Matthews Asia Total Return Bond (formerly Matthews Asia Strategic Income), (MAINX), September 2014

At the time of publication, this fund was named Matthews Asia Strategic Income.

We’ve published several profiles of MAINX.  for background, our February 2013 profile is here.

*Matthews Asia liquidated their two fixed-income funds in March, 2023. In consequence, the information for Marathon Value should be read for archival purposes only.*

Objective and Strategy

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

Adviser

Matthews International Capital Management. Matthews was founded in 1991 and advises the 15 Matthews Asia funds. As of July 31, 2014, Matthews had $27.3 billion in assets under management. On whole, the Matthews Asia funds offer below average expenses. They also publish an interesting and well-written newsletter on Asian investing, Asia Insight.

Manager(s)

Teresa Kong is the lead manager. Before joining Matthews in 2010, she was Head of Emerging Market Investments at Barclays Global Investors (now BlackRock) and responsible for managing the firm’s investment strategies in Emerging Asia, Eastern Europe, Africa and Latin America. In addition to founding the Fixed Income Emerging Markets Group at BlackRock, she was also Senior Portfolio Manager and Credit Strategist on the Fixed Income credit team. She’s also served as an analyst for Oppenheimer Funds and JP Morgan Securities, where she worked in the Structured Products Group and Latin America Capital Markets Group. Kong has two co-managers, Gerald Hwang and Satya Patel. Mr. Hwang for three years managed foreign exchange and fixed income assets for some of Vanguard’s exchange-traded funds and mutual funds before joining Matthews in 2011. Mr. Patel worked more in the hedge fund and private investments universe.

Strategy capacity and closure

“We are,” Ms. Kong notes, “a long way from needing to worry about that.” She notes that Matthews has a long record of moving to close their funds when asset flows and market conditions begin to concern the manager. Both the $8 billion Pacific Tiger (MAPTX) and $5.4 billion Asia Dividend (MAPIX) funds are currently closed.

Management’s Stake in the Fund

As of the April 2014 Statement of Additional Information, Ms. Kong had between $100,000 and 500,000 invested in the fund, as well as substantial investments in seven other Matthews funds.  There’s no investment listed for her co-managers. In addition, two of the fund’s five trustees have invested in it: Geoffrey Bobroff has between $10,000 – 50,000 and Mr. Matthews has over $100,000.

Opening date

November 30, 2011.

Minimum investment

$2500 for regular accounts, $500 for IRAs for the retail shares. The fund’s available, NTF, through most major supermarkets.

Expense ratio

1.10%, after waivers, on $66 million in assets (as of August, 2014). There’s also a 2% redemption fee for shares held fewer than 90 days. The Institutional share class (MINCX) charges 0.90% and has a $3 million minimum.

Comments

If I spoke French, I’d probably shrug eloquently, gesture broadly with an impish Beaujolais and declare “plus ça change, plus c’est la même chose.” (Credit Jean-Baptiste Alphonse Karr, 1849.)

After four conversations with Teresa Kong, spread out over three years, it’s clear that three fundamental things remain unchanged:

  1. Asia remains a powerful and underutilized source of income for many investors. The fundamentals of their fixed-income market are stronger than those in Europe or the U.S. and most investors are systematically underexposed to the Asian market. That underexposure is driven by a quirk of the indexes and of all of the advisors who benchmark against them. Fixed income indexes are generally debt-weighted, that is, they give the greatest weight to the most heavily indebted issuers. Since few of those issuers are domiciled in Asia, most investors have very light exposure to a very dynamic region.
  2. Matthews remains the firm best positioned to help manage your exposure there. The firm has the broadest array of funds, longest history and deepest analyst core dedicated to Asia of any firm in the industry.
  3. MAINX remains a splendid tool for gaining that exposure. MAINX has the ability to invest across a wide array of income-producing securities, including corporate (61% of the portfolio, as of August 2014) and government (22%) bonds, convertibles (9%), equities (5%) and other assets. It has the freedom to hedge its currency exposure and to change duration in response to interest rate shifts. The fund’s risk and return profile maximum drawdown continues to track the firm’s expectations which is good given the number of developments which they couldn’t have plausibly predicted before launch. Ms. Kong reports that “the maximum drawdown over one- and three- months was -4.41% and -5.84%, which occurred in June and May-July 2013, respectively. This occurred during the taper tantrum and is fully in-line with our back-tests. From inception to July 2014, the strategy has produced an annualized return of 6.63% and a Sharpe ratio of 1.12 since inception, fully consistent with our long-term return and volatility expectations.”

The fund lacks a really meaningful Morningstar peer group and has few competitors. That said, it has substantially outperformed its World Bond peer group (the orange line), Aberdeen Asian Bond (AEEAX, yellow) and Wisdom Tree Asia Local Debt ETF (ALD, green).

mainx

In our August 2014 conversation, Ms. Kong made three other points which are relevant for folks considering their options.

  1. the US is being irreversibly marginalized in global financial markets which is what you should be paying attention to. She’s neither bemoaning nor celebrating this observation, she’s just making it. At base, a number of conditions led to the US dollar becoming the world’s hegemonic currency which was reinforced by the Saudi’s decision in the early 1970s to price oil only in US dollars and to US investment flows driving global liquidity. Those conditions are changing but the changes don’t seem to warrant the attention of editors and headline writers because they are so slow and constant. Among the changes is the rise of the renminbi, now the world’s #2 currency ahead of the euro, as a transaction currency, the creation of alternative structures to the IMF which are not dollar-linked or US driven and a frustration with the US regulatory system (highlighted by the $9B fine against BNP Paribas) that’s leading international investors to create bilateral agreements that allow them to entirely skirt us. The end result is that the dollar is likely to be a major currency and perhaps even the dominant currency, but investors will increasingly have the option of working outside of the US-dominated system.
  2. the rising number of “non-rated” bonds is not a reflection on credit quality: the simple fact is that Asian corporations don’t need American money to have their bond offerings fully covered and they certainly don’t need to expense and hassle of US registration, regulation and paying for (compromised) US bond rating firms to rate them. In lieu of US bond ratings, there are Asia bond-rating firms (whose work is not reflecting in Morningstar credit reports) and Matthews does extensive internal research. The depth of the equity-side analyst corps is such that they’re able “to tear apart corporate financials” in a way that few US investors can match.
  3. India is fundamentally more attractive than China, at least for a fixed-income investor. Most investors enthused about India focus on its new prime minister’s reform agenda. Ms. Kong argues that, by far, the more significant player is the head of India’s central bank, who has been in office for about a year. The governor is intent on reducing inflation and is much more willing to deploy the central bank’s assets to help stabilize markets. Right now corporate bonds in India yield about 10% – not “high yield” bond but bonds from blue chip firms – which reflects a huge risk premium. If inflation expectations change downward and inflation falls rather than rises, there’s a substantial interest rate gain to be harvested there. The Chinese currency, meanwhile, is apt to undergo a period of heightened volatility as it moves toward a free float; that is, an exchange rate set by markets rather than by Communist Party dictate. She believes that that volatility is not yet priced in to renminbi-denominated transactions. Her faith is such that the fund has its second greatest currency exposure to the rupee, behind only the dollar.

Bottom Line

MAINX offers rare and sensible access to an important, under-followed asset class. The long track record of Matthews Asia funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class. The fund remains small though that will change. It will post a three-year record in November 2014 and earn a Morningstar rating by year’s end; the chart above hints at the possibility of a four- or five-star rating. Ms. Kong also believes that it’s going to take time for advisors get “more comfortable with Asia Fixed Income as an asset class. It took a decade or so for emerging markets to become more widely adopted and we expect that Asia fixed income will become more ubiquitous as investors gain comfort with Asia as a distinct asset class.” You might want to consider arriving ahead of the crowd. 

Disclosure: while the Observer has no financial or other ties to Matthews Asia or its funds, I do own shares of MAINX in my personal account and have recently added to them.

Fund website

Matthews Asia Strategic Income homepage and Factsheet. There’s a link to a very clear discussion of the fund’s genesis and strategy in a linked document, entitled Matthews Q&A.  It’s worth your time.

© Mutual Fund Observer, 2014. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

 

Matthews Asia Strategic Income (MAINX), February 2013

 

This is an update of the fund profile originally published in February 2012, and updated in March 2012. You can find that profile here

Objective and Strategy

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

Adviser

Matthews International Capital Management. Matthews was founded in 1991 and advises the 13 Matthews Asia funds.   As of December 31, 2012, Matthews had $20.9 billion in assets under management.  On whole, the Matthews Asia funds offer below average expenses.  They also publish an interesting and well-written newsletter on Asian investing, Asia Insight.

Manager(s)

Teresa Kong is the lead manager.  Before joining Matthews in 2010, she was Head of Emerging Market Investments at Barclays Global Investors (now BlackRock) and responsible for managing the firm’s investment strategies in Emerging Asia, Eastern Europe, Africa and Latin America. In addition to founding the Fixed Income Emerging Markets Group at BlackRock, she was also Senior Portfolio Manager and Credit Strategist on the Fixed Income credit team.  She’s also served as an analyst for Oppenheimer Funds and JP Morgan Securities, where she worked in the Structured Products Group and Latin America Capital Markets Group.  Kong has two co-managers, Gerald Hwang, who for three years managed foreign exchange and fixed income assets for some of Vanguard’s exchange-traded funds and mutual funds before joining Matthews in 2011, and Robert Horrocks, Matthews’ chief investment officer.

Management’s Stake in the Fund

As of the April 2012 Statement of Additional Information, Ms. Kong and Mr. Horrocks each had between $100,000 and 500,000 invested in the fund.  About one-third of the fund’s Investor class shares were held by Matthews.

Opening date

November 30, 2011.

Minimum investment

$2500 for regular accounts, $500 for IRAs for the retail shares.  The fund’s available, NTF, through Fidelity, Scottrade, TD Ameritrade, TIAA-CREF and Vanguard and a few others.

Expense ratio

1.40%, after waivers, on $50 million in assets (as of January, 2013).  There’s also a 2% redemption fee for shares held fewer than 90 days.  The Institutional share class (MINCX) charges 1.0% and has a $3 million minimum.

Comments

The events of 2012 only make the case for Matthews Asia Strategic Income more intriguing.  Our original case for MAINX had two premises:

  1. Traditional fixed-income investments are failing. The combination of microscopic domestic interest rates with the slow depreciation of the U.S. dollar and the corrosive effects of inflation means that more and more “risk-free” fixed-income portfolios simply won’t meet their owners’ needs.  Surmounting that risk requires looking beyond the traditional.  For many investors, Asia is a logical destination for two reasons: the fundamentals of their fixed-income market is stronger than those in Europe or the U.S. and most investors are systematically underexposed to the Asian market.
  2.  Matthews Asia is probably the best tool you have for gaining that exposure.  They have the largest array of Asia investment products in the U.S. market, the deepest analytic core and the broadest array of experience.  They also have a long history of fixed-income investing in the service of funds such as Matthews Asian Growth & Income (MACSX).   Their culture and policies are shareholder-friendly and their success has been consistent. 

Three developments in 2012 made the case for looking at MAINX more compelling.

  1. Alarm about the state of developed credit markets is rising.  As of February 2013, Bill Gross anticipates “negative real interest rates approaching minus 2%” and warns “our credit-based financial markets and the economy it supports are levered, fragile and increasingly entropic – it is running out of energy and time.”  Templeton’s Dan Hasentab, “the man who made some of the boldest contrarian bets in the bond market last year has,” The Financial Times reported on January 30, “a new message for investors: get out of supposedly safe government debt now, before it is too late.” The 79 year old maestro behind Loomis Sayles Bond and Strategic Income, Dan Fuss, declares “This is the most overbought market I have ever seen in my life . . . What I tell my clients is, ‘It’s not the end of the world, but . . .”   

    Ms. Kong points to Asia as a powerful counterbalance to these concerns.  Its beta relative to US Treasuries bonds is among the lowest around: If, for example, the 5-year Treasury declines 1% in value, U.S. investment grade debt will decline 0.7%, the global aggregate index 0.5% and Asia fixed-income around 0.25%.

  2. Strategic Income performed beautifully in its first full year.  The fund returned 13.62% in 2012, placing it in the top 10% of Morningstar’s “world bond” peer group.  A more telling comparison was provided by our collaborator, Charles Boccadoro, who notes that the fund’s absolute and risk-adjusted returns far exceeded those of its few Asia-centered competitors.

  3. Strategic Income’s equity exposure may be rising in significance.  The inclusion of an equity stake adds upside, allows the fund to range across a firm’s capital structure and allows it to pursue opportunities in markets where the fixed-income segment is closed or fundamentally unattractive.  Increasingly, the top tier of strategists are pointing to income-producing equities as an essential component of a fixed-income portfolio.

Bottom Line

MAINX offers rare and sensible access to an important, under-followed asset class.  The long track record of Matthews Asia funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class.  By design, MAINX will likely offer the highest Sharpe ratio (a measure of risk-adjusted returns) of any of the Matthews Asia funds. You really want to consider the possibility before the issue becomes pressing.

Fund website

Matthews Asia Strategic Income

Commentary

2013 Q3 Report

© Mutual Fund Observer, 2013. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.

Matthews Asia Strategic Income (MAINX)

The fund:

Matthews Asia Strategic Income (MAINX)

Manager:

Teresa Kong, Manager

The call:

We spent an hour on Tuesday, January 22, talking with Teresa Kong of Matthews Asia Strategic Income. The fund is about 14 months old, has about $40 million in assets, returned 13.6% in 2012 and 11.95% since launch (through Dec. 31, 2012).

Highlights include:

  1. this is designed to offer the highest risk-adjusted returns of any of the Matthews funds. 
  2. the manager describes the US bond market, and most especially Treasuries, as offering “asymmetric risk” over the intermediate term. Translation: more downside risk than upside opportunity. 
  3. given some value in having a fixed income component of one’s portfolio, Asian fixed-income offers two unique advantages in uncertain times. First, the fundamentals of the Asian fixed-income market are very strong. Second, Asian markets have a low beta relative to US intermediate-term Treasuries. 
  4. MAINX is one of the few funds to have positions in both dollar-denominated and local currency Asian debt (and, of course, equities as well). 
  5. in equities, Matthews looks for stocks with “bond-like characteristics.” 
  6. most competitors don’t have the depth of expertise necessary to maximize their returns in Asia. 
  7. TK said explicitly that they have no neutral position or target bands of allocation for anything, i.e., currency exposure, sovereign vs. corporate, or geography. They try to get the biggest bang for the level of risk across the portfolio as a whole, with as much “price stability” (she said that a couple of times) as they can muster.

podcastThe conference call (When you click on the link, the file will load in your browser and will begin playing after it’s partially loaded.)

The profile:

MAINX offers rare and sensible access to an important, under-followed asset class. The long track record of Matthews’ funds suggests that this is going to be a solid, risk-conscious and rewarding vehicle for gaining access to that class.

The Mutual Fund Observer profile of MAINX, updated March, 2012

podcastThe MAINX audio profile

Web:

Matthews Asia Strategic Income Fund

Fact Sheet

2013 Q3 Report

Fund Commentary

Fund Focus: Resources from other trusted sources

Few Alternatives to MAINX

Originally published in February 1, 2013 Commentary

Matthews Asia Strategic Income Fund (MAINX) is a unique offering for US investors. While Morningstar identifies many emerging market and world bond funds in the fixed income category, only a handful truly focus on Asia. From its prospectus:

Under normal market conditions, the Strategic Income Fund seeks to achieve its investment objective by investing at least 80% of its total net assets…in the Asia region. ASIA: Consists of all countries and markets in Asia, including developed, emerging, and frontier countries and markets in the Asian region.

Fund manager Teresa Kong references two benchmarks: HSBC Asian Local Bond Index (ALBI) and J.P. Morgan Asia Credit Index (JACI), which cover ten Asian countries, including South Korea, Hong Kong, India, Singapore, Taiwan, Malaysia, Thailand, Philippines, Indonesia and China. Together with Japan, these eleven countries typically constitute the Asia region. Recent portfolio holdings include Sri Lanki and Australia, but the latter is actually defined as Asia Pacific and falls into the 20% portfolio allocation allowed to be outside Asia proper.

As shown in following table, the twelve Asian countries represented in the MAINX portfolio are mostly republics established since WWII and they have produced some of the world’s great companies, like Samsung and Toyota. Combined, they have ten times the population of the United States, greater overall GDP, 5.1% GDP annual growth (6.3% ex-Japan) or more than twice US growth, and less than one-third the external debt. (Hong Kong is an exception here, but presumably much of its external debt is attributable to its role as the region’s global financial center.)

February 1, 2013

Very few fixed income fund portfolios match Matthews MAINX (or MINCX, its institutional equivalent), as summarized below. None of these alternatives hold stocks.

February 1, 2013

 Aberdeen Asian Bond Fund CSBAX and WisdomTree ETF Asian Local Debt ALD cover the most similar geographic region with debt held in local currency, but both hold more government than corporate debt. CSBAX recently dropped “Institutional” from its name and stood-up investor class offerings early last year. ALD maintains a two-tier allocation across a dozen Asian countries, ex Japan, monitoring exposure and rebalancing periodically. Both CSBAX and ALD have about $500M in assets. ALD trades at fairly healthy volumes with tight bid/ask spreads. WisdomTree offers a similar ETF in Emerging Market Local Debt ELD, which comprises additional countries, like Russia and Mexico. It has been quite successful garnering $1.7B in assets since inception in 2010. Powershares Chinese Yuan Dim Sum Bond ETF DSUM (cute) and similar Guggenheim Yuan Bond ETF RMB (short for Renminbi, the legal tender in mainland China, ex Hong Kong) give US investors access to the Yuan-denominated bond market. The fledgling RMB, however, trades at terribly low volumes, often yielding 1-2% premiums/discounts.

A look at life-time fund performance, ranked by highest APR relative to 3-month TBill:

February 1, 2013

Matthews Strategic Income tops the list, though of course it is a young fund. Still, it maintains low down side volatility DSDEV and draw down (measured by Ulcer Index UI). Most of the offerings here are young. Legg Mason Western Asset Global Government Bond (WAFIX) is the oldest; however, last year it too changed its name, from Western Asset Non-U.S. Opportunity Bond Fund, with a change in investment strategy and benchmark.

Here’s look at relative time frame, since MAINX inception, for all funds listed:

February 1, 2013

February 1, 2013

Charles, 25 January 2013

Matthews Asia Strategic Income (MAINX) – February 2012, revised March 2012

Objective and Strategy

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

Adviser

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

Manager(s)

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

Management’s Stake in the Fund

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

Opening date

November 30, 2011.

Minimum investment

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

Expense ratio

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

Comments

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

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

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

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

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

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

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

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

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

Bottom Line

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

Fund website

Matthews Asia Strategic Income

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

February 1, 2023

Dear friends,

Welcome to February. It’s a month we associate with love, St. Valentine’s Day. As holidays go, it’s another triumph for the marketers. The holiday began life as a Roman fertility festival, Lupercalia, and its attendant parties. Eventually, the Christian church made the same move here as they did with the pagan year-end festival; they repurposed the December solstice festival into Christmas and the February fertility festival into St. Valentine’s Day. The moves gave them one more tool for converting party-loving pagans into … well, party-loving Continue reading →

Investing in 2022: The Indolent Portfolio

Each year, usually in our February issue, I walk through my portfolio. It gives some folks the shivers, and others, a nice sense of superiority. On the whole, it seemed like a good idea to accelerate the schedule this year. I’ll walk through it using the same five-part process that we’ve urged on others.

Step One: Assess my goals and resources

My overarching goal is to have a portfolio that I don’t have Continue reading →

Snowball’s Indolent Portfolio

A tradition dating back to the days of FundAlarm was to annually share our portfolios, and reflections on them, with you.

Four rules have governed my portfolio for the past 15 years or so.

  1. I maintain a stock-light asset allocation.

For any goal that’s closer than 10-15 years away, stock investing is speculation. Stocks rise and fall far more dramatically than other investments and, once they’ve fallen, it sometimes feels like they can’t get up. Equity income funds are typically very conservative vehicles, and yet they took four years to regain their October 2007 peaks. International large cap core funds took seven years to reach break-even while domestic large-cap core funds were underwater for five-and-a-half years. The worst-hit categories languished for nine years.

Research conducted by T. Rowe Price and shared here, on several occasions, led me to conclude that I wouldn’t gain much from a portfolio that exceeds 50% stocks. My target allocation is 50% income (half in cash-like investments, half in somewhat riskier ones) and 50% growth (half in firms domiciled in the US and half elsewhere). Based on a review of 70 years of returns (1949-2018), this allocation would typically Continue reading →

Death Cleaning my portfolio

Or, since I teach at a historically Swedish-Lutheran college, I might use the original Swedish term: I was döstädning my portfolio.

By way of background, my income comes from teaching at the aforementioned Augustana College; it’s exceedingly secure but has not increased much, in real or inflation-adjusted terms, in quite a while. It has “bond-like” qualities. I invest about 13% pretax for retirement, the college has a match that adds about 10% and I squirrel away around 10% of my take-home pay each month. Our home in Davenport is small, snug and affordable. Our cars are used but clean and efficient. Our splurges often enough involve live music and Continue reading →

Snowball’s portfolio

Roy Weitz, founder of FundAlarm and sort of godfather to MFO, annually shared his portfolio, and his reflections on it, with his readers. He owned up to his mistakes, talked through his logic and revealed his plans. When I began contributing to FundAlarm, he encouraged me to do likewise. This essay, then, is an annual “think aloud” exercise that might help you imagine how to make more informed, satisfying decisions for yourself. In constructing it, I drew on my reading and conversations with managers as well as the tools available at Morningstar and MFO Premium.

I’ve thought long and hard to create a portfolio that allows me to be dumb and lazy. My overarching goal is to have a portfolio that lets me Continue reading →

Briefly noted

The industry appears to be in full summer-beach mode, or its doing so splendidly that there’s no need to even think about changing anything. In any case, July saw the smallest number of announced changes in about five years.

Updates

Our July 2017 profile of Matthews Asia Credit Opportunities (MCRDX/MICPX) described it as investing in high-yield bonds. That’s correct but incomplete. Manager Satya Patel reminded us that the fund’s core investments can include “convertibles, hybrids and derivatives with fixed income characteristics.” Indeed, since inception convertible bonds have represented 20-25% of the portfolio. We’ve corrected the profile to reflect that. The fund has built a substantial performance advantage over its peers since inception, similar to the consistent success of its older Continue reading →

Matthews Asia Credit Opportunities (MCRDX/MICPX), July 2017

*Matthews Asia liquidated their two fixed-income funds in March, 2023. Manager Teresa Kong subsequently left the firm. In consequence, the information for Marathon Value should be read for archival purposes only.*

Objective and strategy

The managers seek total return over the long term. They invest in debt issued by Asian corporations, governments and supranatural institutions. The managers invest, primarily, in high-yield, dollar-denominated debt though they define that term broadly enough to incorporate both high-yield bonds and debt-related instruments such as convertible bonds, hybrids and derivatives with fixed income characteristics.  Around 20-25% of the portfolio has been in convertible bonds since inception, and that percentage is been pretty stable from year to year. 

Adviser

Matthews International Capital Management, LLC, the Investment Advisor to the Matthews Asia Funds, was founded Continue reading →

July 1, 2016

Dear friends,

Hi. We’re back. Did you miss us? Chip and I greatly enjoyed our holiday in Scotland; she’s the tiny squidge in the middle of the picture, smiling and waving at you. This shot captures much of the delight of our time there. It’s taken from atop Dun Beag, the remnants of a 2,400 year old fortified keep near Struan, on the Isle of Skye. It’s on the edge of a pasture that stretches for miles, up mountains and down ravines. Sheep grazed all about it, studiously ignoring us. It looks out onto The Inner Seas that separate Skye from the Hebrides. 

dun beag 1

atop dun beag

Chip adds, “And here’s our fearless leader, perched atop Dun Beag, enjoying the glorious views and perfect weather.”

We stopped and hiked here a bit on my birthday, on our way to dinner at the Edinbane Inn. I’d share a picture of our dinner, but then you’d drool on your keyboard and that can’t be good. Continue reading →

June 1, 2016

Dear friends,

They’ve done it again. After 32 years at Augustana, I’m still amazed and delighted each spring. For all that I grumble about their cell phone-addled intellects and inexplicable willingness to drift along sometimes, their energy, bravery and insistence on wanting to do good continue to inspire me. I wish them well and will soon begin to prepare for the challenges posed by my 33rd set of first-year students.

augustana graduation

But not right now. Right now, Chip and I are enjoying being in Scotland, being in each other’s company and being without cell service. Grand and languorous adventure awaits on islands and Highlands. While she and I are away, we’ve turned most of this month’s issue over to our colleagues though I did have time to write just a bit. And so…

Funds without fillers

Here are two simple truths:

  1. Owning stocks makes sense because, over the long run, returns on stocks far outstrip returns on other liquid, publicly-accessible asset classes. Over the past 90 years, large cap stocks have returned 10% a year while government bonds have made 5-6%.

Sadly, that simple observation leads to this sort of silliness:

chart

See? As long as your retirement is at least 87 years off, it’s silly to put your money anywhere other than common stocks. (The article’s author, a pharmacist and active investor, concludes that you shouldn’t trust mutual funds or ETFs but should, instead, be a do-it-yourself value investor. Uhhh … no thanks.) For those of us with a time horizon shorter than 87 years though, there’s a second truth to cope with.

  1. Owning stocks doesn’t always make sense because the price of higher long-term returns is higher immediate volatility. That’s because stocks are more exciting than bonds. Frankly, no normal human ever said “yup, I got me some 30-year Ginnie Mae jumbos with a coupon of 3.5%” with nearly the same visceral delight as “yup, I got into Google at the IPO.” Maaaagic! That desire to own magic often enough leads investors to spend hundreds of dollars to buy shares which are earning just pennies a year. Good news leads to excitement, excitement leads to a desire to own more, that desire leads to a bidding war for shares, which leads to a soaring stock price, which leads to more bidding … and, eventually, a head-first tumble into a black hole.

GMO’s Ben Inker quantified the magnitude of the hysteria: “the volatility of U.S. since 1881 has been a little over 17% per year. The volatility of the underlying fair value of the market has been a little over 1%. Well over 90% of the volatility of the stock market cannot be explained as a rational response to the changing value of the stream of dividends it embodies” (“Keeping the Faith,” Quarterly Letter, 1Q 2016).

One reasonable conclusion, if you accept the two arguments above, is you should rely on stock managers who are not wedded to stocks. When we enter a period when owning stocks makes less sense, then your manager should be free to … well, own less stock. There are at least three ways of doing that: making bets that the market or particular sectors or securities will fall (long/short equity), shifting assets from overvalued asset classes to undervalued ones (flexible portfolios) or selling stocks as they become overvalued and holding the proceeds in cash until stocks become undervalued again (absolute value investing). Any of the three strategies can work though the first two tend to be expensive and complicated.

So why are long/short and flexible portfolios vastly more popular with investors than straightforward value investing? Two reasons:

  1. They’re sexy. It’s almost like being invested in a hedge fund which, despite outrageous expenses, illiquidity, frequent closures and deplorable performance, is where all the Cool Kids hang out.
  2. You demand managers that do something! (Even if it’s something stupid.) Batters who swing at the first pitch, and every pitch thereafter, are exciting. They may go down, but they go down in glory. Batters who wait for a fat pitch, watching balls and marginal strikes go by, are boring. They may get solid hits but fans become impatient and begin screaming “we’re not paying you to stand there, swing!” As the season goes on, batters feel the pressure to produce and end up swinging at more and more bad pitches.

In The Dry Powder Gang, Revisited (May 2016), we concluded:

[B]eing fully invested in stocks all the time is a bad idea. Allowing greed and fear, alternately, to set your market exposure is a worse idea. Believing that you, personally, are magically immune from those first two observations is the worst idea of all.

You should invest in stocks only when you’ll be richly repaid for the astronomical volatility you might be exposed to. Timing in and out of “the market” is, for most of us, far less reliable and far less rewarding than finding a manager who is disciplined and who is willing to sacrifice assets rather than sacrifice you. The dozen teams listed above have demonstrated that they deserve your attention, especially now.

One of those managers, Eric Cinnamond of ASTON River Road Absolute Value (ARIVX) wrote to take issue with our claim that cash necessarily serves as a drag on a portfolio. He writes:

singlesThis is another misconception about not being fully invested. If you have large discounts you can still generate attractive returns without being invested in what I call “fillers.” Just like with processed food, investment fillers are often there just to fill up the portfolio, but often provide little value and in some cases can be hazardous to your health! Open the hood of most fully invested small cap funds and you’ll find plenty of fillers these days, especially in sectors like consumer and health care. The stocks are clearly overvalued but managers think because they’re in lower risk sectors they won’t get destroyed. Good example WD-40 (WDFC) at 30x earnings! Great company but you could lose half your capital if it ever reverted to a more justifiable 7% free cash flow yield. 

That led us to the question, “so, how good are absolute value guys as stock-pickers.” That is, if you don’t feel compelling to buy “fillers” just for the optical value of a full-invested portfolio, how well do the stocks you find compelling perform?

Answer: really quite well. In the chart below, we look at the YTD performance of cash-heavy funds through early May. We then calculate how the stock portion of the portfolio performed, assuming that the cash portion was returning zero. For example, if a fund was 10% invested in stocks and had returned 1% YTD, we impute a stock return of 10% for that period.

