticated consumers of financial products. Liquid Alternatives are not just a democratization of the alternative investing landscape. They represent an evolution in how investors can gain access to strategies that they could never invest in before.

Frankel’s argument is redolent of Morty Schaja’s stance, that RiverPark is bringing hedge fund strategies to the “mass affluent” though with a $1000 minimum, they’re available to the mass mass, too.

Both pieces, despite their possibly excessive fraternity, are worth reading.

Briefly Noted . . .

Manning and Napier is adding options to the funds in their Pro-Blend series. Effective on July 14, 2014, the funds will gain the option of writing (which is to say, say selling) options on securities and pursuing a managed futures (a sort of asset-class momentum) strategy. And since the Pro-Blend funds are used in Manning & Napier’s target-date retirement funds, the strategy changes ripple into them, too.

This month, most especially, I’m drawing on the great good work of The Shadow in tracking down the changes below. “Go raibh mile maith agaibh as bhur gcunamh” big guy! Thanks, too, to the folks on the discussion board for their encouragement during the disruptions caused by my house move this month.

SMALL WINS FOR INVESTORS

Donald P. Carson, formerly the president of an Atlanta-based investment holding company and now a principal at Ansley Securities, joined the Board of The Cook & Bynum Fund (COBYX) in April and has already made an investment in the fund in the range of $100,001 – $500,000.  Two things are quite clear from the research: (1) having directors – as distinct from managers – invested in a fund improves its risk-return profile and (2) it’s relatively rare to see substantial director investment in a fund.  The managers are deeply invested in the fund and it’s great that their directors are, too.

The Osterweis funds (Osterweis, Strategic Income, Strategic Investment and Institutional Equity) will all, effective June 30 2014 drop their 30-day, 2.0% redemption fees.  I’m always ambivalent about eliminating such fees, since they discourage folks from trading in and out of funds, but most folks cheer the flexibility so we’re willing to declare it “a small win.”  

Effective May 16, 2014, the minimum initial investment on the institutional class of the RiverPark funds (Large Growth, RiverPark/Wedgewood Fund, Short Term High Yield, Long/Short Opportunity, RiverPark/Gargoyle Hedged Value, Structural Alpha Fund and Strategic Income) were all reduced from $1,000,000 to $100,000.   Of greater significance to many of us, the expense ratios were reduced for Short Term High Yield (from 1.25% to 1.17% on RPHYX and from 1.00% to 0.91% on RPHIX) and RiverPark/Wedgewood (from 1.25% to 1.05% on RPCFX and from 1.00% to 0.88% on RWGIX).

CLOSINGS (and related inconveniences)

Effective on July 8, 2014, Franklin Biotechnology Discovery Fund (FBDIX) will close to new investors. It’s a fund for thrill seekers – it invests in very, very growth-y midcap biotech firms which are (ready for this?) really volatile. The fund’s returns have averaged about 12% over the past decade – 115 bps better than its peers – but the cost has been high: a beta of 1.77 and a standard deviation nearly 50% about the Specialty-Health group norm. That hasn’t been enough to determine $1.3 billion in investment from flowing in.

Morningstar’s been having real problems with their website this month.  During the last week of the month, some fund profiles were completely unavailable while, in other cases, clicking on the link to one fund would take you to the profile of another. I assume something similar is going on here, since the MPT data for this biotech stock fund benchmarks it against “BofAML Convertible Bonds All Qualities.”

Update: One of the Corporate Communication folks at Morningstar reached out in response to my comment on their site stability which itself was triggered mostly by the vigorous thread on the point. Ms. Spelhaug writes: “Hope you’re well. I saw your column mentioning issues you’ve experienced with the Quote pages on Morningstar.com. I wanted to let you know that we’re aware that there have been some issues and have been in the process of retiring the system that’s causing the problems.”

Effective as of May 30, 2014, the investor class of Samson STRONG Nations Currency Fund (SCRFX) closed its “Investor” class to new investors. On that same day, those shares were re-designated as Institutional Class shares. Given the fund’s parlous performance (down about 8% since inception compared to a peer group that’s down about 0.25%), the closure might be prelude to …. uhhh, further action.

T. Rowe Price Capital Appreciation (PRWCX) will close to new investors on June 30, 2014. Traditionally famous for holding convertible securities, the fund’s fixed-income exposure is almost entirely bonds now with a tiny sliver of convertibles. That reflects the manager’s judgment that converts are way overpriced. The equity part of the portfolio targets blue chips, though the orientation has slowly but surely shifted toward growthier stocks over the years.

The fund is bloated at over $20 billion in assets but it’s sure hard to criticize. It’s posted peer-beating returns in 11 of the past 12 years, including all five years since crossing the $10 billion in AUM threshold. It’s particularly impressive that the fund has outperformed Prospector Capital Appreciation (PCAFX), which is run by Richard Howard, PRWCX’s long-time manager, over the past seven years. While I’m generally reluctant to recommend large funds, much less large funds that are about to close, this one really does warrant a bit of attention on your part.

All classes of the Wells Fargo Advantage Discovery Fund (WFDAX) are closed to new investors. The $3.2 billion fund has posted pretty consistently above average returns, but also consistently above average risks.

OLD WINE, NEW BOTTLES

Effective July 1, 2014, the AllianzGI Structured Alpha Fund (AZIAX) will change its name to the AllianzGI Structured Return Fund. Its investment objective, principal investment strategies, management fee and operating expenses change as well. The plan is to write exchange-traded call options or FLEX call options (i.e. listed options that are traded on an exchange, but with customized strike prices and expiration dates) to generate income and some downside protection. The choice strikes me as technical rather than fundamental, since the portfolio is already comprised of 280 puts and calls. The most significant change is a vast decrease in the fund’s expense ratio, from 1.90% for “A” shares down to 1.15%.

Crow Point Hedged Global Equity Income Fund (CGHAX) has been rechristened Crow Point Defined Risk Global Equity Income Fund. The Fund’s investment objective, policies and strategies remain unchanged.

Hansberger International Growth (HIGGX/HITGX) is in the process of becoming one of the Madison (formerly Mosaic) Funds. I seem to have misread the SEC filing last month and reported that they’re becoming part of the Madison Fund (singular) rather than Madison Funds (plural). The management team is responsible for about $4 billion in mostly institutional assets. They’re located in, and will remain in, Toronto. This will be Madison’s second international fund, beside Madison NorthRoad International (NRIEX) whose managers finish their third solid year at the helm on June 30^th.

Effective June 4 2014, the Sustainable Opportunities (SOPNX) fund gets renamed the Even Keel Multi-Asset Managed Risk Fund. The Fund’s investment objective, policies and strategies remain unchanged. Given the fund’s modest success over its first two years, I suppose there are investors who might have preferred keeping the name and shifting the strategy.

The Munder Funds are in the process of becoming Victory funds. Munder Capital Management, Munder’s advisor, got bought by Victory Capital Management, so the transition is sensible and inevitable. Victory will create a series of “shell” funds which are “substantially similar, if not identical” to existing Munder funds, then merge the Munder funds into them. This is all pending shareholder approval.

Touchstone Core Bond Fund has been renamed Touchstone Active Bond Fund (TOBAX). The numbers on the fund are a bit hard to decipher – by some measures, lots of alpha, by others

Effective on or about July 1, 2014, Transamerica Diversified Equity (TADAX) will be renamed Transamerica US Growth and the principal investment strategy will be tweaked to require 80% U.S. holdings. Roughly speaking, TADAX trailed 90% of its peers during manager Paul Marrkand’s first calendar year. The next year it trailed 80%, then 70% and so far in 2014, 60%.  Based on that performance, I’d put it on your buy list for 2019.

OFF TO THE DUSTBIN OF HISTORY

On May 29, 2014 (happy birthday to me, happy birthday to me …), the tiny and turbulent long/short AllianzGI Redwood Fund (ARRAX) was liquidated and dissolved.

The Giralda Fund (GDAIX) liquidates its “I” shares on June 27, 2014 but promises that you can swap them for “I” shares of Giralda Risk-Managed Growth Fund (GRGIX) if you’d really like.

Harbor Target Retirement 2010 Fund (HARFX) has changed its asset allocation over time in accordance with its glide path and its allocation is now substantially similar to that of Harbor Target Retirement Income Fund, and so 2010 is merging into Retirement Income on Halloween.  Happily, the merger will not trigger a tax bill.

In mid-May, 2014, Huntington suspended sales of the “A” and institutional shares of its Fixed Income Securities, Intermediate Government Income, Mortgage Securities, Ohio Tax-Free, and Short/Intermediate Fixed Income Securities funds.

On May 16, 2014, the Board of Trustees of Oppenheimer Currency Opportunities Fund (OCOAX) approved a plan to liquidate the Fund on or about August 1, 2014.  Since inception, the fund offered its investors the opportunity to turn $100 into $98.50 which a fair number of them inexplicably accepted.

At the recommendation of LSV Asset Management, the LSV Conservative Core Equity Fund (LSVPX) will cease operations and liquidate on or about June 13, 2014. Morningstar has it rated as a four-star fund and its returns have been in the top decile of its large-value peer group over the past five years, which doesn’t usually presage elimination. As the discussion board’s senior member Ted puts it, “With only $15 Million in AUM, and a minimum investment of $100,000 hard to get off the ground in spite of decent performance.”

Turner All Cap Growth Fund (TBTBX) is slated to merge into Turner Midcap Growth Fund (TMGFX) some time in the fall of 2014. Since I’ve never seen the appeal of Turner’s consistently high-volatility funds, I mostly judge nod and mumble about tweedle-dum and …

Wilmington’s small, expensive, risky, underperforming Large-Cap Growth Fund (VLCPX) and regrettably similar Large-Cap Value Fund (VEINX) have each been closed to new investors and are both being liquidated around June 20th.

In Closing . . .

The Morningstar Investment Conference will be one of the highlights of June for us. A number of folks responded to our offer to meet and chat while we’re there, and we’re certainly amenable to the idea of seeing a lot more folks while we’re there.

I don’t tweet (despite Daisy Maxey’s heartfelt injunction to “build my personal brand”) but I do post a series of reports to our discussion board after each day at the conference. If you’re curious and can’t be in Chicago, please to feel free to look in on the board.

Finally, thanks to all those who continue to support the Observer – with their ideas and patience, as much as with their contributions and purchases. It’s been a head-spinning time and I’m grateful to all of you as we work through it.

Just a quick reminder that we’re going to clean our email list. We’ve got two targets, addresses that make absolutely no sense and folks who haven’t opened one of our emails in a year or more.

We’ll talk soon!

Dear friends,

I love language, in both its ability to clarify and to mystify.

Take the phrase “think outside the box.”  You’ve heard it more times than you’d care to count but have you ever stopped to wonder: what box are they talking about?  Maybe someone invented it for good reason, so perhaps you should avoid breaking the box?

In point of fact, it’s this box:

Here’s the challenge that lies behind the aphorism: link all nine dots using four straight lines or fewer, without lifting the pen and without tracing the same line more than once.  There are only two ways to accomplish the feat: (1) rearrange the dots, which is obviously cheating, and (2) work outside the box.  For example:

As we interviewed managers this month, Ed Studzinski, they and I got to talking about investors’ perspectives on the future.  In one camp there are the “glass half-full” guys. Dale Harvey of Poplar Forest Partners Fund (PFPFX) allowed, for example, that there may come a time to panic about the stock market, but it’s not now. He looks at three indicators and finds them all pretty green:

1. His ability to find good investment ideas.  He’s still finding opportunities to add positions to the fund.
2. What’s going on with the Fed? “Don’t fight the Fed” is an axiom for good reason, he notes.  They’ve just slowing the rate of stimulus, not slowing the economy.  You get plenty of advance notice when they really want to start applying the brakes.
3. What’s going on with investor attitudes?  Folks aren’t all whipped-up about stocks, though there are isolated “story” stocks that folks are irrational over.

Against those folks are the “glass half-empty” guys.  Some of those guys are calling the alarm; others stoically endure that leaden feeling in the pit of their stomachs that comes from knowing they’ve seen this show before and it never ends well. By way of illustration:

1. The Leuthold Group believes that large cap stocks are more than 25% overvalued, small caps much more than that, that there could be a substantial correction and that corrections overshoot, so a 40% drop is not inconceivable.
2. Jeremy Grantham of GMO places the market at 65% overvalued. Fortunately, according to a Barron’s interview, it won’t become “a true bubble” until it inflates 30% more and individual investors, still skittish, become “gung-ho.”
3. Mark Hulbert notes that “true insider” stock sales have reached their highest level in a quarter century.  Hulbert notes that insider selling isn’t usually predictive because the term “insider” encompasses both true insiders (directors, presidents, founders, operating officers) and legal insides (any investor who controls more than 5% of the stock).  It turns out that “true” insider selling is predictive of a stock market fall a couple quarters later.  He makes his argument in two similar, but not quite identical, articles in Barron’s and MarketWatch.  (Go read them.)

And me, you ask?  I guess I’m neither quite a glass half full nor a glass half empty sort of investor.  I’m closer to a “don’t drop the glass!” guy.  My non-retirement portfolio remains about where it always is (25% US stocks with a value bias, 25% international stocks with a small/emerging bias, 50% income) and it’s all funded on auto-pilot.  I didn’t lose a mint in ’08, I didn’t make a mint in ’13 and I spend more time thinking about my son’s average (the season starts in the first week of April and he’ll either be on the mound or at second) than about the Dow’s.

“Judge Our Performance Over a Full Market Cycle”

Uh huh! Be careful of what you wish for, Bub. Charles did just check your performance across full market cycles, and it’s not as pretty as you’d like. Here are his data-rich findings:

Ten Market Cycles

In response to the article In Search of Persistence, published in our January commentary, NumbersGirl posted the following on the MFO board:

I am not enamored of using rolling 3-year returns to assess persistence.

A 3-year time period will often be all up or all down. If a fund manager has an investing personality or philosophy then I would expect strong relative performance in a rising market to be negatively correlated with poor relative performance in a falling market, etc.

It seems to me that the best way to measure persistence is over 1 (or better yet more) market cycles.

There followed good discussion about pros and cons of such an assessment, including lack of consistent definition of what constitutes a market cycle.

Echoing her suggestion, fund managers also often ask to be judged “over full cycle” when comparing performance against their peers.

A quick search of literature (eg., Standard & Poor’s Surviving a Bear Market and Doug Short’s Bear Markets in the S&P since 1950) shows that bear markets are generally “defined as a drop of 20% or more from the market’s previous high.” Here’s how the folks at Steele Mutual Fund Expert define a cycle:

Full-Cycle Return: A full cycle return includes a consecutive bull and bear market return cycle.

Up-Market Return (Bull Market): A Bull market in stocks is defined as a 20% rise in the S&P 500 Index from its previous trough, ending when the index reaches its peak and subsequently declines by 20%.

Down-Market Return (Bear Market): A Bear market in stocks is defined as a 20% decline in the S&P 500 Index from its previous peak, and ends when the index reaches its trough and subsequently rises by 20%.

Applying this definition to the SP500 intraday price index indicates there have indeed been ten such cycles, including the current one still in process, since 1956:

The returns shown are based on price only, so exclude dividends. Note that the average duration seems to match-up pretty well with so-called “short term debt cycle” (aka business cycle) described by Bridgewater’s Ray Dalio in the charming How the Economic Machine Works – In 30 Minutes video.

Here’s break-out of bear and bull markets:

The graph below depicts the ten cycles. To provide some historic context, various events are time-lined – some good, but more bad. Return is on left axis, measured from start of cycle, so each builds where previous left off. Short-term interest rate is on right axis.

Note that each cycle resulted in a new all-time market high, which seems rather extraordinary. There were spectacular gains for the 1980 and 1990 bull markets, the latter being 427% trough-to-peak! (And folks worry lately that they may have missed-out on the current bull with its 177% gain.) Seeing the resiliency of the US market, it’s no wonder people like Warren Buffett advocate a buy-and-hold approach to investing, despite the painful -50% or more drawdowns, which have occurred three times over the period shown.

Having now defined the market cycles, which for this assessment applies principally to US stocks, we can revisit the question of mutual fund persistence (or lack of) across them.

Based on the same methodology used to determine MFO rankings, the chart below depicts results across nine cycles since 1962:

Blue indicates top quintile performance, while red indicates bottom quintile. The rankings are based on risk adjusted return, specifically Martin ratio, over each full cycle. Funds are compared against all other funds in the peer group. The number of funds was rather small back in 1962, but in the later cycles, these same funds are competing against literally hundreds of peers.

(Couple qualifiers: The mural does not account for survivorship-bias or style drift. Cycle performance is determined using monthly total returns, including any loads, between the peak-to-peak dates listed above, with one exception…our database starts Jan 62 and not Dec 61.)

Not unexpectedly, the result is similar to previous studies (eg., S&P Persistence Scorecard) showing persistence is elusive at best in the mutual fund business. None of the 45 original funds in four categories delivered top-peer performance across all cycles – none even came close.

Looking at the cycles from 1973, a time when several now well know funds became established, reveals a similar lack of persistence – although one or two come close to breaking the norm. Here is a look at some of the top performing names:

MFO Great Owls Mairs & Powers Balanced (MAPOX) and Vanguard Wellington (VWELX) have enjoyed superior returns the last three cycles, but not so much in the first. The reverse is true for legendary Fidelity Magellan (FMAGX).

Even a fund that comes about as close to perfection as possible, Sequoia (SEQUX), swooned in the late ‘90s relative to other growth funds, like Fidelity Contrafund (FCNTX), resulting in underperformance for the cycle. The table below details the risk and return metrics across each cycle for SEQUX, showing the -30% drawdown in early 2000, which marked the beginning of the tech bubble. In the next couple years, many other growth funds would do much worse.

So, while each cycle may rhyme, they are different, and even the best managed funds will inevitably spend some time in the barrel, if not fall from favor forever.

We will look to incorporate full-cycle performance data in the single-ticker MFO Risk Profile search tool. As suggested by NumbersGirl, it’s an important piece of due diligence and risk cognizance for all mutual fund investors.

26Mar14/Charles

Celebrating one-star funds, part 2!

Morningstar faithfully describes their iconic star ratings as a starting place for additional research, not as a one-stop judgment of a funds merit.  As a practical matter investors do use those star ratings as part of a two-step research process:

Step One: Eliminate those one- and two-star losers

Step Two: Browse the rest

In general, there are worse strategies you could follow. Nonetheless, the star ratings can seriously misrepresent the merits of individual funds.  If a fund is fundamentally misfit to its category (in March we highlighted the plight of short-term high income funds within the high-yield peer group) or if a fund is highly risk averse, there’s an unusually large chance that its star rating will conceal more than it will reveal.  After a long statistical analysis, my colleague Charles concluded in last month’s issue that:

 A consequence of Morningstar’s methodology is that low volatility funds with below average returns can quite possibly be out-ranked by average volatility funds with average returns. Put another way, the methodology generally penalizes funds with high volatility more so than it rewards funds with low volatility.

The Observer categorizes funds differently: our Great Owl funds are those whose risk-adjusted returns are in the top 20% of their peer group for every measurement period longer than one year.  Our risk-adjustment is based on a fund’s Martin ratio which “excels at identifying funds that have delivered superior returns while mitigating drawdowns.”  At base, we’ve made the judgment that investors are more sensitive to the size of a fund’s drawdown – its maximum peak to trough loss – than to the background noise of day-to-day volatility.  As a result, we reward funds that provide good returns while avoiding disastrous losses.

For those interested in a second opinion, here’s the list of all one-star Great Owl funds:

• American Century One Choice 2035 A (ARYAX)
• Aquila Three Peaks High Income A (ATPAX)
• ASTON/River Road Independent Value (ARIVX)
• BlackRock Allocation Target Shares (BRASX)
• Dividend Plus Income (MAIPX)
• Fidelity Freedom Index 2000 (FGIFX)
• Intrepid Income (ICMUX)
• Invesco Balanced-Risk Retire 2030 (TNAAX)
• Invesco Balanced-Risk Retire 2040 (TNDAX)
• Invesco Balanced-Risk Retire 2050 (TNEAX)
• PIMCO 7-15 Year U.S. Treasury Index ETF (TENZ)
• PIMCO Broad U.S. Treasury Index ETF (TRSY)
• RiverPark Short Term High Yield (RPHYX)
• Schwab Monthly Income Max Payout (SWLRX)
• SEI New Jersey Municipal Bond A (SENJX)
• SPDR Nuveen S&P VRDO Municipal Bond (VRD)
• Symons Value (SAVIX)
• Weitz Nebraska Tax-Free Income (WNTFX)
• Wells Fargo Advantage Dow Jones Target 2015 (WFQEX)
• Wells Fargo Advantage Short Term High-Yield Bond (STHBX)

Are we arguing that the Great Owl metric is intrinsically better than Morningstar’s?

Nope.  We do want to point out that every rating system contains biases, although we somehow pretend that they’re “purely objective.”  You need to understand that the fact that a fund’s biases don’t align with a rater’s preferences is not an indictment of the fund (any more than a five-star rating should be taken as an automatic endorsement of it).

Still waiting by the phone

Last month’s celebration of one-star funds took up John Rekenthaler’s challenge to propose new fund categories which were more sensible than the existing assignments and which didn’t cause “category bloat.”

Amiably enough, we suggested short-term high yield as an eminently sensible possibility.  It contains rather more than a dozen funds that act much more like aggressive short-term bond funds than like traditional high-yield bond funds, a category dominated by high-return, high-volatility funds with much longer durations.

So far, no calls of thanks and praise from the good folks in Chicago.  (sigh)

How about another try: emerging markets allocation, balanced or hybrid?  Morningstar’s own discipline is to separate pure stock funds (global or domestic) from stock-bond hybrid funds, except in the emerging markets.  Almost all of the dozen or so emerging markets hybrid funds are categorized as, and benchmarked against, pure equity funds.  Whether that advantages or disadvantages a hybrid fund at any given point isn’t the key; the question is whether it allows investors to accurately assess them.  The hybrid category is well worth a test.

Who’s watching the watchers?

Presidio Multi-Strategy Fund (PMSFX) will “discontinue operations” on April 10, 2014.  It’s a weird little fund with a portfolio about the size of my retirement account.  This isn’t the first time we’ve written about Presidio.  Presidio shared a board with Caritas All-Cap Growth (CTSAX, now Goodwood SMIDcap Discovery).   In July 2013, the Board decided to liquidate Caritas.  In August they reconsidered and turned both funds’ management over to Brenda Smith.  At that time, I expressed annoyance with their limited sense of responsibility:

The alternative? Hire Brenda A. Smith, founder of CV Investment Advisors, LLC, to manage the fund. A quick scan of SEC ADV filings shows that Ms. Smith is the principal in a two person firm with 10 or fewer clients and $5,000 in regulated AUM.

At almost the same moment, the same Board gave Ms. Smith charge of the failing Presidio Multi-Strategy Fund (PMSFX), an overpriced long/short fund that executes its strategy through ETFs.

I wish Ms. Smith and her new investors all the luck in the world, but it’s hard to see how a Board of Trustees could, with a straight face, decide to hand over one fund and resuscitate another with huge structural impediments on the promise of handing it off to a rookie manager and declare that both moves are in the best interests of long-suffering shareholders.

By October, she was gone from Caritas but she’s stayed with Presidio to the bitter end which looks something like this:

This isn’t just a note about a tiny, failed fund.  It’s a note about the Trustees of your fund boards.  Your representatives.  Your voice.  Their failures become your failures.  Their failures cause your failures.

Presidio was overseen by a rent-a-board (more politely called “a turnkey board”); a group of guys who nominally oversee dozens of unrelated funds but who have stakes in none of them.  Here’s a quick snapshot of this particular board:

The Board members are paid $2,000 per fund overseen and meet seven times a year.  The manager received rather more: “For the fiscal year ended May 31, 2013, Presidio Capital Investments, LLC received fees for its services to the Fund in the amount of $101,510,” for managing a $500,000 portfolio.

What other funds do they guide?  There are 22 of them:

• CV Asset Allocation Fund (CVASX);
• Arin Large Cap Theta Fund (AVOAX) managed by Arin Risk Advisors, LLC;
• Crescent Large Cap Macro, Mid Cap Macro and Strategic Income Funds managed by Greenwood Capital Associates, LLC;
• Horizons West Multi-Strategy Hedged Income Fund (HWCVX, formerly known as the Prophecy Alpha Trading Fund);
• Matisse Discounted Closed-End Fund Strategy (MDCAX) managed by Deschutes Portfolio Strategies;
• Roumell Opportunistic Value Fund (RAMVX) managed by Roumell Asset Management, LLC;
• The 11 RX funds (Dynamic Growth, Dynamic Total Return, Non Traditional, High Income, Traditional Equity, Traditional Fixed Income, Tactical Rotation, Tax Advantaged, Dividend Income, and Premier Managers);
• SCS Tactical Allocation Fund (SCSGX) managed by Sentinel Capital Solutions, Inc.;
• Sector Rotation Fund (NAVFX) managed by Navigator Money Management, Inc.; and
• Thornhill Strategic Equity Fund (TSEQX) managed by Thornhill Securities, Inc.

Oh, wait.  Not quite.  Crescent Mid Cap Macro (GCMIX) is “inactive.”  Thornhill Strategic Equity (TSEQX)?  No, that doesn’t seem to be trading either. Can’t find evidence that CV Asset Allocation ever launched. Right, right: the manager of Sector Rotation Fund (NAVFX) is under SEC sanction for “numerous misleading claims,” including reporting on the performance of the fund for periods in which the fund didn’t exist.

The bottom line: directors matter. Good directors can offer a manager access to skills, perspectives and networks that are far beyond his or her native abilities.  And good directors can put their collective foot down on matters of fees, bloat and lackluster performance.

Every one of your funds has a board of directors and you really need to ask just three questions about these guys:

1. What evidence is there that the directors are bringing a meaningful skill set to their post?
2. What evidence is there that the directors have executed serious oversight of the management team?
3. What evidence is there that the directors have aligned their interests with yours?

You need to look at two documents to answer those questions.  The first is the Statement of Additional Information (SAI) which is updated every time the prospectus is.  The SAI lists the board members’ qualifications, compensation, the number of funds each director oversees and the director’s investment in each of them. Here’s a general rule: if they’re overseeing dozens of funds and investing in none of them, back away.  There are some very good funds that use what I refer to as rent-a-boards as a matter of administrative convenience and financial efficiency, but the use of such boards weakens a critical safeguard.  If the board isn’t deeply invested, you need to see that the management team is.

The second document is called the Renewal of Investment Advisory Contract.  Boards are legally required to document their due diligence and to explain to you, the folks who elected them, exactly what they looked at and what they concluded.  These are sometimes freestanding documents but they’re more likely included as a section of the fund’s annual report. Look for errant nonsense, rationalizations and wishful thinking.  If you find it, run away!  Here’s an example of the discussion of fees charged by a one-star fund that trails 96-98% of its peers but charges a mint:

Fee Rate and Profitability – The Trustees considered that the Fund’s advisory fee is the highest in its peer group, while its expense ratio is the second highest. The Trustees considered [the manager’s] explanation that several funds included in the Fund’s peer group are passive index funds, which have extremely low fees because, unlike the Fund, they are not actively managed. The Trustees also considered [the] explanation that the growth strategy it uses to manage the Fund is extremely expensive and labor intensive because it involves reviewing and evaluating 8,000+ stocks four times a year.

Here’s the argument that the board bought: the fund has some of the highest fees in its industry but that’s okay because (1) you can’t expect us to be as cheap as an index fund and (2) we work hard, apparently unlike the 98% of funds that outperform us or charge less.

If you had an employee who was paid more and produced less than anyone else, what would you do?  Then ask: “and why didn’t my board do likewise?”

It’s The Money, Stupid!

By Edward Studzinski

“To be clever enough to get a great deal of money, one must be stupid enough to want it.”

G.K. Chesterton

There is a repetitive scene in the movie “Shakespeare in Love” – an actor and a director are reading through one of young Master Shakespeare’s newest plays, with the ink still drying.  The actor asks how a particular transition is to be made from one scene to the next.  The answer given is, “I don’t know – it’s a mystery.”  Much the same might be said for the process of setting and then regularly reviewing, mutual fund fees. One of my friends made the Long March with Morningstar’s Joe Mansueto from a cave deep in western China to what should now be known now as Morningstar Abbey in Chicago. She used to opine about how for commodity products like equity mutual funds, in a world of perfect competition if one believed economic theory as taught at the University of Chicago, it was rather odd that the clearing price for management fees, rather than continually coming down, seemed mired at one per cent. That comment was made almost twenty years ago. The fees still seem mired there.

One argument might be that you get what you pay for. Unfortunately many actively-managed equity funds that charge that approximately one per cent management fee lag their benchmarks. This presents the conundrum of how index funds charging five basis points (which Seth Klarman used to refer to as “mindless investing”) often regularly outperform the smart guys charging much more. The public airing of personality clashes at bond manager PIMCO makes for interesting reading in this area, but is not necessarily illuminating. For instance, allegedly the annual compensation for Bill Gross is $200M a year. However, much of that is arguably for his role in management at PIMCO, as co-chief investment officer. Some of it is for serving on a daily basis as the portfolio manager for however many funds his name is on as portfolio manager. Another piece of it might be tied to his ownership interest in the business.

The issue becomes even more confusing when you have similar, nay even almost identical, funds being managed by the same investment firm but coming through different channels, with different fees. The example to contrast here again is PIMCO and their funds with multiple share classes and different fees, and Harbor, a number of whose fixed income products are sub-advised by PIMCO and have lower fees for what appear, to the unvarnished eye, to be very similar products often managed by the same portfolio manager. A further variation on this theme can be seen when you have an equity manager running his own firm’s proprietary mutual fund for which he is charging ninety basis points in management fees while his firm is running a sleeve of another equity mutual fund for Vanguard, for which the firm is being paid a management fee somewhere between twenty and thirty basis points, usually with incentives tied to performance. And while the argument is often made that the funds may have different investment philosophies and strategies and a different portfolio manager, there is often a lot of overlap in the securities owned (using  the same research process and analysts).

So, let’s assume that active equity management fees are initially set by charging what everyone else is charging for similar products. One can see by looking at a prospectus, what a competitor is charging. And I can assure you that most investment managers have a pretty good idea as to who their competitors are, even if they may think they really do not have competitors. How do the fees stay at the same level, especially as, when assets under management grow there should be economies of scale?

Ah ha!  Now we reach a matter that is within the purview of the Board of Trustees for a fund or fund group. They must look at the reasonableness of the fees being charged in light of a number of variables, including investment philosophy and strategy, size of assets under management, performance, etc., etc., etc.  And perhaps a principal underpinning driving that annual review and sign-off is the peer list of funds for comparison.

Probably one of the most important assignments for a mutual fund executive, usually a chief financial officer, is (a) making sure that the right consulting firm is hired to put together the peer list of similar mutual funds and (b) confirming that the consulting firm understands their assignment. To use another movie analogy, there is a scene early on in “Animal House” where during pledge week, two of the main characters visit a fraternity house and upon entering, are immediately sent to sit on a couch off in a corner with what are clearly a small group of social outliers. Peer group identification often seems to involve finding a similar group of outliers on the equivalent of that couch.

Given the large number of funds out there, one identifies a similar universe with similar investment strategies, similar in size, but mirabile dictu, the group somehow manages to have similar or inferior performance with similar or higher fees and expenses. What to do, what to do?  Well of course, you fiddle with the break points so that above a certain size of assets under management in the fund, the fees are reduced. And you never have to deal with the issue that the real money is not in the break points but in fees that are too high to begin with. Perish the thought that one should use common sense and look at what Vanguard or Dodge and Cox are charging for base fees for similar products.

There is another lesson to be gained from the PIMCO story, and that is the issue of ownership structure. Here, you have an offshore owner like Allianz taking a hands-off attitude towards their investment in PIMCO, other than getting whatever revenue or income split it is they are getting. It would be an interesting analysis to see what the return on investment to Allianz has been for their original investment. It would also be interesting to see what the payback period was for earning back that original investment. And where lies the fiduciary obligation, especially to PIMCO clients and fund investors, in addition to Allianz shareholders?  But that is a story for another time.

How is any of this to be of use to mutual fund investors and readers of the Observer. I am showing my age, but Vice President Hubert Humphrey used to be nick-named the “Happy Warrior.” One of the things that has become clear to me recently as David and I interview managers who have set up their own firms after leaving the Dark Side, LOOK FOR THE HAPPY WARRIORS. For them, it is not the process of making money. They don’t need the money. Rather they are doing it for the love of investing.  And if nobody comes, they will still do it to manage their own money.  Avoid the ones for whom the money has become an addiction, a way of keeping score. For supplementary reading, I commend to all an article that appeared in the New York Sunday Times on January 19, 2014 entitled “For the Love of Money” by Sam Polk. As with many of my comments, I am giving all of you more work to do in the research process for managing your money. But you need to do it if you serious about investing.  And remember, character and integrity always show through.

And those who can’t teach, teach gym (part 2)

Beginning in 1997, the iconically odd-looking Jim Jubak wrote the wildly-popular “Jubak’s Picks” column for MSN Money.  In 2010, he apparently decided that investment management looked awfully easy and so launched his own fund.

Which stunk.  Over the three years of its existence, it’s trailed 99% of its peers.   And so the Board of Trustees of the Trust has approved a Plan of Liquidation which authorizes the termination, liquidation and dissolution of the Jubak Global Equity Fund (JUBAX). The Fund will be T, L, and D’d on or about May 29, 2014. (It’s my birthday!)

Here’s the picture of futility, with Mr. Jubak on the blue line and mediocrity represented by the orange one:

Yup, $16 million in assets – none of it representing capital gains.

Mr. Jubak joins a long list of pundits, seers, columnists, prognosticators and financial porn journalists who have discovered that a facility for writing about investments is an entirely separate matter from any ability to actually make money.

Among his confreres:

Robert C. Auer, founder of SBAuer Funds, LLC, was from 1996 to 2004, the lead stock market columnist for the Indianapolis Business Journal “Bulls & Bears” weekly column, authoring over 400 columns, which discussed a wide range of investment topics.  As manager of Auer Growth (AUERX), he’s turned a $10,000 investment into $8500 over the course of six years.

Jonathan Clements left a high visibility post at The Wall Street Journal to become Director of Financial Education, Citi Personal Wealth Management.  Sounds fancy.  Frankly, it looks like was relegated to “blogger.”  Mr. Clements recently announced his return to journalism, and the launch of a weekly column in the WSJ.

John Dorfman, a Bloomberg and Wall Street Journal columnist, launched Dorfman Value Fund which finally became Thunderstorm Value Fund (THUNX). Having concluded that low returns, high expenses, a one-star rating, and poor marketing aren’t the road to riches, the advisor recommended that the Board close (on January 17, 2012) and liquidate (on February 29, 2012) the fund.

Ron Insana, who left CNBC in 2006 to form a hedge fund and returned to part-time punditry three years later.  He’s currently (March 28, 2014) prognosticating “a very nasty pullback” in the stock market.

Scott Martin, a contributor to FOX Business Network and a former columnist with TheStreet.com, co-managed Astor Long/Short ETF Fund (ASTLX) for one undistinguished year before moving on.

Steven J. Milloy, “lawyer, consultant, columnist, adjunct scholar,” managed the somewhat looney Free Enterprise Action Fund which merged with the somewhat looney $12 million Congressional Effect Fund (CEFFX), which never hired Mr. Milloy and just fired Congressional Effect Management.

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.

During March, Bro. Studzinski and I contacted a quartet of distinguished managers whose careers were marked by at least two phases: successfully managing large funds within a fund complex and then walking away to launch their own independent firms.  We wanted to talk with them both about their investing disciplines and current funds and about their bigger picture view of the world of independent managers.

Our lead story in May carries the working title, “Letter to a Young Fund Manager.”  We are hoping to share some insight into what it takes to succeed as a boutique manager running your own firm.  Our hope is that the story will be as useful for folks trying to assess the role of small funds in their portfolio as it will be to the (admittedly few) folks looking to launch such funds.

As a preview, we’d like to introduce the four managers and profile their funds:

Evermore Global Value (EVGBX): David Marcus was trained by Michael Price, managed Mutual European and co-managed two other Mutual Series funds, then spent time investing in Europe before returning to launch this remarkably independent “special situations” fund.

Huber Equity Income (HULIX): Joe Huber designed and implemented a state of the art research program at Hotchkis and Wiley and managed their Value Opportunities fund for five years before striking out to launch his own firm and, coincidentally, launched two of the most successful funds in existence.

Poplar Forest Partners (PFPFX): Dale Harvey is both common and rare.  He was a very successful manager for five American Funds who was disturbed by their size.  That’s common.  So he left, which is incredibly rare.  One of the only other managers to follow that path was Howard Schow, founder of the PrimeCap funds.

Walthausen Select Value (WSVRX): John Walthausen piloted both Paradigm Value and Paradigm Select to peer-stomping returns.  He left in 2007 to create his own firm which advises two funds that have posted, well, peer stomping returns.

Launch Alert: Artisan High Income (ARTFX)

On March 19^th, Artisan launched their first fixed-income fund.  The plan is for the manager to purchase a combination of high-yield bonds and other stuff (technically: “secured and unsecured loans, including, without limitation, senior and subordinated loans, delayed funding loans and revolving credit facilities, and loan participations and assignments”). There’s careful attention given to the quality and financial strength of the bond issuer and to the magnitude of the downside risks. The fund might invest globally.

The Fund is managed by Bryan C. Krug.  For the past seven years, Mr. Krug has managed Ivy High Income (WHIAX).  His record there was distinguished, especially for his ability to maneuver through – and profit from – a variety of market conditions.  A 2013 Morningstar discussion of the fund observes, in part:

[T]he fund’s 26% allocation to bonds rated CCC and below … is well above the 15% of its typical high-yield bond peer. Recently, though, Krug has been taking a somewhat defensive stance; he increased the amount of bank loans to nearly 34% as of the end of 2012, well above the fund’s 15% target allocation … Those kinds of calls have allowed the fund to mitigate losses well–performance in 2011’s third quarter and May 2012 are ready examples–as well as to deliver strong results in a variety of other environments. That record and relatively low expenses make for a compelling case here.

$10,000 invested at the beginning of Mr. Krug’s tenure would have grown to $20,700 by the time of his departure versus $16,700 at his average peer. The Ivy fund was growing by $3 – 4 billion a year, with no evident plans for closure.  While there’s no evidence that asset bloat is what convinced Mr. Krug to look for new opportunities, indeed the fund continued to perform splendidly even at $11 billion, a number of other managers have shifted jobs for that very reason.

The minimum initial investment is $1000 for the Investor class and $250,000 for Advisor shares.  Expenses for both the Investor and Advisor classes are capped at 1.25%.

Artisan’s hiring standard has remained unchanged for decades: they interview dozens of management teams each year but hire only when they think they’ve found “category killers.” With 10 of their 12 rated funds earning four- or five-stars, they seem to achieve that goal.  Investors seeking a cautious but opportunistic take on high income investing really ought to look closer.

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.

Funds in registration this month are eligible to launch in late May or early June 2014 and some of the prospectuses do highlight that date.

This month David Welsch tracked down five funds in registration, the lowest totals since we launched three years ago.  Curious.

Manager Changes

On a related note, we also tracked down 43 sets of fund manager changes. The most intriguing of those include Amit Wadhwaney’s retirement from managing Third Avenue International Value (TAVIX) and Jim Moffett’s phased withdrawal from Scout International (UMBWX).

Updates

Our friends at RiverRoad Asset Management report that they have entered a “strategic partnership” with Affiliated Managers Group, Inc.  RiverRoad becomes AMG’s 30^th partner. The roster also includes AQR, Third Avenue and Yacktman.  As part of this agreement, AMG will purchase River Road from Aviva Investors.  Additionally, River Road’s employees will acquire a substantial portion of the equity of the business. The senior professionals at RiverRoad have signed new 10-year employment agreements.  They’re good people and we wish them well.

Even more active share.

Last month we shared a list of about 50 funds who were willing to report heir current active share, a useful measure that allows investors to see how independent their funds are of the index.  We offered folks the chance to be added to the list. A dozen joined the list, including folks from Barrow, Conestoga, Diamond Hill, DoubleLine, Evermore, LindeHanson, Pinnacle, and Poplar Forest. We’ve given our active share table a new home.

ARE YOU ACTIVE?  WOULD YOU LIKE SOMEONE TO NOTICE?

We’ve been scanning fund company sites, looking for active share reports. If we’ve missed you, we’re sorry. Help us correct the oversight  by sending us the link to where you report your active share stats. We’d be more than happy to offer a permanent home for the web’s largest open collection of active share data.

Briefly Noted . . .

For reasons unexplained, GMO has added a “purchase premium” (uhhh… sales load?) and redemption fee of between 8 and 10 basis points to three of its funds: GMO Strategic Fixed Income Fund (GMFIX), GMO Global Developed Equity Allocation Fund (GWOAX) and GMO International Developed Equity Allocation Fund (GIOTX).  Depending on the share class, the GMO funds have investment minimums in the $10 million – $300 million range.  At the lower end, that would translate to an $8,000 purchase premium.  At the high end, it might be $100,000.

Effective April 1, 2014, the principal investment strategy of the Green Century Equity Fund (GCEQX) will be revised to change the index tracked by the Fund, so as to exclude the stocks of companies that explore for, process, refine or distribute coal, oil or gas.

SMALL WINS FOR INVESTORS

The Board of Mainstay Marketfield Fund (MFLDX) has voted to slash the management fee (slash it, I say!) by one basis point! So, in compensation for a sales load (5.75% for “A” shares), asset bloat (at $21 billion, the fund has put on nearly $17 billion since being acquired by New York Life) and sagging performance (it still leads its long/short peer group, but by a slim margin), you save $1 – every year – for every $10,000 you invest.  Yay!!!!!

CLOSINGS (and related inconveniences)

Robeco Boston Partners Long/Short Research Fund (BPRRX)  closed on a day’s notice at the end of March, 2014 because of “a concern that a significant increase in the size of the Fund may adversely affect the implementation of the Fund’s strategy.”  The advisor long-ago closed its flagship Robeco Boston Partners Long/Short Equity (BPLEX) fund.  At the beginning of January 2014 they launched a third offering, Robeco Boston Partners Global Long/Short (BGLSX) which is only available to institutional investors.

Effective as of the close of business on March 28, 2014, Perritt Ultra MicroCap Fund (PREOX) closed to new investors.

OLD WINE, NEW BOTTLES

On March 31, Alpine Innovators Fund (ADIAX) became Alpine Small Cap Fund.  It also ceased to be an all-cap growth fund oriented toward stocks benefiting from the “innovative nature of each company’s products, technology or business model.”  It was actually a pretty reasonable fund, not earth-shattering but decent.  Sadly, no one cared.  It’s not entirely clear that they’re going to swarm on yet another small-blend fund.  The upside is that the new managers have a stint with Lord Abbett Small Cap Blend Fund

Effective on or about April 28, 2014, BNY Mellon Small/Mid Cap Fund‘s (MMCIX) name will be changed to BNY Mellon Small/Mid Cap Multi-Strategy Fund and they’ll go all multi-manager on you.

Effective March 21, 2014, the ticker for the Giant 5 Total Investment System changed from FIVEX to CASHX. Cute.  The board had previously approved replacement of the phrase “Giant 5” with “Index Funds” (no, really), but that hasn’t happened yet.

At the end of April, 2014, Goldman Sachs has consented to modestly shorten the names of some of their funds.

They still don’t fit on one line.

Johnson Disciplined Mid-Cap Fund (JMDIX) is slated to become Johnson Opportunity on May 1, 2014.  At that point, it won’t be restricted to investing in mid-cap stocks anymore.  Good thing, too, since they’re only … how to say this? Intermittently excellent at that discipline.

On May 5, Laudus Mondrian Global Fixed Income Fund (LMGDX) becomes Laudus Mondrian Global Government Fixed Income Fund.  It’s already 90% in government bonds, so the change is mostly symbolic.  At the same time, Laudus Mondrian International Fixed Income Fund (LIFNX) becomes Laudus Mondrian International Government Fixed Income Fund.  It, too, invests now in government bonds.

Effective March 17, 2014, Mariner Hyman Beck Fund (MHBAX) was renamed the Mariner Managed Futures Strategy Fund.

OFF TO THE DUSTBIN OF HISTORY

Effective on or about May 16, 2014, AllianzGI Disciplined Equity Fund (ARDAX) and AllianzGI Dynamic Emerging Multi-Asset Fund (ADYAX) will be liquidated and dissolved. The former is tiny and mediocre, the latter tinier and worse.  Hasta!

Avatar Capital Preservation Fund (ZZZNX), Avatar Tactical Multi-Asset Income Fund (TAZNX), Avatar Absolute Return Fund (ARZNX) and Avatar Global Opportunities Fund (GOWNX) – pricey funds-of-ETFs – ceased operations on March 28, 2014.

Epiphany FFV Global Ecologic Fund (EPEAX) has closed to investors and will be liquidated on April 28, 2014.

Goldman Sachs China Equity Fund (GNIAX) is being merged “with and into” the Goldman Sachs Asia Equity Fund (GSAGX). The SEC filing mumbled indistinctly about “the second quarter of 2014” as a target date.

The $200 million Huntington Fixed Income Securities Fund (HFIIX) will be absorbed by the $5.6 billion Federated Total Return Bond Fund (TLRAX), sometime during the second quarter of 2014.  The Federated fund is pretty consistently mediocre, and still the better of the two.

On March 17, 2014, Ivy Asset Strategy New Opportunities Fund merged into Ivy Emerging Markets Equity Fund (IPOAX, formerly Ivy Pacific Opportunities Fund). On the same day, Ivy Managed European/Pacific Fund merged into Ivy Managed International Opportunities Fund (IVTAX).  (Run away!  Go buy a nice index fund!)

The $2 billion, four-star Morgan Stanley Focus Growth Fund (OMOAX) is merging with $1.3 billion, four-star Morgan Stanley Institutional Growth (MSEGX) at the beginning of April, 2014.  They are, roughly speaking, the same fund.

Parametric Currency Fund (EAPSX), $4 million in assets, volatile and unprofitable after two and a half years – closed on March 25, 2014 and was liquidated a week later.

Pax World Global Women’s Equality Fund (PXWEX) is slated to merged into a newly-formed Pax Global Women’s Index Fund.

On February 25, 2014, the Board of Trustees of Templeton Global Investment Trust on behalf of Templeton Asian Growth Fund approved a proposal to terminate and liquidate Templeton Asian Growth Fund (FASQX). The liquidation is anticipated to occur on or about May 20, 2014. I’m not sure of the story.  It’s a Mark Mobius production and he’s been running offshore versions of this fund since the early 1990s.  This creature, launched about four years ago, has been sucky performance and negligible assets.

Turner Emerging Markets Fund (TFEMX) is being liquidated on or about April 15, 2014.  Why? “This decision was made after careful consideration of the Fund’s asset size, strategic importance, current expenses and historical performance.”  Historical performance?  What historical performance?  Turner launched this fund in August of 2013.  Right.  After six months Turner pulled the plug.  Got long-term planning there, guys!

In Closing . . .

Happy anniversary to us all.  With this issue, the Observer celebrates its third anniversary.  In truth, we had no idea of what we were getting into but we knew we had a worthwhile mission and the support of good people.

We started with a fairly simple, research-based conviction: bloated funds are not good investments.  As funds swells, their investible universes contract, their internal incentives switch from investment excellence to avoiding headline risk, and their reward systems shift to reward asset growth and retention.  They become timid, sclerotic and unrewarding.

To be clear, we know of no reason which supports the proposition that bigger is better, most especially in the case of funds that place some or all of their portfolios in stocks.  And yet the industry is organized, almost exclusively, to facilitate such beasts.  Independent managers find it hard to get attention, are disadvantaged when it comes to distribution networks, and have almost no chance of receiving analyst coverage.

We’ve tried to be a voice for the little guy.  We’ve tried to speak clearly and honestly about the silly things that you’re tempted into doing and the opportunities that you’re likely overlooking.  So far we’ve reached over 300,000 readers who’ve dropped by for well over a million visits.  Which is pretty good for a site with neither commercial endorsements or pictures of celebrities in their swimwear.

In the year ahead, we’ll try to do better.  We’re taking seriously our readers’ recommendation.  One recommendation was to increase the number of fund profiles (done!) and to spend more time revisiting some of the funds we’ve previously written about (done!).  As we reviewed your responses to “what one change could we make to better serve you” question, several answers occurred over and over:

1. People would like more help in assembling portfolios, perhaps in form of model portfolios or portfolio templates.  A major goal for 2014, then, is working more with our friends in the industry to identify useful strategies for allowing folks to identify their own risk/return preferences and matching those to compatible funds.  We need to be careful since we’re not trained as financial advisors, so we want to offer models and illustrations rather than pretend to individual advice.
2. People would like more guidance on the resources already on-site.  We’ve done a poor job in accommodating the fact that we see about 10,000 first-time visitors each month.  As a result, people aren’t aware that we do maintain an archive of every audio-recording of our conference calls (check the Funds tab, then Featured Funds), and do have lists of recommended books (Resources -> Books!) and news sources (Best of the Web).  And so one of our goals for the year ahead is to make the Observer more transparent and more easily navigable.
3. Many people have asked about mid-month updates, at least in the case of closures or other developments which come with clear deadlines.  We might well be able to arrange to send a simple email, rarely more than once a month, if something compelling breaks.
4. Finally, many people asked for guidance for new investors.

Those are all wonderfully sensible suggestions and we take them very seriously.  Our immediate task is to begin inventorying our resources and capabilities; we need to ask “what’s the best we can do with what we’ve got today?” And “how can we work to strengthen our organizational foundation, so that we can help more?”

Those are great questions and we very much hope you join us as we shape the answers in the year ahead.

Finally, I’ll note that I’m shamefully far behind in extending thanks to the folks who’ve contributed to the Observer – by check or PayPal – in the past month.  I’ve launched on a new (and terrifying) adventure in home ownership; I spent much of the past month looking at houses in Davenport with the hopes of having a place by May 1.  I’m about 250 sets of signatures and initials into the process, with just one or two additional pallets of scary-looking forms to go!  Pray for me.

And thanks to you all.

Dear friends,

It’s not a question of whether it’s coming.  It’s just a question of whether you’ve been preparing intelligently.

A wave struck a lighthouse in Douro River in Porto, Portugal, Monday. The wave damaged some nearby cars and caused minor injuries. Pictures of the Day, Wall Street Journal online, January 6, 2014. Estela Silva/European Pressphoto Agency

There’s an old joke about the farmer with the leaky roof that never gets fixed.  When the sun’s out, he never thinks about the leak and when it’s raining, he can’t get up there to fix it anyway.  And so the leak continues.

Our investments likewise: people who are kicking themselves for not having 100% equity exposure in March 2009 and 200% exposure in January 2013 have been pulling money steadily from boring investments and adding them to stocks.  The domestic stock market has seen its 13^th consecutive month of inflows and the S&P 500 closed February at its highest nominal level ever.

I mention this now because the sun has been shining so brightly.  March 9, 2014 marches the five-year anniversary of the current bull market.  In those five years, a $10,000 investment in the S&P500 would have grown to $30,400.  The same amount invested in the NASDAQ on March 9 would have grown to $35,900. The last remnants of the ferocious bear markets of 2000-02 and 2007-09 have faded from the ratings.  And investors really want a do-over.  All the folks hiding under their beds in 2009 and still peering out from under the blankies in 2011 feel cheated and they want in on the action, and they want it now.

Hence inflows into an overpriced market.

Our general suggestion is to learn from the past, but not to live there.  Nothing we do today can capture the returns of the past five years for us.  Sadly, we still can damage the next five.  To help build a strong prospects for our future, we’re spending a bit of time this month talking about hedging strategies – ways to get into a pricey market without quite so much heartache – and cool funds that might be better positioned for the next five than you’d otherwise find.

And, too, we get to celebrate the onset of spring!

The search for active share

It’s much easier to lose in investing than to win.  Sometimes we lose because we’re offered poor choices and sometimes we lose because we make poor ones.  Frankly, it doesn’t take many poor choices to trash the best laid plans.

Winning requires doing a lot of things right.  One of those things is deciding whether – or to what extent – your portfolio should rely on actively and passively managed funds.  A lot of actively managed funds are dismal but so too are a lot of passive products: poorly constructed indexes, trendy themes, disciplines driven by marketing, and high fees plague the index and EFT crowd.

If you are going to opt for active management, you need to be sure that it’s active in more than name alone.  As we’ve shown before, many active managers – especially those trying to deploy billions in capital – offer no advantage over a broad market index, and a lot of disadvantages. 

One tool for measuring the degree to which your manager is active is called, appropriately enough, “active share.”  Active share measures the degree to which your fund’s holdings differ from its benchmark’s.  The logic is simple: you can’t beat an index by replicating it and if you can’t beat it, you should simply buy it.

The study “How Active Is Your Manager” (2009) by Cremers and Petajitso concluded that “Funds with high active share actually do outperform their benchmarks.” The researchers originally looked at an ocean of data covering the period from 1990 to 2003, then updated it through 2009.  They found that funds with active share of at least 90% outperformed their benchmarks by 1.13% (113 basis points per year) after fees. Funds with active share below 60% consistently underperformed by 1.42 percentage points a year, after accounting for fees.

Some researchers have suggested that the threshold for active share needs to be adjusted to account for differences in the fund’s investment universe: a fund that invests in large to mega-cap names should have an active share north of 70%, midcaps should be above 80% and small caps above 90%. 

