Dear friends,

Welcome to the New Year!

And to an odd question: why is it a New Year? That is, why January 1? Most calendrical events correspond to something: cycles of the moon and stars, movement of the seasons, conclusions of wars or deaths of Great Men.

But why January 1? It corresponds with nothing.

The short version of the answer is that the ancient Roman calendar was a holy mess. Literally: the new year started on the day that the high priest, the pontifex, said it started. Understandably, the pontifex was open to … uhh, reason when it came to choosing the date on which the year began. He might shorten the rule of one leader by moving up the date of New Year’s or delaying the inauguration of another ruler by lengthening the preceding year.

In 45 B.C., Julius Caesar had had enough and, with the help of the astronomer Sosigenes, moved Rome from a 10 month calendar with a floating start day and lots of days that didn’t fall in any month to a version of the calendar we use today.

Except that it had a bit of trouble accommodating the fact that the solar year, which isn’t precisely 365 days long. We got far enough out of sync that they had to add seven days to the year 1000 and 10 more days in the mid 15^th century. In 1582, Pope Gregory had had enough and, with the help of Vatican astronomers, created today’s calendar.

Which, by the way, still didn’t have a New Year’s Day and required eliminating 10 entire days from the calendar that year. New Year’s was the solstice in some spots, December 25^th in others and March 25^th, the spring equinox, in others. The pope finally put his foot down and we got January 1^st.

So, why exactly does it make sense for you to gloat, or worry, about how your portfolio did in 2017? The end date of the year is arbitrary. It corresponds neither to the market’s annual flux nor to the longer seven(ish) year cycles in which the market normally rises and falls, much less your own financial needs and resources.

In short, it’s time to look forward with hope and renewed resolve, rather than back with glee or regret.

And so, on to 2018!

It’s deceptively easy to believe that our world is going to hell in a handbasket because the only thing we hear each day is that day’s horrors. Someone got shot. Somewhere got poisoned. Something blew up. Someone betrayed us.

Why all the bad news? Two reasons:

1. News media report on what’s new; that is, they tell us what happened today that was different from what happened yesterday. They’re looking at individual occurrences, especially if they come with striking visual images. We’re not asked to think about the big picture, because the big picture didn’t happen today. And so we fixate on all the little things that did transpire.
2. Bad news sells; more particular, bad news delivered in a howling tone generates outrage and clicks. For political parties, it also generates revenue and delivers votes.

But that’s not the actual story of our lives, is it?

Things are getting better.

At the most superficial level, everything made money in 2017. The only fund categories in the red were bear market funds and energy funds. Once you got into the world of straightforward, diversified investing, everything worked. Every category of US diversified equity fund made money, and every category of international diversified equity fund made more money. The top performing domestic category was large growth, up 27% and paced by funds from Quantified STF, Kinetics and Zevenbergen, all of which topped 50% gains. And even that category gain trailed nine international fund categories. The handful of India funds, for example, averaged 48% gains last year. Emerging markets bonds posted double digit returns, while all other bonds make gains in the single digits. On whole, it wasn’t rational but it was profitable.

Not everything is getting better. Not every day and not every year. But the important things are, year after year, decade after decade, century after century, getting better. They’re getting better because it’s in our nature to seek better, rather than to surrender to worse. For every idiot in the news, ten thousand of us work – quietly and without expectation of attention – to make things better. That’s a great ratio. And greater still if you make it 10,001.

Next steps, part one

Our challenges are very real (and terrifying). But they’ve been very real (and terrifying) for centuries. The question is not “will things get better?” so much as “what’s your plan to make it better in 2018?” With off-year elections impending, will you finally decide it’s worth your while to be heard? Will you plant a rain garden or volunteer in your schools? Will you walk more, be consciously grateful, notice others more? Will you spend less time with your portfolio and more with your neighbors? Will you fuss less about this quarter’s returns and more about the pattern of intentional consumption (see “Life After,” below) and serious savings (as a nation, we hit a decade-low in our savings rate last year) that will support your most important goals?

Will you put down your phone, leave tweeting to the birds and step away from an Amazon-induced impulse to buy? Jonathan Clement shared the link to a really thoughtful piece entitled “Life After Amazon,” chronicling nine discoveries one gentleman made after he shut down his Amazon account and returned to buying real things from real people in the real world. It’s worth reading.

I have faith in you.

Next steps, part two

Charles, our endlessly energetic colleague and major domo of MFO Premium, is offering two online seminars, both on January 4^th, to help acquaint users – new and old – with its offerings and use. There are details in New Year, New Tools in this issue.

