Monthly Archives: September 2013

“Skin in the Game, Part One”

By Edward A. Studzinski

“Virtue has never been as respectable as money.” Mark Twain

One of the more favored sayings of fund managers is that they like to invest with managements with “skin in the game.” This is another instance where the early Buffett (as opposed to the later Buffett) had it right. Managements can and should own stock in their firms. But they should purchase it with their own money. That, like the prospect of hanging as Dr. Johnson said, would truly clarify the mind. In hind sight a major error in judgment was made by investment professionals who bought into the argument that awarding stock options would beneficially serve to align the interests of managements and shareholders. Never mind that the corporate officers should have already understood their fiduciary obligations. What resulted, not in all instances but often enough in the largest capitalization companies, was a class of condottieri such as one saw in Renaissance Italy, heading armies that spent their days marching around avoiding each other, all the while being lavishly paid for the risks they were NOT facing. This sub-set of managers became a new entitled class that achieved great personal wealth, often just by being present and fitting in to the culture. Rather than thinking about truly long-term strategic implications and questions raised in running a business, they acted with a short-duration focus, and an ever-present image of the current share price in the background. Creating sustainable long-term business value rarely entered into the equation, often because they had never seen it practiced.

I understood how much of a Frankenstein’s monster had been created when executive compensation proposals ended up often being the greater part of a proxy filing. A particularly bothersome practice was “reloading” options annually. Over time, with much dilution, these programs transferred significant share ownership to management. You knew you were on to something when these compensation proposals started attracting negative vote recommendations. The calls would initially start with the investor relations person inquiring about the proxy voting process. Once it was obvious that best practices governance indicated a “no” vote, the CFO would call and ask for reconsideration.

How do you determine whether a CEO or CFO actually walks the walk of good capital allocation, which is really what this is all about? One tip-off usually comes from discussions about business strategy and what the company will look like in five to ten years. You will have covered metrics and standards for acquisitions, dividends, debt, share repurchase, and other corporate action. Following that, if the CEO or CFO says, “Why do you think our share price is so low?” I would know I was in the wrong place. My usual response was, “Why do you care if you know what the business value of the company is per share? You wouldn’t sell the company for that price. You aren’t going to liquidate the business. If you did, you know it is worth substantially more than the current share price.” Another “tell” is when you see management taking actions that don’t make sense if building long-term value is the goal. Other hints also raise questions – a CFO leaves “because he wants to enjoy more time with his family.” Selling a position contemporaneously with the departure of a CFO that you respected would usually leave your investors better off than doing nothing. And if you see the CEO or CFO selling stock – “our investment bankers have suggested that I need to diversify my portfolio, since all my wealth is tied up in the company.” That usually should raise red flags that indicate something is going on not obvious to the non-insider.

Are things improving? Options have gone out of favor as a compensation vehicle for executives, increasingly replaced by the use of restricted stock. More investors are aware of the potential conflicts that options awards can create and have a greater appreciation of governance. That said, one simple law or regulation would eliminate many of the potential abuses caused by stock options. “All stock acquired by reason of stock option awards to senior corporate officers as part of their compensation MAY NOT BE SOLD OR OTHERWISE DISPOSED OF UNTIL AFTER THE EXPIRATION OF A PERIOD OF THREE YEARS FROM THE INDIVIDUAL’S LAST DATE OF SERVICE.” Then you might actually see the investors having a better chance of getting their own yachts.

Edward A. Studzinski

September 1, 2013

By David Snowball

Dear friends,

richardMy colleagues in the English department are forever yammering on about this Shakespeare guy.I’m skeptical. First, he didn’t even know how to spell his own name (“Wm Shakspē”? Really?). Second, he clearly didn’t understand seasonality of the markets. If you listen to Gloucester’s famous declamation in Richard III, you’ll see what I mean:

Now is the winter of our discontent
Made glorious summer by this sun of York;
And all the clouds that lour’d upon our house
In the deep bosom of the ocean buried.
Now are our brows bound with victorious wreaths;
Our bruised arms hung up for monuments;
Our stern alarums changed to merry meetings,
Our dreadful marches to delightful measures.

It’s pretty danged clear that we haven’t had anything “made glorious summer by the sun of [New] York.” By Morningstar’s report, every single category of bond and hybrid fund has lost money over the course of the allegedly “glorious summer.” Seven of the nine domestic equity boxes have flopped around, neither noticeably rising nor falling.

And now, the glorious summer passed, we enter what historically are the two worst months for the stock market. To which I can only reply with three observations (The Pirates are on the verge of their first winning season since 1992! The Steelers have no serious injuries looming over them. And Will’s fall baseball practices are upon us.) and one question:

Is it time to loathe the emerging markets? Again?

Yuh, apparently. A quick search in Google News for “emerging markets panic” turns up 3300 stories during the month of August. They look pretty much like this:

panic1

With our preeminent journalists contributing:

panic2

Many investors have responded as they usually do, by applying a short-term perspective to a long-term decision. Which is to say, they’re fleeing. Emerging market bond funds saw a $2 billion outflow in the last week of August and $24 billion since late May (Emerging Markets Fund Flows Investors Are Dumping Emerging Markets at an Accelerating Pace, Business Insider, 8/30/13). The withdrawals were indiscriminate, affecting all regions and both local currency and hard currency securities. Equity funds saw $4 billion outflows for the week, with ETFs leading the way down (Emerging markets rout has investors saying one word: sell, Marketwatch, 8/30/13).

In a peculiar counterpoint, Jason Kepler of Investment News claims – using slightly older data – that Mom and pop can’t quit emerging-market stocks. And that’s good (8/27/13). He finds “uncharacteristic resiliency” in retail investors’ behavior. I’d like to believe him. (The News allows a limited number of free article views; if you’d exceeded your limit and hit a paywall, you might try Googling the article title. Or subscribing, I guess.)

We’d like to make three points.

  • Emerging markets securities are deeply undervalued
  • Those securities certainly could become much more deeply undervalued.
  • It’s not the time to be running away.

Emerging markets securities are deeply undervalued

Wall Street Ranter, an anonymous blogger from the financial services industry and sometime contributor to the Observer’s discussion board, shared two really striking bits of valuation data from his blog.

The first, “Valuations of Emerging Markets vs US Stocks” (7/20/13) looks at a PIMCO presentation of the Shiller PE for the emerging markets and U.S., then at how such p/e ratios have correlated to future returns. Shiller adjusts the market’s price/earnings ratio to eliminate the effect of atypical profit margins, since those margins relentlessly regress to the mean over time. There’s a fair amount of research that suggests that the Shiller PE has fair predictive validity; that is, abnormally low Shiller PEs are followed by abnormally high market returns and vice versa.

Here, with Ranter’s kind permission, is one of the graphics from that piece:

USvsEmergingMarketsShiller

At June 30, 2013 valuations, this suggests that US equities were priced for 4% nominal returns (2-3% real), on average, over the next five years while e.m. equities were priced to return 19% nominal (17% or so real) over the same period. GMO, at month’s end, reached about the same figure for high quality US equities (3.1% real) but a much lower estimate (6.8%) for emerging equities. By GMO’s calculation, emerging equities were priced to return more than twice as much as any other publicly traded asset class.

Based on recent conversations with the folks at GMO, Ranter concludes that GMO suspects that changes in the structure of the Chinese economy might be leading them to overstate likely emerging equity returns. Even accounting for those changes, they remain the world’s most attractive asset class:

While emerging markets are the highest on their 7 year forecast (approx. 7%/year) they are treating it more like 4%/year in their allocations . . . because they believe they need to account for a longer-term shift in the pace of China’s growth. They believe the last 10 years or so have skewed the mean too far upwards. While this reduces slightly their allocation, it still leaves Emerging Markets has one of their highest forecasts (but very close to International Value … which includes a lot of developed European companies).

Ranter offered a second, equally striking graphic in “Emerging Markets Price-to-Book Ratio and Forward Returns (8/9/13).”

EmergingPB

At these levels, he reports, you’d typically expect returns over the following year of around 55%. That data is available in his original article. 

In a singularly unpopular observation, Andrew Foster, manager of Seafarer Overseas Growth & Income (SFGIX/SIGIX), one of the most successful and risk-alert e.m. managers (those two attributes are intimately connected), notes that the most-loathed emerging markets are also the most compelling values:

The BRICs have underperformed to such an extent that their aggregate valuation, when compared to the emerging markets as a whole, is as low as it has been in eight years. In other words, based on a variety of valuation metrics (price-to-book value, price-to-prospective-earnings, and dividend yield), the BRICs are as cheap relative to the rest of the emerging markets as they have been in a long time. I find this interesting. . . for the (rare?) subset of investors contemplating a long-term (10-year) allocation to EM, just as they were better off to avoid the BRICs over the past 5 years when they were “hot,” they are likely to be better off over the next 10 years emphasizing the BRICs now they are “not.”

Those securities certainly could become much more deeply undervalued.

The graphic above illustrates the ugly reality that sometimes (late ’98, all of ’08), but not always (’02, ’03, mid ’11), very cheap markets become sickeningly cheap markets before rebounding. Likewise, Shiller PE for the emerging markets occasionally slip from cheap (10-15PE) to “I don’t want to talk about it” (7 PE). GMO mildly notes, “economic reality and investor behavior cause securities and markets to overshoot their fair value.”

Andrew Foster gently dismisses his own predictive powers (“my record on predicting short-term outcomes is very poor”). At the same time, he finds additional cause for short-term concern:

[M]y thinking on the big picture has changed since [early July] because currencies have gotten into the act. I have been worried about this for two years now — and yet even with some sense it could get ugly, it has been hard to avoid mistakes. In my opinion, currency movements are impossible to predict over the short or long term. The only thing that is predictable is that when currency volatility picks up, is likely to overshoot (to the downside) in the short run.

It’s not the time to be running away.

There are two reasons driving that conclusion. First, you’ve already gotten the timing wrong and you’re apt to double your error. The broad emerging markets index has been bumping along without material gain for five years now. If you were actually good at actively allocating your portfolio, you’d have gotten out in the summer of 2007 instead of thinking that five consecutive years of 25%+ gains would go on forever. And you, like the guys at Cook and Bynum, would have foregone Christmas presents in 2008 in order to plow every penny you had into an irrationally, shockingly cheap market. If you didn’t pull it off then, you’re not going to pull it off this time, either.

Second, there are better options here than elsewhere. These remain, even after you adjust down their earnings and adjust them down again, about the best values you’ll find. Ranter grumbles about the thoughtless domestic dash:

Bottom line is I fail to see, on a relative basis, how the US is more tempting looking 5 years out. People can be scared all they want of catching a falling knife…but it’s a lot easier to catch something which is only 5 feet in the air than something that is 10 feet in the air.

If you’re thinking of your emerging markets stake as something that you’ll be holding or building over the next 10-15 years (as I do), it doesn’t matter whether you buy now or in three months, at this level or 7% up or down from here. It will matter if you panic, leave and then refuse to return until the emerging markets feel “safe” to you – typically around the top of the next market cycle.

It’s certainly possible that you’re systemically over-allocated to equities or emerging equities. The current turbulence might well provide an opportunity to revisit your long-term plan, and I’d salute you for it. My argument here is against actions driven by your gut.

Happily, there are a number of first rate options available for folks seeking risk-conscious exposure to the emerging markets. My own choice, discussed more fully below, is Seafarer. I’ve added to my (small investor-sized) account twice since the market began turning south in late spring. I have no idea of whether those dollars with be worth a dollar or eighty cents or a plugged nickel six months from now. My suspicion is that those dollars will be worth more a decade from now having been invested with a smart manager in the emerging markets than they would have been had I invested them in domestic equities (or hidden them away in a 0.01% bank account). But Seafarer isn’t the only “A” level choice. There are some managers sitting on large war chests (Amana Developing World AMDWX), others with the freedom to invest across asset classes (First Trust/Aberdeen Emerging Opportunities FEO) and even some with both (Lazard Emerging Markets Multi-Strategy EMMOX).

To which Morningstar says, “If you’ve got $50 million to spend, we’ve got a fund for you!”

On August 22nd, Morningstar’s Fund Spy trumpeted “Medalist Emerging-Markets Funds Open for Business,” in which they reviewed their list of the crème de la crème emerging markets funds. It is, from the average investor’s perspective, a curious list studded with funds you couldn’t get into or wouldn’t want to pay for. Here’s the Big Picture:

morningstar-table

Our take on those funds follows.

The medalist …

Is perfect for the investor who …

Acadian EM (AEMGX)

Has $2500 and an appreciation of quant funds

American Funds New World (NEWFX)

Wants to pay 5.75% upfront

Delaware E.M. (DEMAX)

Wants to pay 5.75% upfront for a fund whose performance has been inexplicably slipping, year by year, in each of the past five calendar years.

GMO E.M. III (GMOEX)

Has $50,000,000 to open an account

Harding Loevner E.M. Advisor (HLEMX)

Is an advisor with $5000 to start.

Harding Loevner Inst E.M. (HLMEX)

Has $500,000 to start

ING JPMorgan E.M. Equity (IJPIX)

Is not the public, since “shares of the Portfolio are not offered to the public.”

Parametric E.M. (EAEMX)

Has $1000 and somewhat modest performance expectations

Parametric Tax-Mgd E.M. Inst (EITEX)

Has $50,000 and tax-issues best addressed in his e.m. allocation

Strategic Advisers E.M. (FSAMX)

Is likewise not the general public since “the fund is not available for sale to the general public.”

T. Rowe Price E.M. Stock (PRMSX)

Has $2500 and really, really modest performance expectations.

Thornburg Developing World A (THDAX)

Doesn’t mind paying a 4.50% load

Our recommendations differ from theirs, given our preference for smaller funds that are actually available to the public. Our shortlist:

Amana Developing World (AMDWX): offers an exceedingly cautious take on an exceedingly risky slice of the world. Readers were openly derisive of Amana’s refusal to buy at any cost, which led the managers to sit on a 50% cash stake while the market’s roared ahead. As those markets began their swoon in 2011, Amana began moving in and disposing of more than half of its cash reserves. Still cash-rich, the fund’s relative performance is picking up and its risks remain very muted.

First Trust/Aberdeen Emerging Opportunity (FEO): one of the first emerging markets balanced funds, it’s performed very well over the long-term and is currently selling at a substantial discount to NAV: 12.6%, about 50% greater than its long-term average. That implies that investors might see something like a 5% arbitrage gain once the current panic abates, above and beyond whatever the market provides.

Grandeur Peak Emerging Markets Opportunities (GPEOX): the Grandeur Peak team has been brilliantly successful both here and at Wasatch. Their intention is to create a single master fund (Global Reach) and six subsidiary funds whose portfolios represent slices of the master profile. Emerging Markets has already cleared the SEC registration procedures but hasn’t launched. The Grandeur Peak folks say two factors are driving the delay. First, the managers want to be able to invest directly in Indian equities which requires registration with that country’s equity regulators. They couldn’t begin the registration until the fund itself was registered in the US. So they’re working through the process. Second, they wanted to be comfortable with the launch of Global Reach before adding another set of tasks. Give or take the market’s current tantrum (one manager describes it as “a taper tantrum”), that’s going well. With luck, but without any guarantees, the fund might be live sometime in Q4.