So far, we’ve only seen research validating the 60% and 90% thresholds though the logic of the step system is appealing; of the 5008 publicly-traded US stocks, there are just a few hundred large caps but several thousand small and micro-caps.

There are three problems with the active share data.  We’d like to begin addressing one of them and warn you of the other two.

Problem One: It’s not available.  Morningstar has the data but does not release it, except in occasional essays. Fund companies may or may not have it, but almost none of them share it with investors. And journalists occasionally publish pieces that include an active share chart but those tend to be an idiosyncratic, one-time shot of a few funds. Nuts.

Problem Two: Active share is only as valid as the benchmark used. The calculation of active share is simply a comparison between a fund’s portfolio and the holdings in some index. Pick a bad index and you get a bad answer. By way of simple illustration, the S&P500 stock index has an active share of 100 (woo hoo!) if you benchmark it against the MSCI Emerging Markets Index.

Fund companies might have the same incentive and the same leverage with active share providers that the buyers of bond ratings did: bond issuers could approach three ratings agencies and say “tell me how you’ll rate my bond and I’ll tell you whether we’re paying for your rating.” A fund company looking for a higher active share might simply try several indexes until they find the one that makes them look good. Here’s the warning: make sure you know what benchmark was used and make sure it makes sense.

Problem Three: You can compare active share between two funds only if they’ve chosen to use the same benchmark. One large cap might have an active share of 70 against the Mergent Dividend Achievers Index while another has a 75 against the Russell 1000 Value Index. There’s no way, from that data, to know whether one fund is actually more active than the other. So, look for comparables.

To help you make better decisions, we’ve begun gathering publicly-available active share data released by fund companies.  Because we know that compact portfolios are also correlated to higher degrees of independence, we’ve included that information too for all of the funds we could identify.  A number of managers and advisors have provided active share data since our March 1^st launch.  Thanks!  Those newly added funds appear in italics.

*        Linde Hansen notes that their active share is 98 if you count stocks and cash, 87 if you look only at the stock portion of their portfolio.  To the extent that cash is a conscious choice (i.e., “no stock in our investable universe meets our purchase standards, so we’ll buy cash”), count both makes a world of sense.  I just need to find out how other investors have handled the matter.

Who’s not on the list? 

A lot of firms, some of whose absences are in the ironic-to-hypocritical range. Firms not choosing to disclose active share include:

BlackRock – which employs Anniti Petajisto, the guy who invented active share, as a researcher and portfolio manager in their Multi-Asset Strategies group. (They do make passing reference to an “active share buyback” on the part on one of their holdings, so I guess that’s partial credit, right?)

Fidelity – whose 5 Tips to Pick a Winning Fund tells you to look for “stronger performers [which are likely to] have a high ‘active share’”.  (They do reprint a Reuters article ridiculing a competitor with a measly 56% active share, but somehow skip the 48% for Fidelity Blue Chip Growth, 47% for Growth & Income, the 37% for MegaCap Stock or the under 50% for six of their Strategic Advisers funds). (per the Wall Street Journal, Is Your Fund a Closet Index Fund, January 14, 2014).

Oakmark – which preens about “Harris Associates and Active Share” without revealing any.

Are you active?  Would you like someone to notice?

We’ve been scanning fund company sites for the past month, looking for active share reports. If we’ve missed you, we’re sorry. Help us correct the oversight  by sending us the link to where you report your active share stats. We’d be more than happy to offer a permanent home for the web’s largest open collection of active share data.

Does Size Matter?

By Edward Studzinski

“Convictions are more dangerous enemies of truth than lies.”

                    Nietzsche

One of the more interesting consequences of the performance of equities in 2013 is the ramp-up of the active investment management marketing machines to explain why their performance in many instances lagged that of inexpensive index funds. This has resulted in a manure storm media blitz with terms and phrases such as “stock picker’s market” or “active share” or “concentrated portfolios.” 

“Stock picker’s market” is generally a euphemism for active management. That is, why you should pay me 100 basis points for investing in a subset of the S&P 500, rather than pay Vanguard or some other index fund provider 5 basis points for their product. One of the rationales I used to regularly hear to justify active management fees was that the active manager will know when to get out of the market and when to get back in, whereas the small investor will always go in and out at the wrong time. The period of 2008-2009 puts paid to that argument when one looks at maximum drawdown numbers.  The question it raises however is whether the time horizon most investment managers and investors use is far too short. I think it clearly is and that rather than three years or three to five years, we should be thinking of ten years at a minimum.  Unfortunately, given personnel turnover in many investment organizations, it is difficult for the investing public to know or understand that the people who gave a fund its long-term performance, looking in the rear-view mirror, are not the ones doing the analysis or selecting the investments going forward. And if they are, often their time and attention is pulled in many other directions.  This is why I now, sitting on an endowment investment committee, appreciate why an integral part of the investment consultant’s report covers stability of personnel and succession planning at current firms invested in as well as firms proposed for consideration. Of course, if you are the average retail investor, you are far better off to focus on your risk tolerance, true time horizon, and asset allocation, again making use of low cost index products if you are not going to spend the time and effort to replicate the work of the consultants used by endowments and pension funds.

I am going to leave it to others to discuss “active share.”  I do think the question of “concentrated portfolios” is worth a few thoughts.  I once asked a friend of mine, at a large East Coast fund complex, how he managed to keep track of the two hundred or so stocks in his fund portfolio. His answer was illuminating.  He said that his firm had a very large research department and prided itself on its selection and training of analysts.  Politically then, over time he had to use an idea or two from everyone or every area. His preference would have been to have a much more concentrated portfolio.  I will refer to that then as the “ark” approach to investment management. Other firms, such as Longleaf, have tended from the get-go to have truly concentrated portfolios, say somewhere between twenty to twenty five stocks, given that the benefits of diversification run-out at a certain number of securities. Their rationale has been that rarely, when you are building a portfolio from the bottom up based on what are the most undervalued ideas, do ideas number thirty to forty have the same expected return potential as ideas number one to ten. (That is even more the case with the S&P 500 hitting new all time highs now).

There is another way to look at this which I think makes it more understandable for the average person.  In 2006, Huber Capital Managed LLC performed a study, looking at value-oriented investors, entitled “Limited Assets Under Management is a Competitive Advantage.”   The study assumed an equal weighted portfolio of 2.5% positions (forty stocks) to show how the investable universe of securities shrank at certain asset levels. It looked at the Russell 1000 Value Index and the Russell 2000 Value Index. The conclusion of the study was that as assets under management grew, portfolio managers faced increasingly unpleasant choices. One choice of course was to shrink the investment universe, what I have referred to in the past as the rule limiting investments to securities that can be bought or sold in five days average trading volume.

Another alternative was to increase the number of stocks held in the portfolio. You can see whether your manager has done this by going back five or ten years and looking at annual reports.  When the fund was $5B in asset size, did it own thirty stocks? Do you really believe that with the fund at $10B or $15B in asset size, that it has found another twenty or thirty undervalued stocks?  Look also to see if the number of research analysts has increased materially. Are roughly the same number of analysts covering more names? 

The third choice was to make the fund very concentrated or even non-diversified by SEC standards, with individual positions greater than five per cent. That can work, but it entails taking on career risk for the analysts and fund managers, and enterprise risk for the management company. A fund with $10B in assets under management has available only 50% of the investable set of stocks to invest in, assuming it is going to continue to focus on liquidity of the investment as an implicit criteria. That is why you see more and more pension funds, endowments, and family office managers shifting to low-cost index or ETF vehicles for their large cap investments. The incremental return is not justified by the incremental fee over the low-cost vehicle. And with a long-term time horizon, the compounding effect of that fee differential becomes truly important to returns.

My thanks to Huber Capital Manangement LLC for doing this study, and to Long Short Advisors for making me aware of it in one of their recent reports. Both firms are to be commended for their integrity and honesty. They are truly investment managers rather than asset gatherers. 

On the impact of fund categorization: Morningstar’s rejoinder

Morningstar’s esteemed John Rekenthaler replied to MFO’s February commentary on categorization, although officially “his views are his own.” His February 5 column is entitled How Morningstar Categorizes Funds.

Snowball’s gloss: John starts with a semantic quibble (Charles: “Morningstar says OSTFX is a mid-cap blend fund,” John: “Morningstar does not say what a fund is,” just what category it’s been assigned to), mischaracterizes Charles’s article as “a letter to MFO” (which I mention only because he started the quibble-business) and goes on to argue that the assignment of OSTFX to its category is about as reasonable a choice as could be made. Back to Charles:

Mr. R. uses BobC’s post to frame an explanation of what Morningstar does and does not do with respect to fund categorization. In his usual thoughtful and self-effacing manner, he defends the methodology, while admitting some difficulty in communicating. Fact is, he remains one of Morningstar’s best communicators and Rekenthaler Report is always a must read.

I actually agree with his position on Osterweis. Ditto for his position on not having an All Cap category (though I suspect I’m in the minority here and he actually admits he may be too). He did not address the (mis-)categorization of River Park Short Term High Yield Fund (RPHYX/RPHIX, closed). Perhaps because he is no longer in charge of categorization at Morningstar.

The debate on categorization is never-ending, of course, as evidenced by the responses to his report and the many threads on our own board. For the most part, the debate remains a healthy one. Important for investors to understand the context, the peer group, in which prospective funds are being rated.

In any case and as always, we very much appreciate Mr. Rekenthaler taking notice and sharing his views.

Snowball’s other gloss: geez, Charles is a lot nicer than I am. I respect John’s work but frankly I don’t really tingle at the thought that he “takes notice.” Well, except maybe for that time at the Morningstar conference when he swerved at the last minute to avoid crashing into me. I guess there was a tingle then.

Snowball’s snipe: at the sound of Morningstar’s disdain, MFWire did what MFWire does. They raised high the red-and-white banner, trumpeting John’s argument and concluding with a sharp “grow up, already!” I would have been much more impressed with them if they’d read Charles’s article beforehand. They certainly might have, but there’s no evidence in the article that they felt that need.

One of the joys of writing for the Observer is the huge range of backgrounds and perspectives that our readers bring to the discussion. A second job is the huge range of backgrounds and perspectives that my colleagues bring. Charles, in particular, can hear statistics sing. (He just spent a joyful week in conference studying discounted cash-flow models.) From time to time he tries, gently, to lift the veil of innumeracy from my eyes. The following essay flows from our extended e-mail exchanges in which I struggled to understand the vastly different judgments of particular funds implied by different ways of presenting their risk-adjusted statistics. 

We thought some of you might like to overhear that conversation.  

Morningstar’s Risk Adjusted Return Measure

Central to any fund rating system is the performance measure used to determine percentile rank order. MFO uses Martin ratio, as described Rating System Definitions. Morningstar developed its own risk adjusted return (MRAR), which Nobel Laureate William Sharpe once described as a measure that “…differs significantly from more traditional ones such as various forms of the Sharpe ratio.” While the professor referred to an earlier version of MRAR, the same holds true today.

Here is how Morningstar describes MRAR on its Data FAQ page: Morningstar adjusts for risk by calculating a risk penalty for each fund based on “expected utility theory,” a commonly used method of economic analysis. Although the math is complex, the basic concept is relatively straightforward. It assumes that investors are more concerned about a possible poor outcome than an unexpectedly good outcome and that those investors are willing to give up a small portion of an investment’s expected return in exchange for greater certainty. A “risk penalty” is subtracted from each fund’s total return, based on the variation in its month-to-month return during the rating period, with an emphasis on downward variation. The greater the variation, the larger the penalty. If two funds have the exact same return, the one with more variation in its return is given the larger risk penalty.

For the curious and mathematically inclined, the detailed equations are well documented in The Morningstar Rating Methodology. The following figure illustrates how MRAR behaves for three hypothetical funds over a 3 year period ending Dec 2013:

Each fund in the illustration delivers the same total return, but with varying levels of volatility. The higher the volatility, the lower the risk adjusted return. Fund 0 delivers consistent returns every month with zero volatility; consequently, it receives the highest MRAR, which in this case is the fund’s annualized total return minus the risk-free T-Bill (i.e., it’s the annualized “excess” return).

Morningstar computes MRAR for all funds over equivalent periods, and then percentile ranks them within their respective categories to assign appropriate levels, 1 star for those funds in the lowest group and the coveted 5 star rating for the highest.

It also computes a risk measure MRisk and performs a similar ranking to designate “low” to “high” risk funds within each category. MRisk is simply the difference between the annualized excess return of the fund and its MRAR.

The following figure provides further insight into how MRAR behaves for funds of varying volatility. This time, fund total returns have been scaled to match their category averages, again for the 3 year period ending Dec 2013. The figure includes results from several categories showing MRAR versus the tradition volatility measure, annualized standard deviation.

Once again we see that funds with higher volatility generally receive lower MRARs and that the highest possible MRAR is equal to a fund’s annualized excess return, which occurs at zero standard deviation.

A consequence of Morningstar’s methodology is that low volatility funds with below average returns can quite possibly be out-ranked by average volatility funds with average returns. Put another way, the methodology generally penalizes funds with high volatility more so than it rewards funds with low volatility, since with the latter the benefit is “capped.”

This behavior is different from other risk adjusted return measures based on say Sharpe ratio, as can be seen in the figure below. Here the same funds from above are plotted against Sharpe, but now funds with low volatility are rewarded handsomely, even if they have below average total returns.

Revisiting the Morningstar risk measure MRisk, one finds another observation: it appears to correlate rather satisfactorily against a simple function based on standard deviation (up to about 30% for funds of positive total return without load):

Which means that Morningstar’s risk adjusted return can be estimated from the following:

This simple approximation may come in handy, like when David wonders: “Why do RPHIX and ICMYX, which have superior 3 year Sharpe ratios, rate a very inferior 1 star by Morningstar?” He can use the above calculation to better understand, as illustrated here:

While both do indeed have great 3 year Sharpe ratios – RPHIX is highest of any US fund – they both have below average total returns relative to their current peer group, as represented by say VWEHX, a moderate risk and average returning high yield bond “reference” fund.

Their low volatilities simply get no love from Morningstar’s risk adjusted return measure.

27Feb2014/Charles

Celebrating one-starness

I was having a nice back-channel conversation with a substantially frustrated fund manager this week. He read Charles’s piece on fund categorization and wrote to express his own dismay with the process. He’s running a small fund. It hit its three-year mark and earned five stars. People noticed. Then Morningstar decided to recategorize the fund (into something he thinks he isn’t). And it promptly became one star. And, again, people – potential investors – noticed, but not in a good way.

Five to one, with the stroke of a pen? It happens, but tends not to get trumpeted. After all, it rather implies negligence on Morningstar’s part if they’ve been labeling something as, say, a really good conservative allocation fund for years but then, on further reflection, conclude that it’s actually a sucky high-yield bond or preferred stock fund.

Here’s what Morningstar’s explanation for such a change looks like in practice:

Morningstar Alert

Osterweis Strategic Income Fund OSTIX

12-03-13 01:00 PM

Change in Morningstar Fund Star Rating: The Morningstar Star Rating for this fund has changed from 4 stars to 2 stars. For details, go to http://quicktake.morningstar.com/Fund/RatingsAndRisk.asp?Symbol=OSTIX.

Sadly, when you go to that page there are no details that would explain an overnight drop of that magnitude. On the “performance” page, you will find the clue:

I don’t have an opinion on the appropriateness of the category assignment but it would be an awfully nice touch, given the real financial consequences of such a redesignation, if Morningstar would take three sentences to explain their rationale at the point that they make the change.

Which got me to thinking about my own favorite one-star fund (RiverPark Short Term High Yield RPHYX and RPHIX, which is closed) and Charles’s favorite one-shot stat on a fund’s risk-adjusted returns (its Sharpe ratio).

And so, here’s the question: how many funds have a higher (i.e., better) Sharpe ratio than does RPHYX?

And, as a follow-up, how many have a Sharpe ratio even half as high as RiverPark’s?

That would be “zero” and “seven,” respectively, out of 6500 funds.

Taking up Rekenthaler’s offer

In concluding his response to Charles’s essay, John writes:

A sufficient critique is one that comes from a fund that truly does not behave like others in its category, that contains a proposal for a modification to the existing category system, that does not lead to rampant category proliferation, and that results in a significantly closer performance comparison between the fund and its new category. In such cases, Morningstar will consider the request carefully–and sometimes make the suggested change.

Ummm … short-term high-yield? In general, those are funds that are much more conservative than the high-yield group. The manager at RiverPark Short-Term High Yield (RPHYX) positions the fund as a “cash management” account. The managers at Intrepid Income (ICMYX) claim to be “absolute return” investors. Wells Fargo Advantage Short-Term High-Yield Bond (STHBX) seems similarly positioned. All are one-star funds (as of February 2014) when judged against the high-yield universe.

“Does not behave like others in its category” but “results in a significantly closer performance comparison [within] its new category.” The orange line is the high-yield category. That little cluster of parallel, often overlapping lines below it are the three funds.

“Does not lead to rampant category proliferation.” You mean, like creating a “preferred stock” category with seven funds? That sort of proliferation? If so, we’re okay – there are about twice as many short-term high-yield candidates as preferred stock ones.

I’m not sure this is a great idea. I am pretty sure that dumping a bunch of useful, creative funds into this particular box is a pretty bad one.

Next month’s unsought advice will highlight emerging markets balanced (or multi-asset) funds. We’re up to a dozen of them now and the same logic that pulled US balanced funds out of the equity category and global balanced funds out of the international equity category, seems to be operating here.

Two things you really should read

In general, most writing about funds has the same problem as most funds do: it’s shallow, unoriginal, unreflective. It contributes little except to fill space and get somebody paid (both honorable goals, by the way). Occasionally, though, there are pieces that are really worth some of our time, thought and reflection. Here are two.

I’m not a great fan of ETFs. They’ve always struck me as trading vehicles, tools for allowing hedge funds and others to “make bets” rather than to invest. Chuck Jaffe had a really solid piece entitled “The growing case against ETFs” (Feb. 23, 2014) that makes the argument that ETFs are bad for you. Why? Because the great advantage of ETFs are that you can trade them all day long. And, as it turns out, if you give someone a portfolio filled with ETFs that’s precisely – and disastrously – what they do.

The Observer was founded on the premise that small, independent, active funds are the only viable alternative to a low-cost indexed portfolio. As funds swell, two bad things happen: their investable universe shrinks and the cost of making a mistake skyrockets, both of which lead to bad investment choices. There’s a vibrant line of academic research on the issue. John Rekenthaler began dissecting some of that research – in particular, a recent study endorsing younger managers and funds – in a four-part series of The Rekenthaler Report. At this writing, John had posted two essays: “Are Young Managers All That?” (Feb. 27, 2014) and “Has Your Fund Become Too Large, Or Is Industry Size the Problem?” (Feb. 28, 2014).  The first essay walks carefully through the reasons why older, larger funds – even those with very talented managers – regress. To my mind, he’s making a very strong case for finding capacity-constrained strategies and managers who will close their funds tight and early. The second picks up an old argument made by Charles Ellis in his 1974 “The Loser’s Game” essay; that the growth and professionalization of the investment industry is so great that no one – certainly not someone dragging a load – can noticeably outrun the crowd. The problem is less, John argues, the bloat of a single fund as the effect of “$3 trillion in smart money chasing the same ideas.”  

Regardless of whether you disdain or adore ETFs, or find the industry’s difficulties located at the level of undisciplined funds or an unwieldy industry, you’ll come away from these essays with much to think about.

RiverPark Strategic Income: Another set of ears

I’m always amazed by the number of bright and engaging folks who’ve been drawn to the Observer, and humbled by their willingness to freely share some of their time, insights and experience with the rest of us. One of those folks is an investor and advisor named “Mark” who is responsible for extended family money, a “multi-family office” if you will. He had an opportunity to spend some time chatting with David Sherman in mid-January as he contemplated a rather sizeable investment in RiverPark Strategic Income (RSIVX) for some family members who would benefit from such a strategy. Herewith are some of the reflections he shared over the course of a series of emails with me.

Where he’s coming from

Mark wrote that to him it’s important to understand the “context” of RSIVX. Mr. Sherman manages private strategies and hedge fund monies at Cohanzick Management, LLC. He cut his teeth at Leucadia National (whose principal Ian Cumming is sometimes referred to as Canada’s Warren Buffett) and is running some sophisticated and high entry strategies that have big risks and big rewards. His shop is not as large as some, sure, but Mr. Sherman seems to prefer it that way.

Some of what Mr. Sherman does all day “informs” RSIVX. He comes across an instrument or an idea that doesn’t fit in one strategy but may in another. It has the risk/reward characteristics that he wants for a particular strategy and so he and his team perform their due diligence on it. More on that later.

Where he is

RSIVX only exists, according to Mr. Sherman, because it fills a need. The need is for an annuity like stream of income at a rate that “his mother could live off” and he did not see such a thing in the marketplace. (In 2007 you could park money at American Express Bank in a jumbo CD at 5.5%. No such luck today.) He saw many other total return products out there in the high yield space where an investor can get a bit higher returns than what he envisions. But some of those returns will be from capital appreciation, i.e., returns from in essence trading. Mr. Sherman did not want to rely on that. He wants a lower duration portfolio (3-4 years) that he can possibly but not necessarily hold to get nice, safe, relatively high coupons from. As long as his investor has that timeframe, Mr. Sherman believes he can compound the money at 6-8% annually, and the investor gets his money back plus his return.

Shorter timeframes, because of impatience or poor timing choices, carry no such assurances. It’s not a CD, it’s not a guaranteed annuity from an insurer, but it’s what is available and what he is able to get for an investor.

How? Well, one inefficiency he hopes to exploit is in the composition of SPDR Barclays High Yield Bond (JNK) and iShares High Yield Corporate Bond (HYG). He doesn’t believe they reflect the composition of high yield space accurately with their necessary emphasis on the most liquid names. He will play in a different sandbox with different toys. And he believes it’s no more risky and thinks it is less so. In addition, when the high yield market moves, especially down, those names move fast.

Mark wrote that he asked David whether the smoothness of his returns exhibited in RPHYX and presumably in RSIVX in the future was due or would be due to a laddering strategy that he employed. He said that it was not – RSIVX’s portfolio was more of a barbell presently- and he did not want to be pigeonholed into a certain formula or strategy. He would do whatever it took to produce the necessary safe returns and that may change from time to time depending upon the market.

What changing interest rates might mean

What if rates fall? If rates fall then, sure, the portfolio will have some capital appreciation. What if rates rise? Well, every day and every month, David said, the investor will grind toward the payday on the shorter duration instruments he is holding. Mark-to-market they will be “worth” less. The market will be demanding higher interest rates and what hasn’t rolled off yet will not be as competitive as the day he bought them. The investor will still be getting a relatively high 6-8% return and as opportunities present themselves and with cash from matured securities and new monies the portfolio will be repopulated over time in the new interest rate environment. Best he can do. He does not intend to play the game of hedging. 

Where he might be going

Mark said he also asked about a higher-risk follow-on to RSIVX. He said that David told him that if he doesn’t have something unique to bring that meets a need, he doesn’t want to do it. He believes RPHYX and RSIVX to be unique. He “knew” he could pull off RPHYX, that he could demonstrate its value, and then have the credibility to introduce another idea. That idea is the Strategic Income Fund.

He doesn’t see a need for him to step out on the spectrum right now. There are a hundred competitors out there and a lot of overlap. People can go get a total return fund with more risk of loss. Returns from them will vary a lot from year to year unless conditions are remarkably stable. This [strategy] almost requires a smaller, more nimble fund and manager. Here he is. Here it is. So the next step out isn’t something he is thinking [immediately] about, but he continually brings ideas to Morty.

Mark concludes: “We discussed a few of his strategies that had more risk. They are fascinating but definitely not vanilla or oatmeal and a few I had to write out by hand the mechanics afterward so I could “see” what he was doing. One of them took me about an hour to work through where the return came from and where it could go possibly wrong.

But he described it to me because working on it gave him the inspiration for a totally different situation that, if it came to pass, would be appropriate for RSIVX. It did, is much more vanilla and is in the portfolio. Very interesting and shows how he thinks. Would love to have a beer with this guy.”

Mark’s bottom line(s)

Mark wanted me to be sure to disclose that he and his family have a rather large position in RiverPark Strategic Income now, and will be holding it for an extended period assuming all goes well (years) so, yeah, he may be biased with his remarks. He says “the strategy is not to everyone’s taste or risk tolerance”. He holds it because it exactly fills a need that his family has.

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.

Driehaus Emerging Markets Small Cap Growth (DRESX): There’s a lot to be said for EM small caps. They provide powerful diversification and performance benefits for a portfolio. The knock of them is that they’re too hot to handle. Driehaus’s carefully constructed, hedged portfolio seems to have cooled the handle by a lot.

Guinness Atkinson Inflation Managed Dividend (GAINX): It’s easy to agree that owning the world’s best companies, especially if you buy them on the cheap, is a really good strategy. GAINX approaches the challenge of constructing a very compact, high quality, low cost portfolio with quantitative discipline and considerable thought.

Intrepid Income (ICMUX): What’s not to like about this conservative little short-term, high-yield fund. It’s got it all: solid returns, excellent risk management and that coveted one-star rating! Intrepid, like almost all absolute value investors, is offering an object lesson on the important of fortitude in the face of frothy markets and serial market records.

RiverPark Gargoyle Hedged Value (RGHVX): The short story is this. Gargoyle’s combination of a compact, high quality portfolio and options-based hedging strategy has, over time, beaten just about every reasonable comparison group. Unless you anticipate a series of 20 or 30% gains in the stock market over the rest of the decade, it might be time to think about protecting some of what you’ve already made.

Elevator Talk: Ted Gardner, Salient MLP & Energy Infrastructure II (SMLPX)

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.

Master limited partnerships (MLPs) are an intriguing asset class which was, until very recently, virtually absent from both open-end fund and ETF portfolios.

MLPs are a form of business organization, in the same way corporations are a form of organization. Their shares trade on US exchanges (NYSE and NASDAQ) and they meet the same SEC security registration requirements as corporations do. They were created in the 1980s primarily as a tool to encourage increased energy production in the country and the vast majority of MLPs (75% or so) are in the energy sector.

MLPs are distinct from corporations in a number of ways:

• They’re organized around two groups: the limited partners (i.e., investors) and the general partners (i.e., managers). The limited partners provide capital and receive quarterly distributions.
• MLPs are required, by contract, to pay minimum quarterly distributions to their limited partners. That means that they produce very consistent streams of income for the limited partners.
• MLPs are required, by law, to generate at least 90% of their income from “qualified sources.” Mostly that means energy production and distribution.

The coolest thing about MLPs is the way they generate their income: they operate hugely profitable, economically-insensitive monopolies whose profits are guaranteed by law. A typical midstream MLP might own a gas or oil pipeline. The MLP receives a fee for every gallon of oil or cubic foot of gas moving through the pipe. That rate is set by a federal agency and that rate rises every year by the rate of inflation plus 1.3%. It doesn’t matter whether the price of oil soars or craters; the MLP gets its toll regardless. And it doesn’t really matter whether the economy soars or craters: people still need warm homes and gas to get to work. At worst, bad recessions eliminate a year’s demand rise but haven’t yet caused a net demand decrease. As the population grows and energy consumption rises, the amount moving through the pipelines rise and so does the MLPs income.

Those profits are protected by enormously high entry barriers: building new pipelines cost billions, require endless hearings and permits, and takes years. As a result, the existing pipelines function as de facto a regional monopoly, which means that the amount of material traveling through the pipeline won’t be driven down by competition for other pipelines.

Quick highlights of the benchmark Alerian MLP index:

• From inception through early 2013, the index returned 16% annually, on average.
• For that same period, it had a 7.1% yield which grew 7% annually.
• There is a low correlation – 50 – between the stock market and the index. REITs say at around 70 and utility stocks at 25, but with dramatically lower yield and returns.

Only seven of the 17 funds with “MLP” in their names have been around long enough to quality for a Morningstar rating; all seven are four- or five-star funds, measured against an “energy equity” peer group. Here’s a quick snapshot of Salient (the blue line) against the two five-star funds (Advisory Research MLP & Energy Income INFIX and MLP & Energy Infrastructure MLPPX) and the first open-end fund to target MLPs (Oppenheimer SteelPath MLP Alpha MLPAX):

The quick conclusion is that Salient was one of the best MLP funds until autumn 2013, at which point it became the best one. I did not include the Alerian MLP index or any of the ETFs which track it because they lag so far behind the actively-managed funds. Over the past year, for example, Salient has outperformed the Alerian MLP Index – delivering 20% versus 15.5%.

High returns and substantial diversification. Sounds perfect. It isn’t, of course. Nothing is. MLP took a tremendous pounding in the 2007-09 meltdown when credit markets froze and dropped again in August 2013 during a short-lived panic over changes in MLP’s favorable tax treatment. And it’s certainly possible for individual MLPs to get bid up to fundamentally unattractive valuations.

Ted Gardner is the co‐portfolio manager for Salient’s MLP Complex, one manifestation of which is SMLPX. He oversees and coordinates all investment modeling, due diligence, company visits, and management conferences. Before joining Salient he was both Director of Research and a portfolio manager for RDG Capital and a research analyst with Raymond James. Here are his 200 words on why you should consider getting into the erl bidness:

Our portfolio management team has many years of experience with MLP investing, as managers and analysts, in private funds, CEFs and separate accounts. We considered both the state of the investment marketplace and our own experiences and thought it might translate well into an open-end product.

As far as what we saw in the marketplace, most of the funds out there exist inside a corporate wrapper. Unfortunately C-Corp funds are subject to double taxation and that can create a real draw on returns. We felt like going the traditional mutual fund, registered investment company route made a lot of sense.

We are very research-intensive, our four analysts and I all have a sell side background. We take cash flow modeling very seriously. It’s a fundamental modeling approach, modeling down to the segment levels to understand cash flows. And, historically, our analysts have done a pretty good job at it.

We think we do things a bit differently than many investors. What we like to see is visible growth, which means we’re less yield-oriented than others might be. We typically like partnerships that have a strategic asset footprint with a lot of organic growth opportunities or those with a dropdown story, where a parent company drops more assets into a partnership over time. We tend to avoid firms dependent on third-party acquisitions for growth. And we’ve liked investing in General Partners which have historically grown their dividends at approximately twice the rate of the underlying MLPs.

The fund has both institutional and retail share classes. The retail classes (SMAPX, SMPFX) nominally carry sales loads, but they’re available no-load/NTF at Schwab. The minimum for the load-waived “A” shares is $2,500. Expenses are 1.60% on about $630 million in assets. Here’s the fund’s homepage, but I’d recommend that you click through to the Literature tab to grab some of the printed documentation.

River Park/Gargoyle Hedged Value Conference Call Highlights

On February 12th we spoke for an hour with Alan Salzbank and Josh Parker, both of the Gargoyle Group, and Morty Schaja, CEO of RiverPark Funds. Here’s a brief recap of the highlights:

Alan handles the long portfolio. Josh, a securities lawyer by training, handles the options portfolio. He’s also an internationally competitive bridge player (Gates, Buffett, Parker…) and there’s some reason to believe that the habits of mind that make for successful bridge play also makes for successful options trading. They have 35 and 25 years of experience, respectively, and all of the investment folks who support them at Gargoyle have at least 20 years of experience in the industry. Morty has been investigating buy-write strategies since the mid-1980s and he described the Gargoyle guys as “the team I’ve been looking for for 25 years.”

The fund combines an unleveraged long portfolio and a 50% short portfolio, for a steady market exposure of 50%. The portfolio rebalances between those strategies monthly, but monitors and trades its options portfolio “in real time” throughout the month.

The long portfolio is 80-120 stocks, and stock selection is algorithmic. They screen the 1000 largest US stocks on four valuation criteria (P/B, P/E, P/CF, P/S) and then assign a “J score” to each stock based on how its current valuation compares with (1) its historic valuation and (2) its industry peers’ valuation. They then buy the 100 more undervalued stocks, but maintain sector weightings that are close to the S&P 500’s.

The options portfolio is a collection of index call options. At base, they’re selling insurance policies to nervous investors. Those policies pay an average premium of 2% per month and rise in value as the market falls. That 2% is a long-term average, during the market panic in the fall of 2008, their options were generating 8% per month in premiums.

Why index calls? Two reasons: (1) they are systematically mispriced, and so they always generate more profit than they theoretically should. In particular, they are overpriced by about 35 basis points/month 88% of the time. For sellers, that means something like a 35 bps free lunch. And (2) selling calls on their individual stocks – that is, betting that the stocks in their long portfolio will fall – would reduce returns. They believe that their long portfolio is a collection of stocks superior to any index and so they don’t want to hedge away any of their upside.

And it works. Their long portfolio has outperformed the S&P 500 by an average of 5% per year for 15 years. The entire strategy has outperformed the S&P in the long-term and has matched its returns, with less volatility, in the shorter term. Throughout, it has sort of clubbed its actively-managed long-short peers. It also anticipates clubbing the emerging bevy of buy-write ETFs.

The guys identify two structural advantages they have over an ETF: (1) they buy stocks superior to those in broad indexes and (2) they manage their options portfolio moment by moment, while the ETF just sits and takes hits for 29 out of 30 days each month.

There’s evidence that they’re right. The ETFs are largely based on the CBOE S&P Buy-Write Index (BXM). Between 2000-12, the S&P 500 returned 24% and the BXM returned 52%; the options portion of the Gargoyle portfolio returned 110% while the long portfolio crushed the S&P.

Except not so much in 2008. The fund’s maximum drawdown was 48%, between 10/07 and 03/08. The guys attributed that loss to the nature of the fund’s long portfolio: it buys stocks in badly dented companies when the price of the stock is even lower than the company’s dents would warrant. Unfortunately in the meltdown, those were the stocks people least wanted to own so they got killed. The fund’s discipline kept them from wavering: they stayed 100% invested and rebalanced monthly to buy more of the stocks that were cratering. The payback comes in 2009 when they posted a 42% return against the S&P’s 26% and again in 2010 when they made 18% to the index’s 15%.

The managers believe that ’08 was exceptional, and note that the strategy actually made money from 2000-02 when the market suffered from the bursting of the dot-com bubble.

In general, the strategy fares poorest when the market has wild swings. It fares best in gently rising markets, since both the long and options portfolios can make money if the market rises but less than the strike price of the options – they can earn 2% a month on an option that’s triggered if the market rises by more than 1%. If the market rises but by less than 1%, they pay out nothing, pocket the 2% and pocket the capital appreciation from their long portfolio.

What’s the role of the fund in a portfolio? They view it as a substitute for a large-cap value investment; so if your asset allocation plan is 20% LCV, then you could profitably invest up to 20% of your portfolio in Gargoyle. For the guys, it’s 100% of their US equity exposure.

Morty Speaks!  The rationale for hedging a long-term portfolio.

The Gargoyle call sparked – here’s a surprise – considerable commentary on our discussion board. Some were impressed with Josh and Alan’s fortitude in maintaining their market exposure during the 2007-09 meltdown but others had a more quizzical response. “Expatsp” captured it this way: “Though this seems the best of the long/short bunch, I just don’t see the appeal of long/short funds for anyone who has a long-term horizon.”

No. Not Morty.

There’s a great scene in Big Bang Theory where the brilliant but socially-inept Sheldon clears up a misunderstanding surrounding a comment he made about his roommate: “Ah, I understand the confusion. Uh, I have never said that you are not good at what you do. It’s just that what you do is not worth doing.” Same theme.

Morty Schaja, RiverPark’s president, is in an interesting position to comment on the question. His firm not only advises a pure long/short fund (RiverPark Long/Short Opportunity RLSFX) and a long hedged with options fund (RiverPark Gargoyle), but it also runs a very successful long-only fund (RiverPark Large Cap Growth RPXFX, which he describes as “our five-star secret weapon”).

With the obvious disclaimer that Morty has a stake in the success of all of the RiverPark funds (and the less-obvious note that he has invested deeply in each), we asked him the obvious question: Is it worth doing?

Since RiverPark is one of the very few investment advisors to offer the whole range of hedged funds, I asked Morty to share a quick snapshot of each to illustrate how the different strategies are likely to play out in various sets of market conditions.

Let’s start with the RiverPark Long/Short Opportunity Fund.

How does this compare with the RiverPark/Gargoyle Hedged Value Fund?

And finally, tell us about the new Structural Alpha Fund.

Is the Structural Alpha Fund an absolute return strategy?

Conference Call Upcoming

We haven’t scheduled a call for March. We only schedule calls when we can offer you the opportunity to speak with someone really interesting and articulate.  No one has reached that threshold this month, but we’ll keep looking on your behalf.

Conference call junkies might want to listen in on the next RiverNorth call, which focuses on the RiverNorth Managed Volatility Fund (RNBWX). Managed Volatility started life as RiverNorth Dynamic Buy-Write Fund. Long/short funds comes in three very distinct flavors, but are all lumped in the same performance category. For now, that works to the detriment of funds like Managed Volatility that rely on an options-based hedging strategy. The fund trails the long/short peer group since inception but has performed slightly better than the $8 billion Gateway Fund (GATEX). If you’re interested in the potential of an options-hedged portfolio, you’ll find the sign-up link on RiverNorth’s Events page.  The webcast takes place March 13, 2014 at 3:15 Central.

Launch Alert: Conestoga SMid Cap (CCSMX)

On February 28, 2014, Conestoga Mid Cap (CCMGX) ceased to be. Its liquidation was occasioned by negative assessments of its “asset size, strategic importance, current expenses and historical performance.” It trailed its peers in all seven calendar quarters since inception, in both rising and falling periods. With under $2 million in assets, its disappearance is not surprising.

Two things are surprising, however. First, its poor relative performance is surprising given the success of its sibling, Conestoga Small Cap (CCASX). CCASX is a four-star fund that received a “Silver” designation from Morningstar’s analysts. Morningstar lauds the stable management team, top-tier long-term returns, low volatility (its less volatile than 90% of its peers) and disciplined focus on high quality firms. And, in general, small cap teams have had little problem in applying their discipline successfully to slightly-larger firms.

Second, Conestoga’s decision to launch (on January 21, 2014) a new fund – SMid Cap – in virtually the same space is surprising, given their ability simply to tweak the existing fund. It smacks of an attempt to bury a bad record.

My conclusion after speaking with Mark Clewett, one of the Managing Directors at Conestoga: yeah, pretty much. But honorably.

Mark made two arguments.

1. Conestoga fundamentally mis-fit its comparison group. Conestoga targeted stocks in the $2 – 10 billion market cap range. Both its Morningstar peers and its Russell Midcap Growth benchmark have substantial investments in stocks up to $20 billion. The substantial exposure to those large cap names in a mid-cap wrapper drove its peer’s performance.

   The evidence is consistent with that explanation. It’s clear from the portfolio data that Conestoga was a much purer mid-cap play that either its benchmark or its peer group.

   Portfolio	Conestoga Mid Cap	Russell Mid-cap Growth	Mid-cap Growth Peers
   % large to mega cap	0	35	23
   % mid cap	86	63	63
   % small to micro cap	14	2	14
   Average market cap	5.1M	10.4M	8.4M

    By 2013, over 48% of the Russell index was stocks with market caps above $10 billion.

   Mark was able to pull the attribution data for Conestoga’s mid-cap composite, which this fund reflects. The performance picture is mixed: the composite outperformed its benchmark in 2010 and 2011, then trailed in 2013 and 2013. The fund’s holdings in the $2-5 billion and $5–10 billion bands sometimes outperformed their peers and sometimes trailed badly.

2. Tweaking the old fund would not be in the shareholders’ best interest.  The changes would be expensive and time-consuming. They would, at the same time, leave the new fund with the old fund’s record; that would inevitably cause some hesitance on the part of prospective investors, which meant it would be longer before the fund reached an economically viable size.

The hope is that with a new and more appropriate benchmark, a stable management team, sensible discipline and clean slate, the fund will achieve some of the success that Small Cap’s enjoyed.  I’m hopeful but, for now, we’ll maintain a watchful, sympathetic silence.

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.

Funds in registration this month are eligible to launch in late April or early May 2014 and some of the prospectuses do highlight that date.

This month David Welsch battled through wicked viruses and wicked snowstorms to track down eight funds in registration, one of the lowest totals since we launched three years ago.

The clear standout in the group is Dodge & Cox Global Bond, which the Dodge & Cox folks ran as “a private fund” since the end of December 2012.  It did really well in its one full year of operation – it gained 2.6% while its benchmark lost the same amount – and it comes with D&C’s signature low minimum, low expenses, low drama, team management.

Three other income funds are at least mildly interesting: Lazard Emerging Markets Income, Payden Strategic Income and Whitebox Unconstrained Income.

Manager Changes

On a related note, we also tracked down 50 sets of fund manager changes. The most intriguing of those include fallout from the pissing match at Pimco as Marc Seidner, an El-Erian ally, leaves to become GMO’s head of fixed-income operations.

Updates: The Observer here and there

I had a long conversation with a WSJ reporter which led to a short quotation in “Infrastructure funds are intriguing, but ….” The Wall Street Journal, Feb. 4 2014.  My bottom line was “infrastructure funds appear to be an incoherent mish-mash, with no two funds even agreeing on what sectors are worth including much less what stocks.  I don’t see any evidence of them adding value to a portfolio,” an observation prompted in part by T. Rowe Price’s decision to close their own Global Infrastructure fund. The writer, Lisa Ward, delicately quotes me as saying “you probably already own these same stocks in your other funds.” 

I was quoted as endorsing Artisan Global Small Cap (ARTWX) in Six promising new funds (though the subtitle might have been: “five of which I wouldn’t go near”), Kiplinger’s, Feb. 12 2014.  ARTWX draws on one of the most storied international management teams around, led by Mark Yockey.  The other funds profiled include three mutual funds and two ETFs.  The funds are Miller Income Opportunity (I’ve written elsewhere that “The whole enterprise leaves me feeling a little queasy since it looks either like Miller’s late-career attempt to prove that he’s not a dinosaur or Legg’s post-divorce sop to him”), Fidelity Event-Driven (FARNX: no record that Fido can actually execute with new funds anymore, much less with niche funds and untested managers), and Vanguard Global Minimum Volatility (VMVFX: meh – they work backward from a target risk level to see what returns they can generate).  The ETFs are two of the “smart beta” sorts of products, iShares MSCI USA Quality Factor (QUAL) and Schwab Fundamental U.S. Broad Market (FNDB). 

Finally, there was a very short piece entitled “Actively managed funds with low volatility,” in Bottom Line, Feb. 15 2014.  The publication is not online, at least not in an accessible form.  The editors were looking for funds with fairly well-established track records that have a tradition of low volatility.  I offered up Cook & Bynum Fund (COBYX, I’ve linked to our 2013 profile of them), FPA Crescent (FPACX, in which I’m invested) and Osterweis Fund (OSTWX).

Updates: Forbes discovers Beck, Mack & Oliver Partners (BMPEX)

Forbes rank a nice article on BMPEX, “Swinging at Strikes,” in their February 10, 2014 issue. Despite the lunacy of describing a $175 million fund as “puny” and “tiny,” the author turns up some fun facts to know and tell (the manager, Zac Wydra, was a premed student until he discovered that the sight of blood made him queasy) and gets the fund’s basic discipline right. Zac offers some fairly lively commentary in his Q4 shareholder letter, including a nice swipe at British haughtiness and a reflection on the fact that the S&P 500 is at an all-time high at the same time that the number of S&P 500 firms issuing negative guidance is near an all-time high.

Briefly Noted . . .

BlackRock has added the BlackRock Emerging Markets Long/Short Equity Fund (BLSAX) and the BlackRock Global Long/Short Equity Fund (BDMAX) as part of the constituent fund lineup in its Aggressive Growth, Conservative , Growth and Moderate Prepared Portfolios, and its Lifepath Active-Date series. Global has actually made some money for its investors, which EM has pretty much flatlined while the emerging markets have risen over its lifetime.  No word on a target allocation for either.

Effective May 1, Chou Income (CHOIX) will add preferred stocks to the list of their principal investments: “fixed-income securities, financial instruments that provide exposure to fixed-income securities, and preferred stocks.” Morningstar categorizes CHOIX as a World Bond fund despite the fact that bonds are less than 20% of its current portfolio and non-U.S. bonds are less than 3% of it.

Rydex executed reverse share splits on 13 of its funds in February. Investors received one new share for between three and seven old shares, depending on the fund.

Direxion will follow the same path on March 14, 2014 with five of their funds. They’re executing reverse splits on three bear funds and splits on two bulls.  They are: 

 SMALL WINS FOR INVESTORS

Auxier Focus (AUXIX) is reducing the minimum initial investment for their Institutional shares from $250,000 to $100,000. Investor and “A” shares remain at $5,000. The institutional shares cost 25 basis points less than the others.

TFS Market Neutral Fund (TFSMX) reopened to new investors on March 1, 2014.

At the end of January, Whitebox eliminated its Advisor share class and dropped the sales load on Whitebox Tactical. Their explanation: “The elimination of the Advisor share class was basically to streamline share classes … eliminating the front load was in the best interest of our clients.” The first makes sense; the second is a bit disingenuous. I’m doubtful that Whitebox imposed a sales load because it was “in the best interest of our clients” and I likewise doubt that’s the reason for its elimination.

CLOSINGS (and related inconveniences)

Artisan Global Value (ARTGX) closed on Valentine’s Day.

Grandeur Peak will soft close the Emerging Markets Opportunities (GPEOX) and hard close the Global Opportunities (GPGOX) and International Opportunities (GPIOX) strategies on March 5, 2014.

 Effective March 5, 2014, Invesco Select Companies Fund (ATIAX) will close to all investors.

Vanguard Admiral Treasury Money Market Fund (VUSSX) is really, really closed.  It will “no longer accept additional investments from any financial advisor, intermediary, or institutional accounts, including those of defined contribution plans. Furthermore, the Fund is no longer available as an investment option for defined contribution plans. The Fund is closed to new accounts and will remain closed until further notice.”  So there.

OLD WINE, NEW BOTTLES

Effective as of March 21, 2014, Brown Advisory Emerging Markets Fund (BIAQX) is being changed to the Brown Advisory – Somerset Emerging Markets Fund. The investment objective and the investment strategies of the Fund are not being changed in connection with the name change for the Fund and the current portfolio managers will continue. At the same time, Brown Advisory Strategic European Equity Fund (BIAHX) becomes Brown Advisory -WMC Strategic European Equity Fund.

Burnham Financial Industries Fund has been renamed Burnham Financial Long/Short Fund (BURFX).  It’s a tiny fund (with a sales load and high expenses) that’s been around for a decade.  It’s hard to know what to make of it since “long/short financial” is a pretty small niche with few other players.

Caritas All-Cap Growth Fund has become Goodwood SMID Cap Discovery Fund (GAMAX), a name that my 13-year-old keeps snickering at.  It’s been a pretty mediocre fund which gained new managers in October.

Compass EMP Commodity Long/Short Strategies Fund (CCNAX) is slated to become Compass EMP Commodity Strategies Enhanced Volatility Weighted Fund in May. Its objective will change to “match the performance of the CEMP Commodity Long/Cash Volatility Weighted Index.”  It’s not easily searchable by name at Morningstar because they’ve changed the name in their index but not on the fund’s profile.

Eaton Vance Institutional Emerging Markets Local Debt Fund (EELDX) has been renamed Eaton Vance Institutional Emerging Markets Debt Fund and is now a bit less local.

Frost Diversified Strategies and Strategic Balanced are hitting the “reset” button in a major way. On March 31, 2014, they change name, objective and strategy. Frost Diversified Strategies (FDSFX) becomes Frost Conservative Allocation while Strategic Balanced (FASTX) becomes Moderate Allocation. Both become funds-of-funds and discover a newfound delight in “total return consistent with their allocation strategy.” Diversified currently is a sort of long/short, ETFs, funds and stocks, options mess … $4 million in assets, high expense, high turnover, indifferent returns, limited protection. Strategic Balanced, with a relatively high downside capture, is a bit bigger and a bit calmer but ….

Effective on or about May 30, 2014, Hartford Balanced Allocation Fund (HBAAX) will be changed to Hartford Moderate Allocation Fund.

At the same time, Hartford Global Research Fund (HLEAX) becomes Hartford Global Equity Income Fund, with a so far unexplained “change to the Fund’s investment goal.” 

Effective March 31, 2014, MFS High Yield Opportunities Fund (MHOAX) will change its name to MFS Global High Yield Fund.

In mid-February, Northern Enhanced Large Cap Fund (NOLCX) became Northern Large Cap Core Fund though, at last check, Morningstar hadn’t noticed. Nice little fund, by the way.

Speaking of not noticing, the folks at Whitebox have accused of us ignoring “one of the most important changes we made, which is Whitebox Long Short Equity Fund is now the Whitebox Market Neutral Equity Fund.” We look alternately chastened by our negligence and excited to report such consequential news.

OFF TO THE DUSTBIN OF HISTORY

BCM Decathlon Conservative Portfolio, BCM Decathlon Moderate Portfolio and BCM Decathlon Aggressive Portfolio have decided that they can best serve their shareholders by liquidating.  The event is scheduled for April 14, 2014.

BlackRock International Bond Portfolio (BIIAX) has closed and will liquidate on March 14, 2014.  A good move given the fund’s dismal record, though you’d imagine that a firm with BlackRock’s footprint would want a fund of this name.

Pending shareholder approval, City National Rochdale Diversified Equity Fund (AHDEX) will merge into City National Rochdale U.S. Core Equity Fund (CNRVX) of the Trust. I rather like the honesty of their explanation to shareholders:

This reorganization is being proposed, among other reasons, to reduce the annual operating expenses borne by shareholders of the Diversified Fund. CNR does not expect significant future in-flows to the Diversified Fund and anticipates the assets of the Diversified Fund may continue to decrease in the future. The Core Fund has significantly more assets [and] … a significantly lower annual expense ratio.

Goldman Sachs Income Strategies Portfolio merged “with and into” the Goldman Sachs Satellite Strategies Portfolio (GXSAX) and Goldman Sachs China Equity Fund with and into the Goldman Sachs Asia Equity Fund (GSAGX) in mid-February.

Huntington Rotating Markets Fund (HRIAX) has closed and will liquidate by March 28, 2014.

Shareholders of Ivy Asset Strategy New Opportunities Fund (INOAX) have been urged to approve the merger of their fund into Ivy Emerging Markets Equity Fund (IPOAX).  The disappearing fund is badly awful but the merger is curious because INOAX is not primarily an emerging markets fund; its current portfolio is split between developed and developing.

The Board of Trustees of the JPMorgan Ex-G4 Currency Strategies Fund (EXGAX) has approved the liquidation and dissolution of the Fund on or about March 10, 2014.  The “strategies” in question appear to involve thrashing around without appreciable gain.

After an entire year of operation (!), the KKR Board of Trustees of the Fund approved a Plan of Liquidation with respect to KKR Alternative Corporate Opportunities Fund (XKCPX) and KKR Alternative High Yield Fund (KHYZX). Accordingly, the Fund will be liquidated in accordance with the Plan on or about March 31, 2014 or as soon as practicable thereafter. 

Loomis Sayles Mid Cap Growth Fund (LAGRX) will be liquidated on March 14^th, a surprisingly fast execution given that the Board approved the action just the month before.

On February 13, 2014, the shareholders of the Quaker Small Cap Growth Tactical Allocation Fund (QGASX) approved the liquidation and dissolution of the Fund. 

In Closing . . .

We asked you folks, in January, what made the Observer worthwhile.  That is, what did we offer that brought you back each month?  We poured your answers into a Wordle in hopes of capturing the spirit of the 300 or so responses.

Three themes recurred:  (1) the Observer is independent. We’re not trying to sell you anything.  We’re not trying to please advertisers. We’re not desperate to write inflated drivel in order to maximize clicks. We don’t have a hidden agenda. 

(2) We talk about things that other folks do not. There’s a lot of appreciation for our willingness to ferret out smaller, emerging managers and to bring them to you in a variety of formats. There’s also some appreciate of our willingness to step back from the fray and try to talk about important long-term issues rather than sexy short-term ones.

(3) We’re funny. Or weird. Perhaps snarky, opinionated, cranky and, on a good day, curmudgeonly.

And that helps us a lot.  As we plan for the future of the Observer, we’re thinking through two big questions: where should we be going and how can we get there? We’ll write a bit next time about your answer to the final question: what should we be doing that we aren’t (yet)?

We’ve made a couple changes under the hood to make the Observer stronger and more reliable.  We’ve completed our migration to a new virtual private server at Green Geeks, which should help with reliability and allow us to handle a lot more traffic.  (We hit records again in January and February.)  We also upgraded the software that runs our discussion board.  It gives the board better security and a fresher look.  If you’ve got a bookmarked link to the discussion board, we need you to reset your link to http://www.mutualfundobserver.com/discuss/discussions.  If you use your old bookmark you’ll just end up on a redirect page.  

In April we celebrate our third anniversary. Old, for a website nowadays, and so we thought we’d solicit the insights of some of the Grand Old Men of the industry: well-seasoned, sometimes storied managers who struck out on their own after long careers in large firms. We’re trying hard to wheedle our colleague Ed, who left Oakmark full of years and honors, to lead the effort. While he’s at that, we’re planning to look again at the emerging markets and the almost laughable frenzy of commentary on “the bloodbath in the emerging markets.”  (Uhh … Vanguard’s Emerging Market Index has dropped 8% in a year. That’s not a bloodbath. It’s not even a correction. It’s a damned annoyance. And, too, talking about “the emerging markets” makes about as much analytic sense as talking about “the white people.”  It’s not one big undifferentiated mass).  We’ve been looking at fund flow data and Morningstar’s “buy the unloved” strategy.  Mr. Studzinski has become curious, a bit, about Martin Focused Value (MFVRX) and the arguments that have led them to a 90% cash stake. We’ll look into it.