Coming in February: new profiles, a discussion of two strategies for hedging your portfolio for the inevitable change of direction in the market, an Elevator Talk with a cool multi-alts manager, my annual portfolio disclosure, word of Chip’s first equity fund (at least in her non-retirement account) and more!

See you then!

Charles wanted to both thank you and help you discover some of the stuff that our Premium screener can do for you.

It has two features that most screeners lack, and both of them are Charles! Charles has been thinking about what’s really important for investors to know in order to make the best decisions for themselves and their families. As a result, (1) he’s built in tools – from uncommon risk measures to correlation matrices and rolling return screens – that give you information that’s meaningful. And (2) he revises the site almost monthly to accommodate your needs and interests. Literally: if you write with a concern, you get a prompt answer that actually comes from one or both of us. Quite frequently, you also get new or clarified options added to MFO Premium as a result.

All of which works best if you understand which buttons to push. Charles would like to walk you through that process via a live webinar using Zoom. It’s free and easy.

Here are the details:

Date: January 4, 2018
Time: 11:00 a.m. Eastern and again at 5:00 p.m. Eastern

What you have to do:

1. Select the time that works best for you
2. Click on the corresponding registration link below
3. Join in, listen, talk and enjoy!

Morning Session: 11 a.m. Eastern, Jan. 4

Welcome! You are invited to join a meeting: MFO Premium Update

Overview of site background and demo highlighting newest features.

https://zoom.us/meeting/register/a7cdfa6bdb1561d8dc2040ba88984b7b

After registering, you will receive a confirmation email about joining the meeting.

Afternoon Session: 5:00 p.m. Eastern, Jan 4.

Welcome! You are invited to join a meeting: MFO Premium Update

Overview of site background and demo highlighting newest features.

https://zoom.us/meeting/register/306b3afbd7927709c5b9141539e44ee6

After registering, you will receive a confirmation email about joining the meeting.

Even if you’ve used MFO Premium in the past, you need to consider attending. We’ve done a lot of work in the past couple months to make the interface cleaner and easier, while still adding features. Unless you’re a fan of discovery by clicking randomly around, you’ll find the conversation useful.

If you have questions or concerns ahead of the webinar, drop Charles a line.

The knock on mutual fund performance numbers is that they’re static and arbitrary snapshots that give the illusion of being meaningful. What do you learn from looking at a fund’s five-year performance number? Mostly, you learn that the fund, through skill or luck, did well in the market conditions that obtained between December 2012 and December 2017. Sadly, we don’t have any reason to think those two dates are particularly important (why December 2012? ‘cause it was five years ago, duh!) and we don’t have any reason to believe they’ll tell us about performance in December 2018.

One way of creating a richer portrait of a fund’s risks and returns is by using rolling averages. A fund’s rolling five-year average reflects how it did in every 60 month period as far back as we’ve got data. A six year old fund has one five-year average but 12 rolling five year periods to assess; a ten year old fund has five five-year periods (2012-17, 2011-16) but 60 rolling five year periods.

Karen Wallace at Morningstar recently celebrated “Rolling Returns: A Powerful Analytical Tool That Anyone Can Use”(11/29/17). She notes that “they’re an extremely valuable tool for analyzing fund performance.”

Rolling period returns can provide a more in-depth view into a fund’s performance history than you can get by looking at a single-period trailing return. In a way it’s like comparing a panoramic photo of a forest to a snapshot of a small group of trees.

Rolling returns offer a wider-angle lens into a fund’s full return history. In addition to looking at a fund’s most recent five-year return you could also look at how it performed over many overlapping 60-month periods as far back as your performance data goes, or as far back as the current manager has been in charge, which can help you gain a fuller understanding of its historical performance trends throughout five-year holding periods in a variety of market environments. 

The little complication is that for users wanting to screen the funds or do a side-by-side comparison, the “anyone” in the title translates to “anyone with a Morningstar Direct subscription.” Wikinvest reports the pricing for that service:

Morningstar Direct: Pricing for Morningstar Direct is based on the number of licenses purchased. We charge $16,000 for the first user, $10,500 for the second user, and $8,000 for each additional user.

Speaking on behalf of small investors everywhere: yikes!

Fortunately, those of us who are what Pittsburgh National Bank called “thousandaires” have two affordable and complementary ways to get some of that data.

