January 2020 IssueLong scroll reading

Time Flashing By …. Again

By Edward A. Studzinski

An instance of an

Inability to recall

Makes one wonder if it

Really happened at all    

Momentary by J.P. Niemeyer, 10/28/2019. Niemeyer is a retired naval officer living in Japan who writes about Japan regularly for Red Star Rising.

So, another year, and for those invested, pretty good returns if they stayed invested through-out the year rather than attempting to time the market. The Vanguard S&P 500 Index fund achieved a total return for 2019 of 31.5% with an expense ratio of 4 basis points. Other actively managed equity funds achieved total returns on average ranging from 25% to 40%. I am not going to get into the semantic debate as to whether they were growth or value. Increasingly funds call themselves one thing or the other when the reality is they have a substantial commonality of ownership in various equities. The expense ratios of course are another matter. They do cut into the long-term returns earned by active managers, with often little benefit to the investors but great indirect benefit to the managers and trustees of the actively managed funds.

These days there continues to be concern about the ability of all 1940 Act funds to meet withdrawal requests in a timely manner in the event of a substantial and protracted market decline which triggers an ongoing wave of redemptions. An article worth reading concerning one such situation can be found in The Guardian, 8 June 2019 entitled “Bright star to black hole: the rise and fall of fund manager Neil Woodford.”  In it, 23 consecutive months of withdrawals greater than inflows caused the fund to close to withdrawals. The damage to pensions and other investors in this fund is covered in detail.

Sadly, Woodford Investment Management continued to pay substantial dividends to a company called Woodford Capital. There is a further discussion in the article about the lifestyles of the rich and famous. Most interesting of all is a description of the multitude of large (often greater than 20% of float) investments in small or what in the UK are called unquoted markets (and we would call pink sheet companies). There was an insufficient ability to raise cash quickly to deal with the illiquidity of the investments, many of which were technology or biotech companies bordering on venture capital.

Third Avenue Focused Credit Fund, awash in suddenly illiquid investments, was placed in a sort of receivership on December 11, 2015. Investors could make no withdrawals and the fund’s overseers struggled for 31 months to dispose of what was nominally a portfolio of illiquid investments. Investors received payouts in dribs and drabs – $1.00 per share in July 2017 then $0.42 in October 2017 – until the portfolio was fully liquidated on June 27, 2018. Investors received 85 cents on the dollar.)

Some of you will think that the same thing could not happen here. I would refer you to the issues that surrounded the Third Avenue Focused Credit Fund (TFCIX) and its long-running liquidation. 

I will stress again, think about what you own and when you may need the money. Or, why are you making the investment. Think carefully about what the funds are invested in. Bother to read not just the prospectus and statement of additional information, but also the semi-annual and annual reports to look at what is owned. And if you can’t understand what is owned, you probably shouldn’t be invested in that fund (or in some instances, partnership).

In the UK, and I suspect to a certain extent in this country, there is the potential for a “gating” problem, as a result of illiquid investments. The problem is exacerbated when the investment is one step removed. Investors make an investment in (or are sold) exchange-traded funds or regular mutual funds that trade as liquid assets. Yet they have committed themselves to what are very illiquid investments in their portfolios (think certain types of real estate or alternatively, high-tech new issues). The sizzle is what is being sold, rather than the reality of the income statement, cash flow statement, or balance sheet. One would like to think that the lessons of Teapot Dome and Ponzi have been learned, but maybe not. The next downturn will tell, one way or the other.


There have been a few questions this past month about the Barron’s article I mentioned last month (Leslie Norton, “These Ancient Funds Keep Beating the S&P,” 12/2/2019) concerning several closed-end funds that trade on the exchanges, and have histories going back into the 1920’s.  And as the article indicated, over the very long-term these closed end funds had often outperformed the germane index. I would suggest that those interested in those funds read the article again, as well as the annual and semi-annual reports on the respective websites. All three have Morningstar write-ups. The three are Adams Diversified Equity Fund (ADX); Central Securities Corporation (CET); and General American Investors (GAM). By way of disclosure, I have an investment in Central Securities Corporation (CET).

Given that these closed-end funds often and currently trade at discounts to their net asset value, the ideal place to hold them is in a tax-exempt account such as a Roth IRA or Roth 401(k). All three have management teams that have acted to repurchase stock on the open market when management feels the value opportunity is especially compelling in terms of a discount to NAV (usually more than 10%). And all three are managed internally. And as closed-end funds, they avoid the issue of forced sales to meet withdrawal requests.

Balanced Funds

Often when one looks at balanced funds, the focus tends to be on the equity portion of the portfolio. Make sure you also look at the fixed income or bond side of the portfolio, especially in terms of asset classes and diversity. If a fund, in that portion of the portfolio, owns nothing but straight corporates and governments, there is insufficient diversity. That portion of the fund needs the ability and expertise to also invest in mortgage-backed securities, asset-backed securities, and short-term bank loans. If they don’t (and look in the prospectus) and you don’t see them at any time in the semi-annual or annual reports it tells you something. The investment management firm is skimping on systems or personnel, or alternatively the investment firm itself is in a run-off mode. Having the ability to make those types of investments aided total returns in 2019 at funds managed by some of the larger industry names, such as the Vanguard funds managed for Vanguard by Wellington out of Boston. Alternatively, firms such as Loomis Sayles (closing in on $300B in assets) are being run for the future, with a long-term horizon in mind, since they have a multi-asset class investment capability.

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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.