Please do bookmark our Amazon link.  Every bit helps! 

 As ever,

Dear friends,

Welcome to the New Year.  At least as we calculate it.  The Year of the Horse begins January 31, a date the Vietnamese share.  The Iranians, like the ancient Romans, sensibly celebrate the New Year at the beginning of spring.  A bunch of cultures in South Asia pick mid-April. Rosh Hashanah (“head of the year”) rolls around in September.  My Celtic ancestors (and a bunch of modern Druidic wannabees) preferred Samhain, at the start of November.

Whatever your culture, the New Year is bittersweet.  We seem obsessed with looking back in regret at all the stuff we didn’t do, as much as we look forward to all of the stuff we might yet do.

My suggestion: can the regrets, get off yer butt, and do the stuff now that you know you need to do.  One small start: get rid of that mutual fund.  You know the one.  You’ve been regretting it for years.  You keep thinking “maybe I’ll wait to let it come back a bit.”  The one that you tend to forget to mention whenever you talk about investments.

Good gravy.  Dump it!  It takes about 30 seconds on the phone and no one is going to hassle you about it; it’s not like the manager is going to grab the line and begin pleading for a bit more time.  Pick up a lower cost replacement.  Maybe look into a nice ETF or index fund. Track down a really good fund whose manager is willing to put his own fortune and honor at risk along with yours.

You’ll feel a lot better once you do.

We can talk about your gym membership later.

Voices from the bottom of the well

THESE are the times that try men’s souls. The summer soldier and the sunshine patriot will, in this crisis, shrink from the service of their country; but he that stands by it now, deserves the love and thanks of man and woman. Tyranny, like hell, is not easily conquered; yet we have this consolation with us, that the harder the conflict, the more glorious the triumph. What we obtain too cheap, we esteem too lightly: it is dearness only that gives every thing its value. Heaven knows how to put a proper price upon its goods; and it would be strange indeed if so celestial an article as FREEDOM should not be highly rated.

Thos. Paine, The Crisis, 23 December 1776

Investors highly value managers who are principled, decisive, independent, active and contrarian.  Right up to the moment that they have one. 

Then they’re appalled.

There are two honorable approaches to investing: relative value and absolute value.  Relative value investors tend to buy the best-priced securities available, even if the price quoted isn’t very good.  They tend to remain fully invested even when the market is pricey and have, as their mantra, “there’s always a bull market in something.”  They’re optimistic by nature, enjoy fruity wines and rarely wear bowties.

Absolute value investors tend to buy equities only when they’re selling for cheap.  Schooled in the works of Graham and Dodd, they’re adamant about having “a margin of safety” when investing in an inherently risk asset class like stocks.  They tend to calculate the fair value of a company and they tend to use cautious assumptions in making those calculations.  They tend to look for investments selling at a 30% discount to fair value, or to firms likely to produce 10% internal returns of return even if things turn ugly.  They’re often found sniffing around the piles that trendier investors have fled.  And when they find no compelling values, they raise cash.  Sometimes lots of cash, sometimes for quite a while.  Their mantra is, “it’s not ‘different this time’.”  They’re slightly-mournful by nature, contemplate Scotch, and rather enjoyed Andy Rooney’s commentaries on “60 Minutes.”

If you’re looking for a shortcut to finding absolute value investors today, it’s a safe bet you’ll find them atop the “%age portfolio cash” list.  And at the bottom of the “YTD relative return” list.  They are, in short, the guys you’re now railing against.

But should you be?

I spent a chunk of December talking with guys who’ve managed five-star funds and who were loved by the crowds but who are now suspected of having doubled-up on their intake of Stupid Pills.  They are, on whole, stoic. 

Take-aways from those conversations:

1. They hate cash.  As a matter of fact, it’s second on their most-hated list behind only “risking permanent impairment of capital”.
2. They’re not perma-bears. They love owning stocks. These are, by and large, guys who sat around reading The Intelligent Investor during recess and get tingly at the thought of visiting Omaha. But they love them for the prospect of the substantial, compounded returns they might generate.  The price of those outsized returns, though, is waiting for one of the market’s periodic mad sales.
3. They bought stocks like mad in early 2009, around the time that the rest of us were becoming nauseated at the thought of opening our 401(k) statements. Richard Cook and Dowe Bynum, for example, were at 2% cash in March 2009.  Eric Cinnamond was, likewise, fully invested then.
4. They’ve been through this before though, as Mr. Cinnamond notes, “it isn’t very fun.”  The market moves in multi-year cycles, generally five years long more or less. While each cycle is different in composition, they all have similar features: the macro environment turns accommodative, stocks rise, the fearful finally rush in, stocks overshoot fair value by a lot, there’s an “oops” and a mass exit for the door.  Typically, the folks who arrived late inherit the bulk of the pain.
5. And they know you’re disgusted with them. Mr. Cinnamond, whose fund has compounded at 12% annually for the past 15 years, allows “we get those long-term returns by looking very stupid.”  Richard Cook agrees, “we’re going to look silly, sometimes for three to five years at a stretch.”  Zac Wydra admits that he sometimes looks at himself in the mirror and asks “how can you be so stupid?”

And to those investors who declare, “but the market is reasonably priced,” they reply: “we don’t buy ‘the market.’  We buy stocks.  Find the individual stocks that meet the criteria that you hired us to apply, and we’ll buy them.”

What do they think you should do now?  In general, be patient.  Mr. Cook points to Charlie Munger’s observation:

I think the [Berkshire Hathaway’s] record shows the advantage of a peculiar mind-set – not seeking action for its own sake, but instead combining extreme patience with extreme decisiveness. It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.

Which is hard.  Several of the guys pointed to Seth Klarman’s decision to return $4 billion in capital to his hedge fund investors this month. Klarman made the decision in principle back in September, arguing that if there were no compelling investment opportunities, he’d start mailing out checks.  Two things are worth noting about Klarman: (1) his hedge funds have posted returns in the high teens for over 30 years and (2) he’s willing to sit at 33-50% cash for a long time if that’s what it takes to generate big long-term returns.

Few managers have Klarman’s record or ability to wait out markets.  Mr. Cinnamond noted, “there aren’t many fund managers with a long track record doing this because you’re so apt to get fired.”  Jeremy Grantham of GMO nods, declaring that “career risk” is often a greater driver of a manager’s decisions than market risk is.

In general, the absolute value guys suggest you think differently about their funds than you think about fully-invested relative value ones.  Cook and Bynum’s institutional partners think of them as “alternative asset managers,” rather than equity guys and they regard value-leaning hedge funds as their natural peer group.  John Deysher, manager of Pinnacle Value (PVFIX), recommends considering “cash-adjusted returns” as a viable measure, though Mr. Cinnamond disagrees since a manager investing in unpopular, undervalued sectors in a momentum driven market is still going to look inept.

Our bottom line: investors need to take a lot more responsibility if they’re going to thrive.  That means we’ve got to look beyond simple return numbers and ask, instead, about what decisions led to those returns.  That means actually reading your managers’ commentaries, contacting the fund reps with specific questions (if your questions are thoughtful rather more than knee-jerk, you’d be surprised at the quality of answers you receive) and asking the all-important question, “is my manager doing precisely what I hired him to do: to be stubbornly independent, fearful when others are greedy and greedy when others are fearful?” 

Alternately: buy a suite of broadly diversified, low-cost index funds.  There are several really solid funds-of-index-funds that give you broad exposure to market risk with no exposure to manager risk.  The only thing that you need to avoid at all costs is the herd: do not pay active management prices for the services of managers whose only goal is to be no different than every other timid soul out there.

The Absolute Value Guys

* FPACX’s “moderate allocation” competitors were caught holding bonds this year, dumber even than holding cash.

Don’t worry, relative value guys.  Morningstar’s got your back.

Earnings at S&P500 companies grew by 11% in 2013, through late December, and they paid out a couple percent in dividends.  Arguably, then, stocks are worth about 13% more than they were in January.  Unfortunately, the prices paid for those stocks rose by more than twice that amount.  Stocks rose by 32.4% in 2013, with the Dow setting 50 all-time record highs in the process. One might imagine that if prices started at around fair value and then rose 2.5 times as much as earnings did, valuations would be getting stretched.  Perhaps overvalued by 19% (simple subtraction of the earnings + dividend rise from the price + dividend rise)?

Not to worry, Morningstar’s got you covered.  By their estimation, valuations are up only 5% on the year – from fully valued in January to 5% high at year’s end.  They concluded that it’s certainly not time to reconsider your mad rush into US equities.  (Our outlook for the stock market, 12/27/2013.) While the author, Matthew Coffina, did approvingly quote Warren Buffett on market timing:

Charlie and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of “experts,” or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.

He didn’t, however, invoke what Warren Buffett terms “the three most important words in all of investing,” margin of safety.  Because you can’t be sure of a firm’s exact value, you always need to pay less than you think it’s worth – ideally 30 or 40% less – in order to protect your investors against your own fallible judgment. 

Quo Vadis Japan

I go out of the darkness

Onto a road of darkness

Lit only by the far off

Moon on the edge of the mountains.

Izumi

One of the benefits of having had multiple careers and a plethora of interests is that friends and associates always stand ready with suggestions for you to occupy your time. In January of 2012, a former colleague and good friend from my days with the Navy’s long-range strategic planning group suggested that I might find it interesting to attend the Second China Defense and Security Conference at the Jamestown Foundation. That is how I found myself seated in a conference room in February with roughly a hundred other people. My fellow attendees were primarily from the various alphabet soup governmental agencies and mid-level military officers. 

The morning’s presentations might best be summed up as grudging praise about the transformation of the Chinese military, especially their navy, from a regional force to one increasingly able to project power throughout Asia and beyond to carry out China’s national interests. When I finally could not stand it any longer, after a presentation during Q&A, I stuck my hand up and asked why there was absolutely no mention of the 600 pound gorilla in the corner of the room, namely Japan and the Japanese Maritime Self-Defense Force. The JMSDF was and is either the second or third largest navy in the world. It is considered by many professional observers to be extraordinarily capable. The silence that greeted my question was akin to what one would observe if I had brought in a dog that had peed on the floor. The moderator muttered a few comments about the JMSDF having fine capabilities. We then went on with no mention of Japan again. At that point I realized I had just learned the most important thing that I was going to take from the conference, that Japan (and its military) had become the invisible country of Asia. 

The New Year is when as an investor you reflect back on successes and mistakes. And if one is especially introspective, one can ponder why. For most of 2013, I was banging the drum on two investment themes that made sense to me:  (a) the Japanese equity market and (b) the Japanese currency – the yen – hedged back into U.S. dollars. The broad Japanese market touched highs this month not seen before this century. The dollar – yen exchange rate moved from 89.5 at the beginning of the year to 105.5. In tandem, the themes have proven to be quite profitable. Had an investment been made solely in the Wisdom Tree: Japan Hedged Equity ETF, a total return of 41.8% would have been achieved by the U.S. dollar investor. So, is this another false start for both the Japanese stock market and economy? Or is Japan on the cusp of an economic and political transformation?   

When I mention to institutional investors that I think the change in Japan is real, the most common response I get is a concern about “Abenomics.” This is usually expressed as “They are printing an awful lot of money.”  Give me a break.  Ben Bernanke and his little band of merry Fed governors have effectively been printing money with their various QE efforts. Who thinks that money will be repaid or the devaluation of the U.S. dollar will be reversed?  The same can be said of the EU central bankers.  If anything, the U.S. has been pursuing a policy of beggar thy creditor, since much of our debt is owed to others.  At least in Japan, they owe the money to themselves. They have also gone through years of deflation without the social order and fabric of society breaking down. One wonders how the U.S. would fare in a similar long-term deflationary environment. 

I think the more important distinction is to emphasize what “Abenomics” is not.  It is not a one-off program of purchasing government bonds with a view towards going from a multi-year deflationary spiral to generating a few points of inflation.  It is a comprehensive program aimed at reversing Japan’s economic, political, and strategic slide of the past twenty years. Subsumed under the rubric of “Abenomics” are efforts to increase and widen the acceptance of child care facilities to enable more of Japan’s female talent pool to actively participate in the workforce, a shift in policy for the investments permitted in pension funds to dramatically increase domestic equity exposure, and incentives to transform the Japanese universities into research and resource engines. Similarly, the Japanese economy is beginning to open from a closed economy to one of free trade, especially in agriculture, as Japan has joined the Trans Pacific Partnership. Finally, public opinion has shifted dramatically to a willingness to contemplate revision of Japan’s American-drafted post-war Constitution. This would permit a standing military and a more active military posture. It would normalize Japan as a global nation, and restore a balance of interests and power in East Asia. The ultimate goal then is to restore the self-confidence of the Japanese nation.  So, what awakened Japan and the Japanese?

Strangely enough, the Chinese did it. I have been in Japan four times in the last twenty-two months, which does not make me an expert on anything. But it has allowed me to discern a shift in the mood of the country. Long-time Japan hands had told me that when public opinion in Japan shifts, it shifts all at once and moves together in the same direction. Several months ago, I asked a friend and investment manager who is a long-time resident of Tokyo what had caused that shift in opinion. His response was that most individuals, he as well, traced it to the arrest and detention by the Japanese Coast Guard, of a Chinese fishing vessel and its captain who had strayed into Japanese waters. China responded aggressively, embargoing rare earth materials that the Japanese electronics and automobile industries needed, and made other public bellicose noises. Riots and torching of Japanese plants in China followed, with what seemed to be the tacit approval of the Chinese government. Japan released the ship and its captain, and in Asian parlance, lost face. As my friend explained it, the Japanese public came to the conclusion that the Chinese government was composed of bad people whose behavior was unacceptable. Concurrently, Japan Inc. began to relocate its overseas investment away from China and into countries such as Vietnam, Indonesia, Thailand, and Singapore.

From an investment point of view, what does it all mean? First, one should not look at Prime Minister Abe, Act II (remember that he was briefly in office for 12 months in 2006-2007) in a vacuum. Like Reagan and Churchill, he used his time in the “wilderness years” to rethink what he wanted to achieve for Japan and how he would set about doing it. Second, one of the things one learns about Japan and the Japanese is that they believe in their country and generally trust their government, and are prepared to invest in Japan. This is in stark contrast to China, where if the rumors of capital flows are to be believed, vast sums of money are flowing out of the country through Hong Kong and Singapore. So, after the above events involving China, Abe’s timing in return to office was timely. 

While Japanese equities have surged this year, that surge has been primarily in the large cap liquid issues that are easily studied and invested in by global firms. Most U.S. firms follow the fly-by approach. Go to Tokyo for a week of company meetings, and invest accordingly. Few firms make the commitment of having resources on the ground. That is why if you look at most U.S.-based Japan specialist mutual funds, they all own pretty much the same large cap liquid names, with only the percentages and sector weightings varying. There are tiers of small and mid-cap companies that are under-researched and under-invested in.  If this is the beginning of a secular bull market, as we saw start in the U.S. in 1982, Japan will just be at the beginnings of eliminating the value gap between intrinsic value and the market price of securities, especially in the more inefficiently-traded and under-researched companies. 

So, as Lenin once famously asked, “What is to be done?”  For most individuals, individual stock investments are out of the question, given the currency, custody, language, trading, and tax issues. For exposure to the asset class, there is a lot to be said for a passive approach through an index fund or exchange-traded fund, of which there are a number with relatively low expense ratios. Finally, there are the fifteen or so Japan-only mutual funds. I am only aware of three that are small-cap vehicles – DFA, Fidelity, and Hennessy. There are also two actively-managed closed end funds. I will look to others to put together performance numbers and information that will allow you to research the area and draw your own conclusions.  

Finally, it should be obvious that Japan does not lend itself to simple explanations. As Americans, we are often in a time-warp, thinking that with the atomic bombs, American Occupation and force-fed Constitution, we successfully transformed Japan into a pacifist democratically-styled Asian theme park.  My conclusion is rather that what you see in Japan is not reality (whatever that is) but what they are comfortable with you seeing. I think for instance of the cultural differences with China in a business sense.  With the Chinese businessman, a signed contract is in effect the beginning of the negotiation.  For the Japanese businessman, a signed contract is a commitment to be honored to the letter.

I will leave you with one thing to ponder shared with me by a Japanese friend. She told me that the samurai have been gone for a long time in Japan. But, everyone in Japan still knows who the samurai families are and everyone knows who is of those families and who is not. And she said, everyone from those families still tends to marry into other samurai families.  So I thought, perhaps they are not gone after all.  

Edward Studzinski

From Day One …

… the Observer’s readers were anxious to have us publish lists of Great Funds, as FundAlarm did with its Honor Roll funds.  For a long time I demurred because I was afraid folks would take such a list too seriously.  That is, rather than viewing it as a collection of historical observations, they’d see it as a shopping list. 

After two years and unrelenting inquires, I prevailed upon my colleague Charles to look at whether we could produce a list of funds that had great track records but, at the same time, highlight the often-hidden data concerning those funds’ risks.  With that request and Charles’s initiative, the Great Owl Funds were launched.

And now Charles returns to that troubling original question: what can we actually learn about the future from a fund’s past?

In Search of Persistence

It outperformed nearly 3/4ths of the time, while it under-performed only 5%. NAINX essentially equaled or beat its peers 194 out of 205 periods. Encouraged, the investor purchases the fund making a long-term commitment to buy-and-hold.

It’s now 2013, twenty years later. How has NAINX performed? To the investor’s horror, Virtus Tactical Allocation underperformed 3/4ths of the time since purchased! And the fund that outperformed most persistently? Mairs & Power Balanced (MAPOX), of course.

Back to 1993. This time a more aggressive investor applies the same methodology to the large growth category and finds an extraordinary fund, named Fidelity Magellan (FMAGX).  This fund outperformed nearly 100% of the time across 205 rolling 3-year periods over 20 years versus 31 other long-time peers. But during the next 20 years…? Not well, unfortunately. This investor would have done better choosing Fidelity Contrafund (FCNTX). How can this be? Most industry experts would attribute the colossal shift in FMAGX performance to the resignation of legendary fund manager Peter Lynch in 1990.

MJG, one of the heavy contributors to MFO’s discussion board, posts regularly about the difficulty of staying on top of one’s peer group, often citing results from Standard & Poor’s Index Versus Active Indexing (SPIVA) reports. Here is the top lesson-learned from ten years of these reports:

“Over a five-year horizon…a majority of active funds in most categories fail to outperform indexes. If an investing horizon is five years or longer, a passive approach may be preferable.”

The December 2013 SPIVA “Persistence Scorecard” has just been published, which Joshua Brown writes insightfully about in “Persistence is a Killer.” The scorecard once again shows that only a small fraction of top performing domestic equity mutual funds remain on top across any 2, 3, or 5 year period.

What does mutual fund non-persistence look like across 40 years? Here’s one depiction:

The image (or “mural”) represents monthly rank by color-coded quintiles of risk-adjusted returns, specifically Martin Ratio, for 101 funds across five categories. The funds have existed for 40 years through September 2013. The calculations use total monthly returns of oldest share class only, ignoring any load, survivor bias, and category drift.  Within each category, the funds are listed alphabetically.

There are no long blue/green horizontal streaks. If anything, there seem to be more extended orange/red streaks, suggesting that if mutual fund persistence does exist, it’s in the wrong quintiles! (SPIVA actually finds similar result and such bottom funds tend to end-up merged or liquated.)

Looking across the 40 years of 3-year rolling risk-adjusted returns, some observations:

• 98% of funds spent some periods in every rank level…top, bottom, and all in-between
• 35% landed in the bottom two quintiles most of the time…that’s more than 1/3^rd of all funds
• 13% were in the top two bottom quintiles…apparently harder to be persistently good than bad
• Sequoia (SEQUX) was the most persistent top performer…one of greatest mutual funds ever
• Wall Street (WALLX) was the most persistent cellar dweller…how can it still exist?

The difference in overall return between the most persistent winner and loser is breathtaking: SEQUX delivered 5.5 times more than SP500 and 16 times more than WALLX. Put another way, $10K invested in SEQUX in October 1973 is worth nearly $3M today. Here’s how the comparison looks:

So, while attaining persistence may be elusive, the motivation to achieve it is clear and present.

The implication of a lack of persistence strikes at the core of all fund rating methodologies that investors try to use to predict future returns, at least those based only on historical returns. It is, of course, why Kiplinger, Money, and Morningstar all try to incorporate additional factors, like shareholder friendliness, experience, and strategy, when compiling their Best Funds lists. An attempt, as Morningstar well states, to identify “funds with the highest potential of success.”

The MFO rating system was introduced in June 2013. The current 20-year Great Owls, shown below for moderate allocation and large growth categories, include funds that have achieved top performance rank over the past 20, 10, 5, and 3 year evaluation periods. (See Rating Definitions.)

But will they be Great Owls next year? The system is strictly quantitative based on past returns, which means, alas, a gentle and all too ubiquitous reminder that past performance is not a guarantee of future results. (More qualitative assessments of fund strategy, stewardship, and promise are provided monthly in David’s fund profiles.) In any case and in the spirit of SPIVA, we will plan to publish periodically a Great Owl “Persistence Scorecard.”

31Dec2013/Charles

It’s not exciting just because the marketers say it is

Most mutual funds don’t really have any investment reason to exist: they’re mostly asset gathering tools that some advisor created in support of its business model. Even the funds that do have a compelling case to make often have trouble receiving a fair hearing, so I’m sympathetic to the need to find new angles and new pitches to try to get journalists’ and investors’ attention.

But the fact that a marketer announces it doesn’t mean that journalists need to validate it through repetition. And it doesn’t mean that you should just take in what we’ve written.

Case in point: BlackRock Emerging Markets Long/Short Fund (BLSAX).  Here’s the combination of reasonable and silly statements offered in a BlackRock article justifying long/short investing:

For example, our access to information relies on cutting edge infrastructure to compile vast amounts of obvious and less-obvious sources of publicly available information. In fact, we consume a massive amount of data from more than 25 countries, with a storage capacity 4 times the Library of Congress and 8 times the size of Wikipedia. We take that vast quantity of publicly available information and filter and identify relevant pieces.

Reasonable statement: we do lots of research.  Silly statement: we have a really big hard drive on our computer (“a storage capacity of…”).  Why on earth would we care?  And what on earth does it mean?  “4 times the Library of Congress”?  The LoC digital collection – a small fraction of its total collection – holds three petabytes of data, a statement that folks immediately recognize as nonsensical.  3,000,000 gigabytes.  So the BlackRock team has a 12 petabyte hard drive?  12 petabytes of data?  How’s it used?  How much is reliable, consistent, contradictory or outdated?  How much value do you get from data so vast that you’ll never comprehend it?

NSA’s biggest “data farm” consumes 65 megawatts of power, has melted down 10 times, and – by the fed’s own reckoning – still hasn’t produced demonstrable security gains.  Data ≠ knowledge.

The Google, by the way, processes 20 petabytes of user-generated content per day.

Nonetheless, Investment News promptly and uncritically gloms onto the factoid, and then gets it twice wrong:

The Scientific Active Equity team takes quantitative investing to a whole new level. In fact, the team has amassed so much data on publicly traded companies that its database is now four times the size of Wikipedia and eight times the size of the Library of Congress (Jason Kephart, Beyond black box investing: Fund uses database four times the size of Wikipedia, 12/26/13).

Error 1: reversing the LoC and the Wikipedia.  Error 2: conflating “storage capacity” with “data.” (And, of course, confusing “pile o’ data” with “something meaningful.”)

MFWire promptly grabs the bullhorn to share the errors and the credulity:

This Fund Uses the Data of Eight Libraries of Congress (12/26/13, Boxing Day for our British friends)

The team managing the fund uses gigantic amounts of data — four times the size of Wikipedia and eight times the size of the Library of Congress — on public company earnings, analyst calls, news releases, what have you, to gain on insights into different stocks, according to Kephart.

Our second, perhaps larger, point of disagreement with Jason (who, in fairness, generally does exceptionally solid work) comes in his enthusiasm for one particular statistic:

That brings us to perhaps the fund’s most impressive stat, and the one advisers really need to keep their eyes on: its correlation to global equities.

Based on weekly returns through the third quarter, the most recent data available, the fund has a correlation of just 0.38 to the MSCI World Index and a correlation of 0.36 to the S&P 500. Correlations lower than 0.5 lead to better diversification and can lead to better risk-adjusted returns for the entire portfolio.

Uhhh.  No?

Why, exactly, is correlation The Golden Number?  And why is BlackRock’s correlation enough to make you tingle?  The BlackRock fund has been around just one year, so we don’t know its long-term correlation.  In December, it had a net market exposure of just 9% which actually makes a .36 correlation seem oddly high. BlackRock’s correlation is not distinctively low (Whitebox Long/Short WBLSX has a three-year correlation of 0.33, for instance). 

Nor is low correlation the hallmark of the best long-term funds in the group.  By almost any measure, the best long/short fund in existence is the closed Robeco Boston Partners L/S Equity Fund (BPLEX).  BPLEX is a five-star fund, a Lipper Leader, a Great Owl fund, with returns in the top 4% of its peer group over the past decade. And its long term correlation to the market: 75.  Wasatch Long/Short (FMLSX), another great fund with a long track record: 90. Marketfield (MFLDX), four-star, Great Owl: 67.

The case for BlackRock EM L/S is it’s open. It’s got a good record, though a short one.  In comparison to other, more-established funds, it substantially trails Long-Short Opportunity (LSOFX) since inception, is comparable to ASTON River Road (ARLSX) and Wasatch Long Short (FMLSX), while it leads Whitebox Long-Short (WBLSX), Robeco Boston Partners (BPLEX) and RiverPark Long/Short Opportunity (RLSFX). The fund has nearly $400 million in assets after one year and charges 2% expenses plus a 5.25% front load.  That’s more than ARLSX, WBLSX or FMLSX, though cheaper than LSOFX. 

Bottom Line: as writers, we need to guard against the pressures created by deadlines and the desire for “clicks.”  As readers, you need to realize we have good days and bad and you need to keep asking the questions we should be asking: what’s the context of this number?  What does it mean?  Why am I being given it? How does it compare?  And, as investors, we all need to remember that magic is more common in the world of Harry Potter than in the world we’re stuck with.

Wells Fargo and the Roll Call of the Wretched

Our Annual Roll Call of the Wretched highlights those funds which consistently, over a period of many years, trail their benchmark.  We noted that inclusion on the list signaled one of two problems:

• Bad fund or
• Bad benchmark.

The former problem is obvious.  The latter takes a word of explanation.  There are 7055 distinct mutual funds, each claiming – more or less legitimately – to be different from all of the others.   For the purpose of comparison, Morningstar and Lipper assign them to one of 108 categories.  Some funds fit easily and well, others are laughably misfit.  One example is RiverPark Short-Term High Yield Fund (RPHYX), which is a splendid cash management fund whose performance is being compared to the High-Yield group which is dominated by longer-duration bonds that carry equity-like risks and returns.

You get a sense of the mismatch – and of the reason that RPHYX was assigned one-star – when you compare the movements of the fund to the high-yield group.

That same problem afflicts Wells Fargo Advantage Short-Term High Yield Bond (SSTHX), an entirely admirable fund that returns around 4% per year over the long term in a category that delivers 50% greater returns with 150% greater volatility.  In Morningstar’s eyes, one star.

Joel Talish, one of the managing directors at Wells Fargo Advisors, raised the entirely reasonable objection that SSTHX isn’t wretched – it’s misclassified – and it shouldn’t be in the Roll Call at all. He might well be right. Our strategy has been to report all of the funds that pass the statistical screen, then to highlight those whose performance is better than the peer data suggest.  We don’t tend to remove funds from the list just because we believe that the ratings agencies are wrong. We’ve made that decision consciously: investors need to read these ubiquitous statistical screens more closely and more skeptically.  A pattern of results arises from a series of actions, and they’re meaningful only if you take the time to understand what’s going on. By highlighting solid funds that look bad because of a rater’s unexplained assignments, we’re trying to help folks learn how to look past the stars.

It might well be the case that highlighting and explaining SSTHX’s consistently one-star performance did a substantial disservice to the management team. It was a judgment call on our part and we’ll revisit it as we prepare future features.  For now, we’re hopeful that the point we highlighted at the start of the list: 

Use lists like the Roll Call of the Wretched or the Three Alarm Funds as a first step, not a final answer.  If you see a fund of yours on either list, find out why.  Call the adviser, read the prospectus, try the manager’s letter, post a question on our board.  There might be a perfectly good reason for their performance, there might be a perfectly awful one.  In either case, you need to know.

Observer Fund Profile

Each month the Observer provides in-depth profiles of notable funds that you’d otherwise not hear of.  Our “Most Intriguing New Funds” are funds launched within the past couple years that most frequently feature experienced managers leading innovative newer funds.  “Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

RiverPark Strategic Income (RSIVX): RSIVX sits at the core of Cohanzick’s competence, a conservative yet opportunistic strategy that they’ve pursued for two decades and that offers the prospect of doubling the returns of its very fine Short-Term High Yield Fund.

Elevator Talk: Oliver Pursche, GMG Defensive Beta Fund (MPDAX)

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. 

The traditional approach to buffering the stock market’s volatility without entirely surrendering the prospect of adequate returns was to divide the portfolio between (domestic, large cap) stocks and (domestic, investment grade) bonds, at a ratio of roughly 60/40.  That strategy worked passably well as long as stocks could be counted on to produce robust returns and bonds could be counted on to post solid though smaller gains without fail.  As the wheels began falling off that strategy, advisors began casting about for alternative strategies. 

Some, like the folks at Montebello Partners, began drawing lessons from the experience of hedge funds and institutional alternatives managers.  Their conclusion was that each asset class had one or two vital contributions to make to the health of the portfolio, but that exposure to those assets had to be actively managed if they were going to have a chance of producing equity-like (perhaps “equity-lite”) returns with substantial downside protection.

Their strategy is manifested in GMG Defensive Beta, which launched in the summer of 2009.  Its returns have generally overwhelmed those of its multi-alternative peers (top 3% over the past three years, substantially higher returns since inception) though at the cost of substantially higher volatility.  Morningstar rates it as a five-star fund, while Lipper gives it four stars for both Total Return and Consistency of Return and five stars for Capital Preservation.

Oliver Pursche is the president of Gary M Goldberg Financial Services (hence GMG) one of the four founding co-managers of MPDAX.  Here are his 218 words (on whole, durn close to target) on why you should consider a multi alternative strategy:

Markets are up, and as a result, so are the risks of a correction. I don’t think that a 2008-like crash is in the cards, but we could certainly see a 20% correction at some point. If you agree with me, protecting your hard fought gains makes all the sense in the world, which is why I believe low-volatility and multi-alternative funds like our GMG Defensive Beta Fund will continue to gain favor with investors. The problem is that most of these new funds have no, or only a short track-record, so it’s difficult to know how they will actually perform in a prolonged downturn. One thing is certain, in the absence of a longer-term track record, low fees and low turnover tend to be advantageous to investors. This is why our fund is a no-load fund and we cap our fees at 1.49%, well below most of our peers, and our cap gain distributions have been minimal.

From my perspective, if you’re looking to continue to have market exposure, but don’t want all of the risks associated with investing in the S&P 500, our fund is ideally suited. We’re strategic and tactical at the same time and have demonstrated our ability to remain disciplined, which is (I think) why Morningstar has awarded us a 5 Star ranking.

MPDAX is a no-load fund with a single share class.  The minimum initial investment is $1,000.   Expenses are 1.49% on about $27 million in assets.

The fund’s website is functional but spare.  You get the essential information, but there’s no particular wealth of insight or commentary on this strategy.  There’s a Morningstar reprint available but you should be aware that the file contains one page of data reporting and five pages of definitions and disclaimers.

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.  We’re saddened to report that Tom chose to liquidate the fund.
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 (VCMRX), 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.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.
10. November 2013: Jeffrey Ringdahl of American Beacon Flexible Bond (AFXAX) gives teams from Brandywine Global, GAM and PIMCO incredible leeway wth which to pursue “positive total return regardless of market conditions.” Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Conference Call Highlights

On December 9^th, about 50 of us spent a rollicking hour with David Sherman of Cohanzick Asset Management, discussing his new fund: RiverPark Strategic Income Fund (RSIVX).  I’m always amazed at how excited folks can get about short-term bonds and dented credits.  It’s sort of contagious.

David’s first fund with RiverPark, the now-closed Short Term High Yield (RPHYX), was built around Cohanzick’s strategy for managing its excess cash.  Strategic Income represents their seminal, and core, strategy to fixed-income investing.  Before launching Cohanzick in 1996, David was a Vice President of Leucadia National Corporation, a holding company that might be thought of as a mini-Berkshire Hathaway. His responsibilities there included helping to manage a $3 billion investment portfolio which had an opportunistic distressed securities flair.  When he founded Cohanzick, Leucadia was his first client.  They entrusted him with $150 million, this was the strategy he used to invest it.

Rather than review the fund’s portfolio, which we cover in this month’s profile of it (below), we’ll highlight strategy and his response to listener questions.

The fund focuses on “money good” securities.  Those are securities where, if held to maturity, he’s confident that he’ll get his entire principal and all of the interest due to him.  They’re the sorts of securities where, if the issuer files for bankruptcy, he still anticipates eventually receiving his principal and interest plus interest on his interest.  Because he expects to be able to hold securities to maturity, he doesn’t care about “the taper” and its effects – he’ll simply hold on through any kerfuffle and benefit from regular payments that flow in much like an annuity stream.  These are, he says, bonds that he’d have his mother hold.

Given that David’s mother was one of the early investors in the fund, these are bonds his mother holds.  He joked that he serves as a sort of financial guarantor for her standard of living (if her portfolio doesn’t produce sufficient returns to cover her expenses, he has to reach for his checkbook), he’s very motivated to get this right.

While the fund might hold a variety of securities, they hold little international exposure and no emerging markets debt. They’re primarily invested in North American (77%) and European(14%)  corporate debt, in firms where the accounting is clear and nations where the laws are. The fund’s investment mandate is very flexible, so they can actively hedge portfolio positions (and might) and they can buy income-producing equities (but won’t).

The portfolio focuses on non-investment grade securities, mostly in the B – BB range, but that’s consistent with his intention not to lose his investors’ money. He values liquidity in his investments; that is to say, he doesn’t get into investments that he can’t quickly get out of.  The fund has been letting cash build, and it’s now about 30% of the portfolio.  David’s general preference is to get out too early and lose some potential returns, rather than linger too long and suffer the risk of permanent impairment.

There were rather more questions from callers than we had time to field.  Some of the points we did get to talk about:

David is not impressed with the values available in one- to three-year bonds, they’ve been subject to too much buying by the anxious herd.  He’s currently finding better values in three- to five-year bonds, especially those which are not included in the major bond indexes.  There is, he says, “a lot of high yield value outside of indexed issues.”

About 50% of the corporate bond market qualifies as “high yield,” which gives him lots of opportunities.

This could function as one’s core bond portfolio.  While there will be more NAV volatility because of mark-to-market rules (that is, you have to ask “what would I get if I stupidly decided to sell my entire portfolio in the midst of a particular day’s market panic”), the risk of permanent impairment of capital occurs only if he’s made a mistake.

Munis are a possibility, but they’re not currently cheap enough to be attractive.

If there’s a limited supply of a security that would be appropriate for both Short-Term and here, Short-Term gets dibs.

Cohanzick is really good at pricing their portfolio securities.  At one level, they use an independent pricing service.  At another, getting the price right has been a central discipline since the firm’s founding and he’s comfortable with his ability to do so even with relatively illiquid names.

At base, David believes the fund can generate returns in the 7-8% range with minimal risk of capital loss.  Given his record with Cohanzick and RPHYX, we are confident that he’s capable of delivering on that promise.  By way of full disclosure: In aligning our mouths and our money, both Chip and I added RSIVX to our personal portfolios this fall.  Once we work out all of the Observer’s year-end finances, we also intend to transfer a portion of the money now in MFO’s credit union savings account into an investment in this fund.

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

The RSIVX conference call

As with all of these funds, we’ve created a new featured funds page for the RiverPark Strategic Income Fund, pulling together all of the best resources we have for the fund.

January Conference Call: Matt Moran, ASTON River Road Long/Short

Last winter we spent time talking with the managers of really promising hedged funds, including a couple who joined us on conference calls.  The fund that best matched my own predilections was ASTON River Road Long/Short (ARLSX), extensive details on which appear on our ARLSX Featured Fund Page.   In our December 2012 call, manager Matt Moran argued that:

1. The fund might outperform the stock market by 200 bps/year over a full, 3-5 year market cycle.
2. The fund can maintain a beta at 0.3 to 0.5, in part because of their systematic Drawdown Plan.
3. Risk management is more important than return management, so all three of their disciplines are risk-tuned.

I was sufficiently impressed that I chose to invest in the fund.  That does not say that we believe this is “the best” long/short fund (an entirely pointless designation), just that it’s the fund that best matched my own concerns and interests.  The fund returned 18% in 2013, placing it in the top third of all long/short funds.

Matt and co-manager Dan Johnson have agreed to join us for a second conversation.  That call is scheduled for Wednesday, January 15, from 7:00 – 8:00 Eastern.  Please note that this is one day later than our original announcement. Matt has been kicking around ideas for what he’d like to talk about.  His short-list includes:

• How we think about our performance in 2013 and, in particular, why we’re satisfied with it given our three mandates (equity-like returns, reduced volatility, capital preservation)
• Where we are finding value on the long side.  It’s a struggle…
• How we’re surviving on the short side.  It’s a huge challenge.  Really, how many marginal businesses can keep hanging on because of the Fed’s historic generosity?  Stocks must ultimately earn what underlying business earns and a slug of these firms are earning …
• But, too, our desire not to be carried out in body bags on short side.
• The fact that we sleep better at night with Drawdown Plan in place.  

HOW CAN YOU JOIN IN?

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

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

For those of you new to our conference calls, here’s the short version: we set up an audio-only phone conversation, you register and receive an 800-number and a PIN, our guest talks for about 20 minutes on his fund’s genesis and strategy, I ask questions for about 20, and then our listeners get to chime in with questions of their own.  A couple days later we post an .mp3 of the call and highlights of the conversation. 

WOULD AN ADDITIONAL HEADS UP HELP?

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

February Conference Call: Joshua B. Parker and Alan Salzbank, RiverPark / Gargoyle Hedged Value

We extend our conversation with hedged fund managers in a conversation with Messrs. Parker and Salzbank, whose RiverPark / Gargoyle Hedged Value (RGHVX) we profiled last June, but with whom we’ve never spoken. 

Gargoyle is a converted hedge fund.  The hedge fund launched in 1999 and the strategy was converted to a mutual fund on April 30, 2012.  Rather than shorting stocks, the strategy is to hold a diversified portfolio mid- to large-cap value stocks, mostly domestic, and to hedge part of the stock market risk by selling a blend of index call options. That value focus is both distinctive and sensible; the strategy’s stock portfolio has outperformed the S&P500 by 4.5% per year over the past 23 years. The options overlay generates 1.5 – 2% in premium income per month. The fund ended 2013 with a 29% gain, which beat 88% of its long/short peers.

That call is scheduled for Wednesday, February 12, from 7:00 – 8:00 Eastern.  We’ll provide additional details in our February issue.  

HOW CAN YOU JOIN IN?

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

Launch Alert: Vanguard Global Minimum Volatility Fund (VMVFX)

Vanguard Global Minimum Volatility Fund (VMVFX) launched on December 12, 2013.  It’s Vanguard’s answer to the craze for “smart beta,” a strategy that seemingly promises both higher returns and lower risk over time.  Vanguard dismisses the possibility with terms like “new-age investment alchemy,” and promise instead to provide reasonable returns with lower risk than an equity investor would otherwise be subject to.  They are, they say, “trying to deliver broadly diversified exposure to the equity asset class, with lower average volatility over time than the market. We will use quantitative models to assess the expected volatility of stocks and correlation to one another.”  They also intend to hedge currency risk in order to further dampen volatility. 

Most portfolios are constructed with an eye to maximizing returns within a set of secondary constraints (for example, market cap).  Volatility is then a sort of fallout from the system.  Vanguard reverses the process here by working to minimize the volatility of an all-equity portfolio within a set of secondary constraints dealing with diversification and liquidity.  Returns are then a sort of fallout from the design.  Vanguard recently explained the fund’s distinctiveness in Our new fund offering: What it is and what it isn’t.

The fund will be managed by James D. Troyer, James P. Stetler, and Michael R. Roach.  They are members of the management teams for about a dozen other Vanguard funds.

The Investor share class has a $3,000 minimum initial investment.  The opening expense ratio is 0.30%.

MFS made its first foray into low-volatility investing this month, launching MFS Low Volatility Equity (MLVAX) and MFS Low Volatility Global Equity (MVGAX) just one week before Vanguard. The former will target a volatility level that is 20% lower than that of the S&P 500 Index over a full market cycle, while the latter will target 30% less volatility than the MSCI All Country World Index.  The MFS funds charge about four times what Vanguard does.

Launch Alert II: Meridian Small Cap Growth Advisor (MSGAX)

Meridian Small Cap Growth Fund launched on December 16^th.  The prospectus says very little about what the managers will be doing: “The portfolio managers apply a ‘bottom up’ fundamental research process in selecting investments. In other words, the portfolio managers analyze individual companies to determine if a company presents an attractive investment opportunity and if it is consistent with the Fund’s investment strategies and policies.”

Nevertheless, the fund warrants – and will receive – considerable attention because of the pedigree of its managers.  Chad Meade and Brian Schaub managed Janus Triton (JATTX) together from 2006 – May 2013.  During their tenure, they managed to turn an initial $10,000 investment into $21,400 by the time they departed; their peers would have parlayed $10,000 into just over $14,000.  The more remarkable fact is that the managed it with a low turnover (39%, half the group average), relatively low risk (beta = .80, S.D. about 3 points below their peers) strategy.  Understandably, the fund’s assets soared to $6 billion and it morphed from focused on small caps to slightly larger names.  Regrettably, Janus decided that wasn’t grounds for closing the fund.

Messrs Meade and Schaub joined Arrowpoint Partners in May 2013.  Arrowpoint famously is the home of a cadre of Janus alumni (or escapees, depending):  David Corkins, Karen Reidy, Tony Yao, Minyoung Sohn and Rick Grove.  Together they managed over $2 billion.  In June, they purchased Aster Investment Management, advisor to the Meridian funds, adding nearly $3 billion more in assets.  We’ll reach out to the Arrowpoint folks early in the new year.

The Advisor share class is available no-load and NTF through brokerages like Scottrade, with a $2,500 minimum initial investment.  The opening expense ratio is 1.60%.

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.

Funds in registration this month are eligible to launch in March, 2014 and some of the prospectuses do highlight that date.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves. This month he tracked down 15 no-load retail funds in registration, which represents our core interest. That number is down from what we’d normally see because these funds won’t launch until February 2014; whenever possible, firms prefer to launch by December 30^th and so force a lot of funds into the pipeline in October.

Interesting entries this month include:

Artisan High Income Fund will invest in high yield corporate bonds and debt.  There are two major distinctions here.  First, it is Artisan’s first fixed-income fund.  Second, Artisan has always claimed that they’re only willing to hire managers who will be “category-killers.”  If you look at Artisan’s returns, you’ll get a sense of how very good they are at that task.  Their new high-yield manager, and eventual head of a new, autonomous high-yield team, is Bryan C. Krug who ran the $10 billion, five star Ivy High Income Fund (WHIYX) for the past seven years.  The minimum initial investment will be $1000 for Investor shares and $250,000 for Advisor shares.  The initial expense ratio will be 1.25% for both Investor and Advisor shares.

Brown Advisory Japan Alpha Opportunities Fund will pursue total return by investing principally in Japanese stocks.  The fund will be constructed around a series of distinct “sleeves,” each with its own distinct risk profile but they don’t explain what they might be. They may invest in common and preferred stock, futures, convertibles, options, ADRs and GDR, REITs and ETFs.  While they advertise an all-cap portfolio, they do flag small cap and EM risks.  The fund will be managed by a team from Wellington Management.  The minimum initial investment will be $5000.  The initial expense ratio will be 1.36%. 

Perritt Low Priced Stock Fund will pursue long-term capital appreciation by investing in small cap stocks priced at $15 or less.  I’m a bit ambivalent but could be talked into liking it.  The lead manager also runs Perritt Microcap (PRCGX) and Ultra MicroCap (PREOX), both of which are very solid funds with good risk profiles.  Doubtless he can do it here.  That said, the whole “under $15” thing strikes me as a marketing ploy and a modestly regrettable one. What benefit does that stipulation really offer the investors?  The minimum initial investment will be $1000, reduced to $250 for all sorts of good reasons, and the initial expense ratio will be 1.5%. 

Manager Changes

On a related note, we also tracked down 40 fund manager changes.  The most intriguing of those include what appears to be the abrupt dismissal of Ken Feinberg, one of the longest-serving managers in the Davis/Selected Funds, and PIMCO’s decision to add to Bill Gross’s workload by having him fill in for a manager on sabbatical.

Updates

There are really very few emerging markets investors which whom I’d trust my money.  Robert Gardiner and Andrew Foster are at the top of the list.  There are notable updates on both this month.

Grandeur Peak Emerging Opportunities (GPEOX) launched two weeks ago, hasn’t released a word about its portfolio, has earned one half of one percent for its investors . . . and has drawn nearly $100 million in assets.  Mr. Gardiner and company have a long-established plan to close the fund at $200 million.  I’d encourage interested parties to (quickly!) read our review of Grandeur Peak’s flagship Global Reach fund.  If you’re interested in a reasonably assertive, small- to mid-cap fund, you may have just a few weeks to establish your account before the fund closes.  The advisor does not intend to market the fund to the general public until February 1, by which time it might well be at capacity.

Investors understandably assume that an e.m. small cap fund is necessarily, and probably substantially, riskier than a more-diversified e.m. fund. That assumption might be faulty. By most measures (standard deviation and beta, for example) it’s about 15% more volatile than the average e.m. fund, but part of that volatility is on the upside. In the past five years, emerging markets equities have fallen in six of 20 quarters.   We can look at the performance of DFA’s semi-passive Emerging Markets Small Cap Fund (DEMSX) to gauge the downside of these funds. 

The same pattern is demonstrated by Templeton E.M. Small Cap (TEMMX): higher beta but surprising resilience in declining quarters.  For aggressive investors, a $2,000 foot-in-the-door position might well represent a rational balance between the need for more information and the desire to maintain their options.

Happily, there’s an entirely-excellent alternative to GPEOX and it’s not (yet) near closing to new investors.

Seafarer Overseas Growth & Income (SFGIX and SIGIX) is beginning to draw well-earned attention. Seafarer offers a particularly risk-conscious approach to emerging markets investing.  It offers a compact (40 names), all-cap portfolio (20% in small- and microcap names and 28% in mid-caps, both vastly higher than its peers) that includes both firms domiciled in the emerging markets (about 70%) and those headquartered in the developing world but profiting from the emerging one (30%). It finished 2013 up 5.5%, which puts it in the top tier of all emerging markets funds. 

That’s consistent with both manager Andrew Foster’s record at his former charge (Matthews Asian Growth & Income MACSX which was one of the two top Asian funds in existence through his time there) and Seafarer’s record since launch (it has returned 20% since February 2012 while its average peer made less than 4%). Assets had been growing briskly through the fund’s first full year, plateaued for much of 2013 then popped in December: the fund moved from about $40 million in AUM to $55 million in a very short period. That presumably signals a rising recognition of Seafarer’s strength among larger investors, which strikes me as a very good thing for both Seafarer and the investors.

On an unrelated note, Oakseed Opportunity (SEEDX) has added master limited partnerships to its list of investable securities. The guys continue negotiating distribution arrangements; the fund became available on the Fidelity platform in the second week of December, 2013. They were already available through Schwab, Scottrade, TDAmeritrade and Vanguard.

Briefly Noted . . .

The Gold Bullion Strategy Fund (QGLDX) has added a redemption fee of 2.00% for shares sold within seven days of purchase because, really, how could you consider yourself a long-term investor if you’re not willing to hold for at least eight days?

Legg Mason Capital Management Special Investment Trust (LMSAX) will transition from being a small- and mid-cap fund to a small cap and special situations fund. The advisor warns that this will involve an abnormal turnover in the portfolio and higher-than-usual capital gains distributions. The fund has beaten its peers precisely twice in the past decade, cratered in 2007-09, got a new manager in 2011 and has ascended to … uh, mediocrity since then. Apparently “unstable” and “mediocre” is sufficient to justify someone’s decision to keep $750 million in the fund. 

PIMCO’s RealRetirement funds just got a bit more aggressive. In an SEC filing on December 30, PIMCO shifted the target asset allocations to increase equity exposure and decrease real estate, commodities and fixed income.  Here’s the allocation for an individual with 40 years until retirement

Real estate and commodities are an inflation hedge (that’s the “real” part of RealRetirement) and PIMCO’s commitment to them has been (1) unusually high and (2) unusually detrimental to performance.

SMALL WINS FOR INVESTORS

Effective January 2, 2014, BlackRock U.S. Opportunities Portfolio (BMEAX) reopened to new investors. Skeptics might note that the fund is large ($1.6 billion), overpriced (1.47%) and under-performing (having trailed its peers in four of the past five years), which makes its renewed availability a distinctly small win.

Speaking of “small wins,” the Board of Trustees of Buffalo Funds has approved a series of management fees breakpoints for the very solid Buffalo Small Cap Fund (BUFSX).  The fund, with remains open to new investors despite having nearly $4 billion in assets, currently pays a 1.0% management fee to its advisor.  Under the new arrangement, the fee drops by five basis points for assets from $6 to $7 billion, another five for assets from $7-8 and $8-9 then it levels out at 80 bps for assets over $9 billion.  Those gains are fairly minor (the net fee on the fund at $7 billion is $69.5 million under the new arrangement versus $70 million under the old) and the implication that the fund might remain open as it swells is worrisome.

Effective January 1, 2014, Polaris Global Value Fund (PGVFX) has agreed to cap operating expenses at 0.99%.  Polaris, a four-star fund with a quarter billion in assets, currently charges 1.39% so the drop will be substantial. 

The investment minimum for Institutional Class shares of Yacktman Focused Fund (YAFFX) has dropped from $1,000,000 to $100,000.

Vanguard High-Yield Corporate Fund (VWEHX) has reopened to new investors.  Wellington Management, the fund’s advisor, reports that  “Cash flow to the fund has subsided, which, along with a change in market conditions, has enabled us to reopen the fund.”

CLOSINGS (and related inconveniences)

Driehaus Select Credit Fund (DRSLX) will close to most new investors on January 31, 2014. The strategy capacity is about $1.5 billion and the fund already holds $1 billion, with more flowing in, so they decided to close it just as they closed its sibling, Driehaus Active Income (LCMAX). You might think of it as a high-conviction, high-volatility fixed income hedge fund.

Hotchkis & Wiley Mid-Cap Value (HWMIX) is slated to close to new investors on March 1, 2014. Ted, our board’s most senior member, opines “Top notch MCV fund, 2.8 Billion in assets, and superior returns.”  I nod.

Sequoia (SEQUX) closed to new investors on December 10^th. Their last closure lasted 25 years.

Vanguard Capital Opportunity Fund (VHCOX), managed by PRIMECAP Management Company, has closed again. It closed in 2004, opened the door a crack in 2007 and fully reopened in 2009.  Apparently the $2 billion in new assets generated a sense of concern, prompting the reclosure.

OLD WINE, NEW BOTTLES

Aberdeen Diversified Income Fund (GMAAX), a tiny fund distinguished more for volatility than for great returns, can now invest in closed-end funds.  Two other Aberdeen funds, Dynamic Allocation (GMMAX) and Diversified Alternatives (GASAX), are also now permitted  to invest, to a limited extent, in “certain direct investments” and so if you’ve always wanted exposure to certain direct investments (as opposed to uncertain ones), they’ve got the funds for you.

American Independence Core Plus Fund (IBFSX) has changed its name to the American Independence Boyd Watterson Core Plus Fund, presumably in the hope that the Boyd Watterson name will work marketing magic.  Not entirely sure why that would be the case, but there it is.

Effective December 31, 2013, FAMCO MLP & Energy Income Fund became Advisory Research MLP & Energy Income Fund. Oddly, the announcement lists two separate “A” shares with two separate ticker symbols (INFIX and INFRX).

In February Compass EMP Long/Short Fixed Income Fund (CBHAX) gets rechristened Compass EMP Market Neutral Income Fund and it will no longer be required to invest at least 80% in fixed income securities.  The change likely reflects the fact that the fund is underwater since its November 2013 inception (its late December NAV was $9.67) and no one cares (AUM is $28 million).

In yet another test of my assertion that giving yourself an obscure and nonsensical name is a bad way to build a following (think “Artio”), ING reiterated its plan to rebrand itself as Voya Financial.  The name change will roll out over the first half of 2014.

As of early December, Gabelli Value Fund became Gabelli Value 25 Fund (GABVX). And no, it does not hold 25 stocks (the portfolio has nearly 200 names).  Here’s their explanation: “The name change highlights the Fund’s overweighting of its core 25 equity positions and underscores the upcoming 25^th anniversary of the Fund’s inception.” And yes, that does strike me as something that The Mario came up with and no one dared contradict.