Seafarer Overseas Growth & Income (SFGIX): hugely talented manager, global portfolio, risk conscious, shareholder-centered and successful.

Wasatch Frontier Emerging Small Countries (WAFMX): one of the very few no-load, retail funds that targets the smaller, more dynamic markets rather than markets with billions of people (India and China) or plausible claim to be developed markets (e.g., Korea). The manager, Laura Geritz, has been exceedingly successful. Frontier markets effectively diversify emerging markets portfolios and the fund has drawn nearly $700 million. The key is that Wasatch is apt to close the fund sooner rather than later.

Snowball’s portfolio

Some number of folks have, reasonably enough, asked whether I invest in all of the funds I profile (uhhh … there have been over 150 of them, so no) or whether I have found The Secret Formula (presumably whatever Nicholas Cage has been looking for in all those movies). The answer is less interesting than the question.

I guess my portfolio construction is driven by three dictums:

  1. Don’t pretend to be smarter than you are
  2. Don’t pretend to be braver than you are
  3. There’s a lot of virtue in doing nothing

Don’t pretend to be smarter than you are. If I knew which asset classes were going to soar and which were going to tank in the next six months or year or two, two things would happen. First, I’d invest in the winners. Second, I’d sell my services to ridiculously rich people and sock them with huge and abusive fees that they’d happily pay. But, I don’t.

As a result, I tend to invest in funds whose managers have a reasonable degree of autonomy about investing across asset classes, rather than ones pigeonholed into a small (style) box. That’s a problem: it makes benchmarking hard, it makes maintaining an asset allocation plan hard and it requires abnormally skilled managers. My focus has been on establishing a strategic objective (“increasing exposure to fast growing economies”) and then spending a lot of time trying to find managers whose strategies I trust, respect and understand.

Don’t pretend to be braver than you are. Stocks have a lot in common with chili peppers. In each case, you get a surprising amount of benefit from a relatively small amount of exposure. In each case, increasing exposure quickly shifts the pleasure/pain balance from pleasantly piquant to moronically painful. Some readers think of my non-retirement asset allocation is surprisingly timid: about 50% stocks, 30% bonds, 20% cash equivalents. They’re not much happier about my 70% equity stake in retirement funds. But, they’re wrong.

T. Rowe Price is one of my favorite fund companies, in part because they treat their investors with unusual respect. I found two Price studies, in 2004 and again in 2010, particularly provocative. Price constructed a series of portfolios representing different levels of stock exposure and looked at how the various portfolios would have played out over the past 50-60 years.

The original study looked at portfolios with 20/40/60/80/100% stocks. The update dropped the 20% portfolio and looked at 0/40/60/80/100%. Below I’ve reproduced partial results for three portfolios. The original 2004 and 2010 studies are available at the T. Rowe Price website.

 

20% stocks

60% stocks

100% stocks

 

Conservative mix, 50% bonds, 30% cash

The typical “hybrid”

S&P 500 index

Years studied

1955-03

1949-2009

1949-2009

Average annual return (before inflation)

7.4

9.2

11.0

Number of down years

3

12

14

Average loss in a down year

-0.5

-6.4

-12.5

Standard deviation

5.2

10.6

17.0

Loss in 2008

-0.2*

-22.2

-37.0

* based on 20% S&P500, 30% one-year CDs, 50% total bond index

 Over a 10 year period – reasonable for a non-retirement account – a portfolio that’s 20% stocks would grow from $10,000 to $21,000. A 100% stock portfolio would grow to $28,000. Roughly speaking, the conservative portfolio ends up at 75% of the size of the aggressive one but a pure stock portfolio increases the probability of losing money by 400% (from a 6% chance to 23%), increases the size of your average loss by 2500% (from 0.5% to 12.5%) and triples your volatility. Somewhere in there, it will face the real prospect of a 51% loss, which is the average maximum drawdown for large core stock funds that have been around 20 years or more. Sadly, there’s no way of knowing whether the 51% loss will occur in Year One (where you might have some recovery time) or Year Ten (where you’d be toast).

At 50% equities, I might capture 80% of the market’s gain with 50% of its volatility. If domestic bonds weren’t in such dismal straits, a smaller stock exposure might be justifiable. But they suck so I’m stuck.

There’s a lot of virtue in doing nothing. Our action tends to be a lot more costly than our inaction, so I change my target allocation slowly and change my fund line-up slowly. I’ve held a few retirement plan funds (e.g., Fidelity Low Priced Stock FLPSX) for decades and a number of non-retirement funds since their inception. In general, I’ll only add a fund if it represents an entirely new opportunity set or if it’s replacing an existing fund. On average, I might change out one fund every year or two.


My retirement portfolio is dominated by the providers in Augustana’s 403(b) plan: Fidelity, T. Rowe Price and TIAA-CREF. The college contribution to retirement goes exclusively into TIAA-CREF. CREF Stock accounts for 68%, TIAA Real Estate holds 22% and the rest is in a target-date fund. The Fidelity and Price allocations mirror one another: 33% domestic stock (with a value bias), 33% international stock (with an emerging markets bias) and 33% income (of the eclectic Spectrum Income/Global High Income sort).

My non-retirement portfolio is nine funds and some cash waiting to be deployed.

 

 

Portfolio weight

What was I, or am I, thinking?

Artisan Int’l Value

ARTKX

10%

I bought Artisan Int’l (ARTIX) in January 1996 because of my respect for Artisan and Mr. Yockey’s record. I traded-in my ARTIX shares and bought Int’l Value as soon as it launched because of my respect for Artisan, Mr. Samra and O’Keefe’s pedigree and my preference for value investing. Right so far: the fund is top 1% returns for the year-to-date and the trailing 1-, 3-, 5- and 10-year periods. I meditated upon switching to the team’s Global Value Fund (ARTGX) which has comparable returns, more flexibility and fewer assets.

Artisan Small Value

ARTVX

8

I bought Artisan Small Cap (ARTSX) in the weeks before it closed, also January 1996, for the same reasons I bought ARTIX. And I traded it for Small Cap Value in late 1997 for the same reasons I traded International. That original stake, to which I added regularly, has more than quadrupled in value. The team has been out-of-step with the market lately which, frankly, is what I pay them for. I regret only the need to sell some of my shares about seven years ago.

FPA Crescent

FPACX

17

Crescent is my surrogate for a hedge fund: Mr. Romick has a strong contrarian streak, the ability to invest in almost anything and a phenomenal record of having done so. If you really wanted to control your asset allocation, this would make it about impossible. I don’t.

Matthews Asia Strategic Income

MAINX

6

I bought MAINX in the month after the Observer profiled the fund. Matthews is first rate, the arguments for reallocating a portion of my fixed-income exposure from developed to developing markets struck me as sound and Ms. Kong is really sharp.

And it’s working. My holding is still up about 3% while both the world bond group and Aberdeen Asia Bond trail badly. She’s hopeful that pressure of Asian currencies will provoke economic reform and, in the meantime, has the freedom to invest in dollar-denominated bonds.

Matthews Asian Growth & Income

MACSX

10

I originally bought MACSX while Andrew Foster was manager, impressed by its eclectic portfolio, independent style and excellent risk management. It’s continued to do well after his departure. I sold half of my stake here to invest in Seafarer and haven’t been adding to it in a while because I’m already heavily overweight in Asia. That said, I’m unlikely to reduce this holding either.

Northern Global Tactical Asset Allocation

BBALX

13

I bought BBALX shortly after profiling it. It’s a fund-of-index-funds whose allocation is set by Northern’s investment policy committee. The combination of very low expenses (0.64%), very low turnover portfolios, wide diversification and the ability to make tactical tilts is very attractive. It’s been substantially above average – higher returns, lower volatility – than its peers since its 2008 conversion.

RiverPark Short Term High Yield

RPHYX

11

Misplaced in Morningstar’s “high yield” box, this has been a superb cash management option for me: it’s making 3-4% annually with negligible volatility.

Seafarer Overseas Growth & Income

SFGIX

10

I’m impressed by Mr. Foster’s argument that many other portions of the developing world are, in 2013, where Asia was in 2003. He believes there are rich opportunities outside Asia and that his experience as an Asia investor will serve him in good stead as the new story rolls out. I’m convinced that having an Asia-savvy manager who has the ability to recognize and make investments beyond the region is prudent.

T. Rowe Price Spectrum Income

RPSIX

12

This is a fund of income-oriented funds and it serves as the second piece of the cash-management plan for me. I count on it for about 6% returns a year and recognize that it might lose money on rare occasion. Price is steadfastly sensible and investor-centered and I’m quite comfortable with the trade-off.

Cash

 

2

This is the holding pool in my Scottrade account.

Is anyone likely to make it into my portfolio in 2013-14? There are two candidates:

ASTON/River Road Long-Short (ARLSX). We’ve both profiled the fund and had a conference call with its manager, both of which are available on the Observer’s ARLSX page. I’m very impressed with the quality and clarity of their risk-management disciplines; they’ve left little to chance and have created a system that forces them to act when it’s time. They’ve performed well since inception and have the prospect of outperforming the stock market with a fraction of its risk. If this enters the portfolio, it would likely be as a substitute for Northern Global Tactical since the two serve the same risk-dampening function.

RiverPark Strategic Income (not yet launched). This fund will come to market in October and represents the next step out on the risk-return spectrum from the very successful RiverPark Short Term High Yield (RPHYX). I’ve been impressed with David Sherman’s intelligence and judgment and with RPHYX’s ability to deliver on its promises. We’ll be doing fairly serious inquiries in the next couple months, but the new fund might become a success to T. Rowe Price Spectrum Income.

Sterling Capital hits Ctrl+Alt+Delete

Sterling Capital Select Equity (BBTGX) has been a determinedly bad fund for years. It’s had three managers since 1993 and it has badly trailed its benchmark under each of them. The strategy is determinedly nondescript. They’ve managed to return 3.2% annually over the past 15 years. That’s better – by about 50 bps – than Vanguard’s money market fund, but not by much. Effective September 3, 2013, they’re hitting “reformat.”

The fund’s name changes, to Sterling Capital Large Cap Value Diversified Fund.

The strategy changes, to a “behavioral financed” based system targeting large cap value stocks.

The benchmark changes, to the Russell 1000 Value

And the management team changes, to Robert W. Bridges and Robert O. Weller. Bridges joined the firm in 2008 and runs the Sterling Behavioral Finance Small Cap Diversified Alpha. Mr. Weller joined in 2012 after 15 years at JPMorgan, much of it with their behavioral finance team.

None of which required shareholders’ agreement since, presumably, all aspects of the fund are “non-fundamental.” 

One change that they should pursue but haven’t: get the manager to put his own money at risk. The departing manager was responsible for five funds since 2009 and managed to find nary a penny to invest in any of them. As a group, Sterling’s bond and asset allocation team seems utterly uninterested in risking their own money in a lineup of mostly one- and two-star funds. Here’s the snapshot of those managers’ holdings in their own funds:

stategic allocation

You’ll notice the word “none” appears 32 times. Let’s agree that it would be silly to expect a manager to own tax-free bonds anywhere but in his home jurisdiction. That leaves 26 decisions to avoid their own funds out of a total of 27 opportunities. Most of the equity managers, by contrast, have made substantial personal investments.

Warren Buffett thinks you’ve come to the right place

Fortune recently published a short article which highlighted a letter that Warren Buffett wrote to the publisher of the Washington Post in 1975. Buffett’s an investor in the Post and was concerned about the long-term consequences of the Post’s defined-benefit pension. The letter covers two topics: the economics of pension obligations in general and the challenge of finding competent investment management. There’s also a nice swipe at the financial services industry, which most folks should keep posted somewhere near their phone or monitor to review as you reflect on the inevitable marketing pitch for the next great financial product.

warren

I particularly enjoy the “initially.” Large money managers, whose performance records were generally parlous, “felt obliged to seek improvement or at least the approach of improvement” by hiring groups “with impressive organizational charts, lots of young talent … and a record of recent performance (pg 8).” Unfortunately, he notes, they found it.

The pressure to look like you were earning your keep led to high portfolio turnover (Buffett warns against what would now be laughably low turnover: 25% per annum). By definition, most professionals cannot be above average but “a few will succeed – in a modest way – because of skill” (pg 10). If you’re going to find them, it won’t be by picking past winners though it might be by understanding what they’re doing and why:

warren2

The key: abandon all hope ye who invest in behemoths:

warren3

For those interested in Buffett’s entire reflection, Chip’s embedded the following:

Warren Buffett Katharine Graham Letter


And now for something completely different …

We can be certain of some things about Ed Studzinski. As an investor and co-manager of Oakmark Equity & Income (OAKBX), he was consistently successful in caring for other people’s money (as much as $17 billion of it), in part because he remained keenly aware that he was also caring for their futures. $10,000 entrusted to Ed and co-manager Clyde McGregor on the day Ed joined the fund (01 March 2000) would have grown to $27,750 on the day of his departure (31 December 2011). His average competitor (I’m purposefully avoiding “peer” as a misnomer) would have managed $13,900.

As a writer and thinker, he minced no words.

The Equity and Income Fund’s managers have both worked in the investment industry for many decades, so we both should be at the point in our careers where dubious financial-industry innovations no longer surprise us. Such an assumption, however, would be incorrect.

For the past few quarters we have repeatedly read that the daily outcomes in the securities markets are the result of the “Risk On/Risk Off” trade, wherein investors (sic?) react to the most recent news by buying equities/selling bonds (Risk On) or the reverse (Risk Off). As value investors we think this is pure nonsense. 

Over the past two years, Ed and I have engaged in monthly conversations that I’ve found consistently provocative and information-rich. It’s clear that he’s been paying active attention for many years to contortions of his industry which he views with equal measures of disdain and alarm. 

I’ve prevailed upon Ed to share a manager’s fuss and fulminations with us, as whim, wife and other obligations permit. His first installment, which might also be phrased as the question “Whose skin in the game?” follows.

“Skin in the Game, Part One”

“Virtue has never been as respectable as money.” Mark Twain
 

One of the more favored sayings of fund managers is that they like to invest with managements with “skin in the game.” This is another instance where the early Buffett (as opposed to the later Buffett) had it right. Managements can and should own stock in their firms. But they should purchase it with their own money. That, like the prospect of hanging as Dr. Johnson said, would truly clarify the mind. In hind sight a major error in judgment was made by investment professionals who bought into the argument that awarding stock options would beneficially serve to align the interests of managements and shareholders. Never mind that the corporate officers should have already understood their fiduciary obligations. What resulted, not in all instances but often enough in the largest capitalization companies, was a class of condottieri such as one saw in Renaissance Italy, heading armies that spent their days marching around avoiding each other, all the while being lavishly paid for the risks they were NOT facing. This sub-set of managers became a new entitled class that achieved great personal wealth, often just by being present and fitting in to the culture. Rather than thinking about truly long-term strategic implications and questions raised in running a business, they acted with a short-duration focus, and an ever-present image of the current share price in the background. Creating sustainable long-term business value rarely entered into the equation, often because they had never seen it practiced.

