January, 2011

By Editor

. . . from the archives at FundAlarm

David Snowball’s
New-Fund Page for January, 2011

Dear friends,

Welcome to the New Year! Having survived The Death Cross and the Hindenburg Omen, as well as Elliott Wave theorists’ prediction of a civil war, we enter a new year heartened by a New York Times’ prediction that “most of the good news is already behind us” (“Why Investor Optimism May Be a Red Flag,” 12/25/10). Before embracing the cover stories that tell us “Where to Invest in 2011” (Kiplinger’s) or direct us to “Make Money in 2011” (Money), I thought we might take a look at the decade just passed.

This just in: sometimes academics are right!

Academic researchers seem comfortable with a series of conclusions: over time, small beats large, value beats growth, cheap beats costly, focused beats unfocused, and so on. The combination of our miserable communication skills (“Ex ante asset pricing models provide the normative basis for the commonly used ex post estimation models”) and overweening sense of self-importance (see Robert Arnott) sometimes masks the fact that researchers can have useful things to say. So here’s a quick decennial perspective on the research.

Researcher’s say, expect small to outperform large, value to outperform growth, small value is optimal.

Hey, it did!

Morningstar’s “investment radar” offers a really striking visual representation of the effect. If you set the radar to show all domestic funds, then to show ten-year returns, you’ll see a thousand colored dots each representing one fund. The funds are divided by deciles (top 10% of all funds, next 10%…). If you turn off the middle 80%, leaving only the best 10% and the worst, a striking visual pattern emerges: there’s an almost perfect dividing line from the northwest corner down to the southeast corner. Virtually everything on the left of the line (smaller, lower priced) is bright green, virtually everything on the right (larger, growthier) is bright red.

Almost nothing that favored smaller and cheaper failed. The only wretched funds in that half of the universe were NYSA (NYSAX) whose website has vanished, ING Small Cap Opportunities (five share classes), PFW Water (PFWCX) which used to be the really bad Bender Growth fund before becoming the really bad Water fund, Oberweis Small Cap Opportunity (OBSOX) and Maxim Small Cap Growth(MXSGX) whose manager claims to run “top performing institutional small cap growth portfolios.”

A nearly identical number of funds represented the few bright spots on the larger, growth side. These include Baron Opportunity(BIOPX) and Wasatch Small Growth (WAAEX) are the growthiest survivors. Yacktman (YACKX), Yacktman Focused(YAFFX),Fairholme (FAIRX), MassMutual Select Focused Value(five share classes) and Columbia Strategic (CSVFX) are the large cap winners.

The most striking difference between the winners and the losers: with the exception of the Water fund (constrained by the limited number of watery stocks available) the losers traded at two- to ten-times (125-250% turnover) the rate of the winners (8-75% turnover), and had substantially more expansive portfolios (150 for losers versus 50 for winners).

Researchers say, expect the slow, steady advantages of index funds to win out in the long run

One simple test is to ask how, over the long term, Vanguard’s index funds have fared against the actively-managed universe. Of 23 Vanguard index funds with a record of 10 years or more, 18 have posted average (S&P500, Extended Market) or better (16 others) performance. That is, about 77% are okay to excellent. The laggards in the group are a motley collection: Value, Small Value, Europe, Pacific, and Social Choice.

The second test, though, is to look at Vanguard’s index funds against their comparable actively-managed funds. For this test, I focused on what might be considered “core” funds in a portfolio. Vanguard has 13 actively-managed large cap domestic equity funds and six index funds in the same space. Ten of the 13 actively-managed funds, about 77% by coincidence, have outperformed their indexed counterparts over the past decade. On average, the active funds returned 2.2% per year while the indexes earned 1.4%.

Vanguard’s active fund charge between 0.3 – 0.45% in expenses. If they charged the more-typical 1.25%, their advantage over the indexes would have been lost. So, if it’s not a game of inches, it’s certainly a game of pennies.

Researchers say, Expect focus to win out over diversified.

And it did.

The best test I have is to compare sibling funds. In four instances, a particular manager runs too nearly identical funds, one diversified and one focused. If the researchers are right, the managers’ focused funds should prevail over his more diffuse portfolios. The four sets of funds are Mainstay ICAP Equity and Select, Marsico Growth and Focus, Oakmark and Select, Yacktman and Focused. In every case, the focused fund outperformed the diversified one, though often by fractions of a percent per year.

Researchers say: don’t buy based on past returns. It’s such a powerful temptation that the SEC requires funds to tell investors that a fund’s past performance does not necessarily predict future results.

I looked at the top large cap core funds of the 1990s, and tracked their performance over the past 10 years. Here are their subsequent absolute returns and performance relative to their peers.