GMO, as part of a far larger fund shakeup (see below), has renamed and repurposed four of its institutional funds.  GMO International Core Equity Fund becomes GMO International Large/Mid Cap Equity Fund, GMO International Intrinsic Value Fund becomes GMO International Equity Fund, GMO International Opportunities Equity Allocation Fund becomes GMO International Developed Equity Allocation Fund, and GMO World Opportunities Equity Allocation Fund morphs (slightly) into GMO Global Developed Equity Allocation Fund, all on February 12, 2014. Most of the funds tweaked their investment strategy statements to comply with the SEC’s naming rules which say that if you have a distinct asset class in your name (large/midcap equity), you need to have at least 80% of your portfolio in that class. 

Effective February 28, MainStay Intermediate Term Bond Fund (MTMAX) becomes MainStay Total Return Bond Fund.

Nuveen NWQ Flexible Income Fund (NWQIX), formerly Nuveen NWQ Equity Income Fund has been rechristened as Nuveen NWQ Global Equity Income Fund, with James Stephenson serving as its sole manager.  If you’d like to get a sense of what “survivorship bias” looks like, you might check out Nuveen’s SEC distributions filing and count the number of funds with lines through their names.

Old Westbury Global Small & Mid Cap Fund (OWSMX) has been rechristened as Old Westbury Small & Mid Cap Fund. It’s no longer required to have a global portfolio, but might.  It’s been very solid, with about 20% of its portfolio in ETFs and the rest in individual securities.

At the meeting on December 3, 2013, the Board approved a change in Old Westbury Global Opportunities Fund’s (OWGOX) name to Old Westbury Strategic Opportunities Fund.  Let’s see: 13 managers, $6 billion in assets, and a long-term record that trails 70% of its peers.  Yep, a name change is just what’s needed!

OFF TO THE DUSTBIN OF HISTORY

Jeez, The Shadow is just a wild man here.

On December 6, 2013, the Board of the Conestoga Funds decided to close and liquidate the Conestoga Mid Cap Fund (CCMGX), effective February 28, 2014.  At the same time, they’re launched a SMid cap fund with the same management team.  I wrote the advisor to ask why this isn’t just a scam to bury a bad track record and get a re-do; they could, more easily, just have amended Mid Cap’s principal investment strategy to encompass small caps and called it SMid Cap.  They volunteered to talk then reconsidered, suggesting that they’d be freer to walk me through their decision once the new fund is up and running. I’m looking forward to the opportunity.

Dynamic Energy Income Fund (DWEIS), one of the suite of former DundeeWealth funds, was liquidated on December 31, 2013.

Fidelity has finalized plans for the merger of Fidelity Europe Capital Appreciation Fund (FECAX) into Fidelity Europe Fund (FIEUX), which occurs on March 21.

The institutional firm Grantham, Mayo, van Otterloo (GMO) is not known for precipitous action, so their December announcement of a dozen fund closures is striking.  One set of funds is simply slated to disappear:

In addition, the Board has approved the termination of GMO Asset Allocation International Small Companies Fund and GMO International Large/Mid Cap Value Fund, neither of which had commenced operations.

They then added two sets of fund mergers: GMO Debt Opportunities Fund into GMO Short-Duration Collateral Fund (with the freakish coda that “GMO Short-Duration Collateral Fund is not pursuing an active investment program and is gradually liquidating its portfolio” but absorbing Debt Opportunities gives it reason to live) and GMO U.S. Flexible Equities Fund into GMO U.S. Core Equity Fund, which is expected to occur on or about January 24, 2014.

Not to be outdone, The Hartford Mutual Funds announced ten fund mergers and closures themselves.  Hartford Growth Fund (HGWAX) is merging with Hartford Growth Opportunities Fund (HGOAX), Hartford Global Growth (HALAX) merges with Hartford Capital Appreciation II (HCTAX) and Hartford Value (HVFAX) goes into Hartford Value Opportunities (HV)AX), all effective April 7, 2014. None of which, they note, requires shareholder approval. I have real trouble seeing any upside for the funds’ investors, since most going from one sub-par fund into another and will see expenses drop by just a few basis points. The exceptions are the value funds, both of which are solid and economically viable on their own. In addition, Hartford is pulling the plug on its entire target-date retirement line-up. The funds slated for liquidation are Hartford Target Retirement 2010 through 2050. That dirty deed will be done on June 30, 2014. 

Highbridge Dynamic Commodities Strategy Fund (HDSAX) is slated to be liquidated and dissolved (an interesting visual image) on February 7, 2014. In the interim, it’s going to cash.

John Hancock Sovereign Investors Fund (SOVIX) will merge into John Hancock Large Cap Equity Fund (TAGRX), on or about April 30, 2014.

Principal SmallCap Growth Fund II (PPMIX) will be absorbed by SmallCap Growth Fund I (PGRTX) on or about April 25, 2014.

It’s with some sadness that we bid adieu to Tom Kerr and his Rocky Peak Small Cap Value Fund (RPCSX), which liquidated on December 30.  The fund sagged from “tiny” to “microscopic” by the end of its run, with under a million in assets.  Its performance in 2013 was pretty much calamitous, which was both curious and fatal.  Tom was an experienced manager and sensible guy who will, we hope, find a satisfying path forward. 

In a sort of three-for-one swap, Pax World International Fund (PXIRX) and Pax MSCI EAFE ESG Index ETF (EAPS) are merging to form the Pax World International ESG Index Fund.

On October 21, 2013, the Board of Directors of the T. Rowe Price Summit GNMA Fund (PRSUX) approved a proposed merger with, and into, T. Rowe Price GNMA Fund (PRGMX).

The Vanguard Managed Payout Growth Focus Fund (VPGFX) and Vanguard Managed Payout Distribution Focus Fund (VPDFX) are each to be reorganized into the Vanguard Managed Payout Growth and Distribution Fund (VPGDX) on or about January 17, 2014.

W.P. Stewart & Co. Growth Fund (WPSGX) is merging into the AllianceBernstein Concentrated Growth Fund (WPCSX), which has the same manager, investment discipline and expenses of the WPS fund.  Alliance acquired WPS in December, so the merger was a sort of foregone conclusion.

Wegener Adaptive Growth Fund (WAGFX) decided, on about three days’ notice, to close and liquidate at the end of December, 2013.  It had a couple very solid years (2008 and 2009) then went into the dumper, ending with a portfolio smaller than my retirement account.

A small change

Our navigation menu is growing. If you look along the top of our page, you’ll likely notice that “Featured Funds” is no longer a top-level menu item. Instead the “Featured Funds” category can now be found under the “Fund” or “The Best” menus. Replacing it as a new top-level menu is “Search Tools”, which is the easiest way to directly access new search functionality that Accipiter, Charles, and Chip have been working on for the past few months.

Under Search Tools, you’ll find:

1. Risk Profile – designed to help you understand the different measures of a fund’s risk profile. No one measure of risk captures the full picture and most measures of risk are not self-explanatory. Our Risk Profile reporter allows you to enter a single ticker symbol for any fund and it will generate a short, clear report, in simple, conversational English, that walks you through the various means of risk and returns and will provide you with the profiles for a whole range of possible benchmarks. Alternatively, entering multiple ticker symbols will return a tabular results page, making side-by-side comparisons more convenient.
2. Great Owls – allows you to screen our Great Owl Funds – those which have top tier performance in every trailing period of three years or more – by category or profile. We know that past performance should never be the primary driver of your decision-making, but working from a pool of consistently superior performers and learning more about their risk-return profile strikes us as a sensible place to start.
3. Fund Dashboard – a snapshot of all of the funds we’ve profiled, is updated monthly and is available both as a .pdf and as a searchable and sortable search.
4. Miraculous Multi-Search – Accipiter’s newest screening tool helps us search Charles’ database of risk elements. Searches are available by fund name, category, risk group and age group. There’s even an option to restrict the results to GreatOwl funds. Better yet, you can search on multiple criteria and further refine your results list by choosing to hide certain results.

In Closing . . .

Thank you, dear friends.  It’s been a remarkable year.  In December of 2012, we served 9000 readers.  A year later, 24,500 readers made 57,000 visits to the Observer in December – a gain of 150%.  The amount of time readers spend on site is up, too, by about 50% over last year.  The percentage of new visitors is up 57%.  But almost 70% of visits are by returning readers.

It’s all the more striking because we’re the antithesis of a modern news site: our pieces tend to be long, appear once a month and try to be reflective and intelligent.  NPR had a nice piece that lamented the pressure to be “first, loud and sensational” (This is (not) the most important story of the year, 12/29/2013).  The “reflective and intelligent” part sort of reflects our mental image of who you are. 

We’ve often reminded folks of their ability to help the Observer financially, either through our partnership with Amazon (they rebate us about 7% of the value of items purchased through our link) or direct contributions.  Those are both essential and we’re deeply grateful to the dozens of folks who’ve acted on our behalf.  This month we’d like to ask for a different sort of support, one which might help us make the Observer better in the months ahead.

Would you tell us a bit about who you are and why you’re here?  We do not collect any information about you when you visit. The cosmically-talented Chip found a way to embed an anonymous survey directly in this essay, so that you could answer a few questions without ever leaving the comfort of your chair.  What follows are six quick questions.  We’re setting aside questions about our discussion board for now, since it’s been pretty easy to keep in touch with the folks there.  Complete as many as you’re comfortable with.

We’ll share as soon as we hear back from you.

Thanks to Deb (the first person ever to set up an automatic monthly contribution to the site, which was really startling when we found out), to David and the other contributors scattered (mostly) in warm states (and Indianapolis), and to friends who’ve shared books, cookies, well-wishes and holiday cheer.

Finally, thanks to the folks whose constant presence makes the Observer happen: the folks who’ve spent this entire century supporting the discussion board (BobC, glampig, rono, Slick, the indefatigable Ted, and Whakamole among them) and the hundred or so folks regularly on the board; The Shadow, who can sense the presence of interesting SEC filings from a mile away; Accipiter, whose programming skills – generally self-taught – lie behind our fund searches; Ed, who puzzles and grumbles; Charles, who makes data sing; and the irreplaceable Chip, friend, partner and magician.  I’m grateful to you all and look forward to the adventures of the year ahead.

As ever,

Dear friends,

Welcome.  Do you think it a coincidence that the holiday season occurs at the least promising time of the year?  The days are getting shorter and, for our none-too-distant ancestors, winter represented a period of virtual house arrest.  Night was a time of brigands and beasts.  Even in the largest cities, respectable folks traveled abroad after dark only with armed guard.  In villages and on farms, travel on a clouded night risked disappearance and death.  The homes of all but the richest citizens were, contrary to your mental fantasy of roaring hearths and plentiful candles, often a single room that could boast a single flickering rushlight.  The hungry months of late winter were ahead.

And so they did what any sensible group would do.  They partied.  One day’s worth of oil became eight nights’ worth of light; Jewish friends gathered, ate and gifted.  Bacchus reigned from our Thanksgiving to the Winter Solstice, and the Romans drank straight through it.  The Kalash people of Pakistan sang, danced, lit bonfires and feasted on goat tripe “and other delicacies” (oh, yum!).  Chinese and Korean families gathered and celebrated with balls of glutinous rice (more yum!).  Welsh friends dressed up like wrens (yuh), and marched from home to home, singing and snacking.  Romans in the third century CE celebrated Dies Natalis Solis Invicti (festival of the birth of the Unconquered Sun) on December 25^th, a date later borrowed by Christians for their own mid-winter celebration.  Some enterprising soul, having consumed most of the brandy, inexplicably mashed together figs, stale bread and the rest of the brandy.  Figgy pudding was born and revelers refused to go until they got some (along with a glass of good cheer).

Few of these celebrations recognized a single day, they brought instead Seasons Greetings.  Fewer still celebrated individual success or personal enrichment, they instead brought to the surface the simple truth that we often bury through the rest of the year: we are infinitely poorer alone in our palaces than we are together in our villages.

Season’s greetings, dear friends.

But curb yer enthusiasm

Small investors and great institutions alike are partaking in one of the market’s perennial ceremonies: placing your investments atop an ever-taller pile of dried kindling and split logs.  All of the folks who hated stocks when they were cheap are desperate to buy them now that they’re expensive.

We have one word for you: Don’t.

Or, at the very least, don’t buy them until you’re clear why they weren’t attractive to you five years ago but are calling so loudly to you now.  We’re not financial planners, much like market visionaries, but some very careful folks forecast disappointment for starry-eyed stock investors in the years ahead.

Sam Lee, editor of Morningstar ETFInvestor, warned investors to “Expect Below-Average Stock Returns Ahead” based on his reading of the market’s cyclically-adjusted price/earnings ratio.  He wrote, on November 21, that:

The Shiller P/E recently hit 25. When you invert that you get is another measure that I like: the cyclically adjusted earnings yield. The inverse of the Shiller P/E, 1 divided by 25 is about 0.04, or 4%. And this is the smooth earnings yield of the market. This is actually, I think, a reasonable forecast for what the market can be expected to return during the next 10, 20 years. And a 4% real expected return is well below the historical average of 6.5%. 

The Shiller P/E is saying that the market is overvalued relative to history, that you can expect about 2 percentage points less per year over a long period of time. .. if you believe that the market is mean reverting to its historical Shiller P/E, and that the past is a reasonable guide to the future, then you can expect lower returns than the naive 4% forecast return that I provided.

The institutional investors at Grantham, Mayo, van Otterloo (GMO) believe in the same tendency of markets to revert to their mean valuations and profits to revert to their mean levels (that is, firms can’t achieve record profit levels forever – some combination of worker demands to share the wealth and predatory competitors drawn by the prospect of huge profits, will drive them back down).  After three years of research on their market projection models, GMO added some factors that slightly increased their estimate of the market’s fair value and still came away from the projection that US stocks are poised to trail inflation for the rest of this decade.  Ben Inker writes:

In a number of ways it is a “clean sheet of paper” look at forecasting equities, and we have broadened our valuation approach from looking at valuations through the lens of sales to incorporating several other methods. It results in about a 0.7%/year increase in our forecast for the S&P 500 relative to the old model. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation.

On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. For those interested in the broader U.S. stock market, our forecast for the Wilshire 5000 is a bit worse, at -2.0%, due to the fact that small cap valuations are even more elevated than those for large caps.

In 2013, the average equity investor made inflation plus about 28%.  Through the remainder of the decade, optimists might give you inflation plus 2, 3 or 4%.  Bearish realists are thinking inflation minus 1 or 2%.

The Leuthold Group, looking at the market’s current valuation, is at most masochistically optimistic: they project that a “normal” bear market, starting now, would probably not trim much more than 25% off your portfolio.

What to do?  Diversify, keep expenses aligned with the value added by your managers, seek some income from equities and take time now – before you forget and before some market event makes you want to look away forever – to review your portfolio for balance and performance.  As an essential first step, remember the motto:

Off with their heads!

As the Thanksgiving holiday passes and you begin year-end financial planning, we say it’s time to toss out the turkeys.  There are some funds that we’re not impressed with but which have the sole virtue that they’re not rolling disasters. You know: the overpriced, bloated index-huggers that seemed like the “safe” choice long ago. And now, like mold or lichen, they’ve sort of grown on you.

Fine. Keep ‘em if you must. But at least get rid of the rolling disasters you’ve inherited. There are a bunch of funds whose occasional flashes of adequacy and earnest talk of new paradigms, great rotations, sea changes, and contrarian independence simply can’t mask the fact that they suck. A lot. For a long time.

It’s time to work through your portfolio, fund by fund, and answer the simple question: “if I didn’t already own this fund, is there any chance on earth I’d buy it?” If the answer is “no,” sell.

Mutual Fund Observer is an outgrowth of FundAlarm, whose iconic Three Alarm Funds list continually identified the worst of the worst in the fund industry. For the last several years we’ve published our own Roll Call of the Wretched, an elite list of funds whose ineptitude stretches over a decade or more. In response to requests that arrive every month, we’re happy to announce the re-introduction of the Three Alarm Funds list which will remain an ongoing service of the Observer. So here we go!

The Observer’s Annual “Roll Call of the Wretched”

If you’re resident in one of the two dozen states served by Amazon’s wine delivery service, you might want to buck up your courage with a nice 2007 Domaine Gerard Charvin Chateauneuf du Pape Rhône Valley Red before you settle in to enjoy the Observer’s annual review of the industry’s Most Regrettable funds. Just as last year, we looked at funds that have finished in the bottom one-fourth of their peer groups for the year so far. And for the preceding 12 months, three years, five years and ten years. These aren’t merely “below average.” They’re so far below average they can hardly see “mediocre” from where they are.

When we ran the screen in 2011, there were 151 consistently awful funds, the median size for which is $70 million. In 2012 there were . . . 151 consistently awful funds, the median size for which is $77 million. And now? 152 consistently awful funds (I love consistency), the median size of which is $91 million.

Since managers love to brag about the consistency of their performance, here are the most consistently awful funds that have over a billion in assets. Funds repeating from last year are flagged in red.

Some funds did manage to escape this year’s Largest Wretched Funds list, though the strategies vary: some went extinct, some took on new names, one simply shrank below our threshold and a few rose all the way to mediocrity. Let’s look:

While most Roll Call funds are small enough that they’re unlikely to trouble you, there are 50 more funds with assets between $100 million and a billion. Check to see if any of these wee beasties are lurking around your portfolio:

Morningstar maintains a favorable analyst opinion on three Wretched funds, is Neutral on three (Brandywine BRWIX, Fidelity Freedom 2000 FFFMX and Pioneer PIODX) and Negative on just four (Hussman Strategic Growth HSGFX, Oppenheimer Flexible Strategies QVOPX and two State Farm LifePath funds). The medalist trio are:

And now (drum roll, please), it’s the return of a much-loved classic …

Three Alarm Funds Redux

Roy Weitz first published the legacy Three Alarm fund list in 1996. He wanted to help investors decide when to sell mutual funds. Being on the list was not an automatic sell, but a warning signal to look further and see why.

“I liken the list to the tired old analogy of the smoke detector. If it goes off, your house could be on fire. But it could also be cobwebs in the smoke detector, in which case you just change the batteries and go back to sleep,” he explained in a 2002 interview.

Funds made the list if they trailed their benchmarks for the past 1, 3, and 5 year periods. At the time, he grouped funds into only five equity (large-cap, mid-cap, small-cap, balanced, and international) and six specialty “benchmark categories.” Instead of pure indices, he used actual funds, like Vanguard 500 Index Fund VFINX, as benchmarks. Occasionally, the list would catch some heat because “mis-categorization” resulted in an “unfair” rating. Some things never change.

At the end of the day, however, Mr. Weitz wanted “to highlight the most serious underperformers.” In that spirit, MFO will resurrect the Three Alarm fund list, which will be updated quarterly along with the Great Owl ratings. Like the original methodology, inclusion on the list will be based entirely on absolute, not risk-adjusted, returns over the past 1, 3, and 5 year periods.

Since 1996, many more fund categories exist. Today Morningstar assigns over 90 categories across more than 7500 unique funds, excluding money market, bear, trading, volatility, and specialized commodity. MFO will rate the new Three Alarm funds using the Morningstar categories. We acknowledge that “mis-categorization” may occasionally skew the ratings, but probably much less than if we tried to distill all rated funds into just 11 or so categories.

For more than two-thirds of the categories, one can easily identify a reasonable “benchmark” or reference fund, thanks in part to the proliferation of ETFs. Below is a sample of these funds, sorted first by broad investment Type (FI – Fixed Income, AA – Asset Allocation, EQ – Equity), then Category:

Values in the table include the 3-year annualized standard deviation percentage (STDEV), as well as annualized return percentages (APR) for the past 1, 3, and 5 year periods.

A Return Rating is assigned based how well a fund performs against other funds in the same category during the same time periods. Following the original Three Alarm nomenclature, best performing funds rate a “2” (highlighted in blue) and the worst rate a “-2” (red).

As expected, most of the reference funds rate mid range “0” or slightly better. None produce top or bottom tier returns across all evaluation periods. The same is true for all 60 plus category reference funds. Selecting reference funds in the other 30 categories remains difficult because of their diversity.

To “keep it simple” MFO will include funds on the Three Alarm list if they have the worst returns in their categories across all three evaluation periods. More precisely, Three Alarm Funds have absolute returns in the bottom quintile of their categories during the past 1, 3, and 5 years. Most likely, these funds have also under-performed their “benchmarks” over the same three periods.

There are currently 316 funds on the list, or fewer than 6% of all funds rated. Here are the Three Alarm Funds in the balanced category, sorted by 3 year annualized return:

Like in the original Three Alarm list, a fund’s Risk Rating is assigned based a “potential bad year” relative to other funds in the same category. A Risk Rating of “2” (highlighted in red) goes to the highest risk funds, while “-2” (blue) goes to the lowest risk funds. (Caution: This rating measures a fund’s risk relative to other funds in same category, so a fund in a high volatility category like energy can have high absolute risk relative to market, even if it has a low risk rating in its category.)

“Risk” in this case is based on the 3 year standard deviation and return values. Specifically, two standard deviations are subtracted from the return value. The result is then compared with other funds in the category to assign a rating. The rating is a little more sensitive to downside than the original measure as investors have experienced two 50% drawdowns since the Three Alarm system was first published.

While never quite as popular as the Three Alarm list, Mr. Weitz also published an Honor Roll list. In the redux system, Honor Roll funds have returns in the top quintile of their categories in the past 1, 3, and 5 years. There are currently 339 such funds.

The Three Alarm, Honor Roll, and Reference funds can all be found in a down-loadable *.pdf version.

06Nov2013/Charles

Funds that are hard to love

Not all regrettable funds are defined by incompetent management. Far from it. Some have records good enough that we really, really wish that they weren’t so hard to love (or easy to despise). High on our list:

Oceanstone Fund (OSFDX)

Why would we like to love it? Five-star rating from Morningstar. Small asset base. Flexible mandate. Same manager since launch. Top 1% returns over the past five years.

What makes it hard to love? The fund is entirely opaque and the manager entirely autocratic. Take, for example, this sentence from the Statement of Additional Information:

Ownership of Securities: As of June 30, 2013, the dollar range of shares in the Fund beneficially owned by James J. Wang and Yajun Zheng is $500,001-$1,000,000.

Mr. Wang manages the fund. Ms. Zheng does not. Nor is she a director or board member; she is listed nowhere else in the prospectus or the SAI as having a role in the fund. Except this: she’s married to Mr. Wang. Which is grand. But why is she appearing in the section of the manager’s share ownership?

Mr. Wang was the only manager to refuse to show up to receive a Lipper mutual fund award. He’s also refused all media attempts to arrange an interview and even the chairman of his board of trustees sounds modestly intimidated by him. His explanation of his investment strategy is nonsense. He keeps repeating the magic formula: IV = IV divided by E, times E. No more than a high school grasp of algebra tells you that this formula tells you nothing. I shared it with two professors of mathematics, who both gave it the technical term “vacuous.” It works for any two numbers (4 = 4 divided by 2, times 2) but it doesn’t allow you to derive one value from the other.

The fund’s portfolio turns over at triple the average rate, consists of just five stocks and a 70% cash stake.

Value Line Asset Allocation Fund (VLAAX)

Why would we like to love it? Five-star rating from Morningstar. Consistency below-average to low risk. Small asset base. Same manager for 20 years. Top tier returns over the past decade.

What makes it hard to love? Putting aside the fact that the advisory firm’s name is “value” spelled backward (“Eulav”? Really guys?), it’s this sentence:

Ownership of Securities. None of the portfolio managers of the Value Line Asset Allocation Fund own shares of the Fund. The portfolio manager of the Value Line Small Cap Opportunities Fund similarly does not own shares of that Fund.

It’s also the fact that I’ve tried, on three occasions, to reach out to the fund’s advisor to ask why no manager ever puts a penny alongside his shareholders but they’ve never responded to any of the queries.

But wait! There’s 

Four things strike us as quite good:

1. You probably aren’t invested in any of the really rotten funds!
2. Even if you are, you know they’re rotten and you can easily get out.
3. There are better funds – ones more appropriate to your needs and personality – available.
4. We can help you find them!

Accipiter, Charles and Chip have been working hard to make it easier for you to find funds you’ll be comfortable with. We’d like to share two and have a third almost ready, but we need to be sure that our server can handle the load (we might a tiny bit have precipitated a server crash in November and so we’re being cautious until we can arrange a server upgrade).

The Risk Profile Search is designed to help you understand the different measures of a fund’s risk profile. Most fund profiles reduce a fund’s risks to a single label (“above average”) or a single stat (standard deviation = 17.63). Unfortunately, no one measure of risk captures the full picture and most measures of risk are not self-explanatory (how would you do on a pop quiz over the Martin Ratio?). Our Risk Profile Reporter allows you to enter a single ticker symbol for any fund and it will generate a short, clear report, in simple, conversational English, that walks you through the various means of risk and returns and will provide you with the profiles for a whole range of possible benchmarks. Alternatively, entering multiple ticker symbols will return a tabular results page, making side-by-side comparisons more convenient.

The Great Owl Search Engine allows you to screen our Great Owl Funds – those which have top tier performance in every trailing period of three years or more – by category or profile. We know that past performance should never be the primary driver of your decision-making, but working from a pool of consistently superior performers and learning more about their risk-return profile strikes us as a sensible place to start.

Our Fund Dashboard. a snapshot of all of the funds we’ve profiled, is updated quarterly and is available both as a .pdf and searchable, sortable search.

Accipiter’s Miraculous Multi-Search will, God and server willing, launch by mid-December and we’ll highlight its functions for you in our New Year’s edition.

Touchstone Funds: Setting a high standard on analysis

On November 13, Morningstar published an essay entitled “A Measure of Active Management.” Authored by Touchstone Investments, it’s entirely worth your consideration as one of the most readable walk-throughs available of the literature on active management and portfolio outperformance.

We all know that most actively managed funds underperform their benchmarks, often by more than the amount of their expense ratios. That is, even accounting for an index fund’s low-expense advantage, the average manager seems to actively detract value. Literally, many investors would be better off if their managers were turned to stone (“calling Madam Medusa, fund manager in Aisle Four”), the portfolio frozen and the manager never replaced.

Some managers, however, do consistently earn their keep. While they might or might not produce raw returns greater than those in an index fund, they can fine-tune strategies, moderate risks and keep investors calm and focused.

Touchstone’s essay at Morningstar makes two powerful contributions. First, the Touchstone folks make the criteria for success – small funds, active and focused portfolios, aligned interests – really accessible. Second, they document the horrifying reality of the fund industry: that a greater and greater fraction of all investments are going into funds that profess active management but are barely distinguishable from their benchmarks.

Here’s a piece of their essay:

A surprising take away from the Active Share studies was the clear trend away from higher Active Share (Exhibit 5). The percentage of assets in U.S. equity funds with Active Share less than 60% went from 1.5% in 1980 to 50.2% in 2009. Clearly indexing has had an impact on these results.

Yet mutual funds with assets under management with an Active Share between 20% and 60% (the closet indexers) saw their assets grow from 1.1% in 1980 to 31% in 2009, meaning that closet index funds have seen the greatest proportion of asset growth. Assets in funds managed with a high Active Share, (over 80%), have dropped precipitously from 60% in 1980 to just 19% in 2009.

While the 2009 data is likely exaggerated — as Active Share tends to come down in periods of high market volatility —the longer term trend is away from high Active Share.

 

Cremers and Petajisto speculate that asset growth of many funds may be one of the reasons for the trend toward lower Active Share. They note that the data reveals an inverse relationship between assets in a fund and Active Share. As assets grow, managers may have a tougher time maintaining high Active Share. As the saying goes “nothing fails like success,” and quite often asset growth can lead to a more narrow opportunity set due to liquidity constraints that prevent managers from allocating new assets to their best ideas, they then add more liquid benchmark holdings. Cremers states in his study: “What I say is, if you have skill, why not apply that skill to your whole portfolio? And if your fund is too large to do that, why not close your portfolio?”

In an essentially unprecedented disclosure, Touchstone then published the concentration and Active Share statistics for their entire lineup of funds:

While it’s clear that Touchstone has some great funds and some modest ones, they really deserve attention and praise for sharing important, rarely-disclosed information with all of their investors and with the public at large. We’d be much better served if other fund companies had the same degree of confidence and transparency.

Touchstone is also consolidating four funds into two, effective March 2014. Steve Owen, one of their Managing Directors and head of International Business Development, explains:

With regard to small value, we are consolidating two funds, both subadvised by the same subadvisor, DePrince, Race & Zollo. Touchstone Small Cap Value Fund (TVOAX) was a legacy fund and that will be the receiving fund. Touchstone Small Company Value Fund (FTVAX), the one that is going away, is a fund that was adopted last year when we bought the Fifth Third Fund Family and we replaced the subadvisor at that time with DePrince Race & Zollo. Same investment mandate, same subadvisor, so it was time to consolidate the two funds.

The Mid Value Opportunities Fund (TMOAX)was adopted last year from the Old Mutual Fund Family and will be merged into Touchstone Mid Cap Value Fund (TCVAX). Consolidating the lineup, eliminating the adopted fund in favor of our incumbent from four years ago.

In preparation for the merger, Lee Munder Capital Group has been given manager responsibilities for both mid-cap funds. Neither of the surviving funds is a stand-out performer but bear watching.

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.

Aegis Value (AVALX): There are a few funds that promise to pursue the most inefficient, potentially most profitable corner of the domestic equity mark, ultra-small deep value stocks. Of the handful that pursue it, only one other microcap value fund even comes close to Aegis’s long-term record.

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously. Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds. So far, so good!

Elevator Talk

Elevator Talks are a short feature which offer the opportunity for the managers of interesting funds which we are not yet ready to profile, to speak directly to you. The basic strategy is for the Observer to lay out three paragraphs of introduction and then to give the manager 200 unedited words – about what he’d have time for in an elevator ride with a prospective investors – to lay out his case for the fund.

Our planned Elevator Talk for December didn’t come to fruition, but we’ll keep working with the managers to see if we can get things lined up for January.

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 (VCMRX), 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.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.
10. November 2013: Jeffrey Ringdahl of American Beacon Flexible Bond (AFXAX) gives teams from Brandywine Global, GAM and PIMCO incredible leeway wth which to pursue “positive total return regardless of market conditions.” Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Conference Call Highlights: John Park and Greg Jackson, Oakseed Opportunity

If I had to suggest what characteristics gave an investor the greater prospects for success, I suggest looking for demonstrably successful managers who viscerally disliked the prospect of careless risk and whose interests were visibly, substantially and consistently aligned with yours.

The evidence increasingly suggests that Oakseed Opportunity matches those criteria. On November 18^th, Messrs Jackson and Park joined me and three dozen Observer readers for an hour-long conversation about the fund and their approach to it.

I was struck, particularly, that their singular focus in talking about the fund is “complete alignment of interests.” A few claims particularly stood out:

1. their every investable penny in is in the fund.
2. they intend their personal gains to be driven by the fund’s performance and not by the acquisition of assets and fees
3. they’ll never manage separate accounts or a second fund
4. they created an “Institutional” class as a way of giving shareholders a choice between buying the fund NTF with a marketing fee or paying a transaction fee but not having the ongoing expense; originally they had a $1 million institutional minimum because they thought institutional shares had to be that pricey. Having discovered that there’s no logical requirement for that, they dropped the institutional minimum by 99%.
5. they’ll close on the day they come across an idea they love but can’t invest in
6. they’ll close if the fund becomes big enough that they have to hire somebody to help with it (no analysts, no marketers, no administrators – just the two of them)

Highlights on the investing front were two-fold:

first, they don’t intend to be “active investors” in the sense of buying into companies with defective managements and then trying to force management to act responsibly. Their time in the private equity/venture capital world taught them that that’s neither their particular strength nor their passion.

second, they have the ability to short stocks but they’ll only do so for offensive – rather than defensive – purposes. They imagine shorting as an alpha-generating tool, rather than a beta-managing one. But it sounds a lot like they’ll not short, given the magnitude of the losses that a mistaken short might trigger, unless there’s evidence of near-criminal negligence (or near-Congressional idiocy) on the part of a firm’s management. They do maintain a small short position on the Russell 2000 because the Russell is trading at an unprecedented high relative to the S&P and attempts to justify its valuations require what is, to their minds, laughable contortions (e.g., that the growth rate of Russell stocks will rise 33% in 2014 relative to where they are now.

Their reflections of 2013 performance were both wry and relevant. The fund is up 21% YTD, which trails the S&P500 by about 6.5%. Greg started by imagining what John’s reaction might have been if Greg said, a year ago, “hey, JP, our fund will finish its first year up more than 20%.” His guess was “gleeful” because neither of them could imagine the S&P500 up 27%. While trailing their benchmark is substantially annoying, they made these points about performance:

• beating an index during a sharp market rally is not their goal, outperforming across a complete cycle is.
• the fund’s cash stake – about 16% – and the small short position on the Russell 2000 doubtless hurt returns.
• nonetheless, they’re very satisfied with the portfolio and its positioning – they believe they offer “substantial downside protection,” that they’ve crafted a “sleep well at night” portfolio, and that they’ve especially cognizant of the fact that they’ve put their friends’, families’ and former investors’ money at risk – and they want to be sure that they’re being well-rewarded for the risks they’re taking.

John described their approach as “inherently conservative” and Greg invoked advice given to him by a former employer and brilliant manager, Don Yacktman: “always practice defense, Greg.”

When, at the close, I asked them what one thing they thought a potential investor in the fund most needed to understand in order to know whether they were a good “fit” for the fund, Greg Jackson volunteered the observation “we’re the most competitive people alive, we want great returns but we want them in the most risk-responsible way we can generate them.” John Park allowed “we’re not easy to categorize, we don’t adhere to stylebox purity and so we’re not going to fit into the plans of investors who invest by type.”

They announced that they should be NTF at Fidelity within a week. Their contracts with distributors such as Schwab give those platforms latitude to set the minimums, and so some platforms reflect the $10,000 institutional minimum, some picked $100,000 and others maintain the original $1M. It’s beyond the guys’ control.

Finally, they anticipate a small distribution this year, perhaps $0.04-0.05/share. That reflects two factors. They manage their positions to minimize tax burdens whenever that’s possible and the steadily growing number of investors in the fund diminishes the taxable gain attributed to any of them.

If you’re interested in the fund, you might benefit from reviewing the vigorous debate on the discussion board that followed the call. Our colleague Charles, who joined in on the call, looked at the managers’ previous funds. He writes: “OK, quick look back at LTFAX and OAKGX from circa 2000 through 2004. Ted, even you should be impressed…mitigated drawdown, superior absolute returns, and high risk adjusted returns.”

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

The SEEDX Conference Call

As with all of these funds, we’ve created a new featured funds page for Oakseed Opportunity Fund, pulling together all of the best resources we have for the fund.

December Conference Call: David Sherman, RiverPark Strategic Income

David Sherman

We’d be delighted if you’d join us on Monday, December 9^th, for a conversation with David Sherman of Cohanzick Asset Management and Morty Schaja, president of the RiverPark funds. On September 30, 2013, Cohanzick and Riverpark collaborated on the launch of their second fund together, RiverPark Strategic Income (RSIVX). Two months later, the fund has drawn nearly $90 million into a limited capacity strategy that sort of straddles the short- to intermediate-term border.

David describes this as a conservatively managed fund that focuses on reasonable returns with maximum downside protection. With both this fund and RiverPark Short-Term High-Yield (RPHYX, closed to new investors), David was comfortable having his mom invest in the fund and is also comfortable that if he gets, say, abducted by aliens, the fund could simply and profitably hold all of its bonds to redemption without putting her security as risk. Indeed, one hallmark of his strategy is its willingness to buy and hold to redemption rather than trading on the secondary market.

President Schaja writes, “In terms of a teaser….

• Sherman and his team are hoping for returns in the 6-8% range while managing a portfolio of “Money Good” securities with an average duration of less than 5 years.  Thereby, getting paid handsomely for the risk of rising rates.
• By being small and nimble Sherman and his team believe they can purchase “Money Good” securities with above average market yields with limited risk if held to maturity.
• The fund will be able to take advantage of some of the same securities in the 1-3 year maturity range that are in the short term high yield fund.
• There are “dented Credits” where credit stress is likely, however because of the seniority of the security the Fund will purchase, capital loss is deemed unlikely.

David has the fund positioned as the next step out from RPHYX on the risk-return spectrum and he thinks the new fund will about double the returns on its sibling. So far, so good:

Since I’m not a fan of wild rivers in a fixed-income portfolio, I really appreciate the total return line for the two RiverPark funds. Here’s Strategic Income against its multisector bond peer group:

Well, yes, I know that’s just two months. By way of context, here’s the three year comparison of RPHYX with its wildly-inappropriate Morningstar peer group (high yield bonds, orange), its plausible peer group (short-term bonds, green) and its functional peer, Vanguard’s Prime Money Market (VMMXX, hmmm…goldenrod?):

Our conference call will be Monday, December 9, from 7:00 – 8:00 Eastern. It’s free. It’s a phone call.

How can you join in?

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

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

WOULD AN ADDITIONAL HEADS UP HELP?

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

Launch Alert: Kopernik Global All-Cap Fund (KGGAX and KGGIX)

It’s rare that the departure of a manager triggers that collapse of an empire, but that’s pretty much what happened when David Iben left his Nuveen Tradewinds Global All-Cap Fund (NWGAX) in June 2012. From inception through his departure, a $10,000 investment in NWGAX would have grown by $3750. An investment made in his average peer would have grown by $90.

Iben was hired away from Tradewinds by Jeff Vinik, the former Fidelity Magellan manager who’d left that fund in 1996 to establish his hedge fund firm, Vinik Asset Management. Iben moved with four analysts to Vinik and became head of a 20-person value investing team.

In the six months following his announced intention to depart, Tradewinds lost nearly 75% of its total assets under management. Not 75% of his funds’ assets. 75% of the entire firm’s assets, about $28 billion between investor exits and market declines.

In May 2013, Vinik announced the closure of his firm “citing poor performance over a 10-month period” (Tampa Bay Business Journal, May 3 2013). You’ll have to give me a second to let my eyes return to normal; the thought of closing a firm because of a ten month bad stretch made them roll.  Mr. Iben promptly launched his own firm, backed by a $20 million investment (a/k/a pocket change) by Mr. Vinik.

On November 1, 2013, Kopernik Global Investors launched launched Kopernik Global All-Cap Fund (Class A: KGGAX; Class I: KGGIX) which they hope will become their flagship. By month’s end, the fund had nearly $120 million in assets.

If we base an estimate of Kopernik Global on the biases evident in Nuveen Tradewinds Global, you might expect:

A frequently out-of-step portfolio, which reflects Mr. Iben’s value orientation, disdain for most investors’ moves and affinity for market volatility. They describe the outcome this way:

This investment philosophy implies ongoing contrarian asset positioning, which in turn implies that the performance of Kopernik holdings are less reliant on the prevailing sentiment of market investors. As one would expect with such asset positioning, the performance of Kopernik strategies tend to have little correlation to common benchmarks.

A substantial overweight in energy and basic materials, which Mr. Iben overweighted almost 2:1 relative to his peers. He had a particular affinity for gold-miners.

The potential for a substantial overweight in emerging markets, which Mr. Iben overweighted almost 2:1 relative to his peers.

A slight overweight in international stocks, which were 60% of the Tradewinds’ portfolio but a bit more than 50% of its peers.

The themes of independence, lack of correlation with other investments, and the exploitation of market anomalies recur throughout Kopernik’s website. If you’re even vaguely interested in exploring this fund, you’d better take those disclosures very seriously. Mr. Iben had brilliant performance in his first four years at Tradewinds, and then badly trailed his peers in five of his last six quarters. While we do not know how his strategy performed at Vinik, we do know that 10 months after his arrival, the firm closed for poor performance.

Extended periods of poor performance are one of the hallmarks of independent, contrarian, visionary investors. It’s also one of the hallmarks of self-prepossessed monomaniacs.  Sometimes the latter look like the former. Often enough, the former are the latter.

The first month of Kopernik’s performance (in blue) looks like this:

Mr. Iben is clearly not following the pack. You’d want to be comfortable with where he is leading the caravan before joining.

“A” shares carry a 5.75% load, capped 1.35% expenses and $3000 minimum. Institutional shares are no-load with expenses of 1.10% and a $1 million minimum. The fund is not (yet) available for sale at Schwab or the other major platforms and a Schwab rep says he does not see any evidence of active negotiation with Kopernik but recommends that interested parties check in occasionally at the Kopernik Global All-Cap page at Schwab. The “availability” tab will let you know if it has become available.

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. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves. This month he tracked down 15 no-load retail funds in registration, which represents our core interest. That number is down from what we’d normally see because these funds won’t launch until February 2014; whenever possible, firms prefer to launch by December 30^th and so force a lot of funds into the pipeline in October.

Interesting entries this month include:

American Beacon Global Evolution Frontier Markets Income Fund will be the first frontier market bond fund, focusing on sovereign debt. It will be managed by a team from Global Evolution USA, LLC, a subsidiary of Global Evolution Fondsmæglerselskab A/S. But you already knew that, right?

PIMCO Balanced Income Fund primarily pursues income and will invest globally, both very much unlike the average balanced fund. They’ll invest globally in dividend-paying common and preferred stocks and all flavors of fixed- and floating-rate instruments. The prospectus is still in the early stages of development, so there’s no named manager or expense ratio. This might be good news for Sextant Global High Income (SGHIX), which tries to pursue the same distinctive strategy but has had trouble explaining itself to investors.

SPDR Floating Rate Treasury ETF and WisdomTree Floating Rate Treasury Fund will track index of the as-yet unissued floating rate Treasury notes, the first small auction of which will occur January 29, 2014.

Manager Changes

On a related note, we also tracked down 58 fund manager changes.

Updates: the reorganization of Aegis Value, take two

Last month we noted, with unwarranted snarkiness, the reorganization of Aegis Value Fund (AVALX).  We have now had a chance to further review the preliminary prospectus and a 73-page proxy filing. The reorganization had two aspects, one of which would be immediately visible to investors and the other of which may be significant behind the scenes.

The visible change: before reorganization AVALX operates as a no-load retail fund with one share class and a $10,000 investment minimum.  According to the filings, after reorganization, Aegis is expected to have two share classes.  In the reorganization, a new, front-loaded, retail A-share class would be introduced with a maximum 3.75% sales load but also a series of breakpoint reductions.  There would also be a two-year, 1% redemption fee on some A-share purchases with value in excess of $1 million. There would also be a no-load institutional share class with a published $1,000,000 minimum.  However, current AVALX shareholders would become holders of grandfathered institutional shares not subject to the $1 million investment minimum.

Does this mean that new retail investors get stuck paying a sales load?  No, not necessarily. While the institutional class of Aegis High Yield has the same nominal million dollar minimum as Aegis Value will, it’s currently available through many fund supermarkets with the same $10,000 minimum investment as the retail shares of Aegis Value now have. We suspect that Aegis Value shareholders may benefit from the same sort of arrangement.

Does this mean that retail investors get stuck paying a 1% redemption fee on shares sold early? Again, not necessarily. As best I understand it, the redemption fee applies only to broker-sold A-shares sold in denominations greater than $1 million where the advisor pays a commission to the broker if the shares are then redeemed within two years of purchase.  So folks buying no-load institutional shares or buying “A” shares and actually paying the sales load are expected to be exempt.

The visible changes appear designed to make the fund more attractive in the market and especially to the advisor market, though it remains an open question whether “A” shares are the package most attractive to such folks.  Despite competitive returns over the past five years, the fund’s AUM remains far below its peak so we believe there’s room and management ability for substantially more assets.

The invisible change: two existing legal structures interfere with the advisor’s smooth and efficient organization.  They have two funds (Aegis High Yield AHYAX/AHYFX is the other) with different legal structures (one Delaware Trust, one Maryland Corporation) and different fiscal year ends. That means two sets of bookkeeping and two sets of reports; the reorganization is expected to consolidate the two and streamline the process.  We estimate the clean-up might save the advisor a little bit in administrative expenses.  In the reorganization, AVALX is also eliminating some legacy investment restrictions.  For example, AVALX is currently restricted from holding more than 10% of the publicly-available shares of any company.  The reorganization would lift these restrictions.  While the Fund has in the past only rarely held positions approaching the 10 percent ownership threshold, lifting these kinds of restrictions may provide management with more investment flexibility in the future.

Briefly Noted . . .

In a surprising announcement, Forward Funds removed a four-person team from Cedar Ridge Partners as the sub-advisers responsible for Forward Credit Analysis Long/Short Fund (FLSLX).  The fund was built around Cedar Ridge’s expertise in muni bond investing and the team had managed the fund from inception.  Considered as a “non-traditional bond” fund by Morningstar, FLSLX absolutely clubbed their peers in 2009, 2011, and 2012 while trailing a bit in 2010.  Then this in 2013:

Over the past six months, FLSLX dropped about 14% in value while its peers drifted down less than 2%.

We spoke with CEO Alan Reid in mid-November about the change.  While he praised the Cedar Ridge team for their work, he noted that their strategy seemed to work best when credit spreads were compressed and poorly when they widened.  Bernanke’s May 22 Congressional testimony concerning “tapering” roiled the credit markets, but appears to have gobsmacked the Cedar Ridge team: that’s the cliff you see them falling off.  Forward asked them to “de-risk” the portfolio and shortly afterward asked them to do it again.  As he monitored the fund’s evolution, Mr. Reid faced the question “would I put my money in this fund for the next three to five years?”   When he realized the answer was “no,” he moved to change management.

The new management team, Joseph Deane and David Hammer, comes from PIMCO.  Both are muni bond managers, though neither has run a fund or – so far as I can tell – a long/short portfolio.  Nonetheless they’re back by an enormous analyst corps.  That means they’re likely to have access to stronger research which would lead to better security selection.  Mr. Reid points to three other distinctions:

There is likely to be less exposure to low-quality issues, but more exposure to other parts of the fixed-income market.  The revised prospectus points to “municipal bonds, corporate bonds, notes and other debentures, U.S. Treasury and Agency securities, sovereign debt, emerging markets debt, variable rate demand notes, floating rate or zero coupon securities and nonconvertible preferred securities.”

There is likely to be a more conservative hedging strategy, focused on the use of credit default swaps and futures rather than shorting Treasury bonds.

The fund’s expenses have been materially reduced.  Cedar Ridge’s management fee had already been cut from 1.5% to 1.2% and the new PIMCO team is under contract for 1.0%.

It would be wise to approach with care, since the team is promising but untested and the strategy is new.  That said, Forward has been acting quickly and decisively in their shareholders’ interests and they have arranged an awfully attractive partnership with PIMCO.

Wow.  In mid-November T. Rowe Price’s board decided to merge the T. Rowe Price Global Infrastructure Fund (TRGFX) into T. Rowe Price Real Assets Fund (PRAFX).  Equity CIO John Linehan talked with us in late November about the move.  The short version is this: Global Infrastructure found very little market appeal because the vogue for infrastructure investing is in private equity rather than stocks.  That is, investors would rather own the lease on a toll road than own stock in a company which owns, among other things, the lease on a toll road. Since the fund’s investment rationale – providing a hedge against inflation – can be addressed well in the Real Assets funds, it made business sense to merge Infrastructure away.

Taken as a global stock fund, Infrastructure was small and mediocre. (We warned that “[t]he case for a dedicated infrastructure fund, and this fund in particular, is still unproven.”) Taken as a global stock fund, Real Assets is large and rotten. The key is that “real assets” funds are largely an inflation-hedge, investing in firms that control “stuff in the ground.”  With inflation dauntingly low, all funds with this focus (AllianceBernstein, Cohen & Steers, Cornerstone, Harford, Principal and others offer them) has looked somewhere between “punky” and “putrid.”  In the interim, Price has replaced Infrastructure’s manager (Kes Visuvalingam has replaced Susanta Mazumdar) and suspended its redemption fee, for the convenience of those who would like out early. 

Our Real Assets profile highlights the fact that this portfolio might be used as a small hedge in a diversified portfolio; perhaps 3-5%, which reflects its weight in Price’s asset allocation portfolios.  Mr. Lee warns that the fund, with its huge sector bets on energy and real estate, will underperform in a low-inflation environment and would have no structural advantage even in a moderate rate one. Investors should probably celebrate PRAFX’s underperformance as a sign that the chief scourge of their savings and investments – inflation – is so thoroughly suppressed.

FundX Tactical Total Return Fund (TOTLX) Effective January 31, 2014, the investment objective of the FundX Tactical Total Return Fund is revised to read:  “The Fund seeks long term capital appreciation with less volatility than the broad equity market; capital preservation is a secondary consideration.”

SMALL WINS FOR INVESTORS

CAN SLIM® Select Growth Fund (CANGX) On Monday, November 11, 2013, the Board of Trustees of Professionally Managed Portfolios approved the following change to the Fund’s Summary Prospectus, Prospectus and Statement of Additional Information: The Fund’s Expense Cap has been reduced from 1.70% to 1.39%.

The expense ratio on nine of Guggenheim’s S&P500 Equal Weight sector ETFS (Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Materials, Technology and Utilities) have dropped from 0.50% to 0.40%.

Effective November 15^th, REMS Real Estate Income 50/50 (RREFX) eliminated its sales load and reduced its 12(b)1 fee from 0.35% to 0.25%.  The new investment minimum is $2,500, up from its previous $1,000.  The 50/50 refers to the fund’s target allocation: 50% in the common stock of REITs, 50% in their preferred securities.

Effective mid-November, the Meridian Funds activated Advisor and Institutional share classes.

CLOSINGS (and related inconveniences)

Effective November 18, 2013, the Buffalo Emerging Opportunities Fund (BUFOX), a series of Buffalo Funds, will be closed to all new accounts, including new employer sponsored retirement plans (“ESRPs”).  The Fund will remain open to additional investments by all existing accounts

Invesco European Small Company Fund (ESMAX) will close to all investors effective the open of business on December 4, 2013. The fund has $560 million in AUM, a low turnover style and a splendid record. The long-time lead manager, Jason Holzer, manages 13 other funds, most for Invesco and most in the European and international small cap realms. That means he’s responsible for over $16 billion in assets.  He has over a million invested both here and in his International Small Company Fund (IEGAX).

Effective December 31, 2013, T. Rowe Price New Horizons Fund (PRHNX) will be closed to new investors.  This used to be one of Price’s best small cap growth funds until the weight of $14 billion in assets moved it up the scale.  Morningstar still categorizes it as “small growth” and it still has a fair chunk of its assets in small cap names, but a majority of its holdings are now mid- to large-cap stocks.

Also on December 31, 2013, the T. Rowe Price Small-Cap Stock Fund (OTCFX) will be closed to new investors.  Small Cap is smaller than New Horizons – $9 billion versus $14 billion – and maintains a far higher exposure to small cap stocks (about 70% of the portfolio).  Nonetheless it faces serious headwinds from the inevitable pressure of a rising asset base – up by $2 billion in 12 months.  There’s an interesting hint buried in the fund’s ticker symbol: it was once the Over the Counter Securities Fund.

Too late: Vulcan Value Partners Small Cap Fund (VVPSX), which we profiled as “a solid, sensible, profitable vehicle” shortly after launch, vindicated our judgment when it closed to new investors at the end of November.  The closure came with about one week’s notice, which strikes me as a responsible decision if you’re actually looking to close off new flows rather than trigger a last minute rush for the door.  The fund’s current AUM, $750 million, still gives it plenty of room to maneuver in the small cap realm. 

Effective December 31, 2013, Wells Fargo Advantage Emerging Markets Equity Fund (EMGAX) will be closed to most new investors.  Curious timing: four years in a row (2009-2012) of top decile returns, and it stayed open.  Utterly mediocre returns in 2013 (50^th percentile, slightly underwater) and it closes.

OLD WINE, NEW BOTTLES

BlackRock Emerging Market Local Debt Portfolio (BAEDX) is changing its name and oh so much more.  On New Year’s 2014, shareholders will find themselves invested in BlackRock Emerging Markets Flexible Dynamic Bond Portfolio which certainly sounds a lot more … uhh, flexible.  And dynamic!  I sometimes wonder if fund marketers have an app on their iPhones, rather like UrbanSpoon, where you hit “shake” and slot machine-like wheels start spinning.  When they stop you get some combination of Flexible, Strategic, Multi-, Asset, Manager, Strategy, Dynamic, Flexible and Tactical.

Oh, right.  Back to the fund.  The Flexible Dynamic fund will flexibly and dynamically invest in what it invests in now except they are no longer bound to keep 65% or more in local-currency bonds.

Effective March 1, 2014, BMO Government Income Fund (MRGIX) beomes BMO Mortgage Income Fund. There will be no change in strategy reflecting the fact that the government gets its income from . . . uh, mortgages?

Effective December 11, 2013 Columbia Large Cap Core Fund (NSGAX) will change to Columbia Select Large Cap Equity Fund.  The prospectus for the new version of the fund warns that it might concentrate on a single sector (they name technology) and will likely hold 45-65 stocks, which is about where they already are.  At that same time, Columbia Active Portfolios® – Diversified Equity Income Fund (INDZX) becomes Active Portfolios® Multi-Manager Value Fund and Columbia Recovery and Infrastructure (RRIAX) becomes Columbia Global Infrastructure Fund.  Morningstar rates it as a one-star fund despite high relative returns since inception, which suggests that the fund’s volatility is higher still.