 

Style

Cash

2016 return, as of 5/6/16

Imputed active return

ASTON / River Road Independent Value ARIVX

Small-cap value

85

8.5

56.7

Intrepid Endurance ICMAX

Small-cap value

67

4.2

12.7

Hennessy Total Return HDOGX

Large-cap value, Dogs of the Dow

49

5.3

10.4

Intrepid Disciplined Value ICMCX

Mid-cap value

48

4.8

9.2

Castle Focus MOATX

Global multi-cap core

34

6.0

9.1

Pinnacle Value PVFIX

Small-cap core

47

4.2

8.9

Frank Value FRNKX

Mid-cap core

60

2.8

7.0

Cook & Bynum COBYX

Global large-cap core

37

4.3

6.8

Centaur Total Return TILDX

Equity-income

45

3.6

6.6

Bruce BRUFX

Flexible

26

2.5

3.4

Bread & Butter BABFX

Multi-cap value

42

1.3

2.2

FPA Crescent FPACX

Flexible

36

0.2

0.3

Chou Opportunity CHOEX

Flexible

22

(16.6)

(21.3)

Two plausible benchmarks

Vanguard Total Stock Market VTSMX

Multi-cap core

0

1

1

Vanguard Balanced Index VBINX

Hybrid

2

2.3

2.3

Two things stand out: first, the absolute value guys have, almost without exception, outperformed a fully invested portfolio during the year’s violent ups and downs. Second, the stocks in their portfolios have dramatically outperformed the stocks in a broad market index. Excluding the freakish Chou Opportunity fund, the stocks in the remaining twelve portfolio returned 10.6% on average while the Total Stock Market Index made 1%.

Bottom line: the demand for a fully-invested portfolio forces managers to buy stocks they don’t want to own. Judged by reasonable measures (risk-adjusted returns measured by the Sharpe ratio) over reasonable periods (entire market cycles rather than arbitrary 1/3/5 year snippets), you are better served by portfolios without fillers and by the sorts of managers we characterized as the “we’ve got your back” guys. Go check them out. The clock is ticking and you really don’t do your best work in the midst of a panic.

Wait! You can’t start a new bear market. We’re not done with the last one yet!

Many thoughtful people believe that the bull market that began in March 2009, the second oldest in 70 years, is in its final months. The S&P 500, despite periods of startling volatility, has gone nowhere in the year since reaching its all-time high on May 21, 2015; as I write on May 21, 2016, it sits 1% below that peak. It looks like this:

the s and p 500

That’s bad: Randall Forsyth reports that no bull market in 30 years has gone so long without a new high (“Stocks Are Stuck in the Twilight Zone,” Barrons, 5/21/16). Of 13 bull markets since 1946 that have gone a year without a high, ten have ended in bear markets (“Clock ticks on bull market,” 5/20/16).

Meanwhile earnings have declined for a fourth consecutive quarter (and are well on their way to a fifth quarter). FactSet (5/20/16) notes we haven’t seen a streak that long or a quarterly drop so great since the financial crisis. The stock market is, in consequence, somewhere between “pricey” and “ridiculously pricey.” A new bear market may not be imminent (check with the Fed), but it will arrive sooner rather than later.

“But wait!” cries one cadre of managers, “we can’t have a new bear market yet. The old one hasn’t finished with us yet.”

mauled by the bear

That’s right. There are funds that still haven’t recovered their October 2007 levels. We screened the MFO Premium database, looking for funds that have spent the past 101 months still mauled by the bear.

We’ve found 263 funds, collectively holding $507 billion in assets, that haven’t recovered from the financial crisis. Put another way, $10,000 invested in one of these funds 3,150 days ago in October 2007 still isn’t worth $10,000.

Highlights of the list:

  • Thirteen funds have managed double-digit annual losses since the start of the crisis. These are ranked from the greatest annualized loss down.

Direxion Monthly Emerging Markets Bull 2x (DXELX)
UltraEmerging Markets ProFund (UUPIX)
Guinness Atkinson Alternative Energy (GAAEX)
Midas (MIDSX)
Direxion Monthly 7-10 Year Treasury Bear 2x (DXKSX)
Mobile Telecommunications UltraSector ProFund (WCPIX)
ProShares Ultra Financials(UYG)
Rising Rates Opportunity ProFund (RRPIX)
Banks UltraSector ProFund (BKPIX)
UltraInt’l ProFund (UNPIX)
UltraJapan ProFund (UJPIX)
Calvert Global Energy Solutions (CAEIX)
Rydex Inverse Government Long Bond Strategy (RYJUX)

Ten of those funds could reasonably claim that they’re simple, mechanical trading vehicles which are designed for sophisticated (hah!) investors to hold for hours or a few days, not years. Three of the funds have no such excuse.

  • Sixteen of the funds are double-dippers; they crashed in 2007-09 and then crashed even worse between 2009 and 2016. Technically we’re measuring a fund’s maximum drawdown, the greatest decline registered after it had begun to recover. Most of the double-dippers were leveraged equity, income or currency funds. Four funds managed the feat on (tremendously bad) luck and skill alone. Funds whose maximum drawdowns occurred after March 2009 include
    • Midas, down 88%, bottoming in December 2015
    • Calvert Global Energy Solutions, down 75% and Guinness Atkinson Alternative Energy, down 85%, both as of July 2012
    • Nysa, down 55% as of February 2016.
  • One hundred ninety of the funds, around 72%, are international vehicles: 114 diversified international, 47 are emerging markets funds, 13 Europe-centered and 16 variously Asia-centered. There are no Latin American funds on the list.
  • 78 of the funds are passive, quasi-passive or smart beta sorts of funds, including ETFs, ETNs, mechanical leveraged equity and enhanced index funds. The advisor that appears most frequently is iShares.shame
  • Five simple domestic equity funds must take the Walk of Shame

AMG Managers Brandywine Advisors Mid Cap Growth (BWAFX), a mid-cap growth fund that’s lost 3.7% annually over the full market cycle.

Schneider Value (SCMLX) is a concentrated $20 million deep value fund that’s lost 1.2% annually, buoyed by a 15% return so far in 2016. It has a maddening tendency to finish way above average one year then crash for the next two.

Stonebridge Small Cap Growth (SBSGX) has lost 2.9% annually over the full market cycle but wins points for consistency: by Morningstar’s assessment, it has trailed at least 99% of its peers for the trailing 3, 5, 10 and 15 year periods.

Nysa (NYSAX), a small cap fund that would appall even Steadman. The fund’s not only lost 7.6% per year over the current market cycle, it’s lost over 50% in the 19 years since inception. In a hopeful move, the fund installed a new manager in February, 2013. He’s down 28% since then.

Jacobs Small Cap Growth (JSCGX) is the product of a bizarre marketing decision. In 2010, Jacob Investment Management decided to acquire Rockland Small Cap Growth Fund, a dying small cap fund with a terrible record and rechristen it as their own. The hybrid product is down 4.7% annually over the full market cycle. Since conversion, the fund has trailed its peers every year and appears to trail, well, all of them.

  • 55 are multi-billion dollar funds. The Biggest Losers, all with over $10 billion in assets, are
    • Vanguard Total International Stock Index (VGTSX)
    • Vanguard Emerging Markets Stock Index (VEIEX)
    • iShares MSCI Emerging Markets ETF (EEM)
    • Vanguard FTSE All-World ex US Index ETF (VEU)
    • Financial Select Sector SPDR (XLF)
    • iShares MSCI Eurozone ETF (EZU)

The most famous funds on the list include Janus Overseas (JNSOX), T. Rowe Price Emerging Markets Stock (PRMSX) and Fidelity Overseas (FSOFX), one of 12 Fido funds to earn this sad distinction.

The complete list of Bear Chow Funds is here.

One bit of good news for investors in these funds; others have suffered more. Three funds have waited more than 20 years to recover their previous highs:

20 year bears

Bottom line: if you own one of these funds, you need to actively pursue an answer to the question “why?” First why: why did I choose to invest in this fund in the first place? Was it something I carefully researched, something pushed on me by a broker, an impulse or what? That’s a question only you can answer. Second why: why does this fund appear to be so bad? There might be a perfectly legitimate reason for its apparent misery. If so, either a fund’s representative or your adviser owes you a damned straight, clear explanation. Do not accept the answer “everyone was down” any more than you’d accept “everyone cheats.” Not everyone was down this much and not everyone stayed down. And if, after listening to them bloviate a bit you start to feel the waft of smoke up your … uhh, nethers, you need to fire them.

Smart people saying interesting stuff

Josh Brown, “The Repudiation Phase of the Bubble,” 05/09/2016:

One of the common threads of every financial or asset bubble throughout human history is that they all have a repudiation phase – a moment where all the lies that had been built up alongside the excess are aired in public. Every reputation companies and players get caught up in it… We’re there now. New shit is coming to light every five minutes. Every reputation you thought was untouchable and every omission you’d accepted because it was already accepted by the crowd – all back on the table for discussion (dissection?).

Snowball’s note: for some reason, an old aphorism popped into my head as I read this. “The function of liberal Republicans (yes, there were such once) is to shoot the wounded after the battle.”

Cullen Roche, “A catastrophe looms over high-fee mutual funds and investment advisers,” 04/28/2016:

Back in 2009 I wrote a very critical piece on mutual funds basically calling them antiquated products that do the American public a disservice. I was generalizing, of course, as there are some fine mutual funds out there. However, as a generalization I think it’s pretty fair to say that the vast majority of mutual funds are closet-indexing leaches that do no one any good (except for the management companies who charge the high fees). But there are smart ways to be active and very silly ways to be active. Mutual funds are usually a silly way to be active as they sell the low probability of market-beating returns in exchange for the guarantee of high fees and taxes.

Dan Loeb is right. A catastrophe is coming. The end of an era is here. And the American public is going to be better off because of it.

Snowball’s note: “the vast majority are …” is absolutely correct. The question for me is whether really worthwhile funds will stubbornly insist on self-destructing because (1) the managers are obsessed about talking about raw performance numbers and (2) firms would rather die on their own terms rather than looking for ways to collaborate with other innovators to redefine the grounds of the debate.

Had I mentioned my impending encounter with Cullen Skink (no relation), a sort of Scottish fish chowder?

Meb Faber, “Which Institution Has the Best Asset Allocation Model?” 05/18/2016. After analyzing the recommended asset allocations of the country’s 40 top brokerages and comparing their results over time, Faber fumes:

There you have it – the difference between the most and least aggressive portfolios is a whopping 0.53% a year. Now, how much do you think all of these institutions charge for their services? How many millions and billions in consulting fees are wasted fretting over asset allocation models?

So all those questions that stress you out…

  • “Is it a good time for gold?”
  • “What about the next Fed move – should I lighten my equity positions beforehand?”
  • “Is the UK going to leave the EU, and what should that mean for my allocation to foreign investments?”

Let them go.

If you’re a professional money manager, go spend your time on value added activities like estate planning, insurance, tax harvesting, prospecting, general time with your clients or family, or even golf.

If you’re a retail investor, go do anything that makes you happy.

Either way, stop reading my blog and go live your life.

Snowball’s note: I found the table of asset allocation recommendations fascinating, in about the way that I might find a 40-car pile-up on the Interstate fascinating. Two things stood out. In a broadly overpriced market, none of these firms had the courage to hold more than trivial amounts of cash. And they do have a devotion to hedge funds and spreading the money into every conceivable nook and cranny. I was mostly impressed with Fidelity’s relatively straightforward 60/40 sort of model.

Mr. Faber’s performance analysis is unpersuasive, if not wrong. He looks at how the brokerages various allocations would have performed from 1973 to the present but it appears that he simply assumes that the current asset allocation (4% to EM debt, 14% to private equity, 25% to hedge funds) can be projected backward to 1973. If so … uh, no.

Finally, his analysis implies that high equity exposures – even over a period of decades – do not materially enhance returns. As a practical matter, you’re doing about as well at 40% equity as at 65%. Given that I’ve argued for stock-light portfolios, I’m prone to agree.

Side note to Mr. Faber: I took your advice and am lounging on the Isle of Skye. Did you, or are you scribbling away at yet another life-wasting blog post?

Bob Cochran’s Thinking beyond funds

Robert CochranWe were delighted to announce last month that Bob Cochran joined MFO’s Board of Directors. Bob is the lead portfolio manager, Chief Compliance Officer, and a principal of PDS Planning in Columbus, Ohio, and a long-time contributor to the FundAlarm and MFO discussion boards.

The Observer strives to help two underserved groups: small independent investors and small independent managers. In an experiment in outreach to the former group, and most especially to younger, less confident investors, Bob has agreed to write a series of short articles that help people think beyond funds. That aligns nicely with Meg Faber’s recommendation, above, and with both Bob and Sam Lee’s approach to their clients. All agree that your investments are an important part of your financial life, but they don’t drive your success on their own. Here’s Bob’s first reminder of stuff worth knowing but often overlooked.

They Are Just Documents. How Important Can They Be?

Take a moment and think about what could happen if you were to suddenly become physically or mentally unable to handle your affairs. Young, old, single, married, in a committed relationship or not: the fact is unless you have certain documents in place, your financial and health well being could be in limbo. Everyone should have the following documents created, executed, and ready should they be needed.

  • Durable Power of Attorney, sometimes called a financial power of attorney. This designates someone to act on your behalf should you be unable to pay bills and make other financial decisions. This allows your designee access to bank accounts, brokerage accounts, and retirement accounts (the latter only if specifically stated in the document), and the authority to make deposits, withdrawals, and pay bills, and allow access to any safe deposit boxes.
  • Health Care Power of Attorney, also called a Health Care Directive or Medical Power of Attorney. This document allows your designee the authority to make health care decisions. In some states, this can be what is called a Springing Power of Attorney that takes effect only after your incapacity.

If you do not have these two documents, think of the problems that could arise should you become unable to handle your financial affairs or make health care decisions by yourself. How will your ongoing bills be paid? Who will respond to doctors and health care providers on your behalf? The time and money to have the courts make a ruling could be significant, and that does not ensure it is consistent with your wishes.

Both documents are easily created by your attorney, or you may find them online, specifically for the state in which you live. Generally, your spouse would be named as POA if you are married. If you are single, a parent, relative, or close friend are often selected. Remember the person you name will have broad powers, so be sure it is someone you trust. And be sure you provide a copy of the documents to the person you have named as POA.

Tragedies happen all the time. They are seldom anticipated. We have had clients who have spent money getting these documents created, but have never signed them. This is a huge mistake! Take action today to make sure you live your life on your own terms. After all, it’s your life, plan for it.

On Financial Planners

charles balconyA family friend recently asked me to look at his mutual fund investments. He contributes to these investments periodically through his colleague, a Certified Financial Planner at a long-time neighborhood firm that provides investment services. The firm advertises it’s likely more affordable than other firms thanks to changes in how clients are billed, so it does not “charge hefty annual advisor fees of 1% or more.”

I queried the firm and planner on FINRA’s BrokerCheck site and fortunately found nothing of concern. FINRA stands for Financial Industry Regulatory Authority and is a “not-for-profit organization authorized by Congress to protect America’s investors by making sure the securities industry operates fairly and honestly.”

A couple recent examples of its influence: FINRA Fines Raymond James $17 Million for Systemic Anti-Money Laundering Compliance Failures and FINRA Sanctions Barclays Capital, Inc. $13.75 Million for Unsuitable Mutual Fund Transactions and Related Supervisory Failures.

The BrokerCheck site should be part of the due-diligence for all investors. Here for example is the type of allegations and settlements disclosed against the firm Edward Jones in 2015: “The firm was censured and agreed to pay $13.5 million including interest in restitution to eligible customers … that had not received available sales charge waivers … since 2009, approximately 18,000 accounts purchased mutual fund shares for which an available sales charge waiver was not applied.”

And, here an example of experience listed for an “Investment Adviser Representative” …

ej_qual

But I’m getting sidetracked, so back to my friend’s portfolio review.  Here’s what I found:

  • He has 5 separate accounts – 2 Traditional IRAs, 2 Roth IRAs, and one 529.
  • All mutual funds are American Funds, accessed directly through American Funds website.
  • He owns 34 funds, across the 5 accounts.
  • Adjusting for different share classes (both front-loaded A, and back-loaded B … no longer offered), he owns 8 unique funds.
  • The 8 “unique” funds are not all that unique. Many hold the very same stocks. Amazon was held in 6 different funds. Ditto for Phillip Morris, Amgen, UnitedHealth Group, Home Depot, Broadcom, Microsoft, etc.
  • The 8 funds are, in order of largest allocation (A class symbols for reference): Growth Fund of America (AGTHX), Capital World Growth & Income (CWGIX), Capital Income Builder (CAIBX), American Balanced (ABALX), AMCAP (AMCPX), EuroPacific Growth (AEPGX), New Perspective (ANWPX), and New Economy (CNGAX).

After scratching my head a bit at the sheer number of funds and attendant loads, annual expense ratios, and maintenance fees, I went through the exercise of establishing a comparable portfolio using only Vanguard index funds.

I used Morningstar’s asset allocation tool to set allocations, as depicted below. Not exact, but similar, while exercising a desire to minimize number of funds and maintain simple allocations, like 60/40 or 80/20. I found three Vanguard funds would do the trick: Total Stock Market Index 60%, Total International Market Index 20%, and Total Bond Index 20%.

af_vanguard_alloc

The following table and corresponding plot shows performance since November 2007, start of current market cycle, through April 2016 (click on image to enlarge):

af_vanguard_table_comparable af_vanguard_comparable

As Mr. Buffet would be quick to point out, those who simply invested in the Total Stock Market Index fund received the largest reward, if suffering gut-wrenching drawdown in 2009. The Total Bond Index rose rather steadily, except for brief period in 2013. The 60/40 Balanced Index performed almost as well as the Total stock index, with about 2/3 the volatility. Suspect such a fund is all most investors ever need and believe Mr. Bogle would agree. Similarly, the Vanguard founder would not invest explicitly in the Total International Stock fund, since US S&P 500 companies generate nearly half their revenue aboard. Over this period anyway, underperformance of international stocks detracted from each portfolio.

The result appears quite satisfying, since returns and volatility between the two portfolios are similar. And while past performance is no guarantee of future performance, the Vanguard portfolio is 66 basis points per year cheaper, representing a 5.8% drag to the American Funds’ portfolio over an 8.5 year period … one of few things an investor can control. And that difference does not include the loads American Funds charges, which in my friend’s case is about 3% on A shares.

My fear, of course, is that while this Certified Financial Planner may not directly “charge hefty annual advisor fees,” my friend is being directed toward fee-heavy funds with attendant loads and 12b-1 expenses that indirectly compensate the planner.

Inspired by David’s 2015 review of Vanguard’s younger Global Minimum Volatility Fund (VMVFX/VMNVX) I made one more attempt to simplify the portfolio even more and reduce volatility, while keeping global exposure similar. This fund’s 50/50 US/international stock split combined with the 60/40 stock/bond split of the Vanguard Balanced Fund, produces an even more satisfying allocation match with the American Funds portfolio. So, just two funds, each held at 50% allocation.

Here is updated allocation comparison: 

af_vanguard_alloc_2

And here are the performance comparison summary table and plot from January 2014 through April 2016, or 2.33 years (click image to enlarge):

af_vanguard_table_comparable_2

af_vanguard_comparable_2

I should note that the Global Volatiliy Fund is not an index fund, but actively managed by Vanguard’s Quantitative Equity Group, so this portfolio is also 50/50 passive/active. While the over-performance may temper, lower volatility will persist, as will the substantially lower fees.

Other satisfying aspects of the two comparable Vanguard portfolios are truly unique underlying holdings in each fund and somewhat broader exposure to value and mid/small cap stocks. Both these characteristics have shown over time to deliver premiums versus growth and large cap stocks.

Given the ease at which average investors can obtain and maintain mutual fund portfolios at Vanguard, like those examined here, it’s hard to see how people like my friend will not migrate away from fee-driven financial planners that direct clients to fee-heavy families like American Funds.

Every Active Fund is a Long-Short Fund: A Simple Framework for Assessing the Quality, Quantity and Cost of Active Management

By Sam Lee

Here’s a chart of the 15-year cumulative excess return (that is, return above cash) of a long-short fund. Over this period, the fund generated an annualized excess return of 0.82% with an annualized standard deviation of 4.35%. The fund charges 0.66% and many advisors who sell it take a 5.75% commission off the top.

long-short fund

Though its best returns came during the financial crisis, making it a good diversifier, I suspect few would rush out to buy this fund. Its performance is inconsistent, its reward-to-risk ratio of 0.19 is mediocre, and its effective performance fee of 44% is comparable to that of a hedge fund. There are plenty of better-performing market-neutral or long-short funds with lower effective fees.

Despite the unremarkable record, about $140 billion is invested in a version of this strategy under the name of American Funds Growth Fund of America AGTHX. I simply subtracted the Standard & Poor’s 500 Index’s monthly total return from AGTHX’s monthly total return to create the long-short excess return track record (total return would include the return of cash).

This is an unconventional way of viewing a fund’s performance. But I think it is the right way, because, in a real sense, every active fund is a long-short strategy plus its benchmark.

Ignoring regulatory or legal hurdles, a fund manager can convert any long-only fund into a long-short fund by shorting the fund’s benchmark. He can also convert a long-short fund into a long-only fund by buying benchmark exposure on top of it (and closing out any residuals shorts). I could do the same thing to any fund I own through a futures account by overlaying or subtracting benchmark exposure.

Viewing funds this way has three major benefits. First, it allows you to visualize the timing and magnitude of a fund’s excess returns, which can alter your perception of a fund’s returns in major ways versus looking at a total return table or eyeballing a total return chart. Looking at a fund’s three-, five- and ten-year trailing returns tells you precious little about a fund’s consistency and the timing of its returns. The ten-year return contains the five-year return which contains the three-year return which contains the one-year return. (If someone says a fund’s returns are consistent, citing 3-, 5-, and 10-year returns, watch out!) Rolling period returns are a step up, but neither technique has the fidelity and elegance of simply cumulating a fund’s excess returns.

Second, it makes clear the price, historical quantity and historical quality of a fund’s active management. The “quantity” of a fund’s active management is its tracking error, or the volatility of the fund’s returns in excess of its benchmark. The “quality” of a fund’s management is its information ratio, or excess return divided by tracking error. Taking these two factors into consideration, it becomes clearer whether a fund has offered a good value or not. A fund shouldn’t automatically be branded expensive based on its expense ratio observed in isolation. I would happily give up my left pinky for the privilege of investing in Renaissance Technologies’ Medallion fund, which charges up to 5% of assets and 44% of net profits, and I would consider myself lucky.

Finally, it allows you to coherently assess alternative investments such as market-neutral funds on the same footing as long-only active managers. A depressingly common error in assessing long-short or market neutral funds is to compare their returns against the raw returns of long-only funds or benchmarks. A market neutral fund should be compared against the active component of a long-only manager’s returns.

To make these lessons concrete, let’s perform a simple case study with two funds: Vulcan Value Partners Small Cap VVPSX and Vanguard Market Neutral VMNFX. Here’s a total return chart for both funds since the Vulcan fund’s inception on December 30, 2009. (Note that Vanguard Market Neutral was co-managed by AXA Rosenberg until late 2010, after which Vanguard’s Quantitative Equity Group took full control.)

vmnfx v vvpsx

Given the choice between the two funds, which would you include in your portfolio? Over this period the Vanguard fund returned a paltry 3.7% annually and the Vulcan fund a blistering 14.2%. If you could only own one fund in your portfolio, the Vulcan fund is probably the better choice as it benefits from exposure to market risk and therefore has a much higher expected return. However, if you are looking for the fund that enhances the risk-adjusted return of portfolio, there isn’t enough information to say at this point; it is meaningless to compare a fund with market exposure with a market neutral fund on a total return basis.

A good alternative fund usually neutralizes benchmark-like exposure and leave only active, or skilled-based, returns. A fairer comparison of the two funds would strip out market exposure from Vulcan Small Cap (or, equivalently, add benchmark exposure to Vanguard Market Neutral). In the chart below, I subtracted the returns of the Vanguard Small Cap Value ETF VBR, which tracks the CRSP US Small Cap Value Index, from the Vulcan fund’s returns. While the Vulcan fund benchmarks itself against the Russell 2000 Value index, the Russell 2000 is terribly flawed and has historically lost about 1% to 2% a year to index reconstitution costs. Small-cap managers love the Russell 2000 and its variations because it is a much easier benchmark to beat. Technically, I’m also supposed to subtract the cash return (something like the 3-month T-bill or LIBOR rate) from Vanguard Market Neutral, but cash yields have effectively remained 0% over this period.

vvpsx er v vmnfx

When comparing both funds simply based on their active returns, Vanguard Market Neutral Fund looks outstanding. Investors have paid a remarkably low management fee (0.25%) for strong and consistent outperformance. Even better, the fund’s outperformance was not correlated with broad market movements.

This is not to say that Vanguard has the better fund simply based on past performance. Historical quantitative analysis should supplement, not supplant, qualitative judgment. The quality of the managers and the process have to be taken into account when making a forecast of future outperformance as a fund’s past excess return is very loosely related to its future excess return. There is a short-term correlation, where high recent excess return predicts high future near-term excess return due to a momentum effect, but over longer horizons there is little evidence that high past return predicts high future return. Confusingly, low long-run excess returns predict low future returns, suggesting evidence of persistent negative skill. If a fund has historically displayed a long-term pattern of low active exposure and negative excess returns, its fees should either be extremely low or you shouldn’t own it at all.

—–

There’s a puzzle here. Imagine if Vanguard Market Neutral’s managers simply overlaid static market exposure on their fund. Here’s how their fund would have performed. A long-only fund that has beaten the market by 3.7% a year with minimal downside tracking error over five years would easily attract billions of dollars. But here Vanguard is, wallowing is relative obscurity, despite having remarkably low absolute and relative costs.

Why is this? In theory, the price of active management—in whatever form—should tend to equalize in a competitive market. However, what we see is that long-only active management tends to dominate and is often wildly expensive relative to the true exposures offered, and long-short active management tends to often repackage market beta and overcharge for it, creating pockets of outstanding value among strategies that are truly market neutral and highly active.

I think three forces are at work:

  • Investors do not adjust a fund’s returns for its beta exposures. A high return fund, even if it’s almost from beta, tends to attract assets despite extremely high fees for the actively managed portion.
  • Investors focus on absolute expense ratios, often ignoring the level of active exposure obtained.
  • Investors are uncomfortable with unconventional strategies that use leverage and derivatives and incur high tracking error.

Given these facts, a profit-maximizing fund company will be most rewarded by offering up closet index funds. Alternative managers will offer up market beta in a different form. Active managers that offer truly market neutral exposure will be punished due to their unconventionality and comparisons against forms of active management where beta exposures are baked into the track record.

Investment Implications

When choosing among active strategies, all sources of excess return should be on a level playing field. There is no reason to compare long-only active managers against other long-only active managers. Your portfolio doesn’t care where it gets its excess returns from and neither should you.

However, because investors tend to anchor heavily on absolute expense ratios, the price of active management offered in a long-only format tends to be much more expensive per unit of exposure than in a long-short format. An efficient way to obtain active management while keeping tracking error in check is to construct a barbell of low-cost benchmark-like funds and higher-cost alternative funds.

SamLeeSam Lee and Severian Asset Management

Sam is the founder of Severian Asset Management, Chicago. He is also former Morningstar analyst and editor of their ETF Investor newsletter. Sam has been celebrated as one of the country’s best financial writers (Morgan Housel: “Really smart takes on ETFs, with an occasional killer piece about general investment wisdom”) and as Morningstar’s best analyst and one of their best writers (John Coumarianos: “ Lee has written two excellent pieces [in the span of a month], and his showing himself to be Morningstar’s finest analyst”). He has been quoted by The Wall Street Journal, Financial Times, Financial Advisor, MarketWatch, Barron’s, and other financial publications.  

Severian works with high net-worth partners, but very selectively. “We are organized to minimize conflicts of interest; our only business is providing investment advice and our only source of income is our client fees. We deal with a select clientele we like and admire. Because of our unusual mode of operation, we work hard to figure out whether a potential client, like you, is a mutual fit. The adviser-client relationship we want demands a high level of mutual admiration and trust. We would never want to go into business with someone just for his money, just as we would never marry someone for money—the heartache isn’t worth it.” Sam works from an understanding of his partners’ needs to craft a series of recommendations that might range from the need for better cybersecurity or lower-rate credit cards to portfolio reconstruction. 

The Education of a Portfolio Manager

By Leigh Walzer

Like 3 million of his peers, my son will graduate college this spring. In the technology space many of the innovative companies seem to care less about which elite institution is named on his piece of sheepskin and more about the skillset he brings to the role.

Asset management companies and investors entrusting their money to fund managers might wonder if the guys with fancy degrees actually do better than the rest of the pack.

There is an old adage that that the A students work for the C students. I remember working for Michael Price many years ago. Michael was a proud graduate and benefactor of the University of Oklahoma. He sometimes referred to my group (which did primarily distressed debt) as “the Ivy Leaguers.”

Graduates of Stanford and Harvard outperformed their peers by 1% per year for the past three years.

Thanks to the Trapezoid database, we were able to compile information to see if the Ivy Leaguers (like my son) actually perform better. Our laboratory is the mutual fund universe. We looked at 4000 funds managed by graduates of 400 universities around the world. We focused for this study on results for the three years ending April 30, 2016.

Exhibit Ia'

A few caveats: We concede to purists and academics that our study lacks rigor. The mutual fund database does not capture separate accounts, hedge funds, etc. We excluded many funds (comprising 25% of the AUM in our universe) where we lacked biographical data on the manager. Successful active funds rely on a team so it may be unfair to ascribe success to a single individual; in some cases we arbitrarily chose the first named manager. We used the institution associated with the manager’s MBA or highest degree. Some schools are represented by just 1 or 2 graduates. We combined funds from disparate sectors. Active and rules-based funds are sometimes strewn together. We haven’t yet crunched the numbers on the value of CFA certification. And we draw comparisons without testing for statistical validity.

