November, 2010

By Editor

. . . from the archives at FundAlarm

David Snowball’s
New-Fund Page for November, 2010

Dear friends,

Having survived what are, historically, the two worst months for equity investors, we now enter the “sweet spot” on the calendar. The great bulk of the stock market’s annual returns since 1927 have occurred in the late fall and winter months. In theory, we should all be happy and relieved. Instead, I keep hearing Warren Buffett in the background: “Investors should remember that excitement and expenses are their enemies. . . they should try to be fearful when others are greedy and greedy when others are fearful.” And so, just as we have reason to relax, I think I’ll work a bit on being anxious.

Abetted by financial advisors who are confronting “career risk” (that is, what happens when you annoy enough clients), investors continue to sell domestic equity funds – which have seen steady outflows in each of the past six months – and buy (overpriced) bonds. About the most hopeful sign is that the rates of outflow have slowed dramatically from $7 billion/week at the start of September to just $200 million/week now.

Sniping at the Absolute Return crowd

The pressure to find something new to say, pretty much every day, occasionally produces spectacularly weak arguments. Such was the case with Daisy Maxey’s recent dismissal of absolute return funds in the Wall Street Journal(“Absolute-Return Funds: Low Risk, Low Return,” October 29 2010). Ms. Maxey analyzes three funds (only one of which is an absolute return fund) and quotes as her authorities the manager of a small wealth management firm (albeit one that offers you “a business plan for life”) and a young man who just made the leap from “summer intern” to “new employee” at a well-respected financial research corporation. Her conclusion, unsupported by data or testimony, was that “such funds tend to minimize risk but aren’t likely to consistently deliver positive returns.” There are 16 funds with “Absolute Return” in their names, though she notes that there is no “absolute return” category or peer group in systems such as Morningstar’s, that many de facto absolute return funds don’t use the phrase in their names and that funds whose marketers have chosen the phrase “absolute return” often have nothing in common. Her one source does sniff that “a lot of absolute-return funds [are] coming out that will be what I call ‘no-return funds'” but that’s about it for evidence.

Ms. Maxey’s concern is either that the funds produce “low returns” or that they won’t “consistently deliver positive returns,” which are two very different complaints. I’ll take them in turn as we look at funds (in Morningstar’s system, market neutral, long/short, conservative allocation) whose goal is something like absolute returns.

First, most absolute return funds don’t promise high returns. They attempt to provide something greater than zero (that’s the “absolute” part), regardless of the market environment. Most of the managers I’ve spoken with would be very happy if they could produce consistent gains in the 5 to 7% range. It’s hardly a knock on the funds that they don’t produce something they never claim to produce.

The more serious objection is that they don’t produce absolute returns either. Unfortunately, the market crisis of 2008 – the worst mess in more than three –quarters of a century – makes it hard to generalize since pretty much everything except Treasuries cratered. By way of illustration, there are 422 funds that have produced positive returns in each of the past five years, of which 416 are bond funds. If you change the criteria to “four years of gains and no worse than single-digit losses in 2008,” you get a much more positive picture. Two dozen no-load funds pass the test.

Among the funds that use absolute return strategies, such as shorting the market, a handful survived 2008 and went on to produce gains in both 2009 and 2010. They are:

2008 2009 2010,through 10/29 3 year average
Driehaus Active Income LCMAX 0.4 22.1 4.0 8.4
Quaker Akros Absolute Strategies A AARFX,formerly no-load (2.9) 13.9 1.8 4.2
Vantagepoint Diversifying Strategies VPDAX (6.7) 6.6 4.8 n/a
TFS Market Neutral TFSMX (7.3) 16.6 3.5 4.8
Hussman Strategic Growth HSGFX (9.0) 4.6 2.2 (0.8)

None of the other no-load “Absolute Return” funds qualify under this screen.

Three funds with exceedingly broad mandates – a little stock with precious metals, bonds and cash – have made a case for themselves. Midas Perpetual Portfolio (PRPFX) and Mr. Hussman’s less ambitious Total Return fund, first profiled here in early 2008, are among the few funds never to have lost money in a calendar year. Both have strategies reflecting the Permanent Portfolio (PRPFX ) approach. PRPFX is a fund which makes me slightly crazy (see Permanent Portfolio: Unlikely Superstar? in the September 2010 essay), but which has made its investors a lot of money.

2008 2009 2010,through 10/29 3 year average
Hussman Strategic Total Return HSTRX 6.3 5.8 7.9 7.5
Midas Perpetual Portfolio MPERX 1.2 17.0 6.1 9.1
Permanent Portfolio PRPFX (8.4) 19.1 13.8 7.4

Another fine year for The Fund Morningstar Loves to Hate

Let’s say you had a mutual fund that posted the following returns:

Period Absolute Return Relative Return
Past year 19.4% Top 1% of peer group
Three years (5.3) Top 10%
Five years 9.1 Top 1%
Ten years 11.5 Top 1%
Fifteen years 11.9 Top 1%

And let’s assume that the fund had a substantially below-average expense ratio, and a five-star rating. Add to our fantasy: above average returns in 11 of the past 12 years and top 5% returns about two-thirds of the time. And, what the heck, high tax-efficiency.