I understood how much of a Frankenstein’s monster had been created when executive compensation proposals ended up often being the greater part of a proxy filing. A particularly bothersome practice was “reloading” options annually. Over time, with much dilution, these programs transferred significant share ownership to management. You knew you were on to something when these compensation proposals started attracting negative vote recommendations. The calls would initially start with the investor relations person inquiring about the proxy voting process. Once it was obvious that best practices governance indicated a “no” vote, the CFO would call and ask for reconsideration.

How do you determine whether a CEO or CFO actually walks the walk of good capital allocation, which is really what this is all about? One tip-off usually comes from discussions about business strategy and what the company will look like in five to ten years. You will have covered metrics and standards for acquisitions, dividends, debt, share repurchase, and other corporate action. Following that, if the CEO or CFO says, “Why do you think our share price is so low?” I would know I was in the wrong place. My usual response was, “Why do you care if you know what the business value of the company is per share? You wouldn’t sell the company for that price. You aren’t going to liquidate the business. If you did, you know it is worth substantially more than the current share price.” Another “tell” is when you see management taking actions that don’t make sense if building long-term value is the goal. Other hints also raise questions – a CFO leaves “because he wants to enjoy more time with his family.” Selling a position contemporaneously with the departure of a CFO that you respected would usually leave your investors better off than doing nothing. And if you see the CEO or CFO selling stock – “our investment bankers have suggested that I need to diversify my portfolio, since all my wealth is tied up in the company.” That usually should raise red flags that indicate something is going on not obvious to the non-insider.

Are things improving? Options have gone out of favor as a compensation vehicle for executives, increasingly replaced by the use of restricted stock. More investors are aware of the potential conflicts that options awards can create and have a greater appreciation of governance. That said, one simple law or regulation would eliminate many of the potential abuses caused by stock options. “All stock acquired by reason of stock option awards to senior corporate officers as part of their compensation MAY NOT BE SOLD OR OTHERWISE DISPOSED OF UNTIL AFTER THE EXPIRATION OF A PERIOD OF THREE YEARS FROM THE INDIVIDUAL’S LAST DATE OF SERVICE.” Then you might actually see the investors having a better chance of getting their own yachts.

Edward A. Studzinski

If you’d like to reach Ed, click here. An artist’s rendering of Messrs. Boccadoro and Studzinski appears below.


 

Introducing Charles’ Balcony

balconeySince his debut in February 2012, my colleague Charles Boccadoro has produced some exceedingly solid, data-rich analyses for us, including this month’s review of the risk/return profiles of the FundX family of funds. One of his signature contributions was “Timing Method Performance Over Ten Decades,” which was widely reproduced and debated around the web.

We’re pleased to announce that we’ve collected his essays in a single, easy-to-access location. We’ve dubbed it “Charles’ Balcony” and we even stumbled upon this striking likeness of Charles and the shadowy Ed Studzinski in situ. I’m deeply hopeful that from their airy (aerie or eery) perch, they’ll share their sharp-eyed insights with us for years to come.

Observer fund profiles

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

Advisory Research Strategic Income (ADVNX): you’ve got to love a 10 month old fund with a 10 year track record and a portfolio that Morningstar can only describe as 60% “other.” AR converted a successful limited partnership into the only no-load mutual fund offering investors substantial access to preferred securities.

Beck, Mack and Oliver Partners (BMPEX): we think of it as “Dodge and Cox without the $50 billion in baggage.” This is an admirably disciplined, focused equity fund with a remarkable array of safeguards against self-inflicted injuries.

FPA Paramount (FPRAX): some see Paramount as a 60-year-old fund that seeks out only the highest-quality mid-cap growth stocks. With a just-announced change of management and philosophy, it might be moving to become a first-rate global value fund (with enough assets under management to start life as one of the group’s most affordable entries).

FundX Upgrader (FUNDX): all investors struggle with the need to refine their portfolios, dumping losers and adding winners. In a follow-up to his data-rich analysis on the possibility of using a simple moving average as a portfolio signal, associate editor Charles Boccadoro investigated the flagship fund of the Upgrader fleet.

Tributary Balanced (FOBAX): it’s remarkable that a fund this consistently good – in the top tier of all balanced funds over the past five-, ten-, and fifteen-year periods and a Great Owl by my colleague Charles’ risk/return calculations – hasn’t drawn more attention. It will be more remarkable if that neglect continues despite the recent return of the long-time manager who beat pretty much everyone in sight.

Elevator Talk #8: Steven Vannelli of GaveKal Knowledge Leaders (GAVAX)

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

Steve w logo

Steven Vannelli, Manager

GaveKal Knowledge Leaders (GAVAX) believes in investing only in firms that are committed to being smart, so where did the dumb name come from? GaveKal is a portmanteau formed from the names of the firm’s founders: Charles Gave, Anatole Kaletsky and Louis-Vincent Gave. Happily it changed the fund’s original name from GaveKal Platform Company Fund (named after its European counterpart) to Knowledge Leaders. 

GaveKal, headquartered in Hong Kong, started in 2001 as a global economics and asset allocation research firm. Their other investment products (the Asian Balanced Fund – a cool idea which was rechristened Asian Absolute Return – and Greater China Fund) are available to non-U.S. investors as, originally, was Knowledge Leaders. They opened a U.S. office in 2006. In 2010 they deepened their Asia expertise by acquiring Dragonomics, a China-focused research and advisory firm.

Knowledge Leaders has generated a remarkable record in its two-plus years of U.S. operation. They look to invest in “the best among global companies that are tapping a deep reservoir of intangible capital to generate earnings growth,” where “R&D, design, brand and channel” are markers of robust intangible capital. From launch through the end of June, 2013, the fund modestly outperformed the MSCI World Index and did so with two-thirds less volatility. Currently, approximately 30% of the portfolio is in cash, down from 40% earlier in summer.

Manager Steven Vannelli researches intangible capital and corporate performance and leads the fund’s investment team. Before joining GaveKal, he spent a decade at Alexander Capital, a Denver-based investment advisor. Here’s Mr. Vannelli’s 200 words making his case:

We invest in the world’s most innovative companies. Decades of academic research show that companies that invest heavily in innovation are structurally undervalued due to lack of information on innovative activities. Our strategy capitalizes on this market inefficiency.

To find investment opportunities, we identify Knowledge Leaders, or companies with large stores of intangible assets. These companies often operate globally across an array of industries from health care to technology, from consumer to capital goods. We have developed a proprietary method to capitalize a company’s intangible investments, revealing an important, invisible layer of value inherent to intangible-rich companies. 

The Knowledge Leaders Strategy employs an active strategy that offers equity-like returns with bond-like risk. Superior risk-adjusted returns with low correlation to market indices make the GaveKal Knowledge Leaders Strategy a good vehicle for investors who seek to maximize their risk and return objectives.

The genesis of the strategy has its origin in the 2005 book, Our Brave New World, by GaveKal Research, which highlights knowledge as a scare asset.

As a validation of our intellectual foundation, in July, the US Bureau of Economic Analysis began to capitalize R&D to measure the contribution of innovation spending on growth of the US economy.

The minimum initial investment on the fund’s retail shares is $2,500. There are also institutional shares (GAVIX) with a $100,000 minimum (though they do let financial advisors aggregate accounts in order to reach that threshold). The fund’s website is clean and easily navigated. It would make a fair amount of sense for you to visit to “Fund Documents” page, which hosts the fund’s factsheet and a thoughtful presentation on intangible capital

Our earlier Elevator Talks were:

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

Upcoming conference call: A discussion of the reopening of RiverNorth Strategy Income (RNDLX)

rivernorth reopensThe folks at RiverNorth will host a conference call between the fund’s two lead managers, Patrick Galley of RiverNorth and Jeffrey Gundlach of DoubleLine, to discuss their decision to reopen the fund to new investors at the end of August and what they see going forward (the phrase “fear and loathing” keeps coming up). 

The call will be: Wednesday, September 18, 3:15pm – 4:15pm CDT

To register, go to www.rivernorthfunds.com/events/

The webcast will feature a Q&A with Messrs. Galley and Gundlach.

RNDLX (RNSIX for the institutional class), which the Observer profiled shortly after launch, has been a very solid fund with a distinctive strategy. Mr. Gundlach manages part of his sleeve of the portfolio in a manner akin to DoubleLine Core Fixed Income (DLFNX) and part with a more opportunistic income strategy. Mr. Galley pursues a tactical fixed-income allocation and an utterly unique closed-end fund arbitrage strategy in his slice. The lack of attractive opportunities in the CEF universe prompted the fund’s initial closure. Emily Deter of RiverNorth reports that the opening “is primarily driven by the current market opportunity in the closed-end fund space. Fixed-income closed-end funds are trading at attractive discounts to their NAVs, which is an opportunity we have not seen in years.” Investment News reported that fixed-income CEFs moved quickly from selling at a 2% premium to selling at a 7% discount. 

That’s led Mr. Galley’s move from CEFs from occupying 17% of the portfolio a year ago to 30% today and, it seems, he believes he could pursue more opportunities if he had more cash on hand.

Given RiverNorth’s ongoing success and clear commitment to closing funds well before they become unmanageable, it’s apt to be a good use of your time.

The Observer’s own series of conference calls with managers who’ve proven to be interesting, sharp, occasionally wry and successful, will resume in October. We’ll share details in our October issue.

Funds in Registration

New mutual funds must be registered with the Securities and Exchange Commission before they can be offered for sale to the public. The SEC has a 75-day window during which to call for revisions of a prospectus; fund companies sometimes use that same time to tweak a fund’s fee structure or operating details.

Every day David Welsch, an exceedingly diligent research assistant at the Observer, scours new SEC filings to see what opportunities might be about to present themselves. David tracked down nearly 100 new funds and ETFs. Many of the proposed funds offer nothing new, distinctive or interesting. Some were downright mystifying. (Puerto Rico Shares? Colombia Capped ETF? The Target Duration 2-month ETF?) There were 26 no-load funds or actively-managed ETFs in registration with the SEC this month. 

Funds in registration this month won’t be available for sale until, typically, the end of October or early November 2013.

There are probably more interesting products in registration this month than at any time in the seven years we’ve been tracking them. Among the standouts:

Brown Advisory Strategic European Equity Fund which will be managed by Dirk Enderlein of Wellington Management. Wellington is indisputably an “A-team” shop (they’ve got about three-quarters of a trillion in assets under management). Mr. Enderlein joined them in 2010 after serving as a manager for RCM – Allianz Global Investors in Frankfurt, Germany (1999-2009). Media reports described him as “one of Europe’s most highly regarded European growth managers.”

DoubleLine Shiller Enhanced CAPE will attempt to beat an index, Shiller Barclays CAPE® US Sector TR USD Index, which was designed based on decades of research by the renowned Robert Shiller. The fund will be managed by Jeffrey Gundlach and Jeffrey Sherman.

Driehaus Micro Cap Growth Fund, a converted 15 year old hedge fund

Harbor Emerging Markets Equity Fund, which will be sub-advised by the emerging markets team at Oaktree Capital Management. Oaktree’s a first-tier institutional manager with a very limited number of advisory relationships (primarily with Vanguard and RiverNorth) in the mutual fund world. 

Meridian Small Cap Growth, which will be the star vehicle for Chad Meade and Brian Schaub, who Meridian’s new owner hired away from Janus. Morningstar’s Greg Carlson described them as “superb managers” who were “consistently successful during their nearly seven years at the helm” of Janus Triton.

Plus some innovative offerings from Northern, PIMCO and T. Rowe Price. Details and the list of all of the funds in registration are available at the Observer’s Funds in Registration page or by clicking “Funds” on the menu atop each page.

Manager Changes

On a related note, we also tracked down a record 85 fund manager changes. Investors should take particular note of Eric Ende and Stephen Geist’s exit from FPA Paramount after a 13 year run. The change is big enough that we’ve got a profile of Paramount as one of the month’s Most Intriguing New Funds.

Updates

brettonBretton Fund (BRTNX) is now available through Vanguard. Manager Stephen Dodson writes that after our conference call, several listeners asked about the fund’s availability and Stephen encouraged them to speak directly with Vanguard. Mirabile dictu, the Big V was receptive to the idea.

Stephen recently posted his most recent letter to his shareholders. He does a nice job of walking folks through the core of his investing discipline with some current illustrations. The short version is that he’s looking for firms with durable competitive advantages in healthy industries whose stocks are selling at a substantial discount. He writes:

There are a number of relevant and defensible companies out there that are easily identifiable; the hard part is finding the rare ones that are undervalued. The sweet spot for us continues to be relevant, defensible businesses at low prices (“cheap compounders”). I continue to spend my waking hours looking for them.

Q2 2013 presented slim pickin’s for absolute value investors (Bretton “neither initiated nor eliminated any investments during the quarter”). For all of the market’s disconcerting gyrations this summer, Morningstar calculates that valuations for its Wide Moat and Low Business Uncertainty groups (surrogates for “high quality stocks”) remains just about where they were in June: undervalued by about 4% while junkier stocks remain modestly overvalued.

Patience is hard.

Briefly Noted . . .

Calamos loses another president

James Boyne is resigning as president and chief operating officer of Calamos Investments effective Sept. 30, just eight months after being promoted to president. The firm has decided that they need neither a president nor a chief operating officer. Those responsibilities will be assumed “by other senior leaders” at the firm (see: Black, Gary, below). The preceding president, Nick P. Calamos, decided to “step back” from his responsibilities in August 2012 when, by coincidence, Calamos hired former Janus CEO Gary Black. To describe Black as controversial is a bit like described Rush Limbaugh as opinionated.

They’re not dead yet!

not-dead-yetBack in July, the Board of Caritas All-Cap Growth (CTSAX): “our fund is tiny, expensive, bad, and pursues a flawed investment strategy (long stocks, short ETFs).” Thereupon they reached a sensible conclusion: euthanasia. Shortly after the fund had liquidated all of its securities, “the Board was presented with and reviewed possible alternatives to the liquidation of the Fund that had arisen since the meeting on July 25, 2013.”

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

aum

(I don’t know more about the firm because they have a one page website.)

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

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

Diamond Hill goes overseas, a bit

Effective September 1, 2013, Diamond Hill Research Opportunities Fund (DHROX) gains the flexibility to invest internationally (the new prospectus allows that it “may also invest in non-U.S. equity securities, including equity securities in emerging market countries”) and the SEC filing avers that they “will commence investing in foreign securities.” The fund has 15 managers; I’m guessing they got bored. As a hedge fund (2009-2011), it had a reasonably mediocre record which might have spurred the conversion to a ’40 fund. Which has also had a reasonably mediocre lesson, so points to the management for consistency!

Janus gets more bad news

Janus investors pulled $2.2 billion from the firm’s funds in July, the worst outflows in more than three years. A single investor accounted for $1.3 billion of the leakage. The star managers of Triton and Venture left in May. And now this: they’re losing business to Legg Mason.