I was a little surprised at the mix of colleges managing the nation’s mutual funds. Villanova has an excellent basketball program. But I didn’t expect it to lead the money manager tables. However, nearly all the funds managed by Villanova were Vanguard index funds. The same is true for Shippensburg, St. Joseph’s, Lehigh, and Drexel.

When we concentrated on active funds, the leading schools were Harvard, Wharton, Columbia University, University of Chicago, and Stanford. Note that Queens College cracks the top 10 – this is attributable almost entirely to one illustrious grad: Dina Perry, a money manager at Capital Re.

Who performed the best over the last 3 years? By one measure, Stanford graduates did the best followed by Harvard, Queens College, Dartmouth, and University of Wisconsin. Trapezoid looks mainly at each manager’s skill from security selection. Institutions managing fewer assets have a higher bar to clear to make the list. Managers from these top five schools ranked, on average, in the 77th percentile (100 being best) in their respective categories in skill as measured by Trapezoid.

exhibit II

Exhibit III: Fund Analysis Report for TRAIX

traix

If size and sample size were disregarded, some other colleges would score well. Notably, Hillsdale College benefitted from very strong performance by David Giroux, manager of the T Rowe Price Capital Appreciation Fund (TRAIX – closed to new investors). Wellington’s Jean Hynes lifted Wellesley College to the top echelon. Strong international programs include University of Queensland and CUNEF.

I searched in vain for an alum of Professor Snowball’s Augustana College in our database. Bear in mind though that any Viking who went on to earn a post-graduate degree elsewhere will show up under that school. (Snowball’s note: Augie is a purely undergraduate college and most managers accumulate a grad degree or three, so we’d be invisible. And the only fund manager on our Board of Trustees, Ken Abrams at Vanguard Explorer VEXPX, earned both his degrees at that upstart institution in Palo Alto.)

By and large it doesn’t cost investors more to “hire” graduates of the leading schools. The average fee for active managers at these five schools is 69 bps compared with 87 bps for the overall universe.

It seems remarkable that graduates of Stanford and Harvard outperformed their peers by 1% per year for the past three years. If we add Chicago and Wharton (the next two highest ranked MBA institutions), the advantage for the elite graduates falls to 0.47%. If we expand it to include the 10 universities (as ranked by US News & World Report) the advantage falls to 30bps.

We confess we are a bit surprised by these findings. We wonder how efficient market proponents like Burton Malkiel and Jack Bogle would explain this. (Graduates of their institution, Princeton University, also outperformed the market by 1%.)

If we were recruiting for a mutual fund complex, we would focus on the leading MBA programs. Judging by the numbers many asset managers do precisely that; Over 20% of all active mutual fund managers come from these schools

Does it mean that investors should select managers on the basis of academic credentials? If the choice were between two active funds, the answer is yes. If the choice is between a fund managed actively managed by a Stanford MBA and a passive fund, the answer is less clear. We know for the past 3 years the return produced by a typical Stanford MBA adjusted for the portfolio’s characteristics exceeds expense. But we would need to be fairly confident our stable of well-educated managers would repeat their success over the long haul by a sufficient margin.

Trapezoid’s fundattribution.com website allows registered users to review funds to see whether skill is likely to justify expense for a given fund class. We do this based on a probabilistic analysis which looks at the manager’s entire track record, not just the three-year skill rating. MFO readers may register at www.fundattribution.com for a demo and see the probability for funds in certain investment categories.

Interestingly the school whose fund managers gave us the highest confidence is Dartmouth. But we wouldn’t draw too strong conclusion unless Dartmouth has figured out how to clone its star, Jeff Gundlach of DoubleLine.

Bottom Line:

Graduates of top schools seem to invest better than their peers. Our finding may not be surprising, but it contradicts the precept of efficient market theorists. Knowing the fund manager graduated a top school or MBA program is helpful at the margin but probably not sufficient to choose the fund over a low-cost passive alternative.

Slogo 2What’s the Trapezoid story? Leigh Walzer has over 25 years of experience in the investment management industry as a portfolio manager and investment analyst. He’s worked with and for some frighteningly good folks. He holds an A.B. in Statistics from Princeton University and an M.B.A. from Harvard University. Leigh is the CEO and founder of Trapezoid, LLC, as well as the creator of the Orthogonal Attribution Engine. The Orthogonal Attribution Engine isolates the skill delivered by fund managers in excess of what is available through investable passive alternatives and other indices. The system aspires to, and already shows encouraging signs of, a fair degree of predictive validity.

The stuff Leigh shares here reflects the richness of the analytics available on his site and through Trapezoid’s services. If you’re an independent RIA or an individual investor who need serious data to make serious decisions, Leigh offers something no one else comes close to. More complete information can be found at www.fundattribution.com. MFO readers can sign up for a free demo.

Elevator Talk: Goodwood SMid Cap Discovery (GAMAX/GAMIX)

elevatorSince 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.

Goodwood SMid Cap isn’t your typical small-to-mid cap fund. In 2013, the manager of Caritas All-Cap Growth Fund (CTSAX) decided he’d had enough and left, leading the Board to order the fund’s closure and liquidation. I paraphrased their logic this way: “our fund is tiny, expensive, bad, and pursues a flawed investment strategy (long stocks, short ETFs). We’ll be going now.” Then, after liquidating all of the fund’s holdings, the Board put a stop to the action, appointed a transition manager and two months later sold the fund (and its record) to Goodwood.

The new manager moved it from all-cap growth with shorting via ETFs to small-to-mid cap value. According to one recent interview, the fund was originally a long-only product which has only recently added several hedging options. Managers Ryan Thibodeaux and Josh Pesses have a portfolio of 50-70 stocks with distinct biases toward smaller cap companies and value rather than growth. They’re able to hedge that portfolio with up to 20 short positions, cash, and a mix of puts and call options. Currently the fund’s net market exposure is 75%, which about 40% of the portfolio invested in small- to micro-cap stocks.

0D4_8634_groupMr. Thibodeaux founded Goodwood in 2012 after a nine year stint with Maple Leaf LP, a hedge fund that received a “seed” investment from Julian Robertson’s famous Tiger Management, leading to the informal designation of Maple Leaf as a “Tiger Seed.” Maple Leaf, like Goodwood, was a fundamental, value-biased long/short fund. Mr. Pesses joined Goodwood about a year later. Like Mr. Thibodeaux he was at Maple Leaf, served as a Partner and Senior Equity Research Analyst from 2007 to 2012. Their first products at Goodwood were long/short separate accounts which have done remarkably well. From January 1, 2008 – March 31, 2016, their long/short composite returned 8.6% annually after fees. The average Morningstar peer made 0.7%. That seems like a hopeful sign since those same strategies should help buoy GAMAX.

That said, performance has still been rocky. From the day Goodwood took over the fund (10/01/13) to 05/21/16, GAMAX has lost a bit over 6% while Morningstar’s small-blend category is up 7.3%. In 2015, the fund trailed 100% of its peers but so far in 2016, it’s returned 14.2% and is in the top 1% of its peer group. That sort of divergence led us to ask Messrs. Thibodeaux and Pesses to talk a bit more about what’s up. Here are their 200 (well, okay, 261 but that’s still only 130.5 per manager) words on why you need Goodwood:

There is not much about our firm and the Goodwood SMID Cap Discovery Fund that one would call conventional. From our background, to a geographic location that puts us well off the beaten path, to our atypical entree into the 40 Act world, to our investment strategy – we don’t fit neatly into any one box, Morningstar or otherwise.

When we took an over as manager to an existing mutual fund in October 2013, it was our first foray into the open-end side of the investment business. Up to that point, we’d spent the bulk our careers as analysts at a long/short hedge fund. That experience influences the way we approach stock selection and portfolio construction today and is a differentiator in the 40 Act space.

Our investment process is driven by a fundamental value-based approach, but that is not what sets our work apart. We see flexibility as a hallmark of our more “opportunistic” approach to investing. We invest in the sectors, both long and short, that we have covered for our entire careers – Consumer, Healthcare, Industrials and Technology. We are agnostic to benchmark weightings and when opportunities are scarce, we are comfortable with high cash balances. The Fund is and will always be long-biased, but we actively hedge our exposure using options and look at add alpha where possible through short selling individual securities.

Ultimately, our goal is to achieve superior risk adjusted returns over the intermediate to long term and we believe the Fund can serve as a valuable complement to core or passive Small and Mid cap positions.

The minimum initial investment for GAMAX is $2,500 with an expense ratio of 1.95%. The minimum investment for the institutional shares is $100,000; those shares carry a 1.7% E.R. Here’s the Goodwood website, it’s one of those fancy modern ones that doesn’t facilitate links to individual pages so you’ll have to go and click around a bit. If you’re interested in the strategy, you might choose to read through some of the many articles linked on their homepage.

Launch Alert: Centerstone Investors Fund (CETAX/CENTX)

Centerstone Investors and its sibling Centerstone International (CSIAX/CINTX) launched on May 3, 2016. The Investors fund will be a 60/40-ish global hybrid fund. Their target allocation ranges are 50-80% equity, 20-40% fixed income and 5-20% cash. Up to 20% of the fund might be in high-yield bonds. They anticipate that at least 15% of the total portfolio and at least 30% of their stocks will be non-U.S.

The argument for being excited about Centerstone Investors is pretty straightforward: it’s managed by Abhay Deshpande who worked on the singularly-splendid First Eagle Global (SGENX) fund for 14 years, the last six of them as co-manager. He spent a chunk of that time working alongside the fund’s legendary manager, Jean-Marie Eveillard and eventually oversaw “the vast majority” of First Eagle’s $100 billion. SGENX has a five star rating from Morningstar. Morningstar downgraded the fund from Silver to Bronze as a result of Mr. Deshpande’s departure. Before First Eagle, he was an analyst for Oakmark International and Oakmark International Small Cap and an acquaintance of Ed Studzinski’s. During his callow youth, he was also an analyst for Morningstar.

Here’s the goal: “we hope to address a significant need for investment strategies that effectively seek to manage risk and utilize active reserve management in an effort to preserve value for investors,” says Mr. Deshpande. “It’s our intention to manage Centerstone’s multi-asset strategies in such a way that they can serve as core holdings for patient investors concerned with managing risk.”

Given that he’s running this fund as a near-clone of SGENX, is there any reason to invest here rather than there? I could imagine three:

  1. Deshpande was seen as the driver of SGENX’s success in the years after Mr. Eveillard’s departure, which is reflected in the Morningstar downgrade when he left. So there’s talent on Centerstone’s side.
  2. SGENX has $47 billion in assets and is still open, which limits the fund’s investable universe and largely precludes many of the small issues that drove its early success. Centerstone, with $15 million in assets, should be far more maneuverable for far longer.
  3. First Eagle is in the process of being taken over by two private equity firms after generations as a family-owned business. Centerstone is entirely owned by its founder and employees, so its culture is less at-risk.

The opening expense ratio for “A” shares is 1.36% after waivers and the minimum initial investment is $5000. The “A” shares have a 5% front load but Mr. Deshpande expects that load-waived shares will be widely available. The investment minimum for institutional shares is $100,000 but the e.r. does drop to 1.11%. In lieu of a conventional factsheet, Centerstone provides a thoughtful overview that works through the fund’s strategy and risk-return profile. Centerstone’s homepage is regrettably twitchy but there’s a thoughtful letter from Mr. Deshpande that’s well worth tracking down.

Launch Alert: Matthews Asia Credit Opportunities (MCRDX)

Matthews Asia Credit Opportunities (MCRDX/MICPX) launched on April 29, 2016.

Matthews International Capital Management, LLC, the Investment Advisor to the Matthews Asia Funds, was founded in 1991 by Paul Matthews. Since then they’ve been the only U.S. fund complex devoted to Asia. They have about $21 billion in fund assets and advise18 funds. Of those, two focus on Asian credit markets: Strategic Income (MAINX) and Credit Opportunities.

Both of the credit-oriented funds are managed by Teresa Kong and Satya Patel. Ms. Kong joined Matthews in 2010 after serving as Head of E.M. Investments for BlackRock, then called Barclays Global. She founded their Emerging Markets Fixed Income Group and managed a bunch of portfolios. Her degrees are both from Stanford, she’s fluent in Cantonese and okay at Mandarin. Mr. Patel joined Matthews in 2011 from Concerto Asset Management where he was an investment analyst. He’s also earned degrees from Georgia (B.A.), the London School of Economics (M.A. in accounting and finance) and the University of Chicago (M.B.A. ). The state of his Mandarin is undisclosed.

The fund invests primarily in dollar-denominated Asian credit securities. The fund’s managers want their returns driven by security selection rather than the vagaries of the international currency market. And so “credit” excludes all local currency bonds. At least 80% of the portfolio will be invested in traditional sorts of credit securities – mostly “sub-investment grade securities” – while up to 20% might be placed in convertibles or hybrid securities.

Four things stand out about the fund:

The manager is really good. In our conversations, Ms. Kong has been consistently sharp, clear and thoughtful. Her Strategic Income fund has returned 4.2% annually since inception, in line with its EM Hard Currency Debt peer group, but it has done it with substantially less volatility.

mainx

The fund’s targets are reasonable and clearly expressed. “The objective of the strategy,” Ms. Kong reports, “is to deliver 6-9% return with 6-9% volatility over the long term.”

Their opportunity set is substantial and attractive. The Asia credit market is over $600 billion and the sub-investment grade slice which they’ll target is $130 billion. For a variety of reasons, “about a quarter of Asian bonds are not rated by one of the Big Three US rating agencies anymore,” which limits competition for the bonds since many U.S. investors can only invest in rated bonds. That also increases the prospect for mispricing, which adds the Matthews’ advantage. “Over the past 15 years,” they report, “Asia high yield has a cumulative return double that of European, LATAM and US high yield, with less risk than Europe and LATAM.” Here’s the picture of it all:

annual risk and return

You might draw a line between Asia Credit and Asia HY then assume that the fund will fall on that line rather nearer to Asia HY.

The fund’s returns are independent of the Fed. U.S. investors are rightly concerned about the effect of the Fed’s next couple tightening moves. The correlation between the Asia HY market and the Barclays US Aggregate is only 0.39. Beyond that, the managers have the ability to use U.S. interest rate futures to hedge U.S. interest rate risk.

The opening expense ratio for Investor shares is 1.1% and the minimum initial investment is $2500, reduced to $500 for IRAs. The investment minimum for institutional shares is $3 million but the e.r. does drop to 0.90%. Matthews has provide a thoughtful introduction that works through the fund’s strategy and risk-return profile. The fund’s homepage is understandably thin on content but Matthews, institutionally, is a pretty content-rich site.

Manager Changes

It’s been a singularly quiet month so far, with changes in the management teams at just 32 funds (tabulated below). In truth, none of the additions or subtractions appears to be game-changers.

Because bond fund managers, traditionally, had made relatively modest impacts of their funds’ absolute returns, Manager Changes typically highlights changes in equity and hybrid funds.

Ticker Fund Out with the old In with the new Date
ARDWX Aberdeen Multi-Manager Alternative Strategies Fund II Santa Fe Partners LLC no longer serves as a sub-adviser to the fund, and Henry Davis is no longer listed as a portfolio manager for the fund. Ian McDonald, Averell Mortimer, Darren Wolf, Russell Barlow, Vicky Hudson, Peter Wasko and Kevin Lyons remain on the management team 5/16
ASTYX AllianzGI Best Styles International Equity No one, but … Erik Mulder joined Michael Heldmann and Karsten Niemann in managing the fund. 5/16
AZDAX AllianzGI Global Fundamental Strategy Fund Andreas Utermann is no longer listed as a portfolio manager for the fund. Neil Dwane joins the management team of Armin Kayser, Karl Happe, Eric Boess, and Steven Berexa. 5/16
BGEIX American Century Global Gold Fund William Martin and Lynette Pang are no longer listed as portfolio managers for the fund. Yulin Long and Elizabeth Xie are now managing the fund. 5/16
BDMAX BlackRock Global Long/Short Equity Fund Paul Ebner is no longer listed as a portfolio manager for the fund. Richard Mathieson joins Raffaele Savi and Kevin Franklin in managing the fund. 5/16
BMSAX BlackRock Secured Credit Portfolio Carly Wilson and C. Adrian Marshall are gone. Mitchell Garfin remains and is joined by James Keenan, Jeff Cucunato, Jose Aguilar and Artur Piasecki. 5/16
BIALX Brown Advisory Global Leaders Fund No one, but … Bertie Thomson joins Michael Dillon in managing the fund. 5/16
CSIBX Calvert Bond Portfolio Matthew Duch will no longer serve as a portfolio manager for the fund. Vishal Khanduja and Brian  Ellis will remain on the portfolio management team. 5/16
CGAFX Calvert Green Bond Fund Matthew Duch will no longer serve as a portfolio manager for the fund. Vishal Khanduja and Brian  Ellis will remain on the portfolio management team. 5/16
CYBAX Calvert High Yield Bond Fund Matthew Duch will no longer serve as a portfolio manager for the fund. Vishal Khanduja and Brian  Ellis will remain on the portfolio management team and will be joined by Patrick Faul. 5/16
CFICX Calvert Income Fund Matthew Duch will no longer serve as a portfolio manager for the fund. Vishal Khanduja and Brian  Ellis will remain on the portfolio management team. 5/16
CLDAX Calvert Long-Term Income Fund Matthew Duch will no longer serve as a portfolio manager for the fund. Vishal Khanduja and Brian  Ellis will remain on the portfolio management team. 5/16
CSDAX Calvert Short Duration Income Fund Matthew Duch will no longer serve as a portfolio manager for the fund. Vishal Khanduja and Brian  Ellis will remain on the portfolio management team. 5/16
CULAX Calvert Ultra-Short Income Fund Matthew Duch will no longer serve as a portfolio manager for the fund. Vishal Khanduja and Brian  Ellis will remain on the portfolio management team. 5/16
SDUAX Deutsche Ultra Short Duration Bond Fund, soon to be the Deutsche Fixed Income Opportunities Fund As of August 31, Eric Meyer will no longer serve as a portfolio manager for the fund. John Ryan is joined by Roger Douglas and Rahmila Nadi in managing the fund. 5/16
DGANX Dreyfus Global Infrastructure Fund Joshua Kohn is no longer listed as a portfolio manager for the fund. Maneesh Chhabria is joined by Theodore Brooks on the management team. 5/16
ETMGX Eaton Vance Tax-Managed Small-Cap Fund Nancy Took, lead portfolio manager, announced her intention to retire at the end of October, 2016. Michael McLean and J. Griffith Noble will continue with the fund. 5/16
GSBFX Goldman Sachs Income Builder Fund Effective immediately, Lale Topcuoglu no longer serves as a portfolio manager for the fund. Daniel Lochner, Charles Dane, Colin Bell, Ronald Arons, Andrew Braun and David Beers will continue to manage the fund. 5/16
HBIAX HSBC Global High Income Bond Fund Lisa Chua is no longer listed as a portfolio manager for the fund. Nishant Upadhyay joins Rick Liu and Jerry Samet in managing the fund. 5/16
HBYAX HSBC Global High Yield Bond Fund Lisa Chua is no longer listed as a portfolio manager for the fund. Nishant Upadhyay joins Rick Liu and Mary Gottshall Bowers in managing the fund. 5/16
WASAX Ivy Asset Strategy Fund Mike Avery will no longer manage the fund, effective June 30, 2016. F. Chace Brundige and Cynthia Prince-Fox will continue to co-manager the fund. 5/16
IVTAX Ivy Managed International Opportunities Fund Mike Avery will no longer manage the fund, effective June 30, 2016. At that time, F. Chace Brundige and Cynthia Prince-Fox will become co-managers of the fund. 5/16
JMMAX JPMorgan Multi-Manager Alternatives Fund No one, but … P/E Global LLC has been added as an eleventh subadvisor to the fund. 5/16
SCGLX Scout Global Equity Fund James Moffett and founding manager James Reed are no longer listed as portfolio managers for the fund. Charles John is joined by John Indellicate and Derek Smashey. Somehow the combination of “indelicate” and “smashy” seems like fodder for a bunch of in-jokes. 5/16
UMBWX Scout International Fund Michael P. Fogarty no longer serves as a portfolio manager of the fund. Michael Stack and Angel Luperico will continue to manage the fund. 5/16
SEQUX Sequoia Fund No one, but … John Harris, Arman Gokgol-Kline, Trevor Magyar, and David Sheridan join David Poppe as co-managers. 5/16
TVOAX Touchstone Small Cap Value Fund DePrince Race & Zollo, Inc. will no longer subadvise the fund. Gregory Ramsby and Randy Renfrow will no longer serve as portfolio managers for the fund. Russell Implementation Services will subadvise the fund, with Wayne Holister as portfolio manager, until June 30, 2016. After June 30, LMCG Investments will become the subadvisor to the fund. 5/16
USIFX USAA International Fund No one, but … Filipe Benzinho is joining Susanne Willumsen, James Shakin, Craig Scholl, Paul Moghtader, Ciprian Marin, Taras Ivanenko, Andrew Corry, Daniel Ling and Marcus Smith to manage the fund. 5/16
HEMZX Virtus Emerging Markets Opportunities Fund No one, but … Brian Bandsma and Jin Zhang join Matthew Benkendorf in managing the fund 5/16
JVIAX Virtus Foreign Opportunities Fund No one, but … Daniel Kranson and David Souccar will join Matthew Benkendorf in managing the fund 5/16
NWWOX Virtus Global Opportunities Fund No one, but … Ramiz Chelat will join Matthew Benkendorf in managing the fund 5/16
UNASX Waddell & Reed Advisors Asset Strategy Fund Mike Avery will no longer manage the fund, effective June 30, 2016. F. Chace Brundige and Cynthia Prince-Fox will continue to co-manager the fund. 5/16

A Road Trip to Seafarer

Ben Peters, a CFP and chief compliance officer for Burton Enright Welch in the Bay Area, reported on his field trip to Seafarer in his Q1 shareholder letter. Ben had first learned of Seafarer through the Observer and was kind enough to share these reflections on his trip to Larkspur.

The more we communicated with Seafarer the more confidence we gained. Seafarer’s managers are undeniably, overwhelmingly smart. They have a deep understanding of EM investing and are serious and forthright about the risks. And as with most upper echelon managers, they leave you so impressed as to be uneasy: your impulse is to hand over your last dime.

Our visit to Seafarer’s Larkspur headquarters hammered home our conviction. Many fund managers want to be seen as the masters of the universe. Their offices usually have the downtown location, sweeping views, and fancy artwork to match.

Seafarer’s HQ is refreshing. Seafarer resides in a 3-story, non-descript office park in a quaint Bay-side town. There was no receptionist, flat screen TVs, or abstract paintings … the grand tour didn’t require any walking because the whole office is visible from the middle of the room …

The humble setting is symbolic. Seafarer is one of the lowest fee active emerging markets managers available even though it is relatively small.

Updates

Execution postponed: back in February 2016, the Board of $95 million ASTON Small Cap Fund (ATASX) moved to appoint GW&K Investment Management, LLC as subadviser to the fund in anticipation merging it into the year-old, $1.5 million AMG GW&K Small Cap Growth Fund (GWGIX). In May the board reversed course on the merger, though it still hopes to have GW&K run the fund permanently.

With the same enthusiasm that Republican leaders bring to their belated embrace of Donald Trump, mutual fund advisers are buying active/smart/tilted ETFs to stanch the bleeding. Garth Freisen, a principal at III Capital Management, reports:

[Contining movement of assets from funds to ETFs] helps explain recent moves by traditional asset management companies to acquire ETF-focused firms specializing in the construction of low-cost, active indexing portfolios:

In addition, he notes that Goldman Sachs and Fido are launching their own quant-driven ETFs (“Active Management Is Worth It When The Price Is Right,” 5/23/2016).

Briefly Noted . . .

Boston Partners Emerging Markets Long/Short Fund (BDMAX) has announced that “the Adviser expects that the Fund’s long positions will not exceed approximately 50% of the Fund’s net assets with an average of 30% to 70% net long.” Heretofore the extent of the fund’s market exposure wasn’t constrained in the prospectus.

Stonebridge Capital Management has announced they no longer intend to advise the Stonebridge Small-Cap Growth Fund (SBSGX). The Board is considering alternative plans with respect to the Fund, which may include closure and liquidation of the Fund.” Here’s what the Board has to wrestle with: an utterly dismal track record that will haunt any future manager, $12 million in assets and expenses north of 2.1% per year. One of the two managers has been with the fund for 16 years and still has not invested a penny in it. The only bright side is that the fund has a substantial embedded tax loss (Morningstar estimates about 17%) so liquidation would partially offset taxable gains elsewhere in an investor’s portfolio.

From the file labeled “I learn something new every month.” Touchstone Small Cap Value Fund (TVOAX) is switching managers. On May 20, 2016, DePrince, Race & Zollo, Inc. are out. On June 30, 2016, LMCG steps in. And what happens during the six week interregnum? Russell happens. Russell Implementation Services provides caretaker management in the window between the departure of one manager or team and the arrival of the next. Touchstone’s SEC filing reports:

Russell will make investment decisions for the Fund and also ensure compliance with the Fund’s investment policies and guidelines. Russell has been providing transition management services to clients since 1992. Russell has transitioned nearly $2.3 trillion in assets for clients in over 2,300 transition events in the last three calendar years. As of December 2015, Russell was managing 17 mandates with $1.7 billion in assets across a broad range of asset classes.

That implies $800 billion/year in assets temporarily managed by a caretaker. Who knew?

SMALL WINS FOR INVESTORS

All eight share classes of AB Small Cap Growth (QUASX) re-opened to new investors on June 1, 2016.

Effective June 3, 2016, Dreyfus International Stock Fund (DISAX) will be re-opened to new investors.

Touchstone Sands Capital Select Growth Fund (TSNAX) closed to new accounts, with certain exceptions, on April 8, 2013. With due consideration, the Advisor has determined to re-open the Fund for sales to investors making purchases in an account or relationship related to a fee-based, advisory platform.

CLOSINGS (and related inconveniences)

Undiscovered Managers Behavioral Value Fund (UBVAX) appears to be closing a bit more tightly. The fund is currently closed to new investors which eight classes of exceptions. As of June 27, 2016, the number of exceptions decreases to six and the wording on some of those six seems a bit more restrictive. It appears from the filing that the two lost exceptions will be:

  • Approved brokerage platforms where the Fund is on a recommended list compiled by a Financial Intermediary’s research department as of the Closing Date may continue to utilize the Fund for new and existing accounts.
  • Approved Section 529 college savings plans utilizing the Fund as of the Closing Date may do so for new and existing accounts.

OLD WINE, NEW BOTTLES

On July 1, 2016, BlackRock Managed Volatility Portfolio (PBAIX) will be renamed BlackRock Tactical Opportunities Fund. The revised statement of investment strategy doesn’t mention volatility but, instead, talks about “an appropriate return-to-risk trade-off” and warns of the prospect of frequent trading.

Also on July 1, BlackRock Secured Credit Portfolio (BMSAX) gets renamed BlackRock Credit Strategies Income Fund. Up until now it has invested, quite successfully, in “secured instruments, including bank loans and bonds, issued primarily, but not exclusively, by below investment grade issuers.” Going forward it will have one of those “invest in any danged thing we want to” strategies. Pursuant thereunto, two of the three current managers get sacked and four new managers get added. After the dust settles, four of the fund’s five managers will bear the rank “Managing Director.” The fifth, poor Artur Piasecki, is merely “Director.”

That same exhausting day, BlackRock Managed Volatility Portfolio (PCBAX) becomes BlackRock Tactical Opportunities Fund. The new investment strategy highlights frequent trading and the use of derivatives. It also abandons the old 50% global stocks / 50% global bonds benchmark.

As of August 1, 2016, Deutsche Ultra-Short Duration Fund (SDUAX) will be renamed Deutsche Fixed Income Opportunities Fund. Following the fund’s name change, its amorphous investment goal (“current income consistent with total return”) remains but its strategy changes from allowing up to 50% non-investment grade plus up to 20% cash to 30% non-investment grade with no reference to cash. Its principal benchmark becomes a 3-month LIBOR index.

Effective June 14, 2016, “Fidelity” will replace “Spartan” in the fund name for each Spartan Index Fund a/k/a each Fidelity Index fund.

On July 5, 2016, Victory CEMP Multi-Asset Growth Fund (LTGCX) will be renamed the Victory CEMP Global High Dividend Defensive Fund and its investment objective will change to reflect a dividend income component. This will be the fund’s second name in a year; up until November it was Compass EMP Multi-Asset Growth Fund. It’s a fund of Victory CEMP’s volatility-weighted ETFs. At 2.12% in expenses for 1.46% in long-term annual returns, one might suspect that it’s overpriced.

The sub-adviser to SilverPepper Merger Arbitrage Fund (SPABX/SPAIX) has changed its name from Brown Trout Management, LLC to Chicago Capital Management, LLC.

OFF TO THE DUSTBIN OF HISTORY

AAM/HIMCO Unconstrained Bond Fund (AHUAX) will undergo “termination, liquidation and dissolution” on June 28, 2016.

Eaton Vance Richard Bernstein Market Opportunities Fund (ERMAX) has closed and will liquidate on June 29, 2016. This is another “well, we gave it almost two years (!) before pulling the plug” fund.