10 year return 10 year rank
Hartford Capital Appreciation (ITHAX) 5.23% Top 10% , the fund has been run by the same group of Wellington managers since 1996
Legg Mason Value(LMVTX) (1.65) Bottom 5% overall, with bottom 1% returns in four of the past five years.
Oppenheimer Main Street (MSIGX) 1.64% A bit above average.
Putnam Investors(PINVX) (1.36) Bottom 5% — though rallying. The winning team was gone (without a trace) by 2002 with 10 individuals cycling through since then. Currently it’s no more than a high cost index fund (1.27% expenses despite assets of $4 billion and an index correlation of 98)
RS Large Cap Alpha(GPAFX) 1.32% A bit below average – with six complete management changes in 10 years.

The odds are unlikely to improve. The 25 best funds of the 2000s clocked over 20% annual returns through “the lost decade,” but did it by investing in gold and dictatorships (primarily Russia and China, though I lumped emerging markets in general into this category). While it’s not impossible that one asset class and two countries will rise 750% over the next decade – the outcome of 20% or better growth – it seems vanishingly unlikely.

284 funds beat the 10% threshold that defines the long-term returns of the US stock market. The best diversified equity funds in the bunch were Bridgeway Ultra-Small (BRUSX at 15.6%), CGM Focus (CGMFX, 15%), FBR Focus (FBRVX, 15%), Satuit Microcap(SATMX, 14.7%), Perritt Microcap (PRCGX, 14.5%) and Heartland Value Plus (HRVIX, 14.4%). For the record, that’s four microcap funds, one mid-cap fund whose star manager was squeezed out (and now runs Akre Focus, AKREX) and one fund so volatile (about twice the market’s standard deviation and a 500% annual turnover rate) that is has virtually no long-term investors.

One good strategy is to avoid the previous decade’s biggest losers, a simple notion that has evaded millions of investors.

Vanguard’s worst diversified loser of the decade: Vanguard U.S. Growth (VWUSX), which is closer to Vanguard U.S. Decline with an annualized loss of 3.7%. And $4 billion in assets. Fidelity contributes Fidelity Decline Strategies . . . sorry, Fidelity Growth Strategies(FDEGX), formerly Fidelity Too-Aggressive Growth and Fidelity Submerging Growth, to the list with 5.4% annual losses and over $2 billion in assets. American Century Select (TCWIX) pares $2 billion assets with a half-percentage annual loss. The Janus Fund(JANDX) has dropped 1.1% per year while Legg Mason All Cap (SPAAX) holds a half billion while steadily shrinking by 2.5% per annum.

Legg Mason added Bill Miller to the management team here at the start of 2009, and the fund rallied mightily. At the same time, Miller announced his own successor at the flagship Legg Mason Capital Management Value “C” class shares (LMVTX, formerly just Legg Mason Value). Remarkably low returns remain paired there with remarkably high fees.

Less venturesome folks might have done with boring ol’ planners and scholars suggested: diversify across asset classes, rebalance periodically, keep your expenses down. Funds that followed that simple discipline, and which I’ve used as benchmarks, had an okay decade:

Vanguard Balanced Index (VBINX): up 4.2%

Fidelity Global Balanced (FGLBX) : up 6.7%

Vanguard STAR (VGSTX): up 5.3%

T. Rowe Price Capital Appreciation (PRWCX): up 8.9%

Another possible hedge against this disturbing reality is to consider investing some of your portfolio with companies that get it right. There are a set of boutique firms which have consistently by sticking to their discipline and building stable, supportive management teams. Among the fund companies whose products we’ve profiled, there are a number whose funds beat their benchmarks consistently over the long term. Below are four such companies. Artisan Partners hires only experienced teams of risk-conscious managers and has a tradition of shareholder friendly practices (low minimums, falling expenses, closing funds). Matthews knows Asia better than anyone.Harris Associates understands value. Royce does small and value with passion and discipline. Here’s a recap of their funds’ performance:

Number of funds Winners since inception Winners over 10 years
Artisan 11 11/11 6/6
Matthews 11 9/11 6/6
Oakmark 7 7/7 6/6
Royce 27 19/22 9/9

The poorest Royce funds are only a year or two old. The poorest Matthews ones are single country funds.

There are no guarantees. Ten years ago I might have (though, in truth, wasn’t) writing about Oak Associates or Janus. But there are ways to at least tilting the odds in your favor.

The research says so!

2010: the cloudy crystal ball

It’s the time of year when every financial publication promises to make you rich as Croesus in the year ahead. As a reality check just ahead of that exercise, you might want to consider the one thing the publications rarely mention: the track record of their set of “best funds for 2010.”