The Board of Trustees of Met Investors Series Trust has approved a change of subadviser for the Janus Forty Portfolio from Janus Capital Management to ClearBridge Investments to be effective November 1, 2013 . . . Effective November 1, 2013, the name of the Portfolio will change to ClearBridge Aggressive Growth Portfolio II.

Matthews chucks Taiwan

Matthews Asia China (MCHFX), China Dividend (MCDFX) and Matthews and China Small Companies (MCSMX) have changed their Principal Investment Strategy to delete Taiwan. The text for China Dividend shows the template:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its net assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China and Taiwan.

To:

Under normal market conditions, the Matthews China Dividend Fund seeks to achieve its investment objective by investing at least 80% of its nets assets, which include borrowings for investment purposes, in dividend-paying equity securities of companies located in China.

A reader in the financial services industry, Anonymous Dude, checked with Matthews about the decision. AD reports

The reason was that the SEC requires that if you list Taiwan in the Principal Investment Strategies portion of the prospectus you have to include the word “Greater” in the name of the fund. They didn’t want to change the name of the fund and since they could still invest up to 20% they dropped Taiwan from the principal investment strategies. He said if the limitation ever became an issue they would revisit potentially changing the name. Mystery solved.
 
The China Fund currently has nothing investing in Taiwan, China Small is 14% and China Dividend is 15%. And gracious, AD!

T. Rowe tweaks

Long ago, as a college administrator, I was worried about whether the text in a proposed policy statement might one day get us in trouble. I still remember college counsel shaking his head confidently, smiling and saying “Not to worry. We’re going to fuzz it up real good.” One wonders if he works for T. Rowe Price now? Up until now, many of Price’s funds have had relatively detailed and descriptive investment objectives. No more! At least five of Price’s funds propose new language that reduces the statement of investment objectives to an indistinct mumble. T. Rowe Price Growth Stock Fund (PRGFX) goes from

The fund seeks to provide long-term capital growth and, secondarily, increasing dividend income through investments in the common stocks of well-established growth companies.

To

The fund seeks long-term capital growth through investments in stocks.

Similar blandifications are proposed for Dividend Growth, Equity Income, Growth & Income and International Growth & Income.

Wasatch redefines “small cap”

A series of Wasatch funds, Small Growth, Small Value and Emerging Markets Small Cap are upping the size of stocks in their universe from $2.5 billion or less to $3.0 billion or less. The change is effective in November.

Can you say whoa!? Or WOA?

The Board of Trustees of an admittedly obscure little institutional fund, WOA All Asset (WOAIX), has decided that the best way to solve what ails the yearling fund is to get it more aggressive.

The Board approved certain changes to the Fund’s principal investment strategies. The changes will be effective on or about September 3, 2013. . . the changes in the Fund’s strategy will alter the Fund’s risk level from balanced strategy with a moderate risk level to an aggressive risk level.

Here’s the chart of the fund’s performance since inception against conservative and moderate benchmarks. While that might show that the managers just need to fire up the risk machine, I’d also imagine that addressing the ridiculously high expenses (1.75% for an institutional balanced fund) and consistent ability to lag in both up and down months (11 of 16 and counting) might actually be a better move. 

woa

WOA’s Trustees, by the way, are charged with overseeing 24 funds. No Trustee has a dollar invested in any of those funds.

SMALL WINS FOR INVESTORS

The Board of Trustees of the Direxion Funds and Rafferty Asset Management have decided to make it cheaper for you to own a bunch of funds that you really shouldn’t own. They’re removed the 25 bps Shareholder Servicing Fee from

  • Direxion Monthly S&P 500® Bull 2X Fund
  • Direxion Monthly S&P 500® Bear 2X Fund
  • Direxion Monthly NASDAQ-100® Bull 2X Fund
  • Direxion Monthly Small Cap Bull 2X Fund
  • Direxion Monthly Small Cap Bear 2X Fund
  • Direxion Monthly Emerging Markets Bull 2X Fund
  • Direxion Monthly Latin America Bull 2X Fund
  • Direxion Monthly China Bull 2X Fund
  • Direxion Monthly Commodity Bull 2X Fund
  • Direxion Monthly 7-10 Year Treasury Bull 2X Fund
  • Direxion Monthly 7-10 Year Treasury Bear 2X Fund
  • Dynamic HY Bond Fund and
  • U.S. Government Money Market Fund.

Because Eaton Vance loves you, they’ve decided to create the opportunity for investors to buy high expense “C” class shares of Eaton Vance Bond (EVBCX). The new shares will add a 1.00% back load for sales held less than a year and a 1.70% expense ratio (compared to 0.7 and 0.95 for Institutional and A, respectively). 

The Fairholme Fund (FAIRX) reopened to new investors on August 19, 2013. The other Fairholme family funds, not so much.

The Advisor Class shares of Forward Select Income Fund (FSIMX) reopened to new investors at the end of August.

The Board of Directors of the Leuthold Global Industries Fund (LGINX) has agreed to reduce the Fund’s expense cap from 1.85% to 1.60%.

JacksonPark Capital reduced the minimum initial investment on Oakseed Opportunity Institutional shares (SEDEX) from $1 million to $10,000. Given the 18% lower fees on the institutional class (capped at 1.15% versus 1.40% for retail shares), reasonably affluent retail investors ought to seriously consider pursuing the institutional share class. That said, Oakseed’s minimum investment for the retail shares, as low as $100 for accounts set up with an AIP, are awfully reasonable.

RiverNorth DoubleLine Strategic Income (RNDLX/RNSIX) reopened to new investors at the end of August. Check the “upcoming conference calls” feature, above, for more details.

Westcore Blue Chip Dividend Fund (WTMVX ) lowered the expense ratio on its no-load retail shares from 1.15% to 0.99%, effective September 1. They also changed from paying distributions annually to paying them quarterly. It’s a perfectly agreeable, mild-mannered little fund: stable management, global diversified, reasonable expenses and very consistently muted volatility. You do give up a fair amount of upside for the opportunity to sleep a bit more quietly at night.

CLOSINGS (and related inconveniences)

American Beacon Stephens Small Cap Growth Fund (STSGX) will close to new investors, effective as of September 16, 2013. The no-class share class has returned 11.8% while its peers made 9.3% and it did so with lower volatility. The fund is closing at a still small $500 million.

Neither high fees nor mediocre performance can dim the appeal of AQR Multi-Strategy Alternative Fund (ASANX/ASAIX). The fund has drawn $1.5 billion and has advertised the opportunity for rich investors (the minimum runs between $1 million and $5 million) to rush in before the doors swing shut at the end of September. It’s almost always a bad sign that a fund feels the need to close and the need to put up a flashing neon sign six weeks ahead.

Morgan Stanley Institutional Global Franchise (MSFAX) will close to new investors on Nov. 29, 2013. The current management team came on board four years ago (June 2009) and have posted very good risk-adjusted returns since then. Investors might wonder why a large cap global fund with a small asset base needs to close. The answer is that the mutual fund represents just the tip of the iceberg; this team actually manages almost $17 billion in this strategy, so the size of the separate accounts is what’s driving the decision.

OLD WINE, NEW BOTTLES

At the end of September Ariel International Equity Fund (AINTX) becomes Ariel International Fund and will no longer be required to invest at least 80% of its assets in equities. At the same time, Ariel Global Equity Fund (AGLOX) becomes Ariel Global Fund. The advisor avers that it’s not planning on changing the funds’ investment strategies, just that it would be nice to have the option to move into other asset classes if conditions dictate.

Effective October 30, Guggenheim U.S. Long Short Momentum Fund (RYAMX) will become plain ol’ Guggenheim Long-Short Fund. In one of those “why bother” changes, the prospectus adds a new first sentence to the Strategy section (“invest, under normal circumstances, at least 80% of its assets in long and short equity or equity-like securities”) but maintains the old “momentum” language in the second and third sentences. They’ll still “respond to the dynamically changing economy by moving its investments among different industries and styles” and “allocates investments to industries and styles according to several measures of momentum. “ Over the past five years, the fund has been modestly more volatile and less profitable than its peers. As a result, they’ve attracted few assets and might have decided, as a marketing matter, that highlighting a momentum approach isn’t winning them friends.

As of October 28, the SCA Absolute Return Fund (SCARX) will become the Granite Harbor Alternative Fund and it will no longer aim to provide “positive absolute returns with less volatility than traditional equity markets.” Instead, it’s going for the wimpier “long-term capital appreciation and income with low correlation” to the markets. SCA Directional Fund (SCADX) will become Granite Harbor Tactical Fund but will no longer seek “returns similar to equities with less volatility.” Instead, it will aspire to “long term capital appreciation with moderate correlation to traditional equity markets.” 

Have you ever heard someone say, “You know, what I’m really looking for is a change for a moderate correlation to the equity markets”? No, me neither.

Thomas Rowe Price, Jr. (the man, 1898-1983) has been called “the father of growth investing.” It’s perhaps then fitting that T. Rowe Price (the company) has decided to graft the word “Growth” into the names of many of its funds effective November 1.

T. Rowe Price Institutional Global Equity Fund becomes T. Rowe Price Institutional Global Focused Growth Equity Fund. Institutional Global Large-Cap Equity Fund will change its name to the T. Rowe Price Institutional Global Growth Equity Fund. T. Rowe Price Global Large-Cap Stock Fund will change its name to the T. Rowe Price Global Growth Stock Fund.

Effective October 28, 2013, USB International Equity Fund (BNIEX) gets a new name (UBS Global Sustainable Equity Fund), new mandate (invest globally in firms that pass a series of ESG screens) and new managers (Bruno Bertocci and Shari Gilfillan). The fund’s been a bit better under the five years of Nick Irish’s leadership than its two-star rating suggests, but not by a lot.

Off to the dustbin of history

There were an exceptionally large number of funds giving up the ghost this month. We’ve tracked 26, the same as the number of new no-load funds in registration and well below the hundred or so new portfolios of all sorts being launched. I’m deeply grateful to The Shadow, one of the longest-tenured members of our discussion board, for helping me to keep ahead of the flood.

American Independence Dynamic Conservative Plus Fund (TBBIX, AABBX) will liquidate on or about September 27, 2012.

Dynamic Canadian Equity Income Fund (DWGIX) and Dynamic Gold & Precious Metals Fund (DWGOX), both series of the DundeeWealth Funds, are slated for liquidation on September 23, 2013. Dundee bumped off Dynamic Contrarian Advantage Fund (DWGVX) and announced that it was divesting itself of three other funds (JOHCM Emerging Markets Opportunities Fund JOEIX, JOHCM International Select Fund JOHIX and JOHCM Global Equity Fund JOGEX), which are being transferred to new owners.

Equinox Commodity Strategy Fund (EQCAX) closed to new investors in mid-August and will liquidate on September 27th.

dinosaurThe Evolution Funds face extinction! Oh, the cruel irony of it.

Evolution Managed Bond (PEMVX) Evolution All-Cap Equity (PEVEX), Evolution Market Leaders (PEVSX) and Evolution Alternative Investment (PETRX) have closed to all new investment and were scheduled to liquidate by the end of September. Given their disappearance from Morningstar, one suspects the end came more quickly than we knew.

Frontegra HEXAM Emerging Markets Fund (FHEMX) liquidates at the end of September.

The Northern Lights Board of Trustees has concluded that “based on, among other factors, the current and projected level of assets in the Fund and the belief that it would be in the best interests of the Fund and its shareholders to discontinue the Hundredfold Select Global Fund (SFGPX).”

Perhaps the “other factors” would be the fact that Hundredfold trailed 100% of its peers over the past three- and five-year periods? The manager was unpaid and quite possibly the fund’s largest shareholder ($50-100k in a $2M fund). His Hundredfold Select Equity (SFEOX) is almost as woeful as the decedent, but Hundredfold Select Alternative (SFHYX) is in the top 1% of its peer group for the same period that the others are bottom 1%. That raises the spectre that luck, rather than skill, might be involved.

JPMorgan is cleaning house: JPMorgan Credit Opportunities Fund (JOCAX), JPMorgan Global Opportunities Fund (JGFAX) and JPMorgan Russia Fund (JRUAX) are all gone as of October 4.

John Hancock intends to merge John Hancock High Income (JHAQX) into John Hancock High Yield (JHHBX). I’m guessing at the fund tickers because the names in the SEC filing don’t quite line up with the Morningstar ones.

Legg Mason Esemplia Emerging Markets Long-Short Fund (SMKAX) will be terminated on October 1, 2013. Let’s see: hard-to-manage strategy, high risk, high expenses, high front load, no assets . . . sounds like Legg.

Leuthold Asset Allocation Fund (LAALX) is merging into Leuthold Core Investment Fund (LCORX). The Board of Directors approved a proposal for the Leuthold Asset Allocation to be acquired by the Leuthold Core, sometime in October 2013. Curious. LAALX, with a quarter billion in assets, modestly lags LCORX which has about $600 million. Both lag more mild-mannered funds such as Northern Global Tactical Asset Allocation (BBALX) and Vanguard STAR (VGSTX) over the course of LAALX’s lifetime. This might be less a story about LAALX than about the once-legendary Leuthold Core. Leuthold’s funds are all quant-driven, based on an unparalleled dataset. For years Core seemed unstoppable: between 2003 and 2008, it finished in the top 5% of its peer group four times. But for 2009 to now, it has trailed its peers every year and has bled $1 billion in assets. In merging the two, LAALX investors get a modestly less expensive fund with modestly better performance. Leuthold gets a simpler administrative structure. 

I halfway admire the willingness of Leuthold to close products that can’t distinguish themselves in the market. Clean Tech, Hedged Equity, Undervalued & Unloved, Select Equities and now Asset Allocation have been liquidated.

MassMutual Premier Capital Appreciation Fund (MCALX) will be liquidated, but not until January 24, 2014. Why? 

New Frontiers KC India Fund (NFIFX) has closed and began the process of liquidating their portfolio on August 26th. They point to “difficult market conditions in India.” The fund’s returns were comparable to its India-focused peers, which is to say it lost about 30% in 18 months.

Nomura Partners India Fund (NPIAX), Greater China Fund (NPCAX) and International Equity Fund (NPQAX) will all be liquidated by month’s end.

Nuveen Quantitative Enhanced Core Equity (FQCAX) is slated, pending inevitable shareholder approval, to disappear into Nuveen Symphony Low Volatility Equity Fund (NOPAX, formerly Nuveen Symphony Optimized Alpha Fund)

Oracle Mutual Fund (ORGAX) has “due to the relatively small size of the fund” underwent the process of “orderly dissolution.” Due to the relatively small size? How about, “due to losing 49.5% of our investors’ money over the past 30 months, despite an ongoing bull market in our investment universe”? To his credit, the advisor’s president and portfolio manager went down with the ship: he had something between $500,000 – $1,000,000 left in the fund as of the last SAI.