Eaton Vance Currency Income Advantage Fund (ECIAX) will return its $1 million in assets to investors and vanish, after almost three years of operation, on June 29, 2016.

Goldman Sachs Financial Square Tax-Exempt California Fund (ITCXX) and Goldman Sachs Financial Square Tax-Exempt New York Fund (IYAXX) were slated for liquidation on August 31, 2016 but the Board and advisor got twitchy. Each fund now faces execution on June 10, 2016.

Harbor Funds’ Board of Trustees has determined to liquidate and dissolve the Harbor Unconstrained Bond Fund (HRUBX), which is roughly but not perfectly a clone of PIMCO Unconstrained Bond (PUBDX). The liquidation of the Fund is expected to occur on July 29, 2016.

Little Harbor Multi-Strategy Composite Fund (LHMSX), which you didn’t know existed, now no longer exists.

The Board of Trustees of Northern Funds has decreed that Multi-Manager Large Cap Fund (NMMLX), Multi-Manager Small Cap Fund (NMMSX), and Multi-Manager Mid Cap Fund (NMMCX) be liquidated on July 22, 2016. About that “multi-manager” thing: each of the funds is run by same two Northern Trust managers. They haven’t been noticeably “multi” since about 2012. They have about $900 million in assets between them with the smallest, Small Cap, posted the best relative returns.

Oppenheimer Commodity Strategy Total Return Fund (QRAAX) will liquidate on July 15, 2016. Why, you ask? Uhhhh …

qraax

The Board of Trustees of The Purisima Funds has determined that it is advisable “to liquidate, dissolve and terminate the legal existence” of The Purisima Total Return Fund (PURIX) and The Purisima All-Purpose Fund (PURLX). Their departure is notable primarily because of their manager, Kenneth Fisher, America’s largest investment advisor and source of, oh, I don’t know, one-third of all of the pop-up ads on the internet.

fisher

As of May 9, PURLX had $46,374 and PURIX has $257 million. Whether you judge PURIX as “unimpressive” or “almost freakishly bad” depends on whether you ask Lipper or Morningstar. Lipper benchmarks it against the Flexible Portfolio group, which it trails only modestly since inception. Morningstar categorizes it as domestic large-blend, and it trails the vast majority of such funds over every period from one-year to fifteen. In reality, Lipper is probably a truer fit. The fund is about 65% US large caps, 20% international large caps and 10% “other,” which includes two exchange-traded notes in its top 10 holdings. Regardless of the rater, the funds’ record suggests that Mr. Fisher – son of Phil Fisher (author of Common Stocks and Uncommon Profits, 1958, and “one of the great investors of all time,” according to Morningstar) – seems better suited to marketing than managing.

The month’s oddest closure announcement: “On May 6, 2016, at the recommendation of SF Advisors, LLC, the investment adviser to the Trust, the Trust’s Board of Trustees approved the closing and subsequent liquidation of the Funds. Accordingly, the Funds are expected to cease operations, liquidate any assets, and distribute the liquidation proceeds to shareholders of record on June 6, 2016.” Uhhh … no such funds were ever launched. This raises the same philosophical question as the speculation that near black holes, particles could be destroyed the moment before they’re created. Can funds that have never commenced operations cease them?

Pending shareholder approval (which is a lot like saying “pending the rising of the sun”), Stratus Government Securities (STGSX) and Stratus Growth (STWAX) will liquidate on June 10, 2016. How much suspense is there about the outcome of the vote? Well, the vote is Tuesday, June 7and liquidation is scheduled (tentatively, of course) for Friday of that same week.

Thomson Horstmann & Bryant Small Cap Value Fund (THBSX) will liquidate on June 24, 2016.

Effective May 6, 2016, Virtus Alternative Income Solution Fund, Virtus Alternative Inflation Solution Fund and Virtus Alternative Total Solution Fund were liquidated. Lest that phrase confuse us, the adviser clarifies: “The funds have ceased to exist.”

In Closing . . .

If you own an Android smart phone, you should go download and use the Ampere app. As you’re reading this, Chip and I will be in Scotland, likely in the vicinity of Inverness. One of the great annoyances of modern travel is the phenomenal rate at which phones drain their batteries and the subsequent need to search for charging options in airports and rail stations. What I didn’t know is how much of a different your charging cable makes in how much time it will take to regain a reasonable charge. Ampere is an app which measures, among other useful things, how quickly your phone is recharging.

It turns out that the quality of charging cable makes a huge difference. Below are two screencaps. I started with same charger and the phone then worked my way through a set of four different charging cables. The charge rates varied greatly from cable to cable.

ampereIn the instance above, it would take nearly four times as long to recharge my phone using the cable on the left. Every cable I tested produced a different charge rate, from a low of 300 mA to a high of 1200 mA.

My suggestion for travelers: download Ampere, use it to identify your best-performing cables then ditch the rest, and remember to switch to “airplane mode” for faster charging.

You’re welcome.

As ever, we want to take a moment to offer a sincere xei xei to all the folks who’ve supported us this month in thought, word and deed. To our faithful friends, Deb (still hoping to make it to Albuquerque) and Greg, thank you. Thanks, too, to Andrew, William, Robert, and Jason (all the way from Surrey, UK). We appreciate your generosity. 

We’ll look for you at Morningstar! We’re hopeful of catching up with a number of folks at the conference including folks from Centerstone, Evermore, FPA, Intrepid, Matthews and Seafarer … with maybe just a hint of Poplar Forest, a glimpse of Polaris and the teasing possibility of ride down Queens Road. We’ll post synopses to our discussion board each day and we’ll offer some more-refined prose when you come by for our July issue.

sheep

Remember, as you’re reading this, Chip and I are chillin’ in Scotland. If you’ve got questions or concerns about this month’s issue and you’d like them addressed before my return on June 7th, please drop a note to our colleague and data wizard, Charles Boccadoro. He’s got the keys to the back door.

As ever,

David

Funds in Registration, February and March, 2016

361 Domestic Long/Short Equity Fund

361 Domestic Long/Short Equity Fund will seek long-term capital appreciation while preserving capital in down markets. The plan is sort of encapsulated in the fund’s name. The fund will be managed by Harindra de Silva, Dennis Bein, and Ryan Brown, all of Analytic Investors. Dr. de Silva is, just fyi, famous, renowned, well-respected and successful. The initial expense ratio will be 1.79% and the minimum initial investment is $2,500.

American Beacon Garcia Hamilton Quality Bond Fund

American Beacon Garcia Hamilton Quality Bond Fund will seek high current income consistent with preservation of capital. The plan is to buy 0-7 year investment grade bonds. That’s nice, though I don’t particularly see whether the fund’s competitive advantage might come from. In any case, the fund will be managed by Gilbert Andrew Garcia and Nancy Rodriguez of Garcia, Hamilton & Associates. The initial expense ratio will be 0.84% and the minimum initial investment is $2500.

American Beacon GLG Total Return Fund

American Beacon GLG Total Return Fund will seek high current income and capital appreciation. The plan is to invest in … uh, stuff located in or linked to the emerging markets. Investment decisions are driven by a top-down analysis of the state of the markets and “stuff” might include fixed income securities, equities, ETFs, derivatives, options (“non-deliverable forwards”), and STRIPs. The fund will be managed by Guillermo Ossés, head of emerging market debt strategies for GLC, LLC. The initial expense ratio will be 1.56% and the minimum initial investment is $2,500.

Aasgard Dividend Growth Small & Mid-Cap Fund

Aasgard Dividend Growth Small & Mid-Cap Fund will seek a combination of dividend income and capital appreciation, with a secondary focus on lower than market volatility. The plan is to buy dividend-paying common stocks of small- and medium-sized companies. The portfolio will be sector-neutral with strict limits on position size and industry exposure, though it’s not clear how that affects the “sector-neutral” mandate. The fund will be managed by James Walsh of Coldstream Capital Management. The initial expense ratio will be 1.25% and the minimum initial investment is $2,500. The fund will launch in March.

Chautauqua Global Growth Fund

Chautauqua Global Growth Fund will seek long-term capital appreciation. The plan is to create a portfolio of 35-45 mid- and large-cap growth stocks. The fund will be managed by Brian Beitner. Mr. Beitner is employed by Chautaqua Capital Management, a division of R.W. Baird. The initial expense ratio has not been disclosed and the minimum initial investment is $2,500, reduced to $1,000 for various tax-advantaged accounts. The fund will launch in April.

Chautauqua International Growth Fund

Chautauqua International Growth Fund will seek long-term capital appreciation. The plan is to create a portfolio of 25-35 mid- and large-cap growth stocks. The fund will be managed by Brian Beitner. Mr. Beitner is employed by Chautaqua Capital Management, a division of R.W. Baird. The initial expense ratio has not been disclosed and the minimum initial investment is $2,500, reduced to $1,000 for various tax-advantaged accounts. The fund will launch in April.

CMG Tactical All Asset Strategy Fund

CMG Tactical All Asset Strategy Fund will seek capital appreciation. The plan is to use a momentum-based strategy to invest in ETFs targeting alternative asset classes, stocks, bonds and commodities. The fund will be managed by Steven Blumenthal, PJ Grzywacz and Michael Hee, all of CMG Capital Management. The initial expense ratio for the institutional share class will be 1.40% and the minimum initial investment is $15,000.

Fasanara Capital Absolute Return Multi-Asset Fund

Fasanara Capital Absolute Return Multi-Asset Fund will seek positive absolute returns “over a reasonable period of time.” The plan is to stitch together a three-sleeved garment with a Value Sleeve, a Hedging and Cheap Optionality Sleeve and a Tactical Sleeve. Fans of the Hedging and Cheap Optionality Sleeve shouldn’t get too excited, given the caveat that “the specific strategies the Fund pursues and the manner in which the Fund pursues such strategies may change from time to time.” The fund will be managed by Fasanara’s Francesco Filia. The initial expense ratio will be 1.25% and the minimum initial investment is $1,000.

Matthews Asia Credit Opportunities Fund

Matthews Asia Credit Opportunities Fund will seek total return over the long term. The plan is to invest in Asian bonds, convertibles and derivatives. The language in the prospectus implies that this may be the high-yield/distressed-debt version of their Strategic Income fund. The fund will be managed by Teresa Kong and Satya Patel, who also manage Matthews Asia Strategic Income (MAINX). The initial expense ratio will be 1.10% and the minimum initial investment is $2,500, reduced to $500 for various tax-advantaged accounts.

RiverPark Commercial Real Estate Fund

RiverPark Commercial Real Estate Fund will seek to generate current income and capital appreciation consistent with the preservation of capital by investing in debt instruments that are secured, directly or indirectly, by income-producing commercial real estate assets. The plan is to capture their holdings’ monthly income distributions and to trade rarely but opportunistically. As with other RiverPark funds, this is a converted hedge fund. The hedge fund, GSREA CMBS Credit Opportunities, LLC, averaged 7.7% a year from 2010-2014, the last year for which we have data. Even in its worst quarter, the fund still made money. The fund will be managed by Ed Shugrue, who managed the hedge fund and has 25 years of experience as a commercial real estate investor. The initial expense ratio will be 1.25% and the minimum initial investment is $1,000.

Robinson Income Opportunities Fund

Robinson Income Opportunities Fund will seek total return with an emphasis on providing current income. The plan is to play the RiverNorth game: invest in income-producing closed-end funds when you can identify funds selling at unsustainable discounts to the their NAV. If you don’t find attractively-priced CEFs, they’ll default to low-cost ETFs instead. The fund will be managed by James Robinson. The initial expense ratio has not been released but the minimum initial investment is $2,500. There’s a front load, but it’s easy to find load-waived access.

Summit Global Investments Small Cap Low Volatility Fund

Summit Global Investments Small Cap Low Volatility Fund will try to outperform the Russell 2000 with less volatility. The plan is to find solid, growing companies with low volatility stock, then buy them. The fund will be managed by a team led by Summit’s CIO, David Harden. The initial expense ratio will be 1.48% and the minimum initial investment is $2500.

T. Rowe Price Global Consumer Fund

T. Rowe Price Global Consumer Fund will seek long-term growth of capital through investments in the stocks of companies in the consumer sector. That’s pretty much it, except for the note that “global” in the name means “normally 40% or more outside the U.S.” The fund will be managed by Jason Nogueira. The initial expense ratio will be 1.05% and the minimum initial investment is $2,500, reduced to $1,000 for various tax-advantaged accounts.

Touchstone International Growth Fund

Touchstone International Growth Fund will seek long-term capital growth. The plan is not particularly distinguished: top-down, bottom-up, mostly developed markets, mostly growth stocks. The fund will be managed by Nitin N. Kumbhani of Apex Capital Management. The initial expense ratio will be 1.07% and the minimum initial investment is $2,500, reduced to $1,000 for various tax-advantaged accounts and $100 for accounts established with an automatic investment plan.

Tree Ring Stock Fund

Tree Ring Stock Fund (no, I don’t make this stuff up) will seek capital appreciation. The plan is to buy 30 or so undervalued mid- to large-cap stocks. The fund will be managed by Yung Jer (“JJ”) Lin of Tree Ring Capital. Tree Ring seems to be a one-man operation with $5 million in AUM and no website, which means I can’t help explain the “tree ring” thing to you. The initial expense ratio will be 1.5% and the minimum initial investment is $5000.

Value Line Defensive Strategies Fund

Value Line Defensive Strategies Fund will seek capital preservation and positive returns with low volatility regardless of the market’s directions. It will be a fund of alternatives funds and ETFs. The fund will be managed by “[_____], the Chief Investment Officer and portfolio manager of the Adviser.” As far as I can tell, EULAV (why would you choose to name yourself for the opposite or reverse of “value”?) doesn’t currently have a CIO, hence the [ ]. The initial expense ratio will be and the minimum initial investment is $1,000.

Wilshire Income Fund

Wilshire Income Fund will seek to maximize current income. The plan is to invest in a “multi-sector portfolio of income producing securities of varying maturities.” The fund will be managed by a team led by B. Scott Minerd, Global Chief Investment Officer of Guggenheim. Eventually they’ll add a second sub-advisor. The initial expense ratio has not been disclosed and the minimum initial investment is $2,500.

February 1, 2016

Dear friends,

It’s the BOJ’s fault. Or the price of oil’s. Perhaps the Fed. Probably China. Possibly Putin. Likely ISIL (or Assad). Alternately small investors. (ETF.com assures us it’s definitely not the effect of rapid, block-trading of ETFs on the market, though.) It’s all an overreaction or, occasionally, a lagging one. Could be fears of recession or even fears of fears.

We don’t like randomness. That’s why conspiracy theories are so persistent: they offer simple, satisfying explanations for otherwise inexplicable occurrences. We want explanations and, frankly, the financial media are addicted to offering them. The list in that opening paragraph captures just some of the explanations offered by talking heads to explain January’s turbulence. Those same sages have offered prognostications for the year ahead, ranging from a “cataclysmic” 40% decline and advice to “sell everything” to 7-11% gains, the latter from folks who typically foresee 7-11% gains.

As I drove to campus the other day, watching a huge flock of birds take wing and wheel and listening to financial analysis, it occurred to me that these guys had about as much prospect of understanding the market as they do of understanding the birds’ ballet.

Open confession is good for the soul.

I have two confessions.

First, I can’t find the source of the quotation that serves as the title of this essay. I keep hitting a wall as “Scottish proverb,” with no further discussion. All too often that translates to “some hack at The Reader’s Digest in 1934 made it up and added ‘Scottish proverb’ to dignify the insight.”

Second, until I began this essay, I had only the vaguest idea of how my portfolio had done in 2015. I preach a single doctrine: make a good plan, execute the plan, get on with your life.

Make a good plan: My retirement portfolio is largely hostage to Augustana College. As part of a Retirement Plan Redesign task force a few years ago, we discovered that the college’s plan was too complicated (it offered over 800 funds) and too lax (under 30% of our employees contributed anything beyond the college’s 10% contribution).  The research was clear and we followed it: we dramatically reduced the fund of investment choices so that in each asset class folks had one active fund and one passive fund, installed a lifecycle fund as the default option, the college went from a flat contribution to a modestly more generous one based on a matching system, we auto-enrolled everyone in a payroll deduction which started at 4%, and automatically escalated their contributions annually until they reached 10%. It was, of course, possible to opt out but we counted on the same laziness that kept folks from opting in to keep them from opting out.

We were right. Ninety-some percent of employees now contribute to their own retirements, the amount of money sitting in money markets for years is dramatically reduced, the savings rate is at a record and more accounts seem to contain a mix of assets.

Yay for everyone but me! In pursuit of the common good, I helped strip out my own access to the Fidelity and T. Rowe Price funds that were central to my plan. Those funds are now in a “can’t add more” account and continue to do quite well. Both growth funds (Fidelity Growth Discovery, T. Rowe Price Blue Chip Growth) and international small caps (Fidelity Japan Smaller Companies, T. Rowe Price International Discovery) were thriving, while my substantial emerging markets exposure and a small inflation hedge hurt. In these later years of my career at the college, the vast bulk of my retirement contributions are going into a combination of the CREF Stock Account (60% of my portfolio, down 0.9% in 2015, up 10.5% annually over the past three years), TIAA Real Estate Account (25% of my portfolio, up 8% in 2015, up 10% annually over the past three years) and a TIAA-CREF Retirement Income fund (15% of the portfolio, flat in 2015, up 4.5% over three years) for broad-based fixed income exposure.

My non-retirement account starts with a simple asset allocation:

  • 50% growth / 50% income
  • Within growth, 50% domestic equities, 50% foreign
  • Within domestic, 50% smaller companies, 50% larger
  • Within foreign, 50% developed, 50% emerging
  • Within income, 50% conservative, 50% venturesome.

I know that I could optimize the allocation by adjusting the exact levels of exposure to each class, but I don’t need the extra complexity in my life. In most of my funds, the managers have some wiggle room so that they’re not locked into a single narrow asset class. That makes managing the overall asset allocation a bit trickier, but manageable.

The roster of funds, ranked from my largest to smallest positions:

FPA Crescent FPACX

A pure play on active management.  Mr. Romick is willing to go anywhere and frequently does. He’s been making about 6% a year and has done exceptionally well mitigating down markets. The fund lost 2% in 2015, its third loss in 20 years.

T. Rowe Price Spectrum Income RPSIX

A broadly diversified fund of income funds. Low cost, low drama. It’s been making about 4% in a low-rate environment. The fund lost 2% in 2015, its third loss, and its second-worst, in a quarter century.

Artisan International Value ARTKX

A fund that I’ve owned since inception and one of my few equity-only funds. It’s made about 7% a year and its long-term performance is in the top 1% of its peer group. Closed to new investors.

RiverPark Short-Term High Yield RPHYX

An exceedingly conservative cash-substitute for me. I’m counting on it to beat pure cash by 2-3% a year, which it has regularly managed. Up about 1% in 2015. Closed to new investors.

Seafarer Overseas Growth & Income SFGIX

An outstanding EM equity fund that splits its exposure between pure EM stocks and firms domiciled in developed markets but serving emerging ones. Up about 10% since launch while its peers are down 18%. Down 4% in 2015 while its peers were down 14%.

Artisan Small Cap Value ARTVX

(sigh) More below.

Matthews Asian Growth & Income MACSX

Traditionally one of the least volatile ways to invest in the world’s most dynamic economies. I started here when Mr. Foster, Seafarer’s manager, ran the fund. When he launched Seafarer, I placed half of my MACSX position in his new fund. MACSX has continued to be a top-tier performer but might fall victim to a simplification drive.

RiverPark Strategic Income RSIVX

Mr. Sherman, the RPHYX manager, positions this as “one step out the risk-return spectrum” from his flagship fund. His expectation was to about double RPHYX’s return. He was well on his way to do exactly that until three bad investments and some market headwinds derailed performance over the past six months. Concern is warranted.

Matthews Asian Strategic Income MAINX

The argument here is compelling: the center of the financial universe is shifting to Asia but most investors haven’t caught up with that transition. Matthews is the best Asia-centered firm available in the US retail market and Ms. Kong, the manager, is one of their brightest stars. The fund made a lot of money in its first year but has pretty much broken even over the next three. Sadly, there’s no clear benchmark to help answer the question, “is that great or gross?”

Grandeur Peak Global Reach GPROX

The flagship fund for Grandeur Peak, a firm specializing in global small and microcap growth investing.  The research is pretty clear that this is about the only place where active managers have a persistent edge, and none have had greater success than G.P. The fund was up 8% in 2014 and down 0.6% in 2015, outstanding and respectable performances, respectively.

Northern Global Tactical Asset Allocation BBALX

Northern aspires to be a true global hybrid fund offering low-cost access to global stocks, bonds and alternatives. It looks terrible benchmarked against its US-centered peers but I’m not sure that’s an argument against it.

Grandeur Peak Global Microcap GPMCX

This was simply too intriguing to pass up: G.P. wanted  a tiny fund to invest in the world’s tiniest companies, potentially explosive firms that would need to grow a lot even to become microcaps. It was open by subscription only to current GP shareholders and hard-closed at $27.5 million even before it opened.

ASTON/River Road Long Short ARLSX

This is a very small position, started mostly because I like the guys’ clear thinking and disciplined approach. Having even a small amount in a fund lends me to pay more attention to it, which was the goal. Other than for 2014, it typically finishes in the top third of L/S funds.

Execute the plan. So what did I do in 2015? Added Grandeur Peak Global Microcap and set up a monthly auto-invest. I also (finally!) transferred my Seafarer holdings from Scottrade directly to Seafarer where I took advantage of their offer to make lower-cost institutional shares available to retail investors who met the retail minimum and established an auto-investing plan. Otherwise, it was mostly stay the course and invest monthly.

What’s up for 2016? Artisan Small Cap Value is on the chopping block. Assets in the fund are down nearly 90% from peak, reflecting year after wretched year of underperformance. This is one of my oldest holdings, I’ve owned it since the late 1990s and have substantial embedded capital gains. Three issues are pushing me toward the door:

  1. The managers seem to have fallen into a value trap. Their discipline is explicitly designed to avoid “value traps,” but their dogged commitments to energy and industrials seem to have ensnared them.
  2. They don’t seem to be able to get out. Perhaps I’m jaundiced, but their shareholder communications haven’t been inspiring. The theme is “we’re not going to change our discipline just because it’s not working right now.” My fear is that “disciplined” transitions too easily into “bunkered down.” I experienced something similar with Ron Muhlenkamp of Muhlenkamp Fund (MUHLX), which was brilliant for 15 years then rigidly rotten for a decade. Mr. Muhlenkamp’s mantra was “we’re not sacrificing our long-term discipline for short-term gains” which sounded grand and worked poorly. I know of few instances where once-great funds rebound from several consecutive years in the basement. The question was examined closely by Leigh Walzer of Trapezoid in his December 2015 essay, When Good Managers Go Bad.
  3. Lead manager Scott Satterwhite is retiring in October. The transition has been underway for a long while now but (a) it’s still epochal and (b) performance during the transition has not been noticeable better.

I may surrender to Ed’s desire to have me simplify my portfolio. (Does he simplify his? No, not so far as I can tell.) That might mean moving the MACSX money into Seafarer. Maybe closing out a couple smaller holdings because they’re not financially consequential. My asset allocation is a bit overweight in international stocks right now, so I’m probably going to move some into domestic smaller caps. (Yes, I know. I’ve read the asset class projections but my time horizon is still longer than five to seven years.) And making some progress in debt reduction (I took out a home equity loan to handle some fairly-pressing repairs) would be prudent.

Get on with life. I’m planning on resuming my War on Lawns this spring. I’m having a Davenport firm design a rain garden, an area designed to slow the rush of water off my property during storms, for me and I’ll spend some weeks installing it. I’ll add a bunch of native plants, mostly pollinator-friendly, to another corner once overrun by lawn. Together, I think they’ll make my space a bit more sustainable. Baseball season (which my son interprets as “I need expensive new stuff” season) impends. I really need to focus on strengthening MFO’s infrastructure, now that more people are depending on it. And my academic department continues to ask, “how can we change our teaching to help raise diverse, first-generation college students to that same level of achievement that we’ve traditionally expected?” That’s exhausting but exciting because I think, done right, we can make a huge difference in the lives of lots of bright kids who’ve been poorly served in some of their high schools. As a kid whose parents never had the opportunity to finish high school (World War Two interrupted their teen years), my faith in the transformative power of teaching remains undimmed.

It’ll be a good year.

Emerging markets: About as cheap as it gets

In the course of our conversation about Leuthold Core Investment (LCORX), Doug Ramsay shared the observation that emerging markets stocks are painfully cheap. Leuthold’s chart, below, shows the price/earnings ratio based on five-year normalized earnings for E.M. stocks from 2004 to now. Valuations briefly touched a p/e of 31 in 2007 then fell to 8 within a year. As we end January 2016, prices for E.M. stocks hover within a point of their market-crisis lows.

emerging markets

And still Leuthold’s not investing in them. Their E.M. exposure in Core and Global (GLBLX) are both near all-time lows because their analytics don’t (yet) show signs of a turnaround. Still, Mr. Ramsay notes, “they look impossibly cheap.”

Investing in five-star funds? It’s not as daft as you’d think

We asked the good folks at Morningstar if they’d generate a list of all five-star funds from ten years ago, then update their star ratings from five years ago and today. I’d first seen this data several years ago when it had been requested by a Wall Street Journal reporter and shared with us. The common interpretation is “it’s not worth it, since five-star funds aren’t likely to remain five-star funds.”

I’ve always thought that was the wrong concern. Really, I’m less concerned about whether my brilliant manager remains absolutely brilliant than whether he turns wretched. Frankly, if my funds kept bouncing between “reasonable,” “pretty good” and “really good,” I’d be thrilled. That is, if they stay in the three- to five-star range over time, that’s perfectly respectable.

Chip took the data and converted it into a pivot table. (Up until then, I thought “pivot table” was just another name for a “lazy Susan.” Turns out it’s actually a data visualization tool. Who knew?)

5_stars

Here’s how to read it. There were 354 five-star funds in 2005. Of those, only 16 fell to one-star by 2010. You can see that in the top-center box. Of those 16 one-star funds, none rebounded to five stars by 2015 and only two made it back to four stars. On the upside, 187 of the original 354 remained four- or five-star funds across the whole time period and 245 of 354 never dropped below three stars.

We clearly need to do some refinement of the data to see whether a few categories are highly resilient (for example, single-state muni bond funds might never change their star ratings) and, thus, skewing the results. On whole, though, it seems clear that “first to worst” is a pretty low probability outcome and “first to kinda regrettable” isn’t hugely more likely.

The original spreadsheet is in the Commentary section at MFO Premium, for what interest that holds.

edward, ex cathedraThis Time It Really Is Different!

“Every revolution evaporates and leaves behind only the slime of a new bureaucracy.”

 Kafka

So, time now for something of a follow-up to my suggestion of a year ago that a family unit should own no more than ten mutual funds. As some will recall, I was instructed by “She Who Must Be Obeyed” to follow my own advice and get our own number of fund investments down from the more than twenty-five where it had been. We are now down to sixteen, which includes money market funds. My first observation would be that this is not as easy to do as I thought it would be, especially when you are starting from something of an ark approach (one of these, two of those). It is far easier to do when you start to build your portfolio from scratch, when you can be ruthless about diversification. That is, you don’t really need two large cap growth or four value funds. You may only add a new fund if you get rid of an old fund. You are quite specific about setting out the reasons for investing in a fund, and you are equally disciplined about getting rid of it when the reasons for owning it change, e.g. asset bloat, change in managers, style drift, no fund managers who are in Boston, etc., etc.

Which brings me to a point that I think will be controversial – for most families, mutual fund ownership should be concentrated in tax-exempt (retirement accounts) if taxes matter. And mutual fund ownership in retirement accounts should emphasize passive investments to maximize the effects of lower fees on compounding. It also lessens the likelihood of an active manager shooting himself or herself in the foot by selling the wrong thing at the wrong time because of a need to meet redemptions, or dare I suggest it, panic or depression overwhelm the manager’s common sense in maintaining an investment position (which often hits short seller specialists more than long only investors, but that is another story for another day).

The reasons for this will become clearer as holdings come out for 12/31 and 3/31, as well as asset levels (which will let you know what redemptions are – the rumor is that they are large). It will also become pretty clear as you look at your tax forms from your taxable fund accounts and are wondering where the money will come from to pay the capital gains that were triggered by the manager’s need to raise funds (actually they probably didn’t need to sell to meet redemptions as they all have bank lines of credit in place to cover those periods when redemptions exceed cash on hand, but …..).

The other thing to keep in mind about index funds that are widely diversified (a total market fund for instance) – yes, it will lag on the upside against a concentrated fund that does well. But it will also do better on the downside than a concentrated fund that does not do well. Look at it this way – a fifty stock portfolio that has a number of three and four per cent positions, especially in the energy or energy services sector this past year, that has seen those decline by 50% or more, has a lot of ground to make up. A total stock market portfolio that has a thousand or more positions – one or two or twenty or thirty bad stocks, do not cripple it. And in retirement accounts, it is the compounding effect that you want. The other issue of course is that the index funds will stay fully invested in the indices, rather than be caught out underinvested because they were trying to balance out exiting positions with adding positions with meeting redemptions. The one exception here would be for funds where the inefficiencies of an asset class can lead to a positive sustainable alpha by a good active manager – look for that manager as one to invest with in either taxable or tax-exempt accounts.

