Most funds don’t show up on investors’ radar until they have at least a three year record, which is also the point at which they receive their inaugural Morningstar rating. That’s a generally sensible, sometimes silly constraint since many funds that have been operating for fewer than three years are actually long-tested strategies managed by highly experienced professionals which are just coming to market in a new form. Relatively recent examples of such funds include Andrew Foster’s Seafarer Overseas Growth & Income (SFGIX), Rajiv Jain’s GQG Partners Emerging Markets Equity (GQGPX), Abhay Deshpande’s Centerstone Investors (CETAX), and Amit Wadhwaney’s Moerus Worldwide (MOWNX). Collectively, those four managers had overseen more than $100 billion using strategies later embodied in their “too new to be on the radar” funds.
As a result, MFO Premium has a preset screen to allow us to identify funds which will receive their three-year recognition within the next 12 months. While many of those are undistinguished and we’ve looking closely at just a handful, our performance and risk screens highlighted a handful of funds that are intriguing.
The big picture is that there were 568 funds, CEFs and ETFs, as of 11/30/2018, which have passed their second birthdays but haven’t yet reached their third. About 200 ETFs and 330 mutual funds. Because we prefer investing to speculating, we filtered out the trading funds. Likewise, because we prefer investing to saving, we filtered out the money market funds. Finally, because we prefer things you can actually buy, we filtered out insurance products. That still left us with 490 newer funds, CEFs and ETFs. We then sorted everyone by Lipper category and by Sharpe ratio.
Out-of-favor areas were hot. Our list includes 51 diversified international equity funds and 51 liquid alts funds of various hues and denominations. Five categories logged in with 20-some funds each: 29 global equity (29), US large cap (28), flexible portfolios (24),US small cap (23) and emerging markets (21).
BlackRock and State Street have the greatest number of funds in the pipeline, each with 22 entrants likely to receive their three-year rating in 2019. Fidelity has 18, First Trust has 17, Invesco and WisdomTree each clock in with 14.
Most of the newer funds are being launched by smaller, independent advisers. Fidelity accounts for only 10 of the 330 newer mutual funds, and they’re the most active large firm. Vanguard launched just a couple, T. Rowe Price had five, BlackRock has eight and American Funds has a single entrant.
Only one-third of the funds have enough assets to be financially sustainable. The cutoff number we use, based on conversations with several independent fund managers, is $75 million in AUM. You can certainly run a fund with a smaller asset base, run it well and run it for a long time, but you’re not likely to generate enough in fees to pay yourself. (Apply a management fee of 0.75% to a $50 million base and you’ve got $375,000 to cover all the expenses of the management firm.)
Best advice for crossing the $1 billion in assets mark: have “Fidelity” as the first word in your fund’s name. Of the 26 fund with $1 billion or more in assets, eight are Fidelity funds (an 80% success rate for Fido, in the sense of having eight of 10 funds cross the threshold).
The biggest laggard among the ultra-large cohort is the Global X Robotics & Artificial Intelligence ETF (BOTZ) which trails its science & tech peer group by 4.9% annually; it also has the greatest maximum drawdown and highest volatility in the group. The biggest leader is UBS AG FI Enhanced Global High Yield ETN due March 3 2026 (FIHD), an exchange-traded note that’s outpacing the average high-yield fund by 12.5% annually.
The highest Sharpe ratio, which roughly translates to the best risk-adjusted returns, were posted by the RiverPark CMBS Floating Rate Fund (RCRIX) at 5.26. The fund averaged 4.3% a year without a single losing month. We wrote about the fund at its latest launch, since it’s been offered as a private fund, a sort of closed-end interval fund and now an open-end mutual fund. The second-highest Sharpe ratio was earned by another closed-end fund, PREDEX (PRDEX), which invests “up to 95% of its net assets … in privately offered securities of non-traded institutional real estate funds.” The third-best Sharpe ratio was another former hedge fund with a focus on mortgage-linked securities, Braddock Multi-Strategy Income (BDKAX).
In the area of long-short equity, the right answer was almost always “Gotham.” In the top tier of long-short funds, six were from Joel Greenblatt’s Gotham operation.
|Sharpe ratio||Returns vs peers||Annual returns|
|Gotham Defensive Long 500||1.74||11||16.8|
|Gotham Absolute 500 Core||1.61||5.3||11.1|
|Gotham Enhanced 500 Core||1.59||10.6||16.4|
|Gotham Hedged Core||1.56||5.2||11|
|WisdomTree CBOE S&P 500 PutWrite Strategy||1.34||1.4||8|
|CBOE Vest S&P 500 Buffer Strategy||1.32||2||7.4|
|WisdomTree Dynamic Long/Short US Equity||1.17||6.2||11.4|
|Gotham Hedged Plus||1.16||5.1||10.7|
|Catalyst/Millburn Hedge Strategy||1.13||6||11.1|
|Neuberger Berman US Equity Index PutWrite Strategy||0.95||0.6||6.4|
|Gotham Defensive Long||0.79||2.6||8.4|
Two notes: that means (1) Gotham has launched six new funds in under three years and, at least in the last stages of a bull market, (2) they work.