Quantitative Managed Futures Strategy Fund (QMFAX) will “in the best interests of the Fund and its shareholders” redeem all outstanding shares on September 15th.

The directors of the United Association S&P 500 Index Fund (UASPX/UAIIX) have determined that it’s in their shareholders’ best interest to liquidate. Uhhh … I don’t know why. $140 million in assets, low expenses, four-star rating …

Okay, so the Oracle Fund didn’t seem particularly oracular but what about the Steadfast Fund? Let’s see: “steadfast: firmly loyal or constant, unswerving, not subject to change.” VFM Steadfast Fund (VFMSX) launched less than one year ago and gone before its first birthday.

In Closing . . .

Interesting stuff’s afoot. We’ve spoken with the folks behind the surprising Oberweis International Opportunities Fund (OBIOX), which was much different and much more interesting that we’d anticipated. Thanks to “Investor” for poking us about a profile. In October we’ll have one. RiverPark Strategic Income is set to launch at the end of the month, which is exciting both because of the success of the other fund (the now-closed RiverPark Short Term High Yield Fund RPHYX) managed by David Sherman and Cohanzick Asset Management and because Sherman comes across as such a consistently sharp and engaging guy. With luck, I’ll lure him into an extended interview with me and a co-conspirator (the gruff but lovable Ed Studzinski, cast in the role of a gruff but lovable curmudgeon who formerly managed a really first-rate mutual fund, which he did).

etf_confMFO returns to Morningstar! Morningstar is hosting their annual ETF Invest Conference in Chicago, from October 2 – 4. While, on whole, we’d rather drop by their November conference in Milan, Italy it was a bit pricey and I couldn’t get a dinner reservation at D’O before early February 2014 so we decided to pass it up. While the ETF industry seems to be home to more loony ideas and regrettable business practices than most, it’s clear that the industry’s maturing and a number of ETF products offer low cost access to sensible strategies, some in areas where there are no tested active managers. The slow emergence of active ETFs blurs the distinction with funds and Morningstar does seem do have arranged both interesting panels (skeptical though I am, I’ll go listen to some gold-talk on your behalf) and flashy speakers (Austan Goolsbee among them). With luck, I’ll be able to arrange a couple of face-to-face meetings with Chicago-based fund management teams while I’m in town. If you’re going to be at the conference, feel free to wave. If you’d like to chat, let me know.

mfo-amazon-badgeIf you shop Amazon, please do remember to click on the Observer’s link and use it. If you click on it right now, you can bookmark it or set it as a homepage and then you won’t forget. The partnership with Amazon generates about $20/day which, while modest, allows us to reliably cover all of our “hard” expenses and underwrites the occasional conference coverage. If you’d prefer to consider other support options, that’s great. Just click on “support us” on the top menu bar. But the Amazon thing is utterly painless for you.

The Sufi poet Attar records the fable of a powerful king who asks assembled wise men to create a ring that will make him happy when he is sad, and vice versa. After deliberation the sages hand him a simple ring with the words “This too will pass.” That’s also true of whatever happens to the market and your portfolio in September and October.

Be brave and we’ll be with you in a month!

David

FundX Upgrader Fund (FUNDX), September 2013

By Charles Boccadoro

FundX Upgrader Fund(FUNDX) is now FundX ETF(XCOR) – January 24, 2023

Objective and Strategy

The FUNDX Upgrader Fund seeks to maximize capital appreciation. It is a fund of active or passive funds and ETFs. 70% of the portfolio is in “core funds” which pursue mainstream investments (e.g., Oakmark Global OAKGX), 30% are more aggressive and concentrated funds (e.g., Wasatch Intl Growth WAIGX and SPDR S&P Homebuilders XHB). FUNDX employs an “Upgrading” strategy in which it buys market leaders of the last several months and sells laggards. The fund seems to get a lot of press about “chasing winners,” which at one level it does. But more perhaps accurately, it methodically attempts to capitalize on trends within the market and not be left on the sidelines holding, for example, an all-domestic portfolio when international is experiencing sustained gains.

The advisor’s motto: “We’re active, flexible, and strategic because markets CHANGE.”

Advisor

FundX Investment Group (formerly DAL Investment Company, named after its founder’s children, Douglas and Linda) is the investment advisor, based in San Francisco. It has been providing investment advisory services to individual and institutional investors since 1969. Today, it invests in and provides advice on mutual fund performance through individual accounts, its family of eight upgrader funds, and publication of the NoLoad FundX newsletter.

As of December 31, 2012, the advisor had nearly $900M AUM. About half is in several hundred individual accounts. The remaining AUM is held in the eight funds. All share similar upgrading strategies, but focused on different asset classes and objectives (e.g., fixed income bonds, moderate allocation, aggressive). The figure below summarizes top-level portfolio construction of each upgrader fund, as of June 30, 2013. Two are ETFs. Two others employ more tactical authority, like holding substantial cash or hedging to reduce volatility. FUNDX is the flagship equity fund with assets of $245M. 

2013-08-30_1615 (1)

Managers

All FundX funds are managed by the same team, led by FundX’s president Janet Brown and its CIO Jason Browne.  Ms. Brown joined the firm in 1978, became immersed with its founder’s methodology of ranking funds, assumed increasing money management responsibilities, became editor of their popular newsletter, then  purchased the firm in 1997. Ms. Brown graduated from San Diego State with a degree in art and architecture.  Mr. Browne joined the firm in 2000. He is a San Francisco State graduate who received his MBA from St Mary’s College. The other managers are Martin DeVault, Sean McKeon, and Bernard Burke. They too are seasoned in the study of mutual fund performance. That’s what these folks do.

Strategy Capacity and Closure

FUNDX would likely soft close between $1-1.5B and hard close at $2B, since the other funds and client portfolios use similar strategies. Mr. Browne estimates that the strategy itself has an overall capacity of $3B. In 2007, FUNDX reached $941M AUM. The portfolio today holds 26 underlying funds, with about 50% of assets in just seven funds, which means that the funds selected must have adequate liquidity.

Management Stake in the Fund

Ms. Brown has over $1M in FUNDX and between $100K and $1M in nearly all the firm’s funds. Mr. Browne too invests in all the funds, his largest investment is in tactically oriented TACTX where he has between $100K and $500K. The remaining team members hold as much as $500K in FUNDX and the fixed income INCMX, with smaller amounts in the other funds. None of the firm’s Independent Trustees, which include former President of Value Line, Inc. and former CEO of Rockefeller Trust Co., invest directly in any of the funds, but some hold individual accounts with the firm.

Opening Date

FUNDX was launched November 1, 2001. Its strategy is rooted in the NoLoad FundX Newsletter first published in 1976.

Minimum Investment

$1,000, reduced to $500 for accounts with an automatic investment plan.

Expense Ratio

1.70% as assets of $242 million (as of August 2013).

Comments

“Through bull and bear markets, Hulbert has emerged as the respected third-party authority on investment newsletters that consistently make the grade…for more than three decades, NoLoad FundX has emerged as a top performer in the Hulbert Financial Digest,” which is praise often quoted when researching FundX.

In a recent WSJ article, entitled “Chasing Hot Mutual-Fund Returns,” Mr. Hulbert summarizes results from a FundX study on fund selection, which considered over 300 funds at least two decades old. The study shows that since 1999, a portfolio based on top performing funds of the past year, like that used in the upgrader strategy, well outperforms against SP500 and a portfolio based of top performing funds of the last 10 years.

Hulbert Financial Digest does show the NoLoad FundX newsletter performance ranks among top of all newsletters tracked during the past 15 years and longer, but actually ranks it in lower half of those tracked for the last 10 years and shorter.

A look at FUNDX performance proper shows the flagship fund does indeed best SP500 total return. But a closer look shows its over-performance occurred only through 2007 and it has trailed every year since.

2013-08-27_0554

2013-09-01_0544

Comparisons against S&P 500 may be a bit unfair, since by design FUNDX can be more of an all-cap, global equity fund.  The fund can incrementally shift from all domestic to all foreign and back again, with the attendant change in Morningstar categorization. But Ms. Brown acknowledged the challenge head-on in a 2011 NYT interview: “As much as people in the fund industry may want to measure their performance against a very narrowly defined index, the reality is that most people judge their funds against the SP500, for better or worse.”

Asked about the fall-off, Mr. Browne explained that the recent market advance is dominated by S&P 500. Indeed, many all-cap funds with flexible mandate, like FUNDX, have actually underperformed the last few years. So while the fund attempts to capture momentum of market leaders, it also maintains a level of diversification, at least from a risk perspective, that may cause it to underperform at times. Ideally, the strategy thrives when its more speculative underlying funds experience extended advances of 10 months and more, in alignment with similar momentum in its core funds.

Crucial to their process is maintaining the universe of quality no-load/load-waived funds on which to apply its upgrading strategy. “We used to think it was all about finding the next Yacktman, and while that is still partially true, it’s just as important to align with investment style leaders, whether it is value versus growth, foreign versus domestic, or large versus small.”

Today, “the universe” comprises about 1200 funds that offer appropriate levels of diversification in both investment style and downside risk. He adds that they are very protective when adding new funds to the mix in order to avoid excessive duplication, volatility, or illiquidity. With the universe properly established, the upgrading strategy is applied monthly. The 1200 candidate funds get ranked based on performance of the past 1, 3, 6, and 12 months. Any holding that is no longer in the top 30% of its risk class gets replaced with the current leaders.

Both Ms. Brown and Mr. Browne make to clear that FUNDX is not immune to significant drawdown when the broad market declines, like in 2008-2009. In that way, it is not a timing strategy. That technique, however, can be used in the two more tactical upgrader funds TACTX and TOTLX.

The table below summarizes lifetime risk and return numbers for FUNDX, as well as the other upgrader funds. Reference indices over same periods are included for comparison. Over longer term the four upgrader funds established by 2002 have held-up quite well, if with somewhat higher volatility and maximum drawdown than the indices. Both ETFs have struggled since inception, as has TACTX.

2013-08-31_0939

I suspect that few understand more about mutual fund performance and trends than the folks at FundX. Like many MFO readers, they fully appreciate most funds do not lead persistently and that hot managers do not stay on-top. Long ago, in fact, FundX went on record that chronic underperformance of Morningstar’s 5-star funds is because time frames considered for its ratings “are much too long to draw relevant conclusions of how a fund will do in the near future.” Better instead to “invest based on what you can observe today.” And yet, somewhat ironically, while the upgrading strategy has done well in the long term, FUNDX too can have its time in the barrel with periods of extended underperformance.

While the advisor campaigns against penalizing funds for high expenses, citing that low fees do not guarantee top performance, it’s difficult to get past the high fees of FUNDX and the upgrader funds. The extra expense layer is typical with fund-of-funds, although funds which invest solely in their own firm’s products (e.g., the T. Rowe Price Spectrum Funds and Vanguard STAR VGSTX) are often exceptions.

Bottom Line

It is maddeningly hard, as Value Line and FundX have certainly discovered, to translate portfolios which look brilliant in newsletter systems into actual mutual funds with distinguished records.   The psychological quirks which affect all investors, high operating expenses, and the pressure to gain and retain substantial AUM all erode even the best-designed system.

It might well be that FUNDX’s weak performance in the past half-decade is a statistical anomaly driven by the failure of its system to react quickly enough to the market’s bottoming in the first quarter of 2009 and its enormous surge in the second.   Those sorts of slips are endemic to quant funds.  Nonetheless, the fund has not outperformed a global equity benchmark two years in a row for more than a decade and trails that benchmark by about 1% per year for the decade.   The fact that the FundX team faces those challenges despite access to an enormous amount of data, a clear investment discipline and access to a vast array of funds serves as a cautionary tale to all of us who attempt to actively manage our fund portfolios.

Website

The FundX Investment Group, which links to its investment services, newsletter, and upgrader funds. The newsletter, which can be subscribed on-line for $89 annual, is chock full of good information.

FundX Upgrader Website, this also lists the 2013 Q3 report under the Performance tab.

Fact Sheet

Charles/31Aug2013

Beck, Mack & Oliver Partners Fund (BMPEX), September 2013

By David Snowball

Objective and Strategy

Beck, Mack & Oliver Partners Fund seeks long term capital appreciation consistent with the preservation of capital. It is an all-cap fund that invests primarily in common stock, but has the ability to purchase convertible securities, preferred stocks and a wide variety of fixed-income instruments.  In general, it is a concentrated portfolio of foreign and domestic equities that focuses on finding well-managed businesses with durable competitive advantages in healthy industries and purchasing them when the risk / reward profile is asymmetric to the upside.

Adviser

Beck, Mack & Oliver LLC, founded in 1931. The firm has remained small, with 25 professionals, just seven partners and $4.8 billion under management, and has maintained a multi-generation relationship with many of its clients.  They’re entirely owned by their employees and have a phased, mandatory divestiture for retiring partners: partners retire at 65 and transition 20% of their ownership stake to their younger partners each year.  When they reach 70, they no longer have an economic interest in the firm. That careful, predictable transition makes financial management of the firm easier and, they believe, allows them to attract talent that might otherwise be drawn to the hedge fund world.  The management team is exceptionally stable, which seems to validate their claim.  In addition to the two BM&O funds, the firm maintains 670 “client relationships” with high net worth individuals and families, trusts, tax-exempt institutions and corporations.

Manager

Zachary Wydra.  Mr. Wydra joined Beck, Mack & Oliver in 2005. He has sole responsibility for the day-to-day management of the portfolio.  Prior to joining BM&O, Mr. Wydra served as an analyst at Water Street Capital and as an associate at Graham Partners, a private equity firm. In addition to the fund, he manages the equity sleeve for one annuity and about $750 million in separate accounts.  He has degrees from a bunch of first-rate private universities: Brown, Columbia and the University of Pennsylvania.

Strategy capacity and closure

The strategy can accommodate about $1.5 billion in assets.  The plan is to return capital once assets grow beyond the optimal size and limit investment to existing investors prior to that time.  Mr. Wydra feels strongly that this is a compounding strategy, not an asset aggregation strategy and that ballooning AUM will reduce the probability of generating exceptional investment results.  Between the fund and separate accounts using the strategy, assets were approaching $500 million in August 2013.

Management’s Stake in the Fund

Over $1 million.  The fund is, he comments, “a wealth-creation vehicle for me and my family.”

Opening date

December 1, 2009 for the mutual fund but 1991 for the limited partnership.

Minimum investment

$2500, reduced to $2000 for an IRA and $250 for an account established with an automatic investment plan

Expense ratio

1.0%, after waivers on assets of $50.7 million, as of June 2023. 

Comments

One of the most important, most approachable and least read essays on investing is Charles Ellis, The Loser’s Game (1977).  It’s funny and provocative and you should read it in its entirety.  Here’s the two sentence capsule of Ellis’s argument:

In an industry dominated by highly skilled investors all equipped with excellent technology, winners are no longer defined as “the guys who perform acts of brilliance.”  Winners are defined as “the guys who make the fewest stupid, unnecessary, self-defeating mistakes.”