China, China, China, All the Time

In both the financial print press and the financial media on television and cable, much of the “blame” for market volatility is attributed to nervousness about the Chinese economy, the Chinese stock market, in fact everything to do with China. There generally appear to be two sorts of stories about China these days. One recurring theme is that they are novices at capital markets, currencies, as well as dealing with volatility and transparency in their markets, and that this has exacerbated trends in the swings in the Shanghai market, which has spread to other emerging markets. Another element of this particular them is that China’s economy is slowing and was not transparent to begin with, and that lack of growth will flow through and send the rest of the world into recession. Now, mind you, we are talking about economic growth that by most accounts, has slowed from high single digits recently (above 7%) to what will be a range going forward of low to still mid-single digits (4 – 7%).

I think a couple of comments are in order about this first theme. One, the Shanghai market has very much been intended as a punter’s market, where not necessarily the best companies are listed (somewhat like Vancouver in Canada twenty-odd years ago). The best companies in China are listed on the Hong Kong market – always have been, and will continue to be for the foreseeable future. The second thing to be said is that if you think things happen in China by accident or because they have lost control, you don’t understand very much about China and its thousands of years of history. Let’s be realistic here – the currency is controlled, interest rates are controlled, the companies are controlled, the economy is controlled – so while there may be random events and undercurrents going on, they are probably not the ones we are seeing or are worried about.

This brings me to the second different theme you hear about China these days, which is that China and the Chinese economy have carried the global economy for the last several years, and that even last year, their contribution to the world economy was quite substantial. I realize this runs counter to stories that you hear emanating from Washington, DC these days, but much that you hear emanating from Washington now is quite surreal. But let’s look at a few things. China still has $3 trillion dollars of foreign exchange reserves. China does not look to be a debtor nation. China has really not a lot of places left to spend money domestically since they have a modern transportation infrastructure and, they have built lots of ghost cities that could be occupied by a still growing population. And while China has goods that are manufactured that they would like to export, the rest of the world is not in a buying mood. A rumor which I keep hearing, is that they have more than 30,000 metric tons of gold reserves with which to back their currency, should they so choose (by comparison, the US as of October 2014 was thought to have about 4,200 metric tons in Fort Knox).

For those familiar with magic shows and sleight of hand tricks, I think this is what we are seeing now. Those who watch the cable financial news shows come away with the impression that the world is ending in the Chinese equity markets, and that will cause the rest of the world to end as well. So while you are watching that, let’s see what you are missing. We have a currency that has become a second reserve currency to the world, supplanting the exclusive role of the U.S. dollar as countries that are commodity economies now price their commodities and do trade deals in Chinese currency. And, notwithstanding that, the prices of commodities have fallen considerably, we continue to see acquisition and investment in the securing of commodities (at fire sale prices) by China. And finally, we have a major expansion by China in Africa, where it is securing arable land to provide another bread basket for itself for the future, as well as an area to send parts of it population.

And let me suggest in passing that the one place China could elect to spend massively in their domestic economy is to build up their defense establishment far beyond what they have done to date. After all, President Reagan launched a massive arms build-up by the US during his terms in office, which in effect bankrupted the Soviets as they tried to keep up. One wonders whether we would or could try to keep up should China elect to do the same to us at this point.

So, dear readers, I will leave it to you to figure out which theme you prefer, although I suspect it depends on your time horizon. But let me emphasize again – looking at the equity markets in China means looking at the wrong things. By the end of this year, we should have a better sense of whether the industrial economy is China has undergone a rather strong recovery, driven by the wealth of a growing middle class (which is really quite entrepreneurial, and which to put it into context, should be approaching by the end of this year, 400M in size). And it will really also become clear that much of the capital that has been rumored to be “fleeing” China has to be split out to account for that which is investment in other parts of the world. Paying attention to those investment outflows will give you some insight as to why China still thinks of and refers to itself as, “The Middle Kingdom.”

— by Edward A. Studzinski

Looking for Bartolo Colon

by Leigh Walzer

Bartolo Colon is a baseball pitcher; he is the second oldest active major leaguer.  Ten years ago he won the coveted Cy Young award. Probably no investment firm has asked Colon for an endorsement but maybe they should. More on this shortly.

FROM THE MAILBAG:

A reader in Detroit who registered but has not yet logged into www.Fundattribution.com  writes: “We find little use for back tested or algorithmic results [and prefer an] index-based philosophy for clients.” 

Index funds offer a great approach for anyone who lacks the time or inclination to do their homework. We expect they will continue to gain share and pressure the fees of active managers.

Trapezoid does not advocate algorithmic strategies, as the term is commonly used. Nor do we oppose them. Rather, we rigorously test portfolio managers for skill. Our “null hypothesis” is that a low-cost passive strategy is best. We look for managers which demonstrate their worth, based on skill demonstrated over a sufficient period of time. Specifically, Honor Roll fund classes must have a 60% chance of justifying their expenses. Less than 10% of the fund universe satisfies this test.  Trapezoid does rate some quantitative funds, and we wrote in the November edition of Mutual Fund Observer about some of the challenges of evaluating them.

We do rely on quantitative methods, including back testing, to validate our tests and hone our understanding of how historic skill translates into future success.

VULCAN MIND MELD

A wealth manager (and demo client) from Denver asks our view of his favorite funds, Vulcan Value Partners (VVPLX). Vulcan was incepted December 2009.Prior to founding Vulcan, the manager, C.T. Fitzpatrick, worked for many years at Southeastern under famed value investor O. Mason Hawkins.  Currently it is closed to new investors.

Should investors abandon all their confidence when a good manager retires and passes the baton? Should investors give the fund a mulligan when a poor performer is replaced? Probably not.

VVPLX has performed very well in its 6 years of history. By our measure, investors accumulated an extra 20% compared to index funds based on the managers’ stock selection skill alone. We mentioned it favorably in the October edition of MFO.

Vulcan’s expense structure is 1.08%, roughly 90bps higher than an investor would require to hold a comparable ETF. Think of that as the expense premium to hire an active manager. Based on data through October, we assigned VVPLX a 55% probability of justifying its active expense premium. (This is down from 68% based on our prior evaluation using data through July 2015 and places them outside the Honor Roll.)

The wealth manager questioned why we classify VVPLX as large blend?  Vulcan describes itself as a value manager and the portfolio is heavily weighted toward financial services.

VVPLX is classified as large blend because, over its history, it has behaved slightly more like the large blend aggregate than large value. We base this on comparisons to indices and active funds. One of our upcoming features identifies the peer funds, both active and passive, which most closely resemble a given fund. For a majority of our funds, we supplement this approach by looking at historic holdings. We currently consider factors like the distribution of forward P/E ratios over time. Our categorization and taxonomy do not always conform to services like Morningstar and Lipper, but we do consider them as a starting point, along with the manager’s stated objective.  We frequently change classifications and welcome all input. While categories may be useful in screening for managers, we emphasize that the classifications have no impact on skill ratings, since we rely 100% on objective criteria such as passive indices.

The client noted we identified a few managers following similar strategies to VVPLX who were assigned higher probabilities. How is this possible considering VVPLX trounced them over its six-year history?

Broadly speaking, there are three reasons:

  • Some of the active managers who beat out VVPLX had slightly lower expenses.
  • While VVPLX did very well since 2010, some other funds have proven themselves over much longer periods. We have more data to satisfy ourselves (and our algorithms) that the manager was skillful and not just lucky. 
  • VVPLX’s stock selection skill was not entirely consistent which also hurts its case. From April to October, the fund recorded negative skill of approximately 4%. This perhaps explain why management felt compelled to close the fund 4/22/15.

Exhibit I

    Mgr. Tenure   sS*   sR* Proj.  Skill (Gross) Exp.   ∆   ± Prob.  
Boston Partners All-Cap Value Fund [c] BPAIX 2005   1.4%   0.3% 0.88% 0.80%(b)   23   1.5% 56.1
Vulcan Value Partners Fund VVPLX 2010   3.8%   1.5% 1.19% 1.08%  .25   1.8% 55.2
  1. Annualized contribution from stock selection or sector rotation over manager tenure
  2. Expenses increased recently by 10bps as BPAIX’s board curtailed the fee waiver
  3. Closed to new investors

Exhibit II: Boston Partners All-Cap Value Fund

exhibit ii

Exhibit I compares VVPLX to Boston Partners All-Cap Value Fund. BPAIX is on the cusp of value and blend, much like VVPLX. Our model sees a 56.1% chance that the fund’s skill over the next 12 months will justify its expense structure. According to John Forelli, Senior Portfolio Analyst, the managers screen from a broader universe using their own value metrics. They combine this with in-depth fundamental analysis. As a result, they are overweight sectors like international, financials, and pharma relative to the Russell 3000 (their avowed benchmark.) Boston Partners separately manages approximately $10 billion of institutional accounts which closely tracks BPAIX.

Any reader with the www.fundattribution.com demo can pull up the Fund Analysis for VVPLX.  The chart for BPAIX is not available on the demo (because it is categorized in Large Value) so we present it in Exhibit II.  Exhibit III presents a more traditional attribution against the Russell 3000 Value Fund. Both exhibits suggest Boston Partners are great stock pickers. However, we attribute much less skill to Allocation because our “Baseline Return” construes they are not a dyed-in-the-wool value fund.

VVPLX has shown even more skill over the manager’s tenure than BPAIX and is expected to have more skill next year[1]. But even if VVPLX were open, we would prefer BPAIX due to a combination of cost and longer history. (BPAIX investors should keep an eye on expenses: the trustees recently reduced the fee waiver by 10bps and may move further next year.)

Trapezoid has identified funds which are more attractive than either of these funds. The Trapezoid Honor Roll consists of funds with at least 60% confidence. The methodology behind these findings is summarized at here.

[1] 12 months ending November 2016.

VETERAN BENEFITS

Our review of VVPLX raises a broader question. Investors often have to choose between a fund which posted stellar returns for a short period against another whose performance was merely above average over a longer period.

niese and colonFor those of you who watched the World Series a few months ago, the NY Mets had a number of very young pitchers with fastballs close to 100 miles per hour.  They also had some veteran pitchers like John Niese and the 42-year-old ageless wonder Bartolo Colon who couldn’t muster the same heat but had established their skill and consistency over a long period of time. We don’t know whether Bartolo Colon drank from the fountain of youth; he served a lengthy suspension a few years ago for using a banned substance. But his statistics in his 40s are on par with his prime ten year ago.  

exhibit iii

Unfortunately, for every Bartolo Colon, there is a Dontrelle Willis. Willis was 2003 NL Rookie of the year for the Florida Marlins and helped his team to a World Series victory. He was less effective his second year but by his third year was runner up for the Cy Young award. The “D-Train” spent 6 more years in the major leagues; although his career was relatively free of injuries, he never performed at the same level.

Extrapolating from a few years of success can be challenging. If consistency is so important to investors, does it follow that a baseball team should choose the consistent veterans over the promising but less-tested young arms?

Sometimes there is a tradeoff between expected outcome (∆) and certitude (±).  The crafty veteran capable of keeping your team in the game for five innings may not be best choice in the seventh game of the World Series; but he might be the judicious choice for a general manager trying to stretch his personnel budget. The same is true for investment managers. Vulcan may have the more skillful management team. But considering its longevity, consistency, and expense Boston Partners is the surer bet.

HOW MUCH IS ENOUGH

How long a track record is needed before an investor can bet confident in a portfolio manager? This is not an easy question to answer.

Skill, even when measured properly, is best evaluated over a long period.

In the December edition of MFO (When_Good_Managers_Go_Bad) we profiled the Clearbridge Aggressive Growth fund which rode one thesis successfully for 20 years. Six years of data might tell us less about them than a very active fund.   

Here is one stab at answering the question.  We reviewed the database to see what percentage of fund made the Trapezoid Honor Roll as a function of manager tenure. 

exhibit ivRecall the Trapezoid Honor Roll consists of fund classes for which we have 60% confidence that future skill will justify expense structure.  In Exhibit IV the Honor Roll fund classes are shown in blue while the funds we want no part of are in yellow.  16% of those fund classes where the manager has been on the job for twenty-five years make the Honor Roll compared with just 2% for those on the job less than three years.  The relationship is not a smooth line, but generally managers with more longevity give us more data points allowing us to be more confident of their skill.. or more likely persuade us they lack sufficient skill. 

There is an element of “survivorship” bias in this analysis. Every year 6% of funds disappear; generally, they are the smallest or worst performers. “All-stars” managers are more likely to survive for 20 years. But surprisingly a lot of “bad” managers survive for a long time. The percentage of yellow funds increases just as quickly as the blue.

exhibit vIt seems reasonable to ask why so many “bad” managers survive in a Darwinian business. We surveyed the top 10. (Exhibit V) We find that in the aggregate they have a modicum of skill, but nowhere sufficient to justify what they charge.  We can say with high confidence all these investors would be better off in index funds or (ideally) the active managers on the Trapezoid honor roll.

exhibit vi'We haven’t distinguished between a new manager who takes over an old fund and a brand new fund. Should investors abandon all their confidence when a good manager retires and passes the baton? Should investors give the fund a mulligan when a poor performer is replaced?  Probably not.  From a review of 840 manager changes with sufficient data (Exhibit VI), strong performers tend to remain strong which suggests we may gain confidence by considering the track record of the previous manager.

The “rookie confidence” problem is a challenge for investors. The average manager tenure is about six years and only a quarter of portfolio managers have been on the job longer than 10 years. It is also a challenge for asset managers marketing a new fund or a new manager of an existing fund.  Without a long track record, it is hard to tell if a fund is good – investors have every incentive to stick with the cheaper index fund.  Asset managers incubate funds to give investors a track record but studies suggest investors shouldn’t take much comfort from incubated track records. (Richard Evans, CFA Digest, 2010.) We see many sponsors aggressively waiving fees for their younger funds.  Investors will take comfort when the individuals have a prior track record at another successful fund.  C.T. Fitzpatrick’s seventeen years’ experience under Mason Hawkins seems to have carried over to Vulcan.

BOTTOM LINE:  It is hard to gain complete trust that any active fund is better than an index fund. It is harder when a new captain takes the helm, and harder yet for a brand new fund. The fund with the best five-year record is not necessarily the best choice. Veteran managers are over represented in the Trapezoid Honor Roll — for good reason.

Unlike investing, baseball will always have rookies taking jobs from the veterans. But in 2016 we can still root for Bartolo Colon.

Slogo 2What’s the Trapezoid story? Leigh Walzer has over 25 years of experience in the investment management industry as a portfolio manager and investment analyst. He’s worked with and for some frighteningly good folks. He holds an A.B. in Statistics from Princeton University and an M.B.A. from Harvard University. Leigh is the CEO and founder of Trapezoid, LLC, as well as the creator of the Orthogonal Attribution Engine. The Orthogonal Attribution Engine isolates the skill delivered by fund managers in excess of what is available through investable passive alternatives and other indices. The system aspires to, and already shows encouraging signs of, a fair degree of predictive validity.

The stuff Leigh shares here reflects the richness of the analytics available on his site and through Trapezoid’s services. If you’re an independent RIA or an individual investor who need serious data to make serious decisions, Leigh offers something no one else comes close to. More complete information can be found at www.fundattribution.com. MFO readers can sign up for a free demo.

Why are investors so bad at picking alternatives?

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

Gateway (GATEX) is the $8 billion behemoth of the long-short equity mutual fund category, and one of the biggest alternative mutual funds. I’ve long marveled at this fund’s size given its demonstrable lack of merit as a portfolio diversifier. Over the past 10 years the fund has behaved like an overpriced, underperforming 40% stock, 60% cash portfolio. Its R-squared over this period to the U.S. stock market index is 0.85.

Not only is its past performance damning, but little in the substance of the strategy suggests performance will radically change. Gateway owns a basket of stocks designed to track the S&P 500, with a slight dividend tilt. On this portfolio the managers sell calls on the S&P 500, capping the potential upside of the fund in exchange for a premium up front, and simultaneously buy puts, capping the potential downside of the fund at the cost of a premium up front. By implementing this “collar” strategy, the managers protect the portfolio from extreme ups and downs.

There is another way to soften volatility: Own less equities and more cash—which is pretty much what this fund achieves in a roundabout manner.

Portfolio theory says that an investment is only attractive to the extent that it improves the risk-adjusted return of a portfolio. That means three things matter for each asset: expected return, expected volatility, and expected correlation with other assets in the portfolio. The first two are intuitive, but many investors neglect the correlation piece. A low return, high volatility asset can be an excellent investment if it has a low enough correlation with the rest of the portfolio.

Consider an asset that’s expected to return 0% with stock-like volatility and a perfectly negative correlation to the stock market (meaning it moves in the opposite direction of the market without fail). Many investors, looking at the asset’s standalone returns and volatility, would be turned off. Someone fluent in portfolio theory would salivate. Assume the expected excess return of the stock market is 5%. If you own the stock market and the negatively correlated asset in equal measure, the portfolio’s expected excess return halves to 2.5% and its expected volatility drops to 0%. Apply some leverage to double the portfolio’s return and you end up with a 5% expected excess return with no volatility.

In practice, many investors do not assess assets from the portfolio perspective. They fixate on standalone return and volatility. Much of the time this is a harmless simplification. But it can go wrong when assessing alternatives, such as with Gateway. Judged by its Sharpe ratio and other risk-adjusted measures, Gateway looks like a reasonable investment. Judged by its ability to enhance a portfolio’s risk-adjusted return, it falls flat.

I don’t believe individual investors are responsible for Gateway’s size. If anything, institutional investors (particularly RIAs) are to blame. You would think that supposedly sophisticated investors would not fall into this trap. But they do. A large part of the blame belongs to committee-driven investment processes, which dominate institutional money management. When a committee is responsible for a portfolio, they often hire consultants. These consultants in turn promise to help members of the committee avoid getting fired or sued.

In this context, the consultants like to create model portfolios that have predefined allocations to investment types—X% in large growth, Y% in small-cap value, Z% in long-short equity, and so on—and then find suitable managers within those categories. When picking those managers, they tend to focus on return and volatility as well as performance relative to peers. If not done carefully, a fund like Gateway gets chosen, despite its utter lack of diversifying power.

SamLeeSam Lee and Severian Asset Management

Sam is the founder of Severian Asset Management, Chicago. He is also former Morningstar analyst and editor of their ETF Investor newsletter. Sam has been celebrated as one of the country’s best financial writers (Morgan Housel: “Really smart takes on ETFs, with an occasional killer piece about general investment wisdom”) and as Morningstar’s best analyst and one of their best writers (John Coumarianos: “ Lee has written two excellent pieces [in the span of a month], and his showing himself to be Morningstar’s finest analyst”). He has been quoted by The Wall Street Journal, Financial Times, Financial Advisor, MarketWatch, Barron’s, and other financial publications.  

Severian works with high net-worth partners, but very selectively. “We are organized to minimize conflicts of interest; our only business is providing investment advice and our only source of income is our client fees. We deal with a select clientele we like and admire. Because of our unusual mode of operation, we work hard to figure out whether a potential client, like you, is a mutual fit. The adviser-client relationship we want demands a high level of mutual admiration and trust. We would never want to go into business with someone just for his money, just as we would never marry someone for money—the heartache isn’t worth it.” Sam works from an understanding of his partners’ needs to craft a series of recommendations that might range from the need for better cybersecurity or lower-rate credit cards to portfolio reconstruction. 

 

Smallest, Shortest, Lowest

charles balconyDavid invariably cuts to the chase when it comes to assessing mutual funds. It’s a gift he shares with us each month.

So, in evolving the MFO Premium site, he suggested we provide lists of funds satisfying interesting screening criteria to help users get the most from our search tools.

Last month we introduced two such lists: “Best Performing Rookie Funds” and “Dual Great Owl & Honor Roll Funds.”

This month our MultiSearch screener incorporates three more: “Smallest Drawdown Fixed Income Funds,” “Shortest Recovery Time Small Caps,” and “Lowest Ulcer Moderate Allocation Funds.”

Smallest Drawdown Fixed Income Funds generates a list of Fixed Income (e.g., Bond, Muni) funds that have experienced the smallest levels of Maximum Drawdown (MAXDD) in their respective categories. More specifically, they are in the quintile of funds with smallest MAXDD among their peers.

Looking back at performance since the November 2007, which represents the beginning of the current full market cycle, we find 147 such funds. Two top performing core bond funds are TCW Core Fixed-Income (TGCFX) and RidgeWorth Seix Total Return (SAMFX). The screen also uncovered notables like First Pacific Advisors’ FPA New Income (FPNIX) and Dan Ivascyn’s PIMCO Income (PIMIX).

Here are some risk/return metrics for these Fixed Income funds (click on images to enlarge):

TCW Core Fixed-Income (TGCFX) and RidgeWorth Seix Total Return (SAMFX)
sls_1
First Pacific Advisors’ FPA New Income (FPNIX)
fpnix
PIMCO Income (PIMIX)
pimix_1
pimix_2

Shortest Recovery Time Small Caps generates a list of Small Cap (Small Core, Small Value, Small Growth) funds that have incurred shortest Recovery Times (number of months a fund retracts from previous peak) in their respective categories.

For Full Cycle 5, this screen produces 62 such funds through December 2015. Among the best performing funds with shortest Recovery Times, under 30 months, only one remains open and/or accessible: Queens Road Small Cap Value (QRSVX). It was profiled by David in April 2015.

Here’s a short list and risk/return numbers for QRSVX across various timeframes:
sls_2

Queens Road Small Cap Value (QRSVX)

qrsvx
Lowest Ulcer Moderate Allocation Funds
 generates a list of Mixed Asset Moderate Allocation funds that have incurred the lowest Ulcer Indices in their respective categories. 

Topping the list (fund with lowest UI) is James Balanced: Golden Rainbow (GLRBX), profiled last August :
sls_3

The Alt Perspective: Commentary and news from DailyAlts.

dailyaltsWe can all be thankful that January 2016 is over. I am at a point in my life where I don’t really enjoy rollercoaster rides, of any sort, as much as I did when I was younger. And this past month has been nothing short of a financial rollercoaster. In many ways, however, it shouldn’t have been a surprise that investors decided to take some air out of the balloon.

In a grand experiment, the central banks around the world have been pumping hot air into the global market balloon since November 2008. But the U.S. Fed officially took its foot off the gas pedal and applied a bit of light pressure to the brakes with its scant rate rise in December. And on top of that, China’s slowdown has raised concerns of contagion, and its equity markets have taken the brunt of that concern.

With all of the re-adjustments of market expectations and valuations currently taking place, 2016 may turn out to be quite a good year to be invested in alternatives.

Performance Review

Let’s start with traditional asset classes for the month of January 2015, where the average mutual fund for all of the major equity markets (per Morningstar) delivered negative performance in the month:

  • Large Blend U.S. Equity: -6.95%
  • Small Blend U.S. Equity: -9.18%
  • Foreign Equity Large Blend: -7.32%
  • Diversified Emerging Markets: -6.46%
  • Intermediate Term Bond: 0.94%
  • World Bond: -0.03%
  • Moderate Allocation: -4.36%

Now a look at the liquid alternative categories, per Morningstar’s classification. Only Managed Futures and Bear Market funds generated positive returns in January, as one would expect. Long/Short Equity was down more than expected, but with small cap stocks being down just over 9%, it is not a surprise. Multi-alternative funds held up well, as did market neutral funds.

  • Long/Short Equity: -4.18%
  • Non-Traditional Bonds: -1.15%
  • Managed Futures: 2.34%
  • Market Neutral: -0.22%
  • Multi-Alternative: -1.65%
  • Bear Market: 11.92%

And a few non-traditional asset classes, where none escaped January’s downdraft:

  • Commodities: -3.01%
  • Multi-Currency: -0.49%
  • Real Estate: -5.16%
  • Master Limited Partnerships: -9.77%

Overall, a mixed bag for January.

Asset Flows

One of the more surprising aspects of 2015 was the concentration of asset flows into multi-alternative funds and managed futures funds. All other categories of funds, except for volatility funds, experienced outflows over the full twelve months of 2015, as documented in the below chart:

asset flows

And despite the massive outflows from non-traditional bonds, the category remains the largest with more than $135 billion in assets. This compares to commodities at $67 billion and multi-alternative at $56 billion.

Hot Topics

Only six new liquid alternative funds were launched in January – four were long/short equity funds, one was a managed futures fund and the sixth was a non-traditional bond fund. Of the six funds, two were ETFs, and fairly innovative ETFs at that. We wrote about their structure in an article titled, Reality Shares Builds Suite of Dividend-Themed ETFs.

On the research front, we published summaries of two important research papers in January, both of which have been popular with readers:

If you would like to keep up with all the news from DailyAlts, feel free to sign up for our daily or weekly newsletter.

I’ll be back next month, and until then, let’s hope the rollercoaster ride that started in January has come to an end.

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.

Cognios Market Neutral Large Cap (COGMX): this tiny fund does what its category is supposed to do, but never has. It makes good money even when the market stinks.

Leuthold Core Investment (LCORX): We celebrate the 20th anniversary of Leuthold Core, a singularly disciplined and adaptive fund. Just one more year and it will be old enough to drink! We’re hopeful that the markets don’t give it, or us, reason to.

RiverNorth Opportunities (RIV): This is the closed-end fund for serious investors who know there’s a lot of money to be made in the irrational pricing of closed-end funds, but who don’t have the time or expertise to construct such a portfolio on their own.

Launch Alert: Davenport Balanced Income (DBALX)

Most folks haven’t heard of the Davenport Funds, which is understandable but also too bad. Davenport & Company is an employee-owned investment adviser that’s headquartered in Richmond, VA. They’ve been around since 1863 and now “custodies more than $20 billion in assets.” They manage five no-load funds, all somewhere in the solid-to-excellent range. Their newest fund, Davenport Balanced Income, launched on December 30, 2015.

Three things worth knowing:

  1. The equity portion of the portfolio mirrors the holdings of the Davenport Value and Income Fund (DVIPX). All Davenport funds target firms with exceptionally high levels of insider equity ownership. Value & Income, in particular, targets three investment themes: Dividend Aristocrats, High Yielders with Capital Appreciation Potential and deep-value Contrarian/Special Situations.
  2. Value and Income has performed exceedingly well. The fund just celebrated its fifth anniversary. Morningstar places it in the top 4% of all large value funds since inception. Perhaps more importantly, it significantly outperformed its peers in 2015 and again in 2016’s choppy first month. Since inception, its returns have been about a third higher than its equity income peers while all measures of its volatility have been lower. Based on the conventional measures of risk-adjusted return (Sharpe, Martin and Sortino ratios or Ulcer Index), it’s a Top 20 equity income fund.
  3. The equity allocation is fluid, ranging from 25 to 75% of assets. The balance between the two sleeves is determined by the managers’ analysis of “economic trends, changes in the shape of the yield curve and sector analysis.” The income portion of the portfolio is invested for stability rather than appreciation.

John Ackerly, one of Davenport’s directors, claims they have “a long history of developing funds that manage downside risk and produce positive returns … over full market cycles.” The equity portion of the fund is managed by Davenport’s Investment Policy Committee; the fixed-income portion by two of the guys who manage their fixed-income separate accounts. Their managers have, on average, 30 years of experience. Expenses are capped at 1.25%. The minimum initial investment is $5,000 for regular accounts and $2,000 for tax-advantaged ones. More details are at Davenport Asset Management, with the funds linked under the Strategies tab.

Manager Changes

There’s always churn in the manager ranks. This month we tracked down changes at 67 equity or balanced funds. While no cry out “sea change!”, three fairly well-known Fidelity managers – Peter Saperstone, Adam Kutas and Charles Myers – are having their responsibilities changed. Mr. Kutas drops Latin America to focus on EMEA. Mr. Myers takes a six-month leave of absence starting in March. Mr. Saperstone has been steadily moving away for months. I also discovered that I don’t recognize the names of any of the Janus managers (except, of course, Mr. Gross).

Updates

Speaking of Mr. Gross, his Janus Unconstrained Bond (JUCAX) fund’s performance chart looks like this:

jucax

So far the fund has been above water for about one month, April 2015, since Mr. Gross came on board. That said, it certainly shows a dogged independence compared to its nontraditional bond peers (the orange line). And it does look a lot better than Miller Income Opportunity Fund (LMCJX), Legg Mason’s retirement gift to former star Bill Miller. Mr. Miller co-manages the fund with his son. Together they’ve managed to lose about 24% for their investors in the same period that Mr. Gross dropped two or three.

lmcjx

Briefly Noted . . .

berwyn fundsThere was a great thread on our discussion board about the fate of the Berwyn Funds. The Berwyn funds are advised by The Killen Group. The founder, Robert E. Killen, turned 75 and has chosen to sell his firm to the Chartwell Investment Partners. The fear is that Chartwell will use this as an opportunity to vacuum up assets. Their press release on the acquisition reads, in part:

“This transaction creates an investment management firm with annual revenues approaching $50 million and more than $10 billion in assets under management, as part of our well-defined strategy for growing our Chartwell Investment Partners business into a world-class asset manager,” TriState Capital Chief Executive Officer James F. Getz said. “We have an exceptional opportunity to combine Killen’s highly credible investment performance, particularly by the Morningstar five-star rated Berwyn Income Fund, with our proven national financial services distribution model to meaningfully accelerate growth in client assets….”

The fate of Berwyn’s small no-load shareholders seems unresolved.

Thanks, in passing but as always, to The Shadow, the indomitable Ted and the folks on our discussion board. They track down more cool stuff, and think more interesting thoughts, than about any group I know. I browse their work daily and learn a lot.

GoodHaven Fund (GOODX) is reorganizing itself. The key change is that it will have a new board of trustees, rather than relying on a board provided by the Professionally Managed Portfolios trust.

Effective at the end of January, 2016, the Innealta Capital Country Rotation (ICCNX) and Capital Sector Rotation (ICSNX) funds no longer include “consistent with the preservation of capital” as part of their investment objectives.