Three of the funds are options-based, rather than conventionally investing long in some equities and short in others. The two more-traditional long/short funds in the top tier are:
WisdomTree Dynamic Long/Short US Equity (DYLS), a passive fund that tracks an active index which rather muddies the whole active-passive debate. They invest long in 100 large cap stocks then short the S&P 500 index. The fund can range from 100% long to 100% short. The expense ratio is 0.48%.
Catalyst/Millburn Hedge Strategy (MBXIX) is a converted hedge fund with a strong track record. The hedge fund was reorganized into a mutual fund on December 28, 2015. The portfolio is 30-70% equities; this long portfolio is a passive, buy-and-hold operation to generate market exposure. The remainder of the portfolio is in long and short contracts on equity, fixed income, commodities and currency futures. The combined funds’ returns seem consistent and creditable.
The minimum initial invest is $2500 minimum and the expense ratio is 2.0%.
Other funds that caught our eye
Ladder Select Bond (LSBIX), which has a Sharpe ratio that’s laughably higher than any other core bond fund, 2.27 against runner-up Invesco Total Return ETF at 1.03. Ladder is an institutional real estate investor with $6 billion in AUM and this is an institutional fund with a $100,000 minimum. Like the three funds with the highest Sharpe ratios, this invests in the world of real estate securities. Ladder describes themselves as “inherently conservative … favoring strong downside protected positions with attractive credit metrics.”
BlackRock Emerging Markets Equity Strategies Fund (BEFAX), which had the highest Sharpe ratio of any emerging markets fund (1.33), well ahead of runner-up Ashmore EM Active Equity (0.88) and the rest of the EM pack (0.50). It had a top 1% performance among all EM funds in 2018. It’s a long/short EM equity fund with an experienced manager. Sam Vecht, CFA, and portfolio manager, is head of BlackRock’s Emerging Europe equity team. Mr. Vecht’s service with the firm dates back to 2000, including his years with Merrill Lynch Investment Managers (MLIM), which merged with BlackRock in 2006. Mr. Vecht began his career with MLIM in 2000 as a member of the Global Emerging Markets team. I’m not surprised, given his background, that the fund is substantially overweight in Europe (28% of assets) and in developed markets generally (34% of assets). It’s available no-load at TDAmeritrade, with an e.r. of 1.56%. on $16M in assets.
Holbrook Income (HOBEX/HOBIX) is either a short-term bond fund (Morningstar) or a flexible portfolio fund (Lipper/MFO). Its mandate allows it great flexibility within the fixed-income arena, including investments in closed-end funds and ETFs, with the proviso that it positions itself to deal with a rising-rate environment. As a practical matter, that means that it’s currently acting a lot like a short-term bond fund. If it’s a flexible portfolio, it’s way at the top of the risk-adjusted returns pack and had the group’s smallest drawdown. As a short-term bond fund, it has top 10% returns. The manager is the former president of Leader Capital where he helped manage the Leader Total Return and Leader Short Duration Bond funds. The expense ratio on the Investor shares is high (1.80%) but the initial minimum is low at $2,500.
Guggenheim Diversified Income Fund (GUDPX) elicits more agreement from Morningstar (30-50% equity allocation fund, though it currently holds 22% in global equities) and Lipper (flexible portfolio). It’s a fund-of-funds that’s seeking “high current income with consideration for capital appreciation.” The “diversified” in the name means that it looks for exposure to “different geographic regions, different positions in issuers’ capital structures and different investment styles.” In general, it targets equities and high yield bonds. Performance has been competitive and volatility management has been exceptional. It has a Sharpe ratio of 1.62, while the average for the other 21 flexible funds was 0.48. The “P” shares are available through online brokerages without a load or a transaction fee and without a minimum investment. I’m a bit fretful of the gross expense ratio (5.0%) as well as the capped expense ratio that you actually pay (1.62%). Still the underlying idea seems sensible and the early performance is promising.
State Street Disciplined Global Equity (SSGMX) and SEI Global Managed Volatility (SGMAX) are the two best-performing global funds, but their institutional minimums seem pretty inflexible. No other young global fund has performance that’s immediately crying out for attention. State Street Disciplined US Equity (SSJIX) is similarly top-rated and mostly inaccessible. Pity all around.
Columbia Sustainable International Equity Income ETF (ESGN) takes “sustainability” in two directions; it’s looking for income that’s sustainable in the sense of consistency and for corporations that are sustainable in the sense of ESG practices. The ETF earns Morningstar’s highest sustainability rating, five. It tracks a custom-built index. The fund’s attractiveness depends, in part, on its peer group. Lipper tracks “international equity income” as a separate peer group, Morningstar does not and places it in the “foreign large value” box. Taken as an equity income fund, it’s at the top of the pack with a Sharpe of 0.79 and peer-beating returns. Within the foreign large value group, it’s just slightly above-average. The key attraction would be its low cost (0.45%) and commitment to sustainability.
Cognios Large Cap Growth (COGEX) and Cognios Large Cap Value (COGVX) sit atop the domestic large-cap heap, both handily outperforming their peers with below-market risk. They’re the younger siblings to Cognios Large Cap Market Neutral (COGMX), about the best market-neutral fund out there.
We’ll keep watch for you. Several of these funds are promising in both conception and execution, and we always try to focus on managers who intensely dislike losing your money. In the months ahead, as we become more knowledgeable about them, we’ll begin building out our coverage of them. If there are any that particularly intrigue you, drop me a note!