Dreyfus will ask shareholders to approve a set of as-yet undescribed strategy changes which, if approved, will cause them to change the Dreyfus/Standish Intermediate Tax Exempt Bond Fund to Dreyfus Tax Sensitive Total Return Bond Fund

On February 21, 20414, Dreyfus/The Boston Company Emerging Markets Core Equity Fund will change its name to Dreyfus Diversified Emerging Markets Fund.

Effective December 23, 2013, Forward Select Income Opportunity Fund (FSONX) becomes Forward Select Opportunity Fund.  The fact that neither the fund’s webpage nor its fact sheet report any income (i.e., there’s not even a spot for 30-day SEC yield or anything like it) might be telling us why “income” is leaving the name.

Ivy Pacific Opportunities Fund (IPOAX) seems to have become Ivy Emerging Markets Equity Fund. The new fund’s prospectus shifts it from a mid-to-large cap fund to an all-cap portfolio, adds the proviso that up to 20% of the portfolio might be invested in precious metals. There’s an unclear provision about investing in a Cayman Islands subsidiary to gain commodities exposure but it’s not clear whether that’s in addition to the gold.  And, finally, Ivy Asset Strategy New Opportunities Fund (INOAX) will merge into the new fund in early 2014.  That might come as a surprise to INOAX shareholders, since their current fund is not primarily an emerging markets vehicle.

OFF TO THE DUSTBIN OF HISTORY

Corporate America CU Short Duration Fund (CASDX) liquidated at the end of November.  That’s apparently more evidence of Corporate America’s shortened time horizon.  The fund was open a bit more than a year and pulled in a bit more than $60 million in assets before the advisor thought … what?  “Oh, we’re not very good at this”?  “Oh, we’re not apt to get very good at this”?  “Oh, look!  There’s a butterfly”?

Delaware International Bond Fund (DPIFX) will be liquidated and dissolved on New Year’s Eve.  I knew several grad students who suffered a similar fate that evening.

The Equinox funds plan a wholesale liquidation: Equinox Abraham Strategy Fund (EABIX), Absolute Return Plus Strategy (EMEIX), Eclipse Strategy (EECIX), John Locke Strategy (EJILX), QCM Strategy (EQQCX) and Tiverton Strategy (EQTVX) all meet their maker on December 9^th.  The smallest of these funds has about $8500 in AUM.  Right: not enough to buy a used 2010 Toyota Corolla.  The largest has about $600,000 and, in total, they don’t reach $750,000.  All are classified as “managed futures” funds and no, I have no earthly idea why Equinox has seven such funds: the six dead funds walking and the surviving Equinox Crabel Strategy (EQCRX) which has about $15,000 in AUM.

Given that these funds have $25,000 minimums and half of them have under $25,000 in assets, the clear implications is that several of these funds have one shareholder. In no instance, however, is that one shareholder a manager of the fund since none of the five managers was silly enough to invest.

FundX ETF Upgrader Fund (REMIX) is merging into the FundX Upgrader Fund (FUNDX) and the FundX ETF Aggressive Upgrader Fund (UNBOX) goes into the FundX Aggressive Upgrader Fund (HOTFX), effective January 24, 2014.   My colleague Charles’s thoughtful and extensive analysis of their flagship FundX Upgrader Fund offers them as “a cautionary tale” for folks whose strategy is to churn their portfolios, always seeking hot funds.

An ING fund disappears: ING has designated ING Bond Portfolio (IABPX) as a “disappearing portfolio.”  They craftily plan to ask shareholders in late February to authorize the disappearance.  The largely-inoffensive ING Intermediate Bond Portfolio (IIABX) has been designated as “the Surviving Portfolio.”

But nothing will survive of ING American Funds International Growth and Income Portfolio (IAIPX) or ING American Funds Global Growth and Income Portfolio (IAGPX), both of which will be liquidated on February 7, 2014.

ING PIMCO High Yield Portfolio (IPHYX) disappears on February 14 and is replaced by ING High Yield Portfolio.  See ING decided to replace the world’s most renowned fixed income shop, which was running a four-star $900 million portfolio for them, with themselves with Rick Cumberledge and team, nice people who haven’t previously managed a mutual fund.  The investors get to celebrate a two (count ‘em: 2!) basis point fee reduction as a result.

The Board of Trustees of the JPMorgan India Fund (JIDAX) has approved the liquidation and dissolution of the Fund on or about January 10, 2014.  The fund has a six-year record that’s a bit above average but that comes out as a 17% loss since inception.  The $9.5 million there would have been, and would still be, better used in Matthews India (MINDX).  

We’d already announced the closure and impending liquidation of BlackRock India Fund (BAINX).  The closure occurred October 28 and the liquidation occurs on December 10, 2013.  BAINX – the bane of your portfolio?  due to be bain-ished from it? – is down 14% since launch, its peers are down 21% from the same date. 

The Board of Trustees of the JPMorgan U.S. Real Estate Fund (SUSIX) has approved the liquidation and dissolution of the Fund on or about December 20, 2013.  Color me clueless: it’s an unimpressive fund, but it’s not wretched and it does have $380 million dollars.

Litman Gregory Masters Focused Opportunities Fund (MSFOX) is merging into Litman Gregory Masters Equity Fund (MSENX) because, they explain, MSFOX

… has had net shareholder redemptions over the past five years, causing the asset level of the Focused Opportunities Fund to decline almost 50% over that time period.  The decline in assets has resulted in a corresponding increase in the Focused Opportunities Fund’s expense ratio, and … it is unlikely that the Focused Opportunities Fund will increase in size significantly in the foreseeable future.

The first part of that statement is a bit disingenuous.  MSFOX has $67 million at the moment.  The only time it exceeded that level was in 2007 when, at year end, it had $118 million.  It lost 60% between October 2007 and March 2009 (much more than its peers) and has never regained its place in the market. The Observer has a favorable opinion of the fund, which has earned four stars from Morningstar and five for Returns, Consistency and Preservation from Lipper but its fall does point to the fragility of survival once investors have been burned. This is the second fund to merge into MSENX, Litman Gregory Masters Value was the first, in May 2013.

The Lord hath left the building: the shareholders of Lord Abbett Classic Stock Fund (LRLCX) convened on November 7^th to ponder the future of their fund.  Fifteen days later it was gone, absorbed by Lord Abbett Calibrated Dividend Growth Fund (LAMAX).  Not to suggest that Lord Abbett was going through the motions, but they did put the LAMAX managers in charge of LRLCX back on June 11^th. 

Mercer Investment Management decided to liquidate the Mercer US Short Maturity Fixed Income Fund (MUSMX) on or about December 16, 2013

Monetta has decided to liquidate Monetta Mid-Cap Equity Fund (MMCEX), effective as of the close of business on December 20, 2013.  Robert Baccarella has been running the fund for 20 years, the last four with his son, Robert.  Despite a couple good years, the fund has resided in the 98^th or 99^th percentiles for performance for long ago.

Effective December 9, 2013, the name of the MutualHedge Frontier Legends Fund (MHFAX) changes to Equinox MutualHedge Futures Strategy Fund.  Morningstar has a Neutral rating on the fund and describes it as “good but not great yet” because of some management instability and high expenses.

Paladin Long Short Fund (PALFX) will discontinue operations on December 20, 2013.  Given the fund’s wild churning, this closure might well threaten the profitability of three or four systemically important institutions:

Why, yes, the liquidation is a taxable event for you.  Not so much for the fund’s manager, who has under $50,000 invested.  Given that the fund has, from inception in 2011 to mid-November 2013 lost money for its investors, taxes generated by churn will be particularly galling.

As noted above, T. Rowe Price Global Infrastructure Fund (TRGFX) is slated to merge into T. Rowe Price Real Assets Fund (PRAFX) in the spring of 2014.

Quaker Funds closed Quaker Akros Absolute Return Fund (AARFX) and the Quaker Small-Cap Growth Tactical Allocation Fund (QGASX) on November 5^th in anticipation of liquidating them (an action which requires shareholder approval).  I have no idea of why they’re ditching AARFX.  The fund promises “absolute returns.”  $10,000 invested at inception in 2005 would be worth $10,040 today.  Mission accomplished!

Roosevelt Strategic Income Fund (RSTIX) was liquidated on November 27, 2013.  That’s presumably a low-assets/bad marketing sort of call since the fund had top tier returns compared to its global bond peers over the two-plus years of its existence.  The manager, Arthur Sheer, continues managing Roosevelt Multi-Cap (BULLX).

The Royce Fund’s Board of Trustees approved a plan of liquidation for Royce Global Select Long/Short Fund (RSTFX), to be effective on December 2, 2013. The Fund is being liquidated primarily because it has not attracted and maintained assets at a sufficient level for it to be viable.  The decision elicited several disgusted comments on the board, directed at Royce Funds.  The tenor of the comments was this: “Royce, a Legg Mason subsidiary, has morphed from an investment manager to an asset gatherer.  It’s the Legg Mason mantra: “assets (hence revenues) über alles.”  It’s indisputably the case that Royce rolled out a bunch of funds once it became part of Mason; they ran 11 funds when they were independent, 29 today plus some Legg Mason branded funds (such as Legg Mason Royce Smaller Companies Premier, £ denominated “A” shares in Ireland) and some sub-advised ones.  And the senior Royce managers presume to oversee more funds than almost any serious peer: Charles Royce – 13 funds, Whitney George – 10 funds, David Nadel – 10 funds.

Then, too, it’s not very good. At least over the past three years, it’s badly trailed a whole variety of benchmarks.

Symetra funds has decided, for no immediately evident reason, to liquidate several successful funds (Symetra DoubleLine Total Return, Symetra DoubleLine Emerging Markets Income and Symetra Yacktman Focused).

TEAM Asset Strategy Fund (TEAMX) is liquidating, but it’s doing so with refreshing honesty: it’s “because of a decline in assets due to continued poor performance and significant redemptions.” 

Yep.  You’re reading it right: $10,000 becomes $1904.  75% YTD loss.  To which I can only response: “Go, TEAM, go!  Quickly!  Go now!”

The Board of Directors of Tributary Funds has approved liquidation of Tributary Large Cap Growth Fund (FOLCX) on or about January 29, 2014.  Since David Jordan, manager of the five-star Tributary Balanced (FOBAX) and flagship four-star Growth Opportunities (FOGRX) funds, took over in 2011, the fund has had very competitive returns but not enough to draw serious assets and move the fund toward economic viability.

Vanguard Tax-Managed International Fund (VTMGX) merges into the Vanguard Developed Markets Index Fund, which is expected to occur on or about April 4, 2014.  Finally, a $20 billion closet index fund (the r-squared against the MSCI EAFE Index was nearly 99) that just surrenders to being an index!  In a final dose of irony, VTMGX tracked its index better than does the index fund into which it’s merging.  Indeed, there are seven international large-blend index funds which track their indexes less faithfully than the supposedly-active VTMGX did. 

In Closing . . .

Thanks to all of the folks who join us each month, and thanks especially to those who support the Observer by joining our remarkably thoughtful discussion board, by sharing tips and leads with me by email, and by contributing through PayPal or via our Amazon partnership.  Your interest and engagements helps make up for a lot of late nights and the occasional withering glare as we duck away from family gatherings to write a bit more.

Our partnership with Amazon provides our steadiest income stream: if you buy a $14 book, we get about a buck. If you buy a Cuisinart Brew Central coffeemaker at $78, we get five or six.  Buy an iPad and we get bumpkus (Apple refuses to play along), but that’s okay, they’re cool anyway. There are, nonetheless, way cool smaller retailers that we’ve come across but that you might not have heard of. The Observer has no financial stake in any of this stuff but I like sharing word of things that strike me as really first-rate.

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

Duluth sells clothes, and accessories, for them.  I own rather a lot of it.  Their stuff is remarkably well-made if moderately pricey.  Their sweatshirts, by way of example, are $45-50 when they’re not on sale.  JCPenney claims that their sweatshirts are $48 but on perma-sale for $20 or so.  The difference is that Duluth’s are substantially better: thicker fabric, longer cut, with thoughtful touches like expandable/stretchy side panels.

VoiceBase offers cools, affordable transcription services.  We’re working with the folks at Beck, Mack & Oliver to generate a FINRA-compliant transcript of our October conference call with Zac Wydra.  Step One was to generate a raw transcript with which the compliance folks at Beck, Mack might work. Chip, our estimable technical director, sorted through a variety of sites before settling on VoiceBase.

It strikes us that their service is cool, reliable and affordable.  Here’s the process.  Set up a free account.  Upload an audio file to their site.  About 24 hours later, they’ve generate a free machine-based transcription for you.  If you need greater accuracy than the machine produces – having multiple speakers and variable audio quality wreaks havoc with the poor beastie’s circuits – they provide human transcription within two or three days.

The cool part is that they host the audio on their website in a searchable format.  Go to the audio, type “emerging markets” and the system automatically flags any uses of that phrase and allows you to listen directly to them. If you’d like to play, here is the MFO Conference Call with Zac Wydra.

QuoteArts.com is a small shop that consistently offers a bunch of the most attractive, best written greeting cards (and refrigerator magnets) that I’ve seen.  Steve Metivier, who runs the site, gave us permission to reproduce one of their images (normally the online version is watermarked):

The text reads “A time to quiet our hearts… (inside) to soften our edges, clear our minds, enjoy our world, and to share best wishes for the season. May these days and all the new year be joyful and peaceful.”  It strikes me as an entirely-worthy aspiration.

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

Dear friends,

Occasionally Facebook produces finds that I’m at a loss to explain.  Ecce:

(Thanks to Nina K., a really first-rate writer and first-rate property/insurance lawyer in the Bay State for sharing Mr. Takei’s post with us. Now if I could just get her to restrain the impulse to blurt out, incredulous, “you really find this stuff interesting?”)

Let’s see.  Should I be more curious about the fact that Mr. Takei (iconically Ensign Sulu on Star Trek) manages just a basso profundo “oh myyy” on his post or the fact that he was recently lounging in a waiting room at the University of Iowa Hospitals, a bit west of here?  Perhaps it would be better to let his friends weigh in?

Chip’s vote was to simply swipe her favorite image from the thread, one labeled “a real hedge fund.”

Which is to say, a market that tacks on 29% in a year makes it easy to think of investing as fun and funny again. 

Now if only that popular sentiment could be reconciled with the fact that a bunch of very disciplined, very successful managers are quietly selling down their stocks and building their cash reserves again.

Here’s today’s “know your Morningstar!” quiz.  

Here are the total return charts for two short-term bond funds.  One is the sole Morningstar Gold Medalist in the group, representing “one of the industry’s best managers, and one of the category’s best funds.”  The other is a lowly one-star fund unworthy of Morningstar’s notice 

Question: do you …know your Morningstar!?  Which is the golden child?  Is it blue or orange?

Would it help to know that one of these funds is managed by a multi-trillion dollar titan and the other by a small, distinctive boutique?  Or that one of the funds invests quite conventionally and fits neatly into a style-box while the other is one-of-a-kind?

If you know your Morningstar, you’ll know that “small, distinctive and hard to pigeonhole” is pretty much the kiss of death.  The orange (or gold) line represents PIMCO Low Duration, “D” shares (PLDDX).  It’s a $24 billion “juggernaut” (Morningstar’s term) that’s earned four stars and a Gold designation.  It tends to be in the top quarter of the short-term bond group, though not at its top, and is a bit riskier than average.

The blue line represents RiverPark Short Term High Yield (RPHYX), an absolutely first-rate cash management fund about which we’ve written a lot. And which Morningstar just designated as a one-star fund. Why so?  Because Morningstar classifies it as a “high yield bond” fund and benchmarks it against an investment class that has outperformed the stock market over the past 15 years but with the highest volatility in the fixed-income universe. To be clear: there is essentially no overlap between RiverPark’s portfolio and the average high-yield bond funds and they have entirely different strategies, objectives and risk profiles. Which is to say, Morningstar has managed a classic “walnuts to lug nuts” comparison.

Here’s the defense Morningstar might reasonably make: “we had to put it somewhere.  It says ‘high yield.’  We put it there.”

Here’s our response: “that’s a sad and self-damning answer.  Yes, you had to put it somewhere.  But having put it in a place that you know is wildly inappropriate, you also need to accept the responsibility – to your readers, to RiverPark’s investors and to yourselves – to address your decision.  You’ve got the world’s biggest and best supported corps of analysts in the world. Use them! Don’t ignore the funds that do well outside of the comfortable framework of style boxes, categories and corporate investing! If the algorithms produce palpably misleading ratings, speak up.”

But, of course, they didn’t.

The problem is straightforward: Morningstar’s ratings are most reliable when you least need them. For funds with conventional, straightforward, style-pure disciplines – index funds and closet index funds – the star ratings probably produce a fair snapshot across the funds. But really, how hard is it – even absent Morningstar’s imprimatur – to find the most solid offering among a gaggle of long-only, domestic large cap, growth-at-a-reasonable price funds? You’ll get 90% of the way there with three numbers: five year returns, five year volatility and expense ratio. Look for ones where the first is higher and the second two are lower.

When funds try not to follow the herd, when the manager appears to have a brain and to be using it to pursue different possibilities, is when the ratings system is most prone to misleading readers. That’s when you need to hear an expert’s analysis. 

So why, then, deploy your analysts to write endless prose about domestic large cap funds? Because that’s where the money is.

Morningstar ETF Invest: Rather less useful content than I’d imagined

Morningstar hosted their ETF-focused conference in Chicago at the beginning of October.  The folks report that the gathering has tripled in size over the last couple years, turned away potential registrants and will soon need to move to a new space.  After three days there, though, I came away with few strong reactions.  I was struck by the decision of one keynote speaker to refer to active fixed-income managers as “the enemy” (no, dude, check the mirror) and the apparent anxiety around Fidelity’s decision to enter the ETF market (“Fidelity is coming.  We know they’re coming.  It’s only a matter of time,” warned one).

My greatest bewilderment was at the industry’s apparent insistence on damaging themselves as quickly and thoroughly as possible.  ETFs really have, at most, three advantages: they’re cheap, transparent and liquid.  The vogue seems to be for frittering that away.  More and more advisors are being persuaded to purchase the services of managed portfolio advisors who, for a fee, promise to custom-package (and trade) dozens of ETFs.  I spoke with representatives of a couple index providers, including FTSE, who corroborated Morningstar’s assertion that there are likely two million separate security indexes in operation with more being created daily. And many of the exchange-traded products rely in derivatives to try to capture the movements of those 2,000,000.  On whole, it feels like a systematic attempt to capture the most troubling features of the mutual fund industry – all while preening about your Olympian superiority to the mutual fund industry.

Odd.

The most interesting presentation at the conference was made by Austan Goolsbee, a University of Chicago economist and former chief of the President’s Council of Economic Advisers, who addressed a luncheon crowd. It was a thoroughly unexpected performance: there’s a strong overtone of Jon Stewart from The Daily Show, an almost antic energy. The presentation was one-third Goolsbee family anecdotes (“when I’d complain about a problem, gramma would say ‘80% of us don’t care. . . and the other 20% are glad about it'”), one-third White House anecdotes and one-third economic arguments.

The short version:

• The next 12-18 months will be tough because the old drivers of recovery aren’t available this time. Over the last century, house prices appreciated by 40 basis points annually for the first 90 years. From 2000-08, it appreciated 1350 bps annually. In the future, 40 bps is likely about right which means that a recovery in the housing industry won’t be lifting all boats any time soon.
• We’ll know the economy is recovering when 25 year olds start moving out of their parents’ basements, renting little apartments, buying futons and cheap pots and pans. (Technically, an uptick in household formation. Since the beginning of the recession, the US population has grown by 10 million but the number of households has remained flat.) One optimistic measure that Goolsbee did not mention but which seems comparable: the number of Americans choosing to quit their jobs (presumably for something better) is rising.
• The shutdown is probably a good thing, since it will derail efforts to create an unnecessary crisis around the debt ceiling.
• In the longer term, the US will recover and grow at 3.5% annually, driven by a population that’s growing (we’ll likely peak around 400 million while Japan, Western Europe and Russia contract), the world’s most productive workforce and relatively light taxation. While Social Security faces challenges, they’re manageable. Given the slow rolling crisis in higher education and the near collapse of new business launches over the past decade, I’m actually somewhere between skeptical and queasy on this one.
• The Chinese economic numbers can’t be trusted at all. The US reports quarterly economic data after a 30 day lag and frequently revises the numbers 30 days after that. China reports their quarterly numbers one day after the end of the quarter and has never revised any of the numbers. A better measure of Chinese activity is derivable from FedEx volume (it’s way down) since China is so export driven.

One highlight was his report of a headline from The Onion: “recession-plagued nation demands a new bubble to invest in … so we can get the economy going again. We need a concrete way to create illusory wealth in the near future.”

One of the great things about having Messrs Studzinski and Boccadoro contributing to the Observer is that they’re keen, experienced observers and very good writers.  The other great thing about it is that I no longer have to bear the label, “the cranky one.” In the following essay, Ed Studzinkski takes on one of the beloved touchstones of shareholder-friendly management: “skin in the game.”  Further down, Charles Boccadoro casts a skeptical eye, in a data-rich piece, on the likelihood that an investor’s going to avoid permanent loss of capital.

Skin in the Game, Part Two

The trouble with our times is that the future is not what it used to be.

Paul Valery

Nassim Nicholas Taleb, the author of The Black Swan as well as Antifragile: Things That Gain from Disorder, has recently been giving a series of interviews in which he argues that current investment industry compensation practices lead to subtle conflicts of interest, that end up inuring to the disadvantage of individual investors. Nowhere is this more apparent than when one looks at the mutual fund complexes that have become asset gatherers rather than investment managers.

By way of full disclosure I have to tell you that I am an admirer of Mr. Taleb’s. I was not always the most popular boy in the classroom as I was always worrying about the need to consider the potential for “Black Swan” or outlier events. Unfortunately all one has to have is one investment massacre like the 2008-2009 period. This gave investors a lost decade of investment returns and a potentially permanent loss of capital if they panicked and liquidated their investments. To have a more in-depth appreciation of the concept and its implications, I commend those of you with the time to a careful study of the data that the Mutual Fund Observer has compiled and begun releasing regularly. You should pay particular attention to a number called the “Maximum Drawdown.” There you will see that as a result of that dark period, looking back five years it is a rarity to find a domestic fund manager who did not lose 35-50% of his or her investors’ money. The same is to be said for global and international fund managers who likewise did not distinguish themselves, losing 50-65% of investors’ capital, assuming the investors panicked and liquidated their investments, and many did.

A number of investment managers that I know are not fans of Mr. Taleb’s work, primarily because he has a habit of bringing attention to inconvenient truths. In Fooled by Randomness, he made the case that given the large number of people who had come into the investment management business in recent years, there were a number who had to have generated good records randomly. They were what he calls “spurious winners.” I would argue that the maximum drawdown numbers referred to above confirm that thesis.

How then to avoid the spurious winner? Taleb argues that the hedge fund industry serves as a model, by truly having managers with “skin in the game.” In his experience a hedge fund manager typically has twenty to fifty times the exposure of his next biggest client. That of necessity makes them both more careful and as well as aware of the consequences if they have underinvested in the necessary talent to remain competitive. Taleb quite definitively states, “You don’t get that with fund managers.”

I suspect the counterargument I am going to hear is that fund managers are now required to disclose, by means of reporting within various ranges, the amount of money they have invested in the fund they are managing. Just go to the Statement of Additional Information, which is usually found on a fund website. And if the SAI shows that the manager has more than $1 million invested in his or her fund, then that is supposed to be a good sign concerning alignment of interests. Like the old Hertz commercial, the real rather than apparent answer is “not exactly.”

The gold standard in this regard has been set by Longleaf Partners with their funds. Their employees are required to limit their publicly offered equity investments to funds advised by Southeastern Asset Management, Longleaf’s advisor, unless granted a compliance exception. Their trustees also must obtain permission before making a publicly offered equity investment. That is rather unique in the fund industry, since what you usually see in the marketing brochures or periodic fund reports is something like “the employees and families of blah-blah have more than $X million invested in our funds.” If you are lucky this may work out to be one percent of assets under management in the firm, hardly hedge-fund like metrics. At the same time, you often find trustees of the fund with de minimis investments.

The comparison becomes worse when you look at a fund with $9 billion in assets and the “normal” one percent investment management fee, which generates $90 million in revenue. The fund manager may tell you that his largest equity investment is in the fund and is more than $1 million. But if his annual compensation runs somewhere between $1million and $10 million, and this is Taleb’s strongest point, the fund manager does not have a true disincentive for losing money. The situation becomes even more blurred where compliance policy allows investment in ETF’s or open-ended mutual funds, which in today’s world will often allow a fund manager to construct his own personal market neutral or hedged portfolio, to offset his investment in the fund he is managing.

Is there a solution? Yes, a fairly easy one – adopt as an industry standard through government regulation the requirement that all employees in the investment firm are required to limit their publicly offered equity investments to the funds in the complex. To give credit where credit is due, just as we have a Volcker rule, we can call it the “Southeastern Asset Management” rule. If that should prove too restrictive, I would suggest as an alternative that the SEC add another band of investment ranges above the current $1 million limit, at perhaps $5 million. That at least would give a truer picture for the investor, especially given the money flows now gushing into a number of firms, which often make a $1 million investment not material to the fund manager. Such disclosure will do a better job of attuning investment professionals to what should be their real concern – managing risk with a view towards the potential downside, rather than ignoring risk with other people’s money.

Postscript:

What does it say when such well known value managers as Tweedy, Browne and First Pacific Advisors are letting cash positions rise in their portfolios as they sell and don’t replace securities that have reached their target valuations? Probably the same thing as when one of the people I consider to be one of the outstanding money managers of our time, Seth Klarman at Baupost Partners, announces that he will be returning some capital to his partnership investors at year end. Stay tuned.

So, if it’s “the best,” why can’t people just agree on what it is?

Last month David pointed out how little overlap he found between three popular mutual fund lists: Kiplinger 25, Money 70, and Morningstar’s Fantastic 51. David mused: “You’d think that if all of these publications shared the same sensible goal – good risk-adjusted returns and shareholder-friendly practices – they’d also be stumbling across the same funds. You’d be wrong.”

He found only one fund, Dodge & Cox International Fund DODFX, on all three lists. Just one! Although just one is a statistically better outcome than randomly picking three such lists from the 6600 or so mutual funds and 1000 ETFs, it does seem surprisingly small. 

Opening up the field a little, by replacing the Fantastic 51 with a list of 232 funds formed from Morningstar’s current “Gold-Rated Funds” and “Favorite ETFs,” the overlap does not improve much. Just two funds appear in all three publications: DODFX and Habor Bond Institutional HABDX. Just two!

While perhaps not directly comparable, the table below provides a quick summary of the criteria used by each publication. Money 70 criteria actually include Morningstar’s so-called stewardship grade, which must be one of the least maintained measures. For example, Morningstar awarded Bruce Berkowitz Fund Manager of the Decade, but it never published a stewardship grade for Fairholme.

Overall, however, the criteria seem quite similar, or as David described “good risk-adjusted returns and shareholder-friendly practices.”  Add in experienced managers for good measure and one would expect the lists to overlap pretty well. But again, they don’t.

How do the “forward-looking” recommendations in each of these lists fare against Morningstar’s purely quantitative “backward-looking” performance rating system? Not as well as you might think. There are just seven 5-star funds on Money’s list, or 1-in-10. Kiplinger does the best with six, from a percentage perspective, or almost 1-in-4. (They must have peeked.) Morningstar’s own list includes 44 5-star funds, or about 1-in-5. So, as well intentioned and “forward looking” as these analysts certainly try to be, only a small minority of their “best funds” have delivered top-tier returns.

On the other hand, they each do better than picking funds arbitrarily, if not unwittingly, since Morningstar assigns 5 stars to only about 1-in-17 funds. Neither of the two over-lapping funds that appear on all three lists, DODFX and HABDX, have 5 stars. But both have a commendable 4 stars, and certainly, that’s good enough.

Lowering expectations a bit, how many funds appear on at least two of these lists? The answer: 38, excluding the two trifectas. Vanguard dominates with 14. T. Rowe Price and American Funds each have 4. Fidelity has just one. Most have 4 stars, a few have 3, like SLASX, probably the scariest.

But there is no Artisan. There is no Tweedy. There is no Matthews. There is no TCW or Doubleline. There are no PIMCO bond funds. (Can you believe?) There is no Yacktman. Or Arke. Or Sequoia. There are no funds less than five years old. In short, there’s a lot missing.

There are, however, nine 5-star funds among the 38, or just about 1-in-4. That’s not bad. Interestingly, not one is a fixed income fund, which is probably a sign of the times. Here’s how they stack-up in MFO’s own “backward looking” ratings system, updated through September:

Four are moderate allocation funds: FPACX, PRWCX, VWELX, and TRRBX. Three are Vanguard funds: VWELX, VDIGX, and VASVX. One FMI fund FMIHX and one Oakmark fund OAKIX. Hard to argue with any of these funds, especially the three Great Owls: PRWCX, VWELX, and OAKIX.

These lists of “best funds” are probably not a bad place to start, especially for those new to mutual funds. They tend to expose investors to many perfectly acceptable, if more mainstream, funds with desirable characteristics: lower fees, experienced teams, defensible, if not superior, past performance.

They probably do not stress downside potential enough, so any selection needs to also take risk tolerance and investment time-frame into account. And, incredulously, Morningstar continues to give Gold ratings to loaded funds, about 1-in-7 actually.

The lists produce surprisingly little overlap, perhaps simply because there are a lot of funds available that satisfy the broad screening criteria. But within the little bit of overlap, one can find some very satisfying funds.

Money 70 and Kiplinger 25 are free and online. Morningstar’s rated funds are available for a premium subscription. (Cheapest path may be to subscribe for just one month each year at $22 while performing an annual portfolio review.)

As for a list of smaller, less well known mutual funds with great managers and intriguing strategies? Well, of course, that’s the niche MFO aspires to cover.

23Oct2013/Charles

The Great Owl search engine has arrived

Great Owls are the designation that my colleague Charles Boccadoro gives to those funds which are first in the top 20% of their peer group for every trailing period of three years or more. Because we know that “risk” is often more durable and a better predictor of investor actions than “return” is, we’ve compiled a wide variety of risk measures for each of the Great Owl funds.

Up until now, we’ve been limited to publishing the Great Owls as a .pdf while working on a search engine for them. We’re pleased to announce the launch of the Great Owl Search, 1.0. We expect in the months ahead to widen the engine’s function and to better integrate it into the site. We hope you like it.

For JJ and other fans of FundAlarm’s Three-Alarm and Most Alarming fund lists, we’re working to create a predefined search that will allow you to quickly and reliable identify the most gruesome investments in the fund world. More soon!

Who do you trust for fund information?

The short answer is: not fund companies.  On October 22, the WSJ’s Karen Damato hosted an online poll entitled Poll: The Best Source of Mutual-Fund Information? 

Representing, as I do, Column Three, I should be cheered.  Teaching, as I do, Journalism 215: News Literacy, I felt compelled to admit that the results were somewhere between empty (the margin of error is 10.89, so it’s “somewhere between 16% and 38% think it’s the fund company’s website and marketing materials”) and discouraging (the country’s leading financial newspaper managed to engage the interest of precisely 81 of its readers on this question).

Nina Eisenman, President of Eisenman Associates which oversees strategic communications for corporations, and sometime contributor to the Observer

Asking which of the 3 choices individual investors find “most useful” generates data that creates an impression that they don’t use the other two at all when, in fact, they may use all 3 to varying degrees. It’s also a broad question. Are investors responding based on what’s most useful to them in conducting their initial research or due diligence? For example, I may read about a fund in the Mutual Fund Observer (“other website”) and decide to check it out but I would (hopefully) look at the fund’s website, read the manager’s letters and the fund prospectus before I actually put money in.

When I surveyed financial advisors and RIAs on the same topic, but gave them an option to rate the importance of various sources of information they use, the vast majority used mutual funds’ own websites to some extent as part of their due diligence research. [especially for] fund-specific information (including the fund prospectus which is generally available on the website) that can help investors make educated investment decisions.

Both Nina’s own research and the results of a comparable Advisor Perspectives poll can be found at FundSites, her portal for addressing the challenges and practices of small- to medium sizes fund company websites.

The difference between “departures” and “succession planning”

Three firms this month announced the decisions of superb managers to move on. Happily for their investors, the departures are long-dated and seem to be surrounded by a careful succession planning process.

Mitch Milias will be retiring at the end of 2013

Primecap Management was founded by three American Funds veterans. That generation is passing. Howard Schow has passed away at age 84 in April 2012. Vanguard observer Dan Weiner wrote at the time that “To say that he was one of the best, and least-known investors would be a vast understatement.”  The second of the triumvirate, Mitch Milias, retires in two months at 71.  That leaves Theo Kolokotrones who, at 68, is likely in the latter half of his investing career.  Milias has served as comanager of four Gold-rated funds: Vanguard Primecap  (VPMCX) Vanguard Primecap Core (VPCCX), Primecap Odyssey Growth (POGRX), and  Primecap Odyssey Stock (POSKX).

Neil Woodford will depart Invesco in April, 2014

British fund manager Neil Woodford is leaving after 25 years of managing Invesco Perpetual High Income Fund and the Invesco Perpetual Income Fund. Mr. Woodford apparently is the best known manager in England and described as a “hero” in the media for his resolute style.  He’s decided to set up his own English fund company.  In making the move he reports:

My decision to leave is a personal one based on my views about where I see long-term opportunities in the fund management industry.  My intention is to establish a new fund management business serving institutional and retail clients as soon as possible after 29th April 2014.

His investors seem somehow less sanguine: they pulled over £1 billion in the two weeks after his announcement.  Invesco’s British president describes that reaction as “calm.”

Given Mr. Woodford’s reputation and the global nature of the securities market, I would surely flag 1 May 2014 as a day to peer across the Atlantic to see what “long-term opportunities” he’s pursuing.

Scott Satterwhite will be retiring at the end of September, 2016

Scott Satterwhite joined Artisan from Wachovia Securities in 1997 and was the sole manager of Artisan Small Cap Value (ARTVX) from its launch. ARTVX is also the longest-tenured fund in my non-retirement portfolio; I moved my Artisan Small Cap (ARTSX) investment into Satterwhite’s fund almost as soon as it launched and I’ve never had reason to question that decision.  Mr. Satterwhite then extended his discipline into Artisan Mid Cap Value (ARTQX) and the large cap Artisan Value (ARTLX).  All are, as is typical of Artisan, superb.

Artisan has a really strong internal culture and focus on creating coherent, self-sustaining investment teams.  Three years after launch, Satterwhite’s long-time analyst Jim Kieffer became a co-manager.  George Sertl was added six years after that and Dan Kane six years later.  Mr. Kane is now described as “the informal lead manager” with Satterwhite on ARTVX.  This is probably one of the two most significant manager changes in Artisan’s history (the retirement of its founder was the other) but the firm seems exceptionally well-positioned both to attract additional talent and to manage the required three year transition.

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. 

T. Rowe Price Global Allocation (RPGAX): T. Rowe is getting bold, cautiously.  Their newest and most innovative fund offers a changing mix of global assets, including structural exposure to a single hedge fund, is also broadly diversified, low-cost and run by the team responsible for their Spectrum and Personal Strategy Funds.  So far, so good!

Oops! The fund profile is slightly delayed. Please check back tomorrow.

Elevator Talk: Jeffrey K. Ringdahl of American Beacon Flexible Bond (AFXAX)

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.

In a fundamentally hostile environment, investors need to have a flexible approach to income investing. Some funds express that flexibility by investing in emerging market bonds, financial derivatives such as options, or illiquid securities (think: “lease payments from the apartment complex we just bought”).

American Beacon’s decision was to target “positive total return regardless of market conditions” in their version.  Beacon, like Harbor, positions itself as “a manager of managers” and assembles teams of institutional sub-advisors to manage the actual portfolio.  In this case, they’ve paired Brandywine Global, GAM and PIMCO and have given the managers extraordinarily leeway in pursuing the fund’s objective.  One measure of that flexibility is the fund’s duration, a measure of interest rate sensitivity.  They project a duration of anything from negative five years (effectively shorting the market) to plus eight years (generally the preferred spot for long-term owners of bond funds).  Since inception the fund has noticeably outrun its “nontraditional bond” peers with reasonable volatility.

Jeff Ringdahl is American Beacon’s Chief Operating Officer and one of the primary architects of the Flexible Bond Strategy. He’s worked with a bunch of “A” tier management firms including Touchstone Investments, Fidelity and State Street Global Advisors.   Here are his 245 words (I know, he overshot) on why you should consider a flexible bond strategy:

In building an alternative to a traditional bond fund, our goal was to stay true to what we consider the three tenets of traditional bond investing: current income, principal preservation and equity diversification.  However, we also sought to protect against unstable interest rates and credit spreads.

The word “unconstrained” is often used to describe similar strategies, but we believe “flexible” is a better descriptor for our approach. Many investors associate the word “unconstrained” with higher risk.  We implemented important risk constraints which help to create a lower risk profile. Our multi-manager structure is a key distinguishing characteristic because of its built-in risk management. Unconstrained or flexible bond funds feature a great degree of investment flexibility. While investment managers may deliver compelling risk-adjusted performance by using this enhanced flexibility, there may be an increased possibility of underperformance because there are fewer risk controls imposed by many of our peer funds. In our opinion, if you would ever want to diversify your managers you would do so where the manager had the greatest latitude. We think that this product style is uniquely designed for multi-manager diversification.

Flexible bond investing allows asset managers the ability to invest long and short across the global bond and currency markets to capitalize on opportunities in the broad areas of credit, currencies and yield curve strategies. We think focusing on the three Cs: Credit, Currency and Curve gives us an advantage in seeking to deliver positive returns over a complete market cycle.

The fund has five share classes. The minimum initial investment for the no-load Investor class is $2,500.   Expenses are 1.27% on about $300 million in assets.

The fund’s website is functional but spare.  You get the essential information, but there’s no particular wealth of insight or commentary on this strategy (and there is one odd picture of a bunch of sailboats barely able to get out of one another’s way).

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 (VCMRX), 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.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility
9. October 2013: Bashar Qasem of Wise Capital (WISEX), which provides investors with an opportunity for global diversification in a fund category (short term bonds) mostly distinguished by bland uniformity.

Conference Call Highlights: Zac Wydra of Beck, Mack & Oliver Partners

We looked for a picture of Zac Wydra on the web but found Wydra the Otter instead. We decided that Zac is cute but Wydra is cuter, so… If we can find a t-shirt with Wydra’s picture on it, we might send it along to Zac with our best wishes.

In mid-October we spoke for about an hour with Zac Wydra of Beck, Mack & Oliver Partners Fund (BMPEX). There were about 30 other participants on the call. I’ve elsewhere analogized Beck, Mack to Dodge & Cox: an old money, white shoe firm whose core business is helping the rich stay rich. In general, you need a $3 million minimum investment to engage with them. Partners was created in 1991 as a limited partnership to accommodate the grandkids or staff of their clients, folks who might only have a few hundred thousand to commit. (Insert about here: “Snowball gulps”) The “limited” in limited partnership signals a maximum number of investors, 100. The partnership filled up and prospered. When the managing partner retired, Zac made a pitch to convert the partnership to a ’40 fund and make it more widely available. He argued that he thought there was a wider audience for a disciplined, concentrated fund.

He was made the fund’s inaugural manager. He’s 41 and anticipates running BMPEX for about the next quarter century, at which point he’ll be required – as all partners are – to move into retirement and undertake a phased five year divestment of his economic stake in the firm. His then-former ownership stake will be available to help attract and retain the best cadre of younger professionals that they can find. Between now and retirement he will (1) not run any other pooled investment vehicle, (2) not allow BMPEX to get noticeably bigger than $1.5 billion – he’ll return capital to investors first – and (3) will, over a period of years, train and oversee a potential successor.

In the interim, the discipline is simple:

1. never hold more than 30 securities – he can hold bonds but hasn’t found any that offer a better risk/return profile than the stocks he’s found.
2. only invest in firms with great management teams, a criterion that’s met when the team demonstrates superior capital allocation decisions over a period of years
3. invest only in firms whose cash flows are consistent and predictable. Some fine firms come with high variable flows and some are in industries whose drivers are particularly hard to decipher; he avoids those altogether.
4. only buy when stocks sell at a sufficient discount to fair value that you’ve got a margin of safety, a patience that was illustrated by his decision to watch Bed, Bath & Beyond for over two and a half years before a short-term stumble triggered a panicky price drop and he could move in. In general, he is targeting stocks which have the prospect of gaining at least 50% over the next three years and which will not lose value over that time.
5. ignore the question of whether it’s a “high turnover” or “low turnover” strategy. His argument is that the market determines the turnover rate. If his holdings become overpriced, he’ll sell them quickly. If the market collapses, he’ll look for stocks with even better risk/return profiles than those currently in the portfolio. In general, it would be common for him to turn over three to five names in the portfolio each year, though occasionally that’s just recycling: he’ll sell a good firm whose stock becomes overvalued then buy it back again once it becomes undervalued.

Two listener questions, in particular, stood out:

Kevin asked what Zac’s “edge” was. A focus on cash, rather than earnings, seemed to be the core of it. Businesses exist to generate cash, not earnings, and so BM&O’s valuations were driven by discounted cash flow models. Those models were meaningful only if it were possible to calculate the durability of cash flows over 5 years. In industries where cash flows have volatile, it’s hard to assign a meaningful multiple and so he avoids them.

Seth asked what mistakes have you made and what did you learn from them? Zac hearkened back to the days when the fund was still a private partnership. They’d invested in AIG which subsequently turned into a bloody mess. Ummm, “not an enjoyable experience” was his phrase. He learned from that that “independent” was not always the same as “contrary.” AIG was selling at what appeared to be a lunatic discount, so BM&O bought in a contrarian move. Out of the resulting debacle, Zac learned a bit more respect for the market’s occasionally unexplainable pricings of an asset. At base, if the market says a stock is worth twenty cents a share, you’d better than remarkably strong evidence in order to act on an internal valuation of twenty dollars a share.

Bottom Line: On whole, it strikes me as a remarkable strategy: simple, high return, low excitement, repeatable, sustained for near a quarter century and sustainable for another.

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

The BMPEX Conference Call

As with all of these funds, we’ve created a new featured funds page for Beck, Mack & Oliver Partners Fund, pulling together all of the best resources we have for the fund, including a brand new audio profile in .mp3 format.

When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded. If the file downloads, instead, you may have to double-click to play it.

As promised, my colleague Charles Boccadoro weighs in on your almost-magical ability to turn a temporary loss of principal into a …

Permanent Loss of Capital

The father of value investing, Benjamin Graham, employed the concept of “Margin of Safety” to minimize risk of permanent loss. His great student, Warren Buffett, puts it like this: “Rule No. 1: never lose money; rule No. 2: don’t forget rule No. 1.”

Zachary Wydra, portfolio manager of the 5-star Beck Mack & Oliver Partners (BMPEX) fund, actually cited Mr. Buffett’s quote during the recent MFO conference call.

But a look at Berkshire Hathaway, one of the great stocks of all time, shows it dropped 46% between December 2007 and February of 2009. And, further back, it dropped about the same between June 1998 and February 2002. So, is Mr. Buffett not following his own rule? Similarly, a look at BMPEX shows an even steeper decline in 2009 at -54%, slightly worse than the SP500.

The distinction, of course, is that drawdown does not necessarily mean loss, unless one sells at what is only a temporary loss in valuation – as opposed to an unrecoverable loss, like experienced by Enron shareholders. Since its 2009 drawdown, BMPEX is in fact up an enviable 161%, beating the SP500 by 9%.

Robert Arnott, founder of Research Associates, summarizes as follows: “Temporary losses of value are frequent; at times they can become so frightening that they become permanent—for those that sell.” Distinguishing between temporary drawdown and permanent loss of capital (aka “the ultimate risk”) is singularly the most important, if unnerving, aspect of successful value investing.

Mr. Wydra explains his strategy is to target stocks that have an upside potential over the next three years of at least 50% and will not lose value over that time. Translation: “loss,” as far as BMPEX is concerned, equates to no drawdown over a three year period. A very practical goal indeed, since any longer period would likely not be tolerated by risk averse investors.

And yet, it is very, very hard to do, perhaps even impossible for any fund that is primarily long equities.

Here is downside SP500 total return performance looking back about 52 years:

It says that 3-year returns fall below zero over nearly 30% of the time and the SP500 shows a loss of 20% or more in 15% of 3-year returns. If we compare returns against consumer price index (CPI), the result is even worse. But for simplicity (and Pete’s) sake, we will not. Fact is, over this time frame, one would need to have invested in the SP500 for nearly 12 years continuously to guarantee a positive return. 12 years!

How many equity or asset allocation funds have not experienced a drawdown over any three year period? Very few. In the last 20 years, only four, or about 1-in-1000. Gabelli ABC (GABCX) and Merger (MERFX), both in the market neutral category and both focused on merger arbitrage strategies. Along with Permanent Portfolio (PRPFX) and Midas Perpetual Portfolio (MPREX), both in the conservative allocation category and both with large a percentage of their portfolios in gold. None of these four beat the SP500. (Although three beat bonds and GABCX did so with especially low volatility.)

So, while delivering equity-like returns without incurring a “loss” over a three year period may simply prove too high a goal to come true, it is what we wish was true.

29Oct2013/Charles

Conference Call Upcoming: John Park and Greg Jackson, Oakseed Opportunity, November 18, 7:00 – 8:00 Eastern

On November 18, Observer readers will have the opportunity to hear from, and speak to John Park and Greg Jackson, co-managers of Oakseed Opportunity Fund (SEEDX and SEDEX). John managed Columbia Acorn Select for five and a half years and, at his 2004 departure, Morningstar announced “we are troubled by his departure: Park had run this fund since its inception and was a big driver behind its great long-term record. He was also the firm’s primary health-care analyst.” Greg co-managed Oakmark Global (OAKGX) for over four years and his departure in 2003 prompted an Eeyore-ish, “It’s never good news when a talented manager leaves.”

The guys moved to Blum Capital, a venture capital firm.  They did well, made money but had less fun than they’d like so they decided to return to managing a distinctly low-profile mutual fund.

Oakseed is designed to be an opportunistic equity fund.  Its managers are expected to be able to look broadly and go boldly, wherever the greatest opportunities present themselves.  It’s limited by neither geography, market cap nor stylebox.   John Park laid out its mission succinctly: “we pursue the maximum returns in the safest way possible.”

I asked John where he thought they’d focus their opening comments.  Here’s his reply:

We would like to talk about the structure of our firm and how it relates to the fund at the outset of the call.  I think people should know we’re not the usual fund management company most people think of when investing in a fund. We discussed this in our first letter to shareholders, but I think it’s worthwhile for our prospective and current investors to know that Oakseed is the only client we have, primarily because we want complete alignment with our clients from not only a mutual investment perspective (“skin in the game”), but also that all of our time is spent on this one entity. In addition, being founders of our firm and this fund, with no intentions of ever starting and managing a new fund, there is much less risk to our investors that one or both of us would ever leave. I think having that assurance is important.

Our conference call will be Monday, November 18, from 7:00 – 8:00 Eastern.  It’s free.  It’s a phone call.

How can you join in?

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

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

WOULD AN ADDITIONAL HEADS UP HELP?

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

Conference Call Queue: David Sherman, RiverPark Strategic Income, December 9, 7:00 – 8:00 Eastern

On Monday, December 9, from 7:00 – 8:00 Eastern, you’ll have a chance to meet David Sherman, manager of RiverPark Short Term High Yield (RPHYX) and the newly-launched RiverPark Strategic Income Fund (RSIVX). David positions RSIVX as the next step out on the risk-return ladder from RPHYX: capable of doubling its sibling’s returns with entirely manageable risk.  If you’d like to get ahead of the curve, you can register for the call with David though I will highlight his call in next month’s issue.

Launch Alert: DoubleLine Shiller Enhanced CAPE

On October 29, DoubleLine Shiller Enhanced CAPE (DSEEX and DSENX) launched. The fund will use derivatives to try to outperform the Shiller Barclays CAPE US Sector Total Return Index.  CAPE is an acronym for “cyclically-adjusted price/earnings.”  The measure was propounded by Nobel Prize winning economist Robert Shiller as a way of taking some of the hocus-pocus out of the calculation of price/earnings ratios.  At base, it divides today’s stock price by the average, inflation-adjusted earnings from the past decade.  Shiller argues that current earnings are often deceptive since profit margins tend over time to regress to the mean and many firms earnings run on three to five year cycles.  As a result, the market might look dirt cheap (high profit margins plus high cyclical earnings = low conventional P/E) when it’s actually poised for a fall.  Looking at prices relative to longer-term earnings gives you a better chance of getting sucked into a value trap.

The fund will be managed by The Gundlach and Jeffrey Sherman. Messrs Gundlach and Sherman also work together on the distinctly disappointing Multi-Asset Growth fund (DMLAX), so the combination of these guys and an interesting idea doesn’t translate immediately into a desirable product.  The fact that it, like many PIMCO funds, is complicated and derivatives-driven counsels for due caution in one’s due diligence. The “N” share class has a $2000 minimum initial investment and 0.91% expense ratio.  The institutional shares are about one-third cheaper.

Those interested in a nice introduction to the CAPE research might look at Samuel Lee’s 2012 CAPE Crusader essay at Morningstar. There’s a fact sheet and a little other information on the fund’s homepage.

Funds in Registration (The New Year’s Edition)

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. Any fund that wanted to launch before the end of the year needed to be in registration by mid- to late October.

And there were a lot of funds targeting a year-end launch. Every day David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves.  This month he tracked down 24 no-load retail funds in registration, which represents our core interest.  But if you expand that to include ETFs, institutional funds, reorganized funds and load-bearing funds, you find nearly 120 new vehicles scheduled for Christmas delivery.

Close readers might find the answers to four funds in reg quiz questions:

1. Which manager of a newly-registered fund had the schmanciest high society wedding this year?
2. Which fund in registration gave Snowball, by far, the biggest headache as he tried to translate their prose to English?
3. Which hedge fund manager decided that the perfect time to launch a mutual fund was after getting bludgeoned on returns for two consecutive years?
4. Which managers seem most attuned to young investors, skippering craft that might be described as Clifford the Big Red Mutual Fund and the Spongebob Fund?

Manager Changes

On a related note, we also tracked down 51 fund manager changes.

Updates

One of the characteristics of good managers is their ability to think clearly and one of the best clues to the existence of clear thinking is clear writing. Here’s a decent rule: if they can’t write a grocery list without babbling, you should avoid them. Contrarily, clear, graceful writing often reflects clear thinking.

Many managers update their commentaries and fund materials quarterly and we want to guide you to the most recent discussions and data possible for the funds we’ve written about. The indefatigable Mr. Welsch has checked (and updated) every link and linked document for every fund we’ve profiled in 2013 and for most of 2012. Here’s David’s summary table, which will allow you to click through to a variety of updated documents.

Briefly Noted 

A big ol’ “uhhh” to Advisory Research Emerging Markets All Cap Value Fund (the “Fund”) which has changed both manager (“Effective immediately, Brien M. O’Brien is no longer a portfolio manager of the Fund”) and name (it will be Advisory Research Emerging Markets Opportunities Fund), both before the fund even launched.  A few days after that announcement, AR also decided that Matthew Dougherty would be removed as a manager of the still-unlaunched fund.  On the bright side, it didn’t close to new investors before launch, so that’s good.  Launch date is November 1, 2013.

In a singularly dark day, Mr. O’Brien was also removed as manager of Advisory Research Small Micro Cap Value Fund, which has also not launched and has changed its name: Advisory Research Small Company Opportunities Fund.”

A Centaur arises!  The Tilson funds used to be a two-fund family: the one that Mr. Tilson ran and the one that was really good. After years of returns that never quite matched the hype, Mr. Tilson liquidated his Tilson Focus (TILFX) fund in June 2013.  That left behind the Tilson-less Tilson Dividend Fund (TILDX) which we described as “an awfully compelling little fund.”

Effective November 1, Tilson Dividend became Centaur Total Return Fund (TILDX), named after its long-time sub-adviser, Centaur Capital Partners.  Rick Schumacher, the operations guy at the Centaur funds, elaborates:

Since Tilson is no longer involved in the mutual fund whatsoever, and since the Dividend Fund has historically generated as much (if not more) income from covered call premiums rather than pure dividends, we felt that it was a good time to rebrand the fund.  So, effective today, our fund is now named the Centaur Total Return Fund.  We have kept the ticker (TILDX), as nothing’s really changed as far as the investment objective or strategy of the fund, and besides, we like our track record.  But, we’re very excited about our new Centaur Mutual Funds brand, as it will provide us with potential opportunities to launch other strategies under this platform in the future.

They’ve just launched a clean and appropriate dignified website that both represents the new fund and archives the analytic materials relevant to its old designation.  The fund sits at $65 million in assets with cash occupying about a quarter of its portfolio.  All cap, four stars, low risk. It’s worth considering, which we’ll do again in our December issue.

Laudus Growth Investors U.S. Large Cap Growth Fund is having almost as much fun.  On September 24, its Board booted UBS Global Asset Management as the managers of the fund in favor of BlackRock.  They then changed the name (to Laudus U.S. Large Cap Growth Fund) and, generously, slashed the fund’s expense ratio by an entire basis point from 0.78% to 0.77%.