Manning & Napier has agreed to acquire a majority interest in Rainier Investment Management, the investment adviser to the Rainier Funds. 

Effective February 1, 2016, the T. Rowe Price Mid-Cap Index Fund and the T. Rowe Price Small-Cap Index Fund were added as options for all of the T. Rowe Price Retirement Fund. 

SMALL WINS FOR INVESTORS

Buffalo Emerging Opportunities Fund (BUFOX) and the Buffalo Small Cap Fund (BUFSX) have re-opened to new investors. They were closed for three and six years, respectively. Both funds posted wretched performance in 2014 and 2015 which might be a sign of disciplined investors out of step with an undisciplined market.

The Fairholme Focused Income (FOCIX) and Allocation (FAAFX) funds have reduced their minimum initial investment from $25,000 to $10,000.

Effective January 29, 2016, the redemption fee for the TCM Small Cap Growth Fund (TCMSX) was removed and the fund reduced its minimum initial investment from $100,000 to $2,500. It’s actually a pretty solid little small-growth fund.

Tweedy, Browne Global Value Fund II -Currency Unhedged (the “Fund”) reopened to new investors on February 1, 2016.

Effective as of January 1, 2016, the Valley Forge Fund’s (VAFGX) advisor, Boyle Capital Management, LLC, has voluntarily agreed to waive the full amount of its management fee. The voluntary waiver may be discontinued at any time. It was always a cute, idiosyncratic little fund run by a guy named Bernie Klawans. The sort of fund that had neither a website nor an 800 number. Bernie passed away at age 90, having run the fund until the last six months of his life. His handpicked successor died within the year. The Board of Trustees actually ran the fund for six months. Their eventual choice for a new manager did okay for a year, then performance fell off a cliff in the middle of 2014.

vafgx

It’s never recovered and the fund is down to $7 million in assets, down by two-thirds since Mr. Klawan’s passing.

Vanguard Treasury Money Market Fund (VUSXX) has re-opened to all investors without limitations. It’s been charging four basis points and returning one basis point a year for the past three.

CLOSINGS (and related inconveniences)

AQR Style Premia Alternative Fund and AQR Style Premia Alternative LV Fund will both close to new investors on March 31, 2016. AQR’s Diversified Arbitrage Risk Parity and Multi-Strategy Alternative funds closed in 2012 and 2013. Sam Lee did a really strong analysis of the two Style Premia funds in our September 2015 issue.

Ziegler Strategic Income Fund (ZLSCX) has liquidated its Investor share class and has converted the existing Investor Class accounts into institutional accounts.

OLD WINE, NEW BOTTLES

The American Independence funds announced five name changes, including shortening American Independence to AI.

Old Name New Name
American Independence JAForlines Risk-Managed Allocation AI JAForlines Risk-Managed Allocation
American Independence International Alpha Strategies AI Navellier International
American Independence Boyd Watterson Core Plus AI Boyd Watterson Core Plus
American Independence Kansas Tax-Exempt Bond AI Kansas Tax-Exempt Bond
American Independence U.S. Inflation-Indexed AI U.S. Inflation-Protected

Aston Small Cap Fund (ATASX) – formerly Aston TAMRO Small Cap – is soon-to-be AMG GW&K Small Cap Growth Fund.

On January 28, 2016, Centre Global Select Equity Fund became Centre Global ex-U.S. Select Equity Fund (DHGRX). Not entirely sure why “Global ex-US” isn’t “International,” but maybe they had some monogrammed stationery that they didn’t want to throw out.

Effective on February 19, 2016, Columbia Intermediate Bond Fund (LIBAX) becomes Columbia Total Return Bond Fund

On February 1, 2016, Ivy Global Real Estate Fund (IREAX) became Ivy LaSalle Global Real Estate Fund, and Ivy Global Risk-Managed Real Estate Fund changed to Ivy LaSalle Global Risk-Managed Real Estate Fund (IVRAX). For the past three years, both funds have been sub-advised by Lasalle Investment Management. IVRAX has performed splendidly; IREAX, not so much.

Silly reader. You thought it was Touchstone Small Cap Core Fund. Actually it’s just Touchstone Small Cap Fund (TSFAX). Now, anyway.

OFF TO THE DUSTBIN OF HISTORY

“Because of the difficulty encountered in distributing the Fund’s shares,” 1492 Small Cap Core Alpha Fund (FNTSX) will liquidate on February 26, 2016. The fact that it’s not very good probably contributed to the problem.

American Beacon Retirement Income and Appreciation Fund and American Beacon Treasury Inflation Protected Securities Fund ( ) will be liquidated and terminated on March 31, 2016. Presumably that’s part of the ongoing house-cleaning as American Beacon tries to reposition itself as a sort of alternatives manager.

Anfield Universal Fixed Income Fund (AFLEX) liquidated two of its share classes (A1 and R) on February 1, 2016. Rather than moving those investors into another share class, they received a check in the mail and a tax bill. Odd. 

ASTON/TAMRO International Small Cap Fund (AROWX) liquidated on February 1, 2016. On the one hand, it only had $2 million in assets. On the other, the adviser pulled the plug after just a year. The manager, Waldemar Mozes, is a bright guy with experience at Artisan and Capital Group. He jokingly described himself as “the best fund manager ever to come from Transylvania.” We wish him well.

Columbia Global Inflation-Linked Bond Plus Fund liquidated after very short notice, on January 29, 2016.

Gator Opportunities Fund (GTOAX) thought it had to hang on until March 21, 2016. The board has discovered that a swifter execution would be legal, and now it’s scheduled to disappear on February 15, 2016.

Hodges Equity Income Fund (HDPEX) will merge into Hodges Blue Chip Equity Income Fund (currently named the Hodges Blue Chip 25 Fund HDPBX) at the end of March, 2016.

Its board simultaneously announced new managers for, and liquidation of, KF Griffin Blue Chip Covered Call Fund (KFGAX). The former occurred on January 6, the latter is slated for February 16, 2016.

Madison Large Cap Growth Fund (MCAAX) merges into Madison Investors (MNVAX) on February 29, 2016,

Don’t blink: McKinley Non-U.S. Core Growth Fund (MCNUX) will be gone by February 5, 2016. It was an institutional fund with a minimum investment of $40 million and assets of $37 million, so ….

Midas Magic (MISEX) and Midas Perpetual Portfolio (MPERX) are both slated to merge into Midas Fund (MIDSX). In reporting their taxable distributions this year, Midas announced that “One of Midas’ guiding principles is that we will communicate with our shareholders and prospective investors as candidly as possible because we believe shareholders and prospective investors benefit from understanding our investment philosophy and approach.” That makes it ironic that there’s no hint about why they’ve folding a diversified equity fund and a tactical allocation fund into a gold portfolio with higher fees than either of the other two.

We previously noted the plan to merge the Royce European Small-Cap and Global Value funds into Royce International Premier, pending shareholder approval. The sheep baa’ed shareholders approved the mergers, which will be executed sometime in February, 2016.

On March 24, 2016, Sentinel Mid Cap Fund (SNTNX) will be absorbed by Sentinel Small Company Fund (SAGWX), which have “identical investment objectives and similar investment strategies.” That’s a clear win for the investors, give or take any actual interest in investing in mid-caps. At the same time, Sentinel Sustainable Mid Cap Opportunities Fund (WAEGX) will be absorbed into Sentinel Sustainable Core Opportunities Fund (MYPVX).

TeaLeaf Long/Short Deep Value Fund (LEFAX) closed on January 25 and liquidated on January 29, 2016.

I’m okay with the decision to liquidate UBS U.S. Equity Opportunity Fund (BNVAX): it’s a tiny fund that’s trailed 98% of its peers over the past decade. The UBS board decided you needed to hear their reasoning for the decision, which they included in a section entitled:

Rationale for liquidating the Fund

Based upon information provided by UBS Asset Management (Americas) Inc., the Fund’s investment advisor, the Board determined that “it is in the best interests of the Fund and its shareholders to liquidate and dissolve the Fund pursuant to a Plan of Liquidation (the “Plan”). To arrive at this decision, the Board considered factors that have adversely affected, and will continue to adversely affect, the ability of the Fund to conduct its business and operations in an economically viable manner.”

Quick note to the board: that’s not a rationale. It’s a conclusion (“it’s in your best interest”) and a cryptic passage about the process “we considered factors.”

The Board of Trustees of Monetta Trust has concluded “that it would be in the best interests of the Fund and its shareholders” to liquidate Varsity/Monetta Intermediate Bond Fund (MIBFX), which will occur on February 18, 2016.

Vivaldi Orinda Hedged Equity Fund (OHEAX) is victim of its advisor’s “strategic decision to streamline its product offerings.” The fund will liquidate on February 26, 2016.

Voya Emerging Markets Equity Dividend Fund (IFCAX) will liquidate on April 8, 2016.

In Closing . . .

Please do double-check to see if you’ve set our Amazon link as a bookmark or starting tab in your browser. From Christmas 2014 to Christmas 2015, Amazon’s sales rose 60% but our little slice of the pie fell by 15% in the same period. We try not to be too much of a pesterance on the subject, but the Amazon piece continues as a financial mainstay so it helps to mention it.

If you’re curious about how the Amazon Associates program works, here’s the short version: if you enter Amazon using our link, an invisible little piece of text (roughly: “for the benefit of MFO”) follows you. When you buy something, that tag is attached to your order and we receive an amount equivalent to 6% or so of the value of the stuff ordered. It’s invisible and seamless from your perspective, and costs nothing extra. Sadly the tag expires after a day so if you put something in your cart on Guy Fawkes Day and places the order on Mardi Gras, the link will have expired.

Thanks, too, to the folks whose ongoing support makes it possible for us to keep the lights on (and even to upgrade them to LEDs!). That includes the growing cadre of folks using MFO Premium but also Paul R and Jason B, our most faithful subscribers Deb and Greg, the good folks at Andrei Financial and Gardey Financial and Carl R. (generous repeat offenders in the “keep MFO going” realm).

We’re about 90% done on a profile of the “new” LS Opportunity Fund (LSOFX), so that’s in the pipeline for March. Readers and insiders both have been finding interesting options for us to explore which, with Augustana’s spring break occurring in February, I might actually have time to!

We’ll look for you.

David

November 1, 2015

Dear friends,

As you read this, I’ll be wading through a drift of candy wrappers, wondering if my son’s room is still under there somewhere. Weeks ago my local retailers got into the Halloween spirit by setting up their Christmas displays and now I live in terror of the first notes of that first Christmas carol inflicted over storewide and mall-wide sound systems.

But between the two, I pause for thanksgiving and Thanksgiving. I’m thankful for all the things I don’t have: they’re mostly delusion and clutter. I’m thankful for the stores not open on Black Friday (REI most recently) just as I’m thankful for the ones not open on Sundays (Fareway grocery stores, locally); we’ve got to get past the panic and resentment that arises if there’s a whole day without shopping. I’m grateful for those who conspire to keep me young, if only through their contagious craziness. apple pieI’m grateful for gravy, for the sweet warmth of a friend hugged close, for my son’s stunning ability to sing and for all the time my phone is turned off.

And I’m grateful, most continually, for the chance to serve you. It’s a rare honor.

Had I mentioned apple pie with remarkably thick and flaky crust? If not, that’s way up on the list too.

There’s a break in the rain. Get up on the roof!

… a bear market is not the base case for most of Wall Street. Adam Shell, 9/29/15

Duh. Cheerleaders lead cheers.

Good news: the sun is out. The Total Stock Market Index (VTSMX) soared 7.84% in October, offsetting a 7.29% decline in the third quarter. It’s now above water for the year, through Halloween, with a return of 1.8%. Optimists note that we’re now in the best six months of the year for stocks, and they anticipate healthy gains.

Bad news: none of the problems underlying the third quarter decline have changed.

We have no idea of whether the market will soar, stagger or crash over the next six months. Any of those outcomes are possible, none are predictable. Morningstar’s John Rekenthaler argues that the market isn’t priced for an imminent crash (“Are US stocks overripe?” 10/30/2015). BlackRock’s chief strategist agrees. The Leuthold Group says it’s “a bear until proven otherwise” but does allow for the prospect of a nice, tradable bounce (10/7/2015).

A lot of fairly serious adults are making the same argument: crash or not, the U.S. stock market is priced for futility.

GMO estimates (as of 10/14/2015) US real returns close to zero over the next 5-7 years. They estimate that high quality stocks might make 1% a year, small caps will be flat and large caps in general will lose nearly 1% a year. Those estimates assume simple reversions to long-term average profit margins and stock prices, both of which have been goofed by the Fed’s ongoing zero rate policy.

Jack Bogle (10/14/2015, warning: another auto-launch video) likewise thinks you’ll make about zero. His calculation is a rougher version of GMO’s. Investment gains are dividends plus earnings growth. An optimist would say 2% and 6%, respectively. Bogle thinks the 6% is too optimistic and pencils-in 5%. You then inflate or deflate the investment returns by changes in valuations. He notes that a P/E of 15 is about normal, so if you buy when the P/E is below 15 you get a boost. If you buy when the P/E is above 15, you get a penalty. By his calculations, the market P/E is about 20.

So you start with a 7% investment return (2% + 5%) and begin making deductions:

  • P/E contraction would cost 3% then
  • inflation might easily cost 2%, and of course
  • fund fees and expenses cost 1%, after which
  • stupid investor behavior eats 1.5%.

That leaves you with a “real” return of about zero (which at least cuts into your tax bill).

Henry Blodget was the poster child for the abuses of the financial markets in the 1990s. He went on to launch Business Insider, which became the web most popular business news site. It (well, 88% of it) was just sold to the German publisher Axel Springer for $340 million.

Blodget published an essay (10/4/2015) which concluded that we should anticipate “weak” or “crappy” returns for the next decade. The argument is simple and familiar to folks here: stocks are “fantastically expensive relative to most of recorded history.” Vigorous government intervention prevented the phenomenal collapse that would have returned market valuations to typical bear market lows, building the base for a decades-long bull. Zero interest rates and financial engineering conspired to keep stocks from becoming appropriately loathed (though it is clear that many institutional investors are, for better or worse, making structural changes in their endowment portfolios which brings their direct equity exposure down into the single digits).

Adding fuel to the fire, Rob Arnott’s group – Research Affiliates – has entered the debate. They are, mildly put, not optimistic about US stocks. Like Leuthold and unlike Blodget, they’re actually charged with finding way to invest billions ($174 billion, in RA’s case) profitably.

Key points from their latest essay:

  1. “High stock prices, just like high house prices, are harbingers of low returns.
  2. Investing in price-depressed residential rental property in Atlanta is like investing in EM equities today-the future expected long-term yield is much superior to their respective high-priced alternatives.
  3. Many parallels exist between the political/economic environment and the relative valuation of U.S. and EM equities in the periods from 1994 to 2002 and 2008 to 2015.
  4. Our forecast of the 10-year real return for U.S. equities is 1% compared to that of EM equities at 8%, now valued at less than half the U.S. C A P E.”

hole in roof from animalsBottom line: Leuthold – bear’s at the door. GMO – pretty much zero, real, with the prospect of real ugliness after the US election. Bogle – maybe 2% real. Blodget – “crap.” Research Affiliates – 1%.

For most of us, that’s the hole in the roof.  

Recommendation One: fix it now, while the sun’s out and you’re feeling good about life. Start by looking at your Q3 losses and asking, “so, if I lost twice that much in the next year and didn’t get it back until the middle of President Trump’s second term, how much would that affect my life plans?” If you lost 3%, imagine an additional 6% and shrug, then fine. If you lost 17%, deduct another 34% from your portfolio and feel ill, get up on the roof now!  In general, simplify both your life and your portfolio, cut expenses when you can, spend a bit less, save a bit more. As you look at your portfolio, ask yourself the simple questions: what was I thinking? Why do I need that there? Glance at the glidepaths for T. Rowe Price’s retirement date funds to see how really careful folks think you should be invested. If your allocation differs a lot from theirs, you need to know why. If you don’t know your allocation or don’t have one, now would be the time to learn.

Recommendation Two: reconsider the emerging markets. Emerging markets have been slammed by huge capital outflows as investors panic over the prospect that China is broken. Over a trillion dollars in capital has fled in fear. The “in fear” part is useful to you since it likely signals an overshoot. The International Monetary Fund believes that the fears of Chinese collapse are overblown. Josh Brown, writing as The Reformed Broker, raises the prospect of that emerging markets may well have bottomed. No one doubts that another market panic in the U.S. will drive the emerging markets down again.

That having been said, there’s also evidence that the emerging markets may hold the only assets offering decent returns over the remainder of the decade. GMO estimates that EM stocks (4.6% real/year) and bonds (2.8% real/year) will be the two highest-returning asset classes over the next five-to-seven years. Research Affiliates is more optimistic, suggesting that EM stocks are priced to return 7.9% a year with high volatility, about 1.1% in the US and 5.3% in the other developed markets. Leuthold finds their valuations very tempting. Bill Bernstein (auto-launch video, sorry), an endlessly remarkable soul, allows “They are cheap; they are not good and cheap …  It’s important for small investors to realize that you can’t buy low unless you are willing to deal with bad news.”

Look for ways of decoupling from the herd, since the EM herd is a particularly volatile bunch. That means staying away from funds that focus on the largest, most liquid EM stocks since those are often commodity producers and exporters whose fate is controlled by China’s. That may point toward smaller companies, smaller markets and a domestic orientation. It certainly points toward experienced managers. We commend Driehaus Emerging Markets Small Cap Growth (DRESX), Seafarer Overseas Growth & Income (SFGIX and Matthews Asia Strategic Income (MAINX) to you.

A second approach is to consider a multi-asset or balanced fund targeting the emerging markets. We know of just a handful of such funds:

  • AB Emerging Markets Multi-Asset Portfolio (ABAEX), AllianceBernstein.
  • Capital Emerging Markets Total Opportunities Fund (ETOPX) – a boutique manager affiliated with the American Funds. Capital Guardian Trust Company
  • Dreyfus Total Emerging Markets (DTMAX)
  • Fidelity Total Emerging Markets (FTEMX)
  • Lazard Emerging Markets Multi-Asset (EMMIX)
  • PIMCO Emerging Multi Asset (PEAWX) The fund was liquidated on 14 July 2015.
  • TCW Emerging Markets Multi-Asset Opportunities (TGMEX)
  • First Trust Aberdeen Emerging Opportunities (FEO), a closed-end fund.

Of the options available, Fidelity makes a surprisingly strong showing. We’ll look into it further for you.

Adviser Fund Q3 1-year 3-year 10-year
Fidelity FTEMX (11.1) (6.8) 0.0  
AllianceBernstein ABAEX (10.2) (3.3) (1.7)  
Capital Group ETOPX (10.2) (8.9) (3.2)  
Dreyfus DTMAX (13.4) (12.3) (2.7)  
First Trust/ Aberdeen FEO @NAV (11.7) (11.2) (4.1)  
Lazard EMMIX (13.1) (13.0) (4.6)  
TCW TGMEX (10.3) (7.2) n/a  
           
Benchmarks EM Bonds (6.3) (7.8) (3.7) 6.8
  EM Equity (15.9) (12.2) (2.2) 5.2
  60/40 EM (12.1) (10.4) (2.8) 5.8
  60/40 US (5.6) 1.6 7.5 5.7

Sequoia: “Has anybody seen our wheels? They seem to have fallen off.”

The most famous active fund seems in the midst of the worst screw-up in its history. The fund invested over 30% of its portfolio in a single stock, Valeant Pharmaceuticals (VRX). Valeant made money by buying other pharmaceutical firms, slashing their overhead and jacking up the prices of the drugs they produced. The day after buying to rights to heart medications Nitropress or Isuprel, Valeant increased their prices by six-fold and three-fold, respectively. Hedge funds, and Sequoia, loved it! Everyone else – including two contenders for the Democratic presidential nomination – despised it.

Against the charge that Valeant’s actions are unethical (they put people’s lives at risk in order to reap a windfall profit that they didn’t earn), Sequoia obliquely promises, “When ethical concerns arise, management tends to address them forthrightly, but in the moment.” I have no idea of what “but in the moment” means.

Then, in October, after months of bleeding value, Valeant’s stock did this:

Valeant chart

That collapse, which cost Sequoia shareholders about 6% in a single day, was pursuant to a research report suggesting that Valeant was faking sales through a “phantom pharmacy” it owned. Separately, Federal prosecutors subpoenaed documents related to Valeant’s drug pricing.

Three things stand out:

There’s a serious question about whether Sequoia management drank the Kool-Aid. One intriguing signal that they weren’t maintaining an appropriate distance from Valeant is a tendency, noted by Lewis Braham in a post to our discussion board, for the Sequoia managers to call Valeant CEO Michael D. Pearson, “Mike.” From a call transcript he pointed to:

Mike does not like to issue equity.

… not that Mike would shy away from taking a price increase.

… early on in Mike’s reign …

I think Mike said the company was going to …

We met with Mike a few weeks ago and he was telling us how with $300 million, you can get an awful lot done.

Mike can get a lot done with very little.

Mike is making a big bet.

On whole, he was “Mike” about three times more often than “Mike Pearson.” He was never “Mr. Pearson” or “the CEO.” There was no other CEO given comparable acknowledgement; in the case of their other investments, it was “Google” or “MasterCard.”

Sequoia’s research sounds a lot like Valeant’s press releases. The most serious accusation against Valeant, Sequoia insists in its opening paragraph, “is false.” That confidence rests on a single judgment: that changes in sales and changes in inventory parallel each other, so there can’t be anything amiss. Ummm … Google “manipulate inventory reporting.” The number of tricks that the accountants report is pretty substantial. The federal criminal investigation of Valeant doesn’t get mentioned. There is no evidence that Sequoia heightened its vigilance as Valeant slowly lost two-thirds of its value. Instead, they merely assert that it’s a screaming buy “at seven times the consensus estimate of 2016 cash earnings.”

Two of their independent directors resigned shortly thereafter. Rather than announcing that fact, Sequoia filed a new Statement of Additional information that simply lists three independent trustees rather than five. According to press reports, Sequoia is not interested in explaining the sudden and simultaneous departure. One director refused to discuss it with reporters; the other simply would not answer calls or letters.

Sequoia vigorously defends both Valeant’s management (“honest and extremely driven”) and its numbers. A New York Times analysis by Gretchen Morgenson is caustic about the firm’s insistence on highlighting “adjusted earnings” which distort the picture of the firm’s health. They are, Morgenson argues, “fantasy numbers.”

Sequoia’s recent shareholder letter concludes by advising Valeant to start managing with “an eye on the company’s long-term corporate reputation.” It’s advice that we’d urge upon Sequoia’s managers as well.

The Price of Everything and the Value of Nothing

edward, ex cathedraBy Edward Studzinski

“The pure and simple truth is rarely pure and never simple.”

                             Oscar Wilde

There are a number of things that I was thinking about writing, but given what has transpired recently at Sequoia Fund as a result of its investment in and concentration in Valeant Pharmaceuticals, I should offer some comments and thoughts to complement David’s. Mine are from the perspective of an investor (I have owned shares in Sequoia for more than thirty years), and also as a former competitor.

Sequoia Fund was started back in 1970. It came into its own when Warren Buffett, upon winding up his first investment partnership, was asked by a number of his investors, what they should do with their money since he was leaving the business for the time being. Buffett advised them to invest with the Sequoia Fund. The other part of this story of course is that Buffett had asked his friend Bill Ruane to start the Sequoia Fund so that there would be a place he could refer his investors to and have confidence in how they would be treated.

Bill Ruane was a successful value investor in his own right. He believed in concentrated portfolios, generally fewer than twenty stock positions. He also believed that you should watch those stock investments very carefully, so that the amount of due diligence and research that went into making an investment decision and then monitoring it, was considerable. The usual course of business was for Ruane, Dick Cunniff and almost the entire team of analysts to descend upon a company for a full day or more of meetings with management. And these were not the kind of meetings you find being conducted today, as a result of regulation FD, with company managements giving canned presentations and canned answers. These, according to my friend Tom Russo who started his career at Ruane, were truly get down into the weeds efforts, in terms of unit costs of raw materials, costs of manufacturing, and other variables, that could tell them the quality of a business. In terms of something like a cigarette, they understood what all the components and production costs were, and knew what that individual cigarette or pack of cigarettes, meant to a Philip Morris. And they went into plants to understand the manufacturing process where appropriate.

Fast forward to the year 2000, and yes, there is a succession plan in place at Ruane, with Bob Goldfarb and Carly Cunniff (daughter of Dick, but again, a formidable talent in her own right who would have been a super investor talent if her name had been Smith) in place as President and Executive Vice President of the firm respectively. The two of them represented a nice intellectual and personality balance, complementing or mellowing each other where appropriate, and at an equal level regardless of title.

Unfortunately, fate intervened as Ms. Cunniff was diagnosed with cancer in 2001, and passed away far too early in life, in 2005. Fate also intervened again that year, and Bill Ruane also passed away in 2005.

At that point, it became Bob Goldfarb’s firm effectively, and certainly Bob Goldfarb’s fund. At the end of 2000, according to the 12/31/2000 annual report, Sequoia had 11 individual stock positions, with Berkshire representing 35.6% and Progressive Insurance representing 6.4%. At the end of 2004, according to the 12/31/2004 annual report, Sequoia had 21 individual stock positions, with Berkshire representing 35.3% and Progressive Insurance representing 12.6% (notice a theme here). By the end of 2008, according to the 12/31/2008, Berkshire represented 22.8% of the fund, Progressive was gone totally from the portfolio, and there were 26 individual stock positions in the fund. By the end of 2014, according to the 12/31/2014 report, Sequoia had 41 individual stock positions, with Berkshire representing 12.9% and healthcare representing 21.4%.

So, clearly at this point, it is a different fund than it used to be, in terms of concentration as well as the types of businesses that it would invest in. In 2000 for instance, there was no healthcare and in 2004 it was de minimis. Which begs the question, has the number of high quality businesses expanded in recent years? The answer is probably not. Has the number of outstanding managements increased in recent years, in terms of the intelligence and integrity of those management teams? Again, that would not seem to be the case. What we can say however, is that this is a Goldfarb portfolio, or more aptly, a Goldfarb/Poppe portfolio, distinct from that of the founders.

Would Buffett, if asked today . . . still suggest Sequoia? My suspicion is he would not . . .

An interesting question is, given the fund’s present composition, would Buffett, if asked today for a recommendation as to where his investors should go down the road, still suggest Sequoia? My suspicion is he would not with how the fund is presently managed and, given his public comments advocating that his wife’s money after his demise should go to an S&P 500 index fund.

A fairer question is – why have I held on to my investment at Sequoia? Well, first of all, Bob Goldfarb is 70 and one would think by this point in time he has proved whatever it was that he felt he needed to prove (and perhaps a number of things he didn’t). But secondly, there is another great investor at Ruane, and that is Greg Alexander. Those who attend the Sequoia annual meetings see Greg, because he is regularly introduced, even though he is a separate profit center at Ruane and he and his team have nothing to do with Sequoia Fund. However, Bruce Greenwald of Columbia, in a Value Walk interview in June of 2010 said Buffett had indicated there were three people he would like to have manage his money after he died (this was before the index fund comment). One of them was Seth Klarman at Baupost. Li Lu who manages Charlie Munger’s money was a second, and Greg Alexander at Ruane was the third. Greg has been at Ruane since 1985 and his partnerships have been unique. In fact, Roger Lowenstein, a Sequoia director, is quoted as saying that he knows Greg and thinks Warren is right, but that was all he would say. So my hope is that the management of Ruane as well as the outside directors remaining at Sequoia, wake up and refocus the fund to return to its historic roots.

Why is the truth never pure and simple in and of itself. We have said that you need to watch the changes taking place at firms like Third Avenue and FPA. I must emphasize that one can never truly appreciate the dynamics inside an active management firm. Has a co-manager been named to serve as a Sancho Panza or alternatively to truly manage the portfolio while the lead manager is out of the picture for non-disclosed reasons? The index investor doesn’t have to worry about these things. He or she also doesn’t have to worry about whether an investment is being made or sold to prove a point. Is it being made because it is truly a top ten investment opportunity? But the real question you need to think about is, “Can an active manager be fired, and if so, by whom?” The index investor need not worry about such things, only whether he or she is investing in the right index. But the active investor – and that is why I will discuss this subject at length down the road.

Dancing amidst the elephants: Active large core funds that earn their keep

leigh walzerBy Leigh Walzer

Last month in these pages we reviewed actively managed utility funds. Sadly, we could not recommend any of those funds. Either they charged too much and looked too much like the cheaper index funds or they strayed far afield and failed to distinguish themselves.

We are not here to bury the actively managed fund industry. Trapezoid’s goal is to help investors and allocators identify portfolio managers who have predictable skill and evaluate whether the fees are reasonable. Fees are reasonable if investors can expect with 60% confidence a better return with an active fund than a comparable passive fund. (Without getting too technical, the comparable fund is a time-weighted replication portfolio which tries to match the investment characteristics at a low cost.)

An actively-managed fund’s fees are reasonable if you have at least a 60% prospect of outperforming a comparable passive fund

To demonstrate how this works, we review this month our largest fund category, large blend funds. (We sometimes categorize differently than Morningstar and Lipper. We categorize for investors’ convenience but our underlying ratings process does not rely on performance relative to a peer group.)

We found 324 unique actively-managed large blend funds where the lead manager was on the job at least 3 years.

