June 2017 IssueLong scroll reading

The Boys of Summer

By Edward A. Studzinski

Everything is on such a clear financial basis in France. It is the simplest country to live in. No one makes things complicated by becoming your friend for any obscure reason. If you want people to like you, you have only to spend a little money.


In recent weeks, a number of articles and books have made their way into print, and they are things worth taking a gander at as one ponders where we are in the economic cycle One of my favorite blogs to read is “The Brooklyn Investor,” which can be found at brooklyninvestor.blogspot.com which is updated intermittently. A recent piece was titled “High Fees” and posted May 19, 2017. The author discusses a friend who has a million dollars invested in Fidelity’s Magellan Fund and makes the point that, long past the days of star manager Peter Lynch, and in a far different world, does the friend really think the fund will going forward outperform the S&P 500? The friend does not of course think that that outperformance will occur, which begs the question, why given a 1% expense fee, are you willing to write a check for $10,000 a year or $100,000 over ten years? That is a lot of money, especially for a retired person or someone living on a fixed income. Of course, it is a painless payment, since it is just deducted from the account at the fund level, which is why most people tend not to think about it. But if we are in a world going forward where equities may at best as an asset class return 6% a year, a 1% fee looks very different in terms of order of magnitude.

The author argues that most mutual fund investors tend to be indifferent to the fees, given the stickiness of investing – once committed they leave things alone. The advice given is that for most of us, it would be worth the exercise to figure out what we are really paying in hidden fees on an annual basis. The best real life example for us of course would come if Professor Snowball, having shared the components of his portfolio with us last month, would give us a rough number as to how much in fees is being sucked out of his assets each year.

[Professor Snowball’s obliging report on the magnitude of sucking: in my non-retirement portfolio, which is the one to which Ed is referring, fund expenses consume roughly $591.42 each year.]

One of the hardest questions to answer of course is when the culture changes at a fund organization. Put differently, when did the fund organization you invested in shift from being an investment firm to an asset gathering firm. One clue – if the firm is not employee-owned or, is a subsidiary of a larger organization such as a bank, brokerage firm, or investment bank, odds are you are in the hands of asset gatherers (a variation on being stuck in a “Night of the Living Dead” movie).


I have been critical for a while of the generational shift going on at First Pacific Advisors, where the older partners have been retiring en masse while the mutual fund family has been remade. In recent years, the flagship fund has been FPA Crescent, which ballooned up to $20B in assets while its performance declined, not surprisingly, reflecting the surge in assets and style-drift upward into large and mega cap securities. At the same time, the firm has repositioned and changed the investment objectives for the closed-end fund Source Capital. Indeed, Source Capital (SOR) has become a balanced product, managed by the same team of equity and fixed income managers that run Crescent. There is some degree of overlap between the portfolios, although they are not identical. Morningstar indicates Source Capital has a 91 basis point expense ratio while Crescent has a 107 basis point expense ratio. However, as a closed-end fund with a fixed capital structure, Source is currently trading at an 11% discount to net asset value. So with that discount, assuming a buy and hold investor, you are covering in effect 11 years of expenses. The other advantage Source has of course, which was noted in their first quarter report for this year, was that they repurchased a small number of shares taking advantage of that discount to NAV, which is accretive. Finally, FPA Crescent at this point has $17.3B in assets while Source has $330M in assets under management. I was a fan of the old Source Capital, as it was a superb investment vehicle over the long-term, especially given the original involvement of Charlie Munger with it. I think the new Source could prove an interesting alternative to FPA Crescent and bears watching to see what the new managers do with it. Given overall market valuations as well as concerns with volatility, the fact that the portfolio managers of Source will be freed from concerns about having to raise liquidity by selling into a down market makes it an interesting choice for those worried about having to deal with portfolio drawdowns at the wrong time.


Over the last several weeks, the Wall Street Journal has been running a number of articles about quantitative investing. I recommend them to you. As a value investor who used to both use quantitative models for screening purposes and visit with quants at their conferences, I always found their thinking and inputs both useful and intriguingly divergent from fundamental analysis. (And as an aside, anytime you have an opportunity to hear Andrew Lo of MIT speak, do it). I was not so much taken by the inefficiencies they would find in each new factor model they came up with, complete with back-testing. Rather, to paraphrase Stonewall Jackson, I was more interested in where they were not going. After all, the periods of time when the inefficiencies in valuations that they had found, became increasingly compressed into smaller horizons. And when the elephants begin to dance, it is better to be far, far away. So I would look for uncorrelated pockets of outliers. The area remains a fascinating one to observe, and even more interesting to try and turn those observations into useable rule sets that can be exploited.


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About Edward A. Studzinski

Ed Studzinski has more than 30 years of institutional investment experience. He was a partner at Harris Associates in Chicago, Illinois. Harris is known for its value-oriented, bottom-up investment approach that frames the investment process as owning a piece of the business relative to the business value of the whole, ideally forever. At Harris, Ed was co-manager of the Oakmark Equity & Income Fund (OAKBX). During the nearly twelve years that he was in that role, the fund in 2006 won the Lipper Award in the balanced category for "Best Fund Over Five Years." Additionally, in 2011 the fund won the Lipper Award in the mixed-asset allocation moderate funds category as "Best Fund Over Ten Years. Concurrently Ed was also an equity research analyst, providing many of the ideas that contributed to the fund’s success. He has specialist knowledge in the defense, property-casualty insurance, and real estate industries, having followed and owned companies as diverse as Catellus Development, General Dynamics, Legacy Hotels, L-3, PartnerRe, Progressive Insurance, Renaissance Reinsurance, Rockwell Collins, SAFECO, St. Joe Corporation, Teledyne, and Textron. Before joining Harris Associates, over a period of more than 10 years, Ed was the Chief Investment Officer at the Mercantile National Bank of Indiana, and also served on their Executive and Asset-Liability Committees. Prior to Mercantile, Ed practiced law. A native of Peabody, Massachusetts, he received his A.B. in history (magna cum laude) from Boston College, where he was a Scholar of the College. He has a J.D. from Duke University and an M.B.A. in marketing and finance, as well as a Professional Accounting Program Certificate, from Northwestern University. Ed has earned the Chartered Financial Analyst credential. Ed belongs to the Investment Analyst Societies of Boston, Chicago, and New York City. He is admitted to the Bar in the District of Columbia, Illinois, and North Carolina.