Morningstar offers a picture of a fund’s rolling averages in their fund profiles. From a fund’s profile page, click on “chart” and, on the upper left corner of the chart click the “growth” pulldown menu and select “rolling returns.” You’ll see a chart with a bunch of bars on it. Now under “rolling period” select 36 months. Using Fidelity Low-Priced Stock as our test subject, here’s what you’ll see:

What does that chart tell you? Over the past 10 years, the fund’s worst-ever 36 month stretch saw an annualized loss of 14.5%, March of 2006 to February 2009. That’s the depths of the 2007-09 financial crisis. That’s better than its peers, represented by the orange line. Conclusion: great in bad times, competitive in good times, pretty steady overall.

MFO offers the data in a single, easy to read table. Here’s our version of the Fidelity Low-Priced Stock story.

What does that say? If you’re willing to hold FLPSX for three years (and there are 205 rolling three-year periods in the data), your worst-ever experience was an annualized loss of 14.6% and your best-ever experience would have been a gain of 30.1% annually. Over the long term, investors have received about 11.8% annually in the average three-year period. Solid! You can also see how much it pays to hold on through bad times: the worst-ever single year was a loss of 42.3% and the worst-ever five year stretch was a loss of 3.7% but the fund’s worst-ever decade still paid its investors 6.8% annually. If you compare the average returns, you see a striking stability: 11.8% annually if you’re willing to hold for three years, 11.6% if you’re willing to hold for five years, and 9.8% if you hold a decade. Why does the longest holding period have the lowest return? Because bear markets tend to show up every seven years or so, as a result many five year periods dodge any bear exposure while some 10 year periods contain at least bits of two bear cycles.

Those single-fund charts show you different angles of the same data. MFO Premium adds one additional tool that retail investors can’t access through Morningstar: our fund screener allows you to screen for funds based on their lowest 1, 3, 5, 10 and 20 year rolling averages.

Want a fund that’s never had a losing 12 month period in the past decade? No problem, there are 306 of them. Small problem, they’re all short-term, ultra-short term bond or money market funds.

Here’s a more interesting challenge: can we find a stock-oriented mutual fund that we can trust? We know stocks are volatile, so it’s not reasonable to hope for a fund that has never had a losing three-year run so let’s set reasonable criteria in hopes of finding a fund that has never disappointed. On our screener, I first set four rolling average requirements:

• 3 year rolling average: never worse than -2% / year
• 5 year rolling average: never worse than 0% / year
• 10 year rolling average: never worse than 6% / year
• 20 year rolling average: never worse than 8% / year

What does that mean? I ignored one-year averages because they’re so volatile and you should be ashamed of yourself if you invest with a one-year time horizon. I start with no more than minimal losses over 3 years, no worse than breaking even over five, with solid gains for long-term investors. And, just to placate folks who do freak out about the risk of short, severe downturns, I added a maximum drawdown screen of category 1 or 2; that is, below average to much below average maximum losses. Then I hit “go.”

Out of an 8000 fund universe, only one fund passed our screen. That fund is Oakmark Equity and Income (OAKBX), which our colleague Ed Studzinski co-managed with Clyde McGregor from 2000-early 2012. Here’s Morningstar’s picture of the fund rolling along:

See all those periods where the green line (their peers) was below zero while their blue bars were way above zero? That’s where they’re being smart and risk-conscious, over and over again, while their peers foundered.

MFO’s screener output gives you a more precise slice of the data: over 229 three-year rolling periods, the worst stretch was -2.0/year, the best was 20.1%/year with an average of 9.8% annually for someone holding for 3 years. And 9.7% for 5-year periods, 9.1% for 10 year periods and 9.8% for 20 year ones. Do you get some sense of stunning consistency here? We do.

It has been a superb performer, though its future requires some tempering of expectations. With Ed gone, some of the sparkle is off the prose in their letters to investors. Honestly, I used to look forward to every one of Ed & Clyde’s letters for their insight and sharp writing. That experience makes me grateful that Ed agreed to join MFO’s merry band. And Clyde McGregor expects to retire by age 70; he’s 65 now, so investors need to anticipate some transition beginning in the next three years or so. Mr. McGregor has two co-managers, Colin Hudson and Edward J. Wojciechowski, both of whom joined Harris Associates in 2005 and were named to the fund’s management in 2013. I have no doubt that they’re both bright and industrious souls, but I also have no proof that they’ll meet the ridiculously high standard set by Messrs. McGregor and Studzinski.

But, for now and for the past 30 years, Oakmark Equity and Income has qualified as “the one fund you can trust.”