We recently posted to the www.fundattribution.com website a skill rating for each of these funds. Our “grades” are forward-looking and represent the projected skill decile for each fund over the 12 months ending July 2016.  “A” means top 10%; “J” is bottom 10%. In our back-testing, the average skill for funds rated A in the following year exceeded the skill for B-rated funds, and so on with the funds rated J ranking last. Table I presents the grades for some of the largest funds in the category.  For trapezoid logoexample, the Fidelity Puritan Fund is projected to demonstrate more skill in the coming year than 80-90% of its peer group.

MFO readers who want to see the full list can register for demo access at no cost. (The demo includes a few fund categories and limited functionality.)  Demo users can also see backtesting results.

Table I

Skill Projections for Major US Large Blend Funds

Funds AUM ($bn) Decile
American Funds Inv. Co. of America 69 C
Amer. Funds Fundamental Investors Fund 68 D
Dodge & Cox Stock Fund 56 D
Vanguard Windsor II Fund 44 H
Fidelity Advisor New Insights Fund 26 A
Fidelity Puritan Fund 24 B
Vanguard Dividend Growth Fund 24 H
BlackRock Equity Dividend Fund 22 J
Oakmark Fund 17 B
Davis New York Venture Fund 14 G
John Hancock Disciplined Value Fund 13 E
Invesco Comstock Fund 12 G
JPMorgan US Equity Fund 12 D
Parnassus Core Equity Fund 11 A
JPMorgan US Large-Cap Core Plus Fund 11 A

A few caveats:

  • Our grades represent projected skill, not performance. Gross return reflects skill together with the manager’s positioning. Fund expenses are considered separately.
  • The difference in skill level between an E and F tends to be small while at the extremes the difference between A and B or I and J is larger.
  • Generally, deciles A through E have positive skill while F thru J are negative. The median fund may have skill which is slightly positive. This occurs because of survivorship bias: poorly managed funds are closed or merged out of existence
  • We do not have a financial interest in any of these funds or their advisors

Of course, costs matter. So we ran 1900 large blend fund classes through our Orthogonal Attribution Engine (OAE) to get the probability the investment would outperform its replication portfolio by enough to cover expenses. The good news (for investors and the fund industry) is there are some attractive actively managed funds. Our analysis suggest the fund classes in Table II will outperform passive funds, despite their higher fees.

Table II

Highly-rated Large blend Fund Classes (based on skill through July 2015)

table II

[a]   Morningstar ratings as of 10/20/15. G means gold (e.g. 5G means 5stars and “Gold”), S is silver, B is bronze

[b]   For those of you who like ActiveShare, OAI provides a measure of how active each fund is.  A closet indexer should have an OAI near zero. If we can replicate the fund, even with more complicated techniques, it will also score low. Funds which are highly differentiated can score up to 100.

[c]    Red funds are closed to new investors. Green are limited to institutional investors and retirement plans. Blue are limited to retirement plans

The bad news is that top-rated fund, Vanguard PrimeCap (VPCCX), is closed to new investors. So, too, is Vulcan Value Fund (VVPLX).  Fortunately, the PRIMECAP Odyssey Stock Fund (POSKX) is open and accessible to most investors.  Investors have 66% confidence this fund will generate excess return next year after considering costs. The Primecap funds have done well by overweighting pharma and tech over utilities and financials and have rotated effectively into and out of high-dividend stocks.

In many cases only the institutional or retirement classes are good deals for investors. For example, the Fidelity Advisor New Insights Fund classes I and Z offer 70% confidence; but a new investor who incurs the higher fees/load for classes A, B, C, and T would be less than 55% confident of success. Of course investors who already paid the load should stay the course.

While all these funds are worthy, we have space today to profile just a few funds.

Sterling Capital Special Opportunities Fund (BOPIX, BOPAX, etc.) is just under $1 billion. This fund was once known as BB&T Special Opportunities Equity Fund and was rated five-stars by Morningstar. The rating of the A class later fell to 3 stars and recently regained four-stars. 

Table III

Return Attribution: Sterling Capital Special Opportunities Fund

table III

Special Opps’ gross return was 22% before expenses over the past 3 years. (Table III) Even after fees, returns trounced the S&P500 by over 300bps for the past 3 years and over the past 10 years. The one and 5 year comparisons are less favorable but still positive. Combined skill has been consistently positive over the twelve year history of the fund.

However, that doesn’t tell the whole story. Comparing this to the S&P500 (or the Russell 1000) is neither accurate nor fair. The replicating portfolio – i.e., the one the OAE chooses as the best comparison – is approximately 90% equities (mostly the S&P500 with a smattering of small cap and hedged international which has decreased over time) plus 25% fixed income. The fixed income component surprised us at first, because the portfolio includes no bonds and does not utilize leverage. But the manager likes to write covered calls to generate extra income. We observe he sells about 5% of the portfolio on average about 10 to 20% out of the money. In this way he probably generates premium income of 25bp/yr., which the fixed income component captures well.  As always, the model evaluates the manager based on what he actually does, rather than against his stated benchmark (Russell 1000) or peer group.

Option writing helps explain why his beta is lower (We estimate .89, you will find other figures as low as .84.)  In the eyes of the Orthogonal Attribution Engine, that makes his performance more remarkable. We are not quite so impressed to pay an upfront 5.75% load for BOPAX (Class A), but BOPIX rates well. BOPAX is available no-load and NTF through Schwab and several smaller brokerages.

We had an opportunity to speak to the manager, George Shipp. Table III shows his skill derives much more from stock selection than sector rotation, a view he shared.  We can make a few observations.   He has a team of experienced generalists and a lot of continuity. His operation in Virginia Beach is separate from the other Sterling/BB&T operations in North Carolina.  He also manages Sterling Capital Equity Income (BAEIX), a much larger fund with zero historical overlap. The team follows a stable of companies, mainly industry leaders. They like to buy when the stock is dislocated and they see a catalyst.  The investment process is deliberative. That sounds like a contrarian, value philosophy, but in fact they have an even balance of growth and value investments. We reviewed his portfolio from 5 years ago, several of the top holdings trounced the market. (The exceptions were energy stocks.) Shipp noted he had good timing buying Apple when it was pummeled. He doesn’t specifically target M&A situations, but his philosophy puts the fund in a position to capture positive event risk. It is not unusual for the fund to own the same company more than once.

We also had a chance to speak to the folks at Davis Opportunity Fund (RPEAX). What jumps out about this $530mm fund is their ability to grind out excess return of 1 to 1.25% /yr. for nearly twenty years.  It is no great feat that DGOYX net returns just match the S&P500 for the past 5 years but they managed to do this despite two tailwinds: a 20% foreign allocation (partly hedged) and moderate cash balances. There is an old saw: “You can’t eat relative performance.” But when a fund shows positive relative performance for two decades with some consistency the Orthogonal model concludes the manager is skillful and some of that skill might carry over to the future.   We are willing to pay an incremental 60bp for their institutional class compared with an index fund but we cannot recommend the other share classes. A new co-manager was named in 2013, we see no drop-off in performance since then. (As with Sterling, the team manages a $15bn fund called Davis NY Venture (NYVTX) which does not rate nearly as well; there is some performance correlation between the two funds.)

Their process is geared toward global industry leaders and is somewhat thematic.  OAI of 24 indicates they run a very concentrated portfolio which cannot be easily replicated using passives. (We will talk more about OAI in the future.) Looking back at their portfolio from 5 years ago, their industry weightings were favorable and they did very well with CVS and Google but took hits from Sino Forest (ouch!) and Blount.

In general, the expected skill for a purely passive large blend fund will be close to zero and the probability will be around 50%. (There are exceptions including funds which don’t track well against our indices.)  However, there are a number of quantitatively driven and rules-based funds competing in the large blend space which show skill and some make our list

Table IV

Highly-Rated Large Blend Quantitative Funds

Fund Repr. Class Class Prob Hi-Rated Classes
American Century Legacy Large-Cap Fund ACGOX 72% Instl Inv Adv
PowerShares Buyback Achievers Portfolio PKW 64%  
Wells Fargo Large-Cap Core Fund EGOIX 63% I
Vanguard Structured Broad Market Fund VSBMX 62% I
AMG FQ Tax-Managed US Equity Fund MFQTX 62% Instl
Vanguard Structured Large-Cap Equity Fund VSLPX 61% InstlPlus

We are a little cautious in applying the model to quantitative funds. We know from backtesting that smart managers tend to stay smart, but there is a body of view that good quantitative strategies invite competition and have to be reinvented every few years. Nevertheless, here are the top-rated quant funds. All funds in Table IV carry five-star ratings from Morningstar except ACGOX is rated four-stars)

We had a chance to speak to the team managing American Century Legacy Large Cap (ACGOX), led by John Small and Stephen Pool in Kansas City.  Their approach is to devise models which predict what stock characteristics will work in a given market environment and load up on those stocks. There is some latitude for the managers to override the algorithms. Note this fund is rather small at $23 mm. The fund was evaluated based on data since management started in 2007.  However, the model was overhauled from 2010-2012 and has been tweaked periodically since then as market conditions change. The same team manages three other funds (Legacy Multicap, Legacy Focused, and Veedot); since 2012 they have used the same process, except they apply it to different market sectors.

Bottom Line:

If you are ready to throw in the towel on active funds, you are only 94% right.  There are a few managers who offer investors a decent value proposition. Mostly these managers have sustained good records over long periods with moderate expense levels.   Our thinking on quant funds will evolve over time. Based on our look at American Century Legacy, we suggest investors evaluate these managers based on the ability to react and adapt their quant models rather and not focus too much on the current version of the black box.   Remember to check out our fearless predictions for the entire large blend category at www.fundattribution.com (registration required)

If you have any questions, drop me a line at [email protected]

Five great overlooked little funds

Barron’s recently featured an article by journalist Lewis Braham, entitled “Five great overlooked little funds” (10/17/2015). Lewis, a frequent contributor of the Observer’s discussion board, started by screening for small (>$100 milllion), excellent (top 20% performance over five years) funds, of which he found 173. He then started doing what good journalists do: he dug around to understand when and why size matters, then started talking with analysts and managers. His final list of worthies is:

  • SSgA Dynamic Small Cap(SSSDX) which has been added to Morningstar’s watchlist. A change of management in 2010 turned a perennial mutt into a greyhound. It’s beaten 99% of its peers and charged below average expenses.
  • Hood River Small-Cap Growth(HRSRX) has $97 million but “its 14.1% annualized five-year return beats its peers by 2.3 percentage points a year.” The boutique fund remains small because, the manager avers, “We’re stockpickers, not marketers.”
  • ClearBridge International Small Cap(LCOAX), sibling to a huge domestic growth fund, has a five-year annualized return of 8.5%, which beats 95% of its peers. It has $131 million in assets, 1% of what ClearBridge Aggressive Growth (SHRAX) holds.
  • LKCM Balanced (LKBAX) holds an inexpensive, low-turnover portfolio of blue-chip stocks and high-grade bonds. It’s managed to beat 99% of its peers over the past decade while still attracting just $37 million.
  • Sarofim Equity (SRFMX) is a virtual clone of Dreyfus Appreciation (DGAGX). Both buy ultra-large companies and hold them forever; in some periods, the turnover is 2%. It has a great long-term record and a sucky short-term one.

lewis brahamLewis is also the author of The House that Bogle Built: How John Bogle and Vanguard Reinvented the Mutual Fund Industry(2011), which has earned a slew of positive, detailed reviews on Amazon. He is a graceful writer and lives in Pittsburgh; I’m jealous of both. Then, too, when I Googled his name in search of a small photo for the story I came up with

To which I can only say, “wow.”

Here Mr. Herro, have a smoke and a smile!

After all, science has never been able to prove that smoking is bad for you. Maureen O’Hara, for example, enjoyed the pure pleasure of a Camel:

maureen ohara camel ad

And she passed away just a week ago (24 October 2015), cancer-free, at age 95. And the industry’s own scientists confirm that there are “no adverse effects.”

chesterfield ad

And, really, who’d be in a better position to know? Nonetheless, the Association of National Advertisers warns, this “legal product in this country for over two centuries, manufactured by private enterprise in our free market system” has faced “a fifty-year conspiracy” to challenge the very place of cigarettes in the free enterprise system. The debate has “lost all sense of rationality.”

It’s curious that the industry’s defense so closely mirrors the federal court’s finding against them. Judge Marion Kessler, in a 1700 page finding, concluded that “the tobacco industry has engaged in a conspiracy for decades to defraud or deceive the public … over the course of more than 50 years, defendants lied, misrepresented and deceived the American public … suppress[ed] research, destroyed documents, destroyed the truth and abused the legal system.”

David Herro is the famously successful manager of Oakmark International (OAKIX), as well as 13 other funds for US or European investors. Two of Mr. Herro’s recent statements give me pause.

On climate change: “pop science” and “environmental extremism”

In an interview with the Financial Times, Mr. Herro denounced the 81 corporate leaders, whose firms have a combined $5 trillion market cap, who’d signed on to the White House Climate Pledge (“Fund manager David Herro criticizes corporate ‘climate appeasers,’” 10/21/15). The pledge itself has an entirely uncontroversial premise:

…delaying action on climate change will be costly in economic and human terms, while accelerating the transition to a low-carbon economy will produce multiple benefits with regard to sustainable economic growth, public health, resilience to natural disasters, and the health of the global environment.

As part of the pledge, firms set individual goals for themselves. Coke wants to reduce its carbon footprint by 25%. Facebook promises to power its servers with power from renewables. Bloomberg would like to reduce its energy use by half while achieving an internal rate of return of 20% or more on its energy investments.

To which Mr. Herro roars: “climate appeasers!” They had decided, he charged, to “cave in to pop science and emotion.” Shareholders “should seriously question executives who appease such environmental extremism and zealotry.”

Like others on his island, he engages in a fair amount of arm-flapping. Climate change, he claims, “is not proven by the data.” The Grist.org project, “How to Talk to Climate Deniers” explains the problem of “proof” quite clearly:

There is no “proof” in science — that is a property of mathematics. In science, what matters is the balance of evidence, and theories that can explain that evidence. Where possible, scientists make predictions and design experiments to confirm, modify, or contradict their theories, and must modify these theories as new information comes in.

In the case of anthropogenic global warming, there is a theory (first conceived over 100 years ago) based on well-established laws of physics. It is consistent with mountains of observation and data, both contemporary and historical. It is supported by sophisticated, refined global climate models that can successfully reproduce the climate’s behavior over the last century.

Given the lack of any extra planet Earths and a few really large time machines, it is simply impossible to do any better than this.

But Mr. Herro has a reply at hand: “Their answer is … per cent of scientists and Big Oil. My answer is data, data, data.

What does that even mean, other than the fact that the undergrad science requirement for business majors at Mr. Herro’s alma mater (lovely UW-Platteville) ought to be strengthened? Is he saying that he’s competent to assess climatological data? That he can’t find any data? (If so, check NASA’s “evidence” page here, sir.) That the data’s not perfect? Duh. That you’ve found the data, data, data straight from the source: talk radio and self-published newsletters? Or that there’s some additional bit not provided by the roughly 14,000 peer-reviewed studies that have corroborated the science behind global warming?

Can you imagine what would happen if you used to same criteria for assessing evidence about investments?

None of which I’d mention except for the fact that Herro decided to expand on the subject in his Financial Times interview which moves the quality of his analysis from the realm of the personal to the professional.

waitbutwhyIn my endless poking around, I came upon a clear, thoughtful, entertaining explanation of global warming that even those who aren’t big into science or the news could read, enjoy and learn from. The site is Wait But Why and it attempts to actually explain things (including sad millennials and procrastination) using, well, facts and humor.

Climate Change is a Thing

Let’s ignore all the politicians and professors and CEOs and filmmakers and look at three facts.

  1. Burning Fossil Fuels Makes Atmospheric CO2 Levels Rise
  2. Where Atmospheric CO2 Levels Go, Temperatures Follow
  3. The Temperature Doesn’t Need to Change Very Much to Make Everything Shitty

In between our essays, you should go peek at the site. If you can understand the designs on the stuff in their gift shop, you really should drop me a note and explain it.

On emerging markets: “never again”

In an interview with the Associated Press (“answers have been edited for clarity”), Mr. Herro makes a statement that’s particularly troubling for the future of the Oakmark funds. The article, “Fund manager touts emerging-market stocks” (10/25/15), explains that much of the success of Oakmark International (OAKIX) was driven by Mr. Herro’s prescient and substantial investment in emerging markets:

If we back up to 1998 or 1999, during the Asian financial crisis, we had 25 or 26% of the portfolio in emerging markets. We built up a huge position and we benefited greatly from that the whole next decade. It was the gift that kept giving.

The position was eventually reduced as he harvested gains and valuations in the emerging markets were less attractive. The logical question is, would the fund be bold enough to repeat the decision that “benefited [them] greatly” for an entire decade. Would he ever go back to 25%.

No, no, no. It could come up to 10 or 15% … but we’ll try to cap it there because, nowadays, people use managers (who are dedicated to emerging markets). And we don’t bill ourselves as an emerging-market manager.

This is to say, his decisions are now being driven by the demands of asset gathering and retention, not by the investment rationale. He’ll cap his exposure at perhaps half its previous peak because “people” (read: large investment advisers) want their investments handled by specialists. Having OAKIX greatly overweighted in EMs, even if they were the best values available, would make the fund harder to sell. And so they won’t do it.

Letting marketability drive the portfolio is a common decision, but hardly an admirable one.

A picture for the Ultimus Client Conference folks

At the beginning of September, I had the opportunity to irritate a lot of nice people who’d gathered for the annual client conference hosted by Ultimus Fund Services. My argument about the fund industry was two-fold:

  1. You’re in deep, deep trouble but
  2. There are strategies that have the prospect of reversing your fortunes.

Sometimes the stuff we publish takes three or four months to come together. Our premium site has a feature called “Works in Progress.” It’s the place that we’ll share stuff that’s not ready for publication here. Between now and year’s end, we’ll be posting pieces of the “how to save yourself” essay bit-by-bit.

But that’s not what most folks at the conference wanted to talk about. No, for 12 hours after my talk, the corporate managers at various fund companies and advisers brought up the same topic: I have no idea of how to work with the Millennials in my office. They have no sense of time, urgency, deadlines or focus. What’s going on with these people? All of that was occasioned by a single, off-hand comment I’d made about the peculiar decisions made by a student of mine.

We talked through the evidence on evolving cultural norms and workplace explanations, and I promised to try to help folks find some useful guidance. I found a great explanation of why yuppies are unhappy in an essay at WaitButWhy, the folks above. After explaining why young folks are delusional, they illustrated the average Millennial’s view of their career trajectory:

millennial expectations

If you’ve been banging your head on the desk for a while now, you should read it. You’ll feel better. Pwc, formerly Price, Waterhouse, Cooper, published an intricate analysis (Millennials at work 2015) of Millennial expectations and strategies for helping them be the best they can be. They also published a short version of their recommendations as How to manage the millennials (2015). Scholars at Harvard and the Wharton School of Business are rather more skeptical, taking the counter-intuitive position that there are few real generational differences. Their sources seem intrigued by the notion of work teams that combine people of different generations, who contrasting styles might complement and strengthen one another.

It’s worth considering.

Jack and John, Grumpy Old Men II

Occasionally you encounter essays that make you think, “Jeez, and I thought I was old and grouchy.” I read two in quick, discouraging succession.

grumpyJack Bogle grouched, “I don’t do international.” As far as I can tell, Mr. Bogle’s argument is “the world’s a scary place, so I’m not going there.” At 86 and rich, that’s an easy and sensible personal choice. For someone at 26 or 36 or 46, it seems incredibly short-sighted. While he’s certainly right that “Outside of the U.S., you can be very disappointed,” that’s also true inside the United States. In an oddly ahistoric claim, Bogle extols our 250 year tradition of protecting shareholders rights; that’s something that folks familiar with the world before the Securities Act of 1934 would find freakishly ill-informed.

A generation Mr. Bogle’s junior, the estimable John Rekenthaler surveyed the debate concerning socially responsible investing (alternately, “sustainable” or “ESG”) and grumped, “The debate about the merits of the genre is pointless.” Why? Because, he concludes, there’s no clear evidence that ESG funds perform differently than any other fund. Exactly! We reviewed a lot of research in “It’s finally easgrouchyy being green” (July 2015). The overwhelming weight of evidence shows that there is no downside to ESG investing. You lose nothing by way of performance. As a result, you can express your personal values without compromising your personal rate of return. If you’re disgusted at the thought that your retirement is dependent on addicting third world children to cigarettes or on clearing tropical forests, you can simply say “no.” We profiled clear, palatable investment choices, the number of which is rising.

The freak show behind the curtain: 25,000 funds that you didn’t even know existed

Whatever their flaws (see above), mutual funds are relatively stable vehicles that produce reasonable returns. Large cap funds, on average and after expenses, have returned 7.1% over the past 15 years which puts them 70 bps behind the S&P 500 for the same period.

But those other 25,000 funds …

Which others? ETFs? Nope. There are just about 1,800 of them – with a new, much-needed Social Media Sentiment Index ETF on the way (whew!) – controlling only $3 trillion. You already know about the 7,700 ’40 Act funds and the few hundred remaining CEFs are hardly a blip (with apologies to RiverNorth, to whom they’re a central opportunity).

No, I mean the other 24,725 private funds, the existence of which is revealed in unintelligible detail in a recent SEC staff report entitled Private Fund Statistics, 4th Quarter 2014 (October 2015). That roster includes:

  • 8,625 hedge funds, up by 1100 since the start of 2013
  • 8,407 private equity funds, up by 1400 in that same period
  • 4,058 “other” private funds
  • 2,386 Section 4 private equity funds
  • 1,789 real estate funds
  • 1,541 qualifying hedge funds
  • 1,327 securitized asset funds
  • 504 venture capital funds
  • 69 liquidity funds
  • 49 Section 3 liquidity funds, these latter two being the only categories in decline

The number of private funds was up by 4,200 between Q1/2013 and Q4/2014 with about 200 new advisers entering the market. They have $10 trillion in gross assets and $6.7 trillion in net assets. (Nope, I don’t know what gross assets are.) SEC-registered funds own about 1% of the shares of those private funds.

If Table 20 of the SEC report is to be credited, almost no hedge ever uses a high-frequency trading strategy. (You’ll have to imagine me at my desk, nodding appreciatively.)

Sadly, the report explains nothing. You get tables of technical detail with nary a definition nor an explanation in sight. “Asset Weighted-Average Qualifying Hedge Fund Investor and Portfolio Liquidity” assures that that fund liquidity at seven days is about 58% while investor liquidity in that same period is about 15%. Not a word anywhere freakshowabout what that means. An appendix defines about 10 terms, no one of which is related to their data reports.

A recent report in The Wall Street Journal does share one crucial bit of information: equity hedge funds don’t actually make money for their investors. The HRFX Equity Hedge Fund Index is, they report, underwater over the past decade. That is, “if you have invested … in this type of fund 10 years ago, you would have less than you started with.” An investment in the S&P 500 would have doubled (“Funds wrong-footed as Glencore, others gain,” 10/31/2015).

About a third of hedge funds fold within three years of launch; the average lifespan is just five years. Unlike the case of mutual funds, size seems no guardian against liquidation. Fortress Investment Group is closing its flagship macro fund by year’s end as major domo Michael Novogratz leaves. Renaissance Capital is closing their $1.3 billion futures fund. Bain Capital is liquidating their Absolute Return Capital fund. Many funds, including staunch investors in Valeant such as William Ackman of Pershing Square, are having their worst year since the financial crisis. As a group, they’re underwater for 2015.


Hedge Fund, n. Expensive and exclusive funds numbering in the thousands, of which only about a hundred might be run by managers talented enough to beat the market with consistency and low risk. “The rest,” says the financial journalist Morgan Housel, “charge ten times the fees of mutual funds for half the performance of index funds, pay half the income-tax rates of taxi drivers, and have triple the ego of rock stars. Jason Zweig, The Devil’s Financial Dictionary (2015)


 

 

Matching your funds and your time horizon

The Observer has profiled, and praised, the two RiverPark funds managed by David Sherman of Cohanzick. The more conservative, RiverPark Short Term High Yield (RPHYX/RPHIX, closed), usually makes 300-400 bps over a money market fund with scarcely more volatility. Year-to-date, through Halloween, the fund has returned a bit over 1% in a difficult market. The slightly more aggressive, RiverPark Strategic Income (RSIVX/RSIIX) might be expected to about double its sibling’s return with modest volatility, a feat that it has managed regularly. Strategic has had a performance hiccup lately; leading some of the folks on our discussion board to let us know that they’d headed for the exits.

For me, the questions are (1) is there a systemic problem with the fund? And (2) what’s the appropriate time-frame for assessing the fund’s performance? I don’t see evidence of the former, though we’re scheduled to meet Mr. Sherman in November and will talk more.

On the latter, the Observer’s fund-screener tracks “recovery times” for every fund over 20 time periods. Carl Bacon, in the book, Practical Risk Advanced Performance Measurements (2012), defines recovery time, or drawdown duration, as the time taken to recover from an individual or maximum drawdown to the original level. Recovery time helps investors approximate reasonable holding periods and also assessment periods. If funds of a particular type have recovery times of, say, 18-24 months, then (1) it would be foolish to use them for assets you might need in less than 18-24 months and (2) it would be foolish to panic if it takes them 18-24 months to recover.

Below, for comparison, are the maximum recovery times for the flexible bond funds that Morningstar considers to be the best.

Gold- and Silver-rated Flexible bond funds

Name

Analyst Rating

Recovery Period, in months

2015 returns, through 10/30

Loomis Sayles Bond (LSBDX)

Gold

17

(3.59)

Fidelity Strategic Income (FSICX)

Silver

14

0.78

Loomis Sayles Strategic Income (NEZYX)

Silver

23

(3.98)

PIMCO Diversified Income (PDIIX)

Silver

15

3.17

PIMCO Income (PIMIX)

Silver

18

3.49

Osterweis Strategic Income (OSTIX)

Silver

9

1.65

The Observer has decided to license data for our fund screener from Lipper rather than Morningstar; dealing with the sales rep from Morningstar kept making my systolic soar. Within about a week the transition will be complete. The difference you’ll notice is a new set of fund categories and new peer groups for many funds. Here are the recovery times for the top “flexible income” and “multi-sector” income funds, measured by Sharpe ratio over the current full market cycle (11/2007 – present). This screens out any fund that hasn’t been around for at least eight years.

Name

Category

Recovery Period, in months

Full cycle Sharpe ratio

PIMCO Income (PIMIX, a Great Owl)

Multi-sector

18

1.80

Osterweis Strategic Income (OSTIX)

Multi-sector

9

1.35

Schwab Intermediate Bond (SWIIX)

Multi-sector

16

1.25

Neuberger Berman Strategic Income (NSTLX)

Multi-sector

8

1.14

Cutler Fixed Income (CALFX)

Flexible income

15

1.02

FundX Flexible Income (INCMX)

Multi-sector

18

1.00

Bottom line: Before you succumb to the entirely understandable urge to do something in the face of an unexpected development, it’s essential to ask “am I being hasty?” Measures such as Recovery Time help, both in selecting an investment appropriate to your time horizon and in having reasonable criteria against which to assess the fund’s behavior.


Last fall we were delighted to welcome Mark Wilson, Chief Investment Officer for The Tarbox Group which is headquartered in Newport Beach, California. As founder and chief valet for the website CapGainsValet, Mark provided a remarkable service: free access to both thoughtful commentaries on what proved to be a horror of a tax season and timely data on hundreds of distributions. We’re more delighted that he agreed to join us again for the next few months.

Alive and kicking: The return of Cap Gains Valet

capgainsvaletBy Mark Wilson, APA, CFP®, Chief Valet

CapGainsValet.com is up and running again (and still free). CGV is designed to be the place for you to easily find mutual fund capital gains distribution information. If this concept is new to you, have a look at the Articles section of the CGV website where you’ll find educational pieces ranging from beginner concepts to more advanced tax saving strategies.

It’s quite early in the reporting season, but here are some of my initial impressions:

  • Many firms have already posted 2015 estimates. The site already has over 75 firms’ estimates posted so there is already some good information available. This season I’m expecting to post estimates for over 190 fund firms. I’ll continue to cycle through missing firms and update the fund database as new information becomes available. Keep checking in.
  • This year might feel more painful than last year. Based on estimates I’ve found to-date, I’m expecting total distributions to be lower than last year’s numbers. However, if fund performance ends the year near today’s (flat to down) numbers, investors can get a substantial tax bill without accompanying investment gains.
  • It’s already an unusual year. My annual “In the Doghouse” list compiles funds with estimated (or actual) distributions over 20% of NAV. The list will continue to grow as fund firms post information. Already on the list is a fund that distributed over 80%, an index fund and a “tax-managed” fund – oddball stuff!
  • Selling/swapping a distributing fund could save some tax dollars. If you bought almost any fund this year in a taxable account, you should consider selling those shares if the fund is going to have a substantial distribution. (No, fund companies do not want to hear this.) Tax wise, running some quick calculations can help you decide a good strategy. Be careful not to run afoul of the “wash sale” rules.

Of course, the MFO Discussion board (led by TheShadow) puts together its own list of capital gains distribution links. Be sure to check their work out as that list may have some firms that are not included on CGV due to their smaller asset base. Between the two resources, you should be well covered.

I value the input of the MFO community, so if you have any comments to share about CapGainsValet.com, feel free to contact me.