For each of four major publications, I created an equally weighted portfolio of their 2010 fund picks and compared it to the simplest-available benchmark: a balanced index for portfolios with balance, and a stock or bond index otherwise. They appear in rank-order, by performance. Performance is as of 12/20/2010.

  • Kiplingers. Steven Goldberg, “The 5 Best Stock Funds for 2010,” Kiplinger.com December 18, 2009
Absolute 2010 return Relative 2010 return
Primecap Odyssey Growth (POGRX) 15.5% Middle third
T. Rowe Price Small-Cap Value (PRSVX) 24.5 Middle third
T. Rowe Price Emerging Markets Stock (PRMSX) 15.5 Middle third
Fairholme (FAIRX) 21.5 Top 1%
Masters’ Select International (MSILX) 13.0 Top 10%
Portfolio return:
Vanguard Total World Index (VT) 11% Top third

Comments: good recovery, Mr. G! His 2009 picks including Primecap and Price Emerging Markets, but also two terribly disappointing funds: CGM Focus and Bridgeway Aggressive Investors I. He seems to have dialed-back the risk for 2010, and profited from it.

  • Morningstar. “Where to Invest, 2010.”

This is a long Morningstar stand-alone document, including both market analyses and individual equity recommendations as well as the industry’s longest list of fund recommendations.

Absolute 2010 return Relative 2010 return
Mutual Quest TEQIX 9% Bottom third
T Rowe Price Spectrum Income RPSIX 8.5 Bottom third
Dodge & Cox Income DODIX 6.5 Middle third
Fidelity Government Income FGOVX 5 Middle third
Manning & Napier Worldwide EXWAX 7.5 Middle third
Artisan International Value ARTKX 17.5 Middle third
Wasatch Small Cap Growth WAAEX 29 Middle third
Schwab Total Market Index SWTSX 16 Top third
Royce Premier RYPRX 26 Top third
Vanguard Inflation-Protected Securities VIPSX 6 Top third
Vanguard Convertible Securities VCVSX 18 Top third
Longleaf Partners LLPFX 16.5 Top 10%
Portfolio return: 14%
Vanguard Balanced Index 12.5% Top third

Comments: a nicely-done, T. Rowe Price-ish sort of performance. The collection succeeds less by picking a few “shoot out the lights” stars and more by avoiding silly risks. When your two worst funds are rock-solid, risk-conscious gems, you’re doing good.

  • Money. “Make Money in 2010,” Money magazine, December 2009
Absolute 2010 return Relative 2010 return
FPA New Income (FPNIX) 3.0% Bottom 1%
FMI Large Cap (FMIHX) 11 Bottom third
Jensen (JENSX) 12 Bottom third
T. Rowe Price New Era (PRNEX) 17.5 Middle third
iShares Barclays TIPS Bond (TIP) 5.5 Middle third
Templeton Global Bond (TPINX) 11 Top 5%
Portfolio return:
Vanguard Balanced Index 12.5% Top third

Comments: The folks at Money assumed that high-quality investments – blue chip multinationals, AA bonds – were finally due for their day in the sun. “Don’t hold your breath waiting for gains much beyond 6% in either stocks or bonds for 2010. …The key to surviving is to go for high quality, in both stocks and bonds.” Off by 300% on stocks – the Total Stock Market Index (VTSMX) was up near 18% in late December – but close on bonds. And wrong, for the moment, on quality: Morningstar’s index of high-quality stocks returned about 8% while junkier small-growth stocks returned four times as much.

  • Smart Money. “Where to Invest 2010,” Smart Money, January 2010.
Absolute 2010 return Relative 2010 return
T. Rowe Price Short-Term Bond (PRWBX) 3% Bottom third
Vanguard GNMA (VFIIX) 6.5 Top third
iPath S&P 500 VIX Short-Term Futures ETN (VXX) (72.5) Worst fund in the world
Vanguard Total Bond Market (VBMFX) 6%

Comments: I despaired of this particular essay last year, claiming that “It’s hard to imagine a more useless article for the average investor.” The difficulty is that Smart Money offered four broad scenarios with no probabilities. “If you think that we’ll plod along, then…” without offering their expert judgment on whether plodding would occur. Thanks, Dow Jones!

The funds, above, come from elsewhere in the “Where to” issue and received positive reviews there.

The Strange Life and Quiet Death of Satuit Small Cap

Readers of FundAlarm’s discussion board pointed out, recently, that I failed to eliminate the archived profile of Satuit Small Cap. Sorry ‘bout that!