How might the good folks at Morningstar react? Oh, about the same way you react when, in a darkened room in the middle of the night you step on something squishy. Which is to say, with disgust.

The fund in question is Fidelity Canada (FICDX) and its record has been spectacular. The tiny handful of international funds with comparable 15-year records include First Eagle Global (SGENX), Matthews Asian Growth & Income(MACSX), First Eagle Overseas (SGOVX) and Janus Overseas (JAOSX). Which leads Morningstar to observe:

  • This is one of two funds focused on Canada. If we had to pick, we’d choose the other one. (2009)
  • Approach this mutual fund with caution. (2007)
  • Do you really need a Canada fund, especially now? (2006) Answer: no, “it’s unnecessary and risky.”
  • This mutual fund has been on a hot streak, but cool north winds could easily prevail. (2005)
  • A reversal of fortune. (2004)
  • Should you be looking at this chart-topper? (2003) Answer: no, “it’s hard to justify owning” it.
  • Beating its index-tracking rival handily. (2002) Nonetheless, “it’s a tough sell.”
  • This fund’s purpose can be questioned, but not its execution. (2001)
  • Fidelity Canada has shown resilience in the face of adversity. (2001) Though the fund still “doesn’t have broad appeal.”
  • Fidelity Canada’s high return doesn’t make it a compelling choice. (2001) “It’s hard to make a case for buying this fund.”
  • Even the most loyal Canadian would have a tough time defending Fidelity Canada Fund. (1998)
  • Fidelity Canada Fund is unusual, but it’s not clear if its appeal goes beyond that. (1997)
  • Fidelity Canada Fund looks–and acts–a lot like a natural-resources offering. (1997)
  • Fidelity Canada Fund’s sector bets are giving it a bad case of frostbite. (1997)
  • Fidelity Canada Fund looks more like Siberia. (1996)
  • Fidelity Canada Fund makes about as much sense as a spring break in Saskatoon (1996)

Morningstar’s latest complaint: the manager Doug Lober “isn’t introspective enough.” I think this is the first time I’ve seen Morningstar complain about a manager’s mental acuity. The dim bulb has, by the way, placed the fund in the top 5% of international large-core funds in 2010.

In the meanwhile, Greg Frasier, who managed Fidelity Diversified International (FDIVX) and who was described by Morningstar as “a legend,” attributed his fund’s consistent outperformance to two factors: the wise use of ADRS, and a willingness to invest in Canada. The case for investing in Canada might not be a slam-dunk, but it’s surely better than “spring break in Saskatoon.”

Small, newer funds can be good investments!

Well duh.

Two new studies prove the obvious: old and large aren’t requirements for investment success.

Northern Trust, based in Chicago, specializes in picking fund managers rather than picking individual securities. Their recent study of large-cap manager performance and size, No Contest: Emerging Managers Lap Investment Elephants, concludes that smaller investment firms have better five-year records than either managers at larger firms or the S&P 500, have better performance during bear markets, and are more likely than larger managers to end up in the top quarter of funds.

Lipper reached the same conclusion earlier this year. Their study of Europe-based funds, Ruling Out New Funds? Wrong Decision, finds “[n]o evidence . . . that funds with long track records enjoy better performance or incur less risk than new funds. On the contrary, the empirical data suggest that newly- launched funds post higher average total returns and lower risk data.”

Fund managers respond to charge: “We are not a stegosaurus”

Barron’s writer Tom Sullivan just announced, “It’s Adapt or Die for Fund Businesses” (October 30, 2010). Drawing on a survey of 1000 “distribution professionals” conducted by Strategic Insight, a New York-based research and consulting firm, Sullivan reports that equity funds – which used to draw 65% of inflows – now draw only 25%. The brands of many larger firms have suffered damage that will take years to undo, while smaller and midsized firms have a competitive advantage.

Fund companies seem to be endorsing Mr. Sullivan’s prognosis. One sign of that: the number of long-only equity managers who are suddenly enamored of funky global strategies. Among the funds, newly-launched or still in registration, are:

Aston/River Road Long-Short Fund, in registration and likely to launch around year’s end.

Causeway Global Absolute Return Fund, likewise in registration.

Fairholme Allocation Fund, which will invest in anything, anywhere, in any direction.

Forward Commodity Long/Short Strategy Fund which tracks the Credit Suisse Momentum and Volatility Enhanced Return Strategy Index.

GRT Absolute Return Fund, run by three brilliant equity investors.

Navigator Equity Hedged, which will buy ETFs and put options.