Top developments in fund industry litigation

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

Orders & Decisions

  • A U.S. Magistrate Judge recommended that the court deny First Eagle‘s motion to dismiss fee litigation regarding two of its international equity funds. (Lynn M. Kennis Trust v. First Eagle Inv. Mgmt., LLC)
  • In Jones v. Harris Associates—the fee litigation regarding Oakmark funds in which the U.S. Supreme Court set the legal standard for liability under section 36(b)—the Seventh Circuit denied the plaintiffs’ petition for rehearing en banc in their unsuccessful appeal of the district court’s summary judgment in favor of Harris Associates.
  • J.P. Morgan Investment Management was among six firms named in SEC enforcement actions for short selling violations in advance of stock offerings. J.P. Morgan agreed to pay $1.08 million to settle the charges.
  • Further extending the fund industry’s dismal losing record on motions to dismiss section 36(b) fee litigation, the court denied New York Life‘s motion to dismiss a lawsuit regarding four of its MainStay funds. The court viewed allegations that New York Life delegated “substantially all” of its responsibilities as weighing in favor of the plaintiff’s claim. (Redus-Tarchis v. N.Y. Life Inv. Mgmt., LLC.)
  • After the Tenth Circuit reversed a class certification order in a prospectus disclosure case regarding Oppenheimer‘s California Municipal Bond Fund, the district court reaffirmed the order such that the litigation is once again proceeding as a certified class action. Defendants include independent directors. (In re Cal. Mun. Fund.)
  • Denying Schwab defendants’ petition for certiorari, the U.S. Supreme Court declined to review the controversial Ninth Circuit decision that allowed multiple state common-law claims to proceed with respect to Schwab’s Total Bond Market Fund. Defendants include independent directors. (Northstar Fin. Advisors, Inc. v. Schwab Invs.)
  • In the same lawsuit, the district court partly denied Schwab‘s motion to dismiss, holding (among other things) that defendants had abandoned their SLUSA preclusion arguments with respect to Northstar’s breach of fiduciary duty claims. (Northstar Fin. Advisors, Inc. v. Schwab Invs.)
  • Two UBS advisory firms agreed to pay $17.5 million to settle SEC charges arising from their purported roles in failing to disclose a change in investment strategy by a closed-end fund they advised.
  • By order of the court, the securities fraud class action regarding four Virtus funds transferred from C.D. Cal. to S.D.N.Y. (Youngers v. Virtus Inv. Partners, Inc.)

New Lawsuits

  • Allianz Global Investors and PIMCO are targets of a new ERISA class action that challenges the selection of proprietary mutual funds for the Allianz 401(k) plan. Complaint: “the Fiduciary Defendants treat the Plan as an opportunity to promote the Allianz Family’s mutual fund business and maximize profits at the expense of the Plan and its participants.” (Urakhchin v. Allianz Asset Mgmt. of Am., L.P.)
  • J.P. Morgan is the target of a new section 36(b) excessive fee lawsuit regarding five of its funds. The plaintiffs rely on comparisons to purportedly lower fees that J.P. Morgan charges to other clients. (Campbell Family Trust v. J.P. Morgan Inv. Mgmt., Inc.)
  • Metropolitan West‘s Total Return Bond Fund is the subject of a new section 36(b) excessive fee lawsuit. The plaintiff relies on comparisons to purportedly lower fees that Metroplitan West charges to other clients. (Kennis v. Metro. W. Asset Mgmt., LLC.)

The Alt Perspective: Commentary and news from DailyAlts.

dailyaltsOctober proved to be less than spooky for the equity market as the S&P 500 Index rose 8.44% over the month, leading major asset classes and alternative investment categories. While bonds and commodities were relatively flat, long/short equity funds topped the list of alternative funds and returned an average of 2.88%, while bear market funds shed 11.30% over the month as stocks rallied. Managed futures funds gave back gains they had made earlier in the year with a loss of 1.82% on average, according to Morningstar, while multi-alternative funds posted gains of 1.33%.  All in all, a mixed bag for nearly everything but long-only equity.

Asset Flows

September turned out to be a month when investors decided that it was time to pull money from actively managed mutual funds and ETFs, regardless of asset class, style or strategy – except for alternatives. Every actively managed category, as reported by Morningstar saw outflows other than alternatives, which had net inflows of $719 million to actively managed funds and another $884 million to passively managed alternative mutual funds and ETFs.

As you will recall, volatility started to spike in August when the Chinese devaluated the Yuan, and the turmoil carried into September. But not all alternative categories saw positive inflows in September – in fact few did. Were it not for trading strategy funds, such as inverse funds, the overall alternatives category would be negative:

  • Trading strategies, such as inverse equity funds, added $1.5 billion
  • Multi-alternative funds picked up $998 million
  • Managed futures funds added $744 million
  • Non-traditional bond funds shed $1.3 billion
  • Volatility based funds lost $551 million

New Fund Filings

AlphaCentric and Catalyst both teamed up with third parties to invest in managed futures or related strategies. AlphaCentric partnered with Integrated Managed Futures Corp for a more traditional, single manager managed futures fund while Catalyst is looking to Millburn Ridgefield Corporation to run a managed futures overlay on an equity portfolio – very institutional like!

Another interesting filing was that from a new company called Castlemaine who plans to launch five new alternative mutual funds – all managed by one individual. That’s just hard to do! Hard to criticize that this point, but we will keep an eye on the firm as they come out with new products later this year.

Research

Finally, there were a couple pieces of interesting research that we uncovered this past month, as follows:

Have a wonderful November, and Happy Thanksgiving to all.

Observer Fund Profiles: RNCOX

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.

RiverNorth Core Opportunity (RNCOX). RiverNorth turns the typical balanced strategy (boring investments, low costs) on its head. At the price of higher pass-through costs, the fund attempts to exploit the occasionally-irrational pricing of the closed-end fund market to add a market-neutral layer of returns to a flexible underlying allocation. That’s work well far more often than it hasn’t.

Launch Alert: T. Rowe Price Emerging Markets Value (PRIJX)

Price launched its Emerging Markets Value fund at the end of September. The manager is Ernest C. Yeung. He started at Price in 2003 as an analyst covering E.M. telecommunication stocks. In 2009 he became a co-manager of the International Small Cap Equity strategy (manifested in the U.S. as Price International Discovery PRIDX), where he was the lead guy on Asian stock selection. Nick Beecroft in Price’s Hong Kong office reports that at the end of 2014, “he began to manage a paper portfolio for the new T. Rowe Price Emerging Markets Value Stock Fund, which he then ran until the fund was launched publicly in September 2015. So Ernest [has] been part of our emerging markets team at T. Rowe for over 12 years.”

The fund will target 50-80 stocks and stock selection will drive both country and sector exposure. Characteristics he’ll look for:

  • low valuation on various earnings, book value, sales, and cash flow metrics, in absolute terms and/or relative to the company’s peers or its own historical norm;
  • low valuation relative to a company’s fundamentals;
  • companies that may benefit from restructuring activity or other turnaround opportunities;
  • a sound balance sheet and other positive financial characteristics;
  • strong or improving position in an overlooked industry or country; and
  • above-average dividend yield and/or the potential to grow dividends.

As Andrew Foster and others have pointed out, value investing has worked poorly in emerging markets. Their argument is that many EM markets, especially Asian ones, have powerful structural impediments to unlocking value. Those include interlocking directorships, control residing in founding families rather than in the corporate management, cross-ownership and a general legal disregard for the rights of minority shareholders. I asked the folks at Price what they thought had changed. Mr. Beecroft replied:

We agree that traditional, fundamental value investing can be challenging in emerging markets. Companies can destroy value for years for all the reasons that you mention. Value traps are prevalent as a result. Our approach deliberately differs from the more traditional fundamental value approach. We take a contrarian approach and actively seek stocks that are out of favour with investors or which have been “forgotten” by the market. We also look for them to have a valuation anchor in the form of a secure dividend yield or book value support. These stocks typically offer attractive valuations and with limited downside risk.

But in emerging markets, just being cheap is not enough. So, we look for a re-rating catalyst. This is where our research team comes in. Re-rating catalysts might be external to the company (e.g., industry structure change, or an improving macro environment) or internal (ROE/ROIC improvement, change in management, improved capital allocation policy, restructuring, etc.). Such change can drive a significant re-rating on the stock.

The emerging markets universe is wide and deep. We are able to find attractive upside potential in stocks that other investors are not always focused on.

The fund currently reports about a quarter million in its portfolio. The initial expense ratio, after waivers, is 1.5%. The minimum initial investment is just $1,000.

Funds in Registration

There are fifteen or so new funds in registration this month. Funds in registration with the SEC are not available for sale to the public and the advisors are not permitted to talk about them, but a careful reading of the filed prospectuses gives you a good idea of what interesting (and occasionally appalling) options are in the pipeline. The funds in registration now have a good chance of launching on December 31, which is critical to allowing them to report full-year results for 2016.

There are some interesting possibilities. Joe Huber is launching a mid-cap fund. ASTON will have an Asia dividend one. And Homestead is launching their International II fund, sub-advised by Harding Loevner.

Manager Changes

Chip tracked down 63 manager changes this month, a fairly typical tally. This month continues the trend of many more women being removed from management teams (9) than added to them (1). There were a few notable changes. The outstanding Boston Partners Long/Short Equity Fund (BPLEX) lost one of its two co-managers. Zac Wydra left Beck Mack & Oliver Partners Fund (BMPEX) to become CIO of First Manhattan Corporation. In an unusual flurry, Kevin Boone left Marsico Capital, then Marsico Capital got booted from the Marsico Growth FDP Fund (MDDDX) that Kevin co-managed, then the fund promptly became the FDP BlackRock Janus Growth Fund.

The Navigator: Fund research fast

compassOne of the coolest resources we offer is also one of the least-used: The Navigator. It’s located on the Resources tab at the top-right of each page. If you enter a fund’s name or ticker symbol in The Navigator, it will instantly search 27 sites for information on the fund:

navigator

If you click on any of those links, it takes you directly to the site’s profile of the fund. (Did you even know The Google had fund pages? They do.)

Updates: INNAX, liquidity debate

four starsIn October we featured Capital Innovations Global Agri, Timber, Infrastructure Fund (INNAX) in our Elevator Talk. Energy-light portfolio, distinctive profile given their focus on “soft” resources like trees and cattle. Substantially above-average performance. They’d just passed their three year anniversary and seven days later they received their inaugural star rating from Morningstar. They’re now recognized as a four star fund within the natural resources group.

We’ve argued frequently that liquidity in the U.S. securities market, famously the most liquid in the world, might be drying up. The translation is: you might not be able to get a fair price for your security if you need to sell at the same time lots of other people are. The SEC is propounding rules to force funds to account for the liquidity of their holdings and to maintain a core of highly-liquid securities that would be sufficient to cover several days’ worth of panicked redemptions. The Wall Street Journal provided a nice snapshot of the potential extent of such problems even in large, conservative fixed-income funds. Using the ability to sell a security within seven days, the article “Bond funds push limits” (9/22/2015) estimates the extent of illiquid assets in five funds:

Vanguard High-Yield Corporate

40%

American Funds American High-Income

39%

Vanguard Long-Term Investment Grade

39%

Dodge & Cox Income

31%

Lord Abbett Short Duration Income

29%

Between them, those funds hold $130 billion. The Investment Company Institute, the industry’s mouthpiece, immediately denounced the story.

It’s not quite The Satanic Verses, but ….

the devils financial dictionaryIn October, Jason Zweig published his The Devil’s Financial Dictionary. The title, of course, draws from Ambrose Bierce’s classic The Devil’s Dictionary (1906). Critics of Wall Street still nod at entries like “Finance: the art or science of managing revenues or resources for the best advantage of the manager.”

With a combination of wit and a long career during which he incubates both insight and annoyance, Jason wrote what’s become a bedside companion for me. It’s full of short, snippy entries, each of which makes a point that bears making. I think you’d enjoy it, even if you’re the object of it.


Financial Journalist, n. Someone who is an expert at moving words about markets around on a page or screen until they sound impressive, regardless of whether they mean anything. Until the early 20th century, financial journalists knew exactly what they were doing, as many of them were paid overtly or covertly by market manipulators to promote or trash various investments … Nowadays, most financial journalists are honest, which is progress—and ignorant, which isn’t.


Another thing to be thankful for: New data and our impending launch

We’ll be writing to the 6,000 or so of you on our mailing list in the next week or so with updates about our database and other analytics, as well as word of the formal launch of the “MFO premium” site, which will give all of our contributors access to all of this stuff and more.

charles balconyComparing Lipper Ratings

lipper_logo

MFO recently started computing its risk and performance fund metrics and attendant fund ratings using the Lipper Data Feed Service for U.S. Open End funds. (See MFO Switches To Lipper Database.) These new data have now been fully incorporated on the MFO Premium beta site, and on the Great Owl, Fund Alarm, and Dashboard of Profiled Funds pages of our legacy Search Tools. (The Risk Profile and Miraculous Multi-Search pages will be updated shortly).

Last month we noted that the biggest difference MFO readers were likely to find was in the assigned classifications or categories, which are described in detail here. (Morningstar’s categories are described here,  and Lipper nicely compares the two classification methodologies here.) Some examples differences:

  • Lipper uses “Core” instead of “Blend.” So, you will find Large-Cap Growth, Large-Cap Core, and Large Cap Value.
  • Lipper includes a “Multi-Cap” category, in addition to Large-Cap, Medium-Cap, and Small-Cap. “Funds that, by portfolio practice, invest in a variety of market capitalization ranges …” Examples are Vanguard Total Stock Market Index Inv (VTSMX), Auxier Focus Inv (AUXFX), and Bretton (BRTNX).
  • Lipper does not designate an “Asset Allocation” category type, only “Equity” and “Fixed Income.” The traditional asset allocation funds, like James Balanced: Golden Rainbow Retail (GLRBX) and Vanguard Wellesley Income Inv (VWINX) can be found in the categories “Mixed-Asset Target Allocation Moderate” and “Mixed-Asset Target Allocation Conservative,” respectively.
  • Lipper used “Core Bond” instead of say “Intermediate-Term Bond” to categorize funds like Dodge & Cox Income (DODIX).
  • Lipper extends data back to January 1960 versus January 1962. Number of funds still here today that were here in January 1960? Answer: 72, including T Rowe Price Growth Stock (PRGFX).

A few other changes that readers may notice with latest update:

  • Ratings for funds in all the commodities categories, like Commodities Agriculture, where previously we only included “Broad Basket.”
  • Ratings for funds of leveraged and short bias categories, so-called “trading” funds.
  • Ratings for 144 categories versus 96 previously. We continue to not rate money market funds or funds less than 3 months old.
  • No ratings for funds designated as a “variable insurance product,” which typically cannot be purchased directly by investors. Examples are certain Voya, John Hancock, and Hartford funds.
  • There may be a few differences in the so-called “Oldest Share Class (OSC)” funds. MFO has chosen to define OSC as share class with earliest First Public Offering (FPO) date. (If there is a tie, then fund with lowest expense ratio. And, if tied again, then fund with largest assets under management.)

Overall, the changes appear quite satisfactory.

Briefly Noted . . .

Columbia Acorn Emerging Markets (CAGAX) has lifted the cap on what constitutes “small- and mid-sized companies,” their target universe. It has been $5 billion. Effective January 1 their limit bumps to $10 billion. That keeps their investment universe roughly in line with their benchmark’s.

Goldman Sachs Fixed Income Macro Strategies Fund (GAAMX) is making “certain enhancements” to its investment strategies. Effective November 20, 2015, the Fund will use a long/short approach to invest in certain fixed income securities. The trail of the blue line certainly suggests that “certain enhancements” might well be in order.

Goldman Sachs Fixed Income Macro Strategies Fund chart

Here’s something I’ve not read before: “The shareholder of Leland Thomson Reuters Private Equity Index Fund (LDPAX) … approved changing the Fund’s classification from a diversified Fund to a non-diversified Fund under the Investment Company Act of 1940.”

SMALL WINS FOR INVESTORS

Not a lot to cheer for.

CLOSINGS (and related inconveniences)

The closure of the 361 Managed Futures Strategy Fund (AMFQX/ AMFZX) has been delayed “until certain administrative and other implementation matters have been completed.” The plan is to close by December 31, 2015.

The shareholders of Hennessy Cornerstone Large Growth Fund, the Hennessy Cornerstone Value Fund, and the Hennessy Large Value Fund bravely voted to screw themselves by adding 12(b)1 fees to their funds, beginning on November 1, 2015. The Hennessy folks note, in passing, that “This will increase the fees of the Investor Class shares of such Hennessy Funds.”

Invesco European Small Company Fund (ESMAX) will close to new investors on November 30, 2015. By pretty much all measures, it offers access to higher growth rates at lower valuations than the average European stock fund does. The question for most of us is whether such a geographically limited small cap fund ever makes sense. 

Effective after November 13, 2015, the RiverNorth/DoubleLine Strategic Income Fund (RNDLX) is closed to new investors.

OLD WINE, NEW BOTTLES

On December 30, the microscopic and undististinguished Alger Analyst Fund (SPEAX) will become Alger Mid Cap Focus Fund. Usually when a fund highlights Analyst in its name, it’s run by … well, the firm’s analysts. “Research” often signals the same thing. In this case, the fund has been managed since inception by CEO/CIO Dan Chung. After the name change, the fund will be managed by Alex Goldman. 

In one of those “I just want to slap someone” moves, the shareholders of City National Rochdale Socially Responsible Equity Fund (AHRAX) are voting on whether to become the Baywood SociallyResponsible Fund. The insistence of fund firms to turn two words into one word is silly but I could imagine some argument about the ability to trademark a name that’s one word (DoubleLine) that wouldn’t be available if it were two. But mashed-together with the second half officially italicized? Really, guys? The fact that the fund has trailed 97% of its peers over the past decade suggests the need to step back and ask questions more probing than this.

Effective December 31, 2015, Clearbridge Global Growth (LGGAX) becomes ClearBridge International Growth Fund.

Oppenheimer International Small Company Fund (OSMAX) becomes Oppenheimer International Small-Mid Company Fund on December 30, 2015. It’s a very solid fund except for the fact that, at $5.1 billion, is no longer targets small caps: 75% of the portfolio are mid- to large-cap stocks.

On January 11, 2016, the Rothschild U.S. Large-Cap Core Fund, U.S. Large-Cap Value, U.S. Small/Mid-Cap Core, U.S. Small-Cap Core, U.S. Small-Cap Value and U.S. Small-Cap Growth funds will become part of the Pacific Funds Series Trust. Rothschild expects that they’ll continue to manage the year-old funds with Pacific serving as the parent. The new fund names will be simpler than the old and will drop “U.S.”, though the statement of investment strategies retains U.S. as the focus. The funds will be Pacific Funds Large Cap, Large Cap Value, Small/Mid-Cap, Small-Cap, Small-Cap Value and Small-Cap Growth. It appears that the tickers will change.

On December 18, 2015, SSgA Emerging Markets Fund (SSELX) will become State Street Disciplined Emerging Markets Equity Fund, leading mayhap to speculation that it hadn’t been disciplined up until then. The fund will use quant screens “to select a portfolio that the Adviser believes will exhibit low volatility and provide competitive long-term returns relative to the Index.”

As part of a continuing series of fund adoptions, Sound Point Floating Rate Income Fund (SPRFX) will reorganize into the American Beacon Sound Point Floating Rate Income Fund.

Effective October 28, 2015, Victory Fund for Income became Victory INCORE Fund for Income. Presumably because the audience arose, applauding and calling “incore! incore!” Victory Investment Grade Convertible Fund was also rechristened Victory INCORE Investment Grade Convertible Fund.

And, too, Victory renamed all of its recently-acquired Compass EMP funds. The new names will all begin Victory CEMP. So, for example, in testing the hypothesis that no name is too long and obscure to be attractive, Compass EMP Ultra Short-Term Fixed Income Fund (COFAX) will become Victory CEMP Ultra Short Term Fixed Income Fund.

Voya Growth Opportunities Fund changed its name to Voya Large-Cap Growth Fund.

OFF TO THE DUSTBIN OF HISTORY

3D Printing, Robotics and Technology Fund (TDPNX) will liquidate on November 13, 2015. In less than two years, the managers lost 39% for their investors while the average tech fund rose 20%. The Board blamed “market conditions and economic factors” rather than taking responsibility for a fatally-flawed conception. Reaction on the Observer’s discussion board was limited to a single word: “surprised?”

Not to worry, 3D printing fans! The ETF industry has rushed in to fill the (non-existent) gap with the pending launch of the ARK 3D Printing ETF.

Acadian Emerging Markets Debt Fund (AEMDX) has closed and will liquidate on November 20, 2015. It’s a $36 million institutional fund that’s had one good year in five; otherwise, it trailed 70-98% of its peers. Performance seems to have entirely fallen off a cliff in 2015.

AllianzGI NFJ All-Cap Value Fund (PNFAX) is slated for liquidation on December 11, 2015. Their International Managed Volatility (PNIAX) and U.S. Managed Volatility (NGWAX) funds will follow on March 2, 2016. The theory says that managed volatility funds should be competitive with their benchmarks over the long term by limiting losses during downturns. The latter two funds suffered because they couldn’t consistently manage that feat.

Carne Hedged Equity Fund (CRNEX) was a small, decent long/short fund for four years. Then the recent past happened; the fund went from well above average through December 2013 to well below average since. Finally, the last week of October 2015 happened. Here’s the baffling picture:

Carne Hedged Equity Fund chart

Right: 23% loss over four days in a flat market. No word on the cause, though the liquidation filing does refer to a large redemption and anticipated future redemptions. (Ya think?) So now it’s belatedly becoming “a former fund.” Graveside services will be conducted December 30, 2015.

Forward continues … in reverse? To take one step Forward and two back? Forward Global Dividend Fund (FFLRX) will liquidate on November 17th and the liquidation of Forward Select EM Dividend Fund will occur on December 15, 2015. Those appear to be Forward’s fifth and sixth liquidations in 2015, and the fourth since being acquired by Salient this summer.

In order “to optimize the Goldman Sachs Funds and eliminate overlap,” Goldman Sachs has (insightfully) decided to merge Goldman Sachs International Small Cap Fund (GISAX) into Goldman Sachs International Small Cap Insights Fund (GISAX). The target date is February, 2016. That’s a pretty clean win for shareholders. GISAX is, by far, the larger, stronger and cheaper option.

GuideMark® Global Real Return Fund has been liquidated and terminated and, for those of you who haven’t yet gotten the clue, “shares of the Fund are no longer available for purchase or exchange.”

JPMorgan U.S. Research Equity Plus Fund (JEPAX) liquidated after fairly short notice on October 28, 2015. It was a long/short fund of the 130/30 variety: it had a leveraged long position and a short portfolio which together equaled 100% long exposure. That’s an expensive proposition whose success relies on your ability to get three or four things (extent of leverage, target market exposure, long and short security selection) consistently and repeatedly right. Lipper helpfully classifies it as a “Lipper Alternative Active Extension Fund.” It had a few good years rather precisely offset by bad years; in the end, the fund charged a lot (2.32% despite a mystifying Morningstar report of 1.25%), churned the portfolio (178% per year) but provided nothing special (its returns exactly matched the average 100% long large cap fund).

Larkin Point Equity Preservation Fund (LPAUX), a two-year-old long/short fund of funds, will neither preserve or persevere much longer. It has closed and expects to liquidate on November 16, 2015.

On October 16, 2015, Market Vectors got out of the Quality business as they bumped off the MSCI International Quality, MSCI Emerging Markets Quality Dividend, MSCI International Quality Dividend and MSCI Emerging Markets Quality ETFs.

The Board of Trustees of The Royce Fund recently approved the fund reorganizations effective in the first half of 2016. In the first half of 2016, Royce International Premier (RIPN) will eat two of its siblings: European Small Cap (RESNX) and Global Value (RGVIX). Why does it make sense for a $9 million fund with no star rating to absorb its $22 million and $62 million siblings? Of course, Royce is burying a one-star fund that’s trailed 90% of its peers over the past five years. And, too, a one-star fund that’s trailed 100% in the same period. Yikes. Global Value averaged 0.8% annually over the past five years; its average peer pumped out ten times as much.

While they were at it, Royce’s Board of Trustees approved a plan of liquidation for Royce Micro-Cap Discovery Fund (RYDFX), to be effective on December 8, 2015. The $5 million fund is being liquidated “primarily because it has not attracted and maintained assets at a sufficient level for it to be viable.” That suggests that International Micro Cap (ROIMX) with lower returns, two stars and $6 million in assets might be next in line.

Salient MLP Fund (SAMCX) will liquidate on December 1, 2015. Investors will continue to be able to access the management team’s skills through Salient MLP & Energy Infrastructure Fund II (SMAPX) which has over a billion in assets. It’s not a particularly good fund, but it is better than SAMCX.

Schroder Global Multi-Cap Equity Fund (SQQJX) liquidated on October 27, 2015, just days short of its fifth anniversary.

Sirios Focus Fund (SFDIX) underwent “final liquidation” on Halloween, 2015. It’s another fund abandoned after two years of operation.

Tygh Capital Management has recommended the liquidation of its TCM Small-Mid Cap Growth Fund (TCMMX). That will occur just after Thanksgiving.

Touchstone Growth Allocation Fund (TGQAX) is getting absorbed by Touchstone Moderate Growth Allocation Fund (TSMAX) just before Thanksgiving. Both have pretty sad records, but Growth has the sadder of the two. At the same time, Moderate Growth brings in managers Nathan Palmer and Anthony Wicklund from Wilshire Associates. Wilshire replaces Ibbotson Associates (a Morningstar company) as the fund’s advisor. Both are funds-of-mostly-Touchstone funds. After the repositioning, Moderate Growth will offer 40% non-US exposure with 45-75% of its assets in equities. Currently Growth is entirely equities.

UBS Multi-Asset Income Fund (MAIAX) will liquidate on or about December 3, 2015.

The Virtus Disciplined Equity Style (VDEAX), Virtus Disciplined Select Bond (VDBAX) and Virtus Disciplined Select Country (VDCAX) funds will close on November 20th and will liquidate by December 2, 2015. They share about $7 million in assets and a record of consistent underperformance.

Virtus Dynamic Trend Fund (EMNAX) will merge into Virtus Equity Trend Fund (VAPAX), they’re hoping sometime in the first quarter of 2016. I have no idea of why, since EMNAX has $600 million and a better record than VAPAX.

In Closing . . .

In a good year, nearly 40% of our Amazon revenue is generated in November and December. That’s in part because I endlessly nag people about how ridiculously simple, painless and useful it is to bookmark our Amazon link or set it as one of your tabs that opens whenever you start your favorite browser.

Please don’t make me go find some cute nagging-related image to illustrate this point. Just bookmark our Amazon link or set it as an opening tab. That would help so me. Here’s the link http://www.amazon.com/?_encoding=UTF8&tag=mutufundobse-20. Alternatively, you can click on the banner.

A quick tip of the cap to folks who made tax-deductible contributions to the Observer this month: regular subscribers, Greg and Deb; PayPal contributors, Beatrice and David; and those who preferred to mail checks, Marjorie, Tom G. and the folks at Ultimus Fund Solutions. We’re grateful to all of you.

Schwab IMPACT logoThe fund managers I’ve spoken with are nearly unanimous in their loathing of Schwab. Words like “arrogant, high-handed and extortionate” capture the spirit of their remarks. I hadn’t dealt with the folks at Schwab until now, so mostly I nodded sympathetically. I now nod more vigorously.

It’s likely that we’ll be in the vicinity of, but not at, the Schwab IMPACT conference in November. We requested press credentials and were ignored for a good while. Then after poking a couple more times, we were reminded of how rare and precious they were and were asked to submit examples of prior conference coverage. We did, on September 28th. That’s the last we heard from them so we’ll take that as a “we’re Schwab. Go away, little man.” Drop us a note if you’re going to be there and would like to chat at some nearby coffee shop.

We’ll look for you.

David

February 1, 2015

Dear friends,

Investing by aphorism is a tricky business.

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

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

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

And Gore, accepting the Nobel Prize:

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

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

Weiji, Will Robinson! Weiji!

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

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

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

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

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

Snowball and the power of positive stupidity

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

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

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

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

It’s a nice feeling. 

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

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

Pure equity:

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

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

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

Pure income

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

rphyx

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

rsivx

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

Impure funds

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

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

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

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

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

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

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

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

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

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

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

edward, ex cathedraStrange doings, currency wars, and unintended consequences

By Edward A. Studzinski

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

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

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

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

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

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

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

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

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

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

You are not building an investment ark, where you need two of everything.

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

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

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

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

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

Genius, succession and transition at Third Avenue

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

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

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

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

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

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

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

tavfx

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Where are they now?

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

linkedin

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

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

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

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

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

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

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

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

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

Top developments in fund industry litigation

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

Decision

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

Settlement

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

Briefs

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

Answer

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

The Alt Perspective: Commentary and news from DailyAlts.

dailyaltsBy Brian Haskin, editor of DailyAlts.com

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

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

Asset Flows 2014

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

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

Asset Flows and Growth Rates 2014

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

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

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

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

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

Observer Fund Profiles

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

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

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

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

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

Conference Call Highlights: Bernie Horn, Polaris Global Value

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

Highlights:

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

A couple caller questions struck me as particularly helpful:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

HOW CAN YOU JOIN IN?

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

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

WOULD AN ADDITIONAL HEADS UP HELP?

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

Funds in Registration

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

Manager Changes

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

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

Briefly Noted . . .

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

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

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

SMALL WINS FOR INVESTORS

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

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

CLOSINGS (and related inconveniences)

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

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

OLD WINE, NEW BOTTLES

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

OFF TO THE DUSTBIN OF HISTORY

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

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

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

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

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

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

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

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

In Closing . . .

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

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

out the front window

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

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

Until then, be safe!

David