There are very few funds with a greater number or variety of safeguards to protect the manager from himself than Beck, Mack & Oliver Partners.  Among more than a dozen articulated safeguards:

  • The advisor announced early, publicly and repeatedly that the strategy has a limited capacity (approximately $1.5 billion) and that they are willing to begin returning capital to shareholders when size becomes an impediment to exceptional investment performance.
  • A single manager has sole responsibility for the portfolio, which means that the research is all done (in-house) by the most senior professionals and there is no diffusion of responsibility.  The decisions are Mr. Wydra’s and he knows he personally bears the consequences of those decisions.
  • The manager may not buy any stock without the endorsement of the other BM&O partners.  In a unique requirement, a majority of the other partners must buy the stock for their own clients in order for it to be available to the fund.  (“Money, meet mouth.”)
  • The manager will likely never own more than 30 securities in the portfolio and the firm as a whole pursues a single equity discipline.  In a year, the typical turnover will be 3-5 positions.
  • Portfolio position sizes are strictly controlled by the Kelly Criterion (securities with the best risk-reward comprise a larger slice of the portfolio than others) and are regularly adjusted (as a security’s price rises toward fair value, the position is reduced and finally eliminated; capital is redeployed to the most attractive existing positions or a new position).
  • When the market does not provide the opportunity to buy high quality companies at a substantial discount to fair value, the fund holds cash.  The portfolio’s equity exposure has ranged between 70-90%, with most of the rest in cash (though the manager has the option of purchasing some fixed-income securities if they represent compelling values).

Mr. Wydra puts it plainly: “My job is to manage risk.” The fund’s exceedingly deliberate, careful portfolio construction reflects the firm’s long heritage.  As with other ‘old money’ advisors like Tweedy, Browne and Dodge & Cox, Beck, Mack & Oliver’s core business is managing the wealth of those who have already accumulated a fortune.  Those investors wouldn’t tolerate a manager whose reliance on hunches or oversized bets on narrow fields, place their wealth at risk.  They want to grow their wealth over time, are generally intelligent about the need to take prudent risk but unwilling to reach for returns at the price of unmanaged risk.

That discipline has served the firm’s, and the fund’s, investors quite well.  Their investment discipline seeks out areas of risk/reward asymmetries: places where the prospect of permanent loss of capital is minimal and substantial growth of capital is plausible. They’ve demonstrably and consistently found those asymmetries: from inception through the end of June 2013, the fund captured 101% of the market’s upside but endured less than 91% of its downside. To the uninitiated, that might not seem like a huge advantage.  To others, it’s the emblem of a wealth-compounding machine: if you consistently lose a bit less in bad times and keep a little ahead in good, you will in the long term far outpace your rivals.

From inception through the end of June, 2013, the strategy outpaced the S&P 500 by about 60 basis points annually (9.46% to 8.88%).  Since its reorganization as a fund, the advantage has been 190 basis points (15.18% to 13.28%).  It’s outperformed the market in a majority of rolling three-month periods and in a majority of three-month periods when the market declined.

So what about 2013?  Through late August, the fund posted respectable absolute returns (about 10% YTD) but wretched relative ones (it trailed 94% of its peers).  Why so? Three factors contributed.  In a truly defensive move, the manager avoided the “defensive” sectors that were getting madly bid up by anxious investors.  In a contrarian move, he was buying energy stocks, many of which were priced as if their industry was dying.  And about 20% of the fund’s portfolio was in cash.  Should you care?  Only if your investment time horizon is measured in months rather than years.

Bottom Line

Successful investing does not require either a magic wand or a magic formula.  No fund or strategy will win in each year or every market.  The best we can do is to get all of the little things right: don’t overpay for stocks and don’t over-diversify, limit the size of the fund and limit turnover, keep expenses low and keep the management team stable, avoid “hot” investments and avoid unforced errors, remember it isn’t a game and it isn’t a sprint.  Beck, Mack & Oliver gets an exceptional number of the little things very right.  It has served its shareholders very well and deserves close examination.

Fund website

Beck Mack & Oliver Partners

Fact Sheet

© 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.

Tributary Balanced (FOBAX), September 2013 update

By David Snowball

THIS IS AN UPDATE OF THE FUND PROFILE ORIGINALLY PUBLISHED IN April 2012. YOU CAN FIND THAT PROFILE HERE.

Objective and strategy

Tributary Balanced Fund seeks capital appreciation and current income. They allocate assets among the three major asset groups: common stocks, bonds and cash equivalents. Based on their assessment of market conditions, they will invest 25% to 75% of the portfolio in stocks and convertible securities, and at least 25% in bonds. The portfolio is typically 70-75 stocks from small- to mega-cap and turnover is well under half of the category average.  They currently hold about 60 bonds.

Adviser

Tributary Capital Management.  At base, Tributary is a subsidiary of First National Bank of Omaha and the Tributary Funds were originally branded as the bank’s funds.  Tributary advises six mutual funds, as well as serving high net worth individuals and institutions.  As of June 30, 2013, they had about $1.3 billion under management.

Manager

David C. Jordan, since July 2013.  Mr. Jordan is the Managing Partner of Growth Equities for Tributary and has been managing portfolios since 1982.  He managed this fund from 05/2001 to 07/2010. He has managed four-star Growth Opportunities (FOGRX) since 1998 and two-star Large Cap Growth (FOLCX) since 2011.  Before joining Tributary, he managed investments at the predecessors to Bank One Investment Advisors, Key Trust of the Northwest, and Wells Fargo Denver.

Management’s stake in the fund

Mr. Jordan’s investments are primarily in equities (he reports having “more than half of my financial assets invested in the Tributary Growth Opportunities Fund which I manage”), but he recently invested over $100,000 in the Balanced fund. 

Strategy capacity and closure

The advisor has “not formally discussed strategy capacities for the Balanced Fund, believing that we will not have to seriously consider capacity constraints until the fund is much larger than it is today.”

Opening date

August 6, 1996

Minimum investment

$1000, reduced to $100 for accounts opened with an automatic investing plan.

Expense ratio

0.99%, after a waiver, on $78 million in assets (as of July 2023).  Morningstar describes the expenses as “high,” which is misleading.  Morningstar continues benchmarking FOBAX against “true” institutional functions with minimums north of $100,000.

Comments

The long-time manager of Tributary Balanced has returned.  In what appears to be a modest cost-saving move, Mr. Jordan returned to the helm of this fund after a three year absence. 

If his last stint with the fund, from 2001 – 2010, is any indication, that’s a really promising development.  Over the three years of his absence, Tributary was a very solid fund.  The fund’s three-year returns of 13.1% (through 6/30/2013) place it in the top tier of all moderate allocation funds.  Over the period, it captured more of the upside and a lot less of the downside than did its average peer.  Our original profile concluded with the observation, “Almost no fund offers a consistently better risk-return profile.”

One of the few funds better than Tributary Balanced 2010-2013 might have been Tributary Balanced 2001-2010.  The fund posted better returns than the most highly-regarded, multi-billion dollar balanced funds.  If you compare the returns on an investment in FOBAX and its top-tier peers during the period of Mr. Jordan’s last tenure here (7/30/2001 – 5/10/2010), the results are striking.

Tributary versus Vanguard Balanced Index (VBINX)?  Tributary’s better.

Tributary versus Vanguard STAR (VGSTX)?  Tributary.

Tributary versus Vanguard Wellington (VWELX)?  Tributary.

Tributary versus Dodge and Cox Balanced (DODBX)?  Tributary.

Tributary versus Mairs & Power Balanced (MAPOX)?  Tributary.

Tributary versus T. Rowe Price Capital Appreciation (PRWCX)?  Price, by a mile.  Ehh.  Nobody’s perfect and Tributary did lose substantially less than Cap App during the 10/2007-03/2009 market collapse.

Libby Nelson of Tributary Capital Management reports that “During that time period, David outperformed the benchmark in 7 out of 9 of the calendar years and the five and ten-year performance was in the 10th percentile of its Morningstar Peer Group.”  In 2008, the fund finished in the top 14% of its peer group with a loss of 22.5% while its average peer dropped 28%.  During the 18-month span of the market collapse, Tributary lost 34.7% in value while the average moderate allocation fund dropped 37.3%.

To what could we attribute Tributary’s success? Mr. Jordan’s answer is, “we think a great deal about our investors.  We know that they’re seeking a lower volatility fund and that they’re concerned with downside protection.  We build the portfolio from there.”

Mr. Jordan provided stock picks for the fund’s portfolio even when he was not one of the portfolio managers.  He’s very disciplined about valuations and prefers to pursue less volatile, lower beta, lower-priced growth stocks.  In addition, he invests a greater portion of the portfolio in less-efficient slices of the market (smaller large caps and mid-caps) which results in a median market cap that’s $8 billion lower than his peers.

Responding to the growing weakness in the bond market, he’s been rotating assets into stocks (now about 70% of the portfolio) and shortening the duration of the bond portfolio (from 4.5 years down to 3.8 years).  He reports, “Our outlook is for returns from bonds in the period ahead to be both volatile, and negative, so we will move further toward an emphasis on stocks, which also may be volatile, but we believe will be positive over the next twelve months.”

Bottom Line

The empirical record is pretty clear.  Almost no fund offers a consistently better risk-return profile.  That commitment to consistency is central to Mr. Jordan’s style: “We are more focused on delivering consistent returns than keeping up with momentum driven markets and securities.”  Tributary has clearly earned a spot on the “due diligence” list for any investor interested in a hybrid fund.

Fund website

Tributary Balanced

Fact Sheet

© 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.

North Square Strategic Income (formerly Advisory Research Strategic Income), (ADVNX), September 2013

By David Snowball

At the time of publication, this fund was named Advisory Research Strategic Income.

Objective and Strategy

The fund seeks high current income and, as a secondary objective, long term capital appreciation.  It invests primarily in straight, convertible and hybrid preferred securities but has the freedom to invest in other income-producing assets including common stock.  The advisor wants to achieve “significantly higher yields” than available through Treasury securities while maintaining an investment-grade portfolio.  That said, the fund may invest “to a limited extent” in high-yield bonds, may invest up to 20% in foreign issues and may write covered call options against its holdings.  Morningstar categorizes it as a Long-Term Bond fund, which is sure to generate misleading peer group performance stats since it’s not a long-term bond fund.

Adviser

Advisory Research (ARI).  AR is a Chicago-based advisor for some of the nation’s wealthiest individuals, as well as privately-held companies, endowments, foundations, pensions and profit-sharing plans. They manage over $10.0 billion in total assets and advise the five AR funds.

Manager

Brien O’Brien, James Langer and Bruce Zessar.  Mr. O’Brien is ARI’s CEO.  He has 34 years of investment experience including stints with Marquette Capital, Bear Stearns and Oppenheimer.  He graduated with honors from Boston College with a B.S. in finance and theology.  He oversees four other AR funds.   Mr. Langer is a Managing Director and helps oversee two other AR funds.  Like Mr. O’Brien, he worked for Marquette Associates.  His career started at the well-respected Center for Research in Security Prices at the University of Chicago.  Mr. Zessar has a J.D. from Stanford Law and 11 years of investing experience.  Mr. Zessar also co-manages All-Cap Value (ADVGX). The team manages about $6 billion in other accounts.

Management’s Stake in the Fund

Mr. O’Brien provided a seed investment when the strategy was launched in 2003, and today has over $1 million in the fund.  Mr. Langer has around a half million in the fund and Mr. Zessar had between $10,000 and $50,000 in the fund.   

Strategy capacity and closure

They estimate a strategy capacity of about $1 billion; since they do invest heavily in preferred shares but have the ability to invest elsewhere, they view the cap as flexible.  Mr. Zessar notes that the few others open-end funds specializing in preferred shares have asset bases of $1 – 5 billion.

Opening date

December 31, 2012 after the conversion of one limited partnership account, Advisory Research Value Income Fund, L.P., which commenced operations on June 30, 2003 and the merger of another.

Minimum investment

$2500.

Expense ratio

0.90%, after waivers, on assets of $167.9 million, as of July 2023. 1.15%, after waivers, for “A” class shares. 

Comments

Preferred stocks are odd creatures, at least in the eyes of many investors.  To just say “they are securities with some characteristics of a bond and some of a stock” is correct, but woefully inadequate.  In general, preferred stock carries a ticker symbol and trades on an exchange, like common stock does.  In general, preferred stockholders have a greater claim on a firm’s dividend stream than do common stockholders: preferred dividends are paid before a company decides whether it can pay its common shareholders, tend to be higher and are often fixed, like the coupon on a bond. 

But preferred shares have little potential for capital appreciation; they’re generally issued at $25 and improving fortunes of the issuing firm don’t translate to a rising share price.  A preferred stock may or may not have maturity like a bond; some are “perpetual” and many have 30-40 year maturities.  It can either pay a dividend or interest, usually quarterly or semi-annually.  Its payments might be taxed at the dividend rate or at your marginal income rate, depending.  Some preferred shares start with a fixed coupon payment for, say, ten years and then exchange it for a floating payment fixed to some benchmark.  Some are callable, some are not.  Some are convertible, some are not.

As a result of this complexity, preferred shares tend to be underfollowed and lightly used in open-end funds.  Of the 7500 extant open-end mutual funds, only four specialize in preferred securities: ADVNX and three load-bearing funds.  A far larger number of closed-end funds invest in these securities, often with an overlay of leverage.

What’s the case for investing in preferred stocks

Steady income.  Strategic Income’s portfolio has a yield of 4.69%.  By comparison, Vanguard Intermediate-Term Treasury Fund (VFITX) has a 30-day yield of 1.38% and its broader Intermediate-Term Bond Index Fund (VBIIX) yields 2.64%.

The yield spread between the fed funds rate and the 10-year Treasury is abnormally large at the moment (about 280 bps in late August); when that spread reverts to its normal level (about 150 bps), there’s also the potential for a little capital appreciation in the Strategic Income fund.

In the long term, the managers believe that they will be able to offer a yield of about 200-250 basis points above what you could get from the benchmark 10-year Treasury.  At the same time, they believe that they can do so with less interest rate sensitivity; the fund has, in the past, shown the interest rate sensitivity associated with a bond portfolio that has a six or seven year maturity.

In addition, preferred stocks have traditionally had low correlations to other asset classes.   A 2012 report from State Street Global Advisors, The Case for Preferred Stocks, likes the correlation between preferred shares and bonds, international stocks, emerging markets stocks, real estate, commodities and domestic common stocks for the 10 years from 2003 to 2012:

ssga

As a result, adding preferred stock to a portfolio might both decrease its volatility and its interest rate sensitivity while boosting its income.

What’s the case for investing with Advisory Research

They have a lot of experience in actively managing this portfolio.

Advisory Research launched this fund’s predecessor in 2003.  They converted it to a mutual fund at the end of 2012 in response to investor demands for daily liquidity and corrosive skepticism of LPs in the wake of the Madoff scandal. The existing partners voted unanimously for conversion to a mutual fund.