River Park/Gravity Long-Biased Fund, one of five new funds from an advisor founded by Baron Asset alumni.

That’s in addition to Third Avenue’s decision to launch an unconventional income fund (Third Avenue Focused Credit), Fairholme’s to launch a Focused Income fund, and Driehaus’s to buy an “active income” fund in 2009 and to give the same team a second fund (Driehaus Select Credit). Even some “alternative” managers are branching out, as in the case of Arbitrage Event-Driven or RiverNorth/DoubleLine Strategic Income Fund.

Two questions that potential investors had better answer before opening their wallets: (1) is there any reason to believe that success in long-only equity investing translates to success anywhere else (answer: not particularly) and (2) is there reason to be concerned that adding the obligation to manager complex new vehicles may over-extend the managers and weaken their performance across the board (answer: no one is sure, would you like to figure it out with your money?).

Briefly Noted:

Move over, Geico gecko, here comes Jerry Jordan. Mr. Jordan is now running TV commercials for his five-star Jordan Opportunity (JORDX) fund. The spots, airing on Bloomberg TV, reported show an investor using and finding Jordan Opportunity. Why Morningstar rather than FundAlarm for the spot? “[I]f you’re quoting Morningstar,” the ad agency’s president opines, “you’re basically quoting the Bible.” (I knew I shouldn’t have brought my copy of The Satanic Verses to our last staff meeting!)

Hakan Castegren, manager of the Harbor International Fund and Morningstar’s International Stock Fund Manager of the Year award for 1996 and 2007, passed away October 2, one week shy of his 76th birthday. He was, by all accounts, a good man and a phenomenal manager. His firm, Northern Cross, will continue to sub-advise the Harbor fund.

On October 7, Reuters reported “AQR seeks smaller investors.” Ten days later Investment News updated the search for smaller investors: “Retail investors will no longer be able to buy mutual funds from AQR.” AQR is, of course, AQR Capital Management, a $29 billion institutional quant investor which launched a line of retail funds in 2009. Apparently the numbers weren’t looking good, and the company shifted all of its sales to the advisor-sold channel.

The Board of Trustees approved the liquidation of a slug of PowerShares ETFs, with the executions to occur just before Christmas. The walking dead include

  • Dynamic Healthcare Services Portfolio (PTJ)
  • Dynamic Telecommunications & Wireless Portfolio (PTE)
  • FTSE NASDAQ Small Cap Portfolio (PQSC)
  • FTSE RAFI Europe Portfolio (PEF)
  • FTSE RAFI Japan Portfolio (PJO)
  • Global Biotech Portfolio (PBTQ)
  • Global Progressive Transportation Portfolio (PTRP)
  • NASDAQ-100 BuyWrite Portfolio (PQBW)
  • NXQ Portfolio (PNXQ)
  • Zacks Small Cap Portfolio (PZJ)

Standard & Poor’s recently announced finalists for its U.S. Mutual Fund Excellence Awards Program. Three funds were designated as “new and notable.” They are Dodge & Cox Global (DODWX), Northern Global Sustainability Index Fund(NSRIX) and T. Rowe Price US Large-Cap Core (TRULX).

Those folks at Mutual Fund Wire need to get out more. Writer Hung Tran trumpeted the fact that “[r]ookie mutual fund shop Simple Alternatives is making headlines with its first product: a mutual fund of hedge funds.” The great advantage of their fund (called “S1”) is that it offers “mutual fund-like liquidity terms and fees. The new fund, which debuted on Monday, reportedly charges just 2.95 percent and offers daily redemptions without notice.” Earth to MFWire: 2.95% is extortionate and shouldn’t be preceded by the word “just.” Out of 6250 mutual funds, only 30-odd have expenses this high and they’re generally sad little fly-specks.

The folks at Ironclad Investments (“ironclad” as in the Civil War era navy vessels) just launched two risk-managed funds which use the popular institutional strategy of buying and selling options to limit their volatility while still participating in the market. Ironclad Managed Risk Fund (IRONX, precariously close to IRONY) sells covered put options on a variety of indexes while Ironclad Defined Risk Fund (CLADX) purchases of call options and sells call and put options on ETFs and equity indexes. Both are run by Rudy Aguilera and Jon Gold, both charge 1.25% and have $2500 investment minimums. Since I’d missed them in the “Coming Attractions,” it felt right to acknowledge them here.

In closing . . .

We celebrate the passing of a milestone. FundAlarm’s discussion board recorded its 300,000th message late in October (ironically, one asking about the 300,000th message), then quickly tagged on another 500 messages as folks sorted through their options for finding funds invested in “high quality” American companies and ones holding “rare earth metals” stocks. The board is wonderfully dynamic and diverse. If you haven’t visited, you should. If you have visited but consigned yourself to lurking, speak up, dude! It’s not a discussion without you.