But no joy in Mudville: the shareholder meeting being held to vote on the merger of  Lord Abbett Classic Stock Fund (LRLCX) into Lord Abbett Calibrated Dividend Growth Fund (LAMAX) has been adjourned until November 7, 2013 for lack of a quorum.

Scout Funds are sporting a redesigned website. Despite the fact that our profiles of Scout Unconstrained Bond and Scout Low Duration don’t qualify as “news” for the purposes of their media list (sniffles), I agree with reader Dennis Green’s celebration of the fact the new site is “thoughtful, with a classy layout, and—are you sitting down?— their data are no longer stale and are readily accessible!”  Thanks to Dennis for the heads-up.

Snowball’s portfolio: in September, I noted that two funds were on the watchlist for my own, non-retirement portfolio.  They were Aston River Road Long Short (ARLSX) and RiverPark Strategic Income (RSIVX). I’ve now opened a small exploratory position in Aston (I pay much more attention to a fund when I have actual money at risk) as I continue to explore the possibility of transferring my Northern Global Tactical Asset Allocation (BBALX) investment there.  The Strategic Income position is small but permanent and linked to a monthly automatic investment plan.

For those interested, John Waggoner of USA Today talked with me for a long while about the industry and interesting new funds.  Part of that conversation contributed to his October 17 article, “New Funds Worth Mentioning.”

SMALL WINS FOR INVESTORS

Eaton Vance Asian Small Companies Fund (EVASX) will eliminate its danged annoying “B” share class on November 4, 2013. It’s still trying to catch up from having lost 70% in the 2007-09 meltdown. 

Green Owl Intrinsic Value Fund (GOWLX) substantially reduced its expense cap from 1.40% to 1.10%. It’s been a very solid little large cap fund since its launch in early 2012.

Invesco Balanced-Risk Commodity Strategy Fund (BRCAX) will reopen to new investors on November 8, 2013. The fund has three quarters of a billion in assets despite trailing its peers and losing money in two of its first three years of existence.

As of December, Vanguard Dividend Appreciation Index (VDAIX) will have new Admiral shares with a 0.10% expense ratio and a $10,000 minimum investment. That’s a welcome savings on a fund currently charging 0.20% for the Investor share class.

At eight funds, Vanguard will rename Signal shares as Admiral shares and will lower the minimum investment to $10,000 from $100,000.

Zeo Strategic Income Fund (ZEOIX) dropped its “institutional” minimum to $5,000.  I will say this for Zeo: it’s very steady.

CLOSINGS (and related inconveniences)

The Brown Capital Management Small Company Fund (BCSIX) closed to new investors on October 18, 2013.

Buffalo Emerging Opportunities Fund (BUFOX) formally announced its intention to close to new investors when the fund’s assets under management reach $475 million. At last check, they’re at $420 million.  Five star fund with consistently top 1% returns.  If you’re curious, check quick!

GW&K Small Cap Equity Fund (GWETX) is slated to close to new investors on November 1, 2013.

Matthews Pacific Tiger Fund (MAPTX) closed to new investors on October 25, 2013.

Oakmark International (OAKIX) closed to most new investors as of the close of business on October 4, 2013

Templeton Foreign Smaller Companies (FINEX) will close to new investors on December 10^th.  I have no idea of why: it’s a small fund with an undistinguished but not awful record. Liquidation seems unlikely but I can’t imagine that much hot money has been burning a hole in the managers’ pockets.

Touchstone Merger Arbitrage Fund (TMGAX), already mostly closed, will limit access a bit more on November 11, 2013.  That means closing the fund to new financial advisors.

OLD WINE, NEW BOTTLES

Advisory Research Emerging Markets All Cap Value Fund has renamed itself, before launch, as Advisory Research Emerging Markets Opportunities Fund.

Aegis Value Fund (AVALX) has been reorganized as … Aegis Value Fund (AVALX), except with a sales load (see story above).

DundeeWealth US, LP (the “Adviser”) has also changed its name to “Scotia Institutional Investments US, LP” effective November 1, 2013.

The Hatteras suite of alternative strategy funds (Hatteras Alpha Hedged Strategies, Hedged Strategies Fund, Long/Short Debt Fund, Long/Short Equity Fund and Managed Futures Strategies Fund) have been sold to RCS Capital Corporation and Scotland Acquisition, LLC.  We know this because the SEC filing avers the “Purchaser will purchase from the Sellers and the Sellers will sell to the Purchaser, substantially all the assets related to the business and operations of the Sellers and … the “Hatteras Funds Group.” Morningstar has a “negative” analyst rating on the group but I cannot find a discussion of that judgment.

Ladenburg Thalmann Alternative Strategies Fund (LTAFX) have been boldly renamed (wait for it) Alternative Strategies Fund.  It appears to be another in the expanding array of “interval” funds, whose shares are illiquid and partially redeemable just once a quarter. Its performance since October 2010 launch has been substantially better than its open-ended peers.

Effective October 7, 2013, the WisdomTree Global ex-US Growth Fund (DNL) became WisdomTree Global ex-US Dividend Growth Fund.

U.S. Global Investors MegaTrends Fund (MEGAX) will, on December 20, become Holmes Growth Fund

OFF TO THE DUSTBIN OF HISTORY

On-going thanks to The Shadow for help in tracking the consequences of “the perennial gale of creative destruction” blowing through the industry.  Shadow, a member of the Observer’s discussion community, has an uncanny talent for identifying and posting fund liquidations (and occasionally) launches to our discussion board about, oh, 30 seconds after the SEC first learns of the change.  Rather more than three dozen of the changes noted here and elsewhere in Briefly Noted were flagged by The Shadow.  While my daily reading of SEC 497 filings identified most of the them, his work really does contribute a lot. 

And so, thanks, big guy!

On October 16, 2013, the Board of Trustees of the Trust approved a Plan of Liquidation, which authorizes the termination, liquidation and dissolution of the 361 Absolute Alpha Fund. In order to effect such liquidation, the Fund is closed to all new investment. Shareholders may redeem their shares until the date of liquidation. The Fund will be liquidated on or about October 30, 2013.

City National Rochdale Diversified Equity Fund (the “Diversified Fund”) has merged into City National Rochdale U.S. Core Equity Fund while City National Rochdale Full Maturity Fixed Income Fund was absorbed by City National Rochdale Intermediate Fixed Income Fund

Great-West Ariel Small Cap Value Fund (MXSCX) will merge into Great-West Ariel Mid Cap Value Fund (MXMCX) around Christmas, 2013.  That’s probably a win for shareholders, since SCV has been mired in the muck while MCV has posted top 1% returns over the past five years.

As we suspected, Fidelity Europe Capital Appreciation Fund (FECAX) is merging into Fidelity Europe Fund (FIEUX). FECAX was supposed to be the aggressive growth version of FIEUX but the funds have operated as virtually clones for the past five years.  And neither has particularly justified its existence: average risk, average return, high r-squared despite the advantages of low expenses and a large analyst pool.

The Board of the Hansberger funds seems concerned that you don’t quite understand the implications of having a fund liquidated.  And so, in the announcement of the October 18 liquidation of Hansberger International Fund they helpfully explain: “The Fund no longer exists, and as a result, shares of the Fund are no longer available for purchase.”

Highland Alpha Trend Strategies Fund (HATAX), formerly Pyxis Alpha Trend Strategies Fund, will close on November 20, 2013.  With assets not much greater than my retirement account (and performance vastly below it), I’m not sure that even the manager will notice the disappearance.

Huntington Income Equity (HUINX) will merge into Huntington Dividend Capture Fund (HDCAX) at the end of the first week of December.  It’s never a good sign when the winning fund – the more attractive of the two – trails 80% of its peers.

The JPMorgan Global Opportunities Fund was liquidated and dissolved on or about October 25, 2013. Given that they’re speaking in the past tense, don’t you think that they’d know whether it was “on” or “about”?

Update on the JPMorgan Value Opportunities Fund: an attempt to merge the fund out of existence in September failed because the Board couldn’t get enough shareholders to vote one way or the other.  On October 10, though, they reached a critical mass and folded the fund into JPMorgan Large Cap Value Fund (OLVAX) on October 18^th.

So long to LONGX! Longview Tactical Allocation Fund (LONGX) has closed and will liquidate on November 15, 2013.  700% turnover which might well have led to a joke about their ability to take the long view except for the fact that they’ve joined the zombie legion of walking dead funds.

In a determinedly “WTF?” move, the Mitchell Capital’s Board of Trustees has determined to liquidate the Mitchell Capital All-Cap Growth Fund (MCAEX) “due to the adviser’s business decision that it no longer is economically viable to continue managing the Fund because of the Fund’s small size, the increasing costs associated with managing the Fund, and the difficulty encountered in distributing the Fund’s shares.”  Huh?  “No longer economically viable”?  They only launched this sucker on March 1, 2013.  Seven months, guys?  You hung on seven months and that’s it?  What sort of analytic abilities are on display here, do you suppose?

On October 15, Nomura Partners Funds closed all of its remaining five mutual funds to purchases and exchanges.  They are The Japan Fund (NPJAX), Nomura Partners High Yield (NPHAX), Nomura Partners Asia Pacific Ex Japan (NPAAX), Nomura Partners Global Equity Income (NPWAX), and Nomura Partners Global Emerging Markets (NPEAX).  Here’s a sentence you should take seriously: “The Board will consider the best interests of the investors in each of the Funds and may decide to liquidate, merge, assign the advisory contract or to take another course of action for one or more of the Funds.”  The NPJAX board has acted boldly in the past.  In 2002, it fired the fund’s long-standing adviser, Scudder,Stevens, and turned the fund over to Fidelity to manage.  Then, in 2008, they moved it again from Fidelity to Nomura.  No telling what they might do next.

The firm also announced that it, like DundeeWealth, is planning to get out of the US retail fund business.

The liquidations of Nuveen Tradewinds Global Resources Fund and Nuveen Tradewinds Small-Cap Opportunities Fund are complete.  It’s an ill wind that blows …

Oppenheimer SteelPath MLP and Infrastructure Debt Fund went the way of the wild goose on October 4.

Transamerica is bumping off two sub-advised funds in mid-December: Transamerica International Bond (TABAX), subadvised by J.P. Morgan, and Transamerica International Value Opportunities Fund, subadvised by Thornburg but only available to other Transamerica fund managers.

UBS Global Frontier Fund became UBS Asset Growth Fund (BGFAX) on October 28.  Uhhh … doesn’t “Asset Growth” strike you as pretty much “Asset Gathering”?  Under the assumption that “incredibly complicated” is the magic strategy, the fund will adopt a managed volatility objective that tries to capture all of the upside of the MSCI World Free Index with a standard deviation of no more than 15.  On the portfolio’s horizon: indirect real estate securities, index funds, options and derivatives with leverage of up to 75%. They lose a couple managers and gain a couple in the process.

U.S. Global Investors Global Emerging Markets Fund closed on October 1 and liquidated on Halloween.  If you were an investor in the fund, I’m hopeful that you’d already noticed.  And considered Seafarer as an alternative.

Vanguard plans to merge two of its tax-managed funds into very similar index funds.  Vanguard Tax-Managed International (VTMNX) is merging into Vanguard Developed Markets Index (VDMIX) and Vanguard Tax-Managed Growth & Income (VTMIX) will merge into Vanguard 500 Index (VFINX). Since these were closet index funds to begin with – they have R-squared values of 98.5 and 100(!) – the merger mostly serves to raise the expenses borne by VTMNX investors from 10 basis points to 20 for the index fund.

Vanguard Growth Equity (VGEQX) is being absorbed by Vanguard US Growth (VWUSX). Baillie Gifford, managers of Growth Equity, will be added as another team for US Growth.

Vanguard Managed Payout Distribution Focus (VPDFX) and Vanguard Managed Payout Growth Focus (VPGFX) are slated to merge to create a new fund, Vanguard Managed Payout Fund. At that time, the payout in question will decrease to 4% from 5%.

WHV Emerging Markets Equity Fund (WHEAX) is suffering “final liquidation”  on or about December 20, 2013.  Okay returns, $5 million in assets.

In Closing . . .

As Chip reviewed how folks use our email notification (do they open it?  Do they click through to MFO?), she discovered 33 clicks from folks in Toyko (youkoso!), 21 in the U.K. (uhhh … pip pip?), 13 in the United Arab Emirates (keep cool, guys!) and 10 scattered about India (Namaste!).  Welcome to all.

Thanks to the kind folks who contributed to the Observer this month.  I never second guess folks’ decision to contribute, directly or through PayPal, but I am sometimes humbled by their generosity and years of support.  And so thanks, especially, to the Right Reverend Rick – a friend of many years – and to Andrew, Bradford, Matt, James (uhh… Jimmy?) and you all.  You make it all possible.

Thanks to all of the folks who bookmarked or clicked on our Amazon link.   Here’s the reminder of the easiest way to support the Observer: just use our Amazon link whenever you’d normally be doing your shopping, holiday or other, on Amazon anyway.  They contribute an amount equal to about 7% of the value of all stuff purchased through the link.  It costs you nothing (the cost is already built into their marketing budget) and is invisible.  If you’re interested in the details, feel free to look at the Amazon section under “Support.”  

Remember to join us, if you can, for our upcoming conversations with John, Greg and David.  Regardless, enjoy the quiet descent of fall and its seasonal reminder to slow down a bit and remember all the things you have to be grateful for rather than fretting about the ones you don’t have (and, really, likely don’t need and wouldn’t enjoy).

Cheers!

Welcome to October, the time of pumpkins.

October’s a month of surprises, from the first morning that you see frost on the grass to the appearance of ghosts and ghouls at month’s end.  It’s a month famous of market crashes – 1929, 1987, 2008 – and for being the least hospitable to stocks. And now it promises to be a month famous for government showdowns and shutdowns, when the sales of scary Halloween masks (Barackula, anyone?) take off.

It’s the month of golden leaves, apple cider, backyard fires and weekend football.  (Except possibly back home in Pittsburgh, where some suspect a zombie takeover of the beloved Steelers backfield.)  It’s the month that the danged lawnmower gets put away but the snowblower doesn’t need to be dragged out.

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

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

Better make that “The Fantastic 48,” Russ

Russel Kinnel, Morningstar’s chief fund guy, sent out an email on September 16^th, touting his “Fantastic 51,” described as “51 Funds You Should Know About.”  And if you’ll just pony up the $125 for a Fund Investor subscription, it’s yours!

 Uhhh … might have to pare that back to the Fantastic 48, Russ.  It turns out that a couple of the funds hyped in the email underwent critical changes between the time Mr. Kinnel published that article in May and the time Morningstar’s marketers began pushing it in September.

Let’s start by looking at Mr. K’s criteria, then talking about the flubbed funds and finish by figuring out what we might learn from the list as a whole.

Here are the criteria for being Fantastic this year:

Last year I shared the “Fantastic 46” with you. This year I raised the bar on my tests and still reached 51 funds. Here’s what I want:

1. A fund with expenses in the cheapest quintile
2. Returns that beat the benchmark over the course of the manager’s tenure (minimum five years)
3. Manager investment of at least $500,000
4. A Positive Parent rating
5. A medalist Morningstar Analyst Rating

Sub-text: Fantastic funds are large or come from large fund complexes.  Of the 1150 medalist funds, only 53 have assets under $100 million.  Of those 53, only five or six are the products of independent or boutique firms.  The others are from Fido, MFS, PIMCO or another large firm.  Typically an entire target-date series gets medalized, including the Retirement 2075 fund with $500,003 in it.  By way of comparison, there are 2433 funds with under $100 million in assets.

And it’s certainly the case that the Fantastic 51 is The Corporate Collection: 10 American Funds, 10 Price and nine Vanguard.  Russel holds out the LKCM funds as examples of off-the-radar families, which would be more credible if LKCM Small Cap Equity (LKSCX) didn’t already have $1.1 billion in assets.

And what about the funds touted in the promotional email.  Two stand out: FPA Paramount and Janus Triton.

Morningstar’s take on FPA Paramount

The Mutual Fund Observer’s reply:

Great recommendation, except that the managers you’re touting left the fund and its strategy has substantially changed.  Eric and Steve’s unnamed and unrecognized co-managers are now in charge of the fund and are working to transition it from a quality-growth to an absolute-value portfolio.  Both of those took place in August 2013. 

The MFO recommendation: if you like Eric and Steve’s work, invest in FPA Perennial (FPPFX) which is a fund they actually run, using the strategy that Mr. Kinnel celebrates.

Morningstar’s take on Janus Triton

The Observer’s reply:

Uhhh … a bigger worry here is that Chad and Brian left in early May, 2013. The new manager’s tenure is 14 weeks.  Morningstar’s analysts promptly downgraded the fund to “neutral.” And Greg Carlson fretted that the “manager change leaves Janus Triton with uncertain prospects” because Mr. Coleman has not done a consistently excellent job in his other charges. That would be four months before the distribution of this email promo.

The MFO recommendation: if you’re impressed by Chad and Brian’s work (an entirely reasonable conclusion) check Meridian Growth Legacy Fund (MERDX), or wait until November and invest in their new Meridian Small Cap Growth Fund.

The email did not highlight, but the Fantastic 51 does include, T. Rowe Price New America Growth (PRWAX), whose manager resigned in May 2013.   Presumably these funds ended up in the letter because, contrary to appearances, Mr. Kinnel neither wrote, read nor approved its content (his smiling face and first-personal singular style notwithstanding).  That work was likely all done by a marketer who wouldn’t know Triton from Trident.

The bigger picture should give you pause about the value of such lists.   Twenty-six percent of the funds that were “fantastic” last year are absent this year, including the entire contingent of Fidelity funds.  Thirty-three percent of the currently fantastic funds were not so distinguished twelve months ago.  If you systematically exclude large chunks of the fund universe from consideration (those not medalized) and have a list that’s both prosaic (“tape the names of all of the Price funds to the wall, throw a dart, find your fantasy fund!”) and unstable, you wonder how much insight you’re being offered.

Interested parties might choose to compare last year’s Fantastic 46 list with 2013’s new and improved Fantastic 51. 

About the lack of index funds in the Fantastic 51

Good index funds – ones with little tracking error – can’t beat their benchmarks over time because their return is the benchmark minus expenses.  A few bad index funds – ones with high tracking error, so they’re sometimes out of step with their benchmark – might beat it from time to time, and Gus Sauter was pretty sure that microscopic expenses and canny trade execution might allow him to eke out the occasional win.  But the current 51 has no passive funds.

The authors of S&P Indices Versus Active Funds (SPIVA®) Scorecard would argue that’s a foolish bias.  They track the percentage of funds in each equity category which manage to outperform their benchmark, controlling for survivorship bias.  The results aren’t pretty.  In 17 of 17 domestic equity categories they analyzed, active funds trailed passive.  Not just “most active funds.”  No, no.  The vast majority of active funds.  Over the past five years, 64.08% of large value funds trailed their benchmark and that’s the best performance by any of the 17 groups.  Overall, 72.01% trailed.  Your poorest odds came in the large cap growth, midcap growth and multicap growth categories, where 88% of funds lagged. 

In general, active funds lag passive ones by 150-200 basis points year.  That’s a problem, since that loss is greater than what the fund’s expense ratios could explain.  Put another way: even if actively managed funds had an expense ratio of zero, they’d still modestly trail their passive peers.

There is one and only one bright spot in the picture for active managers: international small cap funds, nearly 90% of which outperform a comparable index. Which international small caps qualify as Fantastic you might ask? That would be, none.

If you were looking for great prospects in the international small cap arena, the Observer recommends that you check Grandeur Peak Global Reach (GPROX) or wait for the launch of one of their next generation of purely international funds. Oberweis International Opportunities (OBIOX), profiled this month, would surely be on the list. Fans of thrill rides might consider Driehaus International Small Cap Growth (DRIOX). Those more interested in restrained, high-probability bets might look at the new Artisan Global Small Cap Fund (ARTWX), a profile of which is forthcoming.

How much can you actually gain by picking a good manager?

It’s hard to find a good manager. It takes time and effort and it would be nice to believe that you might receive a reward commensurate with all your hard work. That is, spending dozens of hours in research makes a lot more sense if a good pick actually has a noticeably pay-off. One way of measuring that pay-off is by looking at the performance difference between purely average managers and those who are well above average. 

The chart below, derived from data in the S&P 2013 SPIVA analysis shows how much additional reward a manager in the top 25% of funds provides compared to a purely average manager.

What might this suggest about where to put your energy?  First and foremost, a good emerging markets manager makes a real difference – the average manager lost money for you, the top tier of guys kept you in the black. Likewise with diversified international funds.  The poorest investment of your time might be in looking for a large cap and especially large cap value manager. Not only do they rarely beat an index fund when they do, the margin of victory is slim. 

The group where good active manager appears to have the biggest payoff – small caps across the board –  is muddied a bit by the fact that the average return was so high to begin with. The seemingly huge 231 bps advantage held by top managers represents just a 28% premium over the work of mediocre managers. In international small caps, the good-manager premium is far higher at 41%.  Likewise, top global managers returned about 42% more than average ones.

The bottom line: invest your intellectual resources where your likeliest to see the greatest reward.  In particular, managers who invest largely or exclusively overseas seem to have the prospect of making a substantial difference in your returns and probably warrant the most careful selection.  Managers in what’s traditionally the safest corner of the equity style box – large core, large  value, midcap value – don’t have a huge capacity to outperform either indexes or peers.  In those areas, cheap and simple might be your mantra.

The one consensus pick: Dodge & Cox International (DODFX)

There are three lists of “best funds” in wide circulation now: the Kiplinger 25, the Fantastic 51, and the Money 70.  You’d think that if all of these publications shared the same sensible goal – good risk-adjusted returns and shareholder-friendly practices – they’d also be stumbling across the same funds.

You’d be wrong. There’s actually just one fund that they all agree on: Dodge & Cox International (DODFX). The fund is managed by the same team that handles all of Dodge & Cox. It’s dragging around $45 billion in assets but, despite consistently elevated volatility, it’s done beautifully. It has trailed its peers only twice in the past decade, including 2008 when all of the D&C funds made a mistimed bet that the market couldn’t get much cheaper.  They were wrong, by about six months and 25% of their assets.

The fund has 94% of its assets in large cap stocks, but a surprisingly high exposure to the emerging markets – 17% to its peers 7%.

My colleague Charles is, even as you read this, analyzing the overlap – and lack of overlap – between such “best funds” lists.  He’ll share his findings with us in November.

Tealeaf Long/Short Deep Value Fund?

Really guys?

Really?

You’ve got a business model that’s predicated upon being ridiculed before you even launch?

The fate of the Palantir (“mystical far-seeing eye”) Fund (PALIX) didn’t raise a red flag?  Nor the Oracle Fund (ORGAX – the jokes there were too dangerous), or the Eye of Zohar Fund (okay, I made that one up)?  It’s hard to imagine investment advisors wanting to deal with their clients’ incredulity at being placed in a fund that sounds like a parody, and it’s harder to imagine that folks like Chuck Jaffe (and, well, me) won’t be waiting for you to do something ridiculous.

In any case, the fund’s in registration now and will eventually ask you for 2.62 – 3.62% of your money each year.

The art of reading tea leaves is referred to as tasseography.  Thought you’d like to know.

A new Fidelity fund is doing okay!

Yeah, I’m surprised to hear me saying that, too.  It’s a rarity.  Still FidelityTotal Emerging Markets (FTEMX) has made a really solid start.  FTEMX is one of the new generation of emerging markets balanced or hybrid funds.  It launched on November 1, 2011 and is managed by a seven-person team.  The team is led by John Carlson, who has been running Fidelity New Markets Income (FNMIX), an emerging markets bond fund, since 1995.  Mr. Carlson’s co-managers in general are young managers with only one other fund responsibility (for most, Fidelity Series Emerging Markets, a fund open only to other Fidelity funds).

The fund has allocated between 60-73% of its portfolio to equities and its equity allocation is currently at a historic high.

Since there’s no “emerging markets balanced” peer group or benchmark, the best we can do is compare it to the handful of other comparable funds we could find.  Below we report the fund’s expense ratios and the amount of money you’d have in September 2013 if you’d invested $10,000 in each on the day that FTEMX launched.

The only fund with even modestly better returns is the closed-end First Trust Aberdeen Emerging Opportunities, about which we wrote a short, positive profile.  That fund’s shares are selling, as of October 1, at a 9.2% discount to its actual net asset value which is a bit more than its 8.9% average discount over the past five years and substantially more than its 7.4% discount over the past three.

Microscopic by Fidelity standard, the fund has just $80 million in assets.  The minimum initial investment is $2500, reduced to $500 for IRAs.

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.

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^thanniversary with returns in the top 10% of its peer group.

Oberweis International Opportunities (OBIOX) brings a unique strategy grounded in the tenets of behavioral finance to the world of international small- and mid-cap growth investing.  The results (top decile returns in three of the past four years) and the firm’s increasingly sophisticated approach to risk management are both striking.

Elevator Talk #9: Bashar Qasem of Wise Capital (WISEX)

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.

Wise Capital (WISEX) provides investors with an opportunity for diversification in a fund category (short term bonds) mostly distinguished by bland uniformity: 10% cash, one equity security thrown in for its thrill-value, about 90% of the bond portfolio would be US with a dribble of Canadian and British issues, 90% A-AAA rated and little distance between the fund and its peers. 

We began searching, late last year, from short-term income funds that offered some prospect of offering atypical returns in a bad environment: negative real short-term rates for now and the prospect of a market overreaction when US rates finally began to rise.  Our touchstones were stable management, a distinctive strategy, and a record of success.  A tiny handful of funds survived the cull.  Among them, PIMCO Short Asset (PAUIX ), Payden Global Low Duration (PYGSX), RiverPark Short Term High Yield (RPHYX), Scout Low Duration (SCLDX) … and Azzad Wise Capital.

WISEX draws on a fundamentally different asset set than any other US fixed-income fund.  Much of the fund’s portfolio is invested in the Islamic world, in a special class of bank deposits and bond-equivalents called Sukuks.  The fund is not constrained to invest solely in either asset class, but its investments are ethically-screened, Shariah-compliant and offers ethical exposure to emerging markets such as Turkey, Indonesia, Malaysia and the Gulf.

Azzad was founded in 1997 by Bashar Qasem, a computer engineer who immigrated to the United States from Jordan at the age of 23.  Here’s Mr. Qasem’s 200 words making his case:

I started Azzad Asset Management back 1997 because I was disappointed with the lack of investment options that aligned with my socially responsible worldview. For similar reasons, I traveled across the globe to consult with scholars and earned licenses to teach and consult on compliance with Islamic finance. I later trained and became licensed to work in the investment industry.

We launched the Azzad Wise Capital Fund in 2010 as a response to calls from clients asking for a fund that respects the Islamic prohibition on interest but still offers a revenue stream and risk/return profile similar to a short-term bond fund. WISEX invests in a variety of Sukuk (Islamic bonds) and Islamic bank deposits involved in overseas development projects. Of course, it’s SEC-registered and governed by the Investment Company Act of 1940. Although it doesn’t deal with debt instruments created from interest-based lending, WISEX shares in the profits from its ventures.

And I’m particularly pleased that it appeals to conservative, income-oriented investors of all backgrounds, Muslim or not. We hear from financial advisors and individual shareholders of all stripes who own WISEX for exposure to countries like Turkey, Malaysia, and Indonesia, as well as access to an alternative asset class like Sukuk.

The fund has a single share class. The minimum initial investment is $4,000, reduced to $300 for accounts established with an automatic investing plan (always a good idea with cash management accounts). Expenses are capped at 1.49% through December, 2018.

For those unfamiliar with the risk/return profile of these sorts of investments, Azzad offers two resources.  First, on the Azzad Funds website, they’ve got an okay (not but great) white paper on Sukuks.  It’s under Investor Education, then White Papers.  Second, on October 23^rd, Mr. Quesam and portfolio manager Jamal Elbarmil will host a free webinar on Fed Tapering and Sukuk Investing.  Azzad shared the announcement with us but I can’t, for the life of me, find it on either of their websites so here’s a .pdf explaining the call.

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 (VCMRX), 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.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.
8. September 2013: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX), which looks to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility

During the summer hiatus on Observer conference calls, my colleague Charles Boccadoro and I have been listening-in on calls sponsored by some of the more interesting fund companies.  We report this month on the highlights of the calls concerning the reopening of RiverNorth/DoubleLine Strategic Income (David) and the evolution of the intriguing Whitebox Tactical Opportunities (Charles) funds.

Conference Call Highlights: RiverNorth/DoubleLine Strategic Income (RNDLX)

Strategic Income was launched on December 30, 2010 and our profile of the fund described it as “compelling.”  We speculated that if an investor were planning to hold only three funds over the long haul, “given its reasonable expenses, the managers’ sustained successes, innovative design and risk-consciousness, this might well be one of those three.”  Both popular ($1.1 billion in the portfolio) and successful (it has outperformed its “multisector bond” peers since inception and in seven of 10 quarters), the fund closed to new investors at the end of March. 2012.  Faced with a substantial expansion in their opportunity set, RiverNorth decided to reopen the fund to new investors 17 months later, at the end of August 2013, with the understanding that it was subject to re-closure if there was a pressing mismatch between the fund’s resources and the opportunities available.

On September 18, 2013, co-managers Jeffrey Gundlach of DoubleLine and Patrick Galley of RiverNorth spoke with interested parties about their decision to re-open the fund and its likely evolution.

By happenstance, the call coincided with the fed’s announcement that they’d put plans to reduce stimulus on hold, an event which led Mr. Gundlach to describe it as “a pivotal day for investor attitudes.” The call addressed three issues:

• The fund’s strategy and positioning.  The fund was launched as an answer to the question, how do income-oriented investors manage in a zero-rate environment?  The answer was, by taking an eclectic and opportunistic approach to exploiting income-producing investments.  The portfolio has three sleeves: core income, modeled after Doubleline’s Core Income Fund, opportunistic income, a mortgage-backed securities strategy which is Doubleline’s signature strength, and RiverNorth’s tactical closed-end income sleeve which seeks to profit from both tactical asset choices and the opportunities for arbitrage gains when the discounts on CEFs become unsustainably large.

  The original allocation was 50% core, 25% opportunistic and 25% tactical CEF.  RiverNorth’s strategy is to change weightings between the sleeves to help the portfolio manage changes in interest rates and volatility; in a highly volatile market, they might reallocate toward the more conservative core strategy while a rising interest rate regime might move them toward their opportunistic and tactical sleeves.  Before closing, much of the tactical CEF money was held in cash because opportunities were so few. 

• The rationale for reopening. Asset prices often bear some vague relation to reality.  But not always.  Opportunistic investors look to exploit other investors’ irrationality.  In 2009, people loathed many asset classes and in 2010 they loathed them more selectively.  As the memory of the crash faded, greed began to supplant fear and CEFs began selling at historic premiums to their NAVs.  That is, investors were willing to pay $110 for the privilege of owning $100 in equities.  Mr. Galley reported that 60% of CEFs sold at a premium to their NAVs in 2012.  2013 brought renewed anxiety, an anxious departure from the bond market by many and the replacement of historic premiums on CEFs with substantial discounts.  As of mid-September, 60% of CEFs were selling at discounts of 5% or more.  That is, investors were willing to sell $100 worth of securities for $95.

  As a whole, CEFs were selling at a 6.5% discount to NAV.  That compared to a premium the year before, an average 1% discount over the preceding three years and an average 3% discount over the preceding decade.

  

  The lack of opportunities in the fixed-income CEF space, a relatively small place, forced the fund’s closure.  The dramatic expansion of those opportunities justified its reopening.  The strategy might be able to accommodate as much as $1.5 billion in assets, but the question of re-closing the fund would arise well before then.

• Listener concerns.  Listeners were able to submit questions electronically to a RiverNorth moderator, an approach rather more cautious than the Observer’s strategy of having callers speak directly to the managers.  Some of the questions submitted were categorized as “repetitive or not worth answering” (yikes), but three issues did make it through. CEFs are traded using an algorithmic trading system developed by RiverNorth. It is not a black box, but rather a proprietary execution system used to efficiently trade closed-end funds based off of discount, instead of price. The size of the fund’s investable CEF universe is about 300 funds, out of 400 extant closed-end fixed-income funds. The extent of leverage in the portfolio’s CEFs was about 20%.

Bottom Line: the record of the managers and the fund deserves considerable respect, as does the advisor’s clear commitment to closing funds when doing so is in their investors’ best interest. The available data clearly supports the conclusion that, even with dislocations in the CEF space in 2013, active management has added considerable value here. 

The data-rich slides are already available by contacting RiverNorth. A transcript of the broadcast will be available on the RiverNorthFunds.com website sometime in October. 

Update: The webcast is now available at https://event.webcasts.com/viewer/event.jsp?ei=1021309 You will be required to register, but you’ll gain access immediately.

Conference Call Highlights: Whitebox Tactical Opportunities Fund (WBMAX and WBMIX)

Portfolio managers Andrew Redleaf and Dr. Jason Cross, along with Whitebox Funds’ President Bruce Nordin, hosted the 2^nd quarter conference call for their Tactical Opportunities Fund (WBMIX) on September 10. Robert Vogel, the fund’s third manager, did not participate. The call provided an opportunity to take a closer look at the fund, which is becoming hard to ignore.

Background

WBMIX is the more directionally oriented sibling of Whitebox’s market-neutral Long Short Equity Fund (WBLFX), which David profiled in April. Whitebox is preparing to launch a third mutual fund, named Enhanced Convertible Fund (WBNIX), although no target date has been established.

Whitebox Advisors, founded by Mr. Redleaf in 1999, manages its mutual funds with similar staff and strategies as its hedge funds. Mr. Redleaf is a deep contrarian of efficient market theory. He works to exploit market irrationalities and inefficiencies, like “mispriced securities that have a relationship to each other.” He received considerable attention for successfully betting against mortgages in 2008.

The Tactical Opportunities Fund seeks to provide “a combination of capital appreciation and income that is consistent with prudent investment management.” It employs the full spectrum of security classes, including stocks, bonds, and options. Its managers reject the notion that investors are rewarded for accepting more risk. “We believe risk does not create wealth, it destroys wealth.” Instead, they identify salient risks and adjust their portfolio “to perform at least tolerably well in multiple likely scenarios.”

The fund has attracted $205M AUM since its inception in December 2011 ­– on the day of the conference call, Morningstar showed AUM at $171M, an increase of $34M in less than three weeks. All three managers are also partners and owners in the firm, which manages about $2.4B in various types of investment accounts, but the SAI filed February 2013 showed none invested in the fund proper. Since this filing, Whitebox reports Mr. Redleaf has become a “significant owner” and that most of its partners and employees are invested in its funds through the company’s 401k program.

Morningstar recently re-categorized WBMIX from aggressive allocation to long-short after Whitebox management successfully appealed to the editorial board. While long-short is currently more appropriate, the fund’s versatility makes it an awkward fit in any category. It maintains two disparate benchmarks, S&P 500 Price Index SPX (excludes dividends) and Barclay’s Aggregate U.S. Bond Total Return Index. Going forward, Whitebox reports it will add S&P 500 Total Return Index as a benchmark.

Ideally, Mr. Redleaf would prefer the fund’s performance be measured against the nation’s best endowment funds, like Yale’s or Havard’s. He received multiple degrees from Yale in 1978. Dr. Cross holds an MBA from University of Chicago and a Ph.D. in Statistics from Yale.

Call Highlights

Most of its portfolio themes were positive or flat for the quarter, resulting in a 1.3% gain versus 2.9% for SP500 Total Return, 2.4% SP500 Price Return, 0.7% for Vanguard’s Balanced Index , and -2.3% for US Aggregate Bonds. In short, WBMIX had a good quarter.

Short Bonds. Whitebox has been sounding warning bells for sometime about overbought fixed income markets. Consequently, it has been shorting 20+ year Treasuries and high-yield bond ETFs, while being long blue-chip equities. If 1Q was “status quo” for investors, 2Q saw more of an orderly rotation out of low yielding bonds and into quality stocks. WBMIX was positioned to take advantage.

Worst-Case Hedge. It continues to hold out-of-money option straddles, which hedge against sudden moves up or down, in addition to its bond shorts. Both plays help in the less probable scenario that “credit markets crack” due to total loss of confidence in bonds, rapid rate increase and mass exodus, taking equities down with them.

Bullish Industrials. Dr. Cross explained that in 2Q they remained bullish on industrials and automakers. After healthy appreciation, they pared back on airlines and large financials, focusing instead on smaller banks, life insurers, and specialty financials. They’ve also been shorting lower yielding apartment REITS, but are beginning to see dislocations in higher yielding REITs and CEFs.

Gold Miner Value. Their one misstep was gold miners, at just under 5% of portfolio; it detracted 150 basis points from 2Q returns. Long a proxy for gold, miners have been displaced by gold ETFs and will no longer be able to mask poor business performance with commodity pricing. Mr. Redleaf believes increased scrutiny on these miners will lead to improved operations and a closure in the spread, reaping significant upside. He cited that six CEOs have retired or been replaced recently. This play is signature Whitebox. The portfolio managers do not see similar inefficiencies in base metal miners.

Large vs Small. Like its miss with gold miners, its large cap versus small cap play has yet to pan-out. It believes small caps are systematically overpriced, so they have been long on large caps while short on small caps. Again, “value arbitrage” Whitebox. The market agreed last quarter, but this theme has worked against the fund since 2Q12.

Heading into 3Q, Whitebox believes equities are becoming overbought, if temporarily, given their extended ascent since 2009. Consequently, WBMIX beta was cut to 0.35 from 0.70. This move appears more tactical than strategic, as they remain bullish on industrials longer term. Mr. Redleaf explains that this is a “game with no called strikes…you never have to swing.” Better instead to wait for your pitch, like winners of baseball’s Home Run Derby invariably do.

Whitebox has been considering an increase to European exposure, if it can find special situations, but during the call Mr. Redleaf stated that “emerging markets is a bit out of our comfort zone.”

Performance To-Date

The table below summaries WBMIX’s return/risk metrics over its 20-month lifetime. The comparative funds were suggested by MFO reader and prolific board contributor “Scott.” (He also brought WBMIX to community attention with his post back in August 2012, entitled “Somewhat Interesting Tiny Fund.”) Most if not all of the funds listed here, at some point and level (except VBINX), tout the ability to deliver balanced-like returns with less risk than the 60/40 fixed balanced portfolio.

While Whitebox has delivered superior returns (besting VBINX, Mr. Aronstein’s Marketfield and Mr. Romick’s Crescent, while trouncing Mr. Arnott’s All Asset and AQR’s Risk Parity), it’s generally done so with higher volatility. But the S&P 500 has had few drawdowns and low downside over this period, so it’s difficult to conclude if the fund is managing risk more effectively. That said, it has certainly played bonds correctly.

Other Considerations

When asked about the fund’s quickly increasing AUM, Dr. Cross stated that their portfolio contains large sector plays, so liquidity is not an issue. He believes that the fund’s capacity is “immense.”

Whitebox provides timely and thoughtful quarterly commentaries, both macro and security specific, both qualitative and quantitative. These commentaries reflect well on the firm, whose very name was selected to highlight a “culture of transparency and integrity.” Whitebox also sponsors an annual award for best financial research. The $25K prize this year went to authors of the paper “Time Series Momentum,” published in the Journal of Financial Economics.

Whitebox Mutual Funds offers Tactical Opportunities in three share classes. (This unfortunate practice is embraced by some houses, like American Funds and PIMCO, but not others, like Dodge & Cox and FPA.) Investor shares carry an indefensible front-load for purchases below $1M. Both Investor and Advisor shares carry a 12b-1 fee. Some brokerages, like Fidelity and Schwab, offer Advisor shares with No Transaction Fee. (As is common in the fund industry, but not well publicized, Whitebox pays these brokerages to do so – an expensive borne by the Advisor and not fund shareholders.) Its Institutional shares WBMIX are competitive currently at 1.35 ER, if not inexpensive, and are available at some brokerages for accounts with $100,000 minimum.

During the call, Mr. Redleaf stated that its mutual funds are cheaper than its hedge funds, but the latter “can hold illiquid and obscure securities, so it kind of balances out.” Perhaps so, but as Whitebox Mutual Funds continues to grow through thoughtful risk and portfolio management, it should adopt a simpler and less expensive fee structure: single share class, no loads or 12b-1 fees, reasonable minimums, and lowest ER possible. That would make this already promising fund impossible to ignore.

Bottom Line

At the end of the day, continued success with the fund will depend on whether investors believe its portfolio managers “have behaved reasonably in preparing for the good and bad possibilities in the current environment.” The fund proper is still young and yet to be truly tested, but it has the potential to be one of an elite group of funds that moderate investors could consider holding singularly – on the short list, if you will, for those who simply want to hold one all-weather fund.

A transcript of the 2Q call should be posted shortly at Whitebox Tactical Opportunities Fund.

27Sept2013/Charles

Conference Call Upcoming: Zachary Wydra, Beck, Mack & Oliver Partners (BMPEX), October 16, 7:00 – 8:00 Eastern

On October 16, Observer readers will have the opportunity to hear from, and speak to Zachary Wydra, manager of Beck, Mack & Oliver Partners (BMPEX).  After review of a lot of written materials on the fund and its investment discipline, we were impressed and intrigued.  After a long conversation with Zac, we were delighted.  Not to put pressure on the poor guy, but he came across as smart, insightful, reflective, animated and funny, often in a self-deprecating way.  We were more delighted when he agreed to spend an hour talking with our readers and other folks interested in the fund.

Mr. Wydra will celebrate having survived both the sojourn to Nebraska and participation in The Last Blast Triathlon by opening with a discussion of the  structure, portfolio management approach and stock selection criteria that distinguish BMPEX from the run-of-the-mill large cap fund, and then we’ll settle in to questions (yours and mine).

Our conference call will be Wednesday, October 16, from 7:00 – 8:00 Eastern.  It’s free.  It’s a phone call.

How can you join in?

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

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

WOULD AN ADDITIONAL HEADS UP HELP?

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

The Conference Call Queue

We have two other calls on tap.  On Monday, November 18, from 7:00 – 8:00 Eastern, you’ll have a chance to meet John Park and Greg Jackson, co-managers of Oakseed Opportunity (SEEDX and SEDEX).  John and Greg have really first-rate experience as mutual fund managers and in private equity, as well.  Oakseed is a focused equity fund that invests in high quality businesses whose managers interests are aligned with their shareholders.  As we note in the Updates section below, they’re beginning to draw both high-quality investors and a greater range of media attention.  If you’d like to get ahead of the curve, you can register for the call with John and Greg though I will highlight their call in next month’s issue.

In early December we’ll give you a chance to speak with the inimitable duo of Sherman and Schaja on the genesis and early performance of RiverPark Strategic Income, the focus of this month’s Launch Alert.

Launch Alert: RiverPark Strategic Income (RSIVX, RSIIX)

There are two things particularly worth knowing about RiverPark Short-Term High Yield (RPHYX): (1) it’s splendid and (2) it’s closed.  Tragically mischaracterized as a high-yield bond fund by Morningstar, it’s actually a cash management fund that has posted 3-4% annual returns and negligible volatility, which eventually drew almost a billion to the fund and triggered its soft close in June.  Two weeks later, RiverPark placed its sibling in registration. That fund went live on September 30, 2013.

Strategic Income will be managed by David Sherman of Cohanzick Management, LLC.  David spent ten years at Leucadia National Corporation where he was actively involved high yield and distressed securities and rose to the rank of vice president.  He founded Cohanzick in 1996 and Leucadia became his first client.  Cohanzick is now a $1.3 billion dollar investment adviser to high net worth individuals and corporations.   

Ed Studzinski and I had a chance to talk with Mr. Sherman and Morty Schaja, RiverPark’s president, for an hour on September 18^th.  We wanted to pursue three topics: the relation of the new fund to the older one, his portfolio strategy, and how much risk he was willing to court. 

RPHYX represented the strategies that Cohanzick uses for dealing with in-house cash.  It targets returns of 3-4% with negligible volatility.  RSIVX represents the next step out on the risk-return continuum.  David believes that this strategy might be reasonably expected to double the returns of RPHYX.  While volatility will be higher, David is absolutely adamant about risk-management.  He intends this to be a “sleep well at night” fund in which his mother will be invested.  He refuses to be driven by the temptation to shoot for “the best” total returns; he would far rather sacrifice returns to protect against loss of principal.  Morty Schaja affirms the commitment to “a very conservative credit posture.”

The strategy snapshot is this.  He will use the same security selection discipline here that he uses at RPHYX, but will apply that discipline to a wider opportunity set.  Broadly speaking, the fund’s investments fall into a half dozen categories:

1. RPHYX overlap holdings – some of the longer-dated securities (1-3 year maturities) in the RPHYX portfolio will appear here and might make up 20-40% of the portfolio.
2. Buy and hold securities – money good bonds that he’s prepared to hold to maturity. 
3. Priority-based debt – which he describes as “above the fray securities of [firms with] dented credit.”  These are firms that “have issue” but are unlikely to file for bankruptcy any time soon.  David will buy higher-order debt “if it’s cheap enough,” confident that even in bankruptcy or reorganization the margin of safety provided by buying debt at the right price at the peak of the creditor priority pyramid should be money good.
4. Off-the-beaten-path debt – issues with limited markets and limited liquidity, possibly small issues of high quality credits or the debt of firms that has solid business prospects but only modestly-talented management teams.  As raters like S&P contract their coverage universe, it’s likely that more folks are off the major firm’s radar.
5. Interest rate resets – uhhh … my ears started ringing during this part of the interview; I had one of those “Charlie Brown’s teacher” moments.  I’m confident that the “cushion bonds” of the RPHYX portfolio, where the coupon rate is greater than the yield-to maturity, would fall into this category.  Beyond that, you’re going to need to call and see if you’re better at following the explanation than I was.
6. And other stuff – always my favorite category.  He’s found some interesting asset-backed securities, fixed income issues with equity-like characteristics and distressed securities, which end up in the “miscellaneous” basket.

Mr. Sherman reiterates that he’s not looking for the highest possible return here; he wants a reasonable, safe return.  As such, he anticipates underperforming in silly markets and outperforming in normal ones.

The minimum initial investment in the retail class is $1,000.  The expense ratio is capped at 1.25%.  The fund is available today at TD and Fidelity and is expected to be available within the next few days at Schwab. More information is available at RiverPark’s website.  As I noted in September’s review of my portfolio, this is one of two funds that I’m almost certain to purchase before year’s end.

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 David Welsch, firefighter/EMT/fund researcher, scours new SEC filings to see what opportunities might be about to present themselves.  This month he tracked down 10 no-load funds in registration, one of the lowest levels in a year (compare it to 26 last month), but it does contain three offerings from first-rate, veteran teams:

361 Multi-Strategy Fund, 361’s fourth alternatives fund, guided by Brian Cunningham (a hedge fund guy), Thomas Florence (ex-Morningstar Investment Management), Blaine Rollins (ex-Janus) and Jeremy Frank.

Croft Focus, which transplants the discipline that’s guided Croft Value for 18 years into a far more concentrated global portfolio.

RSQ International Equity, which marks the re-emergence of Rudolph Riad-Younes and Richard Pell from the ashes of the Artio International crash.

In addition, two first-tier firms (Brookfield and First Eagle) have new funds managed by experienced teams.

Funds in registration this month won’t be available for sale until, typically, the end of November or early December 2013.

Manager Changes

On a related note, we also tracked down 39 fund manager changes.

Updates

The good folks at Oakseed Opportunity (SEEDX and SEDEX) are getting their share of favorable notice.  The folks at Bloomberg featured them in A Fund’s Value: Having Skin in the Game (Sept 6, 2013) while, something called Institutional Imperative made them one of Two Funds on which to Build a Portfolio (Sept 10, 2013).  At last report, they were holding more cash, more international exposure and smaller firms than their peers, none of which has been positive in this year’s market. Somehow the fact that the managers have $10 million of their own money in the fund, and that two phenomenally talented international investors (David Herro of Oakmark and David Samra of Artisan) are also invested in the fund does rather make “weak relative returns in 2013” sound rather like background noise.  Thanks to the indefatigable Denny Baran for sharing both of those links and do consider the opportunity to speak with the Oakseed managers during our November conference call.

Morningstar declared Poplar Forest Partners Fund (PFPFX and IPFPX) to be an Undiscovered Manager (uhhh … okay) and featured them in a Morningstar Advisor Magazine article, “Greener Pastures” (August/September, 2013).  Rob Wherry makes the argument that manager Dale Harvey walked away from managing a $20 billion fund because it was – for reasons he couldn’t control – a $20 billion fund.  “I had to put the money to work. I was managing $20 billion, but I didn’t have $20 billion [worth of] good ideas . . . I had 80 investments, but I only wanted 30.”  It’s a good piece.

Briefly Noted . . .

Since DundeeWealth US, LP, has opted to get out of the US mutual fund business they’re looking for a buyer for their Dynamic Energy Income Fund (DWEIX/DWEJX/DWEKX), Dynamic U.S. Growth Fund (DWUGX/DWUHX/DWUIX) and Mount Lucas U.S. Focused Equity Fund (BMLEX) funds. Failing that, they’re likely to liquidate them. My suggestion for eBaying them was not received warmly (hey, it worked for William Shatner’s $25,000 kidney stone!). If you’re looking for a handful of $50 million funds – one of which, US Growth, is remarkably good – you might give them a call.

Fidelity Global Balanced Fund (FGBLX) manager Ruben Calderon has taken a leave of absence for an unspecified reason.  His co-manager, Geoff Stein, will take sole control.   A chunk of my retirement accounts are, and have for a long time been, invested in the fund and I wish Mr. Calderon all the best with whatever has called him away.

JPMorgan Value Opportunities Fund (JVOAX) isn’t dead yet.  The Board is appalled.  The Board convened a meeting on September 10, 2013, for the purpose of merged Value Opps into JPMorgan Large Cap Value.  Unfortunately, they have not received enough ballots to meet their quorum requirement and the meeting dissolved.  They’ve resolved to try again with the following stern warning to non-voting shareholders:

However, recognizing that it is neither feasible nor legally permitted for the Value Opportunities Fund to conduct a proxy solicitation indefinitely, the Board approved in principle the liquidation of the Value Opportunities Fund if shareholders do not approve the merger when the Meeting is reconvened on October 10, 2013. If the Value Opportunities Fund is liquidated, the Fund’s liquidation may be taxable to a shareholder depending on the shareholder’s tax situation; as a result, the tax-free nature of the merger may be more beneficial to shareholders.

Translation: (a) vote (b) the way we want you to, or we’ll liquidate your fund and jack up your taxes.

Litman Gregory giveth and Litman Gregory taketh away.  The firm has eliminated the redemption fee on its Institutional Class shares, but then increased the minimum investment for Institutional shares of their Equity (MSEFX) and International (MSILX) funds from $10,000 to $100,000.

Vanguard 500 Index Fund ETF Shares (VOO) has announced an odd reverse share split.  As of October 24, 2013, the fund will issue one new share for every two current ones.  Good news: Vanguard expects somewhat lower transaction costs as a result, savings which they’ll pass along to investors.  Bad news: “As a result of the split, VOO shareholders could potentially hold fractional shares. These will be redeemed for cash and sent to the broker of record, which may result in the realization of modest taxable gains or deductible losses for some shareholders.”

Virtus Dynamic AlphaSector Fund (EMNAX), on the other hand, mostly taketh away.  Virtus discontinued the voluntary limit on “Other Expenses” of the fund.  The fund, categorized as a long/short fund though it currently has no reported short positions, charges a lot for modest achievement: Class A Shares, 2.56%; Class B Shares, 3.31%; Class C Shares, 3.31%; and Class I Shares, 2.31%.   Virtus may also recapture fees previously waived. 

SMALL WINS FOR INVESTORS

The Board for Altegris Equity Long Short Fund (ELSAX) voted to reduce Altegris’s management fee from 2.75% to 2.25% of assets.   This qualifies as a small win since that’s still about 50% higher than reasonable.  Aston River Road Long/Short (ARLSX) investors, for example, pays a management fee of 1.20% for considerably stronger performance.  Wasatch Long/Short (FMLSX) investors pay 1.10%.

Altegris Futures Evolution Strategy Fund  (EVOAX) has capped its management fee at 1.50%.

Calamos Convertible Fund (CCVIX) reopened to new investors on September 6^th.

CSC Small Cap Value Fund (CSCSX) has been renamed Cove Street Capital Small Cap Value Fund.  They’ve eliminated their sales loads and reduced the minimum initial investment to $1,000 for Investor class shares and $10,000 for Institutional class shares.   The manager here was part of the team that had fair success at the former CNI Charter RCB Small Cap Value Fund.

CLOSINGS (and related inconveniences)

ASTON/Fairpointe Mid Cap Fund (ABMIX) is set to close on October 18, 2013.  About $5 billion in assets.  Consistently solid performance.  I’m still not a fan of announcing a closing four weeks ahead of the actual event, as happened here.

BMO Small-Cap Growth Fund (MRSCX) is closing effective November 1, 2013.  The closure represents an interesting reminder of the role of invisible assets in capacity limits.  The fund has $795 million in it, but the advisor reports that assets in the small-cap growth strategy as a whole are approaching approximately $1.5 billion.

Invesco European Small Company Fund (ESMAX) closes to new investors on October 4, 2013.  Invesco’s to be complimented on their decision to close the fund while it was still small, under a half billion in assets.