From inception through its conversion to a mutual fund, the L.P. returned 4.24% annually while its benchmark returned 2.44%, an exceptionally wide gap for a fixed-income fund.  Because it’s weakly correlated to the overall stock market, it has held up relatively well in downturns, losing 25.8% in 2008 when the S&P 500 dropped 37%.  The fund’s 28.1% gain in 2009 exceeded the S&P’s 26.5% rebound.  It’s also worth noting that the same management team has been in place since 2003.

The team actively manages the portfolio for both sector allocation and duration.  They have considerable autonomy in allocating the portfolio, and look to shift resources in the direction of finding “safe spread.”  That is, for those investments whose higher yield is not swamped by higher risk.  In mid-2012, 60% of the portfolio was allocated to fixed preferred shares.  In mid-2013, they were half that.  The portfolio instead has 50% in short-term corporate bonds and fixed-to-floating rate securities.  At the same time, they moved aggressively to limit interest-rate risk by dramatically shortening the portfolio’s duration.

Bottom Line

This is not a riskless strategy.  Market panics can drive even fundamentally sound securities lower.  But panics are short-term events.  The challenge facing conservative investors, especially, is long-term: they need to ask the question, “where, in the next decade or so, am I going to find a reasonable stream of income?”  With the end of the 30-year bond bull market, the answer has to be “in strategies that you’ve not considered before, led by managers whose record is solid and whose interests are aligned with yours.” With long-term volatility akin to an intermediate-term corporate bond fund’s, substantial yield, and a stable, talented management team, Advisory Research Strategic Income offers the prospect of a valuable complement to a traditional bond-centered portfolio.

Fund website

North Square Strategic Income.  SSgA’s The Case for Preferred Stock (2012) is also worth reading, recalling that ADVNX’s portfolio is neither all-preferred nor locked into its current preferred allocation.

SSgA’s Preferred Securities 101

2023 Semi-Annual Report

Fact Sheet

© 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.

September 2013, Funds in Registration

By David Snowball

AdvisorShares YieldPro ETF

AdvisorShares YieldPro ETF will be an actively-managed ETF that seeks to provide current income and capital appreciation primarily investing in both long and short positions in other ETFs that offer diversified exposure to income producing securities.  They’ll mostly target securities that provide “competitive yield” but will add in “instruments which provide little or no yield for diversification or risk management purposes.” The fund will be managed by Joshua Emanuel, Chief Investment Officer of Elements Financial Group since 2010.  Before that he was a Principal, Head of Strategy and co-chair of the Investment Management Committee at Wilshire Associates.  The fund’s expense ratio has not yet been set.

American Century Emerging Markets Value Fund

American Century Emerging Markets Value Fund, Investor class shares, will pursue capital growth by investing in e.m. stocks.  They target the 21 markets in the MSCI E.M. index.  It’s a quant portfolio that starts by ranking stocks from most to least attractive based on value, momentum and quality. They then run a portfolio optimizer to balance risk and return.  It will be managed by Vinod Chandrashekaran, Yulin Long, and Elizabeth Xie. All are members of the Quantitative Research team. The expense ratio will be capped at 1.46%.  The minimum initial investment is $2,500.  Launch is set for some time in October.

Brown Advisory Strategic European Equity Fund

Brown Advisory Strategic European Equity Fund, Investor shares, seeks to achieve total return by investing principally in equity securities issued by companies established or operating in Europe.  They may invest directly or through a combination of derivatives.  The fund will be managed by Dirk Enderlein of Wellington Management. Wellington is indisputably an “A-team” shop (they’ve got about three-quarters of a trillion in assets under management).  Mr. Enderlein joined them in 2010 after serving as a manager for RCM – Allianz Global Investors in Frankfurt, Germany (1999-2009). Media reports described him as  “one of Europe’s most highly regarded European growth managers.” The expense ratio will be capped at 1.35%.  The minimum initial investment is $5,000.  Launch is set for some time in October.

DoubleLine Shiller Enhanced CAPE

DoubleLine Shiller Enhanced CAPE, Class N shares, looks for “total return in excess of the Shiller Barclays CAPE® US Sector TR USD Index.”  The Shiller CAPE (cyclically-adjusted price-earnings) index tracks the performance of the four (of ten) sectors which have the best combination of a low CAPE ratio and price momentum on their side.  The fund will attempt to outdo the index by using leverage and by holding a fixed-income portfolio similar to DoubleLine Core Fixed Income’s. The fund will be managed by The Gundlach (given that he sees himself as super-heroic, an Enhanced Cape fits) and Jeffrey Sherman.  The expense ratio will be capped at 0.80%.  The minimum initial investment is $2,000.  Launch is set for some time in October.

Driehaus Micro Cap Growth Fund

Driehaus Micro Cap Growth Fund (and, in truth, pretty much every Driehaus fund) seeks to maximize capital appreciation.  They anticipate investing at least 80% in a non-diversified portfolio of micro-caps then then trading them actively; they anticipate a turnover of 100 – 275%. The managers will be Jeffrey James and Michael Buck.  This is another instance of a limited partnership (or, in this case, two limited partnerships) being converted into mutual funds.  Those were the Driehaus Micro Cap Fund, L.P. and the Driehaus Institutional Micro Cap Fund, L.P.  Mr. James has been running the Micro Cap LP since 1998 and Mr. Buck has been assisting on that portfolio.  The current draft of the prospectus does not include the LP’s track record.  The expense ratio will be capped, but it has not yet been announced.  The minimum initial investment is $10,000.

Even Keel Managed Risk Fund

Even Keel Managed Risk Fund will seek to provide total return consistent with long-term capital preservation, while seeking to manage volatility and reduce downside risk during severe, sustained market declines.  It will be a hedged large cap equity portfolio.  The managers will be Blake Graves and Zack Brown of Milliman Financial Risk Management LLC.  The expense ratio will be capped at 0.97%.  The minimum initial investment is $3,000.

Even Keel Opportunities Managed Risk Fund

Even Keel Opportunities Managed Risk Fund will seek to provide total return consistent with long-term capital preservation, while seeking to manage volatility and reduce downside risk during severe, sustained market declines. It will be a hedged SMID cap portfolio.  The managers will be Blake Graves and Zack Brown of Milliman Financial Risk Management LLC.  The expense ratio will be capped at 0.97%.  The minimum initial investment is $3,000.

Even Keel Developed Markets Managed Risk Fund

Even Keel Developed Markets Managed Risk Fund will seek to provide total return consistent with long-term capital preservation, while seeking to manage volatility and reduce downside risk during severe, sustained market declines.  It will be an international equity portfolio hedged with long/short exposure to index, Treasury and currency futures.  The managers will be Blake Graves and Zack Brown of Milliman Financial Risk Management LLC.  The expense ratio will be capped at 0.97%.  The minimum initial investment is $3,000.

Even Keel Emerging Markets Managed Risk Fund

Even Keel Emerging Markets Managed Risk Fund will seek to provide total return consistent with long-term capital preservation, while seeking to manage volatility and reduce downside risk during severe, sustained market declines.  It will be an emerging markets equity portfolio hedged with long/short exposure to index, Treasury and currency futures.  .  The managers will be Blake Graves and Zack Brown of Milliman Financial Risk Management LLC.  The expense ratio will be capped at 0.97%.  The minimum initial investment is $3,000.

Fidelity Short Duration High Income

Fidelity Short Duration High Income will pursue high current income and is willing to accept some capital appreciation.  The prospectus is really kind of an ill-written jumble, they have an unnatural affinity for bullet-pointed lists.  At base, they’ll invest mostly in BB or B-rated securities with a duration of three years or less but they might slip in defaulted securities, common stock and floating rate loans.  It will be managed by Matthew Conti (lead portfolio manager) and Michael Plage. Mr. Conti also manages Fidelity Focused High Income (FHIFX) about which Morningstar is unimpressed, and bits of other bond funds. The expense ratio will be capped at 0.80%.  The minimum initial investment is $2,500.  Launch is set for some time in October.

Harbor Emerging Markets Equity Fund

Harbor Emerging Markets Equity Fund will seek long-term growth by investing at least 65% (?) of its portfolio in what the managers believe to be high-quality firms located in, or doing serious business in, the emerging markets. All Harbor funds are sub-advised.  This one is managed by Frank Carroll and Tim Jensen of Oaktree Capital Management. Oaktree is a first-tier institutional manager which has agreed to sub-advise very few (uhh, two?) mutual funds.  They have an emerging markets equity composite, representing their work for private clients, but the current prospectus does not reveal the composite’s age or performance.  The fund is scheduled to go live on November 1.  It would be prudent to check in then. The expense ratio will be capped at 1.62%.  The minimum initial investment is $2,500.

Hull Tactical US ETF

Hull Tactical US ETF will be an actively-managed ETF that pursues long-term growth by playing with fire.  It will invest in a combination of other ETFs that match the S&P, match the inverse of the S&P or are leveraged to returns of the S&P.  The managers will position that fund somewhere between 200% long and 100% short, with the additional possibility of 100% cash.  The fund will be managed by Blair Hull, Founder and Chairman of HTAA, and Brian von Dohlen, their Senior Financial Engineer.  Expenses not yet set.

Manning & Napier Equity Income

Manning & Napier Equity Income, Class S shares, wants to provide “total return through a combination of current income, income growth, and long-term capital appreciation.” They’re going to target income-paying equity securities including common and preferred stocks, convertible securities, REITs, MLPs, ETFs and interests in business development companies.  The fund will be managed by Michael J. Magiera, Managing Director of Equity Income Group, Christopher F. Petrosino, Managing Director of the Quantitative Strategies Group, Elizabeth Mallette and William Moore.  The expense ratio will be capped, but it has not yet been announced.  The minimum initial investment is $2,000.

Manning & Napier Emerging Opportunities

Manning & Napier Emerging Opportunities Series, Class S shares, will seek long-term growth by investing primarily in a domestic mid-cap growth portfolio.  Their target is companies growing at least twice as fast as the overall economy. The fund will be managed by Ebrahim Busheri, Managing Director of Emerging Growth Group, Brian W. Lester and Ajay M. Sadarangani. The expense ratio will be capped, but it has not yet been announced.  The minimum initial investment is $2,000.

Meridian Small Cap Growth

Meridian Small Cap Growth will pursue long-term growth of capital by investing primarily in equity securities of small capitalization companies.  The bottom line is that this is the new platform for the two star managers, Chad Meade and Brian Schaub, who Meridian’s new owner hired away from Janus. Morningstar’s Greg Carlson described them as “superb managers” who were “consistently successful during their nearly seven years at the helm of this small-growth fund,” referring to Janus Triton. The expense ratio is not set.  The minimum initial investment is $1,000.

Northern Multi-Manager Emerging Markets Debt Opportunity Fund

Northern Multi-Manager Emerging Markets Debt Opportunity Fund will seek both income and capital appreciation by investing in emerging and frontier market debt.  That includes a wide variety of corporate and government bonds, preferred and convertible securities and derivatives.  The sub-advisers include teams from a Northern Trust subsidiary, Bluebay Asset Management (a British firm with $56 billion in AUM) and Lazard. The expense ratio, after waivers, is capped at 0.93%.  The prospectus covers only an institutional class, with a $1 million minimum.

PIMCO TRENDS Managed Futures Strategy Fund

PIMCO TRENDS Managed Futures Strategy Fund, “D” shares for retail, will seek “absolute risk-adjusted returns.”  The plan is to invest in derivatives (and an unnamed off-shore fund run by PIMCO) linked to interest rates, currencies, mortgages, credit, commodities, equity indices and volatility-related instruments; they’ll invest in sectors trending higher and can short the ones trending lower.  They plan on having a volatility target but haven’t yet announced it.  In general, managed futures funds have been a raging disappointment (the group has losses over every trailing period from one day to five years).  In general, PIMCO funds excel.  It’ll be interested to see which precedent prevails.  The manager is as-yet unnamed and the expense ratio is not set.  The minimum initial investment is $2,500 for “D” shares purchased through a supermarket.

Redwood Managed Volatility Fund

Redwood Managed Volatility Fund, “N” class shares, will seek “a combination of total return and prudent management of portfolio downside volatility and downside loss.”  The strategy is pretty distinctive: invest in high-yield bonds when the high-yield market is trending up and in short-term bonds whenever the high-yield market is trending down.  The fund will be managed by Michael Messinger and Bruce DeLaurentis.  Mr. Messinger seems to be a business/marketing guy while DeLaurentis is the investor.  Mr. DeLaurentis’s separate accounts composite at Kensington Management, stretching back 20 years, seems fairly impressive.  He’s returned about 10% over 20 years, 11% over 10 years, and 15% over five years. The expense ratio is not set.  The minimum initial investment is $10,000.

Rx Fundamental Growth Fund

Rx Fundamental Growth Fund, Advisor shares, will seek capital appreciation by investing in stocks.  The description is pretty generic.  The highlight of this offering is their manager, Louis Navellier.  Mr. Navellier is a famous growth-investing newsletter guy.  He once had a line of mutual funds that merged with a couple Touchstone funds.  The Touchstone fund Navellier subadvises is fairly mild-mannered though its performance in recent years has been weak.  His separate account composites show mostly lackluster to abysmal performance over the past 7-10 years.  The expense ratio is capped at 2.06%.  The minimum initial investment is $250.

Steinberg Select Fund

Steinberg Select Fund, Investor class, will seek growth by investing in stocks of all sizes.  It will likely invest in developed foreign stocks as well, but there’s not much of a discussion of asset class weighting.  It seems like they’re looking for defensive names, but that’s not crystal clear.  Michael Steinberg will head the investment team.  Their all-cap concentrated value composite has a substantial lead over its benchmark since inception in 1990 and about a 150 bps annual lead in the past 10 years, but seems to have taken a dramatic dive in the 2007-09 crash.  The expense ratio is capped at 1.0%.  The minimum initial investment is $10,000.

Stone Toro Relative Value Fund

Stone Toro Relative Value Fund will seek capital appreciation with a secondary focus on current income. It invests in an all-cap portfolio, primarily of dividend-paying stock.  Up to 40% might be invested in international stocks via ADRs.  They warn that their strategy involves active and frequent trading. The manager will be Michael Jarzyna, Founding Partner and CIO of Stone Toro.  The expense ratio is capped at 1.57%.  The minimum initial investment is $1000.

T. Rowe Price Global Industrials Fund

T. Rowe Price Global Industrials Fund will pursue long-term capital growth by investing in a global, diversified portfolio of industrial sector stocks.  The general rule seems to be, if it requires a large factory, it’s in.  The fund will be managed by Peter Bates, an industrials analyst who joined Price in 2002 but who has no prior fund management record.  The expense ratio is capped at 1.05%.  The minimum initial investment is $2500, reduced to $1000 for IRAs.

Thomson Horstmann & Bryant Small Cap Value Fund

Thomson Horstmann & Bryant Small Cap Value Fund, Investor shares, is looking for capital appreciation.  The plan is to invest in small-value stocks but there’s nothing in the prospectus that distinguishes their strategies from anyone else’s.  The fund will be managed by Christopher N. Cuesta, who joined THB in 2002 and has managed micro-cap accounts for them since 2004 and small cap ones since 2005.  He’d previously worked at Salomon Smith Barney and Van Eck.  This private accounts composite shows persistently high beta, excellent upmarket performance and very weak downmarket performance.  The expense ratio is capped at 1.5%. The minimum initial investment is $100. 