In reality, Small Cap turned out to be the firm’s lonely step-child. It was an adopted child, have begun life as the Genomics Fund,world’s first and only mutual fund specializing in investing in the dynamic, new genomics industry!” After years of wretched performance, Satuit Microcap’s manager took over the fund and, eventually, rebranded it as Satuit Small Cap. I could do so because an exciting genomics fund is virtually identical to a diversified small cap one with virtually no genomics investments. We know that’s true because the fund solemnly attested to the fact: “The Fund was reorganized as a separate series of the Satuit Capital Management Trust on November 1, 2007. The Fund has the same investment strategy as the Predecessor Fund.” Similarly, PFW Water fund (ridiculed above) had the same strategy as Bender Growth, give or take investing in water.

The firm’s passion for the fund seemed limited from the start: there was little information about it at Satuit’s website, the website continued to refer to Microcap as if it were the firm’s only product, and the manager declined the opportunity to invest it in. There’s limited information about the new fund on the website. For example, most of the site’s text says “the” fund when referring to Satuit Microcap.

The manager’s last letter to his few investors (the fund had under $2 million, down by more than 60%) was full of . . . uh, full of . . . optimism!

I began writing this letter on Tuesday September 15th, 2009.  What a difference a year makes.  Last year I was writing about Monday September 15th, 2008.  It was the day that Lehman Bros filed for Chapter 11 Bankruptcy and Bank of America bought Merrill Lynch. And I said, “My sense is that by the time you read this letter, those events will be water-under-the-bridge, much like the JP Morgan acquisition of Bear Stearns and the Treasury take-over of Fannie Mae and Freddie Mac are today.”  Fortunately, these events are water under a very high bridge.  I’m glad it’s all behind us!


Robert J. Sullivan

Chief Investment Officer

Portfolio Manager, SATSX

Eight weeks late, the Board – presumably at Mr. Sullivan’s recommendation – liquidated the fund. There was no explanation for why the fund wasn’t simply merged into its successful sibling.

Briefly noted:

  • Causeway has added an “investor” share class to their Global Value (CGVIX) fund. Up until now, Global Value has required a $1 million minimum. The fund is not quite two years old and has been a respectable but unspectacular performer. The new share class charges 1.35% with a $5000 investment minimum.
  • Brett Favre is not the only weary warrior leaving the field one last (?) time. Michael Fasciano decided in October to liquidate the new Aston/Fasciano SmallCap Fund (AFASX). Mike explained it as a matter of simple economics: despite respectable returns in its first three quarters of operation, Aston was able to attract very little interest in the fund. Under the terms of his operating agreement, Mike had to underwrite half the cost of operating AFASX. Facing a substantial capital outflow and no evidence that assets would be growing quickly, he made the sensible, sad, painful decision to pull the plug. The fund ends its short life having made a profit for its investors, a continuation of a quarter-century tradition of which Mike is justifiably proud.
  • When a door closes, a window opens. Just as Aston/Fasciano liquidates, Aston/River Road Independent Value (ARIVX) launches! Eric Cinnamond, the founding manager of Intrepid Small Cap (ICMAX) left to join River Road in September. He’s been heading River Road’s “Independent Value” team and has just opened his new Independent Value fund. The fund focuses on high-quality small- to mid-cap stocks. The initial expense ratio is 1.41% with a $2500 investment minimum, which exactly match the terms and conditions of his former fund. Given Mr. Cinnamond’s top 1% returns, consistently low risk scores and string of five-star ratings from Morningstar, fans of his work have reason to be intrigued by the chance to access Mr. Cinnamond’s skills tied to a tiny asset base. With luck, we’ll profile his new fund in the months ahead.

In closing . . .

Ten years ago, the FundAlarm discussion board was abuzz. In his December “Highlights and Commentary,” Roy reviewed the recent scandal in Strong’s bond funds, which would eventually doom the firm, and lambasted a remarkable collection of sad-sack Internet funds (Monument Digital Technology or de Leon Internet 100, anybody?) Bob C warned of the imminent closing of Scudder Funds’ no-load shares. Roy offered T. Rowe Price Science & Tech as a stocking stuffer, which was certainly a better idea than most of the other options circulating on the board: Firsthand E-CommerceIPS MillenniumStrong Enterprise . . . Happily, most of the comments about those funds were deeply cautionary and much of the discussion center on tax-management, portfolio allocations and strong management teams. Ten years, and 280,000 posts (!) later, we’d like to recognize the good and thoughtful folks who have been sharing their reflections, now and over the decade past.

Below is a Wordle, a visual representation of data frequency generated at Wordle.net. I sampled the names appearing on our current discussion threads and added those prominent in December 2005 and December 2000. To you all, and to them all, thanks for making FundAlarm what it is!

{image removed}

A blessed New Year to all!