Touchstone Sands Capital Select Growth Fund (TSNAX) instituted a soft-close on April 8, 2013.  That barely slowed the inrush of money and the fund is now up to $5.5 billion in assets.  In response, the advisor will institute additional restrictions on October 21, 2013. In particular, existing RIA’s already using the fund can continue to use the fund for both new and existing clients.  They will not be able to accept any new RIA’s after that date.

Virtus Emerging Markets Opportunities Fund (HEMZX), a four-star medalist run by Morningstar’s International Stock Fund Manager of the Year Rajiv Jain, has closed to new investors.

OLD WINE, NEW BOTTLES

FMI Focus (FMIOX) will reorganize itself into Broadview Opportunity Fund in November.  It’s an exceedingly solid small-cap fund (four stars, “silver” rated, nearly a billion in assets) that’s being sold to its managers.

Invesco Disciplined Equity Fund (AWEIX) will, pending shareholder approval on October 17, become AT Disciplined Equity Fund.

Meridian Value (MVALX) is Meridian Contrarian Fund.  Same investment objective, policies, strategies and team. 

Oppenheimer Capital Income Fund (OPPEX) has gained a little flexibility; it can now invest 40% in junk bonds rather than 25%.  The fund was crushed during the meltdown in 2007-09.  Immediately thereafter its managers were discharged and it has been pretty solid since then.

Effective October 1, 2013, Reaves Select Research Fund (RSRAX) became Reaves Utilities and Energy Infrastructure Fund, with all of the predictable fallout in its listed investment strategies and risks.

Smith Group Large Cap Core Growth Fund (BSLGX) will, pending shareholder approval, be reorganized into an identical fund of the same name in early 2014. 

Tilson Dividend Fund (TILDX) has been sold to its long-time subadviser, Centaur Capital Partners, LP, presumably as part of the unwinding of the other Tilson fund.

U.S. Global Investors Government Securities Savings Fund (UGSCX) is being converted from a money market fund to an ultra-short bond fund, right around Christmas.

OFF TO THE DUSTBIN OF HISTORY

American Century announced that it will merge American Century Vista Fund (TWVAX) into American Century Heritage (ATHAX).  Both are multibillion dollar midcap growth funds, with Heritage being far the stronger. The merger will take place Dec. 6, 2013.

EGA Emerging Global ordered the liquidation of a dozen of emerging markets sector funds, all effective October 4, 2013.  The dearly departed:

• EGShares GEMS Composite ETF (AGEM)
• EGShares Basic Materials GEMS ETF (LGEM)
• EGShares Consumer Goods GEMS ETF (GGEM)
• EGShares Consumer Services GEMS ETF (VGEM)
• EGShares Energy GEMS ETF (OGEM)
• EGShares Financials GEMS ETF (FGEM)
• EGShares Health Care GEMS ETF (HGEM)
• EGShares Industrials GEMS ETF (IGEM)
• EGShares Technology GEMS ETF (QGEM)
• EGShares Telecom GEMS ETF (TGEM)
• EGShares Utilities GEMS ETF (UGEM)
• EGShares Emerging Markets Metals & Mining ETF (EMT)

FCI Value Equity Fund (FCIEX) closed September 27, on its way to liquidation.  The Board cited “the Fund’s small size and the increasing costs associated with advising a registered investment company” but might have cited, too, the fact that it trails 97% of its peers over the past five years and tended to post two awful years for every decent one.

Natixis Hansberger International Fund (NEFDX) will liquidate on October 18, 2013, a victim of bad returns, high risk, high expenses, wretched tax efficiency … all your basic causes.

Loomis Sayles Multi-Asset Real Return Fund (MARAX) liquidates at the end of October, 2013.  The fund drew about  $25 million in assets and was in existence for fewer than three years.  “Real return” funds are designed to thrive in a relatively high or rising inflation rate environment.  Pretty much any fund bearing the name has been thwarted by the consistent economic weakness that’s been suppressing prices.

I really like Manning & Napier.  They are killing off three funds that were never a good match for the firm’s core strengths.  Manning & Napier Small Cap (MNSMX), Life Sciences (EXLSX), and Technology (EXTCX) will all cease to exist on or about January 24, 2014.  My affection for them comes to mind because these funds, unlike the vast majority that end up in the trash heap, were all economically viable.  Between them they have over $600 million in assets and were producing $7 million/year in revenue for M&N.  The firm’s great strength is risk-conscious, low-cost, team-managed diversified funds.  Other than a real estate fund, they offer almost no niche products really.  Heck, the tech fund even had a great 10-year record and was no worse than mediocre in shorter time periods.  But, it seems, they didn’t make sense given M&N’s focus. 

Metzler/Payden European Emerging Markets Fund (MPYMX) closed on September 30, 2013.  It actually outperformed the average European equity fund over the past decade but suffered two cataclysm losses – 74% from June 2008 to March 2009 and 33% in 2011 – that surely sealed its fate.  We reviewed the fund favorably as a fascinating Eurozone play about seven years ago. 

Nuveen International (FAIAX) is slated to merge into Nuveen International Select (ISACX), which is a case of a poor fund with few assets joining an almost-as-poor fund with more assets (and, not coincidentally, the same managers). 

PIA Moderate Duration Bond Fund (PIATX) “will be liquidating its assets on October 31, 2013.  You are welcome, however, to redeem your shares before that date.”  As $30 million in assets, it appears that most investors didn’t require the board’s urging before getting out.

U.S. Global Investors Tax Free Fund (USUTX) will merge with a far better fund, Near-Term Tax Free (NEARX) on or about December 13, 2013.

U.S. Global Investors Treasury Securities Cash (USTXX) vanishes on December 27, 2013.

Victoria 1522 Fund (VMDAX) has closed and will liquidate on October 10, 2013.  Nice people, high fees, weak performance, no assets. 

Westcore Small-Cap Opportunity Fund (WTSCX) merges into the Westcore Small-Cap Value Dividend Fund (WTSVX) on or about November 14, 2013.  It’s hard to make a case for the surviving fund (it pays almost no dividend and trails 90% of its peers) except to say it’s better than WTSCX.  Vanguard has an undistinguished SCV index fund that would be a better choice than either.

In Closing . . .

At the beginning of October, we’ll be attending Morningstar’s ETF Invest Conference in Chicago, our first tentative inquiry, made in hopes of understanding better the prospects of actively-managed ETFs.  I don’t tweet (I will never tweet) but I will try to share daily updates and insights on our discussion board.  We’ll offer highlights of the conference presentations in our November issue.

Thanks to all of the folks who bookmarked or clicked on our Amazon link.  There was a gratifyingly sustained uptick in credit from Amazon, on the order of a 7-8% rise from our 2013 average.  Thanks especially to those who’ve supported the Observer directly (Hi, Joe!  It’s a tough balance each month: we try to be enjoyable without being fluffy, informative without being plodding.  Glad you think we make it.) or via our PayPal link (Thanks, Ken!  Thanks, Michelle.  Sorry I didn’t extend thanks sooner.  And thanks, especially, to Deb.  You make a difference).  It does make a difference.

We’ll see you just after Halloween.  If you have little kids who enjoy playing on line, one of Chip’s staff made a little free website that lets kids decorate jack-o-lanterns.  It’s been very popular with the seven-and-under set. 

Take care!

David

Dear friends,

My colleagues in the English department are forever yammering on about this Shakespeare guy.I’m skeptical. First, he didn’t even know how to spell his own name (“Wm Shakspē”? Really?). Second, he clearly didn’t understand seasonality of the markets. If you listen to Gloucester’s famous declamation in Richard III, you’ll see what I mean:

Now is the winter of our discontent
Made glorious summer by this sun of York;
And all the clouds that lour’d upon our house
In the deep bosom of the ocean buried.
Now are our brows bound with victorious wreaths;
Our bruised arms hung up for monuments;
Our stern alarums changed to merry meetings,
Our dreadful marches to delightful measures.

It’s pretty danged clear that we haven’t had anything “made glorious summer by the sun of [New] York.” By Morningstar’s report, every single category of bond and hybrid fund has lost money over the course of the allegedly “glorious summer.” Seven of the nine domestic equity boxes have flopped around, neither noticeably rising nor falling.

And now, the glorious summer passed, we enter what historically are the two worst months for the stock market. To which I can only reply with three observations (The Pirates are on the verge of their first winning season since 1992! The Steelers have no serious injuries looming over them. And Will’s fall baseball practices are upon us.) and one question:

Is it time to loathe the emerging markets? Again?

Yuh, apparently. A quick search in Google News for “emerging markets panic” turns up 3300 stories during the month of August. They look pretty much like this:

With our preeminent journalists contributing:

Many investors have responded as they usually do, by applying a short-term perspective to a long-term decision. Which is to say, they’re fleeing. Emerging market bond funds saw a $2 billion outflow in the last week of August and $24 billion since late May (Emerging Markets Fund Flows Investors Are Dumping Emerging Markets at an Accelerating Pace, Business Insider, 8/30/13). The withdrawals were indiscriminate, affecting all regions and both local currency and hard currency securities. Equity funds saw $4 billion outflows for the week, with ETFs leading the way down (Emerging markets rout has investors saying one word: sell, Marketwatch, 8/30/13).

In a peculiar counterpoint, Jason Kepler of Investment News claims – using slightly older data – that Mom and pop can’t quit emerging-market stocks. And that’s good (8/27/13). He finds “uncharacteristic resiliency” in retail investors’ behavior. I’d like to believe him. (The News allows a limited number of free article views; if you’d exceeded your limit and hit a paywall, you might try Googling the article title. Or subscribing, I guess.)

We’d like to make three points.

• Emerging markets securities are deeply undervalued
• Those securities certainly could become much more deeply undervalued.
• It’s not the time to be running away.

Emerging markets securities are deeply undervalued

Wall Street Ranter, an anonymous blogger from the financial services industry and sometime contributor to the Observer’s discussion board, shared two really striking bits of valuation data from his blog.

The first, “Valuations of Emerging Markets vs US Stocks” (7/20/13) looks at a PIMCO presentation of the Shiller PE for the emerging markets and U.S., then at how such p/e ratios have correlated to future returns. Shiller adjusts the market’s price/earnings ratio to eliminate the effect of atypical profit margins, since those margins relentlessly regress to the mean over time. There’s a fair amount of research that suggests that the Shiller PE has fair predictive validity; that is, abnormally low Shiller PEs are followed by abnormally high market returns and vice versa.

Here, with Ranter’s kind permission, is one of the graphics from that piece:

At June 30, 2013 valuations, this suggests that US equities were priced for 4% nominal returns (2-3% real), on average, over the next five years while e.m. equities were priced to return 19% nominal (17% or so real) over the same period. GMO, at month’s end, reached about the same figure for high quality US equities (3.1% real) but a much lower estimate (6.8%) for emerging equities. By GMO’s calculation, emerging equities were priced to return more than twice as much as any other publicly traded asset class.

Based on recent conversations with the folks at GMO, Ranter concludes that GMO suspects that changes in the structure of the Chinese economy might be leading them to overstate likely emerging equity returns. Even accounting for those changes, they remain the world’s most attractive asset class:

While emerging markets are the highest on their 7 year forecast (approx. 7%/year) they are treating it more like 4%/year in their allocations . . . because they believe they need to account for a longer-term shift in the pace of China’s growth. They believe the last 10 years or so have skewed the mean too far upwards. While this reduces slightly their allocation, it still leaves Emerging Markets has one of their highest forecasts (but very close to International Value … which includes a lot of developed European companies).

Ranter offered a second, equally striking graphic in “Emerging Markets Price-to-Book Ratio and Forward Returns (8/9/13).”

At these levels, he reports, you’d typically expect returns over the following year of around 55%. That data is available in his original article. 

In a singularly unpopular observation, Andrew Foster, manager of Seafarer Overseas Growth & Income (SFGIX/SIGIX), one of the most successful and risk-alert e.m. managers (those two attributes are intimately connected), notes that the most-loathed emerging markets are also the most compelling values:

The BRICs have underperformed to such an extent that their aggregate valuation, when compared to the emerging markets as a whole, is as low as it has been in eight years. In other words, based on a variety of valuation metrics (price-to-book value, price-to-prospective-earnings, and dividend yield), the BRICs are as cheap relative to the rest of the emerging markets as they have been in a long time. I find this interesting. . . for the (rare?) subset of investors contemplating a long-term (10-year) allocation to EM, just as they were better off to avoid the BRICs over the past 5 years when they were “hot,” they are likely to be better off over the next 10 years emphasizing the BRICs now they are “not.”

Those securities certainly could become much more deeply undervalued.

The graphic above illustrates the ugly reality that sometimes (late ’98, all of ’08), but not always (’02, ’03, mid ’11), very cheap markets become sickeningly cheap markets before rebounding. Likewise, Shiller PE for the emerging markets occasionally slip from cheap (10-15PE) to “I don’t want to talk about it” (7 PE). GMO mildly notes, “economic reality and investor behavior cause securities and markets to overshoot their fair value.”

Andrew Foster gently dismisses his own predictive powers (“my record on predicting short-term outcomes is very poor”). At the same time, he finds additional cause for short-term concern:

[M]y thinking on the big picture has changed since [early July] because currencies have gotten into the act. I have been worried about this for two years now — and yet even with some sense it could get ugly, it has been hard to avoid mistakes. In my opinion, currency movements are impossible to predict over the short or long term. The only thing that is predictable is that when currency volatility picks up, is likely to overshoot (to the downside) in the short run.

It’s not the time to be running away.

There are two reasons driving that conclusion. First, you’ve already gotten the timing wrong and you’re apt to double your error. The broad emerging markets index has been bumping along without material gain for five years now. If you were actually good at actively allocating your portfolio, you’d have gotten out in the summer of 2007 instead of thinking that five consecutive years of 25%+ gains would go on forever. And you, like the guys at Cook and Bynum, would have foregone Christmas presents in 2008 in order to plow every penny you had into an irrationally, shockingly cheap market. If you didn’t pull it off then, you’re not going to pull it off this time, either.

Second, there are better options here than elsewhere. These remain, even after you adjust down their earnings and adjust them down again, about the best values you’ll find. Ranter grumbles about the thoughtless domestic dash:

Bottom line is I fail to see, on a relative basis, how the US is more tempting looking 5 years out. People can be scared all they want of catching a falling knife…but it’s a lot easier to catch something which is only 5 feet in the air than something that is 10 feet in the air.

If you’re thinking of your emerging markets stake as something that you’ll be holding or building over the next 10-15 years (as I do), it doesn’t matter whether you buy now or in three months, at this level or 7% up or down from here. It will matter if you panic, leave and then refuse to return until the emerging markets feel “safe” to you – typically around the top of the next market cycle.

It’s certainly possible that you’re systemically over-allocated to equities or emerging equities. The current turbulence might well provide an opportunity to revisit your long-term plan, and I’d salute you for it. My argument here is against actions driven by your gut.

Happily, there are a number of first rate options available for folks seeking risk-conscious exposure to the emerging markets. My own choice, discussed more fully below, is Seafarer. I’ve added to my (small investor-sized) account twice since the market began turning south in late spring. I have no idea of whether those dollars with be worth a dollar or eighty cents or a plugged nickel six months from now. My suspicion is that those dollars will be worth more a decade from now having been invested with a smart manager in the emerging markets than they would have been had I invested them in domestic equities (or hidden them away in a 0.01% bank account). But Seafarer isn’t the only “A” level choice. There are some managers sitting on large war chests (Amana Developing World AMDWX), others with the freedom to invest across asset classes (First Trust/Aberdeen Emerging Opportunities FEO) and even some with both (Lazard Emerging Markets Multi-Strategy EMMOX).

To which Morningstar says, “If you’ve got $50 million to spend, we’ve got a fund for you!”

On August 22^nd, Morningstar’s Fund Spy trumpeted “Medalist Emerging-Markets Funds Open for Business,” in which they reviewed their list of the crème de la crème emerging markets funds. It is, from the average investor’s perspective, a curious list studded with funds you couldn’t get into or wouldn’t want to pay for. Here’s the Big Picture:

Our take on those funds follows.

Our recommendations differ from theirs, given our preference for smaller funds that are actually available to the public. Our shortlist:

Amana Developing World (AMDWX): offers an exceedingly cautious take on an exceedingly risky slice of the world. Readers were openly derisive of Amana’s refusal to buy at any cost, which led the managers to sit on a 50% cash stake while the market’s roared ahead. As those markets began their swoon in 2011, Amana began moving in and disposing of more than half of its cash reserves. Still cash-rich, the fund’s relative performance is picking up and its risks remain very muted.

First Trust/Aberdeen Emerging Opportunity (FEO): one of the first emerging markets balanced funds, it’s performed very well over the long-term and is currently selling at a substantial discount to NAV: 12.6%, about 50% greater than its long-term average. That implies that investors might see something like a 5% arbitrage gain once the current panic abates, above and beyond whatever the market provides.

Grandeur Peak Emerging Markets Opportunities (GPEOX): the Grandeur Peak team has been brilliantly successful both here and at Wasatch. Their intention is to create a single master fund (Global Reach) and six subsidiary funds whose portfolios represent slices of the master profile. Emerging Markets has already cleared the SEC registration procedures but hasn’t launched. The Grandeur Peak folks say two factors are driving the delay. First, the managers want to be able to invest directly in Indian equities which requires registration with that country’s equity regulators. They couldn’t begin the registration until the fund itself was registered in the US. So they’re working through the process. Second, they wanted to be comfortable with the launch of Global Reach before adding another set of tasks. Give or take the market’s current tantrum (one manager describes it as “a taper tantrum”), that’s going well. With luck, but without any guarantees, the fund might be live sometime in Q4.

Seafarer Overseas Growth & Income (SFGIX): hugely talented manager, global portfolio, risk conscious, shareholder-centered and successful.

Wasatch Frontier Emerging Small Countries (WAFMX): one of the very few no-load, retail funds that targets the smaller, more dynamic markets rather than markets with billions of people (India and China) or plausible claim to be developed markets (e.g., Korea). The manager, Laura Geritz, has been exceedingly successful. Frontier markets effectively diversify emerging markets portfolios and the fund has drawn nearly $700 million. The key is that Wasatch is apt to close the fund sooner rather than later.

Snowball’s portfolio

Some number of folks have, reasonably enough, asked whether I invest in all of the funds I profile (uhhh … there have been over 150 of them, so no) or whether I have found The Secret Formula (presumably whatever Nicholas Cage has been looking for in all those movies). The answer is less interesting than the question.

I guess my portfolio construction is driven by three dictums:

1. Don’t pretend to be smarter than you are
2. Don’t pretend to be braver than you are
3. There’s a lot of virtue in doing nothing

Don’t pretend to be smarter than you are. If I knew which asset classes were going to soar and which were going to tank in the next six months or year or two, two things would happen. First, I’d invest in the winners. Second, I’d sell my services to ridiculously rich people and sock them with huge and abusive fees that they’d happily pay. But, I don’t.

As a result, I tend to invest in funds whose managers have a reasonable degree of autonomy about investing across asset classes, rather than ones pigeonholed into a small (style) box. That’s a problem: it makes benchmarking hard, it makes maintaining an asset allocation plan hard and it requires abnormally skilled managers. My focus has been on establishing a strategic objective (“increasing exposure to fast growing economies”) and then spending a lot of time trying to find managers whose strategies I trust, respect and understand.

Don’t pretend to be braver than you are. Stocks have a lot in common with chili peppers. In each case, you get a surprising amount of benefit from a relatively small amount of exposure. In each case, increasing exposure quickly shifts the pleasure/pain balance from pleasantly piquant to moronically painful. Some readers think of my non-retirement asset allocation is surprisingly timid: about 50% stocks, 30% bonds, 20% cash equivalents. They’re not much happier about my 70% equity stake in retirement funds. But, they’re wrong.

T. Rowe Price is one of my favorite fund companies, in part because they treat their investors with unusual respect. I found two Price studies, in 2004 and again in 2010, particularly provocative. Price constructed a series of portfolios representing different levels of stock exposure and looked at how the various portfolios would have played out over the past 50-60 years.

The original study looked at portfolios with 20/40/60/80/100% stocks. The update dropped the 20% portfolio and looked at 0/40/60/80/100%. Below I’ve reproduced partial results for three portfolios. The original 2004 and 2010 studies are available at the T. Rowe Price website.

 Over a 10 year period – reasonable for a non-retirement account – a portfolio that’s 20% stocks would grow from $10,000 to $21,000. A 100% stock portfolio would grow to $28,000. Roughly speaking, the conservative portfolio ends up at 75% of the size of the aggressive one but a pure stock portfolio increases the probability of losing money by 400% (from a 6% chance to 23%), increases the size of your average loss by 2500% (from 0.5% to 12.5%) and triples your volatility. Somewhere in there, it will face the real prospect of a 51% loss, which is the average maximum drawdown for large core stock funds that have been around 20 years or more. Sadly, there’s no way of knowing whether the 51% loss will occur in Year One (where you might have some recovery time) or Year Ten (where you’d be toast).

At 50% equities, I might capture 80% of the market’s gain with 50% of its volatility. If domestic bonds weren’t in such dismal straits, a smaller stock exposure might be justifiable. But they suck so I’m stuck.

There’s a lot of virtue in doing nothing. Our action tends to be a lot more costly than our inaction, so I change my target allocation slowly and change my fund line-up slowly. I’ve held a few retirement plan funds (e.g., Fidelity Low Priced Stock FLPSX) for decades and a number of non-retirement funds since their inception. In general, I’ll only add a fund if it represents an entirely new opportunity set or if it’s replacing an existing fund. On average, I might change out one fund every year or two.

My retirement portfolio is dominated by the providers in Augustana’s 403(b) plan: Fidelity, T. Rowe Price and TIAA-CREF. The college contribution to retirement goes exclusively into TIAA-CREF. CREF Stock accounts for 68%, TIAA Real Estate holds 22% and the rest is in a target-date fund. The Fidelity and Price allocations mirror one another: 33% domestic stock (with a value bias), 33% international stock (with an emerging markets bias) and 33% income (of the eclectic Spectrum Income/Global High Income sort).

My non-retirement portfolio is nine funds and some cash waiting to be deployed.

Is anyone likely to make it into my portfolio in 2013-14? There are two candidates:

ASTON/River Road Long-Short (ARLSX). We’ve both profiled the fund and had a conference call with its manager, both of which are available on the Observer’s ARLSX page. I’m very impressed with the quality and clarity of their risk-management disciplines; they’ve left little to chance and have created a system that forces them to act when it’s time. They’ve performed well since inception and have the prospect of outperforming the stock market with a fraction of its risk. If this enters the portfolio, it would likely be as a substitute for Northern Global Tactical since the two serve the same risk-dampening function.

RiverPark Strategic Income (not yet launched). This fund will come to market in October and represents the next step out on the risk-return spectrum from the very successful RiverPark Short Term High Yield (RPHYX). I’ve been impressed with David Sherman’s intelligence and judgment and with RPHYX’s ability to deliver on its promises. We’ll be doing fairly serious inquiries in the next couple months, but the new fund might become a success to T. Rowe Price Spectrum Income.

Sterling Capital hits Ctrl+Alt+Delete

Sterling Capital Select Equity (BBTGX) has been a determinedly bad fund for years. It’s had three managers since 1993 and it has badly trailed its benchmark under each of them. The strategy is determinedly nondescript. They’ve managed to return 3.2% annually over the past 15 years. That’s better – by about 50 bps – than Vanguard’s money market fund, but not by much. Effective September 3, 2013, they’re hitting “reformat.”

The fund’s name changes, to Sterling Capital Large Cap Value Diversified Fund.

The strategy changes, to a “behavioral financed” based system targeting large cap value stocks.

The benchmark changes, to the Russell 1000 Value

And the management team changes, to Robert W. Bridges and Robert O. Weller. Bridges joined the firm in 2008 and runs the Sterling Behavioral Finance Small Cap Diversified Alpha. Mr. Weller joined in 2012 after 15 years at JPMorgan, much of it with their behavioral finance team.

None of which required shareholders’ agreement since, presumably, all aspects of the fund are “non-fundamental.” 

One change that they should pursue but haven’t: get the manager to put his own money at risk. The departing manager was responsible for five funds since 2009 and managed to find nary a penny to invest in any of them. As a group, Sterling’s bond and asset allocation team seems utterly uninterested in risking their own money in a lineup of mostly one- and two-star funds. Here’s the snapshot of those managers’ holdings in their own funds:

You’ll notice the word “none” appears 32 times. Let’s agree that it would be silly to expect a manager to own tax-free bonds anywhere but in his home jurisdiction. That leaves 26 decisions to avoid their own funds out of a total of 27 opportunities. Most of the equity managers, by contrast, have made substantial personal investments.

Warren Buffett thinks you’ve come to the right place

Fortune recently published a short article which highlighted a letter that Warren Buffett wrote to the publisher of the Washington Post in 1975. Buffett’s an investor in the Post and was concerned about the long-term consequences of the Post’s defined-benefit pension. The letter covers two topics: the economics of pension obligations in general and the challenge of finding competent investment management. There’s also a nice swipe at the financial services industry, which most folks should keep posted somewhere near their phone or monitor to review as you reflect on the inevitable marketing pitch for the next great financial product.

I particularly enjoy the “initially.” Large money managers, whose performance records were generally parlous, “felt obliged to seek improvement or at least the approach of improvement” by hiring groups “with impressive organizational charts, lots of young talent … and a record of recent performance (pg 8).” Unfortunately, he notes, they found it.

The pressure to look like you were earning your keep led to high portfolio turnover (Buffett warns against what would now be laughably low turnover: 25% per annum). By definition, most professionals cannot be above average but “a few will succeed – in a modest way – because of skill” (pg 10). If you’re going to find them, it won’t be by picking past winners though it might be by understanding what they’re doing and why:

The key: abandon all hope ye who invest in behemoths:

For those interested in Buffett’s entire reflection, Chip’s embedded the following:

Warren Buffett Katharine Graham Letter

And now for something completely different …

We can be certain of some things about Ed Studzinski. As an investor and co-manager of Oakmark Equity & Income (OAKBX), he was consistently successful in caring for other people’s money (as much as $17 billion of it), in part because he remained keenly aware that he was also caring for their futures. $10,000 entrusted to Ed and co-manager Clyde McGregor on the day Ed joined the fund (01 March 2000) would have grown to $27,750 on the day of his departure (31 December 2011). His average competitor (I’m purposefully avoiding “peer” as a misnomer) would have managed $13,900.

As a writer and thinker, he minced no words.

The Equity and Income Fund’s managers have both worked in the investment industry for many decades, so we both should be at the point in our careers where dubious financial-industry innovations no longer surprise us. Such an assumption, however, would be incorrect.

For the past few quarters we have repeatedly read that the daily outcomes in the securities markets are the result of the “Risk On/Risk Off” trade, wherein investors (sic?) react to the most recent news by buying equities/selling bonds (Risk On) or the reverse (Risk Off). As value investors we think this is pure nonsense. 

Over the past two years, Ed and I have engaged in monthly conversations that I’ve found consistently provocative and information-rich. It’s clear that he’s been paying active attention for many years to contortions of his industry which he views with equal measures of disdain and alarm. 

I’ve prevailed upon Ed to share a manager’s fuss and fulminations with us, as whim, wife and other obligations permit. His first installment, which might also be phrased as the question “Whose skin in the game?” follows.

“Skin in the Game, Part One”

One of the more favored sayings of fund managers is that they like to invest with managements with “skin in the game.” This is another instance where the early Buffett (as opposed to the later Buffett) had it right. Managements can and should own stock in their firms. But they should purchase it with their own money. That, like the prospect of hanging as Dr. Johnson said, would truly clarify the mind. In hind sight a major error in judgment was made by investment professionals who bought into the argument that awarding stock options would beneficially serve to align the interests of managements and shareholders. Never mind that the corporate officers should have already understood their fiduciary obligations. What resulted, not in all instances but often enough in the largest capitalization companies, was a class of condottieri such as one saw in Renaissance Italy, heading armies that spent their days marching around avoiding each other, all the while being lavishly paid for the risks they were NOT facing. This sub-set of managers became a new entitled class that achieved great personal wealth, often just by being present and fitting in to the culture. Rather than thinking about truly long-term strategic implications and questions raised in running a business, they acted with a short-duration focus, and an ever-present image of the current share price in the background. Creating sustainable long-term business value rarely entered into the equation, often because they had never seen it practiced.

I understood how much of a Frankenstein’s monster had been created when executive compensation proposals ended up often being the greater part of a proxy filing. A particularly bothersome practice was “reloading” options annually. Over time, with much dilution, these programs transferred significant share ownership to management. You knew you were on to something when these compensation proposals started attracting negative vote recommendations. The calls would initially start with the investor relations person inquiring about the proxy voting process. Once it was obvious that best practices governance indicated a “no” vote, the CFO would call and ask for reconsideration.

How do you determine whether a CEO or CFO actually walks the walk of good capital allocation, which is really what this is all about? One tip-off usually comes from discussions about business strategy and what the company will look like in five to ten years. You will have covered metrics and standards for acquisitions, dividends, debt, share repurchase, and other corporate action. Following that, if the CEO or CFO says, “Why do you think our share price is so low?” I would know I was in the wrong place. My usual response was, “Why do you care if you know what the business value of the company is per share? You wouldn’t sell the company for that price. You aren’t going to liquidate the business. If you did, you know it is worth substantially more than the current share price.” Another “tell” is when you see management taking actions that don’t make sense if building long-term value is the goal. Other hints also raise questions – a CFO leaves “because he wants to enjoy more time with his family.” Selling a position contemporaneously with the departure of a CFO that you respected would usually leave your investors better off than doing nothing. And if you see the CEO or CFO selling stock – “our investment bankers have suggested that I need to diversify my portfolio, since all my wealth is tied up in the company.” That usually should raise red flags that indicate something is going on not obvious to the non-insider.

Are things improving? Options have gone out of favor as a compensation vehicle for executives, increasingly replaced by the use of restricted stock. More investors are aware of the potential conflicts that options awards can create and have a greater appreciation of governance. That said, one simple law or regulation would eliminate many of the potential abuses caused by stock options. “All stock acquired by reason of stock option awards to senior corporate officers as part of their compensation MAY NOT BE SOLD OR OTHERWISE DISPOSED OF UNTIL AFTER THE EXPIRATION OF A PERIOD OF THREE YEARS FROM THE INDIVIDUAL’S LAST DATE OF SERVICE.” Then you might actually see the investors having a better chance of getting their own yachts.

Edward A. Studzinski

If you’d like to reach Ed, click here. An artist’s rendering of Messrs. Boccadoro and Studzinski appears below.

Introducing Charles’ Balcony

Since his debut in February 2012, my colleague Charles Boccadoro has produced some exceedingly solid, data-rich analyses for us, including this month’s review of the risk/return profiles of the FundX family of funds. One of his signature contributions was “Timing Method Performance Over Ten Decades,” which was widely reproduced and debated around the web.

We’re pleased to announce that we’ve collected his essays in a single, easy-to-access location. We’ve dubbed it “Charles’ Balcony” and we even stumbled upon this striking likeness of Charles and the shadowy Ed Studzinski in situ. I’m deeply hopeful that from their airy (aerie or eery) perch, they’ll share their sharp-eyed insights with us for years to come.

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. 

Advisory Research Strategic Income (ADVNX): you’ve got to love a 10 month old fund with a 10 year track record and a portfolio that Morningstar can only describe as 60% “other.” AR converted a successful limited partnership into the only no-load mutual fund offering investors substantial access to preferred securities.

Beck, Mack and Oliver Partners (BMPEX): we think of it as “Dodge and Cox without the $50 billion in baggage.” This is an admirably disciplined, focused equity fund with a remarkable array of safeguards against self-inflicted injuries.

FPA Paramount (FPRAX): some see Paramount as a 60-year-old fund that seeks out only the highest-quality mid-cap growth stocks. With a just-announced change of management and philosophy, it might be moving to become a first-rate global value fund (with enough assets under management to start life as one of the group’s most affordable entries).

FundX Upgrader (FUNDX): all investors struggle with the need to refine their portfolios, dumping losers and adding winners. In a follow-up to his data-rich analysis on the possibility of using a simple moving average as a portfolio signal, associate editor Charles Boccadoro investigated the flagship fund of the Upgrader fleet.

Tributary Balanced (FOBAX): it’s remarkable that a fund this consistently good – in the top tier of all balanced funds over the past five-, ten-, and fifteen-year periods and a Great Owl by my colleague Charles’ risk/return calculations – hasn’t drawn more attention. It will be more remarkable if that neglect continues despite the recent return of the long-time manager who beat pretty much everyone in sight.

Elevator Talk #8: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX)

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.

Steven Vannelli, Manager

GaveKal Knowledge Leaders (GAVAX) believes in investing only in firms that are committed to being smart, so where did the dumb name come from? GaveKal is a portmanteau formed from the names of the firm’s founders: Charles Gave, Anatole Kaletsky and Louis-Vincent Gave. Happily it changed the fund’s original name from GaveKal Platform Company Fund (named after its European counterpart) to Knowledge Leaders. 

GaveKal, headquartered in Hong Kong, started in 2001 as a global economics and asset allocation research firm. Their other investment products (the Asian Balanced Fund – a cool idea which was rechristened Asian Absolute Return – and Greater China Fund) are available to non-U.S. investors as, originally, was Knowledge Leaders. They opened a U.S. office in 2006. In 2010 they deepened their Asia expertise by acquiring Dragonomics, a China-focused research and advisory firm.

Knowledge Leaders has generated a remarkable record in its two-plus years of U.S. operation. They look to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility. Currently, approximately 30% of the portfolio is in cash, down from 40% earlier in summer.

Manager Steven Vannelli researches intangible capital and corporate performance and leads the fund’s investment team. Before joining GaveKal, he spent a decade at Alexander Capital, a Denver-based investment advisor. Here’s Mr. Vannelli’s 200 words making his case:

We invest in the world’s most innovative companies. Decades of academic research show that companies that invest heavily in innovation are structurally undervalued due to lack of information on innovative activities. Our strategy capitalizes on this market inefficiency.

To find investment opportunities, we identify Knowledge Leaders, or companies with large stores of intangible assets. These companies often operate globally across an array of industries from health care to technology, from consumer to capital goods. We have developed a proprietary method to capitalize a company’s intangible investments, revealing an important, invisible layer of value inherent to intangible-rich companies. 

The Knowledge Leaders Strategy employs an active strategy that offers equity-like returns with bond-like risk. Superior risk-adjusted returns with low correlation to market indices make the GaveKal Knowledge Leaders Strategy a good vehicle for investors who seek to maximize their risk and return objectives.

The genesis of the strategy has its origin in the 2005 book, Our Brave New World, by GaveKal Research, which highlights knowledge as a scare asset.

As a validation of our intellectual foundation, in July, the US Bureau of Economic Analysis began to capitalize R&D to measure the contribution of innovation spending on growth of the US economy.

The minimum initial investment on the fund’s retail shares is $2,500. There are also institutional shares (GAVIX) with a $100,000 minimum (though they do let financial advisors aggregate accounts in order to reach that threshold). The fund’s website is clean and easily navigated. It would make a fair amount of sense for you to visit to “Fund Documents” page, which hosts the fund’s factsheet and a thoughtful presentation on intangible capital. 

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 (VCMRX), 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.”
6. August 2013: Brian Frank, Frank Value Fund (FRNKX), a truly all-cap value fund with a simple, successful discipline: if one part of the market is overpriced, shop elsewhere.
7. August 2013: Ian Mortimer and Matthew Page of Guinness Atkinson Inflation Managed Dividend (GAINX), a global equity fund that pursues firms with “sustainable and potentially rising dividends,” which also translates to firms with robust business models and consistently high return on capital.

Upcoming conference call: A discussion of the reopening of RiverNorth Strategy Income (RNDLX)

The folks at RiverNorth will host a conference call between the fund’s two lead managers, Patrick Galley of RiverNorth and Jeffrey Gundlach of DoubleLine, to discuss their decision to reopen the fund to new investors at the end of August and what they see going forward (the phrase “fear and loathing” keeps coming up). 

The call will be: Wednesday, September 18, 3:15pm – 4:15pm CDT

To register, go to www.rivernorthfunds.com/events/

The webcast will feature a Q&A with Messrs. Galley and Gundlach.

RNDLX (RNSIX for the institutional class), which the Observer profiled shortly after launch, has been a very solid fund with a distinctive strategy. Mr. Gundlach manages part of his sleeve of the portfolio in a manner akin to DoubleLine Core Fixed Income (DLFNX) and part with a more opportunistic income strategy. Mr. Galley pursues a tactical fixed-income allocation and an utterly unique closed-end fund arbitrage strategy in his slice. The lack of attractive opportunities in the CEF universe prompted the fund’s initial closure. Emily Deter of RiverNorth reports that the opening “is primarily driven by the current market opportunity in the closed-end fund space. Fixed-income closed-end funds are trading at attractive discounts to their NAVs, which is an opportunity we have not seen in years.” Investment News reported that fixed-income CEFs moved quickly from selling at a 2% premium to selling at a 7% discount. 

That’s led Mr. Galley’s move from CEFs from occupying 17% of the portfolio a year ago to 30% today and, it seems, he believes he could pursue more opportunities if he had more cash on hand.

Given RiverNorth’s ongoing success and clear commitment to closing funds well before they become unmanageable, it’s apt to be a good use of your time.

The Observer’s own series of conference calls with managers who’ve proven to be interesting, sharp, occasionally wry and successful, will resume in October. We’ll share details in our October 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 David Welsch, an exceedingly diligent research assistant at the Observer, scours new SEC filings to see what opportunities might be about to present themselves. David tracked down nearly 100 new funds and ETFs. Many of the proposed funds offer nothing new, distinctive or interesting. Some were downright mystifying. (Puerto Rico Shares? Colombia Capped ETF? The Target Duration 2-month ETF?) There were 26 no-load funds or actively-managed ETFs in registration with the SEC this month. 

Funds in registration this month won’t be available for sale until, typically, the end of October or early November 2013.

There are probably more interesting products in registration this month than at any time in the seven years we’ve been tracking them. Among the standouts:

Brown Advisory Strategic European Equity Fund which will be managed by Dirk Enderlein of Wellington Management. Wellington is indisputably an “A-team” shop (they’ve got about three-quarters of a trillion in assets under management). Mr. Enderlein joined them in 2010 after serving as a manager for RCM – Allianz Global Investors in Frankfurt, Germany (1999-2009). Media reports described him as “one of Europe’s most highly regarded European growth managers.”

DoubleLine Shiller Enhanced CAPE will attempt to beat an index, Shiller Barclays CAPE® US Sector TR USD Index, which was designed based on decades of research by the renowned Robert Shiller. The fund will be managed by Jeffrey Gundlach and Jeffrey Sherman.

Driehaus Micro Cap Growth Fund, a converted 15 year old hedge fund

Harbor Emerging Markets Equity Fund, which will be sub-advised by the emerging markets team at Oaktree Capital Management. Oaktree’s a first-tier institutional manager with a very limited number of advisory relationships (primarily with Vanguard and RiverNorth) in the mutual fund world. 

Meridian Small Cap Growth, which will be the star vehicle for Chad Meade and Brian Schaub, who Meridian’s new owner hired away from Janus. Morningstar’s Greg Carlson described them as “superb managers” who were “consistently successful during their nearly seven years at the helm” of Janus Triton.

Plus some innovative offerings from Northern, PIMCO and T. Rowe Price. 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 record 85 fund manager changes. Investors should take particular note of Eric Ende and Stephen Geist’s exit from FPA Paramount after a 13 year run. The change is big enough that we’ve got a profile of Paramount as one of the month’s Most Intriguing New Funds.

Updates

Bretton Fund (BRTNX) is now available through Vanguard. Manager Stephen Dodson writes that after our conference call, several listeners asked about the fund’s availability and Stephen encouraged them to speak directly with Vanguard. Mirabile dictu, the Big V was receptive to the idea.

Stephen recently posted his most recent letter to his shareholders. He does a nice job of walking folks through the core of his investing discipline with some current illustrations. The short version is that he’s looking for firms with durable competitive advantages in healthy industries whose stocks are selling at a substantial discount. He writes:

There are a number of relevant and defensible companies out there that are easily identifiable; the hard part is finding the rare ones that are undervalued. The sweet spot for us continues to be relevant, defensible businesses at low prices (“cheap compounders”). I continue to spend my waking hours looking for them.

Q2 2013 presented slim pickin’s for absolute value investors (Bretton “neither initiated nor eliminated any investments during the quarter”). For all of the market’s disconcerting gyrations this summer, Morningstar calculates that valuations for its Wide Moat and Low Business Uncertainty groups (surrogates for “high quality stocks”) remains just about where they were in June: undervalued by about 4% while junkier stocks remain modestly overvalued.

Patience is hard.

Briefly Noted . . .

Calamos loses another president

James Boyne is resigning as president and chief operating officer of Calamos Investments effective Sept. 30, just eight months after being promoted to president. The firm has decided that they need neither a president nor a chief operating officer. Those responsibilities will be assumed “by other senior leaders” at the firm (see: Black, Gary, below). The preceding president, Nick P. Calamos, decided to “step back” from his responsibilities in August 2012 when, by coincidence, Calamos hired former Janus CEO Gary Black. To describe Black as controversial is a bit like described Rush Limbaugh as opinionated.

They’re not dead yet!

Back in July, the Board of Caritas All-Cap Growth (CTSAX): “our fund is tiny, expensive, bad, and pursues a flawed investment strategy (long stocks, short ETFs).” Thereupon they reached a sensible conclusion: euthanasia. Shortly after the fund had liquidated all of its securities, “the Board was presented with and reviewed possible alternatives to the liquidation of the Fund that had arisen since the meeting on July 25, 2013.”

The alternative? Hire Brenda A. Smith, founder of CV Investment Advisors, LLC, to manage the fund. A quick scan of SEC ADV filings shows that Ms. Smith is the principal in a two person firm with 10 or fewer clients and $5,000 in regulated AUM. 

(I don’t know more about the firm because they have a one page website.)

At almost the same moment, the same Board gave Ms. Smith charge of the failing Presidio Multi-Strategy Fund (PMSFX), an overpriced long/short fund that executes its strategy through ETFs. 

I wish Ms. Smith and her new investors all the luck in the world, but it’s hard to see how a Board of Trustees could, with a straight face, decide to hand over one fund and resuscitate another with huge structural impediments on the promise of handing it off to a rookie manager and declare that both moves are in the best interests of long-suffering shareholders.

Diamond Hill goes overseas, a bit

Effective September 1, 2013, Diamond Hill Research Opportunities Fund (DHROX) gains the flexibility to invest internationally (the new prospectus allows that it “may also invest in non-U.S. equity securities, including equity securities in emerging market countries”) and the SEC filing avers that they “will commence investing in foreign securities.” The fund has 15 managers; I’m guessing they got bored. As a hedge fund (2009-2011), it had a reasonably mediocre record which might have spurred the conversion to a ’40 fund. Which has also had a reasonably mediocre lesson, so points to the management for consistency!

Janus gets more bad news

Janus investors pulled $2.2 billion from the firm’s funds in July, the worst outflows in more than three years. A single investor accounted for $1.3 billion of the leakage. The star managers of Triton and Venture left in May. And now this: they’re losing business to Legg Mason.

The Board of Trustees of Met Investors Series Trust has approved a change of subadviser for the Janus Forty Portfolio from Janus Capital Management to ClearBridge Investments to be effective November 1, 2013 . . . Effective November 1, 2013, the name of the Portfolio will change to ClearBridge Aggressive Growth Portfolio II.

Matthews chucks Taiwan

Matthews Asia China (MCHFX), China Dividend (MCDFX) and Matthews and China Small Companies (MCSMX) have changed their Principal Investment Strategy to delete Taiwan. The text for China Dividend shows the template:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its net assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China and Taiwan.

To:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its nets assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China.

A reader in the financial services industry, Anonymous Dude, checked with Matthews about the decision. AD reports

T. Rowe tweaks

Long ago, as a college administrator, I was worried about whether the text in a proposed policy statement might one day get us in trouble. I still remember college counsel shaking his head confidently, smiling and saying “Not to worry. We’re going to fuzz it up real good.” One wonders if he works for T. Rowe Price now? Up until now, many of Price’s funds have had relatively detailed and descriptive investment objectives. No more! At least five of Price’s funds propose new language that reduces the statement of investment objectives to an indistinct mumble. T. Rowe Price Growth Stock Fund (PRGFX) goes from

The fund seeks to provide long-term capital growth and, secondarily, increasing dividend income through investments in the common stocks of well-established growth companies.

To

The fund seeks long-term capital growth through investments in stocks.

Similar blandifications are proposed for Dividend Growth, Equity Income, Growth & Income and International Growth & Income.

Wasatch redefines “small cap”

A series of Wasatch funds, Small Growth, Small Value and Emerging Markets Small Cap are upping the size of stocks in their universe from $2.5 billion or less to $3.0 billion or less. The change is effective in November.

Can you say whoa!? Or WOA?

The Board of Trustees of an admittedly obscure little institutional fund, WOA All Asset (WOAIX), has decided that the best way to solve what ails the yearling fund is to get it more aggressive.

The Board approved certain changes to the Fund’s principal investment strategies. The changes will be effective on or about September 3, 2013. . . the changes in the Fund’s strategy will alter the Fund’s risk level from balanced strategy with a moderate risk level to an aggressive risk level.

Here’s the chart of the fund’s performance since inception against conservative and moderate benchmarks. While that might show that the managers just need to fire up the risk machine, I’d also imagine that addressing the ridiculously high expenses (1.75% for an institutional balanced fund) and consistent ability to lag in both up and down months (11 of 16 and counting) might actually be a better move. 

WOA’s Trustees, by the way, are charged with overseeing 24 funds. No Trustee has a dollar invested in any of those funds.

SMALL WINS FOR INVESTORS

The Board of Trustees of the Direxion Funds and Rafferty Asset Management have decided to make it cheaper for you to own a bunch of funds that you really shouldn’t own. They’re removed the 25 bps Shareholder Servicing Fee from

• Direxion Monthly S&P 500® Bull 2X Fund
• Direxion Monthly S&P 500® Bear 2X Fund
• Direxion Monthly NASDAQ-100® Bull 2X Fund
• Direxion Monthly Small Cap Bull 2X Fund
• Direxion Monthly Small Cap Bear 2X Fund
• Direxion Monthly Emerging Markets Bull 2X Fund
• Direxion Monthly Latin America Bull 2X Fund
• Direxion Monthly China Bull 2X Fund
• Direxion Monthly Commodity Bull 2X Fund
• Direxion Monthly 7-10 Year Treasury Bull 2X Fund
• Direxion Monthly 7-10 Year Treasury Bear 2X Fund
• Dynamic HY Bond Fund and
• U.S. Government Money Market Fund.

Because Eaton Vance loves you, they’ve decided to create the opportunity for investors to buy high expense “C” class shares of Eaton Vance Bond (EVBCX). The new shares will add a 1.00% back load for sales held less than a year and a 1.70% expense ratio (compared to 0.7 and 0.95 for Institutional and A, respectively). 

The Fairholme Fund (FAIRX) reopened to new investors on August 19, 2013. The other Fairholme family funds, not so much.

The Advisor Class shares of Forward Select Income Fund (FSIMX) reopened to new investors at the end of August.

The Board of Directors of the Leuthold Global Industries Fund (LGINX) has agreed to reduce the Fund’s expense cap from 1.85% to 1.60%.

JacksonPark Capital reduced the minimum initial investment on Oakseed Opportunity Institutional shares (SEDEX) from $1 million to $10,000. Given the 18% lower fees on the institutional class (capped at 1.15% versus 1.40% for retail shares), reasonably affluent retail investors ought to seriously consider pursuing the institutional share class. That said, Oakseed’s minimum investment for the retail shares, as low as $100 for accounts set up with an AIP, are awfully reasonable.

RiverNorth DoubleLine Strategic Income (RNDLX/RNSIX) reopened to new investors at the end of August. Check the “upcoming conference calls” feature, above, for more details.

Westcore Blue Chip Dividend Fund (WTMVX ) lowered the expense ratio on its no-load retail shares from 1.15% to 0.99%, effective September 1. They also changed from paying distributions annually to paying them quarterly. It’s a perfectly agreeable, mild-mannered little fund: stable management, global diversified, reasonable expenses and very consistently muted volatility. You do give up a fair amount of upside for the opportunity to sleep a bit more quietly at night.

CLOSINGS (and related inconveniences)

American Beacon Stephens Small Cap Growth Fund (STSGX) will close to new investors, effective as of September 16, 2013. The no-class share class has returned 11.8% while its peers made 9.3% and it did so with lower volatility. The fund is closing at a still small $500 million.

Neither high fees nor mediocre performance can dim the appeal of AQR Multi-Strategy Alternative Fund (ASANX/ASAIX). The fund has drawn $1.5 billion and has advertised the opportunity for rich investors (the minimum runs between $1 million and $5 million) to rush in before the doors swing shut at the end of September. It’s almost always a bad sign that a fund feels the need to close and the need to put up a flashing neon sign six weeks ahead.

Morgan Stanley Institutional Global Franchise (MSFAX) will close to new investors on Nov. 29, 2013. The current management team came on board four years ago (June 2009) and have posted very good risk-adjusted returns since then. Investors might wonder why a large cap global fund with a small asset base needs to close. The answer is that the mutual fund represents just the tip of the iceberg; this team actually manages almost $17 billion in this strategy, so the size of the separate accounts is what’s driving the decision.

OLD WINE, NEW BOTTLES

At the end of September Ariel International Equity Fund (AINTX) becomes Ariel International Fund and will no longer be required to invest at least 80% of its assets in equities. At the same time, Ariel Global Equity Fund (AGLOX) becomes Ariel Global Fund. The advisor avers that it’s not planning on changing the funds’ investment strategies, just that it would be nice to have the option to move into other asset classes if conditions dictate.

Effective October 30, Guggenheim U.S. Long Short Momentum Fund (RYAMX) will become plain ol’ Guggenheim Long-Short Fund. In one of those “why bother” changes, the prospectus adds a new first sentence to the Strategy section (“invest, under normal circumstances, at least 80% of its assets in long and short equity or equity-like securities”) but maintains the old “momentum” language in the second and third sentences. They’ll still “respond to the dynamically changing economy by moving its investments among different industries and styles” and “allocates investments to industries and styles according to several measures of momentum. “ Over the past five years, the fund has been modestly more volatile and less profitable than its peers. As a result, they’ve attracted few assets and might have decided, as a marketing matter, that highlighting a momentum approach isn’t winning them friends.

As of October 28, the SCA Absolute Return Fund (SCARX) will become the Granite Harbor Alternative Fund and it will no longer aim to provide “positive absolute returns with less volatility than traditional equity markets.” Instead, it’s going for the wimpier “long-term capital appreciation and income with low correlation” to the markets. SCA Directional Fund (SCADX) will become Granite Harbor Tactical Fund but will no longer seek “returns similar to equities with less volatility.” Instead, it will aspire to “long term capital appreciation with moderate correlation to traditional equity markets.” 

Have you ever heard someone say, “You know, what I’m really looking for is a change for a moderate correlation to the equity markets”? No, me neither.

Thomas Rowe Price, Jr. (the man, 1898-1983) has been called “the father of growth investing.” It’s perhaps then fitting that T. Rowe Price (the company) has decided to graft the word “Growth” into the names of many of its funds effective November 1.

T. Rowe Price Institutional Global Equity Fund becomes T. Rowe Price Institutional Global Focused Growth Equity Fund. Institutional Global Large-Cap Equity Fund will change its name to the T. Rowe Price Institutional Global Growth Equity Fund. T. Rowe Price Global Large-Cap Stock Fund will change its name to the T. Rowe Price Global Growth Stock Fund.

Effective October 28, 2013, USB International Equity Fund (BNIEX) gets a new name (UBS Global Sustainable Equity Fund), new mandate (invest globally in firms that pass a series of ESG screens) and new managers (Bruno Bertocci and Shari Gilfillan). The fund’s been a bit better under the five years of Nick Irish’s leadership than its two-star rating suggests, but not by a lot.

Off to the dustbin of history

There were an exceptionally large number of funds giving up the ghost this month. We’ve tracked 26, the same as the number of new no-load funds in registration and well below the hundred or so new portfolios of all sorts being launched. I’m deeply grateful to The Shadow, one of the longest-tenured members of our discussion board, for helping me to keep ahead of the flood.

American Independence Dynamic Conservative Plus Fund (TBBIX, AABBX) will liquidate on or about September 27, 2012.

Dynamic Canadian Equity Income Fund (DWGIX) and Dynamic Gold & Precious Metals Fund (DWGOX), both series of the DundeeWealth Funds, are slated for liquidation on September 23, 2013. Dundee bumped off Dynamic Contrarian Advantage Fund (DWGVX) and announced that it was divesting itself of three other funds (JOHCM Emerging Markets Opportunities Fund JOEIX, JOHCM International Select Fund JOHIX and JOHCM Global Equity Fund JOGEX), which are being transferred to new owners.

Equinox Commodity Strategy Fund (EQCAX) closed to new investors in mid-August and will liquidate on September 27^th.

The Evolution Funds face extinction! Oh, the cruel irony of it.

Evolution Managed Bond (PEMVX) Evolution All-Cap Equity (PEVEX), Evolution Market Leaders (PEVSX) and Evolution Alternative Investment (PETRX) have closed to all new investment and were scheduled to liquidate by the end of September. Given their disappearance from Morningstar, one suspects the end came more quickly than we knew.

Frontegra HEXAM Emerging Markets Fund (FHEMX) liquidates at the end of September.