WCM Focused Emerging Markets Fund

WCM Focused Emerging Markets Fund, Investor class, will seek long-term capital appreciation by investing in emerging and frontier markets stocks and corporate bonds.  They can also invest in multinational corporations with large e.m. footprints.  The fund will be non-diversified.   Beyond being “bottom up” investors, details are a bit sketchy.  The fund will be managed by a team from WCM Investment Management, led by Sanjay Ayer. Their emerging markets composite has a two year history.  It appears to have substantially outperformed an e.m. equity index in 2011 and trailed it in 2012.  The expense ratio is not yet set. The minimum initial investment is $1000. 

WCM Focused Global Growth Fund

WCM Focused Global Growth Fund, Investor class, will seek long-term capital appreciation by investing in a non-diversified portfolio of global blue chip stocks.  The fund will be managed by a team from WCM Investment Management, led by Sanjay Ayer. Their Quality Global Growth composite has a five year history.  It appears to have substantially outperformed a global equity index over the past five years, though it trailed it in 2012. The expense ratio is not yet set. The minimum initial investment is $1000. 

West Shore Real Asset Income Fund

West Shore Real Asset Income Fund, “N” class, will seek a combination of capital growth and current income.  30-50% will be in dividend-paying US equities, 30-50% in “foreign securities that the Adviser believes will provide returns that exceed the rate of inflation” and 20% in alternative investments, such as hedge funds.  There’s no evidence (e.g., a track record) to suggest that this is a particularly good idea.  The fund will be managed by Steve Cordasco, President of West Shore, Michael Shamosh, and James G. Rickards. The expense ratio is capped at 2.0%. The minimum initial investment is $2500. 

FPA Paramount (FPRAX), September 2013

By David Snowball

Objective and Strategy

The FPA Global Value Strategy will seek to provide above-average capital appreciation over the long term while attempting to minimize the risk of capital losses by investing in well-run, financially robust, high-quality businesses around the world, in both developed and emerging markets.

Adviser

FPA, formerly First Pacific Advisors, which is located in Los Angeles.  The firm is entirely owned by its management which, in a singularly cool move, bought FPA from its parent company in 2006 and became independent for the first time in its 50 year history.  The firm has 28 investment professionals and 72 employees in total.  Currently, FPA manages about $25 billion across four equity strategies and one fixed income strategy.  Each strategy is manifested in a mutual fund and in separately managed accounts; for example, the Contrarian Value strategy is manifested in FPA Crescent (FPACX), in nine separate accounts and a half dozen hedge funds.  On April 1, 2013, all FPA funds became no-loads.

Managers

Pierre O. Py and Greg Herr.  Mr. Py joined FPA in September 2011. Prior to that, he was an International Research Analyst for Harris Associates, adviser to the Oakmark funds, from 2004 to 2010.  Mr. Py has managed FPA International Value (FPIVX) since launch. Mr. Herr joined the firm in 2007, after stints at Vontobel Asset Management, Sanford Bernstein and Bankers Trust.  He received a BA in Art History at Colgate University.  Mr. Herr co-manages FPA Perennial (FPPFX) and the closed-end Source Capital (SOR) funds with the team that used to co-manage FPA Paramount.  Py and Herr will be supported by the two research analysts, Jason Dempsey and Victor Liu, who also contribute to FPIVX.

Management’s Stake in the Fund

As of the last SAI (September 30, 2012), Mr. Herr had invested between $1 and $10,000 in the fund and Mr. Py had no investment in it.  Mr. Py did have a very large investment in his other charge, FPA International Value.

Opening date

September 8, 1958.

Minimum investment

$1,500, reduced to $100 for IRAs or accounts with automatic investing plans.

Expense ratio

0.94% on $323 million in assets, as of August 2013.

Comments

We’ve never before designated a 55-year-old fund as a “most intriguing new fund,” but the leadership and focus changes at FPRAX warrant the label.

I’ve written elsewhere that “Few fund companies get it consistently right.  By “right” I don’t mean “in step with current market passions” or “at the top of the charts every year.”  By “right” I mean two things: they have an excellent investment discipline and they treat their shareholders with profound respect.

FPA gets it consistently right.

FPA has been getting it right with the two funds overseen by Eric Ende and Stephen Geist: FPA Paramount (since March 2000) and FPA Perennial (since 1995 and 1999, respectively).   Morningstar designates Paramount as a five-star world stock fund and Perennial as a three-star domestic mid-cap growth fund (both as of August, 2013).  That despite the fact that there’s a negligible difference in the fund’s asset allocation (cash/US stock/international stock) and no difference in their long-term performance.  The chart below shows the two funds’ returns and volatility since Geist and Ende inherited Paramount.

fpa paramount

To put it bluntly, both have consistently clubbed every plausible peer group (mid-cap growth, global stock) and benchmark (S&P 500, Total Stock Market, Morningstar US Growth composite) that I compared them to.  By way of illustration, $10,000 invested in either of these funds in March 2000 would have grown to $35,000 by August 2013.  The same amount in the Total Stock Market index would have hit $16,000 – and that’s the best of any of the comparison groups.

To be equally blunt, the funds mostly post distinctions without a difference.  In theory Paramount has been more global than Perennial but, in practice, both remained mostly focused on high-quality U.S. stocks. 

FPA has decided to change that.  Geist and Ende will now focus on Perennial, while Py and Herr reshape Paramount.  There are two immediately evident differences:

  1. The new team is likely to transition toward a more global portfolio.  We spoke with Mr. Py after the announcement and he downplayed the magnitude of any immediate shifts.  He does believe that the most attractive valuations globally lie overseas and the most attractive ones domestically lie among large cap stocks.  That said, it’s unlikely the case that FPA brought over a young and promising international fund manager with the expectation that he’ll continue to skipper a portfolio with only 10-15% international exposure.
  2. The new team is certain to transition toward a more absolute value portfolio.  Mr. Py’s investment approach, reflected in the FPIVX prospectus, stresses “Low Absolute Valuation. The Adviser only purchases shares when the Adviser believes they offer a significant margin of safety (i.e. when they trade at a significant discount to the Adviser’s estimate of their intrinsic value).”  In consequence of that, “the limited number of holdings in the portfolio and the ability to hold cash are key aspects of the portfolio.”  At the last portfolio report, International Value held 24 stocks and 38% cash while Paramount held 31 and 10%.  Given that the investment universe here is broader than International’s, it’s unlikely to hold huge cash stakes but likely that it might drift well north of its current level at times.

Bottom Line

Paramount is apt to become a very solid, but very different fund under its new leadership.  There will certainly be a portfolio restructuring and there will likely be some movement of assets as investors committed to Ende and Geist’s style migrate to Perennial.  The pace of those changes will dictate the magnitude of the short-term tax burden that shareholders will bear. 

Fund website

FPA Paramount Fund

2013 Q3 Report and Commentary

Fact Sheet

© 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.

Manager changes, August 2013

By Chip

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

Dt

TWCIX

American Century Select

No one, but . . .

Analyst Chris Krantz is promoted to comanager.

8/13

TWCUX

American Century Ultra

No one, but . . .

Analyst Jeff Bourke is promoted to comanager.

8/13

BACHX

BlackRock Emerging Markets Dividend

Andrew Swan, under whom the fund remained microscope and wan, is out

Dhiren Shah and Luiz Soares

8/13

CEIAX

Calvert Equity Income Fund

No one, but . . .

Natalie Trunow joins the team.

8/13

CGOIX

Century Growth Opportunities Fund

David Borah

Donald Bisson remains

8/13

DSGAX

Dreyfus Select Managers Small Cap Growth Fund

Subadvisor King Investment Advisors.

The other five subadvisers remain.

8/13

MIDVX

DWS Mid Cap Value

Subadvisor Dreman Value Management is out.

The in-house team of Richard Glass, Richard Hanlon, and Mary Schafer, will take over.

8/13

RRRAX

DWS RREEF Real Estate Securities

Jerry W. Ehlinger

Joseph Fisher and David Zonavetch join John Robertson and John Vojticek

8/13

KDSAX

DWS Small Cap Value

Subadvisor Dreman Value Management is out.  DVM is another of those guru-driven firms that’s been spiraling steadily down.

The in-house team of Richard Glass, Richard Hanlon, and Mary Schafer, will take over.

8/13

ETTGX

Eaton Vance Tax-Managed Growth Fund 1.1

Duncan Richardson will be retiring as of Oct. 31st

The rest of the team, Lewis R. Piantedosi, Michael A. Allison and Yana S. Barton, remains.

8/13

EXTGX

Eaton Vance Tax-Managed Growth Fund 1.2

Duncan Richardson will be retiring as of Oct. 31st

The rest of the team, Lewis R. Piantedosi, Michael A. Allison and Yana S. Barton, remains.

8/13

FDEGX

Fidelity Growth Strategies Fund

Christopher Lee

Jean Park 

8/13

FSESX

Fidelity Select Energy Service

No one, but . . .

Ben Shuleva joins Jonathan Kasen

8/13

FPRAX

FPA Paramount

Steven Geist and Eric Ende are stepping down after 13 years as part of a strategy change

Gregory Herr and Pierre Py move into the lead.

8/13

FPPFX

FPA Perennial

No one, but . . .

Gregory Herr will join existing managers Eric Ende and Steven Geist

8/13

GCIAX

Goldman Sachs International Equity Insights

Nellie Bronner

Osman Ali and Takashi Suwabe will join the team.

8/13

GICAS

Goldman Sachs International Small Cap Insights

Nellie Bronner

Osman Ali and Takashi Suwabe will join the team.

8/13

SEQAX

Guggenheim World Equity Income

The Rydex team of Michael Byrum, Michael Dellap, and Ryan Harder

Ole Jakob Wold, Farhan Sharaff, Scott Hammond, and Nardin Baker.

8/13

GSCYX

Guidestone Small Cap Equity Fund

Chris Diegelman, one of the managers from sub-advisor Western Asset

The rest of the 15 person, 6 sub-advisor team remains.

8/13

XXXXX

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Heather Hackett is out.  The legal filing fees alone must surely have approached the amount of her salary; her departure triggered something let seven separate sets of SEC filings.

Frank van Etten is taking her place

8/13

LETRX

ING Russia Fund

Angus Alexander Robertson

Renat Nadyukov

8/13

JXBAX

JPMorgan Access Balanced Fund

Subadvisors FMI, Osterweis, and Shenkman are out.

The other five subadvisers remain.

8/13

JXGAX

JPMorgan Access Growth Fund

Subadvisors FMI, Osterweis, and Shenkman are out.

The other five subadvisers remain.

8/13

LAALX

Leuthold Asset Allocation

Eric Weigal is out and the fund is about to dissolve.

The rest of the team remains.

8/13

LSLTX

Leuthold Select Industries Fund

Eric Weigal

Greg Swenson joins the team

8/13

MIMFX

Managers Micro-Cap Fund

No one, but . . .

Arthur K. Weise joins the team.

8/13

MFWTX

MFS Global Total Return

No one, but . . .

Pilar Gomez-Bravo and Robert Persons will join the team

8/13

NABAX

Neuberger Berman Absolute Return Multi-Manager Fund

No one, but . . .

Loeb Arbitrage Management is a new subadviser to the fund, with Gideon King, Scott Williams, Blaine Marder, Adam Weingarten and Brian Anderson running their sleeve.

8/13

EMGRX

Nuveen Small Cap Select

No one, but . . .

Mark Traster move into lead manager role, and Gregory Ryan joins Allen Steinkopf as comanager

8/13

NTEAX

Nuveen Tradewinds Emerging Markets

Michael Hart, a founding manager of this one-star mess

Emily Alejos, the other founder, will serve as the sole portfolio manager

8/13

OAAAX

Oppenheimer Active Allocation Fund

Alan C. Gilston

Mark Hamilton

8/13

OACIX

Oppenheimer Conservative Investor Fund

Alan C. Gilston

Mark Hamilton

8/13

ODAAX

Oppenheimer Diversified Alternatives Fund

Alan C. Gilston

Mark Hamilton

8/13

OAAIX

Oppenheimer Equity Investor Fund

Alan C. Gilston

Mark Hamilton

8/13

OAMIX

Oppenheimer Moderate Investor Fund

Alan C. Gilston

Mark Hamilton

8/13

PAGVX

Putnam American Government Income Fund

Daniel S. Choquette

Michael V. Salm 

8/13

PINCX

Putnam Income Fund

Daniel S. Choquette

Michael Murphy joins Brett Kozlowski and Michael Salm

8/13

PGSIX

Putnam U.S. Government Income Trust

Daniel S. Choquette

Michael V. Salm 

8/13

BPLEX

Robeco Boston Partners Long/Short Equity Fund

Mark E. Donovan  leaves after a great 15 year stint

Ali Motamed, who’s been with Robeco since 2003,  joins Robert Jones

8/13

SSVAX

SunAmerica Value Fund

Steven Neimeth

Jay Merchant

8/13

LCGAX

Transamerica Large Cap Growth

James P. Haynie

Pamela Woo joins Jeffrey Bray

8/13

TTAAX

Transamerica Tactical Allocation

Sridip Mukhopadhyaya

Frank Koster joins David Halfpap and Frank Rybinski

8/13

IGTAX

Transamerica Tactical Income

Sridip Mukhopadhyaya

Frank Koster joins David Halfpap and Frank Rybinski

8/13

ATTRX

Transamerica Tactical Rotation

Sridip Mukhopadhyaya

Frank Koster joins David Halfpap and Frank Rybinski

8/13

FOBAX

Tributary Balanced

John Harris and Kurt Spieler left after an exceedingly solid three year stint

David Jordan, skipper from 2001-2010 returns

8/13

VSSGX

VALIC Company I Small-Mid Growth

Chad Meade and Brian Schaub, who left Janus for Arrowpoint and leadership of the Meridian Growth fund

Steven Barry and Jeffrey Rabinowitz

8/13

VEXPX

Vanguard Explorer

No one, but . . .

A seventh subadvisor, Stephens Investment Group, with Ryan Crane and three comanagers.

8/13

FMIEX

Wasatch Large Cap Value

Long-term managers Michael Shinnick, now, and Ralph Shive at the end of September

David R. Powers

8/13

WFGBX

Wells Fargo Advantage Growth Balanced Fund

The entire Wells Capital Management, Inc. team of  Doug Beath, Petros Bocray and Jeffrey P. Mellas

Christian Chan and Kandarp Acharya

8/13

WFMAX

Wells Fargo Advantage Moderate Balanced Fund

The entire Wells Capital Management, Inc. team of  Doug Beath, Petros Bocray and Jeffrey P. Mellas

Christian Chan and Kandarp Acharya

8/13

WRAIX

Wilmington Multi-Manager Alternatives

Daniel Keating

Everyone else remains.

8/13