I wonder, sometimes, if I’m more irked by high fund fees because they degrade my returns or because they reflect an annoying sense of entitlement on the part of managers who think we owe them a lifestyle far more opulent than our own. At base, is my objection practical or moral?

Landon Thomas’s long article in the New York Times looks at Ron Baron’s comp and pushes me hard in the direction of the latter: Mr. Baron seems to have an almost superhuman sense of his own worth (“Why Are Mutual Fund Fees So High? This Billionaire Knows,” 12/30/17). For those who don’t subscribe to the Times, CNBC published a good excerpt of the piece.

Here’s a precis of the article:

1. The Baron funds charge a lot, even after their assets hit the multi-billion dollar range. Mr. Thomas reports that Baron’s fees are about 50% above the industry average.
2. Founder Ron Baron is perfectly happy with that arrangement, “We have made $23.6 billion for our clients,” he says. We’ll note two flaws in this argument: (1) the vast bulk of those returns are simple growth in the stock market, not Mr. Baron’s brilliance and (2) the bulk of the outperformance is ancient history. Mr. Baron cites the record since inception (a 30 year span) for his two oldest funds, while neglecting to mention the fact that Baron Asset has trailed both its peer group and low-cost competitors such as Vanguard Mid Cap Growth (VMGRX) over the past 20 years.
3. Baron is living high, and loves it. He’s worth $2 billion, his family has $670 million invested in the funds, he owns a $150 million home and his annual shareholder meetings are platforms on which to display, and through which to validate, his vast wealth.
4. The system is rigged to keep it that way. Many members of his board of trustees, nominally his investors’ representatives, have been in that role for 30 years, a well compensated (the firm’s 2017 Statement of Additional Information reports compensation of $115,000 – 143,750 for the independent trustees) for a distinctly part-time job and have absolutely no incentive to rock the boat. The board has agreed to a contract that compensates Mr. Baron and other key players based on the firm’s assets under management, which creates an incentive to vacuum up money whenever the opportunity permits. That helps explain the 0.25% 12(b)1 marketing fee he imposes.

Investors have noticed. Assets at Baron Growth (BGRFX) have fallen from $6.9 billion in 2007 to $2.7 billion today and his flagship Baron Asset (BARAX) fund has dropped from $4.3 billion to $2.0 billion.

Mr. Baron, unworried, smiles and maintains both funds’ high fees. With a management fee of 1.0%, those two funds alone generate $47 million a year in revenue for his management company.

The sense of entitlement is regrettably common. Our colleague, Charles Boccadoro, has been visiting fund advisers over the past few months, and he’s coming away repeatedly frustrated by the simple fact that managers charge as much as they can get away with. Investopedia reports the industry-wide averages:

A survey conducted by Russell Reynolds Associates revealed that fund managers at banks make an average of $140,000, while mutual fund managers at insurance companies make $175,000. Fund managers at brokerage firms make $222,000, and mutual fund companies’ mutual fund managers make an average of $436,500. Managers working for larger funds make significantly more …

We’ll note that the $436,500 isn’t the average for excellent managers, entrepreneurial managers or large-fund managers. No, no, it’s what the average schmoo pockets. And there’s a 95% chance that the schmoo in question offers less value than keeping the money yourself and buying an index fund.

There are managers who earn their fees and more. Indeed, some managers simultaneously over-earn their fees and reduce them to offer greater benefit to their investors; Andrew Foster and the folks at Seafarer are a case in point. Many managers of small funds make nothing, regardless of what the prospectus says. By way of example, on behalf of an MFO reader (hi, Judith!) who had questions about prospectus provisions concerning a performance bonus for the manager and other expenses, we reached out to Rondure Global. They confirmed what we told our reader: the manager is underwriting the firm’s existence, rather than vice versa. As a brand new operation, Rondure depends on a line of credit from its partner Grandeur Peak

…and from Laura Gertiz herself to keep the firm afloat for quite some time. Laura may take a very small amount of compensation this year (only enough to allow her to participate in our 401k program), however most of the expenses are coming out of her own pocket at this juncture so it doesn’t make sense for her to be paid any significant amount. That will obviously change in the future, however, you should be aware that if Laura does earn a bonus after profitability is reached, 100% of it will be plowed back into the funds on a long-term vesting schedule in order to align her incentives with those of our investors.