The Northern Lights Board of Trustees has concluded that “based on, among other factors, the current and projected level of assets in the Fund and the belief that it would be in the best interests of the Fund and its shareholders to discontinue the Hundredfold Select Global Fund (SFGPX).”

Perhaps the “other factors” would be the fact that Hundredfold trailed 100% of its peers over the past three- and five-year periods? The manager was unpaid and quite possibly the fund’s largest shareholder ($50-100k in a $2M fund). His Hundredfold Select Equity (SFEOX) is almost as woeful as the decedent, but Hundredfold Select Alternative (SFHYX) is in the top 1% of its peer group for the same period that the others are bottom 1%. That raises the spectre that luck, rather than skill, might be involved.

JPMorgan is cleaning house: JPMorgan Credit Opportunities Fund (JOCAX), JPMorgan Global Opportunities Fund (JGFAX) and JPMorgan Russia Fund (JRUAX) are all gone as of October 4.

John Hancock intends to merge John Hancock High Income (JHAQX) into John Hancock High Yield (JHHBX). I’m guessing at the fund tickers because the names in the SEC filing don’t quite line up with the Morningstar ones.

Legg Mason Esemplia Emerging Markets Long-Short Fund (SMKAX) will be terminated on October 1, 2013. Let’s see: hard-to-manage strategy, high risk, high expenses, high front load, no assets . . . sounds like Legg.

Leuthold Asset Allocation Fund (LAALX) is merging into Leuthold Core Investment Fund (LCORX). The Board of Directors approved a proposal for the Leuthold Asset Allocation to be acquired by the Leuthold Core, sometime in October 2013. Curious. LAALX, with a quarter billion in assets, modestly lags LCORX which has about $600 million. Both lag more mild-mannered funds such as Northern Global Tactical Asset Allocation (BBALX) and Vanguard STAR (VGSTX) over the course of LAALX’s lifetime. This might be less a story about LAALX than about the once-legendary Leuthold Core. Leuthold’s funds are all quant-driven, based on an unparalleled dataset. For years Core seemed unstoppable: between 2003 and 2008, it finished in the top 5% of its peer group four times. But for 2009 to now, it has trailed its peers every year and has bled $1 billion in assets. In merging the two, LAALX investors get a modestly less expensive fund with modestly better performance. Leuthold gets a simpler administrative structure. 

I halfway admire the willingness of Leuthold to close products that can’t distinguish themselves in the market. Clean Tech, Hedged Equity, Undervalued & Unloved, Select Equities and now Asset Allocation have been liquidated.

MassMutual Premier Capital Appreciation Fund (MCALX) will be liquidated, but not until January 24, 2014. Why? 

New Frontiers KC India Fund (NFIFX) has closed and began the process of liquidating their portfolio on August 26^th. They point to “difficult market conditions in India.” The fund’s returns were comparable to its India-focused peers, which is to say it lost about 30% in 18 months.

Nomura Partners India Fund (NPIAX), Greater China Fund (NPCAX) and International Equity Fund (NPQAX) will all be liquidated by month’s end.

Nuveen Quantitative Enhanced Core Equity (FQCAX) is slated, pending inevitable shareholder approval, to disappear into Nuveen Symphony Low Volatility Equity Fund (NOPAX, formerly Nuveen Symphony Optimized Alpha Fund)

Oracle Mutual Fund (ORGAX) has “due to the relatively small size of the fund” underwent the process of “orderly dissolution.” Due to the relatively small size? How about, “due to losing 49.5% of our investors’ money over the past 30 months, despite an ongoing bull market in our investment universe”? To his credit, the advisor’s president and portfolio manager went down with the ship: he had something between $500,000 – $1,000,000 left in the fund as of the last SAI.

Quantitative Managed Futures Strategy Fund (QMFAX) will “in the best interests of the Fund and its shareholders” redeem all outstanding shares on September 15^th.

The directors of the United Association S&P 500 Index Fund (UASPX/UAIIX) have determined that it’s in their shareholders’ best interest to liquidate. Uhhh … I don’t know why. $140 million in assets, low expenses, four-star rating …

Okay, so the Oracle Fund didn’t seem particularly oracular but what about the Steadfast Fund? Let’s see: “steadfast: firmly loyal or constant, unswerving, not subject to change.” VFM Steadfast Fund (VFMSX) launched less than one year ago and gone before its first birthday.

In Closing . . .

Interesting stuff’s afoot. We’ve spoken with the folks behind the surprising Oberweis International Opportunities Fund (OBIOX), which was much different and much more interesting that we’d anticipated. Thanks to “Investor” for poking us about a profile. In October we’ll have one. RiverPark Strategic Income is set to launch at the end of the month, which is exciting both because of the success of the other fund (the now-closed RiverPark Short Term High Yield Fund RPHYX) managed by David Sherman and Cohanzick Asset Management and because Sherman comes across as such a consistently sharp and engaging guy. With luck, I’ll lure him into an extended interview with me and a co-conspirator (the gruff but lovable Ed Studzinski, cast in the role of a gruff but lovable curmudgeon who formerly managed a really first-rate mutual fund, which he did).

MFO returns to Morningstar! Morningstar is hosting their annual ETF Invest Conference in Chicago, from October 2 – 4. While, on whole, we’d rather drop by their November conference in Milan, Italy it was a bit pricey and I couldn’t get a dinner reservation at D’O before early February 2014 so we decided to pass it up. While the ETF industry seems to be home to more loony ideas and regrettable business practices than most, it’s clear that the industry’s maturing and a number of ETF products offer low cost access to sensible strategies, some in areas where there are no tested active managers. The slow emergence of active ETFs blurs the distinction with funds and Morningstar does seem do have arranged both interesting panels (skeptical though I am, I’ll go listen to some gold-talk on your behalf) and flashy speakers (Austan Goolsbee among them). With luck, I’ll be able to arrange a couple of face-to-face meetings with Chicago-based fund management teams while I’m in town. If you’re going to be at the conference, feel free to wave. If you’d like to chat, let me know.

If you shop Amazon, please do remember to click on the Observer’s link and use it. If you click on it right now, you can bookmark it or set it as a homepage and then you won’t forget. The partnership with Amazon generates about $20/day which, while modest, allows us to reliably cover all of our “hard” expenses and underwrites the occasional conference coverage. If you’d prefer to consider other support options, that’s great. Just click on “support us” on the top menu bar. But the Amazon thing is utterly painless for you.

The Sufi poet Attar records the fable of a powerful king who asks assembled wise men to create a ring that will make him happy when he is sad, and vice versa. After deliberation the sages hand him a simple ring with the words “This too will pass.” That’s also true of whatever happens to the market and your portfolio in September and October.

Be brave and we’ll be with you in a month!

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

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:

*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’):

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 know that for lots of you, this is the season of Big Questions:

• Is the Fed’s insistence on destroying the incentive to save (my credit union savings account is paying 0.05%) creating a disastrous incentive to move “safe” resources into risky asset classes?
• Has the recent passion for high quality, dividend-paying stocks already consumed most of their likely gains for the next decade?
• Should you Sell in May and Go Away?
• Perhaps, Stay for June and Endure the Swoon?

My set of questions is a bit different:

• Why haven’t those danged green beans sprouted yet?  It’s been a week.
• How should we handle the pitching rotation on my son’s Little League team?  We’ve got four games in the span of five days (two had been rained out and one was hailed out) and just three boys – Will included! – who can find the plate.
• If I put off returning my Propaganda students’ papers one more day, what’s the prospect that I’ll end up strung up like Mussolini?

Which is to say, summer is creeping upon us.  Enjoy the season and life while you can!

Of Acorns and Oaks

It’s human nature to make sense out of things.  Whether it’s imposing patterns on the stars in the sky (Hey look!  It’s a crab!) or generating rules of thumb for predicting stock market performances (It’s all about the first five days of the day), we’re relentless in insisting that there’s pattern and predictability to our world.

One of the patterns that I’ve either discerning or invented is this: the alumni of Oakmark International seem to have startlingly consistent success as portfolio managers.  The Oakmark International team is led by David Herro, Oakmark’s CIO for international equities and manager of Oakmark International (OAKIX) since 1992.  Among the folks whose Oakmark ties are most visible:

The Oakmark alumni certainly extend far beyond this list and far back in time.  Ralph Wanger, the brilliant and eccentric Imperial Squirrel who launched the Acorn Fund (ACRNX) and Wanger Asset Management started at Harris Associates.  So, too, did Morningstar founder Joe Mansueto.  Wanger frequently joked that if he’d only hired Mansueto when he had the chance, he would not have been haunted by questions for “stylebox purity” over the rest of his career.  The original manager of Oakmark Fund (OAKMX) was Robert Sanborn, who got seriously out of step with the market for a bit and left to help found Sanborn Kilcollin Partners.  He spent some fair amount of time thereafter comparing how Oakmark would have done if Bill Nygren had simply held Sanborn’s final portfolio, rather than replacing it.

In recent times, the attention centers on alumni of the international side of Oakmark’s operation, which is almost entirely divorced from its domestic investment operation.  It’s “not just on a different floor, but almost on a different world,” one alumnus suggested.  And so I set out to answer the questions: are they really that consistently excellent? And, if so, why?

The answers are satisfyingly unclear.  Are they really consistently excellent?  Maybe.  Pierre Py made a couple interesting notes.  One is that there’s a fair amount of turnover in Herro’s analyst team and we only notice the alumni who go on to bigger and better things.  The other note is that when you’ve been recognized as the International Fund Manager of the Decade and you can offer your analysts essentially unlimited resources and access, it’s remarkably easy to attract some of the brightest and most ambitious young minds in the business.

What, other than native brilliance, might explain their subsequent success?  Dan O’Keefe argues that Herro has been successful in creating a powerful culture that teaches people to think like investors and not just like analysts.  Analysts worry about finding the best opportunities within their assigned industry; investors need to examine the universe of all of the opportunities available, then decide how much money – if any – to commit to any of them.  “If you’re an auto industry analyst, there’s always a car company that you think deserves attention,” one said.  Herro’s team is comprised of generalists rather than industry specialists, so that they’re forced to look more broadly.  Mr. Py compared it to the mindset of a consultant: they learn to ask the big, broad questions about industry-wide practices and challenges, rising and declining competitors, and alternatives.  But Herro’s special genius, Pierre suggested, was in teaching young colleagues how to interview a management team; that is, how to get inside their heads, understand the quality of their thinking and anticipate their strengths and mistakes.   “There’s an art to it that can make your investment process much better.”  (As a guy with a doctorate in communication studies and a quarter century in competitive debate, I concur.)

The question for me is, if it works, why is it rare?  Why is it that other teams don’t replicate Herro’s method?  Or, for that matter, why don’t they replicate Artisan Partner’s structure – which is designed to be (and has been) attractive to the brightest managers and to guard (as it has) against creeping corporatism and groupthink?  It’s a question that goes far beyond the organization of mutual funds and might even creep toward the question, why are so many of us so anxious to be safely mediocre?

Three Messages from Rob Arnott

Robert D. Arnott manages PIMCO’s All Asset (PAAIX) and leveraged All Asset All Authority (PAUIX) funds. Morningstar gives each fund five stars for performance relative to moderate and world allocation peers, in addition to gold and silver analyst ratings, respectively, for process, performance, people, parent and price. On PAAIX’s performance during the 2008 financial crises, Mr. Arnott explains: “I was horrified when we ended the year down 15%.” Then, he learned his funds were among the very top performers for the calendar year, where average allocation funds lost nearly twice that amount. PAUIX, which uses modest leverage and short strategies making it a bit more market neutral, lost only 6%.

Of 30 or so lead portfolio managers responsible for 110 open-end funds and ETFs at PIMCO, only William H. Gross has a longer current tenure than Mr. Arnott. The All Asset Fund was launched in 2002, the same year Mr. Arnott founded Research Affiliates, LLC (RA), a firm that specializes in innovative indexing and asset allocation strategies. Today, RA estimates $142B is managed worldwide using its strategies, and RA is the only sub-advisor that PIMCO, which manages over $2T, credits on its website.

On April 15^th, CFA Society of Los Angeles hosted Mr. Arnott at the Montecito Country Club for a lunch-time talk, entitled “Real Return Investing.” About 40 people attended comprising advisors, academics, and PIMCO staff. The setting was elegant but casual, inside a California mission-style building with dark wooden floors, white stucco walls, and panoramic views of Santa Barbara’s coast. The speaker wore one of his signature purple-print ties. After his very frank and open talk, which he prefaced by stating that the research he would be presenting is “just facts…so don’t shoot the messenger,” he graciously answered every question asked.

Three takeaways: 1) fundamental indexing beats cap-weighed indexing, 2) investors should include vehicles other than core equities and bonds to help achieve attractive returns, and 3) US economy is headed for a 3-D hurricane of deficit, debt, and demographics. Here’s a closer look at each message:

Fundamental Indexation is the title of Mr. Arnott’s 2005 paper with Jason Hsu and Philip Moore. It argues that capital allocated to stocks based on weights of price-insensitive fundamentals, such as book value, dividends, cash flow, and sales, outperforms cap-weighted SP500 by an average of 2% a year with similar volatilities. The following chart compares Power Shares FTSE RAFI US 1000 ETF (symbol: PRF), which is based on RA Fundamental Index (RAFI) of the Russell 1000 companies, with ETFs IWB and IVE:

And here are the attendant risk-adjusted numbers, all over same time period:

RAFI wins, delivering higher absolute and risk-adjusted returns. Are the higher returns a consequence of holding higher risk? That debate continues. “We remain agnostic as to the true driver of the Fundamental indexes’ excess return over the cap-weighted indexes; we simply recognize that they outperformed significantly and with some consistency across diverse market and economic environments.” A series of RAFIs exist today for many markets and they consistently beat their cap-weighed analogs.

All Assets include commodity futures, emerging market local currency bonds, bank loans, TIPS, high yield bonds, and REITs, which typically enjoy minimal representation in conventional portfolios. “A cult of equities,” Mr. Arnott challenges, “no matter what the price?” He then presents research showing that while the last decade may have been lost on core equities and bonds, an equally weighted, more broadly diversified, 16-asset class portfolio yielded 7.3% annualized for the 12 years ending December 2012 versus 3.8% per year for the traditional 60/40 strategy. The non-traditional classes, which RA coins “the third pillar,” help investors “diversify away some of the mainstream stock and bond concentration risk, introduce a source of real returns in event of prospective inflation from monetizing debt, and seek higher yields and/or rates of growth in other markets.”

Mr. Arnott believes that “chasing past returns is likely the biggest mistake investors make.” He illustrates with periodic returns such as those depicted below, where best performing asset classes (blue) often flip in the next period, becoming worst performers (red)…and rarely if ever repeat.

Better instead to be allocated across all assets, but tactically adjust weightings based on a contrarian value-oriented process, assessing current valuation against opportunity for future growth…seeking assets out of favor, priced for better returns. PAAIX and PAUIX (each a fund of funds utilizing the PIMCO family) employ this approach. Here are their performance numbers, along with comparison against some competitors, all over same period:

The All Asset funds have performed very well against many notable allocation funds, like OAKBX and VWENX, protecting against drawdowns while delivering healthy returns, as evidenced by high Martin ratios. But static asset allocator PRPFX has actually delivered higher absolute and risk-adjusted returns. This outperformance is likely attributed its gold holding, which has detracted very recently. On gold, Mr. Arnott states: “When you need gold, you need gold…not GLD.” Newer competitors also employing all-asset strategies are ABRYX and AQRIX. Both have returned handsomely, but neither has yet weathered a 2008-like drawdown environment.

The 3-D Hurricane Force Headwind is caused by waves of deficit spending, which artificially props-up GDP, higher than published debt, and aging demographics. RA has published data showing debt-to-GDP is closer to 500% or even higher rather than 100% value oft-cited, after including state and local debt, Government Sponsored Enterprises (e.g., Fannie Mae, Freddie Mac), and unfunded entitlements. It warns that deficit spending may feel good now, but payback time will be difficult.

“Last year, the retired population grew faster than the population of working age adults, yet there was no mention in the press.” Mr. Arnott predicts this transition will manifest in a smaller labor force and lower productivity. It’s inevitable that Americans will need to “save more, spend less, and retire later.” By 2020, the baby boomers will be outnumbered 2:1 by votes, implying any “solemn vows” regarding future entitlements will be at risk. Many developed countries have similar challenges.

Expectations going forward? Instead of 7.6% return for the 60/40 portfolio, expect 4.5%, as evidenced by low bond and dividend yields. To do better, Mr. Arnott advises investing away from the 3-D hurricane toward emerging economies that have stable political systems, younger populations, and lower debt…where fastest GDP growth occurs. Plus, add in RAFI and all asset exposure.

Are they at least greasy high-yield bonds?

One of the things I most dislike about ETFs – in addition to the fact that 95% of them are wildly inappropriate for the portfolio of any investor who has a time horizon beyond this afternoon – is the callous willingness of their boards to transmute the funds.  The story is this: some marketing visionary decides that the time is right for a fund targeting, oh, corporations involved in private space flight ventures and launches an ETF on the (invented) sector.  Eight months later they notice that no one’s interested so, rather than being patient, tweaking, liquidating or merging the fund, they simply hijack the existing vehicle and create a new, entirely-unrelated fund.

Here’s news for the five or six people who actually invested in the Sustainable North American Oil Sands ETF (SNDS): you’re about to become shareholders in the YieldShares High Income ETF.  The deal goes through on June 21.  Do you have any say in the matter?  Nope.  Why not?  Because for the Sustainable North American Oil Sands fund, investing in oil sands companies was legally a non-fundamental policy so there was no need to check with shareholders before changing it. 

The change is a cost-saving shortcut for the fund sponsors.  An even better shortcut would be to avoid launching the sort of micro-focused funds (did you really think there was going to be huge investor interest in livestock or sugar – both the object of two separate exchange-traded products?) that end up festooning Ron Rowland’s ETF Deathwatch list.

Introducing the Owl

Over the past month chip and I have been working with a remarkably talented graphic designer and friend, Barb Bradac, to upgrade our visual identity.  Barb’s first task was to create our first-ever logo, and it debuts this month.

Cool, eh?

We started by thinking about the Observer’s mission and ethos, and how best to capture that visually.  The apparent dignity, quiet watchfulness and unexpected ferocity of the Great Horned Owl – they’re sometimes called “tigers with wings” and are quite willing to strike prey three times their own size – was immediately appealing.  Barb’s genius is in identifying the essence of an image, and stripping away everything else.  She admits, “I don’t know what to say about the wise old owl, except he lends himself soooo well to minimalist geometric treatment just naturally, doesn’t he? I wanted to trim off everything not essential, and he still looks like an owl.”

At first, we’ll use our owl in our print materials (business cards, thank-you notes, that sort of thing) and in the article reprints that funds occasionally commission.  For those interested, the folks at Cook and Bynum asked for a reprint of Charles’s excellent “Inoculated by Value”  essay and our new graphic identity debuted there.  With time we’ll work with Barb and Anya to incorporate the owl – who really needs a name – into our online presence as well.

The Observer resources that you’ve likely missed!

Each time we add a new resource, we try to highlight it for folks.  Since our readership has grown so dramatically in the past year – about 11,000 folks drop by each month – a lot of folks weren’t here for those announcements.  As a public service, I’d like to highlight three resources worth your time.

The Navigator is a custom-built mutual fund research tool, accessible under the Resources tab.  If you know the name of a fund, or part of the name or its ticker, enter it into The Navigator.  It will auto-complete the fund’s name, identify its ticker symbols and  immediately links you to reports or stories on that fund or ETF on 20 other sites (Yahoo Finance, MaxFunds, Morningstar).  If you’re sensibly using the Observer’s resources as a starting point for your own due diligence research, The Navigator gives you quick access to a host of free, public resources to allow you to pursue that goal.

Featured Funds is an outgrowth of our series of monthly conference calls.  We set up calls – free and accessible to all – with managers who strike us as being really interesting and successful.  This is not a “buy list” or anything like it.  It’s a collection of funds whose managers have convinced me that they’re a lot more interesting and thoughtful than their peers.  Our plan with these calls is to give every interested reader to chance to hear what I hear and to ask their own questions.  After we talk with a manager, the inestimably talented Chip creates a Featured Fund page that draws together all of the resources we can offer you on the fund.  That includes an mp3 of the conference call and my take on the call’s highlights, an updated profile of the fund and also a thousand word audio profile of the fund (presented by a very talented British friend, Emma Presley), direct links to the fund’s own resources and a shortcut to The Navigator’s output on the funds.

There are, so far, seven Featured Funds:

• ASTON/RiverRoad Long/Short (ARLSX)
• Cook and Bynum (COBYX)
• Matthews Asia Strategic Income (MAINX)
• RiverPark Long/Short Opportunity (RLSFX)
• RiverPark Short-Term High Yield (RPHYX)
• RiverPark/Wedgewood (RWGFX)
• Seafarer Overseas Growth and Income (SFGIX)

Manager Change Search Engine is a feature created by Accipiter, our lead programmer, primarily for use by our discussion board members.  Each month Chip and I scan hundreds of Form 497 filings at the SEC and other online reports to track down as many manager changes as we can.  Those are posted each month (they’re under the “Funds” tab) and arranged alphabetically by fund name.  Accipiter’s search engine allows you to enter the name of a fund company (Fidelity) and see all of the manager changes we have on record for them.  To access the search engine, you need to go to the discussion board and click on the MGR tab at top.  (I know it’s a little inconvenient, but the program was written as a plug-in for the Vanilla software that underlies the discussion board.  It will be a while before Accipiter is available to rewrite the program for us, so you’ll just have to be brave for a bit.)

Valley Forge Fund staggers about

For most folks, Valley Forge Fund (VAFGX) is understandably invisible.  It was iconic mostly because it so adamantly rejected the trappings of a normal fund.  It was run since the Nixon Administration by Bernard Klawans, a retired aerospace engineer.  He tended to own just a handful of stocks and cash.  For about 20 years he beat the market then for the next 20 he trailed it.  In the aftermath of the late 90s mania, he went back to modestly beating the market.  He didn’t waste money on marketing or even an 800-number and when someone talked him into having a website, it remained pretty much one page long.

Mr. Klawans passed away on December 22, 2011, at the age of 90.  Craig T. Aronhalt who had co-managed the fund since the beginning of 2009 died on November 3, 2012 of cancer.  Morningstar seems not to have noticed his death: six months after passing away, they continue listing him as manager. It’s not at all clear who is actually running the thing though, frankly, for a fund that’s 25% in cash it’s having an entirely respectable year with a gain of nearly 10% through the end of April.

The more-curious development is the Board’s notice, entitled “Important information about the Fund’s Lack of Investment Adviser”

For the period beginning April 1, 2013 through the date the Fund’s shareholders approve a new investment advisory agreement (estimated to be achieved by May 17, 2013), the Fund will not be managed by an investment adviser or a portfolio manager (the “Interim Period”).  During the Interim Period, the Fund’s portfolio is expected to remain largely unchanged, subject to the ability of the Board of Directors of the Fund to, as it deems appropriate under the circumstances, make such portfolio changes as are consistent with the Fund’s prospectus.  During the Interim Period, the Fund will not be subject to any advisory fees.

Because none of the members of Fund’s Board of Directors has any experience as portfolio managers, management risk will be heightened during the Interim Period, and you may lose money.

How does that work?  The manager died at the beginning of November but the board doesn’t notice until April 1?  If someone was running the portfolio since November, the law requires disclosure of that fact.  I know that Mr. Buffett has threatened to run Berkshire Hathaway for six months after his death, so perhaps … ? 

If that is the explanation, it could be a real cost-savings strategy since health care and retirement benefits for the deceased should be pretty minimal.

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. 

FPA International Value (FPIVX): It’s not surprising that manager Pierre Py is an absolute return investor.  That is, after all, the bedrock of FPA’s investment culture.  What is surprising is that it has also be an excellent relative return vehicle: despite a substantial cash reserve and aversion to the market’s high valuations, it has also substantially outperformed its fully-invested peers since inception.

Oakseed Opportunity Fund (SEEDX): Finally!  Good news for all those investors disheartened by the fact that the asset-gatherers have taken over the fund industry.  Jackson Park has your back.

“Stars in the Shadows” are older funds that have attracted far less attention than they deserve. 

Artisan Global Value Fund (ARTGX): I keep looking for sensible caveats to share with you about this fund.  Messrs. Samra and O’Keefe keep making my concerns look silly, so I think I might give up and admit that they’re remarkable.

Payden Global Low Duration Fund (PYGSX): Short-term bond funds make a lot of sense as a conservative slice of your portfolio, most especially during the long bull market in US bonds.  The question is: what happens when the bull market here stalls out?  One good answer is: look for a fund that’s equally adept at investing “there” as well as “here.”  Over 17 years of operation, PYGSX has made a good case that they are that fund.

Elevator Talk #4: Jim Hillary, LS Opportunity Fund (LSOFX)

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.

Mr. Hillary manages Independence Capital Asset Partners (ICAP), a long/short equity hedge fund he launched on November 1, 2004 that serves as the sub-advisor to the LS Opportunity Fund (LSOFX), which in turn launched on September 29, 2010. Prior to embarking on a hedge fund career, Mr. Hillary was a co-founder and director of research for Marsico Capital Management where he managed the Marsico 21^st Century Fund (MXXIX) until February 2003 and co-managed all large cap products with Tom Marsico. In addition to his US hedge fund and LSOFX in the mutual fund space, ICAP runs a UCITS for European investors. Jim offers these 200 words on why his mutual fund could be right for you:

In 2004, I believed that after 20 years of above average equity returns we would experience a period of below average returns. Since 2004, the equity market has been characterized by lower returns and heightened volatility, and given the structural imbalances in the world and the generationally low interest rates I expect this to continue.  Within such an environment, a long/short strategy provides exposure to the equity market with a degree of protection not provided by “long-only” funds.

In 2010, we agreed to offer investors the ICAP investment process in a mutual fund format through LSOFX. Our process aims to identify investment opportunities not limited to style or market capitalization. The quality of research on Wall Street continues to decline and investors are becoming increasingly concerned about short-term performance. Our in-depth research and long-term orientation in our high conviction ideas provide us with a considerable advantage. It is often during times of stress that ICAP uncovers unusual investment opportunities. A contrarian approach with a longer-term view is our method of generating value-added returns. If an investor is searching for a vehicle to diversify away from long-only, balanced or fixed income products, a hedge fund strategy like ours might be helpful.

The fund has a single share class with no load and no 12b-1 fees. The minimum initial investment is $5,000 and net expenses are capped at 1.95%. More information about the Advisor and Sub-Advisor can be found on the fund’s website, www.longshortadvisors.com. Jim’s most recent commentary can be found in the fund’s November 2012 Semi-Annual Report.

RiverPark/Wedgewood Fund: Conference Call Highlights

I had a chance to speak with David Rolfe of Wedgewood Partners and Morty Schaja, president of RiverPark Funds. A couple dozen listeners joined us, though most remained shy and quiet. Morty opened the call by noting the distinctiveness of RWGFX’s performance profile: even given a couple quarters of low relative returns, it substantially leads its peers since inception. Most folks would expect a very concentrated fund to lead in up markets. It does, beating peers by about 10%. Few would expect it to lead in down markets, but it does: it’s about 15% better in down markets than are its peers. Mr. Schaja is invested in the fund and planned on adding to his holdings in the week following the call.

The strategy: Rolfe invests in 20 or so high-quality, high-growth firms. He has another 15-20 on his watchlist, a combination of great mid-caps that are a bit too small to invest in and great large caps a bit too pricey to invest in. It’s a fairly low turnover strategy and his predilection is to let his winners run. He’s deeply skeptical of the condition of the market as a whole – he sees badly stretched valuations and a sort of mania for high-dividend stocks – but he neither invests in the market as a whole nor are his investment decisions driven by the state of the market. He’s sensitive to the state of individual stocks in the portfolio; he’s sold down four or five holdings in the last several months nut has only added four or five in the past two years. Rather than putting the proceeds of the sales into cash, he’s sort of rebalancing the portfolio by adding to the best-valued stocks he already owns.

His argument for Apple: For what interest it holds, that’s Apple. He argues that analysts are assigning irrationally low values to Apple, somewhere between those appropriate to a firm that will never see real topline growth again and one that which see a permanent decline in its sales. He argues that Apple has been able to construct a customer ecosystem that makes it likely that the purchase of one iProduct to lead to the purchase of others. Once you’ve got an iPod, you get an iTunes account and an iTunes library which makes it unlikely that you’ll switch to another brand of mp3 player and which increases the chance that you’ll pick up an iPhone or iPad which seamlessly integrates the experiences you’ve already built up. As of the call, Apple was selling at $400. Their sum-of-the-parts valuation is somewhere in the $600-650 range.

On the question of expenses: Finally, the strategy capacity is north of $10 billion and he’s currently managing about $4 billion in this strategy (between the fund and private accounts). With a 20 stock portfolio, that implies a $500 million in each stock when he’s at full capacity. The expense ratio is 1.25% and is not likely to decrease much, according to Mr. Schaja. He says that the fund’s operations were subsidized until about six months ago and are just in the black now. He suggested that there might be, at most, 20 or so basis points of flexibility in the expenses. I’m not sure where to come down on the expense issue. No other managed, concentrated retail fund is substantially cheaper – Baron Partners and Edgewood Growth are 15-20 basis points more, Oakmark Select and CGM Focus are 15-20 basis points less while a bunch of BlackRock funds charge almost the same.

Bottom Line: On whole, it strikes me as a remarkable strategy: simple, high return, low excitement, repeatable and sustained for near a quarter century.

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

The RWGFX Conference Call

When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded. If the file downloads, instead, you may have to double-click to play it.

Conference Call Upcoming: Bretton Fund (BRTNX), May 28, 7:00 – 8:00 Eastern

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

As of 12/30/12, the fund held just 16 stocks.  Nearly as much is invested in microcaps as in megacaps. In addition to being agnostic about size, the fund is also unconstrained by style or sector.  Half of the fund’s holdings are characterized as “growth” stocks, half are not.   The fund offers no exposure at all in seven of Morningstar’s 11 industry sectors, but is over weighted by 4:1 in financials. 

In another of those “don’t judge it against the performance of groups to which it doesn’t belong” admonitions, it has been assigned to Morningstar’s midcap blend peer group though it owns only one midcap stock.

Our conference call will be Tuesday, May 28, from 7:00 – 8:00 Eastern.

How can you join in?  Just click

Members of our standing Conference Call Notification List will receive a reminder, notes from the manager and a registration link around the 20^th of May.  If you’d like to join about 150 of your peers in receiving a monthly notice (registration and the call are both free), feel free to drop me a note.

Launch Alert: ASTON/LMCG Emerging Markets (ALEMX)

This is Aston’s latest attempt to give the public – or at least “the mass affluent” – access to managers who normally employ distinctive strategies on behalf of high net worth individuals and institutions.  LMCG is the Lee Munder Capital Group (no, not the Munder of Munder NetNet and Munder Nothing-but-Net fame – that’s Munder Capital Management, a different group).  Over the five years ended December 30, 2012, the composite performance of LMCG’s emerging markets separate accounts was 2.8% while their average peer lost 0.9%.  In 2012, a good year for emerging markets overall, LMCG made 24% – about 50% better than their average peer.  The fund’s three managers, Gordon Johnson, Shannon Ericson and Vikram Srimurthy, all joined LMCG in 2006 after a stint at Evergreen Asset Management.  The minimum initial investment in the retail share class is $2500, reduced to $500 for IRAs.  The opening expense ratio will be 1.65% (with Aston absorbing an additional 4.7% of expenses).  The fund’s homepage is cleanly organized and contains links to a few supporting documents.

Launch Alert II: Matthews Asia Focus and Matthews Emerging Asia

On May 1, Matthews Asia launched two new funds. Matthews Asia Focus Fund (MAFSX and MIFSX) will invest in 25 to 35 mid- to large-cap stocks. By way of contrast, their Asian Growth and Income fund has 50 stocks and Asia Growth has 55. The manager wants to invest in high-quality companies and believes that they are emerging in Asia. “Asia now [offers] a growing pool of established companies with good corporate governance, strong management teams, medium to long operating histories and that are recognized as global or regional leaders in their industry.” The fund is managed by Kenneth Lowe, who has been co-managing Matthews Asian Growth and Income (MACSX) since 2011. The opening expense ratio, after waivers, is 1.91%. The minimum initial investment is $2500, reduced to $500 for an IRA.

Matthews Emerging Asia Fund (MEASX and MIASX) invests primarily in companies located in the emerging and frontier Asia equity markets, such as Bangladesh, Cambodia, Indonesia, Malaysia, Myanmar, Pakistan, Philippines, Sri Lanka, Thailand and Vietnam. It will be an all-cap portfolio with 60 to 100 names. The fund will be managed by Taizo Ishida, who also manages managing the Asia Growth (MPACX) and Japan (MJFOX) funds. The opening expense ratio, after waivers, is 2.16%. The minimum initial investment is $2500, reduced to $500 for an IRA.

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 (see “Synthetic Reverse Convertibles,” below).

Funds in registration this month won’t be available for sale until, typically, the beginning of July 2013. We found fifteen no-load, retail funds (and Gary Black) in the pipeline, notably:

AQR Long-Short Equity Fund will seek capital appreciation through a global long/short portfolio, focusing on the developed world.  “The Fund seeks to provide investors with three different sources of return: 1) the potential gains from its long-short equity positions, 2) overall exposure to equity markets, and 3) the tactical variation of its net exposure to equity markets.”  They’re targeting a beta of 0.5.  The fund will be managed by Jacques A. Friedman, Lars Nielsen and Andrea Frazzini (Ph.D!), who all co-manage other AQR funds.  Expenses are not yet set.  The minimum initial investment for “N” Class shares is $1,000,000 but several AQR funds have been available through fund supermarkets for a $2500 investment.  AQR deserves thoughtful attention, but their record across all of their funds is more mixed than you might realize.  Risk Parity has been a fine fund while others range from pretty average to surprisingly weak.

RiverPark Structural Alpha Fund will seek long-term capital appreciation while exposing investors to less risk than broad stock market indices.  Because they believe that “options on market indices are generally overpriced,” their strategy will center on “selling index equity options [which] will structurally generate superior returns . . . [with] less volatility, more stable returns, and reduce[d] downside risk.”  This portfolio was a hedge fund run by Wavecrest Asset Management.  That fund launched on September 29, 2008 and will continue to operate under it transforms into the mutual fund, on June 30, 2013.  The fund made a profit in 2008 and returned an average of 10.7% annually through the end of 2012.  Over that same period, the S&P500 returned 6.2% with substantially greater volatility.  The Wavecrest management team, Justin Frankel and Jeremy Berman, has now joined RiverPark – which has done a really nice job of finding talent – and will continue to manage the fund.   The opening expense ratio with be 2.0% after waivers and the minimum initial investment is $1000.

Curiously, over half of the funds filed for registration on the same day.  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.

Manager Changes

On a related note, we also tracked down 37 fund manager changes. Those include Oakmark’s belated realization that they needed at least three guys to replace the inimitable Ed Studzinski on Oakmark Equity and Income (OAKBX), and a cascade of changes triggered by the departure of one of the many guys named Perkins at Perkins Investment Management.

Briefly Noted . . .

Seafarer visits Paris: Seafarer has been selected to manage a SICAV, Essor Asie (ESSRASI).  A SICAV (“sea cav” for the monolingual among us, Société d’Investissement À Capital Variable for the polyglot) is the European equivalent of an open-end mutual fund. Michele Foster reports that “It is sponsored by Martin Maurel Gestion, the fund advisory division of a French bank, Banque Martin Maurel.  Essor translates to roughly arising or emerging, and Asie is Asia.”  The fund, which launched in 1997, invests in Asia ex-Japan and can invest in both debt and equity.  Given both Mr. Foster’s skill and his schooling at INSEAD, it seems like a natural fit.

Out of exuberance over our new graphic design, we’ve poured our Seafarer Overseas Growth and Income (SFGIX) profile into our new reprint design template.  Please do let us know how we could tweak it to make it more visually effective and functional.

Nile spans the globe: Effective May 1, 2013, Nile Africa Fixed Income Fund became Nile Africa and Frontier Bond Fund.  The change allows the fund to add bonds from any frontier-market on the planet to its portfolio.

Nationwide is absorbing 17 HighMark Mutual Funds: The changeover will take place some time in the third quarter of 2013.  This includes most of the Highmark family and the plan is for the current sub-advisers to be retained.  Two HighMark funds, Tactical Growth & Income Allocation and Tactical Capital Growth, didn’t make the cut and are scheduled for liquidation.

USAA is planning to launch active ETFs: USAA has submitted paperwork with the SEC seeking permission to create 14 actively managed exchange-traded funds, mostly mimicking already-existing USAA mutual funds. 

Small Wins for Investors

On or before June 30, 2013, Artio International Equity, International Equity II and Select Opportunities funds will be given over to Aberdeen’s Global Equity team, which is based in Edinburgh, Scotland.  The decline of the Artio operation has been absolutely stunning and it was more than time for a change.  Artio Total Return Bond Fund and Artio Global High Income Fund will continue to be managed by their current portfolio teams.

ATAC Inflation Rotation Fund (ATACX) has reduced the minimum initial investment for its Investor Class Shares from $25,000 to $2,500 for regular accounts and from $10,000 to $2,500 for IRA accounts.

Longleaf Partners Global Fund (LLGLX) reopened to new investment on April 16, 2013.  I was baffled by its closing – it discovered, three weeks after launch, that there was nothing worth buying – and am a bit baffled by its opening, which occurred after the unattractive market had risen by another 3%.

Vanguard announced on April 3 that it is reopening the $9 billion Vanguard Capital Opportunity Fund (VHCOX) to individual investors and removing the $25,000 annual limit on additional purchases.  The fund has seen substantial outflows over the past three years.  In response, the board decided to make it available to individual investors while leaving it closed to all financial advisory and institutional clients, other than those who invest through a Vanguard brokerage account.  This is a pretty striking opportunity.  The fund is run by PRIMECAP Management, which has done a remarkable job over time.

Closings

DuPont Capital Emerging Markets Fund (DCMEX) initiated a “soft close” on April 30, 2013.

Effective June 30, 2013, the FMI Large Cap (FMIHX) Fund will be closed to new investors.

Eighteen months after launching the Grandeur Peak Funds, Grandeur Peak Global Advisors announced that it will soft close both the Grandeur Peak Global Opportunities Fund (GPGOX) and the Grandeur Peak International Opportunities (GPIOX) Fund on May 1, 2013.

After May 17, 2013 the SouthernSun Small Cap Fund (SSSFX) will be closed to new investors.  The fund has pretty consistently generated returns 50% greater than those of its peers.  The same manager, Michael Cook, also runs the smaller, newer, midcap-focused SouthernSun US Equity Fund (SSEFX).  The latter fund’s average market cap is low enough to suggest that it holds recent alumni of the small cap fund.  I’ll note that we profiled all four of those soon-to-be-closed funds when they were small, excellent and unknown.

Touchstone Merger Arbitrage Fund (TMGAX) closed to new accounts on April 8, 2013.   The fund raised a half billion in under two years and substantially outperformed its peers, so the closing is somewhere between “no surprise” and “reassuring.”

Old Wine, New Bottles

In one of those “what the huh?” announcements, the Board of Trustees of the Catalyst Large Cap Value Fund (LVXAX) voted “to change in the name of the Fund to the Catalyst Insider Buying Fund.” Uhh … there already is a Catalyst Insider Buying Fund (INSAX). 

Lazard U.S. High Yield Portfolio (LZHOX) is on its way to becoming Lazard U.S. Corporate Income Portfolio, effective June 28, 2013.  It will invest in bonds issued by corporations “and non-governmental issuers similar to corporations.”  They hope to focus on “better quality” (their term) junk bonds. 

Off to the Dustbin of History

Dreyfus Small Cap Equity Fund (DSEAX) will transfer all of its assets in a tax-free reorganization to Dreyfus/The Boston Company Small Cap Value Fund (STSVX).

Around June 21, 2013, Fidelity Large Cap Growth Fund (FSLGX) will disappear into Fidelity Stock Selector All Cap Fund (FDSSX). This is an enormously annoying move and an illustration of why one might avoid Fidelity.  FSLGX’s great flaw is that it has attracted only $170 million; FDSSX’s great virtue is that it has attracted over $3 billion.  FDSSX is an analyst-run fund with over 1100 stocks, 11 named managers and a track record inferior to FSLGX (which has one manager and 134 stocks).

Legg Mason Capital Management All Cap Fund (SPAAX) will be absorbed by ClearBridge Large Cap Value Fund (SINAX).  The Clearbridge fund is cheaper and better, so that’s a win of sorts.

In Closing …

If you haven’t already done so, please do consider bookmarking our Amazon link.  It generates a pretty consistent $500/month for us but I have to admit to a certain degree of trepidation over the imminent (and entirely sensible) change in law which will require online retailers with over a $1 million in sales to collect state sales tax.  I don’t know if the change will decrease Amazon’s attractiveness or if it might cause Amazon to limit compensation to the Associates program, but it could.

As always, the Amazon and PayPal links are just … uhh, over there —>

That’s all for now, folks!

Dear friends,

Welcome to the end of a long, odd month.  The market bounced.  The pope took a long victory lap around St. Peter’s Square in his Popemobile before giving up the red shoes for life. King Richard III was discovered after 500 years buried under a parking lot with evidence of an ignominious wound in his nether regions.  At about the same time, French scientists discovered the Richard the Lionheart’s heart had been embalmed with daisies, myrtle, mint and frankincense and stored in a lead box.  A series of named storms (Nemo?  Really?  Q?) wacked the Northeast.

And I, briefly, had fantasies of enormous wealth.  My family discovered a long forgotten stock certificate issued around the time of the First World War in my grandfather’s name.  After some poking about, it appeared that a chain of mergers and acquisitions led from a small Ohio bank to Fifth Third Bank, to whom I sent a scan of the stock certificate.  While I waited for them to marvel at its antiquity and authenticity, I reviewed my lessons in the power of compounding.  $100 in 1914, growing at 5% per year, would be worth $13,000 now.  Cool.  But, growing at 10% per year – the amount long-term stock investors are guaranteed, right? – it would have grown to $13,000,000.  In the midst of my reverie about Chateau Snowball, Fifth Third wrote back with modestly deflating news: there was no evidence that the stock hadn’t been redeemed. There was also no evidence that it had been, but after 90 years presumption appears to shift in the bank’s favor. (Who’d have guessed?)  

It looks like I better keep my day job.  (Which, happily enough, is an immensely fulfilling one.)

Longleaf Global and its brethren

Two bits of news lay behind this story.  First, Longleaf freakishly closed its new Longleaf Partners Global Fund (LLGFX) after just three weeks.  Given that Longleaf hadn’t launched a fund in 15 years, it seemed odd that this one was so poorly-planned that they’d need to immediately close the door.  

At around the same time, I received a cheerful note from Tom Pinto, a long-time correspondent of ours and vice president at Mount & Nadler. Mount & Nadler (presided over, these last 33 years, by the redoubtable Hedda Nadler) does public relations for mutual funds and other money management folks. They’ve arranged some really productive conversations (with, for example, David Winters and Bruce Berkowitz) over the years and I tend to take their notes seriously. This one celebrated an entirely remarkable achievement for Tweedy Browne Global Value (TBGVX):

Incredibly, when measured on a rolling 10-year basis since its inception through 11/30/12 using monthly returns, the fund is batting 1000, having outperformed its benchmark – MSCI EAFE — in 115 out of 115 possible 10-year holding periods over the last 19 plus years it has been in existence. It also outperformed its benchmark in 91% of the rolling five-year periods and 82% of the rolling three-year periods. 

That one note combined three of my favorite things: (1) consistency in performance, (2) Tweedy, Browne and (3) Hedda.

Why consistency? It helps investors fight their worst enemy: themselves.  Very streaky funds have very streaky investors, folks who buy and sell excessively and, in most cases, poorly.  Morningstar has documented a regrettably clear pattern of investors earning less –sometimes dramatically less – than their funds, because of their ill-time actions.  Steady funds tend to have steady investors; in Tweedy’s case, “investor returns” are close to and occasionally higher than the fund’s returns.

Why Tweedy? It’s one of those grand old firms – like Dodge & Cox and Northern – that started a century or more ago and that has been quietly serving “old wealth” for much of that time.  Tweedy, founded in 1920 as a brokerage, counts Benjamin Graham, Walter Schloss and Warren Buffett among its clients.  They’ve only got three funds (though one does come in two flavors: currency hedged and not) and they pour their own money into them.  The firm’s website notes:

 As of December 31, 2012, the current Managing Directors and retired principals and their families, as well as employees of Tweedy, Browne had more than $759.5 million in portfolios combined with or similar to client portfolios, including approximately $101.9 million in the Global Value Fund and $57.9 million in the Value Fund, $6.8 million in the Worldwide High Dividend Yield Value Fund and $3.7 million in the Global Value Fund II — Currency Unhedged.

Value (low risk, four stars) and Global Value (low risk, five stars) launched in 1993.  The one with the long name (low risk, five stars) launched 14 years later, in 2007.  Our profile of the fund, Tweedy Browne Worldwide High Dividend Yield Value (TBHDX), appeared as soon as it was launched.  At that point, Global Value was rated by Morningstar as a two-star fund. Nonetheless, I plowed in with the argument that it represented a compelling opportunity:

They are really good stock-pickers.  I know, I know: “gee, Dave, can’t you read?  Two blinkin’ stars.”  Three things to remember.  First, the validity of Morningstar’s peer ratings depend on the validity of their peer group assignment.  In the case of Global Value, they’re categorized as small-mid foreign value (which has been on something of a tear in recent years), despite the fact that 60% of their portfolio is in large cap stocks.

Second, much of the underperformance for Global Value is attributable to their currency hedging.

Third, they provide strong absolute returns even when they have weak relative ones.  In the case of Global Value they have churned out returns around 17-18% over the trailing three- and five-year periods.  Combine that with uniformly “low” Morningstar risk scores for both funds and you get an awfully compelling risk/return profile.

Bottom Line: there’s a lot to be said, especially in uncertain times, for picking cautious, experienced managers and giving them broad latitude.  Worldwide High Dividend Yield has both of those attributes and it’s likely to be a remarkably rewarding instrument for folks who like to sleep well at night.

Why Hedda? I’ve never had the pleasure of meeting Hedda in person, but our long phone conversations over the years make it clear that she’s smart, funny, and generous and has an incredible institutional memory.  When I think of Hedda, the picture that pops into mind is Edna Mode from The Incredibles, darling. 

The Observer’s specialty are new and small funds.  The problem in covering Tweedy is that the next new fund is apt to launch around about the time that you folks start receiving copies of the Observer by direct neural implants.  I had similar enthusiasm for other long-interval launches, including Dodge and Cox Global (“Let’s be blunt about this. If this fund fails, it’s pretty much time for us to admit that the efficient market folks are right and give up on active management.”) and Oakmark Global Select (“both of the managers are talented, experienced and disciplined. Investors willing to take the risk are getting access to a lot of talent and a unique vehicle”).

That led to the question: what happens when funds that never launch new funds, launch new funds?

With the help of the folks on the Observer’s discussion board and, most especially, Charles Boccadoro, we combed through hundreds of records and tracked down all of the long-interval launches that we could. “Long-interval launches” were those where a firm hadn’t launched in anew fund in 10 years or more.  (Dodge & Cox – with five fund launches in 81 years – was close enough, as was FMI with a launch after nine-and-a-fraction years.) We were able to identify 17 funds, either retail or nominally institutional but with low minimum shares, that qualified. 

We looked at two measures: how did they do, compared to their Morningstar peers, in their first full year (so, if they launched in October 2009, we looked at 2010) and how have they done since launch? 

While this isn’t a sure thing, there are good explanations for the success.  At base, these are firms that are not responding to market pressures and that have extremely coherent disciplines.  The fact that they choose to launch after a decade or more speaks to a combination of factors: they see something important and they’re willing to put their reputation on the line.  Those are powerful motivators driving highly talented folks.

What might be the next funds to track?  Two come to mind.  Longleaf Global launched 15 years after Longleaf International (LLINX) and would warrant serious consideration when it reopens.  And BBH Global Core Select will be opening in the next month, 15 years after BBH Core Select (BBTRX and BBTEX).  Core Select has been wildly successful and has just closed to new investors. Global Core Select will use the same team and the same strategy. 

(Thanks to my collaborators on this piece: Mike M, Andrei, Charles and MourningStars.)

The Phrase, “Oh, that can’t be good” comes to mind

I read a lot of fund reports – annual, semi-annual and monthly.  I read most of them to find up what’s going on with the fund.  I read a few because I want to find up what’s going on with the world.  One of the managers whose opinion I take seriously is Steven Romick, of FPA Crescent (FPACX). 

They wanted to make two points. One: you were exactly right to notice that one paragraph in the Annual Report. It was, they report, written with exceeding care and intention. They believe that it warrants re-reading, perhaps several times. For those who have not read the passage in question:

Opportunity: When thinking about closing, we also think about the investing environment —both the current opportunity set and our expectations for future opportunities. Currently, we find limited prospects. However, we believe the future opportunity set will be substantial. As we have oft discussed, we are managing capital in the face of Central Bankers’ “grand experiment” that we do not believe will end well, fomenting volatility and creating opportunity. We continue to maintain a more defensive posture until the fallout. Though underperformance might be the price we pay in the interim should the market continue to rise, we believe in focusing on the preservation of capital before considering the return on it. The imbalances that we see, coupled with the current positioning of our Fund, give us confidence that over the long term, we will be able to invest our increased asset base in compelling absolute value opportunities.

Fund flows: We are sensitive to the negative impact that substantial asset flows (in or out) can have on the management and performance of a portfolio. At present, asset flows are not material relative to the size of the Fund, so we believe that the portfolio is not harmed. However, while members of the Investment Committee will continue to be available to existing clients, we have restricted discussions with new relationships so that our attention can be on investment management rather than asset gathering.

For now, we are satisfied with the team’s capabilities, the Fund’s positioning, and the impact of asset flows. As fellow shareholders, should anything cause us to doubt the likelihood of meeting our stated objectives we will close the Fund as we did before, and/or return capital to our shareholders.

What might be the sound bites in that paragraph? “We think about future opportunities. They will be substantial. For now we’ll focus on the preservation of capital. Soon enough, there will be billions of dollars’ worth of compelling absolute value opportunities.” In the interim, they know that they’re both growing and underperforming. They’ve cut off talk with potential new clients to limit the first and are talking with the rest of us so that we understand the second.

Point two: they’ve closed Crescent before. They’ll do it again if they don’t anticipate the opportunity to find good uses for new cash.

Artisan goes public.  Now what?

Artisan Partners are one on my favorite investment management firms.  Their policies are consistently shareholder friendly, their management teams are stable and disciplined, and their funds are consistently top-notch.

And now you’ll be able to own a piece of the action.  Artisan will offer shares to the public, with the proceeds used to resolve some debt and make it possible for some of the younger partners to gain an equity stake in the firm.  Three questions arise:

• Is this good for the investors in Artisan’s funds?
• Should you consider buying the stock?
• And would it all work a bit better with Godiva chocolate?

What happens now with the Artisan funds?

The concern is that Artisan is gaining a fiduciary responsibility to a large set of outside shareholders.   Their obligation to those shareholders is to increase Artisan’s earnings which, with other fund companies, has translated to (1) gather assets and (2) gather attention.  There’s only been one academic study on the difference in performance between publicly-owned and privately-held fund companies, and that study looked only at Canadian firms.  That study found:

… publicly-traded management companies invest in riskier assets and charge higher management fees relative to the funds managed by private management companies. At the same time, however, the risk-adjusted returns of the mutual funds managed by publicly-traded management companies do not appear to outperform those of the mutual funds managed by private management companies. This finding is consistent with both the risk reduction and agency cost arguments that have been made in the literature.  (M K Berkowitz, Ownership, Risk and Performance of Mutual Fund Management Companies, 2001)

The only other serious investigation that I know of was undertaken by Bill Bernstein, and reported in his book The Investor’s Manifesto.  Bernstein’s opinion of the financial services industry in general and of actively-managed funds in particular is akin to his opinions on astrology and reading goat entrails.  Think I’m kidding?  Here’s Bill:

The prudent investor treats almost the entirety of the financial industrial landscape as an urban combat zone. This means any stock broker or full-service brokerage firm, any newsletter, any advisor who purchases individual securities, any hedge fund. Most mutual fund companies spew more toxic waste into the investment environment than a third-world refinery. Most financial advisors cannot invest their way out a paper bag. Who can you trust? Almost no one.

Bill looked at the performance of 18 fund companies, five of which were not publicly-traded.  In particular, he looked at the average star ratings for their funds (admittedly an imperfect measure, but among the best we’ve got).  The privately-held firms placed 1st, 2nd, 3rd, 6th and 9^th in performance.  The lowest positions were all public firms with a record of peddling bloated, undistinguished funds to an indolent public.  His recommendation is categorical: “Do not invest with any mutual fund family that is owned by a publicly traded parent company.”

While the conflicts between the interests of the firm’s stockholders and the funds’ shareholders are real and serious, it’s also true that a number of public firms – the Affiliated Managers Group and T. Rowe Price, notably – have continued offered solid funds and reasonable prices.  While it’s possible that Artisan will suddenly veer off the path that’s made them so admirable, that’s neither necessary nor immediately probable.

So, should you buy the stock instead of the funds?