For investors, there are two dangerous questions: (1) how much am I paying? And (2) am I beating the market? They’re dangerous because they encourage you to judge your manager on irrelevant criteria. In place of the first question, we’d suggest asking “am I getting full value for what I’m paying?” Managers can add significant value by moderating risk, offering access to intriguing and otherwise inaccessible asset classes or by giving you the confidence to hold on through tough times. Your worst enemy is you, and your best friend can be a manager who makes you a better investor.

In place of the second question, we’d suggest asking, “is this manager helping me achieve my life goals?” Unless you are a terribly sad and lonely person, you’re really not going to want “he outperformed the Dow by 0.25% annually over his long life” to be the first line in your eulogy. Market-beating means nothing! Losing 19% when the market loses 20% is nothing to cheer. Suffering vertigo and anxiety as your manager charges into, and beats, a foam-filled market is nothing to cheer. Beating the market steadily, whether by 1 basis point or 1000, tells us nothing about whether you’ve been able to lead the life you’ve aspired to. Focus, instead, on what’s meaningful: are you making steady gains of the sort that will allow you to enjoy life, to make a difference in the world, and be rich with friends and family? If so, you’re winning. Celebrate.

BUT if you’re one of the millions of investors whose investments serve mainly to underwrite the lifestyle of an unimaginative member of the herd, act now! MFO Premium offers one very fine suite of tools for assessing whether you’re being treated reasonably (check your manager’s five- and ten-year rolling averages to see whether you might reasonably expect the sorts of returns you need to meet your goals) while ActiveShare.Info offers another.

ActiveShare, underwritten by the folks at Touchstone Investments and guided by the research of Martijn Cremers of Notre Dame, offers another. For domestic equity funds, Active Shares measures the proportion of a fund’s portfolio that simply mimics an index’s; the “different from the index” proportion is called the active share and it’s where the manager can add value. Funds with high active share – 70% or more, depending on the asset class – have the greatest potential to justify their “active” expenses. The site even allows you to calculate what you’re actually paying for the manager’s skill by factoring the size of the active share into an expense ratio calculation: a 1% fee on a fund with 100% active share means all of your money pays for independence from the index, so your active share costs you 1%. Contrarily, a 1% fee on a fund with 10% active shares means the expense ratio on the active part of the account is nearly 10%! Avoid such funds.

Bottom line: for investors in the Baron funds, the same questions apply. Are you so heartened by Mr. Baron’s showmanship and reassuring visage that you’re willing to pay a 50% upcharge for his funds? If so, you’re being charged fairly. If not, check out Nicholas II Fund (NNTWX) which has been around longer, charges less, returns more and has a smaller asset base.

Likewise merci, danke and, more than all, thanks!

On December 17^th, I wrote a note to the 7,000 or so folks on our mailing list. The sad part of the note was reminding folks of the end of our associate’s relationship with Amazon which had so long provided our ability to cover our “hard” bills such as webhosting and email. The glad part was announcing a challenge gift of $2000, offered by three MFO readers who wanted to do the best they could to support us. Their offer was straightforward: we’ll put in a dollar of our own money for every dollar contributed by others, up to a total match of $2000.

That seemed hopeful, as well as very generous. We wrote, hoping that perhaps 20 of you might make $100 contributions, an amount which would trigger your access to MFO Premium (Charles has been streamlining the site and adding features again), allow us to access the full challenge amount and cover more than a third of our Amazon loss.

Ummm … you were magnificent overachievers. Rather than 20 contributions, we received about 200. They ranged from $7.11 to $500, in addition to the original challenge gifts. Tadas Viskanta, master of Abnormal Returns, helped by tweeting out to appeal for his followers to consider chipping in $10 each. Several long-time friends in the industry helped out, as did a huge number of new folks. About 40 people contributed $100 or more and gained MFO Premium (some folks sent letters without sharing email addresses, please write Charles if you’re among them so he can get you set up). Our correspondents ranged from Alaska to Florida (both of which are currently warmer than the Quad Cities).

And not a few tacked on 2.5% to offset PayPal’s cut. Thanks for the extra, it was a very sweet gesture.

It is, by the way, intensely satisfying to have members who feel so strongly about the value this site offers. We’re deeply grateful, both for our own sakes and for the sake of the 24,000 other readers you’ve just helped out.

And so, thanks to …

Please forgive us if we’ve missed your name – I’m sitting amidst a pile of paper, feeling just a little befuddled.

And thanks to our anonymous challenge donors, to Deb W. for helping us think more clearly and to our regular subscribers, Greg and Brian, for their continued support.